1
UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2000

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

FOR THE TRANSITION PERIOD FROM ________ TO ________

COMMISSION FILE NUMBER: 0-24531

COSTAR GROUP, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 52-2091509
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

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

(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

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

As of October 1, 2000, there were 15,430,427 shares outstanding of the
Registrant's Common Stock, par value $.01.

COSTAR GROUP, INC.

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

Condensed Consolidated Statements of Operations.........................3

Condensed Consolidated Balance Sheets...................................4

Condensed Consolidated Statements of Cash Flows.........................5

Notes to Condensed Consolidated Financial Statements....................6

Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations.........................9

Item 3 - Quantitative and Qualitative Disclosures About Market Risk............ 18

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings......................................................19

Item 2 - Changes in Securities..................................................19

Item 3 - Defaults upon Senior Securities........................................19

Item 4 - Submission of Matters to a Vote of Security Holders....................19

Item 5 - Other Information......................................................19

Item 6 - Exhibits and Reports on Form 8-K.......................................19

Signatures.......................................................................20

PART 1 FINANCIAL INFORMATION

ITEM 1 FINANCIAL STATEMENTS

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

For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------------- -----------------------
2000 1999 2000 1999
--------------------------- -----------------------

Revenues $ 15,717 $ 8,021 $ 41,661 $ 21,326
Cost of revenues 8,356 3,616 22,063 9,278
--------------------------- -----------------------
Gross margin 7,361 4,405 19,598 12,048
Operating expenses:
Selling and marketing 9,441 4,847 29,011 11,853
Software development 1,085 289 2,807 838
General and administrative 7,376 3,174 19,457 7,682
Purchase amortization 2,359 588 6,835 1,636
Acquired in-process development - - 5,812 -
---------------------------- ----------------------
20,261 8,898 63,922 22,009
---------------------------- ----------------------
Loss from operations (12,900) (4,493) (44,324) (9,961)
Loss on disposal of assets - - (182) -
Other income, net 807 1,234 2,766 1,912
---------------------------- ----------------------
Net loss before income taxes (12,093) (3,259) (41,740) (8,049)
Income tax benefit 523 - 1,933 -
---------------------------- -----------------------
Net loss $(11,570) $ (3,259) $(39,807) $ (8,049)
============================ =======================
Basic and diluted net loss per share $ (0.75) $ (0.25) $ (2.65) $ (0.71)
============================ =======================
Weighted average common shares 15,411 12,823 15,020 11,331
============================ =======================

See accompanying notes.

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

September 30, December 31,
2000 1999
----------------------------
ASSETS (unaudited)

Current assets:
Cash and cash equivalents $ 55,771 $ 94,074
Accounts receivable, less allowance for doubtful
accounts of $1,668 and $756 as of
September 30, 2000 and December 31, 1999 5,607 2,841
Prepaid expenses and other current assets 1,186 2,458
----------------------------
Total current assets 62,564 99,373

Property and equipment 22,574 8,259
Accumulated depreciation (5,282) (2,377)
----------------------------
17,292 5,882

Intangible and other assets 79,587 31,222
Deposits 553 428
----------------------------
Total assets $159,996 $136,905
============================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 13,441 $ 7,585
Deferred revenue 7,244 2,635
----------------------------
Total current liabilities 20,685 10,220

Long term liabilities 962 -

Deferred taxes 3,388 6,988

Stockholders' equity 134,961 119,697
----------------------------
Total liabilities and stockholders' equity $159,996 $136,905
============================

See accompanying notes.

