COSTAR GROUP, INC. - FORM 10-K/A

Attached files

file	filename
EX-31.1 - CEO CERTIFICATION - COSTAR GROUP, INC.	ceocert.htm
EX-31.2 - CFO CERTIFICATION - COSTAR GROUP, INC.	cfocert.htm
EX-23.1 - CONSENT OF E&AMP;Y - COSTAR GROUP, INC.	ey-consent.htm
EX-32.2 - CFO 906 CERTIFICATION - COSTAR GROUP, INC.	cfo-906_cert.htm
EX-32.1 - CEO 906 CERTIFICATION - COSTAR GROUP, INC.	ceo-906_cert.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

Amendment No. 1

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

Commission file number 0-24531

CoStar Group, Inc.

(Exact name of registrant as specified in its charter)

Delaware		52-2091509
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2 Bethesda Metro Center, 10th Floor, Bethesda, Maryland 20814

(Address of principal executive offices) (zip code)

(301) 215-8300

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $.01 par value	NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

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 of the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files.) Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Based on the closing price of the common stock on June 30, 2009 on the Nasdaq Stock Market, Nasdaq Global Select Market, the aggregate market value of registrant’s common stock held by non-affiliates of the registrant was approximately $641 million.

As of February 19, 2010, there were 20,581,462 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement, which is expected to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year ended December 31, 2009, are incorporated by reference into Part III of this Report.

Explanatory Note

This Amendment No. 1 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, which was filed with the U.S. Securities and Exchange Commission on February 26, 2010 (the “Original Filing”), is filed solely to correct a typographical error that resulted in the independent registered public accounting firm’s report included in Part II, Item 8 truncating the following words from the final paragraph of the financial statement opinion: “an unqualified opinion thereon.” This Amendment No. 1 corrects the audit report to properly include the words “an unqualified opinion thereon” at the end of the final paragraph of the financial statement opinion. Except as described above, no other amendments are being made to the Original Filing. This Amendment No. 1 does not reflect events occurring after the Original Filing or modify or update the disclosure contained therein in any way other than as required to reflect the amendment discussed above. Pursuant to Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended, the complete text of Item 8, as amended, is repeated in this Amendment No. 1.

PART II

Item 8.

Financial Statements and Supplementary Data

COSTAR GROUP, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULE

AND SUPPLEMENTARY FINANCIAL INFORMATION

Reports of Independent Registered Public Accounting Firm	3
Consolidated Statements of Operations for the years ended December 31, 2007, 2008 and 2009	5
Consolidated Balance Sheets as of December 31, 2008 and 2009	6
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2007, 2008 and 2009	7
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2008 and 2009	8
Notes to Consolidated Financial Statements	9
Schedule II - Valuation and Qualifying Accounts	35
Consolidated Quarterly Results of Operations	35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of CoStar Group, Inc.

We have audited the accompanying consolidated balance sheets of CoStar Group, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CoStar Group, Inc. at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As also discussed in Note 9 to the consolidated financial statements, under the heading Income Taxes, the Company adopted FASB authoritative guidance regarding Accounting for Uncertainty in Income Taxes effective January 1, 2007.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CoStar Group Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

McLean, Virginia

February 25, 2010

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of CoStar Group, Inc.

We have audited CoStar Group, Inc.’s (“CoStar”) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). CoStar’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, CoStar maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2009 and 2008 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2009 of CoStar Group, Inc. and our report dated February 25, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

McLean, Virginia

February 25, 2010

COSTAR GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Year Ended December 31,
	2007			2008		2009

Revenues	$	192,805		$	212,428	$	209,659
Cost of revenues		76,704			73,408		73,714
Gross margin		116,101			139,020		135,945

Operating expenses:
Selling and marketing		51,777			41,705		42,508
Software development		12,453			12,759		13,942
General and administrative		36,569			39,888		44,248
Gain on lease settlement, net		(7,613	)		¾		¾
Purchase amortization		5,063			4,880		3,412
		98,249			99,232		104,110
Income from operations		17,852			39,788		31,835
Interest income, net		8,045			4,914		1,253
Income before income taxes		25,897			44,702		33,088
Income tax expense, net		9,946			20,079		14,395
Net income	$	15,951		$	24,623	$	18,693

Net income per share ¾ basic	$	0.84		$	1.27	$	0.95
Net income per share ¾ diluted	$	0.82		$	1.26	$	0.94

Weighted average outstanding shares ¾ basic		19,044			19,372		19,780
Weighted average outstanding shares ¾ diluted		19,404			19,550		19,925

See accompanying notes.

COSTAR GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands except per share data)

	December 31,
	2008			2009
ASSETS

Current assets:
Cash and cash equivalents	$	159,982		$	205,786
Short-term investments		35,268			20,188
Accounts receivable, less allowance for doubtful accounts of approximately $3,213 and $2,863 as of December 31, 2008 and 2009, respectively		12,294			12,855
Deferred income taxes, net		2,036			3,450
Prepaid expenses and other current assets		2,903			5,128
Total current assets		212,483			247,407

Long-term investments		29,340			29,724
Deferred income taxes, net		3,392			1,978
Property and equipment, net		16,876			19,162
Goodwill		54,328			80,321
Intangibles and other assets, net		16,421			23,390
Deposits and other assets		1,544			2,597
Total assets	$	334,384		$	404,579

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,636		$	3,667
Accrued wages and commissions		7,217			9,696
Accrued expenses		7,754			14,167
Income taxes payable		1,907			¾
Deferred revenue		9,442			14,840
Deferred rent		1,180			1,377
Total current liabilities		29,136			43,747

Deferred income taxes, net		132			¾
Income taxes payable		1,695			1,826

Commitments and contingencies		¾			¾

Stockholders’ equity:
Preferred stock, $0.01 par value; 2,000 shares authorized; none outstanding		¾			¾
Common stock, $0.01 par value; 30,000 shares authorized; 19,733 and 20,617 issued and outstanding as of December 31, 2008 and 2009, respectively		197			206
Additional paid-in capital		333,983			364,635
Accumulated other comprehensive loss		(13,796	)		(7,565	)
Retained earnings (accumulated deficit)		(16,963	)		1,730
Total stockholders’ equity		303,421			359,006
Total liabilities and stockholders’ equity	$	334,384		$	404,579

See accompanying notes.

COSTAR GROUP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

										Additional			Accumulated Other			Retained Earnings			Total
	Comprehensive Income			Common Stock						Paid-In Capital			Comprehensive Income (Loss)			(Accumulated Deficit)			Stockholders’ Equity
	Comprehensive Income			Shares			Amount			Paid-In Capital			Comprehensive Income (Loss)			(Accumulated Deficit)			Stockholders’ Equity
Balance at December 31, 2006					19,081		$	191		$	302,936		$	4,520		$	(57,537	)	$	250,110
Tax benefit adjustment					¾			¾			26			¾			¾			26
Balance at January 1, 2007					19,081			191			302,962			4,520			(57,537	)		250,136
Net income		15,951			¾			¾			¾			¾			15,951			15,951
Foreign currency translation adjustment		873			¾			¾			¾			873			¾			873
Net unrealized gain on investments		233			¾			¾			¾			233			¾			233
Comprehensive income	$	17,057
Exercise of stock options					289			3			8,127			¾			¾			8,130
Restricted stock grants					131			1			(1	)		¾			¾			¾
Restricted stock grants surrendered					(58	)		¾			(635	)		¾			¾			(635	)
Consideration for Propex					22			¾			1,010			¾			¾			1,010
Stock compensation expense, net of forfeitures					¾			¾			5,399			¾			¾			5,399
ESPP					9			¾			448			¾			¾			448
Excess tax benefit for exercised stock options					¾			¾			260			¾			¾			260
Balance at December 31, 2007					19,474			195			317,570			5,626			(41,586	)		281,805
Net income		24,623			¾			¾			¾			¾			24,623			24,623
Foreign currency translation adjustment		(14,061	)		¾			¾			¾			(14,061	)		¾			(14,061	)
Net unrealized loss on investments		(5,361	)		¾			¾			¾			(5,361	)		¾			(5,361	)
Comprehensive income	$	5,201
Exercise of stock options					198			2			6,555			¾			¾			6,557
Restricted stock grants					102			1			¾			¾			¾			1
Restricted stock grants surrendered					(49	)		(1	)		(695	)		¾			¾			(696	)
Stock compensation expense, net of forfeitures					¾			¾			4,907			¾			¾			4,907
ESPP					8			¾			329			¾			¾			329
Excess tax benefit for exercised stock options					¾			¾			5,317			¾			¾			5,317
Balance at December 31, 2008					19,733			197			333,983			(13,796	)		(16,963	)		303,421
Net income		18,693			¾			¾			¾			¾			18,693			18,693
Foreign currency translation adjustment		3,671			¾			¾			¾			3,671			¾			3,671
Net unrealized gain on investments		2,560			¾			¾			¾			2,560			¾			2,560
Comprehensive income	$	24,924
Exercise of stock options					85			¾			2,232			¾			¾			2,232
Restricted stock grants					237			2			¾			¾			¾			2
Restricted stock grants surrendered					(44	)		¾			(672	)		¾			¾			(672	)
Stock compensation expense, net of forfeitures					¾			¾			6,438			¾			¾			6,438
ESPP					7			¾			230			¾			¾			230
Consideration for PPR					573			6			20,897			¾			¾			20,903
Consideration for Resolve Technology					26			1			1,124			¾			¾			1,125
Excess tax benefit for exercised stock options					¾			¾			403			¾			¾			403
Balance at December 31, 2009					20,617		$	206		$	364,635		$	(7,565	)	$	1,730			359,006

See accompanying notes.

