10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 3, 2007

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 .

Commission file number 0-14970

COST PLUS, INC.

(Exact name of registrant as specified in its charter)

California	94-1067973
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
200 4th Street Oakland, California	94607
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code(510) 893-7300

Name of Each Exchange on Which Registered:

The NASDAQ Stock Market LLC (NASDAQ Global Select)

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

Common Stock, $.01 par value Preferred SharePurchase Rights

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  ¨    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  ¨    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 for the past 90 days.    Yes  x    No  ¨

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.    x

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

Large accelerated filer  ¨ Accelerated filer  x Non-accelerated filer  ¨

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

The aggregate market value of voting stock held by non-affiliates of the registrant based upon the closing sale price of the common stock on July 28, 2006, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $298.5 million as reported for such date on the Nasdaq Global Select Market. As of April 24, 2007, 22,084,239 shares of Common Stock, $.01 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held July 12, 2007 (“Proxy Statement”) are incorporated by reference into Part III of this Annual Report on Form 10-K to the extent stated herein. Except with respect to information specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part hereof.

COST PLUS, INC.

TABLE OF CONTENTS

2006 FORM 10-K

		Page
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	5
Item 1B.	Unresolved Staff Comments	11
Item 2.	Properties	11
Item 3.	Legal Proceedings	12
Item 4.	Submission of Matters to a Vote of Security Holders	12
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	15
Item 6.	Selected Financial Data	17
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	18
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 8.	Financial Statements and Supplementary Data	29
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	53
Item 9A.	Controls and Procedures	53
Item 9B.	Other Information	54
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	55
Item 11.	Executive Compensation	55
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	55
Item 13.	Certain Relationships and Related Transactions, and Director Independence	56
Item 14.	Principal Accounting Fees and Services	56
PART IV
Item 15.	Exhibits, Financial Statement Schedules	57

Some of the statements under the sections entitled “Business”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Risk Factors,” and elsewhere in this Annual Report on Form 10-K contain forward-looking statements, which reflect Cost Plus, Inc.’s (the “Company”) current beliefs and estimates with respect to future events and the Company’s future financial performance, business, operations and competitive position. Forward looking statements may be identified by use of the words “may,” “should,” “expects,” “anticipates,” “estimates,” “believes,” “looking ahead,” “forecast,” “projects,” “continues,” “intends,” “likely,” “plans” and similar expressions. The forward-looking statements involve known and unknown risks and uncertainties which may cause the Company’s actual results or performance to differ materially from those expressed in such forward-looking statements due to a number of factors including those set forth in Risk Factors in this Form 10-K and in documents which are incorporated by reference herein. The Company may from time to time make additional written and oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission. You should not place undue reliance on our forward-looking statement, as they are not guarantees of future results, levels of activity or performance and represent the Company’s expectations only as of the date they are made. The Company does not undertake any obligation to update any forward-looking statement that may be made from time to time by or on behalf of the Company.

PART I

ITEM 1. BUSINESS

The Company

Cost Plus, Inc. and its subsidiaries (“Cost Plus World Market,” or “the Company”) is a leading specialty retailer of casual home furnishings and entertaining products in the United States. As of February 3, 2007, the Company operated 287 stores under the name “World Market,” “Cost Plus World Market,” “Cost Plus Imports” and “World Market Stores” in 34 states. Cost Plus World Market’s business strategy is to differentiate itself by offering a large and ever-changing selection of unique products, many of which are imported, at value prices in an exciting shopping environment. Many of Cost Plus World Market’s products are proprietary or private label, often incorporating the Company’s own designs, “World Market” brand name, quality standards and specifications and typically are not available at department stores or other specialty retailers.

Cost Plus World Market’s expansion strategy is to open stores primarily in metropolitan and suburban markets that can support multiple stores and enable the Company to achieve advertising, distribution and operating efficiencies. The Company may also enter mid-size markets that can support one or two stores that the Company believes can meet its profitability criteria. The Company’s stores are located predominantly in high traffic metropolitan and suburban locales, often near major malls. In the fiscal year ended February 3, 2007, the Company opened a total of 24 new stores, including 16 in the existing markets of the San Francisco Bay Area, San Diego, Sacramento, and Los Angeles, CA; Portland, OR; Seattle, WA; Dallas Ft. Worth and San Antonio, TX; Washington D.C.; Chicago, IL; Las Vegas, NV; Madison, WI; and eight in the new markets of Opelika, AL; Salem, OR; Chattanooga and Knoxville, TN; and Daytona Beach, Ft. Lauderdale, Melbourne, and Naples, FL. In addition to opening 24 new stores in fiscal 2006, the Company also closed four stores. In fiscal 2007, the Company intends to primarily focus on opening stores in existing states in order to reinforce its brand and to maximize the effectiveness of its advertising budget.

The Company’s website address is www.worldmarket.com. The Company has made available through its Internet website, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Definitive Proxy Statement and Section 16 filings and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act”), as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC. Cost Plus, Inc. was organized as a California corporation in November 1946.

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Merchandising

Cost Plus World Market’s merchandising strategy is to offer customers a broad selection of distinctive items related to the theme of casual home furnishing and entertaining.

Products. The Company believes its distinctive and unique merchandise and shopping environment differentiates it from other retailers. Many of Cost Plus World Market’s products are proprietary or private label. “World Market” brand name or other brand names exclusive to the Company often incorporate the Company’s own designs, and have quality standards and specifications typically not available at department stores or other specialty retailers. In addition to strengthening the stores’ product offering, proprietary and private label goods typically offer higher gross margins and stronger consumer values than branded goods. A significant portion of Cost Plus World Market’s products are made abroad in over 50 countries and many of these goods are handcrafted by local artisans. The Company’s product offering is designed to provide solutions to customers’ casual living and home entertaining needs. The offerings include home decorating items such as furniture, rugs, pillows, bedding, lamps, window coverings, frames, and baskets. Cost Plus World Market’s furniture products include ready-to-assemble living and dining room pieces, unusual handcrafted case goods and occasional pieces, as well as outdoor furniture made from a variety of materials such as rattan, hardwood and wrought iron. The Company also sells a number of tabletop and kitchen items including glassware, ceramics, textiles and cooking utensils. Kitchen products include an assortment of products organized around a variety of themes such as baking, food preparation, barbecue and international dining.

Cost Plus World Market offers a number of gift and decorative accessories, including collectibles, candles, framed art, jewelry and Holiday and other seasonal items. Because many of the gift and collectible items come from around the world, they contribute to the exotic atmosphere of the stores.

Cost Plus World Market also offers its customers a wide selection of gourmet foods and beverages, including wine, microbrewed and imported beer, coffee, tea and bottled water. The wine assortment offers a number of moderately priced premium wines, including a variety of well recognized labels, as well as wines not readily available at neighborhood wine or grocery stores that have been privately bottled and imported from around the world. State regulations may limit or restrict the Company’s ability to sell alcoholic beverages. Consumable products, particularly beverages, generally have lower margins than the Company’s average. Gourmet foods include packaged products from around the world and seasonal items that relate to “old world” Holidays and customs. Packaged snacks, candy and pasta are often displayed in open barrels and crates. Food items typically have a shelf life of six months or longer.

The Company classifies sales into the home furnishings and consumables product lines with sales as a percentage of total sales for the prior three fiscal years for these categories as follows:

	Fiscal Year Ended
	February 3, 2007		January 28, 2006		January 29, 2005
Home Furnishings	61	%	61	%	62	%
Consumables	39	%	39	%	38	%

The Company replaces or updates many of the items in its merchandise assortment on a regular basis in order to encourage repeat shopping and to promote a sense of discovery. The Company marks down retail prices of items that do not meet its turnover expectations.

Format and Presentation. The Company’s stores are designed to evoke the feeling of a “world marketplace” through colorful and creative visual displays and merchandise presentations, including goods in open barrels and crates, groupings of related products in distinct “shops” within the store and in-store activities such as food and coffee tastings. The Company believes that its “world marketplace” effect provides customers with a fun shopping experience and encourages browsing throughout the store.

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The average selling space of a Cost Plus World Market store is approximately 15,700 square feet, which allows flexibility for merchandise displays, product adjacencies and directed traffic patterns. Complementary products are positioned in proximity to one another and cross merchandising themes are used in merchandise displays to tie different product offerings together. The floor plan allows the customer to see virtually all of the different product areas in a Cost Plus World Market store from the store center where four quadrant zones, with bulk displays highlighting sharply priced items, lead the customer into different product areas. The Company has a seasonal shop located in the heart of the store to feature seasonal products and themes, such as the Holiday shop, harvest and outdoor. Store signage, including permanent as well as promotional signs, is developed by the Company’s in-house graphic design department. End caps, bulk stacks and free standing displays are changed frequently. Approximately 3,000 square feet of back office and stock space are included in the total square footage, which averages about 18,700 square feet per store.

The Cost Plus World Market store format is also designed to reinforce the Company’s value image through exposed ceilings, concrete floors, simple wooden fixtures and open or bulk presentations of merchandise. The Company displays most of its inventory on the selling floor and makes effective use of vertical space, such as a display of chairs arranged on a wall and rugs hanging vertically from fixtures.

The Company believes that its customers usually visit a Cost Plus World Market store as a destination with a specific purchase in mind. The Company makes use of frequent receipts of products, seasonal themes and products, and consumable products to encourage frequent return visits by its customers. The Company also believes that once in the store, its customers often spend additional time shopping and browsing, which results in customers purchasing more items than they originally intended.

Pricing. Cost Plus World Market offers quality products at competitive prices. The Company complements its competitive everyday prices with selected product promotions and opportunistic buys, enabling the Company to pass on additional savings to the customer. The Company routinely shops a variety of retailers to ensure that its products are competitively priced.

Planning and Buying. Cost Plus World Market effectively manages a large number of products by utilizing centralized merchandise planning, tracking and replenishment systems. The Company regularly monitors merchandise activity at the item level through its management information systems to identify and respond to product trends. The Company maintains its own central buying staff that is responsible for establishing the assortment of inventory within its merchandise classifications each season, including integrating current trends or themes identified by the Company into its different product categories. The Company attempts to moderate the risk associated with merchandise purchasing by testing selected new products in a limited number of stores. The Company’s long-standing relationships with overseas suppliers, its international buying agency network and its knowledge of the import process facilitate the planning and buying process. The buyers work closely with suppliers to develop unique products that will meet customers’ expectations for quality and value.

Advertising

The Company’s marketing program is a multimedia strategy utilizing print, electronic and non traditional media, including weekly newspaper circulars, daily newspaper advertisements, direct mail, radio, e-mail correspondence and search functionality. Each medium is used to highlight product offerings and communicate promotional activity. In addition, the Company uses a series of advertising elements and store-based event activity to highlight grand openings of new stores. This activity is directed to be both specific to each store opening and to the general market in which the new store is located.

The Company offers selected products on its website at www.worldmarket.com, which provides customers with purchase options and product information for items sold in stores. The Company’s website is designed to leverage a multi-channel philosophy giving customers an additional touch point with its merchandise and marketing and to increase traffic at its stores.

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Product Sourcing and Distribution

The Company purchases most of its inventory centrally, which allows the Company to take advantage of volume purchase discounts and improve controls over inventory and product mix. The Company purchases its merchandise from approximately 2,000 suppliers, one of which represented approximately 9% of total purchases in the fiscal year ended February 3, 2007. A significant portion of Cost Plus World Market’s products are made abroad in over 50 countries in Europe, North and South America, Asia, Africa and Australia. The Company has established a well developed overseas sourcing network and enjoys long standing relationships with many of its vendors. As is customary in the industry, the Company does not have long-term contracts with any suppliers. The Company’s buyers often work with suppliers to produce unique products exclusive to Cost Plus World Market. The Company believes that, although there could be delays in changing suppliers, alternate sources of merchandise for core product categories are available at comparable prices. Cost Plus World Market typically purchases overseas products on either a free-on-board or ex-works basis, and the Company’s insurance on such goods commences at the time it takes ownership. The Company also purchases a number of domestic products, especially in the gourmet food and beverage area. Due to state regulations, wine and beer are purchased from local distributors, with purchasing primarily controlled by the corporate buying office.

The Company currently services its stores from its distribution centers located in Stockton, California and Windsor, Virginia. Domestically sourced merchandise is usually delivered to the distribution centers by common carrier or by Company trucks. Any significant interruption in the operation of these facilities would have a material adverse effect on the Company’s financial position and results of operations.

Management Information Systems

Each of the Company’s stores is linked to the Cost Plus World Market headquarters in Oakland, California through a point-of-sale system and frame relay data network that interfaces with an IBM AS/400 computer. The Company’s information systems keep records, which are updated daily, of each merchandise item sold in each store, as well as financial, sales and inventory information. The point-of-sale system also has scanning, “price look-up” and on-line credit/debit card approval capabilities, all of which improve transaction accuracy, speed checkout time and increase overall store efficiency. The Company continually upgrades its in-store information systems to improve information flow to store management and enhance other in-store administration capabilities.

Purchasing operations are facilitated by the use of computerized merchandise information systems that allow the Company to analyze product sell-through and assist the buyers in making merchandise decisions. The Company’s central replenishment system includes SKU and store-specific “model stock” logic that enables the Company to maintain adequate stock levels on basic goods in each location.

The Company uses several other management information and control systems to direct its operations and finances. These computerized systems are designed to ensure the integrity of the Company’s inventory, allow the merchandising staff to reprice merchandise, process payroll, pay bills, control cash, maintain fixed assets and track promotions throughout all of the Company’s stores. The Company’s distribution operations use systems to receive, locate, pick and ship inventory to stores. The Company believes that these systems allow for higher operating efficiency and improve profitability.

Additional systems also enable the Company to produce the periodic financial reports necessary for developing budgets and monitoring individual store and consolidated Company performance.

Competition

The markets served by Cost Plus World Market are highly competitive. The Company competes against a diverse group of retailers ranging from specialty stores to department stores and discounters. The Company’s product offerings compete with such retailers as Bed Bath & Beyond, Target, Linens n’ Things, Crate & Barrel,

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Pottery Barn, Michaels Stores, Pier 1 Imports, Trader Joe’s and Williams-Sonoma. Most specialty retailers tend to have higher prices and a narrower assortment of products and department stores typically have higher prices than Cost Plus World Market for similar merchandise. Discounters may have lower prices than Cost Plus World Market, but the product assortment is generally more limited. The Company competes with these and other retailers for customers principally on the basis of price, assortment of products, brand name recognition, suitable retail locations and qualified management personnel.

Employees

As of February 3, 2007, the Company had 2,704 full-time and 4,037 part-time employees. Of these, 5,926 were employed in the Company’s stores and approximately 815 were employed in the distribution centers and corporate office. The Company regularly supplements its work force with temporary staff, especially in the fourth fiscal quarter of each year to service increased customer traffic during the peak Holiday season. Employees in 11 stores in Northern California are covered by a collective bargaining agreement, which expires on May 31, 2008. The Company believes that it enjoys good relationships with its employees.

Trademarks

The Company regards its trademarks and service marks as having significant value and as being important to its marketing efforts. The Company has registered its “Aaku,” “Asian Passage,” “Atacama with logo” and “Atacama” logo, “Castello Del Lago,” “Cost Plus,” “Cost Plus World Market,” “Crandall Brooks,” “Credo,” “Crossroads,” “Donaletta with logo,” “Electric Reindeer” and “Electric Reindeer” logo, “Marche du Monde with logo” and “Marche du Monde” logo, “Market Classics,” “Maui Morning,” “Mercado Del Mundo,” “Praline Perk,” “Seacliff” and “Seacliff” logo, “Soiree,” “Texas Turtle,” “Villa Vitale,” and “World Market” marks with the United States Patent and Trademark Office on the Principal register. In Canada, the Company has registered its “Cost Plus” mark and has applied to register its “Cost Plus World Market” and “World Market” marks. In the European Union, the Company has registered its “World Market” and logo mark. In Mexico, the Company has registered its “Mercado Del Mundo” and “World Market” marks. The Company’s policy is to pursue prompt and broad registration of its marks and to vigorously oppose infringement of its marks.

ITEM 1A.    RISK FACTORS

The following information describes certain significant risks and uncertainties inherent in our business. You should carefully consider these risks and uncertainties, together with the other information contained in this Annual Report on Form 10-K and in the Company’s other public filings. If any of such risks and uncertainties actually occurs, the Company’s business, financial condition or operating results could differ materially from the plans, projections and other forward-looking statements included in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report and in the Company’s other public filings. In addition, if any of the following risks and uncertainties, or if any other disclosed risks and uncertainties, actually occurs, the Company’s business, financial condition or operating results could be harmed substantially, which could cause the market price of our stock to decline, perhaps significantly.

We face significant competition in our industry.

The markets that we serve are very competitive. We compete against a diverse group of retailers ranging from specialty stores to department stores and discounters. Our product offerings compete with such retailers as Bed Bath & Beyond, Target, Linens n’ Things, Crate & Barrel, Pottery Barn, Michaels Stores, Pier 1 Imports, Trader Joe’s and Williams-Sonoma. We compete with these and other retailers for customers, suitable retail locations and qualified management personnel. Some of our competitors have greater resources, more customers, and greater brand recognition. They may secure better terms from vendors, adopt more aggressive pricing, and devote more resources to technology, distribution, and marketing. Competitive pressures or other factors could

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cause us to lose market share, which may require us to lower prices, increase marketing and advertising expenditures, or increase the use of discounting or promotional campaigns, each of which would adversely affect our margins and could result in a decrease in our operating results and profitability.

Our business is highly seasonal and our operating results fluctuate significantly from quarter to quarter.

Our business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the Holiday season. Due to the importance of the Holiday selling season, the fourth quarter of each fiscal year has historically contributed, and we expect will continue to contribute, a large percentage of our net sales and much of our net income for the entire fiscal year. Any factors that have a negative effect on our business during the Holiday selling season in any year, including unfavorable economic conditions, would materially and adversely affect our financial condition and results of operations. We generally experience lower sales and earnings during the first three quarters and, as is typical in the retail industry, may incur losses in these quarters. The results of our operations for these interim periods are not necessarily indicative of the results for our full fiscal year.