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

For the Nine Months
Ended September 30,
---------------------------
2000 1999
---------------------------

Operating activities:
Net loss $ (39,807) $ (8,049)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 2,905 801
Amortization 10,802 2,678
Acquired in-process development 5,812 -
Loss on disposal of assets 182 -
Provision for losses on accounts receivable 1,330 363
Income tax benefit (1,933) -
Changes in operating assets and liabilities 970 1,358
---------------------------
Net cash used in operating activities (19,739) (2,849)

Investing activities:
Net purchases of property and equipment (10,448) (3,436)
Intangible and other assets ( 3,427) (1,285)
Acquisitions (net of acquired cash) (2,407) (10,230)
---------------------------
Net cash used in investing activities (16,282) (14,951)

Financing activities:
Payment of long-term liability (3,569) -
Net proceeds from exercise of stock options 1,287 -
Net proceeds from public offering - 97,411
---------------------------
Net cash (used in) provided by financing activities (2,282) 97,411

Net(decrease) increase in cash and cash equivalents (38,303) 79,611
Cash and cash equivalents at beginning of period 94,074 19,667
---------------------------
Cash and cash equivalents at end of period $ 55,771 $ 99,278
===========================

See accompanying notes.

COSTAR GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

CoStar Group, Inc. is a Delaware corporation and was incorporated in
February 1998 to succeed its predecessors, Realty Information Group L.P.
("RIGLP") and OLD RIG, Inc. ("RIGINC"). RIGLP was an operating entity, while
RIGINC was a shell holding entity. In connection with the Company's Initial
Public Offering on July 1, 1998 ("the Offering"), RIGLP and RIGINC merged with
the Company pursuant to the RIG Contribution Agreement dated March 5, 1998. The
limited partners of RIGLP (other than RIGINC) and all of the stockholders of
RIGINC received 3.03 shares of Common Stock of the Company per each limited
partnership unit or share of common stock exchanged, for a total of 5,754,017
shares. As a result of the reorganization of these entities, the Company owned
(directly or indirectly) all of the capital stock of RIGINC and all the equity
of RIGLP.

The merger has been accounted for as a reorganization of entities under
common control similar to a pooling of interests. Following the merger, each
shareholder of the Company maintained their exact same ownership of the
operating entity, RIGLP, as before the merger. The transfer of assets and
liabilities of RIGLP and RIGINC have been recorded at the historical carrying
values. The financial statements are presented as if the Company was in
existence throughout all periods presented, as one operating entity. All share
amounts have been restated to reflect the conversion of partnership units to
common stock of the Company. On January 1, 1999, RIGLP and RIGINC were merged
into a newly formed corporation, CoStar Realty Information, Inc. ("CoStar
Realty"), a wholly owned subsidiary of the Company.

Additionally, the consolidated financial statements of the Company
include the accounts of New Market Systems ("NMS") acquired on March 1, 1997, C
Data Services, Inc. ("CDS") acquired on August 14, 1998, LeaseTrend, Inc.
("LeaseTrend") acquired on January 8, 1999, Jamison Research, Inc. ("Jamison")
acquired on January 22, 1999, ARES Development Group, LLC ("ARES") acquired on
September 15, 1999, and COMPS.COM, Inc. ("Comps") acquired on February 10, 2000.
CDS was merged into CoStar Realty on January 1, 1999, and LeaseTrend and Jamison
were merged into CoStar Realty on December 31, 1999.

INTERIM FINANCIAL STATEMENTS

The accompanying unaudited condensed consolidated financial statements
of CoStar Group, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information. In
the opinion of the Company's management, the financial statements reflect all
adjustments necessary to present fairly the results of operations for the three
and nine-month periods ended September 30, 2000 and 1999, the Company's
financial position at September 30, 2000, and the cash flows for the nine-month
periods ended September 30, 2000 and 1999. These adjustments are of a normal
recurring nature.

Certain notes and other information have been condensed or omitted from
the interim financial statements presented in this Quarterly Report on Form
10-Q. Therefore, these financial statements should be read in conjunction with
the Company's 1999 Annual Report on Form 10-K and the Company's March 31, 2000
and June 30, 2000 Quarterly Reports on Form 10-Q.

The results of operations for the three and nine month periods ended
September 30, 2000 are not necessarily indicative of future financial results.

CONSOLIDATION

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

USE OF ESTIMATES

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

RECLASSIFICATIONS

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

3. ACQUISITIONS

On January 8, 1999, the Company acquired all of the common stock of
LeaseTrend, Inc., a Cincinnati based provider of commercial real estate
information, for $4,500,000 in cash and 566,671 shares of the Company's common
stock. The transaction was accounted for as a purchase and the consideration was
valued for accounting purposes at approximately $9,200,000 including acquisition
expenses.