COSTAR GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2007			2008			2009
Operating activities:
Net income	$	15,951		$	24,623		$	18,693
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		7,778			8,360			7,583
Amortization		8,369			8,441			7,093
Deferred income tax expense, net		9,946			2,148			(2,428	)
Provision for losses on accounts receivable		2,464			4,042			4,172
Excess tax benefit from stock options		(260	)		(5,317	)		(403	)
Stock-based compensation expense		5,440			4,940			6,460
Leasehold write-off		¾			¾			603
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(2,944	)		(6,196	)		(1,610	)
Interest receivable		(67	)		533			97
Prepaid expenses and other current assets		(755	)		1,464			(1,521	)
Deposits and other assets		(670	)		652			(1,013	)
Accounts payable and other liabilities		6,981			(3,044	)		2,655
Deferred revenue		(501	)		262			(812	)
Net cash provided by operating activities		51,732			40,908			39,569

Investing activities:
Purchases of investments		(116,609	)		(4,839	)		¾
Sales of investments		107,286			63,949			17,159
Purchases of property and equipment and other assets		(14,271	)		(3,656	)		(10,544	)
Acquisitions, net of cash acquired		(16,737	)		(3,024	)		(3,207	)
Net cash (used in) provided by investing activities		(40,331	)		52,430			3,408

Financing activities:
Excess tax benefit from stock options		260			5,317			403
Repurchase of restricted stock to satisfy tax withholding obligations		(635	)		(695	)		(672	)
Proceeds from exercise of stock options		8,536			6,853			2,441
Net cash provided by financing activities		8,161			11,475			2,172

Effect of foreign currency exchange rates on cash and cash equivalents		64			(2,616	)		655
Net increase in cash and cash equivalents		19,626			102,197			45,804
Cash and cash equivalents at beginning of year		38,159			57,785			159,982
Cash and cash equivalents at end of year	$	57,785		$	159,982		$	205,786

See accompanying notes.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009

1. ORGANIZATION

CoStar Group, Inc. (the “Company”) has created a comprehensive, proprietary database of commercial real estate information covering the United States, as well as parts of the United Kingdom and France. Based on its unique database, the Company provides information, marketing and analytic services to the commercial real estate and related business community and operates within two segments, U.S. and International. The Company’s information, marketing and analytic services are typically distributed to its clients under subscription-based license agreements, which typically have a minimum term of one year and renew automatically.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Accounting policies are consistent for each operating segment.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States of America 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 on the consolidated statements of cash flows have been reclassified to conform to the Company’s current presentation.

Revenue Recognition

The Company primarily derives revenues from providing access to its proprietary database of commercial real estate information. The Company generally charges a fixed monthly amount for its subscription-based services. Subscription contract rates are based on the number of sites, number of users, organization size, the client’s business focus and the number of services to which a client subscribes. Subscription-based license agreements typically have a minimum term of one year and renew automatically.

Revenue is recognized when (1) there is persuasive evidence of an arrangement, (2) the fee is fixed and determinable, (3) services have been rendered and payment has been contractually earned and (4) collectability is reasonably assured.

Revenues from subscription-based services are recognized on a straight-line basis over the term of the agreement. Deferred revenue results from advance cash receipts from customers or amounts billed in advance to customers from the sales of subscription licenses and is recognized over the term of the license agreement.

Cost of Revenues

Cost of revenues principally consists of salaries and related expenses for the Company’s researchers who collect and analyze the commercial real estate data that is the basis for the Company’s information, marketing and analytic services. Additionally, cost of revenues includes the cost of data from third party data sources, which is expensed as incurred, and the amortization of database technology.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Significant Customers

No single customer accounted for more than 5% of the Company’s revenues for each of the years ended December 31, 2007, 2008 and 2009.

Foreign Currency Translation

The Company’s functional currency in its foreign locations is the local currency. Assets and liabilities are translated into U.S. dollars as of the balance sheet date. Revenues, expenses, gains and losses are translated at the average exchange rates in effect during each period. Gains and losses resulting from translation are included in accumulated other comprehensive income (loss). Net gains or losses resulting from foreign currency exchange transactions are included in the consolidated statements of operations. There were no material gains or losses from foreign currency exchange transactions for the years ended December 31, 2009 and 2008.

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss were as follows (in thousands):

	Year Ended December 31,
	2008				2009
Foreign currency translation adjustment		$	(8,521	)		$	(4,850	)
Accumulated net unrealized loss on investments, net of tax			(5,275	)			(2,715	)
Total accumulated other comprehensive loss		$	(13,796	)		$	(7,565	)

Advertising Costs

The Company expenses advertising costs as incurred. Advertising expenses were approximately $2.3 million, $2.8 million and $3.3 million for the years ended December 31, 2007, 2008 and 2009, respectively.

Income Taxes

Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and the basis reported in the Company’s consolidated financial statements. Deferred tax liabilities and assets are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted rates expected to be in effect during the year in which the differences reverse. Valuation allowances are provided against assets, including net operating losses, if it is anticipated that some or all of an asset may not be realized through future taxable earnings or implementation of tax planning strategies.

Net Income Per Share

Net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period on a basic and diluted basis. The Company’s potentially dilutive securities include stock options and restricted stock. Diluted net income per share considers the impact of potentially dilutive securities except in periods in which there is a net loss, as the inclusion of the potential common shares would have an anti-dilutive effect.

Stock-Based Compensation

Equity instruments issued in exchange for employee services are accounted for using a fair-value based method and the fair value of such equity instruments is recognized as expense in the consolidated statements of operations.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Stock-Based Compensation ¾ (Continued)

Stock-based compensation cost is measured at the grant date of the share-based awards based on their fair values, and is recognized on a straight line basis as expense over the vesting periods of the awards, net of an estimated forfeiture rate.

Cash flows resulting from excess tax benefits are classified as part of cash flows from operating and financing activities. Excess tax benefits represent tax benefits related to stock based compensation in excess of the associated deferred tax asset for such equity compensation. Net cash proceeds from the exercise of stock options were approximately $8.5 million; $6.9 million and $2.4 million for the years ended December 31, 2007, 2008 and 2009, respectively. There were approximately $260,000, $5.3 million and $403,000 of excess tax benefits realized from stock option exercises for the years ended December 31, 2007, 2008 and 2009.

Stock-based compensation expense for stock options, restricted stock and the employee stock purchase plan included in the Company's results of operations for the years ended December 31, was as follows (in thousands):

	Year Ended December 31,
	2007		2008		2009
Cost of revenues	$	926	$	547	$	888
Selling and marketing		1,118		400		1,125
Software development		340		423		588
General and administrative		3,056		3,570		3,859
Total	$	5,440	$	4,940	$	6,460

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of money market fund investments and U.S. Government Securities. As of December 31, 2008 and 2009, cash of approximately $518,000 and $519,000, respectively, was held to support letters of credit for security deposits.

Investments

The Company determines the appropriate classification of debt and equity investments at the time of purchase and reevaluates such designation as of each balance sheet date. The Company considers all of its investments to be available-for-sale. Short-term investments consist of commercial paper, government/federal notes and bonds and corporate obligations with maturities greater than 90 days at the time of purchase. Available-for-sale short-term investments with contractual maturities beyond one year are classified as current in the Company’s consolidated balance sheets because they represent the investment of cash that is available for current operations. Long-term investments consist of auction rate securities. Investments are carried at fair market value.

Concentration of Credit Risk and Financial Instruments

The Company performs ongoing credit evaluations of its customers’ financial condition and generally does not require that its customers’ obligations to the Company be secured. The Company maintains reserves for credit losses, and such losses have been within management’s expectations. The large size and widespread nature of the Company’s customer base and lack of dependence on individual customers mitigate the risk of nonpayment of the Company’s accounts receivable. The carrying amount of the accounts receivable approximates the net realizable value. The carrying value of the Company’s financial instruments including cash and cash equivalents, short-term investments, long-term investments, accounts receivable, accounts payable, and accrued expenses approximates fair value.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Allowance for Doubtful Accounts

The allowance for doubtful accounts is based on the Company’s assessment of the collectability of customer accounts. The Company regularly reviews the allowance by considering factors such as historical experience, the aging of the balances, and current economic conditions that may affect a customer’s ability to pay.

Property and Equipment

Property and equipment are stated at cost. All repairs and maintenance costs are expensed as incurred. Depreciation and amortization are calculated on a straight-line basis over the following estimated useful lives of the assets:

Leasehold improvements		Shorter of lease term or useful life
Furniture and office equipment		Five to seven years
Research vehicles		Five years
Computer hardware and software		Two to five years

Qualifying internal-use software costs incurred during the application development stage, which consist primarily of outside services and purchased software license costs, are capitalized and amortized over the estimated useful life of the asset. All other costs are expensed as incurred.

Goodwill, Intangibles and Other Assets

Goodwill represents the excess of costs over the fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually by reporting unit. The Company’s operating segments, U.S. and International, are the reporting units tested for potential impairment. The goodwill impairment test is a two-step process. The first step is to determine the fair value of each reporting unit. The estimate of the fair value of each reporting unit is based on a projected discounted cash flow model that includes significant assumptions and estimates including the Company’s future financial performance and a weighted average cost of capital. The fair value of each reporting unit is compared to the carrying amount of the reporting unit. If the carrying value of the reporting unit exceeds the fair value, then the second step of the process is performed to measure the impairment loss. The impairment loss is measured based on a projected discounted cash flow method using a discount rate determined by the Company’s management to be commensurate with the risk in its current business model.

Intangible assets with estimable useful lives that arose from acquisitions on or after July 1, 2001, are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up, and reviewed for impairment.

Acquired database technology, customer base and trade names and other are related to the Company’s acquisitions (See Notes 3, 7 and 8). Acquired database technology and trade names and other are amortized on a straight-line basis over periods ranging from two to ten years. The acquired intangible asset characterized as customer base consists of one distinct intangible asset composed of acquired customer contracts and the related customer relationships. Acquired customer bases that arose from acquisitions prior to July 1, 2001 are amortized on a straight-line basis principally over a period of ten years. Acquired customer bases that arose from acquisitions on or after July 1, 2001 are amortized on a 125% declining balance method over ten years. The cost of capitalized building photography is amortized on a straight-line basis over five years.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Long-Lived Assets

Long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimate undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount for which the carrying amount of the asset exceeds the fair value of the asset.

Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

Recent Accounting Pronouncements

In February 2007, the FASB issued authoritative guidance on the fair value option for financial assets and financial liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This guidance is effective for fiscal years beginning on or after December 31, 2007. The Company adopted this guidance on January 1, 2008 and has not elected to apply the fair value option to any of its financial instruments. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

In December 2007, the FASB issued authoritative guidance on business combinations, which changes the accounting for any business combination the Company enters into with an acquisition date after December 31, 2008. Under this guidance, an acquiring entity is required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. This guidance changes the accounting treatment and disclosure for certain specific items in a business combination. The Company adopted this guidance on January 1, 2009 and has recorded assets acquired and liabilities assumed at fair value.

In December 2007, the FASB issued authoritative guidance on non-controlling interest, which establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance is effective for fiscal years beginning on or after December 15, 2008. The Company adopted this guidance on January 1, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

In April 2008, the FASB issued authoritative guidance on existing intangibles or expected future cash flows from those intangibles, which is effective for all fiscal years and interim periods beginning after December 15, 2008. Early adoption of this guidance is not permitted. This guidance requires additional footnote disclosures about the impact of the Company’s ability or intent to renew or extend agreements related to existing intangibles or expected future cash flows from those intangibles, how the Company accounts for costs incurred to renew or extend such agreements, the time until the next renewal or extension period by asset class, and the amount of renewal or extension costs capitalized, if any. For any intangibles acquired after December 31, 2008, this guidance requires that the Company consider its experience regarding renewal and extensions of similar arrangements in determining the useful life of such intangibles. If the Company does not have experience with similar arrangements, this guidance requires that the Company use the assumptions of a market participant putting the intangible to its highest and best use in determining the useful life. The Company adopted this guidance on January 1, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Recent Accounting Pronouncements¾ (Continued)

In June 2008, the FASB issued authoritative guidance related to determining whether instruments granted in share-based payment transactions are participating securities. This guidance clarifies that unvested share-based payment awards with a right to receive non-forfeitable dividends are participating securities. This guidance is effective for all annual and interim periods beginning after December 15, 2008. Adoption of this standard will require the two-class method of calculating basic earnings per share to the extent that unvested share-based payments have the right to receive non-forfeitable dividends. The Company adopted this guidance on January 1, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

In April 2009, the FASB issued authoritative guidance related to the initial recognition, measurement and subsequent accounting for assets and liabilities arising from pre-acquisition contingencies in a business combination. It requires that such assets acquired or liabilities assumed be initially recognized at fair value at the acquisition date if fair value can be determined during the measurement period. When fair value cannot be determined, companies should typically account for the acquired contingencies using existing guidance. This guidance requires that companies expense acquisition and deal-related costs that were previously allowed to be capitalized. This guidance also requires that a systematic and rational basis for subsequently measuring and accounting for the assets or liabilities be developed depending on their nature. This guidance was effective for contingent assets or liabilities arising from business combinations with an acquisition date on or after January 1, 2009. The adoption of this guidance changes the accounting treatment and disclosure for certain specific items in a business combination with an acquisition date subsequent to December 31, 2008. The Company adopted this guidance on January 1, 2009, and expensed acquisition and deal-related costs of approximately $700,000 associated primarily with the acquisitions of Property and Portfolio Research, Inc. (“PPR”) and Resolve Technology, Inc. (“Resolve Technology”).

In April 2009, the FASB issued authoritative guidance for determining whether a market is active or inactive, and whether a transaction is distressed. This guidance is applicable to all assets and liabilities (financial and non-financial) and will require enhanced disclosures. The Company adopted this guidance for its interim period ending June 30, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position, but did require additional disclosures in the Company’s financial statements.

In April 2009, the FASB issued authoritative guidance requiring disclosures in interim reporting periods concerning the fair value of financial instruments that were previously only required in the annual financial statements. The Company adopted the provisions of this guidance for the interim period ending June 30, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position, but did require additional disclosures in the Company’s financial statements.

In April 2009, the FASB issued authoritative guidance that redefines what constitutes an other-than-temporary impairment, defines credit and non-credit components of an other-than-temporary impairment, prescribes their financial statement treatment, and requires enhanced disclosures relating to such impairments. The Company adopted this guidance for the interim period ending June 30, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position, but did require additional disclosures in the Company’s financial statements.

In May 2009, the FASB issued authoritative guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This guidance was effective for all interim and annual reporting periods ending after June 15, 2009. This guidance has not and is not expected to result in significant changes in the subsequent events that the Company reports, either through recognition or disclosure, in its financial statements.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ¾ (CONTINUED)

Recent Accounting Pronouncements¾ (Continued)

In June 2009, the FASB issued authoritative guidance to amend the manner in which entities evaluate whether consolidation is required for variable interest entities (VIE). Previously, variable interest holders were required to determine whether they had a controlling financial interest in a VIE based on a quantitative analysis of the expected gains and/or losses of the entity. The new guidance requires an enterprise with a variable interest in a VIE to qualitatively assess whether it has a controlling financial interest in the entity, and if so, whether it is the primary beneficiary. This guidance also requires that companies continually evaluate VIEs for consolidation, rather than assessing whether consolidation is required based upon the occurrence of triggering events. This guidance enhances disclosures to provide financial statement users with greater transparency about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets. This guidance will be effective for the first annual reporting period beginning after November 15, 2009. This guidance is not expected to materially impact the Company’s results of operations, financial position or related disclosures.

In June 2009, the FASB issued authoritative guidance which replaced the previous hierarchy of U.S. GAAP and establishes the FASB Codification as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. This guidance is effective for financial statements issued for interim and annual periods ending after September 15, 2009. This guidance did not materially impact the Company’s results of operations or financial position, but did require changes to the disclosures in the Company’s financial statements.

In July 2009, the FASB issued authoritative guidance to improve the consistency with which companies apply fair value measurements guidance to liabilities. This guidance is effective for interim and annual periods beginning after September 30, 2009. This guidance is not expected to materially impact the Company’s results of operations, financial position or related disclosures.

In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for measuring and allocating revenue to one or more units of accounting. In addition, the FASB issued authoritative guidance on arrangements that include software elements. Under this guidance, tangible products containing software components and non-software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance. This guidance is effective using the prospective application or the retrospective application for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with earlier application permitted. The Company is currently assessing the impacts adoption of this guidance may have on its financial statements.

In January 2010, the FASB issued authoritative guidance that amends the disclosure requirements related to recurring and nonrecurring fair value measurements. This guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (assets and liabilities measured using observable inputs such as quoted prices in active markets) and Level 2 (assets and liabilities measured using inputs other than quoted prices in active markets that are either directly or indirectly observable) of the fair value measurement hierarchy, including the amount and reason of the transfers. Additionally, this guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the additional disclosure for Level 3 assets and liabilities, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. This guidance is not expected to materially impact the Company’s results of operations or financial position, but will require changes to the disclosures in its interim and annual financial statements.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

3. ACQUISITIONS

On April 1, 2008, the Company acquired certain assets of First CLS, Inc. (doing business as the Dorey Companies and DoreyPRO), an Atlanta-based provider of local commercial real estate information for $3.0 million in initial cash consideration and deferred consideration of $1.7 million paid during the third quarter of 2009.

On July 17, 2009, the Company acquired all of the issued and outstanding equity securities of PPR, and its wholly owned subsidiary Property and Portfolio Research Ltd., providers of real estate analysis, market forecasts and credit risk analytics to the commercial real estate industry. The Company acquired PPR from DMG Information, Inc. (“DMGI”) in exchange for 572,999 shares of CoStar common stock, which had an aggregate value of approximately $20.9 million as of the closing date. On July 17, 2009, 433,667 shares of the Company’s common stock were issued to DMGI, and the remaining 139,332 shares were issued to DMGI on September 28, 2009 after taking into account post-closing purchase price adjustments. The purchase accounting is preliminary and is subject to change upon completion of the purchase accounting.

The purchase price for the PPR acquisition was allocated as follows (in thousands):

Working capital	$	(5,479	)
Acquired trade names and other		810
Acquired customer base		5,300
Acquired database technology		3,700
Goodwill		16,572
Total purchase consideration	$	20,903

On October 19, 2009, the Company acquired all of the outstanding capital stock of Resolve Technology, a Delaware corporation, for approximately $4.5 million, consisting of approximately $3.4 million in cash and 25,886 shares, or approximately $1.1 million, of CoStar common stock, which shares are subject to a three-year lockup. Additionally, the seller may be entitled to receive (i) a potential deferred cash payout two years after closing based on the incremental growth of Resolve Technology’s revenue, and (ii) other potential deferred cash payouts for successful completion of operational and sales milestones during the period from closing through June 30, 2013, which period may be subject to extension to a date no later than December 31, 2014. The purchase accounting is preliminary and is subject to change upon completion of the purchase accounting.

The purchase price for the Resolve acquisition was allocated as follows (in thousands):

Purchase price in cash and stock	$	4,499
Deferred consideration		3,052
Total purchase consideration	$	7,551

Working capital	$	(550	)
Acquired trade names and other		430
Acquired customer base		890
Acquired database technology		1,200
Goodwill		5,581
Total purchase consideration	$	7,551

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

3. ACQUISITIONS ¾ (CONTINUED)

These acquisitions were accounted for using purchase accounting. The purchase price for the First CLS, Inc. acquisition was primarily allocated to acquired customer base and goodwill. For each of the PPR and Resolve Technology acquisitions, the purchase price was allocated to various working capital accounts, developed technology, customer base, trademarks, non-competition agreements and goodwill. The acquired customer base for the acquisitions, which consists of one distinct intangible asset for each acquisition and is composed of acquired customer contracts and the related customer relationships, is being amortized on a 125% declining balance method over ten years. The identified intangibles will be amortized over their estimated useful lives. Goodwill for these acquisitions will not be amortized, but is subject to annual impairment tests. Goodwill is comprised of acquired workforce. The results of operations of First CLS, Inc., PPR, and Resolve Technology have been consolidated with those of the Company since the respective dates of the acquisitions and are not considered material to the Company’s consolidated financial statements. Accordingly, pro forma financial information has not been presented for any of the acquisitions.