We also must make decisions regarding merchandise well in advance of the season in which it will be sold. If the demand for our merchandise is significantly different than we have projected, it would harm our business and operating results, either as a result of lost sales due to insufficient inventory or lower gross margin due to the need to mark down excess inventory.

Our quarterly operating results may also fluctuate based on such factors as:

• delays in the flow of merchandise to our stores;

• the number and timing of new store openings and related store pre-opening expenses;

• the amount of sales contributed by new and existing stores;

• the mix of products sold;

• the timing and level of markdowns;

• store closings or relocations;

• competitive factors;

• changes in fuel and other shipping costs;

• general economic conditions;

• labor market fluctuations;

• the impact of terrorist activities;

• our ability to acquire merchandise and manage inventory levels;

• our ability to retain and increase sales to existing customers, attract new customers, and satisfy our customers’ demands;

• changes in accounting rules and regulations; and

• unseasonable weather conditions.

These fluctuations may also cause a decline in the market price of our common stock.

Our success depends to a significant extent upon the overall level of consumer spending.

As a retail business our success depends to a significant extent upon the overall level of consumer spending. Among the factors that affect consumer spending are the general state of the economy, the level of consumer

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debt, prevailing interest rates and consumer confidence in future economic conditions. A substantial number of our stores are located in the western United States, especially in California. Lower levels of consumer spending in this region could have a material adverse affect on our financial condition and results of operations. Reduced consumer confidence and spending may result in reduced demand for our merchandise, may limit our ability to increase prices and may require us to incur higher selling and promotional expenses, which in turn would harm our business and operating results.

The occurrence or the threat of international conflicts or terrorist activities could harm our business and result in business interruptions.

Most of the merchandise that we sell is purchased in other countries and must be shipped to the United States, transported from the port of entry to our distribution centers in California or Virginia and distributed to our stores from the distribution centers. The precise timing and coordination of these activities is crucial to our business. The occurrence or threat of international conflicts or terrorist activities and the responses to those developments, for example, the temporary shutdown of a port that we use, could have a significant impact upon our business, our personnel and facilities, our customers and suppliers, the retail and financial markets and general economic conditions.

Our business and operating results are sensitive to changes in energy and transportation costs.

We incur significant costs for the purchase of fuel in transporting goods from foreign ports and to our distribution centers and stores and for utility services in our stores, distribution centers and corporate offices. We continually negotiate pricing for certain transportation contracts and, in a period of rising fuel costs such as we have recently experienced, we expect that our vendors for these services will increase their rates to compensate for the higher energy costs. We may not be able to pass these increased costs on to our customers.

We must continue to increase sales from existing stores and open new stores to carry out our growth strategy.

Our ability to increase our sales and earnings depends in part on our ability to continue to open new stores and to operate these stores on a profitable basis. Our continued growth also depends on our ability to increase sales in our existing stores. We opened a net of 20 stores in fiscal 2006 and presently anticipate opening a net of 12 stores in fiscal 2007. In fiscal 2007, the Company plans to focus on opening stores in existing markets. When we open additional stores in existing markets it can result in lower sales from existing stores in that market. The success of our planned expansion will depend upon many factors, including the following:

• our ability to identify suitable markets for expansion,

• the selection, availability and leasing of suitable sites on acceptable terms,

• the hiring, training and retention of qualified management and other store personnel,

• satisfaction of regulatory requirements in new markets, including alcoholic beverage regulations,

• control of costs associated with entering new markets, including advertising and distribution costs; and

• our ability to maintain adequate systems, controls and procedures, including product distribution facilities, store management, financial controls and information systems.

We cannot assure that we will be able to achieve our planned expansion, integrate new stores effectively into our existing operations or operate our new stores profitably.

Our operating results will be harmed if we are unable to improve our comparable store sales.

Our success depends, in part, upon our ability to improve sales at our existing stores. Our comparable store sales, which are defined as sales by stores that have completed 14 full fiscal months of sales, fluctuate from year

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to year. Fiscal 2006 was 53 weeks; therefore, to ensure a meaningful comparison, comparable store sales for fiscal 2006 were measured on a 53-week basis. In all other years presented, comparable store sales were measured on a 52-week basis. In fiscal 2006, comparable store sales decreased by 3.3% from fiscal 2005. Various factors affect comparable store sales, including:

• the general retail sales environment,

• our ability to source and distribute products efficiently,

• changes in our merchandise mix,

• competition,

• current economic conditions,

• the timing of release of new merchandise and promotional events,

• the success of marketing programs, and

• weather conditions.

These factors and others may cause our comparable store sales to differ significantly from prior periods and from expectations. If we fail to meet the comparable store sales expectations of investors and security analysts in one or more future periods, the price of our common stock could decline.

We face a number of risks because we import much of our merchandise.

We import a significant amount of our merchandise from over 50 countries and numerous suppliers. We have no long-term contracts with our suppliers but instead rely on long-term relationships that we have established with many of these suppliers. Our future success will depend to a significant extent on our ability to maintain our relationships with our suppliers or to develop new ones. As an importer, our business is subject to the risks generally associated with doing business abroad such as the following:

• foreign governmental regulations,

• economic disruptions,

• delays in shipments,

• freight cost increases,

• changes in political or economic conditions in countries from which we purchase products, and

• the effect of trade regulation by the United States, including quotas, duties and taxes and other charges or restrictions on imported merchandise.

If these factors or others made the conduct of business in particular countries undesirable or impractical or if additional quotas, duties taxes or other charges or restrictions were imposed by the United States on the importation of our products, our business and operating results would be harmed.

Interruption of the supply chain and/or ability to obtain products from suppliers

The products we sell are procured from a wide variety of domestic and foreign suppliers and are distributed to our stores through distribution facilities in Stockton, California and Windsor, Virginia, as well as direct store delivery. Any significant interruption in our ability to source the products and the efficiency of distributing such products to our stores, including any interruption as a result of the construction of the new and expanded Stockton facility currently in progress, would harm our business and operating results.

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We may not be able to forecast customer preferences accurately in our merchandise selections.

Our success depends in part on our ability to anticipate the tastes of our customers and to provide merchandise that appeals to their preferences. Our strategy requires our merchandising staff to introduce products from around the world that meet current customer preferences and that are affordable, distinctive in quality and design and that are not widely available from other retailers. Many of our products require long order lead times. In addition, a large percentage of our merchandise changes regularly. Our failure to anticipate, identify or react appropriately to changes in consumer trends could cause excess inventories and higher markdowns or a shortage of products and could harm our business and operating results.

We rely on various key management personnel to ensure our success and have had significant management changes in the past year.

Our success will continue to depend on our key management personnel. The loss of the services of one or more of these executive officers or other key employees could harm our business and operating results. We do not maintain any key man life insurance policies.

We have significant indebtedness

We have significant long-term debt and may incur substantial additional debt in the future. A significant portion of our future cash flow from operating activities is likely to remain dedicated to the payment of interest and the repayment of principal on our indebtedness. There is no guarantee that we will be able to meet our debt service obligations. If we are unable to generate sufficient cash flow or obtain funds for required payments, or if we fail to comply with our debt covenants, we would be in default and the lenders would have the right to accelerate full payment of the loans. In such event, we might not have sufficient cash resources to repay the lenders and we might not be able to refinance our debt on terms acceptable to us, or at all. Our indebtedness could limit our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions or other purposes in the future, as needed; to plan for, or react to, changes in our business and competition; and to react in the event of an economic downturn.

Our common stock may be subject to substantial price and volume fluctuations.

The market price of our common stock is affected by factors such as fluctuations in our operating results, a downturn in the retail industry, changes in interest rates, changes in financial estimates by us or securities analysts and recommendations by securities analysts regarding our company, other retail companies or the retail industry in general, and general market and economic conditions. In addition, the stock market can experience price and volume fluctuations that are unrelated to the operating performance of particular companies.

Impact of natural disasters

The occurrence of one or more natural disasters, including earthquakes (particularly in California where our Stockton distribution center is located and approximately 30 percent of our sales were generated in fiscal 2006) could result in the disruption in the supply of our products and distribution of products to our stores, damage to and the temporary closure of one or more stores and interruption in our labor staffing. These, and other potential outcomes of a natural disaster, could materially and adversely affect our results of operations.

We may be subject to significant liability should the consumption of any of our products cause injury, illness or death.

Our business is subject to product recalls in the event of contamination, product tampering, mislabeling or damage to our products. We cannot assure you that product-liability claims will not be asserted against us or that we will not be obligated to recall our products in the future. A product-liability judgment against us or a product recall could have a material adverse effect on our business, financial condition or results of operations.

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Our business is subject to risks associated with fluctuations in the values of foreign currencies against the United States dollar.

We have significant purchase obligations with suppliers outside of the United States. During fiscal 2006, approximately 3.0% of these purchases were settled in currencies other than the United States dollar. Fluctuations in the rates of exchange between the dollar and other currencies could harm our operating results. We have not hedged our currency risk in the past and do not currently anticipate doing so in the future.

Provisions in our charter documents as well as our stockholders’ rights plan could prevent or delay a change in control of our Company and may reduce the market price of our common stock.

Certain provisions of our articles of incorporation and bylaws may have the effect of making it more difficult for a third party to acquire, or may discourage a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain of these provisions allow us to issue preferred stock without any vote or further action by the shareholders. In addition, the right to cumulate votes in the election of directors has been eliminated. These provisions may make it more difficult for shareholders to take certain corporate actions and could have the effect of delaying or preventing a change in control of the Company. In addition, our board of directors has adopted a preferred share purchase rights agreement. Pursuant to the rights agreement, our board of directors declared a dividend of one right to purchase one one-thousandth share of our Series A Participating Preferred Stock for each outstanding share of our common stock. These rights could have the effect of delaying, deferring or preventing a change of control of our Company, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock. The rights agreement could also limit the price that investors might be willing to pay in the future for our common stock.

Lawsuits and other claims against our Company may adversely affect our operating results.

We are involved in litigation, claims and assessments incidental to our business, the disposition of which is not expected to have a material effect on our financial position or results of operations. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions related to these matters. We accrue our best estimate of the probable cost for the resolution of claims. When appropriate, such estimates are developed in consultation with outside counsel handling the matters and are based upon a combination of litigation and settlement strategies. To the extent additional information arises or our strategies change, it is possible that our best estimate of our probable liability may change.

If we fail to maintain an effective system of internal control, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which could harm our business and the trading price of our stock.

Effective internal control is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. We have in the past discovered, and may in the future discover, areas of our internal control that need improvement including control deficiencies that may constitute material weaknesses. For example, as of February 3, 2007, the Company did not maintain effective controls over inventory management, accounts payable, and inventory reserves. Management has determined that these control deficiencies constituted material weakness as of February 3, 2007. Consequently, management concluded that the Company’s internal control over financial reporting was not effective as of February 3, 2007 based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Any failure to implement or maintain the improvements in our internal control over financial reporting, or difficulties encountered in the implementation of these improvements in our controls, could cause us to fail to meet our reporting obligations. Any failure to improve our

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internal control to address these identified weaknesses could also cause investors to lose confidence in our reported financial information, which could have a negative impact on the trading price of our stock.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

Not Applicable.

ITEM 2.    PROPERTIES

As of May 3, 2007, the Company operated 291 stores in 34 states. The average selling space of a Cost Plus World Market store was approximately 15,700 square feet. The total average square footage of a Cost Plus World Market store was approximately 18,700 square feet, including a back stock room and office space. The table below summarizes the distribution of stores by state:

Alabama..	5	Idaho..	2	Minnesota.	7	Oregon.	7
Arizona	10	Illinois	19	Mississippi	1	South Carolina	7
California	72	Indiana	2	Missouri	6	South Dakota	1
(Northern California	31)	Iowa	1	Montana	1	Tennessee	4
(Southern California	41)	Kansas	2	Nebraska	2	Texas	30
Colorado	8	Kentucky	2	Nevada	5	Utah	1
Delaware	1	Louisiana	6	New Mexico	3	Virginia	10
Florida	13	Maryland	3	North Carolina	12	Washington	11
Georgia	8	Michigan	12	Ohio	13	Wisconsin	4

The Company leases land and buildings for 286 stores (of which 13 are capital leases) and leases land and owns the buildings for six stores. The Company currently leases its executive headquarters in Oakland, CA pursuant to a lease that expires in October 2008.

The Company currently leases a distribution center of approximately 500,000 square feet in Stockton, CA (“Stockton DC”) on 55 acres of land. The Stockton DC is the Company’s primary furniture distribution facility for its stores in the western United States. The Company owned the property prior to leasing it. On April 7, 2006, Cost Plus, Inc. entered into a sale-leaseback transaction with Inland Real Estate Acquisitions, Inc., a third party real estate investment trust (“Inland”). In connection with the transaction, the Company sold its Stockton DC to Inland for net proceeds of $29.8 million and then entered into a lease agreement with Inland to lease the property back. The initial term of the building lease expires April 30, 2026. The company has two options to renew for five year terms each and one option to renew for a term of four years. The Company accounted for the sale and leaseback of the property as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet.

In fiscal 2006, the Company began construction of a 500,000 square foot general merchandise distribution facility adjacent to the aforementioned Stockton DC. The estimated completion date is June of 2007. The planned facility will replace an existing 520,000 square foot distribution facility leased in Stockton, CA pursuant to a lease that expires in December 2009, with an option to give 90 days notice to terminate the lease in December 2007.

The Company currently leases a distribution center of approximately 1,000,000 square feet in Windsor, VA on 82 acres of land. The Company owned the property prior to leasing it. On December 21, 2006, Cost Plus, Inc. entered into a sale-leaseback transaction with Inland. In connection with the transaction, the Company sold its Windsor, VA distribution center property to Inland for net proceeds of $52.3 million and then entered into a lease agreement with Inland to lease the property back. The initial term of the lease expires December 31, 2026. The Company has the option to renew for four consecutive terms of five years each. The Company accounted for the sale and leaseback of the property as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet.

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The Company believes its current distribution facilities are adequate to meet its needs but continues to evaluate distribution facility requirements to accommodate future store growth.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any pending legal proceeding other than ordinary claims and litigation that arise in the ordinary course of business. Based on currently available information, management does not believe that the ultimate outcome of any unresolved matters, individually or in the aggregate, is likely to have a material adverse effect on the Company’s financial position or results of operations. However, litigation is subject to inherent uncertainties, and management’s view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Company’s financial position and results of operations for the period in which the unfavorable outcome occurs, and potentially in future periods.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of the Company are as follows:

Name	Age	Position
Barry J. Feld	50	Chief Executive Officer, President and Director
Michael J. Allen	52	Executive Vice President, Store Operations
Joan S. Fujii	60	Executive Vice President, Human Resources
Thomas D. Willardson	56	Executive Vice President and Chief Financial Officer
Jane L. Baughman	40	Senior Vice President, Financial Operations
Gail H. Fuller	55	Senior Vice President, Brand Management
Rayford K. Whitley	43	Senior Vice President, Supply Chain
George K. Whitney	53	Senior Vice President, Merchandising

Mr. Feld joined the Company in October 2005 as Chief Executive Officer and President. Mr. Feld has served as a Director of the Company since February 2001. Prior to joining the Company, Mr. Feld was President, Chief Executive Officer and Chairman of the Board of Directors of Portrait Corporation of America, Inc., from August 1999 to October 2005. Portrait Corporation of America, Inc. is an operator of portrait studios and other specialty retail products focused on serving the discount retail market and the sole portrait photography provider to Wal-Mart Stores, Inc. From November 1998 to June 1999, Mr. Feld was President, Chief Operating Officer and member of the Board of Directors of Vista Eyecare, Inc., a specialty eyecare retailer. Mr. Feld joined Vista Eyecare as a result of its acquisition of New West Eyeworks, Inc., where he had been serving as President and as a Director since May 1991 and as Chief Executive Officer and a Director since February 1994. From 1987 to May 1991, Mr. Feld was with Frame-n-Lens Optical, Inc., where he served as its president prior to joining New West Eyeworks.

Mr. Allen joined the Company in December 1988 as a Regional Manager, later was promoted to Director of Store Operations and in 1998 became Vice President, Real Estate and Store Development. In March 2002, Mr. Allen was promoted to Senior Vice President, Store Operations. In November 2004, Mr. Allen was promoted to Executive Vice President, Store Operations with responsibility for Store Operations, Development and Real Estate. Prior to coming to Cost Plus World Market, he was a District Manager for Liquor Barn, a discount beverage retailer, from 1986 to 1988. From 1981 to 1985, he was a store manager for Safeway Corporation, a food grocery chain.

Ms. Fujii was named the Company’s Executive Vice President, Human Resources in July 2005. Ms. Fujii joined the Company in May 1991 and served as Senior Vice President, Human Resources from February 1998 to May 2005. From October 1994 to February 1998, Ms. Fujii served as Vice President, Human Resources. From May 1991 to October 1994, Ms. Fujii served as the Company’s Director of Human Resources. From September 1975 to May 1991, she was employed by Macy’s California in various operations and human resources management positions, ultimately serving as Vice President, Human Resources at Macy’s Union Square store in San Francisco.

Mr. Willardson joined the Company in February 2006 as Executive Vice President and Chief Financial Officer. Mr. Willardson served as a Director of the Company since March 1991, except for a period of approximately three months during 1996. Upon joining the Company as an employee, Mr. Willardson resigned from his position as a Director. From April 2004 to February 2006, Mr. Willardson served as Chief Financial Officer of WebSideStory, Inc., a leading provider of on-demand digital marketing applications. From August 2003 until April 2004 he served as Chief Financial Officer of Archimedes Technology Group Holdings, LLC, a privately held technology development company. From March 2002 until August 2003, Mr. Willardson was an independent financial consultant. From June 1998 to March 2002, Mr. Willardson was the Senior Vice President, Finance and Treasurer of Leap Wireless International, Inc., a wireless communications carrier.

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Ms. Baughman joined the company in February 1996 as Manager of Merchandise Planning. She was promoted to Director of Financial Planning in June 1999 and then to Vice President of Financial Planning, Treasurer and Corporate Secretary in August 2001. In October 2006, she was promoted to Senior Vice President of Financial Operations. Prior to joining the Company, Ms. Baughman served in various financial positions for The Nature Company and The Gap, Inc., and in investment banking as a financial analyst for Dillon Read, Inc.