On January 22, 1999, the Company acquired all of the common stock of
Jamison Research, Inc., an Atlanta based provider of commercial real estate
information, for $5,284,000 in cash and 446,637 shares of the Company's common
stock. The transaction was accounted for as a purchase and the consideration was
valued for accounting purposes at approximately $10,300,000 including
acquisition expenses.

On September 15, 1999, the Company acquired all of the membership
interests of ARES Development Group, LLC, Los Angeles based developers and
distributors of ARES for ACT!, for $250,000 in cash and 33,208 shares of the
Company's common stock. The transaction was accounted for as a purchase and the
consideration was valued for accounting purposes at approximately $1,265,000
including acquisition expenses. In addition, the acquisition agreement provided
for $1,000,000 of additional consideration (in a combination of cash and stock)
that may be paid by the Company upon the achievement of certain operating goals
by the members of ARES. In February 2000, the Company issued 2,140 shares of its
common stock and paid $437,500 in cash to the members of ARES for the
achievement of the first operating goal by the members of ARES. In October 2000,
the Company issued 2,196 shares of its common stock and paid $437,500 in cash to
the members of ARES for achievement of the second (and final) operating goal by
the members of ARES.

On February 10, 2000, the Company completed the acquisition of Comps
under a merger agreement, dated as of November 3, 1999, among the Company, Comps
and Acq Sub, Inc. ("Acq Sub"), a wholly owned subsidiary of the Company. Comps'
primary asset is a database of commercial real estate sales information. In
connection with the transaction, Comps was merged with and into Acq Sub, which
was the surviving corporation in the merger. Immediately after the merger, Acq
Sub changed its name to Comps, Inc. The aggregate consideration included
$49,015,905 in cash paid to former holders of Comps common stock (excluding cash
paid for fractional shares), and 2,259,034 shares of the Company's common stock
(including shares issued to former warrant holders of Comps). The transaction
was accounted for as a purchase and the consideration was valued for accounting
purposes at approximately $101,379,000 including acquisition expenses. The
purchase price has been allocated on a preliminary basis to the assets and
liabilities acquired based on the estimated fair values of the assets acquired
and the liabilities assumed.

The operations of all acquired businesses were included in the Company's
statement of operations after the respective date of acquisitions. Except for
the portion of the purchase price of acquisitions acquired with cash, these
transactions have been excluded from the statements of cash flows.

7
8

The Company's unaudited pro forma condensed consolidated statements of
operations for the nine month periods ended September 30, 2000 and 1999,
assuming the acquisition of LeaseTrend, Jamison, ARES and Comps had been
consummated as of January 1 of each period, is summarized as follows (in
thousands, except per share data):

For the Nine Month Period
Ended September 30,
2000 1999
------------------------

Revenues $ 43,336 $ 22,081
-------- --------
Net loss $(44,623) $( 8,466)
======== ========
Weighted average shares 15,357 11,415
======== ========
Net loss per share - basic and diluted $ (2.91) $ (0.74)
======== ========

4. INTANGIBLE AND OTHER ASSETS

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

September 30, December 31,
2000 1999
-------- --------

Capitalized product development costs $ 1,801 $ 1,435
Accumulated amortization (846) (617)
-------- --------
955 818
-------- --------
Building photography 4,412 3,118
Acquired technology 19,708 3,552
Customer base 31,600 19,347
Tradename 4,198 -
Goodwill 34,794 9,894
Accumulated amortization (16,080) (5,507)
-------- --------
78,632 30,404
-------- --------
Intangible and other assets $79,587 $ 31,222
======== ========

5. NEW ACCOUNTING PRONOUNCEMENTS

In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and hedging activities. The Company
intends to adopt SFAS 133 in the first quarter of fiscal 2001. The adoption of
SFAS 133 is not expected to have an effect on the financial position or results
of operations of the Company.