4. INVESTMENTS

Scheduled maturities of investments classified as available-for-sale as of December 31, 2009 are as follows (in thousands):

Maturity	Fair Value
Due in:
2010	$	3,072
2011-2014		16,634
2015-2019		106
2020 and thereafter		30,100
Available-for-sale investments	$	49,912

The realized gains on the Company’s investments for the years ended December 31, 2008 and 2009 were approximately $329,000 and $4,000, respectively. The realized losses on the Company’s investments for the years ended December 31, 2008 and 2009 were approximately $489,000 and $5,000, respectively.

Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis. A decline in market value of any available-for-sale security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Dividend and interest income are recognized when earned.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

4. INVESTMENTS ¾ (CONTINUED)

As of December 31, 2009, the amortized cost basis and fair value of investments classified as available-for-sale are as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Collateralized debt obligations	$	12,987	$	5	$	(14	)	$	12,978
Corporate debt securities		6,396		331		¾			6,727
Residential mortgage-backed securities		394		¾		(7	)		387
Government-sponsored enterprise obligations		97		¾		(1	)		96
Auction rate securities		32,750		¾		(3,026	)		29,724
Available-for-sale investments	$	52,624	$	336	$	(3,048	)	$	49,912

The unrealized losses on the Company’s investments as of December 31, 2008 and 2009 were generated primarily from changes in interest rates. The losses are considered temporary, as the contractual terms of these investments do not permit the issuer to settle the security at a price less than the amortized cost of the investment. Because the Company does not intend to sell these instruments and it is not more likely than not that the Company will be required to sell these instruments prior to anticipated recovery, which may be maturity, it does not consider these investments to be other-than-temporarily impaired as of December 31, 2008 and 2009. See Note 5 to the consolidated financial statements for further discussion on the fair value of the Company’s financial assets.

The components of the investments in an unrealized loss position for more than twelve months consists of the following (in thousands):

	December 31,
	2008					2009
	Aggregate Fair Value		Gross Unrealized Losses			Aggregate Fair Value		Gross Unrealized Losses
Collateralized debt obligations	$	19,151	$	(1,323	)	$	7,578	$	(14	)
Corporate debt securities		2,558		(156	)		¾		¾
Residential mortgage-backed securities		427		(15	)		387		(7	)
Government-sponsored enterprise obligations		¾		¾			96		(1	)
Auction rate securities		¾		¾			29,724		(3,026	)
	$	22,136	$	(1,494	)	$	37,785	$	(3,048	)

The components of the investments in an unrealized loss position for less than twelve months consists of the following (in thousands):

	December 31,
	2008					2009
	Aggregate Fair Value		Gross Unrealized Losses			Aggregate Fair Value		Gross Unrealized Losses
Collateralized debt obligations	$	3,022	$	(84	)	$	¾	$	¾
Corporate debt securities		3,807		(268	)		¾		¾
Residential mortgage-backed securities		36		(1	)		¾		¾
Government-sponsored enterprise obligations		130		(14	)		¾		¾
Auction rate securities		29,340		(3,710	)		¾		¾
	$	36,335	$	(4,077	)	$	¾	$	¾

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

4. INVESTMENTS ¾ (CONTINUED)

The gross unrealized gains on the Company’s investments as of December 31, 2008 and 2009 were approximately $128,000 and $336,000, respectively.

5. FAIR VALUE

In September 2006, the FASB issued authoritative guidance which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. The Company adopted this guidance as of January 1, 2008 for financial instruments. Although the adoption of the guidance did not materially impact its financial position, results of operations, or cash flow, the Company is now required to provide additional disclosures as part of its financial statements.

There is a three-tier fair value hierarchy, which categorizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table represents the Company's fair value hierarchy for its financial assets (cash, cash equivalents and investments) and liabilities measured at fair value on a recurring basis as of December 31, 2009 (in thousands):

	Level 1		Level 2		Level 3		Total
Assets:
Cash	$	38,721	$	¾	$	¾	$	38,721
Money market funds		167,065		¾		¾		167,065
Collateralized debt obligations		¾		12,978		¾		12,978
Corporate debt securities		¾		6,727		¾		6,727
Residential mortgage-backed securities		¾		387		¾		387
Government-sponsored enterprise obligations		¾		96		¾		96
Auction rate securities		¾		¾		29,724		29,724
Total assets measured at fair value	$	205,786	$	20,188	$	29,724	$	255,698
Liabilities:
Deferred consideration	$	¾	$	¾	$	3,082	$	3,082
Total liabilities measured at fair value	$	¾	$	¾	$	3,082	$	3,082

The Company’s Level 2 assets consist of collateralized debt obligations, corporate debt securities, residential mortgage-backed securities and government-sponsored enterprise obligations, which do not have directly observable quoted prices in active markets. The Company’s Level 2 assets are valued using matrix pricing.

The Company’s Level 3 assets consist of auction rate securities (“ARS”), whose underlying assets are primarily student loan securities supported by guarantees from the Federal Family Education Loan Program (“FFELP”) of the U.S. Department of Education.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

5. FAIR VALUE ¾ (CONTINUED)

The following table summarizes changes in fair value of the Company’s Level 3 assets from December 31, 2007 to December 31, 2009 (in thousands):

	Auction Rate Securities
Balance at December 31, 2007	$	53,975
Unrealized loss included in other comprehensive loss		(3,710	)
Net settlements		(20,925	)
Balance at December 31, 2008	$	29,340
Unrealized gain included in other comprehensive loss		684
Net settlements		(300	)
Balance at December 31, 2009	$	29,724

ARS are variable rate debt instruments whose interest rates are reset approximately every 28 days. The underlying securities have contractual maturities greater than twenty years. The ARS are recorded at fair value.

As of December 31, 2009, the Company held ARS with $32.8 million par value, all of which failed to settle at auction. The majority of these investments are of high credit quality with AAA credit ratings and are primarily student loan securities supported by guarantees from the FFELP of the U.S. Department of Education. The Company may not be able to liquidate and fully recover the carrying value of the ARS in the near term. As a result, these securities are classified as long-term investments in the Company’s consolidated balance sheet as of December 31, 2009.

While the Company continues to earn interest on its ARS investments at the contractual rate, these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, the estimated fair value of the ARS no longer approximates par value. The Company has used a discounted cash flow model to determine the estimated fair value of its investment in ARS as of December 31, 2009. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, credit spreads, timing and amount of cash flows, liquidity risk premiums, expected holding periods, and default risk. Based on this assessment of fair value, as of December 31, 2009, the Company determined there was a decline in the fair value of its ARS investments of approximately $3.0 million. The decline was deemed to be a temporary impairment and recorded as an unrealized loss in accumulated other comprehensive loss in stockholders’ equity. In addition, while a majority of the ARS are currently rated AAA, if the issuers are unable to successfully close future auctions and their credit ratings deteriorate, the Company may be required to record additional unrealized losses in accumulated other comprehensive loss or an other-than-temporary impairment charge to earnings on these investments.

The Company’s Level 3 liabilities consist of a $3.1 million liability for deferred consideration related to the October 19, 2009 acquisition of Resolve Technology. The deferred consideration is for (i) a potential deferred cash payout two years after closing based on the incremental growth of Resolve Technology’s revenue, and (ii) other potential deferred cash payouts for successful completion of operational and sales milestones during the period from closing through June 30, 2013, which period may be subject to extension to a date no later than December 31, 2014.

The following table summarizes changes in fair value of the Company’s Level 3 liabilities from December 31, 2008 to December 31, 2009 (in thousands):

	Deferred Consideration
Balance at December 31, 2008	$	¾
Deferred consideration upon acquisition		3,052
Accretion for 2009		30
Balance at December 31, 2009	$	3,082

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

5. FAIR VALUE ¾ (CONTINUED)

The Company has used a discounted cash flow model to determine the estimated fair value of its Level 3 liabilities as of December 31, 2009. The significant assumptions used in preparing the discounted cash flow model include the discount rate, estimates for future incremental revenue growth and probabilities for completion of operational and sales milestones.