Ms. Fuller was named Senior Vice President of Brand Management in September 2004. Ms. Fuller joined the Company in October 1989 and has served in various positions. From January 2001 to September 2004 she served as Vice President, Divisional Merchandising Manager. Ms. Fuller left the Company from April 1999 to January 2001 to serve as Vice President, General Merchandising Manager at Earthsake, a specialty retailer.

Mr. Whitley joined the Company in November 2005 as Senior Vice President, Supply Chain. He is responsible for global logistics and the distribution network, as well as for the merchandise planning & allocation and business intelligence teams. Prior to joining Cost Plus World Market, Mr. Whitley served from August 2001 to October 2005 in a variety of roles at Williams-Sonoma, Inc. culminating in the position of Vice President, Supply Chain Optimization & Store Operations. From August 1998 to August 2001, Mr. Whitley worked for The Gap, Inc. as Director, Supply Chain Strategy. Prior to joining The Gap, Inc., Mr. Whitley was a management consultant with Coopers & Lybrand, LLP in their Retail Strategy Practice. Prior to Coopers & Lybrand. LLP, Mr. Whitley was a management consultant in the West Coast Supply Chain Practice of Ernst & Young, LLP.

Mr. Whitney joined the Company in December 2006 as Senior Vice President of Merchandising, bringing 29 years of retail and wholesale merchandising, as well as product development experience. He held a number of senior level buying and store merchandising positions with Macy’s West, including Vice President, District Merchandising Manager for The Cellar (housewares and food) from 1990 to 1995. After 17 years at Macy’s, Mr. Whitney went on to a variety of entrepreneurial retail and wholesale ventures, including Vice President of Merchandising for the Discovery Channel retail venture. From 1999 to 2002 Mr. Whitney held the position of Vice President, GMM for Home Style with the television retailer, QVC, Inc. During 2002 Mr. Whitney relocated to Hong Kong, where he was the founder and Managing Director of a product development trading company subsidiary for Thomas Pacconi Classics International Ltd., a major home products supplier. Upon returning to the U.S. during 2004, he served as Vice President for Replication Services for CAV Distributing Corp., a privately held DVD manufacturer, licensor and distributor.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Company’s common stock is currently traded on the over-the-counter market and is quoted on the Nasdaq Stock Market under the symbol “CPWM.” The following table sets forth the high and low closing sales prices, for the periods indicated, as reported by the Nasdaq National Market.

Fiscal Year Ended February 3, 2007

	Price Range
	High		Low
First Quarter	$	20.18	$	16.21
Second Quarter		17.38		13.26
Third Quarter		13.51		9.36
Fourth Quarter		14.18		9.64

Fiscal Year Ended January 28, 2006

	Price Range
	High		Low
First Quarter	$	28.92	$	23.19
Second Quarter		26.02		21.30
Third Quarter		23.73		14.32
Fourth Quarter		20.04		15.36

As of March 21, 2007, the Company had 44 shareholders of record, excluding shareholders whose stock is held by brokers and other institutions on behalf of the shareholders. The Company estimated it had approximately 7,600 shareholders in total as of the same date.

Dividend Policy

To date, the Company has paid no cash dividends on its common stock, and the Company has no current intentions to do so.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

In March 2003, the Company announced a stock repurchase program that was approved by its Board of Directors to repurchase up to 500,000 shares of its common stock. The Company repurchased 425,500 shares in fiscal 2004 under the program. On November 18, 2004, the Company’s Board of Directors authorized the repurchase of an additional 1,000,000 shares creating a total of 1,074,500 shares available for repurchase under the program. There were no shares repurchased under the program during fiscal 2006 or fiscal 2005. The program does not require the Company to repurchase any common stock and may be discontinued at any time.

Securities Authorized for Issuance Under Equity Compensation Plans

Information regarding the securities authorized for issuance under the Company’s equity compensation plans is incorporated by reference from our proxy statement to be filed for our 2007 Annual Meeting of Shareholders. See Item 12 of this Form 10-K.

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PERFORMANCE GRAPH

The following graph shows a comparison of cumulative total return for our common stock, the Nasdaq National Market—U.S. Index and the Nasdaq CRSP Retail Group Index from February 2, 2002 through the fiscal year ended February 3, 2007. In preparing the graph it was assumed that: (i) $100 was invested on February 2, 2002 in our common stock at $27.00 per share (adjusted for stock splits), the Nasdaq National Market—U.S. Index and the Nasdaq CRSP Retail Group Index; and (ii) all dividends were reinvested.

Notwithstanding anything to the contrary set forth in any of our previous filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 that might incorporate future filings, including this proxy statement, in whole or in part, the following performance graph shall neither be incorporated by reference into any such filings; nor be incorporated by reference into any future filings.

* $100 invested on 1/31/02 in stock or index-including reinvestment of dividends

Fiscal year ending February 3, 2007.

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ITEM 6. SELECTED FINANCIAL DATA

Five Year Summary of Selected Financial Data

(In thousands, except per share and selected operating data)	Fiscal Year1
	2006			2005			2004			2003			2002
				(As Restated 4)			(As Restated4)
Statement of Operations Data:
Net sales	$	1,040,309		$	970,441		$	908,560		$	801,566		$	692,301
Cost of sales and occupancy		739,257			649,041			601,732			520,109			449,185
Gross profit		301,052			321,400			306,828			281,457			243,116
Selling, general and administrative expenses		318,477			281,719			251,223			220,288			192,990
Store preopening expenses		5,650			8,186			7,552			6,845			6,586
Impairment of goodwill		4,178			—			—			—			—
Income (loss) from operations		(27,253	)		31,495			48,053			54,324			43,540
Net interest expense		7,126			5,143			2,983			3,285			3,452
Income (loss) before income taxes		(34,379	)		26,352			45,070			51,039			40,088
Income tax (benefit) expense		(11,843	)		9,763			16,891			18,352			12,134
Net income (loss)	$	(22,536	)	$	16,589		$	28,179		$	32,687		$	27,954
Net income (loss) per share—basic	$	(1.02	)	$	0.75		$	1.29		$	1.51		$	1.29
Net income (loss) per share—diluted	$	(1.02	)	$	0.75		$	1.26		$	1.46		$	1.26
Weighted average shares Outstanding—basic		22,068			22,004			21,840			21,624			21,696
Weighted average shares outstanding—diluted		22,068			22,100			22,323			22,349			22,158
Selected Operating Data:
Percent of net sales:
Gross profit		28.9	%		33.1	%		33.8	%		35.1	%		35.1	%
Selling, general and administrative expenses		30.6	%		29.0	%		27.7	%		27.5	%		27.9	%
Income (loss) from operations		(2.6	)%		3.2	%		5.3	%		6.7	%		6.3	%
Number of stores:
Opened during period		24			35			34			31			26
Closed during period		4			5			1			2			1
Open at end of period		287			267			237			204			175
Average sales per selling square foot2	$	237		$	247		$	260		$	267		$	266
Comparable store sales increase (decrease)3		(3.3	)%		(2.6	)%		0.9	%		2.7	%		5.6	%
Balance Sheet Data (at period end):
Working capital	$	198,749		$	188,463		$	193,406		$	183,644		$	141,229
Total assets		569,546			529,571			492,203			433,041			384,563
Long-term debt and capital lease obligations, less current portion		121,567			62,319			50,591			36,167			37,972
Total shareholders’ equity		291,459			310,395			287,481			262,718			221,870
Current ratio		2.73			2.60			2.62			2.77			2.42
Debt to equity ratio		42.4	%		22.3	%		18.9	%		14.5	%		17.9	%

1. The Company’s fiscal year end is the Saturday closest to the end of January. Fiscal 2006 was 53 weeks and ended on February 3, 2007. All other fiscal years presented consisted of 52 weeks.

2. Calculated using net sales for stores open during the entire period divided by the selling square feet of such stores.

3. A store is included in comparable store sales the first day of the fiscal month beginning with the fourteenth full fiscal month of sales. Comparable store sales for fiscal 2006 were measured on a 53-week basis. In all other years presented, comparable store sales were measured on a 52-week basis.

4. See Note 2 to the consolidated financial statements.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with the accompanying audited consolidated financial statements and notes thereto that are included elsewhere in this Form 10-K. The fiscal year ended February 3, 2007 (fiscal 2006) included 53 weeks, fiscal year ended January 28, 2006 (fiscal 2005) included 52 weeks, and the fiscal year ended January 29, 2005 (fiscal 2004). The discussion and analysis gives effect to the restatement of the consolidated financial statements discussed in Note 2 to the consolidated financial statements.

Overview

Cost Plus, Inc is a leading specialty retailer of casual home furnishings and entertaining products. As of February 3, 2007, the Company operated 287 stores in 34 states. The stores feature an ever-changing selection of casual home furnishings, housewares, gifts, decorative accessories, gourmet foods and beverages offered at competitive prices and imported from more than 50 countries. Many items are unique and exclusive to Cost Plus World Market. The value, breadth and continual refreshment of products invites customers to come back throughout a lifetime of changing home furnishings and entertaining needs.

Fiscal 2006 was a challenging year for the Company. While the Company achieved $1 billion in net sales for the first time, it also had its first net loss for a fiscal year since going public in 1996. In fiscal 2006, net sales increased 7.2% to $1.04 billion from $970.4 million in fiscal 2005 while comparable store sales for the year decreased 3.3% compared to a 2.6% decrease last year.

Net loss in fiscal 2006 was $22.5 million, or $1.02 per diluted share versus net income in fiscal 2005 of $16.6 million or $0.75 per diluted share. Fiscal 2006 results included $0.17 per diluted share for a markdown charge taken in the second quarter to clear discontinued merchandise, and also included significant additional markdowns related to promotional activities to clear seasonal merchandise in the second half of the year. The net loss also includes a non-cash impairment charge of $4.2 million for the write-down of intangible assets related to goodwill and $3.2 million from the recording of share-based compensation due to the adoption of FASB Statement No. 123(R), “Share-Based Payment,” (“SFAS 123(R)”) at the beginning of fiscal 2006.

In fiscal 2006, the Company continued to experience a declining same store sales trend. In order to reverse this trend and improve its financial performance the Company has focused on the following key initiatives: 1) improving customer traffic in stores by developing marketing and media plans that are tailored by market; 2) integrating the merchandising and marketing efforts to drive sales and maximize the return on marketing expenditures while increasing brand awareness; 3) redefining the Company’s pricing and promotion strategy to emphasize the Company’s value proposition; 4) optimizing inventory to ensure the right merchandise is in stores at the right time; and 5) focusing efforts on improving performance in markets and stores that are underperforming.

The Company has taken actions which it believes will lead to the successful implementation of its key initiatives. While some of these actions, such as taking significant markdowns on selected merchandise and increasing spending on advertising, have had a negative effect on the Company’s profitability in the short run, the Company believes its actions are necessary for future success.

The Company opened 24 new stores and closed four during fiscal 2006 to end the year with 287 stores. Although the Company still believes there is ample room for more than 600 stores in the United States it has slowed new store growth to 16 new stores and plans to close four stores in fiscal 2007 in order to focus on the initiatives previously mentioned.

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Restatement

In preparing the Company’s fiscal 2006 consolidated financial statements, the Company discovered errors in the way it had accounted for inventory and the related balances in accounts payable and cost of sales. The errors resulted in the understatement of cost of goods sold for fiscal 2004 and 2005. As a result, the Company has restated the accompanying consolidated financial statements for the fiscal years ended January 28, 2006 and January 29, 2005. The effect of the restatement for fiscal 2004 of $2.0 million is also reflected as a reduction of the Company’s previously reported retained earnings balance of $132.2 million at January 29, 2005. The restatement did not impact the Company’s previously reported net cash flows, revenues or comparable store sales, or its compliance with revolving line of credit covenants. See Note 2 to the consolidated financial statements for more information.

Fiscal 2006 (53 weeks) Compared to Fiscal 2005 (52 weeks)

Net Sales Net sales consist almost entirely of retail sales, but also include direct-to-consumer sales and shipping revenue. Net sales increased $69.9 million, or 7.2%, to $1.04 billion in 2006 from $970.4 million in 2005. The increase in net sales was attributable to an increase in new store sales store sales partially offset by a decrease in comparable store sales. Comparable store sales decreased 3.3%, or $32.1 million, in 2006 compared to a decrease of 2.6%, or $22.4 million, in 2005. Comparable store sales decreased primarily as a result of decreased customer traffic and a decrease in average transaction size. The decrease in average transaction size was primarily due to heavy discounting and a focus on providing more value-oriented products. As of February 3, 2007, the calculation of comparable store sales included a base of 260 stores. A store is generally included as comparable at the beginning of the fourteenth month after its grand opening. New store sales increased $102.0 million, primarily driven by new store openings. As of February 3, 2007, the Company operated 287 stores compared to 267 stores as of January 28, 2006. Consistent with the National Retail Federation reporting calendar fiscal 2006 was a fifty-three week year for the Company compared to a fifty-two week year in fiscal 2005.

The Company classifies its sales into the home furnishings and consumables product lines. Home furnishings were 61% of sales and consumables were 39% of sales in 2006 and 2005.

Cost of Sales and Occupancy Cost of sales and occupancy, which consists of costs to acquire merchandise inventory, costs of freight and distribution, as well as certain facility costs, increased $90.2 million, or 13.9%, to $739.3 million in 2006 compared to $649.0 million in 2005. As a percentage of net sales, total cost of sales and occupancy increased 420 basis points to 71.1% in 2006 from 66.9% in 2005. The 420 basis point increase was due to an increase in cost of goods sold of 350 basis points and an increase in occupancy costs of 70 basis points. The increase in cost of sales as a percentage of net sales was primarily attributable to significant markdowns the Company recorded in the second quarter to clear discontinued merchandise and additional markdowns taken throughout the year on primarily seasonal merchandise. Higher distribution center costs and freight costs also contributed to the increase. The 70 basis point increase in occupancy costs was primarily due to decreased leverage on sales as a result of lower comparable store sales in 2006 and higher average occupancy costs for newer stores.

Selling, General and Administrative (“SG&A”) Expenses SG&A expenses increased $36.8 million, or 13.0%, to $318.5 million in 2006 compared to $281.7 million in 2005. As a percentage of net sales, SG&A expenses for 2006 increased 160 basis points to 30.6% in 2006 from 29.0% in 2005. This was primarily due to an increase in payroll and benefits costs of 80 basis points and an increase in advertising expense of 30 basis points. The increase in store payroll and advertising as a percentage of net sales was primarily due to decreased leverage on sales as a result of lower comparable store sales in fiscal 2006. The increase also included 30 basis points from the recording of share-based compensation due to the adoption of SFAS 123(R), “Share-Based Payment,”at the beginning of fiscal 2006.

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Store Preopening Expenses Store preopening expenses, which include rent expense incurred prior to opening as well as grand opening advertising and preopening merchandise setup expenses, were $5.7 million in 2006 compared to $8.2 million in 2005. The Company opened 24 stores in 2006 compared to 35 stores in 2005. Per store average preopening expense was flat compared to last year. Rent expense included in store preopening expenses was approximately $1.1 million in 2006 versus $1.6 million in 2005. Store preopening expenses vary depending on the amount of time between the possession date and the store opening, the particular store site and whether it is located in a new or existing market.

Impairment of Goodwill The Company recorded a $4.2 million non-cash charge as a result of the impairment to goodwill. Based upon its annual goodwill impairment test performed in the fourth quarter of 2006, the Company reduced all of the goodwill attributed to the acquisition of Cost Plus, Inc. by BC Investments, Inc. in November of 1987. The impairment has been included as a separate line item before “income from operations” in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”

Net Interest Expense Net interest expense, which includes interest on capital leases and debt, net of interest earned on investments, was $7.1 million in 2006 compared to $5.1 million in 2005. The increase in net interest expense was primarily due to additional long-term debt related to the sale-leaseback of the Stockton distribution center and higher average net borrowings under the Company’s revolving line of credit. Excluded from net interest expense was interest capitalized primarily related to distribution center projects totaling $729,000 and $434,000 for fiscal years 2006 and 2005, respectively.

Income Taxes The Company’s effective tax rate was a benefit of 34.4% in 2006 and a rate of 37.0% in 2005. The decrease in the tax rate was primarily due to the adoption of SFAS 123(R), “Share-Based Payment,” and an impairment write down of non-deductible goodwill. For fiscal 2007, the Company expects that the effective tax rate will be approximately 39.5%, including the benefit from employment and capital investment tax credits, and the detriment related to SFAS 123(R).

Fiscal 2005 Compared to Fiscal 2004

Net Sales Net sales consist almost entirely of retail sales, but also include direct-to-consumer sales and shipping revenue. Net sales increased $61.9 million, or 6.8%, to $970.4 million in 2005 from $908.6 million in 2004. The increase in net sales was attributable to an increase in non-comparable store sales partially offset by a decrease in comparable store sales. Comparable store sales decreased 2.6%, or $22.4 million, in 2005 compared to an increase of 0.9%, or $7.1 million, in 2004. Comparable store sales decreased primarily as a result of decreased customer traffic partially offset by an increase in average transaction size. The increase in average transaction size per customer resulted primarily from strong net sales in products such as furniture that carry a higher average price. As of January 28, 2006, the calculation of comparable store sales included a base of 234 stores. A store is generally included as comparable at the beginning of the fourteenth month after its grand opening. Non-comparable store sales increased $84.3 million, primarily driven by new store openings. As of January 28, 2006, the Company operated 267 stores compared to 237 stores as of January 29, 2005.

The Company classifies its sales into the home furnishings and consumables product lines. Home furnishings were 61% of sales in 2005 compared to 62% in 2004 and consumables were 39% of sales in 2005 compared to 38% in 2004.

Cost of Sales and Occupancy Cost of sales and occupancy, which consists of costs to acquire merchandise inventory, costs of freight and distribution, as well as certain facility costs, increased $47.3 million, or 7.9%, to $649.0 million in 2005 compared to $601.7 million in 2004. As a percentage of sales, total cost of sales and occupancy increased 70 basis points to 66.9% in 2005, from 66.2% in 2004. The 70 basis point increase was due to an increase in occupancy costs from decreased leverage on sales as a result of lower comparable store sales in 2005 and higher average occupancy costs for newer stores. Cost of sales was flat compared to last year as a

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percentage of sales primarily due to stronger sales in certain higher margin categories and higher initial markups, offset by higher fuel costs, higher markdowns, and higher relative distribution center costs included in cost of sales as a result of lower inventory levels. The higher markdowns were largely related to promotional activities during the year.