In 1999, the Securities and Exchange Commission ("SEC") staff issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements". SAB 101 explains how generally accepted accounting principles
should be applied in the recognition of revenue in financial statements. The
Company will implement SAB 101 in the fourth quarter of 2001. The adoption of
SAB 101 is not expected to have a material effect on the financial position or
results of operations of the Company.

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

The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains "forward-looking statements," which
involve many risks and uncertainties that could cause actual results to differ
materially from these statements. Factors that could cause or contribute to such
differences include, but are not limited to, successful adoption of the
Company's products, competition, changes in the commercial real estate industry,
managerial execution, development of the Company's sales force, employee
retention, and ability to adapt to technological changes. More information about
potential factors that could cause actual results to differ materially include,
but are not limited to, those stated below under the headings "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Risk Factors", those stated in the Company's Form 10-K for the year ended
December 31, 1999 under the headings "Risk Factors" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and those stated
in the Company's Form S-3 filed June 16, 2000 under the heading "Risk Factors".
All forward-looking statements are based on information available to the
Company on the date of this filing, and the Company assumes no obligation to
update such statements. The following discussion should be read in conjunction
with the Company's filings with the Securities and Exchange Commission and the
unaudited condensed consolidated financial statements included herein.

OVERVIEW

The Company is the leading provider of information services to the U.S.
commercial real estate industry. We are creating a digital marketplace where the
members of the commercial real estate and related business community can
continuously interact and facilitate transactions by efficiently exchanging
accurate and standardized information. Our wide array of digital service
offerings includes a leasing marketplace, a selling marketplace, comparable
sales information, decision support, tenant information, property marketing, and
industry news. Substantially all of our current services are digitally delivered
over the Internet.

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

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

We consider regions that have had ongoing operations for at least 18
months to be established, and we currently generate positive cash flow from our
operations in established regions. This has occurred as a result of continued
revenue growth over a relatively fixed cost base for the production and
distribution of existing products and services. As of September 30, 2000, the
following regions are those that have been in operation for more than 18 months
and that we consider to be established: Washington, New York, Los Angeles,
Chicago, San Francisco, Philadelphia, Boston, Houston San Diego and Phoenix.
These regions provide us with substantial cash flow, which we reinvest into the
business. Since our inception, the development of our business has required
substantial investments for the expansion of services and the establishment of
operating regions, which has resulted in substantial net losses on an overall
basis.

The incremental cost of introducing new services in an established
region in the future may reduce the profitability of a region or cause it to
incur losses. We expect continued development and distribution of new services,
expansion of all existing services across current markets and geographic
expansion in the United States and international markets. Therefore, while we
expect operations in existing established regions to remain profitable and
provide substantial funding, we expect our overall expansion activities to
generate significant losses and negative cash flow from operations during the
next 15 months.

9
10

Although our services are expanding rapidly, our CoStar Property, CoStar
Tenant and CoStar COMPS services currently generate the largest portion of our
revenue. The CoStar Property, CoStar Tenant and CoStar COMPS contracts range
from terms of one to three years and generally renew automatically. Upon
renewal, many of the contract rates increase automatically in accordance with
contract provisions or as a result of renegotiations. To encourage clients to
use our services regularly, we generally charge fixed amounts rather than fees
based on actual system usage. We charge our clients based on the number of
sites, organization size, the company's business focus, and the number of
services to which a client subscribes. Our contract renewal rate currently
exceeds 90% on an annual basis. Our clients pay contract fees on an annual,
quarterly, or monthly basis. We recognize this revenue over the life of the
contract on a straight-line basis beginning with the installation or renewal
date. Annual and quarterly advance payments result in deferred revenue,
substantially reducing the working capital requirements generated by the growth
in our accounts receivable.

THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2000

REVENUES. Revenues increased 96% from $8,021,000 for the three months ended
September 30, 1999 to $15,717,000 for the three months ended September 30, 2000.
The increase resulted primarily from growth in the Company's client base in
established regions, expansion of emerging and acquired regions entered during
1999 and revenues from the acquisition of Comps. Our Comps division contributed
$4.5 million to revenues for the three months ended September 30, 2000.