6. PROPERTY AND EQUIPMENT

Property and equipment consists of the following (in thousands):

	December 31,
	2008			2009

Leasehold improvements	$	7,808		$	10,333
Furniture, office equipment and research vehicles		19,305			20,279
Computer hardware and software		27,938			28,259
		55,051			58,871
Accumulated depreciation and amortization		(38,175	)		(39,709	)
Property and equipment, net	$	16,876		$	19,162

7. GOODWILL

The changes in the carrying amount of goodwill by operating segment consist of the following (in thousands):

	United States			International			Total
Goodwill, December 31, 2007	$	30,428		$	31,426		$	61,854
Acquisitions		1,119			¾			1,119
Effect of foreign currency translation		¾			(8,645	)		(8,645	)
Goodwill, December 31, 2008		31,547			22,781			54,328
Acquisitions		23,858			¾			23,858
Effect of foreign currency translation		¾			2,280			2,280
Purchase accounting adjustment		(145	)		¾			(145	)
Goodwill, December 31, 2009	$	55,260		$	25,061		$	80,321

The Company recorded goodwill of approximately $1.1 million in connection with the First CLS, Inc. acquisition in April 2008, which was decreased by $145,000 in 2009, upon completion of purchase accounting. Approximately $1.7 million in additional goodwill was recorded in connection with the First CLS, Inc. acquisition as a result of the payment of deferred consideration of $1.7 million in August 2009. The Company recorded goodwill of approximately $16.6 million in connection with the July 2009 acquisition of PPR. Initially in July 2009, the Company had recorded $12.1 million in goodwill for the PPR acquisition, that was increased by $4.5 million in December 2009 upon completion of the Company’s review of the income tax attributes and deferred taxes related to the PPR.purchase accounting. The Company recorded goodwill of approximately $5.6 million in connection with the Resolve Technology acquisition in October 2009

During the fourth quarters of 2008 and 2009, the Company completed the annual impairment test of goodwill and concluded that goodwill was not impaired.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

8. INTANGIBLES AND OTHER ASSETS

Intangibles and other assets consist of the following (in thousands, except amortization period data):

							Weighted-Average
	December 31,						Amortization Period
	2008			2009			(in years)

Building photography	$	11,011		$	11,504			5
Accumulated amortization		(7,711	)		(9,089	)
Building photography, net		3,300			2,415

Acquired database technology		20,711			25,790			4
Accumulated amortization		(20,361	)		(21,144	)
Acquired database technology, net		350			4,646

Acquired customer base		48,198			55,770			10
Accumulated amortization		(37,192	)		(41,208	)
Acquired customer base, net		11,006			14,562

Acquired trade names and other		7,744			9,755			7
Accumulated amortization		(5,979	)		(7,988	)
Acquired trade names and other, net		1,765			1,767

Intangibles and other assets, net	$	16,421		$	23,390

Amortization expense for intangibles and other assets was approximately $8.4 million for the years ended December 31, 2007 and 2008, respectively and $7.1 million for the year ended December 31, 2009.

In the aggregate, amortization for intangibles and other assets existing as of December 31, 2009 for future periods is expected to be approximately $3.8 million, $3.4 million, $3.3 million, $2.3 million and $1.8 million for the years ending December 31, 2010, 2011, 2012, 2013 and 2014, respectively.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

9. INCOME TAXES

The components of the provision (benefit) for income taxes attributable to operations consist of the following (in thousands):

	Year Ended December 31,
	2007			2008			2009

Current:
Federal	$	574		$	18,289		$	15,194
State		821			3,842			1,593
Foreign		¾			¾			26
Total current		1,395			22,131			16,813
Deferred:
Federal		9,716			(408	)		(2,097	)
State		72			(52	)		(199	)
Foreign		(1,237	)		(1,592	)		(122	)
Total deferred		8,551			(2,052	)		(2,418	)
Total provision for income taxes	$	9,946		$	20,079		$	14,395

The components of deferred tax assets and liabilities consists of the following (in thousands):

	December 31,
	2008			2009

Deferred tax assets:
Reserve for bad debts	$	928		$	1,093
Accrued compensation		2,144			3,156
Stock compensation		2,115			3,168
Net operating losses		3,077			2,985
Accrued reserve		¾			238
Capital loss carryovers		345			348
Unrealized loss on securities		2,088			1,076
Other liabilities		1,401			317
Total deferred tax assets		12,098			12,381

Deferred tax liabilities:
Prepaids		(522	)		(638	)
Depreciation		(626	)		(587	)
Intangibles		(2,607	)		(2,743	)
Total deferred tax liabilities		(3,755	)		(3,968	)

Net deferred tax asset		8,343			8,413
Valuation allowance		(3,047	)		(2,985	)
Net deferred taxes	$	5,296		$	5,428

The net long-term deferred tax liability shown on the balance sheet includes deferred tax liabilities and assets related to the international operations of the Company.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

9. INCOME TAXES ¾ (CONTINUED)

For the years ended December 31, 2008 and 2009, a valuation allowance has been established for certain deferred tax assets due to the uncertainty of realization. The Company’s change in valuation allowance was an increase of approximately $3.0 million for the year ended December 31, 2008 and a decrease of approximately $62,000 for the year ended December 31, 2009. The decrease for the year ended December 31, 2009 is primarily due to the decrease in unrealized losses on securities, which was offset by an increase in the valuation allowance for foreign loss carryforwards. The valuation allowance for the deferred tax asset for unrealized losses has been recorded as an adjustment to accumulated other comprehensive loss. The valuation allowance for the years ended December 31, 2008 and 2009 also includes an allowance for capital loss carryforwards and for state net operating loss carryforwards.

For the year ended December 31, 2009, the Company had income of approximately $39.0 million subject to applicable U.S. federal and state income tax laws and a loss of approximately $5.9 million subject to applicable international tax laws.

The Company’s provision for income taxes resulted in effective tax rates that varied from the statutory federal income tax rate as follows (in thousands):

	Year Ended December 31,
	2007			2008		2009

Expected federal income tax provision at statutory rate	$	8,805		$	15,646	$	11,581
State income taxes, net of federal benefit		841			2,505		1,778
Foreign income taxes, net effect		156			497		347
Stock compensation		146			87		300
(Decrease) increase in valuation allowance		(274	)		1,023		1,446
Disregarded entity election		¾			¾		(1,477	)
Other adjustments		272			321		420
Income tax expense, net	$	9,946		$	20,079	$	14,395

The Company paid approximately $1.1 million, $13.4 million, and $19.4 million in income taxes for the years ended December 31, 2007, 2008 and 2009, respectively.

The Company has net operating loss carryforwards for international income tax purposes of approximately $12.6 million, which do not expire.

The Company adopted FASB authoritative guidance for uncertain income tax positions on January 1, 2007. As a result of the implementation of this guidance, the Company recognized no material adjustment in the liability for unrecognized income tax benefits. At the adoption date of January 1, 2007, the Company had $217,000 of unrecognized tax benefits, all of which would favorably affect the effective tax rate if recognized in future periods, and $52,000 of accrued penalties and $47,000 of accrued interest. The Company’s continuing practice is to recognize interest and penalties related to income tax matters in income tax expense.

The following tables summarize the activity related to the Company’s unrecognized tax benefits (in thousands):

Unrecognized tax benefit as of January 1, 2007	$	217
Increase for current year tax positions		44
Decrease for prior year tax positions		(6	)
Expiration of the statute of limitation for assessment of taxes		(22	)
Unrecognized tax benefit as of December 31, 2007	$	233

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

9. INCOME TAXES ¾ (CONTINUED)

Unrecognized tax benefit as of December 31, 2007	$	233
Increase for current year tax positions		1,451
Decrease for prior year tax positions		(9	)
Expiration of the statute of limitation for assessment of taxes		(117	)
Unrecognized tax benefit as of December 31, 2008		1,558
Increase for current year tax positions		69
Increase for prior year tax positions		257
Expiration of the statute of limitation for assessment of taxes		(28	)
Unrecognized tax benefit as of December 31, 2009	$	1,856

Approximately $217,000 and $142,000 of the unrecognized tax benefit as of December 31, 2009, and 2008, respectively, would favorably affect the annual effective tax rate, if recognized in future periods. During 2009, the Company recognized approximately $(10,000) of interest and $20,000 of penalties, and had total accruals of approximately $164,000 for interest and $54,000 for penalties as of December 31, 2009. During 2008, the Company recognized approximately $145,000 of interest and $9,000 of penalties, and had total accruals of approximately $173,000 for interest and $34,000 for penalties as of December 31, 2008. The Company does not anticipate the amount of the unrecognized tax benefits to change significantly over the next twelve months.

The Company’s federal and state income tax returns for tax years 2006 through 2008 remain open to examination. The Company’s U.K. income tax returns for tax years 2003 through 2008 remain open to examination.

10. GAIN ON LEASE SETTLEMENT, NET

On September 14, 2007, CoStar Limited, a wholly owned U.K. subsidiary of CoStar, entered into an agreement with Trafigura Limited to assign to Trafigura the leasehold interest in the office space located in London. The lease assignment was completed on December 19, 2007. As a result, CoStar U.K. was paid approximately $7.6 million, net of expenses, for the assignment of the lease. The expenses associated with the lease settlement included legal, moving and the disposal of assets.

11. COMMITMENTS AND CONTINGENCIES

The Company leases office facilities and office equipment under various noncancelable-operating leases. The leases contain various renewal options. Rent expense for the years ended December 31, 2007, 2008 and 2009 was approximately $8.1 million, $8.0 million and $9.1 million, respectively.

Future minimum lease payments as of December 31, 2009 are as follows (in thousands):


2010	$	10,530
2011		6,840
2012		4,911
2013		2,410
2014		651
2015 and thereafter		883
	$	26,225

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

11. COMMITMENTS AND CONTINGENCIES ¾ (CONTINUED)

The Company and its wholly owned subsidiary CoStar U.K. Limited are defendants in legal proceedings filed in England by Nokia U.K. Limited (“Nokia”) related to obligations under an agreement to sublease certain office space from Nokia. Nokia served its complaint upon the Company in September 2009, and the litigation is in its very early stages. If there is a trial, it is not expected to occur until October 2010. The Company has filed a response asserting that Nokia’s claim is without merit. The Company intends to defend itself vigorously against Nokia’s claim. Since the outcome of these legal proceedings is uncertain at this time and because Nokia has requested equitable relief as an alternative to financial relief, the Company cannot estimate the amount of liability, if any, that could result from an adverse resolution of this matter.

On December 23, 2008, the Company initiated a Financial Industry Regulatory Authority (“FINRA”) arbitration against Credit Suisse First Boston (“CSFB”) related to CSFB’s purchase of auction rate securities for the Company’s account. An arbitration hearing was originally scheduled to begin during the week beginning December 7, 2009, but was rescheduled at the request of CSFB and is now set to begin on March 8, 2010. The Company expects to receive a ruling on its claim during the second quarter of 2010. Since the outcome of this legal proceeding is uncertain at this time, the Company cannot estimate the amount of gain or loss, if any, that could result from the resolution of this matter.