Selling, General and Administrative (“SG&A”) Expenses SG&A expenses increased $30.5 million, or 12.1%, to $281.7 million in 2005 compared to $251.2 million in 2004. As a percentage of net sales, SG&A expenses for 2005 were 29.0% compared to 27.7% for 2004. The 130 basis point increase was primarily due to decreased leverage on sales as a result of lower comparable store sales. The increase in SG&A as a percentage of net sales also included $2.4 million of expense related to the departure of the Company’s CEO, $0.9 million in charges related to the closing of five stores, and start-up costs of $0.7 million related to the launch of the Company’s online store.

Store Preopening Expenses Store preopening expenses, which include rent expense incurred prior to opening as well as grand opening advertising and preopening merchandise setup expenses, were $8.2 million in 2005 compared to $7.6 million in 2004. The Company opened 35 stores in 2005 compared to 34 stores in 2004. Per store average preopening expense increased in 2005 due to higher average occupancy costs incurred prior to the store opening date. Rent expense included in store preopening expenses was approximately $1.6 million in 2005 versus $1.0 million in 2004. Store preopening expenses vary depending on the amount of time between the possession date and the store opening, the particular store site and whether it is located in a new or existing market.

Net Interest Expense Net interest expense, which includes interest on capital leases and debt, net of interest earned on investments, was $5.1 million in 2005 compared to $3.0 million in 2004. The increase in net interest expense for 2005 was due to additional long-term debt related to distribution center projects and higher average net borrowings under the Company’s revolving line of credit combined with higher interest rates. The increase was partially offset by lower interest on capital leases largely due to the termination of the Virginia distribution center capital lease, which was replaced with a lower interest rate loan used to purchase the facility.

Income Taxes The Company’s effective tax rate was 37.0% in 2005 and 37.5% in 2004. The decrease in the tax rate was primarily due to an increased benefit from employment and capital investment tax credits.

Liquidity and Capital Resources

The Company’s cash and cash equivalents balance at the end of fiscal 2006 was $12.7 million compared to $40.4 million at the end of fiscal 2005. The Company’s primary uses for cash are to fund operating expenses, inventory requirements and new store expansion. Historically, the Company has financed its operations primarily from internally generated funds and seasonal borrowings under a revolving credit facility. The Company believes that the combination of its cash and cash equivalents, internally generated funds and available borrowings will be sufficient to finance its working capital, new store expansion and distribution center project requirements for at least the next 12 months.

Distribution Center Activities On April 7, 2006, the Company entered into a sale-leaseback transaction with Inland Real Estate Acquisitions, Inc., a third party real estate investment trust (“Inland”). In connection with the transaction, the Company sold its Stockton, CA distribution center property to Inland for net proceeds of $29.8 million. The property sold consists of an approximately 500,000 square foot building located on approximately 55 acres. The Company entered into a lease agreement with Inland to lease the property back. The Company used a portion of the proceeds from the sale of the property of approximately $29.8 million to retire $18.2 million of long-term debt related to the Company’s purchase of the property, and the remaining proceeds were used for other business purposes. The Company accounted for the transaction as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet. The Company also recorded a financing obligation in the amount of approximately $29.8 million, which will be amortized over the 34 year

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period of the leases (including option periods) and approximates the discounted value of total maximum lease payments under the leases.

In fiscal 2006, the Company began construction of a 500,000 square foot general merchandise distribution facility adjacent to the aforementioned facility. The planned facility will replace an existing 520,000 square foot distribution facility leased in Stockton, CA. The total estimated cost of construction including fixtures for the new facility will be approximately $48.8 million; $36.8 million spent in fiscal 2006 and $12.0 million expected to be spent in fiscal 2007. The higher relative cost of the expansion of the facility is primarily attributable to the cost of equipment and racking associated with a general merchandise facility versus a furniture facility as well as increases in cost of construction and materials. The estimated completion date is June of 2007 and the Company is financing the construction through debt.

On December 21, 2006, the Company entered into a sale-leaseback transaction with Inland related to its Virginia distribution center property. In connection with the transaction, the Company sold its Virginia distribution center property to Inland for net proceeds of $52.3 million. The property sold consisted of approximately 84 acres including a distribution facility of approximately 1,000,000 square feet. The Company entered into a lease agreement with Inland to lease the property back. The Company used a portion of the proceeds from the sale of the property of approximately $52.3 million to retire $34.1 million of long-term debt related to the Company’s purchase of the property, and the remaining proceeds were used to fund operations. The Company accounted for the transaction as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet. The Company also recorded a financing obligation in the amount of approximately $52.3 million, which will be amortized over the 40 year period of the leases (including option periods) and approximates the discounted value of total maximum lease payments under the leases.

Cash Flows From Operating Activities Net cash used in operating activities totaled $19.4 million for fiscal 2006 versus net cash provided by operating activities of $44.2 million in fiscal 2005. The decrease in net cash provided by operations was primarily due to the net loss of $22.5 million in fiscal 2006 versus net income of $16.6 million in fiscal 2005. The decrease was also due to an increase in other assets related to an income tax receivable of $11.0 million due to the Company’s net loss for the year and higher inventory growth.

Net cash provided by operating activities totaled $44.2 million for fiscal 2005, an increase of $17.5 million from fiscal 2004. The increase in net cash provided by operations was primarily due to decreased inventory growth compared to the prior year as a result of improved inventory management and a decrease in other assets primarily related to the timing of rent payments. The increase was partially offset by changes in accounts payable due to the timing of payments and lower merchandise inventory payables at year end due to the timing of receipts, and lower net income adjusted for non-cash depreciation and amortization and deferred income taxes.

Cash Flows From Investing Activities Net cash used in investing activities totaled $63.8 million in fiscal 2006, a decrease of $2.1 million from fiscal 2005. In fiscal 2006, the Company’s capital expenditures were $67.5 million compared to $66.0 million in fiscal 2005. The Company spent $36.8 million in fiscal 2006 on the expansion of the Stockton distribution facility versus $33.0 million in fiscal 2005 on the purchase and renovation of the Stockton distribution facility. The Company received net proceeds from the sale of property and equipment of $3.7 million in fiscal 2006 compared to $0.1 million in fiscal 2005.

Net cash used in investing activities totaled $65.9 million in fiscal 2005, a decrease of $2.2 million from fiscal 2004. In fiscal 2005, the Company’s capital expenditures were $66.0 million compared to $77.1 million in fiscal 2004. The fiscal 2005 net capital expenditures do not include $3.0 million related to year end construction in progress balances that are included in accounts payable. In addition, the Company spent $33.0 million in fiscal 2005 on the purchase and renovation of the Stockton distribution facility versus $49.7 million on the purchase and expansion of the Virginia distribution facility in fiscal 2004. There were no maturities of short-term investments in fiscal 2005 versus $9.0 million in fiscal 2004.

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The Company estimates that fiscal 2007 capital expenditures will approximate $36.9 million; including approximately $6.7 million for new stores, $12.0 million to expand the distribution center in Stockton, CA, $7.7 million for management information systems and distribution center projects, and $10.5 million allocated to investments in existing stores and various other corporate projects.

Cash Flows From Financing Activities Net cash provided by financing activities was $55.5 million for fiscal 2006 compared to $19.2 million in fiscal 2005. The company incurred $82.1 million in long-term debt in fiscal 2006 related to the sale-leaseback of the Stockton and Virginia distribution centers versus $20.0 million of long-term debt in fiscal 2005 for the purchase of the Stockton distribution facility. In turn, the Company used a portion of the proceeds from the sale of its distribution centers to retire $52.3 million of existing long-term debt. During fiscal 2006, The Company began construction of a 500,000 square foot general merchandise distribution facility in Stockton, California that resulted in long-term debt of $30.5 million. In 2006, the Company received $207,000 from the issuance of common stock in connection with the exercise of employee stock options compared to $4.5 million in fiscal 2005.

Net cash provided by financing activities was $19.2 million for fiscal 2005 compared to $31.9 million in fiscal 2004. The decrease in net cash provided by financing activities was due to lower proceeds from long-term debt and the issuance of common stock. The Company incurred $20.0 million of long-term debt in fiscal 2005 for the purchase of the Stockton distribution facility versus $40.0 million in fiscal 2004 for the purchase and expansion of the Virginia distribution facility. The Company received $4.5 million in fiscal 2005 from the issuance of common stock in connection with the exercise of employee stock options and its employee stock purchase plan versus $10.0 million received last year. In addition, there was no common stock repurchased under the Company’s stock repurchase program in fiscal 2005 compared to $14.9 million repurchased in fiscal 2004.

Revolving lines of Credit In November 2004, the Company entered into an unsecured five year revolving line of credit agreement (the “Agreement”) with a group of banks that terminated and replaced an existing revolving credit facility. The Agreement allows for cash borrowings and letters of credit under an unsecured revolving credit facility of up to $50.0 million from January through June of each year, increasing to $125.0 million from July through December of each year to coincide with the Company’s Holiday borrowing needs. The Agreement includes a one-time option to increase the size of the revolving credit facility to $150.0 million. Interest is paid quarterly in arrears and bears interest, at the Company’s election, based on a rate equal to Bank of America’s prime rate or LIBOR plus an applicable margin that is based on the Company’s Consolidated Adjusted Leverage Ratio, as defined in the Agreement. The Agreement requires a 30-day “clean-up period” in which Adjusted Total Outstandings, as defined in the Agreement, do not exceed $30.0 million for not less than 30 consecutive days during the period from January 1 through March 31 of each year. The Company is subject to a minimum consolidated tangible net worth requirement, and annual capital expenditures are limited under the Agreement. The Agreement includes limitations on the ability of the Company to incur debt, grant liens, make acquisitions and dispose of assets and also prohibits the Company from making cash dividend payments with respect to any capital stock. The events of default under the Agreement include payment defaults, cross defaults with certain other indebtedness, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lenders under the Agreement may, among other remedies, eliminate their commitments to make credit available, declare due all unpaid principal amounts outstanding, and require cash collateral for any letter of credit obligations. As of February 3, 2007, the Company was in compliance with its loan covenant requirements, had no outstanding borrowings under its line of credit and had $13.8 million outstanding in letters of credit.

On April 28, 2006, Cost Plus, Inc. (the “Company”) entered into an unsecured 18 month revolving credit facility agreement with Bank of America, N.A. as the lender (the “Credit Facility”). The Credit Facility allows for borrowings of up to $40.0 million to be used for costs and expenses related to the construction of an additional distribution center adjacent to the Company’s existing facility in Stockton, California. The Credit Facility will be repaid in monthly payments of accrued interest, with the entire outstanding balance payable on October 27, 2007. The Credit Facility will bear interest, at the Company’s election, at a rate based on LIBOR plus a margin or Bank of America’s prime rate (or the Federal Funds Rate plus 0.5%, if greater). In addition the

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Company will pay a fee on the unused portion of the Credit Facility (the “Unused Fee”). The Unused Fee will be payable quarterly in arrears. The applicable margin and the Unused Fee will be based upon the Company’s consolidated adjusted leverage ratio, as defined in the agreement. The Company is subject to a minimum consolidated tangible net worth and limitations on capital expenditures. Further, the Credit Facility contains restrictive covenants limiting the ability of the Company and its subsidiaries to, among other things, grant liens, make investments, incur indebtedness, enter into mergers, dispose of assets, repurchase stock, change its business, enter into transactions with affiliates, and prohibits the Company from making cash dividend payments with respect to any capital stock. The events of default under the Credit Facility include, among other things, payment defaults, breaches of certain covenants, misrepresentations, cross-defaults with certain other indebtedness, bankruptcy events, judgments, certain ERISA events and changes of control. In the event of a default, the Credit Facility requires the Company to pay incremental interest at the rate of 2.0% and could result in the acceleration of the Company’s obligations under the Credit Facility and an obligation of any guarantor to pay the full amount of the Company’s obligations under the Credit Facility. As of February 3, 2007, the Company was in compliance with its loan covenant requirements and had $30.5 million in borrowings outstanding under its line of credit.

As previously mentioned, the maturity date on the Credit Facility is October 27, 2007. The Company classified the $30.5 million of borrowings outstanding under the Credit Facility as long-term debt in accordance with SFAS No. 6, “Classification of Short-Term Obligations Expected to be Refinanced.” The Company has an existing agreement with Inland that specifies Inland will make a payment to the Company equal to the total cost of construction of the additional distribution facility in Stockton, CA upon completion of the construction, which is expected to be on or around July 2007. At this time, the Company plans to pay down the existing $30.5 million of borrowings and will enter into continued financing with Inland whereby the future lease payments that are owed under the current lease agreement for the existing Stockton distribution center will increase accordingly. The future lease payments will be determined by multiplying the cost of construction times an interest rate equal to the 10-year treasure rate plus 2.0% and an average lender’s spread.

Contractual Obligations and Commercial Commitments The following table provides summary information concerning the Company’s future contractual obligations and commercial commitments as of February 3, 2007:

Contractual Obligations (in millions)	Less than 1 year		1-3 years		3-5 Years		After 5 Years		Total Amount Committed
Operating leases	$	84.0	$	243.8	$	127.7	$	159.0	$	614.5
Capital leases (principal and interest)		2.6		6.2		2.8		9.7		21.3
Long-term debt		0.5		2.7		1.9		107.1		112.2
Merchandise letters of credit		6.5		—		—		—		6.5
Standby letters of credit		7.3		—		—		—		7.3
Purchase obligations1		121.2		—		—		—		121.2
Severance payments2		0.2		—		—		—		0.2
Interest3		5.8		22.9		15.6		209.1		253.4
Total	$	228.1	$	275.6	$	148.0	$	484.9	$	1,136.6

1. As of February 3, 2007, the Company had approximately $121.2 million of outstanding purchase orders, which were primarily related to merchandise inventory. Such purchase orders are generally cancelable at the discretion of the Company until the order has been shipped. The table above excludes certain immaterial executory contracts for goods and services that tend to be recurring in nature and similar in amount year over year.

2. Payable to the Company’s former CEO, Controller, and EVP of Merchandising. See Exhibits 10.13, 10.22 and 10.17 to this Form 10-K.

3. Represents interest expected to be paid on our financing obligations under sale-leaseback and the line of credit related to the distribution center construction.

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Off Balance Sheet Arrangements

Other than the operating leases and letters of credit discussed above, the Company has no financial arrangements involving special-purpose entities or lease agreements, commonly described as synthetic leases, or any off-balance sheet arrangements that have a material current effect, or that are reasonably likely to have a material future effect, on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Impact of New Accounting Standards

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination based on the technical merits. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company will implement FIN 48 at the beginning of fiscal 2007, and any cumulative effect resulting from the change in accounting principle will be recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact, if any, that the adoption of FIN 48 will have on its financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for companies with fiscal years ending after November 15, 2006 and is required to be adopted by the Company in its fiscal year ending February 3, 2007. The adoption of SAB No. 108 did not have an impact on the Company’s financial position or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 157 on its financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specific election dates. This statement does not require any new fair value measurements. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 159 on its financial statements.

Inflation

The Company does not believe that inflation has had a material effect on its financial condition and results of operations during the past three fiscal years. However, there can be no assurance that the Company’s business will not be affected by inflation in the future.

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Quarterly Results and Seasonality

The following tables set forth the Company’s unaudited quarterly operating results for the eight most recent quarterly periods. The financial information gives effect to the restatement discussed in Note 2 to the consolidated financial statements.

(In thousands, except per share data and number of stores)	Fiscal Quarters Ended
	April 29, 2006			July 29, 2006			October 28, 2006			February 3, 2007¹
	(As Restated)			(As Restated)			(As Restated)
Net sales	$	212,964		$	215,275		$	215,405		$	396,665
Gross profit		65,382			53,669			65,320			116,681
Net income (loss)		(3,537	)		(14,205	)		(12,244	)		7,450
Net income (loss) per weighted average share
Basic	$	(0.16	)	$	(0.64	)	$	(0.55	)	$	0.34
Diluted	$	(0.16	)	$	(0.64	)	$	(0.55	)	$	0.34
Number of stores open at end of period		272			274			283			287
	Fiscal Quarters Ended
(In thousands, except per share data and number of stores)	April 30, 2005			July 30, 2005			October 29, 2005			January 28, 2006¹
	(As Restated)			(As Restated)			(As Restated)			(As Restated)
Net sales	$	200,023		$	202,766		$	200,679		$	366,973
Gross profit		63,030			69,664			69,263			119,443
Net income (loss)		(2,370	)		1,787			(1,130	)		18,302
Net income (loss) per weighted average share
Basic	$	(0.11	)	$	0.08		$	(0.05	)	$	0.83
Diluted	$	(0.11	)	$	0.08		$	(0.05	)	$	0.83
Number of stores open at end of period		238			246			258			267

1. The three months ended February 3, 2007 was a fourteen-week period as compared to the three months ended January 28, 2006 which was a thirteen-week period.

The Company’s business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales and earnings during the fourth quarter (Holiday) season. Due to the importance of the Holiday selling season, the fourth quarter of each fiscal year has historically contributed, and the Company expects it will continue to contribute, a disproportionate percentage of the Company’s net sales and most of its net income for the entire fiscal year. Any factors negatively affecting the Company during the Holiday selling season in any year, including unfavorable economic conditions, could have a material adverse effect on the Company’s financial condition and results of operations. The Company generally experiences lower sales and earnings during the first three quarters and, as is typical in the retail industry, may incur losses in these quarters. The results of operations for these interim periods are not necessarily indicative of the results for a full fiscal year. In addition, the Company makes decisions regarding merchandise well in advance of the season in which it will be sold. Significant deviations from projected demand for products could have a material adverse effect on the Company’s financial condition and results of operations, either by lost gross sales due to insufficient inventory or lost gross margin due to the need to mark down excess inventory.