GROSS MARGINS. Gross margins increased 67% from $4,405,000 for the three months
ended September 30, 1999 to $7,361,000 for the three months ended September 30,
2000, while gross margin percentages were 55% and 47% of revenue, respectively.
The increase in gross margins resulted principally from significant revenue
growth from established regions. The decline in gross margin percentages
resulted primarily from investments in research for the expansion in both
emerging and acquired regions and from lower gross margins in the recently
acquired Comps business. Furthermore, our cost of revenues for the three months
ended September 30, 2000 includes purchase price amortization from the
LeaseTrend, Jamison, ARES and Comps acquisitions of approximately $1,277,000
compared to approximately $175,000 for the same period in 1999.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased 95%
from $4,847,000 for the three months ended September 30, 1999 to $9,441,000 for
the three months ended September 30, 2000. Selling and marketing expenses
increased primarily as a result of the expansion of the sales force and
marketing efforts required for growth, particularly in emerging regions, and for
the marketing surrounding the launch of our CoStar Exchange product.

SOFTWARE DEVELOPMENT. Software development expenses increased 275% from $289,000
for three months ended September 30, 1999 to $1,085,000 for the three months
ended September 30, 2000 reflecting development costs for the increased number
of products we now support including CoStar COMPS and CoStar Exchange.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 132% from $3,174,000 for the three months ended September 30, 1999 to
$7,376,000 for the three months ended September 30, 2000. General and
administrative expenses primarily increased due to the hiring of new employees
to support the expanding scope of our operations and client base and also the
increase in employees due to the acquisition of Comps.

PURCHASE AMORTIZATION. Purchase amortization increased 301% from $588,000 for
the three months ended September 30, 1999 to $2,359,000 for the three months
ended September 30, 2000. Purchase amortization increased primarily due to the
acquisition of Comps.

OTHER INCOME, NET. Interest and other income decreased from $1,234,000 for the
three months ended September 30, 1999 to $807,000 for the three months ended
September 30, 2000. This decrease reflects the decrease in interest earned on
the proceeds from the follow-on public offering as cash balances have declined.

INCOME TAX BENEFIT. An income tax benefit of $523,000 for the three months ended
September 30, 2000 is a result of the impact of the reversal of the deferred tax
liability in connection with the amortization of identified intangible assets
established during recent acquisitions.

11
12

NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2000

REVENUES. Revenues increased 95% from $21,326,000 for the nine months ended
September 30, 1999 to $41,661,000 for the nine months ended September 30, 2000.
The increase resulted primarily from growth in the Company's client base in
established regions, expansion of emerging and acquired regions entered during
1999 and revenues from the acquisition of Comps. Our Comps division contributed
$10.7 million to revenues for the nine months ended September 30, 2000.

GROSS MARGINS. Gross margins increased 63% from $12,048,000 for the nine months
ended September 30, 1999 to $19,598,000 for the nine months ended September 30,
2000, while gross margin percentages were 56% and 47% of revenue, respectively.
The increase in gross margins resulted principally from significant revenue
growth from established regions. The decline in gross margin percentages
resulted primarily from investments in research for the expansion in both
emerging and acquired regions and from lower gross margins in the recently
acquired Comps business. Furthermore, our cost of revenues for the nine months
ended September 30, 2000 includes purchase price amortization from the
LeaseTrend, Jamison, ARES and Comps acquisitions of approximately $3,398,000
compared to approximately $565,000 for the same period in 1999.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased 145%
from $11,853,000 for the nine months ended September 30, 1999 to $29,011,000 for
the nine months ended September 30, 2000. Selling and marketing expenses
increased primarily as a result of the expansion of the sales force and
marketing efforts required for growth, particularly in emerging regions, and for
the marketing surrounding the launch of our CoStar Exchange product.