On December 8, 2009, a former employee filed a lawsuit against the Company in the United States District Court for the Southern District of California alleging violations of the Fair Labor Standards Act and California state wage-and-hour laws and seeking unspecified damages under those laws. The complaint also seeks to declare a class of all similarly situated employees to pursue similar claims. The Company believes that the lawsuit is meritless and intends to defend itself vigorously against these claims and any certification of class status. Nevertheless, because the lawsuit is in its early stages, the outcome of the claim is uncertain at this time and the Company cannot estimate the amount of liability, if any, that could result from an adverse resolution of this matter.

In December 2009, the Company and LoopNet, Inc. settled all pending litigation between the companies. No monetary consideration was involved in the settlement.

Currently, and from time to time, the Company is involved in litigation incidental to the conduct of its business. In accordance with GAAP, the Company records a provision for a liability when it is both probable that a liability has been incurred and the amount can be reasonably estimated. At the present time, while it is reasonably possible that an unfavorable outcome may occur as a result of the Company’s current litigation, management has concluded that it is not probable that a loss has been incurred in connection with the Company’s current litigation. In addition, the Company is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome in the Company’s current litigation and accordingly, the Company has not recognized any liability in the consolidated financial statements for unfavorable results, if any. Legal defense costs are expensed as incurred.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

12. SEGMENT REPORTING

Due to the increased size, complexity, and funding requirements associated with the Company’s international expansion, in 2007 the Company began to manage the business geographically in two operating segments, with the primary areas of measurement and decision-making being the U.S. and International, which includes the U.K. and France. The Company’s subscription-based information services, consisting primarily of CoStar Property Professional®, CoStar Tenant®, CoStar COMPS Professional®, and FOCUSTM services, currently generate more than 95% of the Company’s total revenues. CoStar Property Professional, CoStar Tenant, and CoStar COMPS Professional are generally sold as a suite of similar services and comprise the Company’s primary service offering in the U.S. operating segment. FOCUS is the Company’s primary service offering in the International operating segment. Management relies on an internal management reporting process that provides revenue and segment EBITDA, which is the Company’s net income before interest, income taxes, depreciation and amortization. Management believes that segment EBITDA is an appropriate measure for evaluating the operational performance of our segments. EBITDA is used by management to internally measure operating and management performance and to evaluate the performance of the business. However, this measure should be considered in addition to, not as a substitute for or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP.

Summarized information by segment was as follows (in thousands):

	Year Ended December 31,
	2007			2008			2009
Revenues
United States	$	170,298		$	190,075			$	191,556
International
External customers		22,507			22,353				18,103
Intersegment revenue		¾			¾				898
Total international revenue		22,507			22,353				19,001
Intersegment eliminations		¾			¾				(898	)
Total revenues	$	192,805		$	212,428			$	209,659

EBITDA
United States	$	32,872		$	58,813			$	47,697
International		1,127			(2,224	)			(1,186	)
Total EBITDA	$	33,999		$	56,589			$	46,511

Reconciliation of EBITDA to net income
EBITDA	$	33,999		$	56,589			$	46,511
Purchase amortization in cost of revenues		(2,170	)		(2,284	)			(2,389	)
Purchase amortization in operating expenses		(5,063	)		(4,880	)			(3,412	)
Depreciation and other amortization		(8,914	)		(9,637	)			(8,875	)
Interest income, net		8,045			4,914				1,253
Income tax expense, net		(9,946	)		(20,079	)			(14,395	)
Net income	$	15,951		$	24,623			$	18,693

Intersegment revenue is attributable to services performed by Property and Portfolio Research Ltd., a wholly owned subsidiary of PPR, for PPR. Intersegment revenue is recorded at cost plus an agreed margin, which the Company believes approximates fair value. U.S. EBITDA includes a corresponding cost for the services performed by Property and Portfolio Research Ltd. for PPR

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)

12.	SEGMENT REPORTING — (CONTINUED)

International EBITDA includes a corporate allocation of approximately $2.6 million, $1.1 million and $500,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

Summarized information by segment consists of the following (in thousands):

	December 31,
	2008			2009
Property and equipment, net
United States	$	13,927		$	14,851
International		2,949			4,311
Total property and equipment, net	$	16,876		$	19,162

Goodwill
United States	$	31,547		$	55,260
International		22,781			25,061
Total goodwill	$	54,328		$	80,321

Assets
United States	$	353,084		$	424,479
International		43,474			44,558
Total segment assets	$	396,558		$	469,037

Reconciliation of segment assets to total assets
Total segment assets	$	396,558		$	469,037
Investment in subsidiaries		(18,343	)		(18,344	)
Intercompany receivables		(43,831	)		(46,114	)
Total assets	$	334,384		$	404,579

Liabilities
United States	$	24,180		$	37,838
International		40,053			46,678
Total segment liabilities	$	64,233		$	84,516

Reconciliation of segment liabilities to total liabilities
Total segment liabilities	$	64,233		$	84,516
Intercompany payables		(33,270	)		(38,943	)
Total liabilities	$	30,963		$	45,573

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

13. STOCKHOLDERS’ EQUITY

Preferred Stock

The Company has 2,000,000 shares of preferred stock, $0.01 par value, authorized for issuance. The Board of Directors may issue the preferred stock from time to time as shares of one or more classes or series.

Common Stock

The Company has 30,000,000 shares of common stock, $0.01 par value, authorized for issuance. Dividends may be declared and paid on the common stock, subject in all cases to the rights and preferences of the holders of preferred stock and authorization by the Board of Directors. In the event of liquidation or winding up of the Company and after the payment of all preferential amounts required to be paid to the holders of any series of preferred stock, any remaining funds shall be distributed among the holders of the issued and outstanding common stock.

14. NET INCOME PER SHARE

The following table sets forth the calculation of basic and diluted net income per share (in thousands except per share data):

	Year Ended December 31,
	2007		2008		2009
Numerator:
Net income	$	15,951	$	24,623	$	18,693
Denominator:
Denominator for basic net income per share ¾ weighted-average outstanding shares		19,044		19,372		19,780
Effect of dilutive securities:
Stock options and restricted stock		360		178		145
Denominator for diluted net income per share ¾ weighted-average outstanding shares		19,404		19,550		19,925

Net income per share ¾ basic	$	0.84	$	1.27	$	0.95
Net income per share ¾ diluted	$	0.82	$	1.26	$	0.94

Stock options to purchase approximately 80,400, 250,200 and 483,800 shares were outstanding as of December 31, 2007, 2008 and 2009, respectively, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares and, therefore, the effect would have been anti-dilutive.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

15. EMPLOYEE BENEFIT PLANS

Stock Incentive Plans

In June 1998, the Company’s Board of Directors adopted the 1998 Stock Incentive Plan (as amended, the “1998 Plan”) prior to consummation of the Company’s initial public offering. In April 2007, the Company’s Board of Directors adopted the CoStar Group, Inc. 2007 Stock Incentive Plan (as amended, the “2007 Plan”), subject to stockholder approval, which was obtained on June 7, 2007. All shares of common stock that were authorized for issuance under the 1998 Plan that, as of June 7, 2007, remained available for issuance under the 1998 Plan (excluding shares subject to outstanding awards) were rolled into the 2007 Plan and, as of that date, no shares of common stock were available under the 1998 Plan. The 1998 Plan continues to govern unexercised and unexpired awards issued under the 1998 Plan prior to June 7, 2007. The 1998 Plan provides for the grant of stock and stock options to officers, directors and employees of the Company and its subsidiaries. Stock options granted under the 1998 Plan might be incentive or non-qualified. The exercise price for an incentive stock option may not be less than the fair market value of the Company’s common stock on the date of grant. The vesting period of the options and restricted stock grants is determined by the Board of Directors and is generally three to four years. Upon the occurrence of a Change of Control, as defined in the 1998 Plan, all outstanding unexercisable options and restricted stock grants under the 1998 Plan immediately become exercisable.

The 2007 Plan provides for the grant of stock options, restricted stock, restricted stock units, and stock appreciation rights to officers, employees, directors and consultants of the Company and its subsidiaries. Stock options granted under the 2007 Plan may be non-qualified or may qualify as incentive stock options. Except in limited circumstances related to a merger or other acquisition, the exercise price for an option may not be less than the fair market value of the Company’s common stock on the date of grant. The vesting period for each grant of options, restricted stock, restricted stock units and stock appreciation rights under the 2007 Plan is determined by the Board of Directors and is generally three to four years, subject to minimum vesting periods for restricted stock and restricted stock units of at least one year. The Company has reserved the following shares of common stock for issuance under the 2007 Plan: (a) 1,000,000 shares of common stock, plus (b) 121,875 shares of common stock that were authorized for issuance under the 1998 Plan that, as of June 7, 2007, remained available for issuance under the 1998 Plan (not including any Shares that were subject as of such date to outstanding awards under the 1998 Plan), and (c) any shares of common stock subject to outstanding awards under the 1998 Plan as of June 7, 2007 that on or after such date cease for any reason to be subject to such awards (other than by reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and nonforfeitable shares). Unless terminated sooner, the 2007 Plan will terminate in April 2017, but will continue to govern unexercised and unexpired awards issued under the 2007 Plan prior to that date. Approximately 880,000 and 430,000 shares were available for future grant under the 2007 Plan as of December 31, 2008 and 2009, respectively.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

15. EMPLOYEE BENEFIT PLANS ¾ (CONTINUED)

Stock Incentive Plans ¾ (Continued)

Option activity was as follows:

	Number of Shares			Range of Exercise Price		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2006		1,274,477		$	9.00 - $52.13	$	32.23
Granted		7,000		$	48.25 - $54.12	$	50.77
Exercised		(288,757	)	$	9.00 - $45.18	$	28.16
Canceled or expired		(24,875	)	$	21.28 - $51.92	$	44.82
Outstanding at December 31, 2007		967,845		$	16.20 - $54.12	$	33.25
Granted		93,900		$	43.99 - $55.07	$	45.76
Exercised		(198,434	)	$	17.77 - $45.18	$	33.05
Canceled or expired		(47,725	)	$	39.00 - $52.13	$	46.36
Outstanding at December 31, 2008		815,586		$	16.20 - $55.07	$	33.98
Granted		267,756		$	25.00 - $40.13	$	31.05
Exercised		(85,228	)	$	17.35 - $36.38	$	26.20
Canceled or expired		(44,818	)	$	30.06 - $46.81	$	39.40
Outstanding at December 31, 2009		953,296		$	16.20 - $55.07	$	33.60		5.54	$	9,119

Exercisable at December 31, 2007		826,782		$	16.20 - $52.13	$	31.07
Exercisable at December 31, 2008		701,975		$	16.20 - $54.12	$	31.84
Exercisable at December 31, 2009		650,063		$	16.20 - $55.07	$	33.60		3.87	$	6,376

The aggregate intrinsic value is calculated as the difference between (i) the closing price of the common stock at December 31, 2007, 2008 and 2009 and (ii) the exercise prices of the underlying awards, multiplied by the shares underlying options as of December 31, 2007, 2008 and 2009, that had an exercise price less than the closing price on that date. Options to purchase 288,757, 198,434, and 85,228 shares were exercised for the years ended December 31, 2007, 2008, and 2009, respectively. The aggregate intrinsic value of options exercised, determined as of the date of option exercise, was $7.5 million, $3.4 million and $1.2 million, respectively.

At December 31, 2009, there was $11.3 million of unrecognized compensation cost related to stock-based payments, net of forfeitures, which is expected to be recognized over a weighted-average-period of 2.2 years.

The weighted-average grant date fair value of each option granted during the years ended December 2007, 2008 and 2009 was $32.70, $27.81and $12.72, respectively.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

15. EMPLOYEE BENEFIT PLANS ¾ (CONTINUED)

Stock Incentive Plans ¾ (Continued)

The Company estimated the fair value of each option granted on the date of grant using the Black-Scholes option-pricing model, using the assumptions noted in the following table:

	Year Ended December 31,
	2007			2008			2009

Dividend yield		0	%		0	%		0	%
Expected volatility		61	%		59	%		43	%
Risk-free interest rate		4.7	%		3.0	%		2.2	%
Expected life (in years)		5			5			3

The assumptions above and the estimation of expected forfeitures are based on multiple facts, including historical employee behavior patterns of exercising options and post-employment termination behavior, expected future employee option exercise patterns, and the historical volatility of the Company’s stock price.

The following table summarizes information regarding options outstanding at December 31, 2009:

		Options Outstanding						Options Exercisable
Range of Exercise Price		Number of Shares		Weighted-Average Remaining Contractual Life (in years)		Weighted-Average Exercise Price		Number of Shares		Weighted-Average Exercise Price
$	16.20 - $20.30		146,522		2.13	$	18.85		146,522	$	18.85
$	20.60 - $24.88		44,000		2.33	$	23.13		44,000	$	23.13
$	25.00 - $25.00		133,600		9.16	$	25.00		0	$	0.00
$	25.01 - $30.06		139,516		3.26	$	28.71		139,516	$	28.71
$	30.75 - $37.42		108,276		8.93	$	36.62		7,063	$	31.86
$	38.63 - $39.53		106,057		4.00	$	39.10		106,057	$	39.10
$	39.81 - $43.99		106,375		7.31	$	43.00		50,289	$	42.56
$	44.06 - $51.92		150,950		5.74	$	47.89		149,616	$	47.88
$	54.12 - $54.12		3,000		7.42	$	54.12		2,000	$	54.12
$	55.07 - $55.07		15,000		8.67	$	55.07		5,000	$	55.07
$	16.20 - $55.07		953,296		5.54	$	33.60		650,063	$	33.60

The following table presents unvested restricted stock awards activity for the year ended December 31, 2009:

	Number of Shares			Weighted-Average Grant Date Fair Value per Share
Unvested restricted stock at December 31, 2008		273,353		$	49.12
Granted		236,661		$	29.43
Vested		(67,433	)	$	45.52
Canceled		(23,234	)	$	34.33
Unvested restricted stock at December 31, 2009		419,347		$	39.40

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

15. EMPLOYEE BENEFIT PLANS ¾ (CONTINUED)

Employee 401(k) Plan

The Company maintains a 401(k) Plan (the “401(k)”) as a defined contribution retirement plan for all eligible employees. The 401(k) provides for tax-deferred contributions of employees’ salaries, limited to a maximum annual amount as established by the Internal Revenue Service. In 2007and 2008, the Company matched 100% of employee contributions up to a maximum of 6% of total compensation. In 2009, the Company matched 50% of employee contributions up to a maximum of 6% of total compensation. Amounts contributed to the 401(k) by the Company to match employee contributions for the years ended December 31, 2007, 2008 and 2009 were approximately $2.3 million, $2.6 million and $1.4 million, respectively. The Company paid administrative expenses in connection with the 401(k) plan of approximately $22,000, $28,000 and $0 for the years ended December 31, 2007, 2008 and 2009, respectively.

Employee Pension Plan

The Company maintains a company personal pension plan for all eligible employees in the Company’s London, England office. The plan is a defined contribution plan. Employees are eligible to contribute a portion of their salaries, subject to a maximum annual amount as established by the Inland Revenue. The Company contributes a match subject to the percentage of the employees’ contribution. Amounts contributed to the plan by the Company to match employee contributions for the years ended December 31, 2007, 2008 and 2009 were approximately $281,000, $265,000 and $130,000, respectively.

Employee Stock Purchase Plan

As of August 1, 2006, the Company introduced an Employee Stock Purchase Plan (“ESPP”), pursuant to which eligible employees participating in the plan authorize the Company to withhold from the employees’ compensation and use the withheld amounts to purchase shares of the Company's common stock at 90% of the market price. Participating employees are able to purchase common stock under this plan during the offering period. The offering period begins the second Saturday before each of the Company’s regular pay dates and ends on each of the Company’s regular pay dates. There were 78,840 and 72,237 shares available for purchase under the plan as of December 31, 2008 and 2009, respectively and approximately 7,400 and 6,600 shares of the Company’s common stock were purchased during 2008 and 2009, respectively.

16. RELATED PARTY TRANSACTIONS

In April 2009, the Company entered into an engagement with ghSMART & Company, Inc. (“ghSMART”), a management consulting firm, to evaluate the Company’s sales force senior management and provide guidance with respect to hiring and recruiting best practices for the Company’s sales force. Randy Street, a Partner of ghSMART, is the brother-in-law of the Company’s Chief Executive Officer. Mr. Street has acted and will continue to act as the senior client manager on this project. He has a less than 0.5 percent equity stake in ghSMART. Mr. Street is paid 25 percent of the amounts paid by the Company pursuant to the engagement. Pursuant to the engagement, the Company paid ghSMART approximately $202,000 plus expenses. The Audit Committee reviewed and approved the engagement with ghSMART prior to commencement of the engagement. In October 2009, the Audit Committee reviewed and approved phase II of the engagement for an additional amount of approximately $255,000 plus expenses. Mr. Street will act in the same capacity during phase II and receive the same percentage compensation for this portion of the engagement. The Company may enter into additional engagements with ghSMART in the future.

COSTAR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ¾ (CONTINUED)

17. SUBSEQUENT EVENTS

In February 2010, the Company purchased a 169,429 square-foot LEED Gold certified office building located at 1331 L Street, NW in downtown Washington, D.C. together with the tenancy in the underlying ground lease for the property for a purchase price of $41.25 million in cash. This facility will be used primarily by the Company’s U.S. segment. The Company intends to begin relocating its Bethesda-based employees and infrastructure to the new building starting in the second quarter of 2010. The Company currently expects to complete its relocation by October 2010 and allow the lease of its Bethesda property to expire.

In February 2010, the Company assumed the ground lease for the parcel of land under a building purchased in Washington, D.C. The lease, which expires February 29, 2088, requires the payment of minimum annual rent of $778,000 through February 29, 2012, then $918,040 annually to February 29, 2024. Thereafter, the minimum rate is adjusted to fair market value, as defined in the lease, once every 7 years.

Subsequent events have been evaluated through February 25, 2010, the date these financial statements were issued.

Schedule II – Valuation and Qualifying Accounts

Years Ended December 31, 2009, 2008, and 2007 (in thousands):


Allowance for doubtful accounts and billing adjustments (1)	Balance at Beginning of Year		Charged to Expense		Write-offs, Net of Recoveries		Balance at End of Year
Year ended December 31, 2009	$	3,213	$	4,172	$	4,522	$	2,863
Year ended December 31, 2008	$	2,959	$	4,042	$	3,788	$	3,213
Year ended December 31, 2007	$	1,966	$	2,464	$	1,471	$	2,959

(1)	Additions to the allowance for doubtful accounts are charged to bad debt expense. Additions to the allowance for billing adjustments are charged against revenues.