The Company’s quarterly results of operations may also fluctuate based upon such factors as delays in the flow of merchandise, the ability to realize the expected operational and cost efficiencies from its distribution centers, the number and timing of store openings and related store preopening expenses, the amount of net sales contributed by new and existing stores, the mix of products sold, the timing and level of markdowns, store closings or relocations, competitive factors, changes in fuel and other shipping costs, general economic conditions, geopolitical conditions, fluctuations in the value of the U.S. dollar against foreign currencies, labor market fluctuations, changes in accounting rules and regulations and unseasonable weather conditions.

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Critical Accounting Policies and Estimates

Cost Plus, Inc.’s and its subsidiaries’ discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Estimates and assumptions include, but are not limited to, inventory values, fixed asset lives, intangible asset values, deferred income taxes, self-insurance reserves and the impact of contingencies and litigation. The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions. The Company has also chosen certain accounting policies when options are available, including the retail inventory method of accounting for inventories and, prior to fiscal 2006, the intrinsic value method to account for common stock options. These accounting policies are applied consistently for all years presented except for the adoption of SFAS 123R as of January 29, 2006. Operating results would be affected if other alternatives were used. Information about the impact on operating results by using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” as it relates to fiscal 2005, is included in Note 1 to the consolidated financial statements.

Although not all inclusive, the Company believes that the following represent the more critical estimates and assumptions used in the preparation of the consolidated financial statements.

Revenue Recognition The Company recognizes revenue from the sale of merchandise either at the point of sale in its stores or at the time of receipt by the customer for merchandise purchased from its website. Revenue from sales of gift cards is deferred until redemption or until the likelihood of redemption by the customer is remote (gift card breakage). Income from gift card breakage is recorded as a reduction to selling, general and administrative expenses. Shipping and handling fees charged to customers are recognized as revenue at the time the merchandise is delivered to the customer. The Company’s revenues are reported net of discounts and returns, including an allowance for estimated returns. The allowance for sales returns is based on historical experience and was approximately $0.4 million at the end of fiscal 2006 and $0.3 million at the end of fiscal 2005 and 2004.

Inventory Inventories are stated at the lower of cost or market with cost determined under the retail inventory method (“RIM”), in which the valuation of inventories at cost and gross margins is calculated by applying a calculated cost-to-retail ratio to the retail value of inventories. RIM is an averaging method that is widely used in the retail industry due to its practicality. The Company’s use of the RIM results in valuing inventories at lower of cost or market as markdowns are currently taken as a reduction of the retail value of inventories. Inherent in the RIM calculation are certain significant management judgments and estimates including, among others, merchandise markon, markdowns and shrinkage, which impact the ending inventory valuation at cost as well as gross margin. The Company’s RIM utilizes multiple departments in which fairly homogeneous classes of merchandise inventories having similar gross margins are grouped. Management believes that the Company’s RIM provides an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market. Inventory costs also include certain buying and distribution costs related to the procurement, processing and transportation of merchandise.

Other Accounting Estimates Estimates inherent in the preparation of the Company’s financial statements include those associated with the evaluation of the recoverability of deferred tax assets, the adequacy of tax contingencies, the impairment of goodwill and long-lived assets and those estimates used in the determination of liabilities related to litigation, claims and assessments.

The Company assesses the likelihood that deferred tax assets will be realized in the future, and records a valuation allowance, if necessary, to reduce deferred tax assets to the amount that it believes is more likely than not to be realized. The Company also records reserves for estimates of probable settlements of income tax audits.

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To the extent that estimates of probable settlements change or final tax outcomes are different than the amounts recorded, such differences will impact the income tax provision in the period in which such determination is made. The Company’s effective tax rate may be materially impacted by changes in the estimated level of earnings, changes in the deferred tax valuation allowance or changes in the expected outcome of audits. The Company does not currently have a valuation allowance for its deferred tax assets.

The Company performs an impairment test of goodwill annually or earlier if conditions indicate an earlier review is necessary. If the estimated fair value is less than the carrying value, goodwill is impaired and will be written down to its estimated fair value. During the fourth quarter of fiscal 2006, the Company performed its annual impairment test of goodwill using a market value approach and concluded that its goodwill was impaired. Accordingly, the Company recognized a non-cash impairment charge of $4.2 million in fiscal 2006 to write down all of the goodwill on its consolidated balance sheet. The Company’s goodwill of $4.2 million represented the difference between the purchase price and the related underlying tangible and identifiable intangible net asset values resulting from the acquisition of Cost Plus, Inc by BC Investments, Inc. in November 1987.

The Company is involved in litigation, claims and assessments incidental to its business, the disposition of which is not expected to have a material effect on the Company’s financial position or results of operations. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in the Company’s assumptions related to these matters. The Company accrues its best estimate of the probable cost for the resolution of claims. When appropriate, such estimates are developed in consultation with outside counsel handling the matters and are based upon a combination of litigation and settlement strategies. To the extent additional information arises or the Company’s strategies change, it is possible that the Company’s best estimate of its probable liability may change.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to financial market risks, which include changes in U.S. interest rates and foreign exchange rates. The Company does not engage in financial transactions for trading or speculative purposes.

Interest Rate Risk The interest payable on the Company’s bank lines of credit are based on variable interest rates and therefore are affected by changes in market interest rates. In addition, the Company has fixed and variable income investments classified as cash and cash equivalents which are also affected by changes in market interest rates. If interest rates on existing variable rate debt were to rise 75 basis points (a 10% change from the Company’s borrowing rate as of February 3, 2007), the Company’s results of operations and cash flows would not be materially affected.

Foreign Currency Risks The majority of purchase obligations outside of the United States of America into which the Company enters are settled in U.S. dollars, therefore, the Company has only minimal exposure to foreign currency exchange risks. The cost of products purchased in international markets can be affected by changes in foreign currency exchange rates and significant exchange rate changes could have a material impact on future product costs. The extent to which an increase in costs from foreign currency exchange rate changes will be able to be recovered in higher prices charged to customers is uncertain. The Company does not hedge against foreign currency risks.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO COSOLIDATED FINANCIAL STATEMENTS

	Page
Consolidated Financial Statements of Cost Plus, Inc.
Report of Independent Registered Public Accounting Firm	30
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting	31
Consolidated Balance Sheets	33
Consolidated Statements of Operations	34
Consolidated Statements of Shareholders’ Equity	35
Consolidated Statements of Cash Flows	36
Notes to the Consolidated Financial Statements	37

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Cost Plus, Inc.:

We have audited the accompanying consolidated balance sheets of Cost Plus, Inc. and subsidiaries (the “Company”) as of February 3, 2007 and January 28, 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three fiscal years in the period ended February 3, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of February 3, 2007 and January 28, 2006, and the results of their operations and their cash flows for each of the three fiscal years in the period ended February 3, 2007, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment,” on January 29, 2006.

As discussed in Note 2 to the consolidated financial statements, the accompanying fiscal 2005 and 2004 consolidated financial statements have been restated.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of February 3, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 4, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an adverse opinion on the effectiveness of the Company’s internal control over financial reporting because of material weaknesses.

/s/    DELOITTE & TOUCHE LLP

San Francisco, California

May 4, 2007

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING

To the Board of Directors and Shareholders of Cost Plus, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting , that Cost Plus, Inc. and subsidiaries (the “Company”) did not maintain effective internal control over financial reporting as of February 3, 2007, because of the effect of the material weaknesses identified in management’s assessment based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment: i) reconciliation of the inventory sub-ledgers to the general ledger to ensure data integrity and identify potential errors in inventory; ii) reconciliation of accounts payable sub-ledger to the general ledger to properly record received but not invoiced inventory and invoiced but not received inventory; iii) review of vendor returns and receiving adjustments to ensure accurate reflection in the inventory and accounts payable balances; iv) timely and accurate processing of inventory received but not invoiced; v) consistent treatment and recording of reserve estimates and vi) the proper investigation and resolution of reconciling items on a timely basis. These material weaknesses were considered in determining the nature, timing, and extent of audit tests

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applied in our audit of the consolidated financial statements as of and for the fiscal year ended February 3, 2007, of the Company and this report does not affect our report on such financial statements.

In our opinion, management’s assessment that the Company did not maintain effective internal control over financial reporting as of February 3, 2007, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of February 3, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the fiscal year ended February 3, 2007, of the Company and our report dated May 4, 2007 expressed an unqualified opinion on those financial statements and included an explanatory paragraph related to the adoption of a new accounting standard.

/s/    DELOITTE & TOUCHE LLP

San Francisco, California

May 4, 2007

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Consolidated Balance Sheets

(In thousands, except share amounts)	February 3, 2007		January 28, 2006
			(As Restated, see Note 2)
ASSETS
Current assets:
Cash and cash equivalents	$	12,697	$	40,382
Merchandise inventories, net		264,056		250,411
Other current assets		36,722		15,294
Total current assets		313,475		306,087
Property and equipment, net		232,459		203,873
Goodwill, net		—		4,178
Other assets, net		23,612		15,433
Total assets	$	569,546	$	529,571
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	69,925	$	64,367
Income taxes payable		—		6,908
Accrued compensation		10,922		13,084
Current portion of long-term debt		541		5,267
Other current liabilities		33,338		27,998
Total current liabilities		114,726		117,624
Capital lease obligations		9,911		12,268
Long-term debt		111,656		50,051
Other long-term obligations		41,794		39,233
Commitments and contingencies (See Note 11)
Shareholders’ equity:
Preferred stock, $.01 par value: 5,000,000 shares authorized; none issued and outstanding		—		—
Common stock, $.01 par value: 67,500,000 shares authorized; issued and outstanding 22,084,239 and 22,060,788 shares		220		220
Additional paid-in capital		167,019		163,571
Retained earnings		124,220		146,756
Accumulated other comprehensive loss		—		(152	)
Total shareholders’ equity		291,459		310,395
Total liabilities and shareholders’ equity	$	569,546	$	529,571

See notes to consolidated financial statements.

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Consolidated Statements of Operations

	Fiscal Year Ended
(In thousands, except per share amounts)	February 3, 2007			January 28, 2006		January 29, 2005
				(As Restated, see Note 2)		(As Restated, see Note 2)
Net sales	$	1,040,309		$	970,441	$	908,560
Cost of sales and occupancy		739,257			649,041		601,732
Gross profit		301,052			321,400		306,828
Selling, general and administrative expenses		318,477			281,719		251,223
Store preopening expenses		5,650			8,186		7,552
Impairment of goodwill		4,178			—		—
Income (loss) from operations		(27,253	)		31,495		48,053
Net interest expense		7,126			5,143		2,983
Income (loss) before income taxes		(34,379	)		26,352		45,070
Income tax provision (benefit)		(11,843	)		9,763		16,891
Net income (loss)	$	(22,536	)	$	16,589	$	28,179
Net income (loss) per weighted average share
Basic	$	(1.02	)	$	0.75	$	1.29
Diluted	$	(1.02	)	$	0.75	$	1.26
Weighted average common and common equivalent shares outstanding
Basic		22,068			22,004		21,840
Diluted		22,068			22,100		22,323

See notes to consolidated financial statements.

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Consolidated Statements of Shareholders’ Equity

(In thousands, except shares)	Common Stock					Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity			Comprehensive Income
	Shares		Amount
										(As Restated, see Note 2)						(As Restated, see Note 2)			(As Restated, see Note 2)
Balance at January 31, 2004	21,822,781		$	218		$	148,263		$	114,237		$	—		$	262,718
Common stock issued under Employee Stock Purchase Plan	14,881			—			468									468
Exercise of common stock options	420,397			4			9,575									9,579
Repurchase of common stock	(425,500	)		(4	)		(2,620	)		(12,249	)					(14,873	)
Tax effect of disqualifying common stock dispositions							2,497									2,497
Net income (As Restated, see Note 2)										28,179						28,179		$	28,179
Other comprehensive loss, net of related tax effect													(1,087	)		(1,087	)		(1,087	)
Balance at January 29, 2005 (As Restated, see Note 2)	21,832,559			218			158,183			130,167			(1,087	)		287,481		$	27,092
Common stock issued under Employee Stock Purchase Plan	12,065			—			267									267
Exercise of common stock options	216,164			2			4,182									4,184
Share-based compensation expense from the acceleration of employee stock options							630									630
Tax effect of disqualifying common stock dispositions							309									309
Net income (As Restated, see Note 2)										16,589						16,589		$	16,589
Other comprehensive income, net of related tax effect													935			935			935
Balance at January 28, 2006 (As Restated, see Note 2)	22,060,788			220			163,571			146,756			(152	)		310,395		$	17,524
Exercise of common stock options	23,451			—			207									207
Share-based compensation							3,230									3,230
Tax effect of disqualifying common stock dispositions							11									11
Net loss										(22,536	)					(22,536	)	$	(22,536	)
Other comprehensive income, net of related tax effect													152			152			152
Balance at February 3, 2007	22,084,239		$	220		$	167,019		$	124,220		$	—		$	291,459		$	(22,384	)

See notes to consolidated financial statements.

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Consolidated Statements of Cash Flows

	Fiscal Year Ended
(In thousands)	February 3, 2007			January 28, 2006			January 29, 2005
				(As Restated, see Note 2)			(As Restated, see Note 2)
Cash Flows From Operating Activities:
Net income (loss)	$	(22,536	)	$	16,589		$	28,179
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		33,513			28,659			25,900
Deferred income taxes		(4,432	)		(3,402	)		2,123
Tax effect of disqualifying common stock dispositions		11			309			2,497
Share-based compensation expense		3,230			630			—
Loss on asset disposal		540			587			—
Impairment loss on goodwill		4,178			—			—
Changes in assets and liabilities:
Merchandise inventories		(13,645	)		(188	)		(39,791	)
Other assets		(22,649	)		3,776			(5,768	)
Accounts payable		6,152			(11,562	)		11,921
Income taxes payable		(6,908	)		(1,450	)		(3,669	)
Other liabilities		3,119			10,250			5,262
Net cash provided by (used in) operating activities		(19,427	)		44,198			26,654
Cash Flows From Investing Activities:
Maturity of short-term investments		—			—			8,999
Purchases of property and equipment		(67,476	)		(66,033	)		(77,084	)
Proceeds from sale of property and equipment		3,710			129			—
Net cash used in investing activities		(63,766	)		(65,904	)		(68,085	)
Cash Flows From Financing Activities:
Proceeds from long-term debt		112,554			20,000			40,000
Prepayment of long-term debt		(52,278	)		—			—
Principal payments on long-term debt		(3,396	)		(3,813	)		(870	)
Debt issuance costs		—			—			(634	)
Principal payments on capital lease obligations		(1,579	)		(1,467	)		(1,752	)
Common stock repurchases		—			—			(14,873	)
Proceeds from the issuance of common stock		207			4,450			10,047
Net cash provided by financing activities		55,508			19,170			31,918
Net decrease in cash and cash equivalents		(27,685	)		(2,536	)		(9,513	)
Cash and Cash Equivalents:
Beginning of period		40,382			42,918			52,431
End of period	$	12,697		$	40,382		$	42,918
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	7,383		$	5,437		$	3,343
Cash paid for income taxes	$	10,605		$	14,353		$	15,156
Non-Cash Financing and Investing:
Termination of capital leases:
Reduction in capital lease obligations	$	816		$	—		$	21,240
Reduction in capital lease assets	$	564		$	—		$	19,584

See notes to consolidated financial statements.

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Notes to Consolidated Financial Statements

Note 1. Summary of Business and Significant Accounting Policies

Business Cost Plus, Inc. and its subsidiaries (“Cost Plus World Market” or “the Company”) is a specialty retailer of casual home living and entertaining products. At February 3, 2007, the Company operated 287 stores in 34 states under the names “World Market,” “Cost Plus World Market,” “Cost Plus Imports,” and “World Market Stores.” The Company’s product offerings are designed to provide solutions to customers’ casual home furnishing and home entertaining needs. The offerings include home decorating items such as furniture and rugs, as well as a variety of tabletop and kitchen products. Cost Plus World Market stores also offer a number of gift and decorative accessories including collectibles, cards, wrapping paper and other seasonal items. In addition, Cost Plus World Market offers its customers a wide selection of gourmet foods and beverages, including wine, micro-brewed and imported beer, coffee and tea. The Company accounts for its operations as one operating segment.

Fiscal Year The Company’s fiscal year end is the Saturday closest to the end of January. The current and prior fiscal years ended February 3, 2007 (fiscal 2006), January 28, 2006 (fiscal 2005) and January 29, 2005 (fiscal 2004). The fiscal year ended February 3, 2007 (fiscal 2006) contained 53 weeks. All other fiscal years presented consist of 52 weeks.

Principles of Consolidation The consolidated financial statements include the accounts of Cost Plus, Inc. and its subsidiaries. Intercompany balances and transactions are eliminated in consolidation.

Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosures of contingent assets and liabilities, as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The Company’s significant accounting judgments and estimates affect the valuation of inventories, depreciable lives and impairments of long-lived assets, accrued liabilities, deferred taxes, self-insurance reserves and allowances for sales returns.

Estimated Fair Value of Financial Instruments The carrying value of cash and cash equivalents, accounts receivable, accounts payable, long-term debt and unrealized gains and losses on interest rate swaps approximate their estimated fair value.

Cash Equivalents The Company considers all highly liquid investments with original maturities of 90 days or less as cash equivalents.

Inventories Inventories are stated at lower of cost or market under the retail inventory method (“RIM”), in which the valuation of inventories at cost and gross margins are calculated by applying a calculated cost-to-retail ratio to the retail value of inventories. Cost includes certain buying and distribution costs related to the procurement, processing and transportation of merchandise. Management believes that the Company’s RIM provides an inventory valuation which reasonably approximates cost and results in carrying inventory at the lower of cost or market.

Property and Equipment Buildings, furniture, fixtures and equipment are stated at cost and are depreciated using the straight-line method over the following estimated useful lives:

Buildings	40 years
Store fixtures and equipment	3-10 years
Leasehold improvements	Lesser of life of the asset or lease term
Computer equipment and software	3-10 years

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Capital Leases Property subject to a non-cancelable lease that meets the criteria of a capital lease is capitalized as an asset in property and equipment and is amortized on a straight-line basis over the lease term.