SOFTWARE DEVELOPMENT. Software development expenses increased 235% from $838,000
for nine months ended September 30, 1999 to $2,807,000 for the nine months ended
September 30, 2000 reflecting development costs for the increased number of
products we now support including CoStar COMPS and CoStar Exchange.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 153% from $7,682,000 for the nine months ended September 30, 1999 to
$19,457,000 for the nine months ended September 30, 2000. General and
administrative expenses increased due to the hiring of new employees to support
the expanding scope of our operations and client base and also the increase in
employees due to the acquisition of Comps.

PURCHASE AMORTIZATION. Purchase amortization increased 318% from $1,636,000 for
the nine months ended September 30, 1999 to $6,835,000 for the nine months ended
September 30, 2000. Purchase amortization increased primarily due to the
acquisition of Comps.

ACQUIRED IN-PROCESS DEVELOPMENT. Acquired in-process development costs of
$5,812,000 for the nine months ended September 30, 2000 consist of in-process
development costs written off as part of the Comps acquisition.

OTHER INCOME, NET. Interest and other income increased from $1,912,000 for the
nine months ended September 30, 1999 to $2,766,000 for the nine months ended
September 30, 2000. This increase was a direct result of interest earned on the
proceeds from the follow-on public offering.

INCOME TAX BENEFIT. An income tax benefit of $1,933,000 for the nine months
ended September 30, 2000 is a result of the impact of the reversal of the
deferred tax liability in connection with the amortization of identified
intangible assets established during recent acquisitions.

LIQUIDITY AND CAPITAL RESOURCES

Our cash and cash equivalents balance was $55,771,000 at September 30,
2000, a decrease of $38,303,000 from $94,074,000 at December 31, 1999. This
decrease was due principally to the $2,407,000 (net of acquired cash) used for
the acquisition of Comps on February 10, 2000, cash used in operating
activities, $10,448,000 in purchases of property and equipment, debt repayments
of $3,569,000, and $1,294,000 in purchased building photography. During the
third quarter of 2000, we financed our operations and growth through cash flow
from the established regions and the proceeds of the follow-on offering. Net
cash used in operations for the nine months ended September 30, 2000 was
$19,739,000 compared to net cash used by operating activities of $2,849,000 for
the nine months ended September 30, 1999. This was a direct result of
investments in research for the expansion in both emerging and acquired
regions, the development and launch of new services and the acquisition of
Comps. Additionally, we received advance payments from clients on a number of
contracts, resulting in the generation of cash as reflected in deferred revenue
balances of $7,244,000 and $2,635,000 as of September 30, 2000 and December 31,
1999, respectively. This increase in deferred revenues was a result of the
acquisition of Comps as well as a large number of annual contracts billed in
the first half of 2000.

Net cash used in investing activities amounted to $16,282,000 for the
nine months ended September 30, 2000, including $2,407,000 (net of acquired
cash) for the acquisition of Comps. Additional investing activities included
purchased building photography and purchase of property and equipment,
consisting principally of leasehold improvements, computers and office
equipment. As a result of our expansion, we have entered into numerous operating
leases for office space throughout the country, including the Company's and
Comps' headquarters and have commitments for rent payments ranging from
$2,436,000 to $4,405,000 annually over the next ten years. We currently have no
material commitments for capital expenditures.

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

During the first nine months of 2000, we experienced significant losses
and negative operating cash flow as a result of expansion in emerging regions,
expansion of services in established regions, costs for the introduction of new
products and the acquisition of Comps. Some of these costs are non-recurring,
and many are fixed operating costs, which will not directly increase as a result
of the related expected growth in revenue. Based on current plans we believe
that our available cash combined with positive cash flow from our established
regions should be sufficient to fund our operations for at least the next two
years.

Through June 30, 1998, we operated as either a Subchapter S corporation
or a limited partnership, and we were not subject to corporate income taxes.
After June 30, 1998, we became a taxable entity. Although we have experienced
losses to date, future profits, to the extent not offset by the benefits of loss
carryforwards, would result in income tax liabilities. During 2000, we recorded
purchase price adjustments of approximately $14.2 million related to our
acquisition of Comps. These adjustments resulted in a decrease of the deferred
tax liability and related goodwill resulting from the recording of acquired net
operating loss carryforwards. The Company expects to finalize its purchase price
allocation during the fourth quarter of 2000.