Consolidated Quarterly Results of Operations (Unaudited)

The following tables summarize our consolidated results of operations on a quarterly basis for the indicated periods (in thousands, except per share amounts, and as a percentage of total revenues):

	2008								2009
	Mar. 31		Jun. 30		Sep. 30		Dec. 31		Mar. 31		Jun. 30		Sep. 30		Dec. 31
Revenues	$	52,264	$	53,478	$	53,757	$	52,929	$	51,370	$	50,064	$	53,590	$	54,635
Cost of revenues		19,721		18,341		17,613		17,733		16,894		16,744		19,149		20,927
Gross margin		32,543		35,137		36,144		35,196		34,476		33,320		34,441		33,708
Operating expenses		25,313		26,627		24,864		22,428		23,735		25,129		27,490		27,756
Income from operations		7,230		8,510		11,280		12,768		10,741		8,191		6,951		5,952
Interest and other income, net		1,938		1,243		951		782		442		322		263		226
Income before income taxes		9,168		9,753		12,231		13,550		11,183		8,513		7,214		6,178
Income tax expense, net		4,126		4,318		5,586		6,049		5,077		3,897		2,889		2,532
Net income	$	5,042	$	5,435	$	6,645	$	7,501	$	6,106	$	4,616	$	4,325	$	3,646
Net income per share - basic	$	0.26	$	0.28	$	0.34	$	0.39	$	0.31	$	0.24	$	0.22	$	0.18
Net income per share - diluted	$	0.26	$	0.28	$	0.34	$	0.38	$	0.31	$	0.24	$	0.22	$	0.18

	2008												2009
	Mar. 31			Jun. 30			Sep. 30			Dec. 31			Mar. 31			Jun. 30			Sep. 30			Dec. 31
Revenues		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%
Cost of revenues		37.7			34.3			32.8			33.5			32.9			33.4			35.7			38.3
Gross margin		62.3			65.7			67.2			66.5			67.1			66.6			64.3			61.7
Operating expenses		48.5			49.8			46.2			42.4			46.2			50.2			51.3			50.8
Income from operations		13.8			15.9			21.0			24.1			20.9			16.4			13.0			10.9
Interest and other income, net		3.7			2.3			1.8			1.5			0.9			0.6			0.5			0.4
Income before income taxes		17.5			18.2			22.8			25.6			21.8			17.0			13.5			11.3
Income tax expense, net		7.9			8.0			10.4			11.4			9.9			7.8			5.4			4.6
Net income		9.6	%		10.2	%		12.4	%		14.2	%		11.9	%		9.2	%		8.1	%		6.7	%

PART IV

Item 15.

Exhibits and Financial Statement Schedules

(a)(1) The following financial statements are filed as a part of this report: CoStar Group, Inc. Consolidated Financial Statements.

(a)(2) Financial statement schedules: Schedule II - Valuation and Qualifying Accounts.

(a)(3) The documents required to be filed as exhibits to this Report under Item 601 of Regulation S-K are listed in the Exhibit Index included elsewhere in this report, which list is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Bethesda, State of Maryland, on the 3rd day of March 2010.

	COSTAR GROUP, INC.

	By:	/s/ Brian J. Radecki
		Brian J. Radecki
		Chief Financial Officer

INDEX TO EXHIBITS

Exhibit No.		Description
2.1		Offer Document by CoStar Limited for the share capital of Focus Information Limited (Incorporated by reference to Exhibit 2.1 to Amendment No. 2 to the Registration Statement on Form S-3 of the Registrant (Reg. No. 333-106769) filed with the Commission on August 14, 2003).
3.1		Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 the Registration Statement on Form S-1 of the Registrant (Reg. No. 333-47953) filed with the Commission on March 13, 1998 (the “1998 Form S-1”)).
3.2		Certificate of Amendment of Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 1999).
3.3		Amended and Restated By-Laws (Incorporated by reference to Exhibit 3.3 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
4.1		Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Registrant’s Report on Form 10-K for the year ended December 31, 1999).
*10.1		CoStar Group, Inc. 1998 Stock Incentive Plan, as amended (Incorporated by reference to Exhibit 10.1 to the Registrant’s Report on Form 10-Q for the quarter ended September 30, 2005).
*10.2		CoStar Group, Inc. 2007 Stock Incentive Plan, as amended (Incorporated by reference to Exhibit 10.2 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.3		CoStar Group, Inc. 2007 Stock Incentive Plan French Sub-Plan (Incorporated by reference to Exhibit 10.3 to the Registrant’s Report on Form 10-K for the year ended December 31, 2007).
*10.4		Form of Stock Option Agreement between the Registrant and certain of its officers, directors and employees (Incorporated by reference to Exhibit 10.8 to the Registrant’s Report on Form 10-K for the year ended December 31, 2004).
*10.5		Form of Stock Option Agreement between the Registrant and Andrew C. Florance (Incorporated by reference to Exhibit 10.8.1 to the Registrant’s Report on Form 10-K for the year ended December 31, 2004).
*10.6		Form of Restricted Stock Agreement between the Registrant and certain of its officers, directors and employees (Incorporated by reference to Exhibit 10.9 to the Registrant’s Report on Form 10-K for the year ended December 31, 2004).
*10.7		Form of 2007 Plan Restricted Stock Grant Agreement between the Registrant and certain of its officers, directors and employees (Incorporated by reference to Exhibit 99.1 to the Registrant’s Report on Form 8-K filed June 22, 2007).
*10.8		Form of 2007 Plan Incentive Stock Option Grant Agreement between the Registrant and certain of its officers and employees (Incorporated by reference to Exhibit 10.8 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.9		Form of 2007 Plan Incentive Stock Option Grant Agreement between the Registrant and Andrew C. Florance (Incorporated by reference to Exhibit 10.9 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.10		Form of 2007 Plan Nonqualified Stock Option Grant Agreement between the Registrant and certain of its officers and employees (Incorporated by reference to Exhibit 10.10 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.11		Form of 2007 Plan Nonqualified Stock Option Grant Agreement between the Registrant and certain of its directors (Incorporated by reference to Exhibit 10.11 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.12		Form of 2007 Plan Nonqualified Stock Option Grant Agreement between the Registrant and Andrew C. Florance (Incorporated by reference to Exhibit 10.12 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.13		Form of 2007 Plan French Sub-Plan Restricted Stock Agreement between the Registrant and certain of its employees (Incorporated by reference to Exhibit 10.10 to the Registrant’s Report on Form 10-K for the year ended December 31, 2007).
*10.14		CoStar Group, Inc. Employee Stock Purchase Plan (Incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
*10.15		Employment Agreement for Andrew C. Florance (Incorporated by reference to Exhibit 10.2 to Amendment No. 1 to the Registration Statement on Form S-1 of the Registrant (Reg. No. 333-47953) filed with the Commission on April 27, 1998).

INDEX TO EXHIBITS ¾ (Continued)

Exhibit No.		Description
*10.16		First Amendment to Andrew C. Florance Employment Agreement, effective January 1, 2009 (Incorporated by reference to Exhibit 10.16 to the Registrant’s Report on Form 10-K for the year ended December 31, 2008).
*10.17		Executive Service Contract dated February 16, 2007, between Property Investment Exchange Limited and Paul Marples (Incorporated by reference to Exhibit 10.14 to the Registrant’s Report on Form 10-K for the year ended December 31, 2007).
*10.18		Form of Indemnification Agreement between the Registrant and each of its officers and directors (Incorporated by reference to Exhibit 10.1 to the Registrant’s Report on Form 10-Q for the quarter ended March 31, 2004).
10.19		Office Lease, dated August 12, 1999, between CoStar Realty Information, Inc. and Newlands Building Ventures, LLC (Incorporated by reference to Exhibit 10.2 to the Registrant’s Report on Form 10-Q for the quarter ended September 30, 1999).
10.20		Office Sublease, dated June 14, 2002, between CoStar Realty Information, Inc., CoStar Group, Inc. and Gateway, Inc. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2002).
10.21		Exercise of option to extend lease term and sublease amendment, dated February 22, 2007 between Gateway, Inc. and CoStar Realty Information, Inc. and CoStar Group, Inc. (Incorporated by reference to Exhibit 10.11 to the Registrant’s Report on Form 10-K for the year ended December 31, 2006).
10.22		Addendum No. 3 to Office Lease, dated as of May 12, 2004, between Newlands Building Venture, LLC, and CoStar Realty Information, Inc. (Incorporated by reference to Exhibit 10.1 to the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2004).
10.23		Office Lease, dated as of February 23, 2005, between CoStar Realty Information, Inc. and Crestpointe III, LLC. (Incorporated by reference to Exhibit 10.13 to the Registrant’s Report on Form 10-K for the year ended December 31, 2004).
10.24		Office Lease Agreement, dated March 16, 2007, between Corporate Place I Business Trust and CoStar Group, Inc. (Incorporated by reference to Exhibit 10.2 to the Registrant’s Report on Form 10-Q for the quarter ended March 31, 2007).
10.25		Agreement for Lease among Nokia U.K. Limited, Focus Information Limited and CoStar Group, Inc., dated November 23, 2007 (Incorporated by reference to Exhibit 10.22 to the Registrant’s Report on Form 10-K for the year ended December 31, 2007).
10.26		Agreement for Lease between CoStar UK Limited and Wells Fargo & Company, dated August 25, 2009 (Incorporated by reference to Exhibit 10.26 to the Registrant’s Report on Form 10-K for the year ended December 31, 2009).
10.27		Addendum No. 5 to Office Lease, dated as of October 23, 2009, between Newlands Building Venture, LLC, and CoStar Realty Information, Inc. (Incorporated by reference to Exhibit 10.27 to the Registrant’s Report on Form 10-K for the year ended December 31, 2009).
10.28		Sub-Underlease between CoStar UK Limited and Wells Fargo & Company, dated November 18, 2009 (Incorporated by reference to Exhibit 10.28 to the Registrant’s Report on Form 10-K for the year ended December 31, 2009).
10.29		Contract for Sale and Purchase between Focus Information Limited and Trafigura Limited, dated September 14, 2007 (Incorporated by reference to Exhibit 10.1 to the Registrant’s Report on Form 10-Q for the quarter ended September 30, 2007).
21.1		Subsidiaries of the Registrant (Incorporated by reference to Exhibit 21.1 to the Registrant’s Report on Form 10-K for the year ended December 31, 2009).
23.1		Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm (filed herewith).
31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1		Certification of Principal Executive Officer pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2		Certification of Principal Financial Officer pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

* Management Contract or Compensatory Plan or Arrangement.

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