Other Assets Other assets include deferred compensation plan assets, lease rights and interests, deferred taxes and other intangibles. Lease rights and interests are amortized on a straight-line basis over their related lease terms.

Goodwill and Other Intangibles The Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” on February 3, 2002 and ceased amortizing $4.2 million of goodwill and $0.7 million in intangible assets as of that date. As required by this pronouncement, the Company completed the annual impairment tests. Based upon the impairment tests performed for the year ended February 3, 2007, the Company concluded that its goodwill was impaired which resulted in a non-cash impairment charge of $4.2 million in fiscal 2006. See Note 3 for additional information.

Impairment of Long-Lived and Intangible Assets The Company reviews long-lived assets and intangible assets with finite useful lives for impairment at least annually or whenever events or changes in circumstances indicate that their carrying values may not be recoverable. Using its best estimates based on reasonable assumptions and projections, the Company records an impairment loss to write such assets down to their estimated fair values if the carrying values of the assets exceed their related undiscounted expected future cash flow. Store specific long-lived assets and intangible assets with finite lives are evaluated at an individual store level, which is the lowest level at which individual cash flows can be identified. Corporate assets or other long-lived assets that are not store specific are evaluated at a consolidated entity level. Based on the impairment tests performed, there was no impairment of long-lived and intangible assets with finite lives in fiscal 2006, 2005, or 2004. There can be no assurance that future long-lived and intangible asset impairment tests will not result in a charge to earnings.

At February 3, 2007, the gross carrying value of intangible assets subject to amortization was $3.0 million with accumulated amortization of $2.4 million. Amortization expense related to these assets, primarily lease rights, totaled approximately $52,000 in fiscal 2006, and $136,000 in each of fiscal 2005 and 2004. The Company expects amortization expense for the existing intangible assets will be approximately $50,000 for fiscal 2007, and approximately $45,000, $37,000, $37,000 and $36,000 for fiscal 2008, 2009, 2010 and 2011, respectively.

Insurance The Company is self-insured for workers’ compensation, general liability costs, and certain health insurance plans with per occurrence and aggregate limits on losses. The Company maintains a comprehensive property insurance policy. The self-insurance liability recorded in the financial statements is based on claims filed and an estimate of claims incurred but not yet reported. The following sets forth the significant insurance coverage by major category:

Workers’ compensation: The Company retains losses on individual claims up to a maximum of $300,000.

General liability insurance: The Company retains losses on individual claims up to a maximum of $300,000.

Property insurance: The Company maintains a $250,000 deductible for each submitted claim.

Health insurance: The Company has a stop loss provision per claim of $300,000.

Deferred Rent Certain of the Company’s operating leases contain predetermined fixed escalations of minimum rentals during the initial term. For these leases, the Company recognizes the related rental expense on a straight-line basis over the life of the lease from the date the Company takes possession of the facility and records the difference between amounts charged to operations and amounts paid as deferred rent. As part of its lease agreements, the Company may receive certain lease incentives, primarily tenant improvement allowances. These allowances are also deferred and are amortized as a reduction of rent expense on a straight-line basis over the life of the lease. The cumulative net excess of recorded rent expense over lease payments made in the amount

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of $38.5 million and $36.1 million is reflected in other long-term obligations on the consolidated balance sheets as of February 3, 2007 and January 28, 2006, respectively.

Share-Based Compensation As of February 3, 2007, the Company had stock options and awards outstanding under three share-based compensation plans, which are described more fully in Note 9. Prior to January 29, 2006, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” Effective January 29, 2006, the company adopted the fair value recognition provisions of FASB Statement No. 123(R), “Share-Based Payment,” (“SFAS 123(R)”) using the modified-prospective-transition method. Under that transition method, compensation cost recognized in fiscal 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 29, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to January 29, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results for prior periods have not been restated.

Prior to the adoption of SFAS 123(R), the Company presented all benefits of tax deductions resulting from the exercise of share-based payment awards as operating cash flows in its statements of cash flows. SFAS 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those stock awards (excess tax benefits) to be classified as financing cash flows. In fiscal 2006, the Company had no excess tax benefits required to be reported as a financing cash flow.

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest. In accordance with SFAS 123(R), compensation expense for all share-based payment awards granted prior to January 29, 2006 will continue to be recognized based on the multiple option approach (accelerated method) and compensation expense for all share-based payment awards granted subsequent to January 28, 2006 will be recognized using the straight-line method. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The Company recognized share-based compensation expense of $3.2 million in fiscal 2006. Share-based compensation expense is included as a component of selling, general and administrative expenses. At year end, there was $4.5 million of total unrecognized compensation cost related to nonvested share-based payments that is expected to be recognized over a weighted-average period of approximately 1.3 years.

Had share-based employee compensation expense been determined based upon the fair values at the grant dates for awards under the Company’s stock plans in accordance with SFAS 123 for fiscal 2005 and 2004, the Company’s pro forma net income, and basic and diluted net income per common share would have been as follows:

	Fiscal Year Ended
(In thousands, except per share data)	January 28, 2006			January 29, 2005
	(As Restated, see Note 2)			(As Restated, see Note 2)
Net income, as reported	$	16,589		$	28,179
Add: Share-based compensation expense included in reported net income, net of related tax effect		381			—
Deduct: Total share-based employee compensation expense determined under fair value based method for all awards, net of related tax effect		(4,485	)		(4,266	)
Pro forma net income	$	12,485		$	23,913
Basic net income per weighted average share:
As reported	$	0.75		$	1.29
Pro forma	$	0.57		$	1.09
Diluted net income per weighted average share:
As reported	$	0.75		$	1.26
Pro forma	$	0.56		$	1.07

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Pro forma disclosures for fiscal 2006 are not presented because employee stock options were accounted for using SFAS 123(R)’s fair-value method for all of fiscal 2006.

The following table presents the weighted average assumptions used in the option pricing model for the stock options granted during fiscal 2006, 2005, and 2004:

	Fiscal Year Ended
	February 3, 2007		January 28, 2006		January 29, 2005
			(Pro forma)		(Pro forma)
Expected dividend rate	—		—		—
Volatility	45.1	%	47.9	%	56.0	%
Risk-free interest rate	4.4	%	4.1	%	2.6	%
Expected lives (years)	4.8		4.2		4.2

The fair value of each option grant was estimated using the Black-Scholes option-pricing model, which was also used for the Company’s pro forma disclosure required under SFAS 123. The Company used its historical stock price volatility for a period approximating the expected life as the basis for its expected volatility assumption consistent with SFAS 123(R) and Staff Accounting Bulletin (“SAB”) No. 107. The expected life of stock options represents the weighted-average period the stock options are expected to remain outstanding. The Company has elected to follow the guidance of SAB 107 and adopt the simplified method in determining expected life for its stock option awards. The expected dividend yield assumption is based on the Company’s history of zero dividend payouts and the expectation that no dividends will be paid in the foreseeable future. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to the expected life of the stock option.

Revenue Recognition The Company recognizes revenue from the sale of merchandise either at the point of sale in its stores or at the time of receipt by the customer for merchandise purchased from its website. Revenue from sales of gift cards is deferred until redemption or until the likelihood of redemption by the customer is remote (gift card breakage). Income from gift card breakage is recorded as a reduction to selling, general, and administrative expenses. Shipping and handling fees charged to the customers are recognized as revenue at the time the merchandise is delivered to the customer. The Company’s revenues are reported net of discounts and returns, including an allowance for estimated returns. The allowance for sales returns is based on historical experience and was approximately $0.4 million at the end of fiscal 2006, and $0.3 million at the end of fiscal 2005 and 2004.

Cost of Sales and Occupancy Cost of sales includes costs to acquire merchandise inventory and costs of freight and distribution. The costs of maintaining warehouse facilities including depreciation, rent, utilities and certain indirect costs such as product purchasing activities and logistics are also charged to cost of sales. Occupancy costs include rent expense under store lease agreements, utility costs, common area maintenance costs charged to the Company by landlords and property taxes.

Vendor Credits and Rebates The Company’s policy is to recognize vendor credits and rebates in accordance with the provisions of the Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” Markdown allowances are recognized as a credit to cost of sales upon the later of sale of the individual units or receipt of the markdown allowance. Once granted, the Company recognizes volume rebates ratably over the period rebates are earned unless they are not reasonably estimable, in which case they are recognized when the milestones are achieved. Only when achievement of the rebate appears probable does the Company recognize the credit over the milestone period. The rebates are recognized as a credit to cost of sales. Lost sales allowances for items such as defective merchandise and shipping delays are recognized as a credit to cost of sales as the related specific merchandise is sold.

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Selling, General and Administrative Expenses Selling, general and administrative expenses include costs related to functions such as advertising, store operations expenses, corporate management, marketing, administration and legal and accounting, among others. Such costs include compensation, insurance costs, employment taxes, property taxes, credit card fees, management information systems operating costs, telephone and other communication charges, travel related expenses, professional and other consulting fees and utilities, among other costs.

Advertising Expense Advertising costs, which include newspaper, radio, and other media advertising, are expensed as incurred or the point of first broadcast or distribution. For fiscal 2006, 2005 and 2004, advertising costs were $64.0 million, $56.7 million and $52.3 million, respectively.

Store Preopening Expenses Store preopening expenses include rent expense incurred prior to opening as well as grand opening advertising, labor, travel and hiring expenses and are expensed as incurred.

Concentration of Credit Risk Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of cash and cash equivalents. The Company places its cash and cash equivalents with high quality financial institutions. At times, such balances may be in excess of FDIC insurance limits.

Income Taxes Income taxes are accounted for using an asset and liability approach that requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns. For fiscal 2006, the Company had a net deferred tax asset of $5.3 million, of which $14.9 million was included in other assets and $9.6 million was included in other current liabilities on the Company’s consolidated balance sheet. For fiscal 2005, the Company had a net deferred tax asset of $0.9 million, of which $7.7 million was included in other assets and $6.8 million was included in other current liabilities on the Company’s consolidated balance sheet.

Comprehensive Income Comprehensive income consists of net income and unrealized gains and losses on interest rate swaps. The Company accounts for its interest rate swaps as cash flow hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activity.”

Net Income per Share SFAS No. 128, “Earnings Per Share,” requires earnings per share (“EPS”) to be computed and reported as both basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents outstanding during the period. Diluted EPS reflects the potential dilution that could occur if options to purchase common stock were exercised into common stock.

The following is a reconciliation of the weighted average number of shares used in the Company’s basic and diluted per share computations:

	Fiscal Year Ended
(In thousands)	February 3, 2007	January 28, 2006	January 29, 2005
Basic shares	22,068	22,004	21,840
Effect of dilutive stock options	—	96	483
Diluted shares	22,068	22,100	22,323

Certain options to purchase common stock were outstanding but were not included in the computation of diluted earnings per share because the effect would be anti-dilutive. For the fiscal years ended February 3, 2007, January 28, 2006, and January 29, 2005 there were anti-dilutive options of 2,178,962; 1,395,699; and 504,000 respectively.

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New Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination based on the technical merits. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company will implement FIN 48 at the beginning of fiscal 2007, and any cumulative effect resulting from the change in accounting principle will be recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact, if any, that the adoption of FIN 48 will have on its financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for companies with fiscal years ending after November 15, 2006 and is required to be adopted by the Company in its fiscal year ending February 3, 2007. The adoption of SAB No. 108 did not have an impact on the Company’s financial position or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 157 on its financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specific election dates. This statement does not require any new fair value measurements. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 159 on its financial statements.

Note 2. Restatement

In preparing the Company’s fiscal 2006 consolidated financial statements, the Company discovered errors in the way it had accounted for inventory and the related balances in accounts payable and cost of sales. The errors resulted in the understatement of cost of goods sold for fiscal 2004 and 2005. As a result, the Company has restated the accompanying consolidated financial statements for the fiscal years ended January 28, 2006 and January 29, 2005. The effect of the restatement for fiscal 2004 of $2.0 million is also reflected as a reduction of the Company’s previously reported retained earnings balance of $132.2 million at January 29, 2005. The restatement did not impact the Company’s previously reported net cash flows, revenues or comparable store sales, or its compliance with revolving line of credit covenants.

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The following is a summary of the significant effects of the restatement on the Company’s consolidated balance sheet at January 28, 2006 and its consolidated statements of operations and cash flows for the fiscal years ended January 28, 2006 and January 29, 2005.

Fiscal Year Ended January 28, 2006	As Previously Reported			As Restated
Consolidated Balance Sheet Data
Merchandise inventories, net	$	252,791		$	250,411
Total current assets		308,467			306,087
Total assets		531,951			529,571
Accounts payable		57,351			64,367
Income taxes payable		10,618			6,908
Total current liabilities		114,318			117,624
Retained earnings		152,442			146,756
Total shareholders equity		316,081			310,395
Total liabilities and shareholders equity		531,951			529,571
Consolidated Statement of Operations Data
Cost of sales and occupancy		643,020			649,041
Gross profit		327,421			321,400
Income from operations		37,516			31,495
Income before income taxes		32,373			26,352
Income tax provision		12,140			9,763
Net income		20,233			16,589
Net income per weighted average share-Basic		0.92			0.75
Net income per weighted average share-Diluted		0.92			0.75
Consolidated Statement of Cash Flows Data
Net income		20,233			16,589
Merchandise inventories		328			(188	)
Accounts payable		(18,099	)		(11,562	)
Income taxes payable		927			(1,450	)
Fiscal Year Ended January 29, 2005	As Previously Reported			As Restated
Consolidated Statement of Operations Data
Cost of sales and occupancy		598,357			601,732
Gross profit		310,203			306,828
Income from operations		51,428			48,053
Income before income taxes		48,445			45,070
Income tax provision		18,224			16,891
Net income		30,221			28,179
Net income per weighted average share-Basic		1.38			1.29
Net income per weighted average share-Diluted		1.35			1.26
Consolidated Statement of Cash Flows Data
Net income		30,221			28,179
Merchandise inventories		(42,687	)		(39,791	)
Accounts payable		11,442			11,921
Income taxes payable		(2,336	)		(3,669	)

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Note 3. Goodwill Impairment Loss

The Company performs an impairment test of goodwill annually or earlier if conditions indicate an earlier review is necessary. If the estimated fair value is less than the carrying value, goodwill is impaired and will be written down to its estimated fair value. During the fourth quarter of fiscal 2006, the Company performed its annual impairment test of goodwill using a market value approach and concluded that its goodwill was impaired. Accordingly, the Company recorded a non-cash goodwill impairment charge of $4.2 million in fiscal 2006 to write down all of the goodwill on its consolidated balance sheet. The Company’s goodwill of $4.2 million represented the difference between the purchase price and the related underlying tangible and identifiable intangible net asset values resulting from the acquisition of Cost Plus, Inc. by BC Investments, Inc. in November 1987.

Note 4. Property and Equipment

Property and equipment consist of the following:

(In thousands)	February 3, 2007			January 28, 2006
Land and land improvements	$	—		$	12,659
Building and leasehold improvements		149,112			175,923
Facilities subject to sale and leaseback		79,430			—
Furniture, fixtures and equipment		136,255			120,631
Facilities under capital leases		27,594			29,551
Total		392,391			338,764
Less accumulated depreciation and amortization		(159,932	)		(134,891	)
Property and equipment, net	$	232,459		$	203,873

Note 5. Other Assets

Other assets consist of the following:

(In thousands)	February 3, 2007			January 28, 2006
Deferred income taxes	$	14,932		$	7,689
Lease rights and interests		3,011			3,146
Other intangibles		2,073			1,744
Deferred compensation plan assets		3,062			3,100
Other		5,291			4,381
Total		28,369			20,060
Less accumulated amortization		(4,757	)		(4,627	)
Other assets, net	$	23,612		$	15,433

Note 6. Leases

The Company leases certain properties consisting of retail stores, distribution centers, corporate offices and equipment. Store leases typically contain initial terms and provisions for two to three renewal options of five to ten years each. The retail stores, distribution centers and corporate office leases generally provide that the Company assumes the maintenance and all or a portion of the property tax obligations on the leased property. Certain store leases also require contingent rent bases on store revenues.

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The minimum rental payments required under capital leases (with interest rates ranging from 3.2% to 12.7%) and non-cancelable operating leases with a remaining lease term in excess of one year at February 3, 2007 are as follows:

(In thousands)	Capital Leases			Operating Leases		Total
Fiscal year:
2007	$	2,569		$	83,990	$	86,559
2008		2,561			85,022		87,583
2009		2,190			82,263		84,453
2010		1,410			76,537		77,947
2011		1,410			67,689		69,099
Thereafter through the year 2040		11,137			219,040		230,177
Minimum lease commitments		21,277		$	614,541	$	635,818
Less amount representing interest		(9,811	)
Present value of capital lease obligations		11,466
Less current portion		(1,555	)
Long-term portion	$	9,911

Interest expense related to capital leases was $1.3 million, $1.5 million, and $2.2 million for fiscal 2006, 2005, and 2004, respectively.

Minimum and contingent rental expense under operating and capital leases and sublease rental income is as follows:

	Fiscal Year Ended
(In thousands)	February 3, 2007			January 28, 2006			January 29, 2005
Operating leases:
Minimum rental expense	$	80,384		$	70,566		$	62,001
Contingent rental expense		656			757			823
Less sublease rental income		(551	)		(506	)		(372	)
Total	$	80,489		$	70,817		$	62,452
Capital leases—contingent rental expense	$	1,688		$	1,466		$	1,308

Total minimum rental income to be received from non-cancelable sublease agreements through 2011 is approximately $1.3 million as of February 3, 2007.