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

13
14

RISK FACTORS

Investing in our common stock involves a high degree of risk. You should
consider the following risk factors, as well as the risk factors contained in
our Form S-3 filed on June 16, 2000, and our Form 10K for the fiscal year ended
December 31, 1999, before deciding to purchase any shares of our common stock.
The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also impair our business operations. If any of the
following risks actually occur, our business, financial condition, operating
results and stock price could be materially adversely affected.

Our future profitability is uncertain due to our continuing operating
losses. We have never recorded an overall operating profit because the
investment required for geographic expansion and new services has exceeded the
profits generated in our established markets. We intend to maintain our
investment in expansion and new services and will therefore sustain substantial
losses for at least the next fifteen months. Our ability to earn a profit will
largely depend on our ability to manage our growth, and to generate profits from
services that exceed our investment in geographic expansion and new services. In
addition, our ability to earn a profit or to increase revenues could be affected
by the factors set forth below. We may not be able to generate revenues
sufficient to earn a profit, to maintain profits on a quarterly or annual basis,
or to sustain or increase our future revenue growth.

Our operating results may fluctuate significantly. Our revenues and
operating results may fluctuate with general economic conditions and also for
many other reasons, such as: competition; our investments in geographic
expansion; the timing of new service introductions and enhancements; the success
of new products; the timing of investing the net proceeds from our offerings;
acquisitions of other companies or assets; sales, brand enhancement and
marketing promotional activities; managerial execution; client training and
support activities; the development of our sales force; loss of clients or
revenues due to competition or consolidation in the real estate industry;
changes in client budgets; or our investments in other corporate resources.

We may not be able to attract and retain clients. Our success and our
growth in revenues depends on attracting and retaining subscribers to our
services. The CoStar Property, CoStar Tenant and CoStar COMPS subscription
contracts, which generate the largest portion of our revenue, range from terms
of one to three years. At the end of the term of each agreement our clients may
decide not to renew their agreements as a result of several factors, including
alternative products, consolidation in the real estate industry, or economic or
competitive pressures.

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

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

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

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

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

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

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

15
16

Unsatisfactory Internet performance, interruption or failure could have
an adverse effect on our business. Our business increasingly depends upon the
satisfactory performance, reliability and availability of our Web site, the
Internet and the World Wide Web. Problems with our Web site, the Internet or the
Web may impede the development of our business for a number of reasons. As the
number of Internet users or their use of Internet resources continues to grow,
and as companies deliver increasingly larger amounts of data over the Internet,
the Internet's infrastructure must also grow. Growth in Internet usage that is
not matched by comparable growth of the infrastructure supporting the Internet
could result in slower response time, cause outright failure of the Internet, or
otherwise adversely affect usage.

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

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

We may be unable to enforce or defend our ownership and use of
intellectual property. The success of our business depends in large part on the
intellectual property involved in our methodologies, database and software. We
rely on a combination of trade secret, patent and copyright laws, nondisclosure
and noncompetition provisions, license agreements and other contractual
provisions and technical measures to protect our intellectual property rights.
We cannot guarantee that we will always succeed in this effort. Legal standards
relating to the validity, enforceability and scope of protection of proprietary
rights in Internet-related businesses are uncertain and evolving, and we can
give no assurance regarding the future viability or value of any of our
proprietary rights. Our business could be significantly harmed if we do not
succeed in protecting our intellectual property. The same would be true if a
court should find that our services infringe other persons' intellectual
property rights. Any intellectual property lawsuits in which we might become
involved, either as a plaintiff, or as a defendant, could cost us a significant
amount of time and money.

Litigation in which we become involved may adversely affect our
business. We currently and from time to time are involved in litigation
incidental to the conduct of our business. There can be no assurance that we
will have insurance to cover our pending claims or our future claims. If any
pending claims or future claims are adversely determined, they could have a
material adverse effect on our financial position or results of operations.