Note 7. Long-term Debt and Revolving Lines of Credit

The Company’s long-term debt balance as of February 3, 2007 and January 28, 2006 is summarized as follows:

(In thousands)	February 3, 2007			January 28, 2006
Loan for Stockton distribution center purchase	$	—		$	18,578
Loan for Virginia distribution center purchase		—			17,490
Loan for Virginia distribution center expansion		—			19,250
Obligation under sale and leaseback
Stockton distribution center		29,448			—
Virginia distribution center		52,249			—
Line of Credit for Stockton distribution center construction		30,500			—
Total long-term debt		112,197			55,318
Less current portion		(541	)		(5,267	)
Long-term debt, net	$	111,656		$	50,051

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Total long-term debt matures as follows:

(In thousands)	Long-term Debt
Fiscal year:
2007	$	541
2008		876
2009		887
2010		938
2011		944
Thereafter through the year 2046		108,011
Total long-term debt	$	112,197

On April 7, 2006, the Company entered into a sale-leaseback transaction with Inland Real Estate Acquisitions, Inc., a third party real estate investment trust (“Inland”). In connection with the transaction, the Company sold its Stockton, CA. distribution center property to Inland for net proceeds of $29.8 million. The property sold consisted of a 500,000 square foot building located on approximately 55 acres. At the closing on April 7, 2006, the Company entered into a lease agreement with Inland to lease the property back. The Company used a portion of the proceeds from the sale of the property of approximately $29.8 million to retire $18.2 million of long-term debt related to the Company’s purchase of the property, and the remaining proceeds were used for other business purposes. The Company accounted for the transaction as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet. The Company also recorded a financing obligation in the amount of approximately $29.8 million, which will be amortized over the 34 year period of the leases (including option periods) and approximates the discounted value of total maximum lease payments under the leases. Monthly lease payments are accounted for as principal and interest payments (at an approximate annual rate of 7.2%) on the recorded obligation. As of February 3, 2007, the balance of the financing obligation was $29.4 million and was included on the Company’s consolidated balance sheet as long-term debt. The Company also terminated the interest rate swap agreement related to the aforementioned long-term debt.

On December 21, 2006, the Company entered into a sale-leaseback transaction with Inland, in which the Company sold its Windsor, VA distribution center property to Inland for net proceeds of $52.3 million. The property sold consisted of a 1,000,000 square foot building located on approximately 82 acres. At the closing on December 21, 2006, the Company entered into a lease agreement with Inland to lease the property back. The Company used a portion of the net proceeds from the sale of approximately $52.3 million to pay-off the long-term debt of $34.1 million related to the Company’s purchase of the property, and used the remaining proceeds for other business purposes. The Company accounted for the transaction as a financing whereby the net book value of the asset remains on the Company’s consolidated balance sheet. The Company also recorded a financing obligation in the amount of approximately $52.3 million, which will be amortized over the 40 year period of the leases (including option periods) and approximates the discounted value of total maximum lease payments under the leases. Monthly lease payments are accounted for as principal and interest payments (at an approximate annual rate of 8.5%) on the recorded obligation. As of February 3, 2007, the balance of the financing obligation was $52.2 million and was included on the Company’s consolidated balance sheet as long-term debt. The Company also terminated the interest rate swap agreement related to the aforementioned long-term debt.

On April 28, 2006, the Company entered into an unsecured 18 month revolving credit facility agreement with Bank of America, N.A. as the lender (the “Credit Facility”). The Credit Facility allows for borrowings of up to $40.0 million to be used for costs and expenses related to the construction of an additional distribution center adjacent to the Company’s existing facility in Stockton, California. The Credit Facility will be repaid in monthly payments of accrued interest, with the entire outstanding balance payable on October 27, 2007. The Credit Facility will bear interest, at the Company’s election, at a rate based on LIBOR plus a margin or Bank of America’s prime rate (or the Federal Funds Rate plus 0.5%, if greater). In addition the Company will pay a fee on the unused portion of the Credit Facility (the “Unused Fee”). The Unused Fee will be payable quarterly in

46

arrears. The applicable margin and the Unused Fee will be based upon the Company’s consolidated adjusted leverage ratio, as defined in the agreement. The Company is subject to a minimum consolidated tangible net worth and limitations on capital expenditures. Further, the Credit Facility contains restrictive covenants limiting the ability of the Company and its subsidiaries to, among other things, grant liens, make investments, incur indebtedness, enter into mergers, dispose of assets, repurchase stock, change its business, enter into transactions with affiliates, and prohibits the Company from making cash dividend payments with respect to any capital stock. The events of default under the Credit Facility include, among other things, payment defaults, breaches of certain covenants, misrepresentations, cross-defaults with certain other indebtedness, bankruptcy events, judgments, certain ERISA events and changes of control. In the event of a default, the Credit Facility requires the Company to pay incremental interest at the rate of 2.0% and could result in the acceleration of the Company’s obligations under the Credit Facility and an obligation of any guarantor to pay the full amount of the Company’s obligations under the Credit Facility. As of February 3, 2007, the Company was in compliance with its loan covenant requirements and had $30.5 million in borrowings outstanding under its line of credit.

As previously mentioned, the maturity date on the Credit Facility is October 27, 2007. The Company classified the $30.5 million of borrowings outstanding under the Credit Facility as long-term debt in accordance with SFAS No. 6, “Classification of Short-Term Obligations Expected to be Refinanced.” The Company has an existing agreement with Inland that specifies Inland will make a payment to the Company equal to the total cost of construction of the additional distribution facility in Stockton, CA upon completion of the construction, which is expected to be on or around July 2007. At this time, the Company plans to pay down the existing $30.5 million of borrowings and will enter into continued financing with Inland whereby the future lease payments that are owed under the current lease agreement for the existing Stockton distribution center will increase accordingly. The future lease payments will be determined by multiplying the cost of construction times an interest rate equal to the 10-year treasure rate plus 2.0% and an average lender’s spread.

In November 2004, the Company entered into an unsecured five year revolving line of credit agreement (the “Agreement”) with a group of banks that terminated and replaced an existing revolving credit facility. The Agreement allows for cash borrowings and letters of credit under an unsecured revolving credit facility of up to $50.0 million from January through June of each year, increasing to $125.0 million from July through December of each year to coincide with the Company’s Holiday borrowing needs. The Agreement includes a one-time option to increase the size of the revolving credit facility to $150.0 million. Interest is paid quarterly in arrears based on a rate equal to Bank of America’s prime rate or LIBOR plus an applicable margin that is based on the Company’s Consolidated Adjusted Leverage Ratio, as defined in the Agreement. The Agreement requires a 30-day “clean-up period” in which Adjusted Total Outstandings, as defined in the Agreement, do not exceed $30.0 million for not less than 30 consecutive days during the period from January 1 through March 31 of each year. The Company is subject to a minimum consolidated tangible net worth requirement, and annual capital expenditures are limited under the Agreement. The Agreement includes limitations on the ability of the Company to incur debt, grant liens, make acquisitions and dispose of assets and also prohibits the Company from making cash dividend payments with respect to any capital stock. The events of default under the Agreement include payment defaults, cross defaults with certain other indebtedness, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lenders under the Agreement may, among other remedies, eliminate their commitments to make credit available, declare due all unpaid principal amounts outstanding, and require cash collateral for any letter of credit obligations. As of February 3, 2007, the Company was in compliance with its loan covenant requirements, had no outstanding borrowings under its line of credit and had $13.8 million outstanding in letters of credit.

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Note 8. Income Taxes

The provision for income taxes consists of the following:

	Fiscal Year Ended
(In thousands)	February 3, 2007			January 28, 2006			January 29, 2005
Current:
Federal	$	(7,396	)	$	11,939		$	12,230
State		84			1,273			1,753
Total current		(7,312	)		13,212			13,983
Deferred:
Federal		(2,538	)		(1,859	)		3,192
State		(1,993	)		(1,590	)		(284	)
Total deferred		(4,531	)		(3,449	)		2,908
Provision for income taxes	$	(11,843	)	$	9,763		$	16,891

The differences between the U.S. federal statutory tax rate and the Company’s effective tax rate are as follows:

	Fiscal Year Ended
	February 3, 2007		January 28, 2006		January 29, 2005
U.S. federal statutory tax rate	(35.0	)%	35.0	%	35.0	%
State income taxes (net of U.S. federal income tax benefit)	(1.4	)	2.8		3.9
Benefit of wage and other tax credits	(2.1	)	(3.3	)	(1.8	)
Non-deductible expenses	0.9		0.8		0.3
Goodwill impairment	3.6		—		—
Other	(0.4	)	1.7		0.1
Effective income tax rate	(34.4	)%	37.0	%	37.5	%

Significant components of the Company’s deferred tax assets and liabilities are as follows:

	Fiscal Year Ended
	February 3, 2007				January 28, 2006
	Deferred Tax Assets		Deferred Tax Liabilities		Deferred Tax Assets		Deferred Tax Liabilities
Capitalized inventory costs	$	—	$	10,529	$	—	$	7,413
Trade discounts		—		826		—		541
Prepaid expenses		—		1,010		—		805
Deferred rent		16,011		—		15,134		—
Capital leases		526		—		419		—
Lease rights		—		254		—		290
Depreciation		—		9,037		—		12,790
Deferred compensation		1,272		—		1,324		—
Interest rate SWAP’s		—		—		—		112
Credit and net operating loss carryforwards		9,357		—		7,590		—
Deductible reserves and other		3,696		—		613		—
State taxes		—		3,866		—		2,220
Subtotal		30,862		25,522		25,080		24,171
Valuation allowance		—		—		—		—
Total	$	30,862	$	25,522	$	25,080	$	24,171

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At February 3, 2007, the Company had California state enterprise zone credit carryforwards of $8.0 million that have no expiration date. The Company also had state net operating loss carryforwards of $10.0 million that will expire in 5 to 14 years, and $18.0 million that will expire in 15 to 20 years.

Note 9. Equity and Stock Compensation Plans

Shareholder Rights Plan Each outstanding share of common stock has a Preferred Share Purchase Right (expiring on June 30, 2008) that is exercisable only upon the occurrence of certain change in control events.

Options As of February 3, 2007 the Company had options outstanding under three stock option plans; the 1995 Stock Option Plan (“1995 Plan”), the 2004 Stock Plan (“2004 Plan”), and the 1996 Director Stock Option Plan (“Director Option Plan”).

The 1995 Plan permitted the granting of options to employees and directors to purchase, at fair market value as of the date of grant, up to 5,968,006 shares of common stock, less the aggregate number of shares related to options granted and outstanding under the 1994 Plan (821,120 shares). Options are exercisable over ten years and vest as determined by the Board of Directors, generally over three or four years. A 900,000 share increase in the number of shares of common stock reserved for issuance was approved by the Board of Directors and shareholders in 2002 and is included in the share count above. The 1995 Plan was terminated in November 2005.

The 2004 Plan was approved by the Board of Directors and shareholders in fiscal 2004 and was last amended by the shareholders in June 2006. The 2004 Stock Plan permits the granting of up to 2,800,000 shares, which includes 900,000 new shares, 100,000 shares transferred from the 1995 plan, 800,000 shares subject to outstanding options under the 1995 Plan if they expire without being exercised, and 1,000,000 shares approved by both the Board of Directors and shareholders in 2006. Under the 2004 Plan, incentive stock options must be granted at fair market value as of the grant date and non-statutory options may be granted at 25% to 100% of the fair market value on the grant date. The term of the options granted under the 2004 Plan and the date when the options become exercisable is determined by the Board of Directors. However, in no event will a stock option granted under the 2004 Plan be exercised more than ten years after the date of grant. The 2004 Plan also includes the ability to grant restricted stock, stock appreciation rights, performance shares, and deferred stock units.

The Director Option Plan was approved by the Board of Directors and shareholders in fiscal 1996, and was last amended by the shareholders in June 2006. The 1996 Director Option Plan permits the granting of options for up to 703,675 shares of common stock to non-employee directors at fair market value as of the date of grant. Options are exercisable over a maximum term of ten years and vest as determined by the Board of Directors, generally over four years. The number of shares of common stock reserved for issuance under the Director Option Plan increased by 150,000 in 2002, 100,000 in 2004, and 200,000 in 2006. All increases were approved by the Board of Directors and shareholders and are included in the share count above.

As of February 3, 2007 there were 1,986,858 shares of commons stock available for future grant under the Company’s stock plans.

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A summary of activity under the Company’s option plans is set forth below:

	Options		Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value (In thousands)
Outstanding, January 31, 2004	2,066,651		$	22.48
Granted (Weighted average fair value per share granted of $17.67)	556,000			38.41
Exercised	(420,397	)		22.78
Cancelled or expired	(293,502	)		25.99
Outstanding, January 29, 2005	1,908,752		$	26.51
Granted (Weighted average fair value per share granted of $9.81)	692,500			23.30
Exercised	(216,164	)		19.36
Cancelled or expired	(472,184	)		30.27
Outstanding, January 28, 2006	1,912,904		$	25.24
Granted (Weighted average fair value per share granted of $8.44)	563,000			18.53
Exercised	(23,451	)		9.04
Cancelled or expired	(273,491	)		26.77
Outstanding, February 3, 2007	2,178,962		$	23.49	5.4	$	—
Exercisable, February 3, 2007	1,069,067		$	24.55	4.8	$	—

The aggregate intrinsic value in the table above is the difference between the market value of the Company’s common stock on the last day of business for the period indicated and the exercise price. Cash received as a result of stock options exercised in fiscal 2006 was $207,000, and the actual tax benefit realized for tax deductions from stock options exercised totaled $10,652. The total intrinsic value of stock options exercised in fiscal 2006 was $126,831.

During the first quarter of fiscal 2006, the Company granted performance share awards (“Performance Shares”) to certain key employees under the 2004 Stock Plan. Performance Shares entitle the holder to receive a number of shares of the Company’s common stock within a specified range of shares at the end of the vesting period. Performance shares are vested using a non-discretionary formula that is based on the Company achieving certain thresholds of comparable store sales growth and income from operations during the performance period.

The following table summarizes Performance Share activity during fiscal 2006, with the shares granted representing the maximum number of shares that could be achieved:

	Shares		Weighted Average Grant Date Fair Value Per Share
Outstanding at January 28, 2006	—		$	—
Granted	89,250			17.00
Vested	—			—
Forfeited	(89,250	)		17.00
Outstanding at February 3, 2007	—		$	—

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The following table summarizes information about the weighted average remaining contractual life (in years) and the weighted average exercise prices for stock options both outstanding and exercisable as of February 3, 2007:

	Options Outstanding				Options Exercisable
Actual Range of Exercise	Number Outstanding	Remaining Life (Yrs.)	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
$  7.00 – $ 8.00	2,255	0.1	$	7.00	2,255	$	7.00
10.36 –   10.76	67,513	2.4		10.68	47,513		10.65
10.77 –   14.06	12,604	1.2		13.89	12,604		13.89
14.07 –   18.23	441,469	5.2		16.36	145,469		16.06
18.24 –   25.44	966,990	5.5		21.56	490,865		22.83
25.45 –   38.50	688,131	5.7		32.26	370,361		32.41
$  7.00 – $38.50	2,178,962	5.4	$	23.49	1,069,067		24.55

Note 10. Employee Benefit Plans

The Company has a 401(k) plan for employees who meet certain service and age requirements. Participants may contribute the lesser of 60% of their annual base salary or $15,500, and participants age 50 or older may contribute an additional catch-up deferral amount of up to $5,000 per year. Effective March 1, 2006, the Company matched 100% of employee contributions up to the first 3% of base salary and matched 50% of employee contributions in excess of 3% of base salary up to a maximum of 5% of base salary. On March 1, 2006 the Company revised its plan so that all unvested and current contributions made on behalf of the employee were immediately 100% vested. The Company contributed approximately $1,485,000 in fiscal 2006, $625,000 in fiscal 2005, and $556,000 in fiscal 2004. In fiscal 2005 and 2004, the Company matched 50% of the first 4% of base salary that the employee contributed to the 401(k) plan and contributions made on behalf of the employee vested evenly over five years.

In addition, a non-qualified deferred compensation plan was available to certain employees whose benefits were limited under Section 401(k) of the U.S. Internal Revenue Service Code. Compensation deferrals approximated $64,000 in fiscal 2006, $510,000 for fiscal 2005 and $566,000 for fiscal 2004. The Company terminated its deferred compensation plan on March 1, 2006. In the fist quarter of fiscal 2007 each deferred compensation plan participant received a lump sum distribution of the full value of their respective account.

Note 11. Commitments and Contingencies

The Company is involved in litigation, claims and assessments incidental to its business, the disposition of which is not expected to have a material effect on the Company’s financial position or results of operations. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in the Company’s assumptions related to these matters. The Company accrues its best estimate of the probable cost for the resolution of claims. When appropriate, such estimates are developed in consultation with outside counsel handling these matters and are based upon a combination of litigation and settlement strategies. To the extent additional information arises or the Company’s strategies change, it is possible that the Company’s best estimate of its probable liability in these matters may change.

51

Note 12. Quarterly Information (unaudited)

The following tables set forth the Company’s unaudited quarterly operating results for the eight most recent quarterly periods. The financial information gives effect to the restatement discussed in Note 2 to the consolidated financial statements.

	Fiscal Quarters Ended
(In thousands, except per share data)	April 29, 20061						July 29, 20061						October 28, 20061						February 3, 20072
	As Previously Reported			As Restated			As Previously Reported			As Restated			As Previously Reported			As Restated
Net sales	$	212,964		$	212,964		$	215,275		$	215,275		$	215,405		$	215,405		$	396,665
Gross profit		63,307			65,382			58,549			53,669			66,172			65,320			116,681
Net income (loss)		(4,792	)		(3,537	)		(11,252	)		(14,205	)		(11,730	)		(12,244	)		7,450
Net income (loss) per weighted average share
Basic	$	(0.22	)	$	(0.16	)	$	(0.51	)	$	(0.64	)	$	(0.53	)	$	(0.55	)	$	0.34
Diluted	$	(0.22	)	$	(0.16	)	$	(0.51	)	$	(0.64	)	$	(0.53	)	$	(0.55	)	$	0.34

	Fiscal Quarters Ended
(In thousands, except per share data)	April 30, 2005						July 30, 2005				October 29, 2005						January 28, 20062
	As Previously Reported			As Restated			As Previously Reported		As Restated		As Previously Reported			As Restated			As Previously Reported		As Restated
Net sales	$	200,023		$	200,023		$	202,766	$	202,766	$	200,679		$	200,679		$	366,973	$	366,973
Gross profit		66,719			63,030			69,221		69,664		66,732			69,263			124,749		119,443
Net income (loss)		(138	)		(2,370	)		1,518		1,787		(2,660	)		(1,130	)		21,513		18,302
Net income (loss) per weighted average share
Basic	$	(0.01	)	$	(0.11	)	$	0.07	$	0.08	$	(0.12	)	$	(0.05	)	$	0.98	$	0.83
Diluted	$	(0.01	)	$	(0.11	)	$	0.07	$	0.08	$	(0.12	)	$	(0.05	)	$	0.97	$	0.83

1. The Company’s Forms 10-Q for fiscal 2007 will reflect the restated quarterly data for the corresponding quarters in fiscal 2006.