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

Our business depends on our management team's ability to execute our
business plan. We have recently added several key officers to our management
team. Our business depends on the successful integration of these new officers,
and the ability of our assembled management team to successfully execute our
business plan. The inability of our management team to successfully integrate
our new officers or execute our business plan could have an adverse effect on
our operations.

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

General economic conditions could have an adverse effect on our
business. The commercial real estate industry is particularly affected by
negative trends in the general economy. The success of our business depends on a
number of factors relating to general global, national, regional and local
economic conditions, including inflation, interest rates, perceived and actual
economic conditions, taxation policies, availability of credit, employment
levels, and wage and salary levels. A negative trend in any of these general
economic conditions could adversely affect our business.

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

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

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

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

International expansion may result in new business risks. If we expand
internationally, this expansion could subject us to new business risks,
including: adapting to the differing business practices and laws in foreign
commercial real estate markets; difficulties in managing foreign operations;
limited protection for intellectual property rights in some countries;
difficulty in accounts receivable collection and longer collection periods; cost
of enforcement of contractual obligations; impact of recessions in economies
outside the United States; currency exchange rate fluctuations; and potentially
adverse tax consequences.

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

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

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not have significant exposure to market risks
associated with the changes in interest rates related to its cash equivalent
securities held as of September 30, 2000.

PART II. OTHER INFORMATION

ITEM 1 LEGAL PROCEEDINGS

On November 5, 1999, a suit was filed in the Court of Chancery of the
State of Delaware in and for New Castle County under the caption Morris v. Avis,
et al (C.A. 197554). The suit alleged breaches of fiduciary duties by the former
members of the board of directors of Comps and Summit Partners. On November 8,
1999, a suit was filed in the Superior Court of the State of California of and
for the County of San Diego captioned Berghoff v. Comps.com et al (case no. GIC
738362). The allegations in the California lawsuit were similar to the
allegations in the Delaware suit. The plaintiffs in both of these lawsuits had
requested monetary damages and injunctive relief to prevent the consummation of
the merger between Comps and the Company. On January 6, 2000, the Delaware suit
was voluntarily dismissed by the plaintiff. On February 4, 2000, the parties to
the California lawsuit entered into a Memorandum of Understanding that set forth
their agreement to settle the lawsuit. The parties subsequently negotiated and
executed a more detailed Joint Stipulation and Agreement of Compromise,
Settlement and Release ("Joint Stipulation"). On April 7, 2000, the Court
entered an Order of Preliminary Class Action Settlement, consistent with the
terms of the Joint Stipulation. On September 15, 2000, the Court entered a Final
Order and Judgment approving the settlement and dismissing the suit.

The Company currently and from time to time is involved in litigation
incidental to the conduct of its business. The Company is not a party to any
lawsuit or proceeding that, in the opinion of management of the Company, is
likely to have a material adverse effect on the Company's financial position or
results of operations.

ITEM 2 CHANGES IN SECURITIES

In connection with the acquisition of ARES, the Company issued to Terry
McKiernan and Michael Griffin, the sole members of ARES, an aggregate of 2,140
shares of common stock, par value $.01 per share, on February 28, 2000 and an
aggregate of 2,196 shares of common stock, par value $.01 per share, on October
10, 2000. Such shares comprised part of the consideration for the acquisition
for ARES and were issued in reliance on the exemption from registration under
Section 4(2) of the Securities Act of 1933, as amended.

ITEM 3 DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5 OTHER INFORMATION

None

ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K

A current report on Form 8-K was filed by the Company on September 26,
2000 announcing the appointment of its Chief Operating Officer, Lawrence J.
Dressel. A current report on Form 8-K was also filed by the Company on October
26, 2000 with respect to the press release announcing the Company's third
quarter earnings.

EXHIBIT NUMBER: EXHIBIT DESCRIPTION:

10.1 Employment Agreement for Lawrence J. Dressel

27 Financial Data Schedule

SIGNATURES

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

COSTAR GROUP, INC.

Date: November 14, 2000 By: /s/ Frank A. Carchedi

-------------------------------
Frank A. Carchedi
Chief Financial Officer
(Principal Financial and Accounting Officer
and Duly Authorized Officer)