2. The three months ended February 3, 2007 was a fourteen-week period as compared to the three months ended January 28, 2006 which was a thirteen-week period.

52

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.     CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report. Based on this evaluation, we discovered a material weakness, as described below, in our “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and referred to hereafter as our “internal controls”), and thus in our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act, and referred to hereafter as our “disclosure controls”).

In addition, the Company restated its financial statements for fiscal years 2004, 2005 and for the first three quarters of fiscal 2006, as described in Notes 2 and 12 to the consolidated financial statements and included in Item 8 herein. Therefore, our principal executive and financial officers each concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective in ensuring that information required to be disclosed by us in reports filed or submitted under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. 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 U.S. generally accepted accounting principles (GAAP). Because of its inherent limitations, internal controls over financial reporting may not prevent or detect all misstatements.

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Management conducted an assessment of the effectiveness of our internal control over financial reporting as of February 3, 2007, based upon the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management has concluded that, as of February 3, 2007, we did not maintain effective internal control over financial reporting. Management identified material weaknesses in internal control over financial reporting as it relates to inventory management, accounts payable and inventory reserves. Specifically, the Company’s controls failed to adequately identify, document and analyze the conditions that should have been considered relative to i) reconciliation of the inventory sub-ledgers to the general ledger to ensure data integrity and identify potential errors in inventory; ii) reconciliation of accounts payable sub-ledger to the general ledger to properly record received not invoiced inventory and invoiced not received inventory; iii) review of vendor returns and receiving adjustments to ensure

53

accurate reflection in the inventory and accounts payable balances; iv) timely and accurate processing of inventory received not invoiced; v) consistent treatment and recording of reserve estimates and vi) the proper investigation and resolution of reconciling items on a timely basis. These material weaknesses resulted in incorrect accounting for inventory and accounts payable and contributed to the restatement for the fiscal years 2004 and 2005 and for the first three quarters of fiscal 2006.

Our independent registered public accounting firm, Deloitte and Touche LLP, has issued an audit report on our assessment of our internal control over financial reporting. The report is included on page 31 in Item 8 of this Annual Report on Form 10-K.

Changes in Internal Control Over Financial Reporting

There were no changes in internal control in the fourth quarter of fiscal 2006. The remediation measures described below commenced after the fiscal year end.

Remediation of Material Weaknesses

To address the material weaknesses discussed above, management has undertaken the following actions:

1. The Company has added personnel with the requisite knowledge of internal controls and financial reporting to strengthen the quality of the reconciliation processes within the inventory and accounts payable areas.

2. The Company will add quality control reviews within the accounting function to ensure reconciliations are completed accurately, in a timely manner and with proper management review.

3. The Company has added, and is reviewing options to add, additional system based integrity controls to ensure the accurate and complete flow of data between the sub-ledgers and the general ledger.

4. The Company is lowering the threshold required for management review and approval of accounts payable and inventory transactions.

5. The Company is strengthening internal policies within the accounts payable area to identify and limit the conditions under which purchase transactions can occur and age without a three-way match of purchase order, receipt and vendor invoice.

6. The Company has strengthened internal accounting policies to require a consistent application of all reserves and estimate methodologies.

ITEM 9B.     OTHER INFORMATION

None

54

PART III

Information called for by Part III (Items 10, 11, 12, 13 and 14) of this report on Form 10-K has been omitted as the Company intends to file with the Securities and Exchange Commission not later than June 1, 2007 a definitive Proxy Statement pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934. Such information will be set forth in such Proxy Statement and is incorporated herein by reference.

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information regarding (i) the Company’s directors, (ii) compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, as well as (iii) any material changes to procedures by which security holders may recommend nominees to the Company’s board of directors, standing audit committee and audit committee financial expert are incorporated herein by reference to the sections entitled “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Corporate Governance,” respectively, in our Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders. The information required by this item concerning executive officers is incorporated herein by reference to the section entitled “Executive Officers of the Registrant” at the end of Part I of this report.

The Company has adopted a Code of Ethics for Principal Executive and Senior Financial Officers, which is listed as an exhibit to this report on Form 10-K. The policy applies to the Company’s Chief Executive Officer and the Chief Financial Officer, who also serves as the principal accounting officer.

ITEM 11.    EXECUTIVE COMPENSATION

The information required by this item is incorporated herein by reference to the section entitled “Executive Compensation” in the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated herein by reference to the sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation” in the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders.

The following table sets forth information as of February 3, 2007 about our common stock that may be issuable upon the exercise of options and rights granted to employees, consultants and members of our Board of Directors under all existing equity compensation plans.

	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted-average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by shareholders
1995 Stock Option Plan1	883,131	$	26.12	—
1996 Director Option Plan	349,491		25.68	214,715
2004 Stock Plan	946,340		20.23	1,772,143
Equity compensation plans not approved by shareholders	—		—	—
Total	2,178,962	$	23.49	1,986,858

1. The 1995 Stock Option Plan was replaced by the 2004 Stock Plan in July 2005. 100,000 remaining shares available for grant under the 1995 Stock Option Plan were transferred to the 2004 Stock Plan and the 1995

55

Stock Option Plan was terminated for any new grants. Up to 800,000 shares subject to outstanding options under the 1995 Stock Option Plan may be transferred to the 2004 Stock Plan if they expire without being exercised and as of February 3, 2007 the Company had transferred 718,483 shares.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Certain information required by this item is incorporated herein by reference to the section entitled “Certain Relationships and Related Transactions” in the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders.

ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this item is incorporated herein by reference to the section entitled “Audit and Related Fees for Fiscal Years 2006 and 2005” in the Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders.

56

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)1. Financial Statements: See “Index to Consolidated Financial Statements” in Part II, Item 8 on page 29 of this Form 10-K.

    2. Financial Statement Schedules:

Financial statement schedules of Cost Plus, Inc. have been omitted from Item 15 because they are not applicable or the information is included in the financial statements or notes thereto.

(b) List of Exhibits:

Exhibit No.	Description of Exhibits
3.1	Amended and Restated Articles of Incorporation as filed with the California Secretary of State on April 1, 1996, incorporated by reference to Exhibit 3.1 to the Form 10-K filed for the year ended February 1, 1997.
3.1.1	Certificate of Amendment of Restated Articles of Incorporation as filed with the California Secretary of State on February 25, 1999, incorporated by reference to Exhibit 3.1 to the Form 10-Q filed for the quarter ended May 1, 1999.
3.1.2	Certificate of Amendment of Restated Articles of Incorporation as filed with the California Secretary of State on September 24, 1999, incorporated by reference to Exhibit 3.1.2 of the Form 10-K filed for the year ended January 29, 2000.
3.2	Certificate of Determination as filed with California Secretary of State on July 27, 1998, incorporated by reference to Exhibit 3.2 to the Form 10-K filed for the year ended January 30, 1999.
3.3	Amended and Restated By-laws dated May 12, 2006, incorporated by reference to Exhibit 3.1 to the Form 10-Q filed for the quarter ended April 29, 2006.
4.0	Preferred Shares Rights Agreement, dated June 30, 1998, between Cost Plus, Inc. and BankBoston, N.A., including the Certificate of Determination, the form of Rights Certificate and the Summary of Rights, incorporated by reference to Exhibit 1 to the Form 8-A filed on July 27, 1998.
4.1	Amendment to Preferred Shares Rights Agreement, dated June 2, 2003, between Cost Plus, Inc. and EquiServe Trust Company, N.A, incorporated by reference to exhibit 4.3 to the Form 8-A/A filed on July 11, 2003.
10.1	Form of Indemnification Agreement, as amended and restated, between the Company and each of its directors and officers, incorporated by reference to Exhibit 10.1 to the Form 10-Q filed for the quarter ended July 29, 2006.
10.2	Lease Agreement, dated August 27, 1991, as amended, between the Company and The Stockton Port District for certain warehouses for storage and distribution located in Stockton, California and extension thereto dated February 21, 1996, incorporated by reference to Exhibit 10.6 to the Registration Statement on Form S-1 effective April 3, 1996.
10.2.1	Letters dated December 3, 2004 and December 9, 2004 extending the Lease Agreement, dated August 27, 1991, as amended, between the Company and The Stockton Port District for certain warehouses for storage and distribution located in Stockton, California and extension thereto dated February 21, 1996, incorporated by reference to Exhibit 10.2.1 to the Form 10-K filed for the year ended January 28, 2006.
10.3	Lease agreement between the Company and Square I, LLC for certain Corporate office space located in Oakland, California, incorporated by reference to Exhibit 10.1 to the Form 10-Q filed for the quarter ended October 31, 1998.

57

Exhibit No.	Description of Exhibits
10.4	Amendment to Credit Agreement dated April 7, 2006, between Cost Plus, Inc., the lenders named therein, and Bank of America, N.A., amending the Credit Agreement dated November 10, 2004, between Cost Plus, Inc., the lenders named therein and Bank of America, N.A., as the administrative agent and letter of credit issuer, incorporated by reference to Exhibit 10.3 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.5	Credit Agreement dated April 28, 2006 between Cost Plus, Inc. and Bank of America, N.A., as lender, incorporated by reference to Exhibit 10.1 of the Form 10-Q filed on April 29, 2006.
10.6	Purchase and Sale Agreement between Cost Plus, Inc. and Inland Real Estate Acquisitions, Inc., as purchaser, incorporated by reference to Exhibit 10.2 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.6.1	Lease Agreement between Cost Plus, Inc., as lessee, and Inland Western Stockton Airport Way, L.L.C. (“First Landlord”), as lessor, dated as of April 7, 2006, incorporated by reference to Exhibit 10.2.1 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.6.2	Subground Lease Agreement between Cost Plus, Inc., as lessee, and Western Stockton Ground Tenant, L.L.C. (“Second Landlord”), as lessor, dated as of April 7, 2006, incorporated by reference to Exhibit 10.2.2 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.7	Purchase and Sale Agreement and Joint Escrow Instructions dated October 26, 2006 between Cost Plus, Inc. and Inland Real Estate Acquisitions, Inc., as purchaser, incorporated by reference to Exhibit 10.1 of the Form 10-Q filed on October 28, 2006.
10.7.1	Lease Agreement between Cost Plus, Inc., as lessee, and Inland RI Holding, LLC, Bruning Holding, LLC, JM 55th Holding LLC, 55th Holding LLC, Rockford Bruning Holding, LLC, Commons Holding, LLC, Deer Park Holding, LLC, BA WR Holding, LLC, Hartland Holding, LLC, as lessor, dated as of December 21, 2006.
10.8¨	1995 Stock Option Plan, as amended, incorporated by reference to Exhibit 10.1 of the Form 10-Q filed for the quarter ended August 3, 2002.
10.8.1¨	Form of Stock Option Agreement, 1995 Stock Option Plan, incorporated by reference to Exhibit 10.4 to the Form 10-K filed for the year ended February 1, 1997.
10.9¨	Cost Plus, Inc. 1996 Director Option Plan as amended June 22, 2006, incorporated by reference to exhibit 10.2 to the Form 10-Q filed for quarter ended July 29, 2006.
10.9.1¨	Form of Stock Option Agreement, 1996 Director Option Plan, incorporated by reference to Exhibit 10.4 to the Form 10-Q filed for the quarter ended July 31, 1999.
10.10¨	Cost Plus, Inc. 2004 Stock Plan, as amended June 22, 2006, incorporated by reference to exhibit 10.3 to the Form 10-Q filed for quarter ended July 29, 2006.
10.10.1¨	Form of Option Agreement, 2004 Stock Plan, incorporated by reference to Exhibit 10.2 of the Form 8-K filed on November 23, 2004.
10.11¨	Cost Plus, Inc. Deferred Compensation Plan as amended and restated effective May 21, 2004, incorporated by reference to Exhibit 4.6 of the registration statement on Form S-8 effective September 3, 2004.
10.12¨	Form of Notice of Grant of Performance Shares and Performance Share Agreement under the 2004 Stock Plan, incorporated by reference to Exhibit 10.1 of the Form 8-K filed on April 21, 2006.
10.13¨	Employment Agreement, dated July 3, 2002, between Cost Plus, Inc. and Murray H. Dashe, incorporated by reference to Exhibit 10.3 to the Form 10-Q filed for the quarter ended August 3, 2002.

58

Exhibit No.	Description of Exhibits
10.14¨	Employment Agreement, dated October 24, 2005, between Cost Plus, Inc. and Barry J. Feld, incorporated by reference to Exhibit 10.1 to the Form 10-Q filed for the quarter ended October 29, 2005.
10.15¨	Fourth Amended and Restated Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Joan S. Fujii, incorporated by reference to Exhibit 10.8 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.16¨	Fourth Amended and Restated Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Michael J. Allen, incorporated by reference to Exhibit 10.6 of the Form 10-Q filed for the quarter ended April 29, 2006.
10.17¨	Amended and Restated Employment Severance Agreement dated April 29, 2005, between Cost Plus, Inc. and Theresa Strickland, incorporated by reference to Exhibit 10.5 of the Form 10-Q filed for the quarter ended April 30, 2005.
10.18¨	Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Frank Castiglione, incorporated by reference to Exhibit 10.7 to the Form 10-Q filed for the quarter ended April 29, 2006.
10.19¨	Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Rayford Whitley, incorporated by reference to Exhibit 10.9 to the Form 10-Q filed for the quarter ended April 29, 2006.
10.20¨	Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Thomas Willardson, incorporated by reference to Exhibit 10.10 to the Form 10-Q filed for the quarter ended April 29, 2006.
10.21¨	Second Amended and Restated Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Jane Baughman, incorporated by reference to Exhibit 10.2 to the Form 10-Q filed for the quarter ended October 28, 2006.
10.22¨	Second Amended and Restated Employment Severance Agreement dated April 17, 2006, between Cost Plus, Inc. and Chris Miller, incorporated by reference to Exhibit 10.4 to the Form 10-Q filed for the quarter ended July 29, 2006.
10.23¨	Employment Severance Agreement dated December 11, 2006, between Cost Plus, Inc. and George Whitney.
10.24¨	Fiscal 2007 Management Incentive Plan, incorporated by reference to Exhibit 10.1 of the Form 8-K filed on April 12, 2007.
14	Code of Business Conduct and Ethics, incorporated by reference to Exhibit 14 of the Form 10-K filed for the year ended January 29, 2005.
14.1	Code of Ethics for Principal Executive and Senior Financial Officers, incorporated by reference to Exhibit 14 of the Form 10-K/A filed for the year ended January 29, 2005.
21	List of Subsidiaries of the Company.
23	Consent of Independent Registered Public Accounting Firm.
31.1	Certification of the Chief Executive Officer of the Registration pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Chief Financial Officer of the Registration pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of the Chief Executive Officer and Chief Financial Officer of the Registration pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

¨ Management compensation plan or arrangement.

59

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

	COST PLUS, INC.
Date: May 4, 2007	By:	/s/    Barry J. Feld
		Barry J. Feld
		Chief Executive Officer and President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/    Barry J. Feld         Barry J. Feld	Director, Chief Executive Officer and     President     (Principal Executive Officer)	May 4, 2007
/s/    Thomas D. Willardson         Thomas D. Willardson	Executive Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)	May 4, 2007
/s/    Christopher V. Dodds         Christopher V. Dodds	Director	May 4, 2007
/s/    Joseph H. Coulombe         Joseph H. Coulombe	Director	May 4, 2007
/s/    Danny W. Gurr         Danny W. Gurr	Director	May 4, 2007
/s/    Kim D. Robbins         Kim D. Robbins	Director	May 4, 2007
/s/    Fredric M. Roberts         Fredric M. Roberts	Director, Chairman of the Board	May 4, 2007

60

EX-10.7.1

Exhibit 10.7.1

LEASE AGREEMENT

Dated as of December 21, 2006

between

INLAND RI HOLDING, LLC, a Delaware limited liability company

BRUNING HOLDING, LLC, a Delaware limited liability company

JM 55^TH HOLDING LLC, a Delaware limited liability company

55^th HOLDING LLC, a Delaware limited liability company

ROCKFORD BRUNING HOLDING, LLC, a Delaware limited liability company

COMMONS HOLDING, LLC, a Delaware limited liability company

DEER PARK HOLDING, LLC, a Delaware limited liability company

BA WR HOLDING, LLC, a Delaware limited liability company

HARTLAND HOLDING, LLC, a Delaware limited liability company,

As Lessor

and

Cost Plus, Inc., a California corporation

as Lessee

Property:

Cost Plus World Market

Distribution Facility

Isle of Wight, Virginia

TABLE OF CONTENTS

			PAGE
ARTICLE 1	DEFINITIONS; RESTATEMENT		1
	Section 1.1.	Restatement
	Section 1.2.	Definitions	1
ARTICLE 2	LEASE OF PROPERTY		1
	Section 2.1.	Demise and Lease	1
ARTICLE 3	RENT		2
	Section 3.1.	Base Rent	2
	Section 3.2.	Supplemental Rent	2
	Section 3.3.	Method of Payment	2
	Section 3.4.	Late Payment	2
	Section 3.5.	Net Lease, No Setoff, Etc	2
	Section 3.6.	True Lease	2
ARTICLE 4	INTENTIONALLY OMITTED		4
ARTICLE 5	RENEWAL OPTIONS		4
	Section 5.1.	Renewal Options	4
	Section 5.2.	Lease Provisions Applicable During Renewal	5
ARTICLE 6	LESSEE’S ACCEPTANCE OF PROPERTY, ENFORCEMENT OF WARRANTIES		5
	Section 6.1.	Waivers	5
	Section 6.2.	Lessee’s Right to Enforce Warranties	6
ARTICLE 7	LIENS		6
	Section 7.1.	Liens	6
ARTICLE 8	USE AND REPAIR		7
	Section 8.1.	Use	7
	Section 8.2.	Maintenance	7
	Section 8.3.	Alterations	7
	Section 8.4.	Title to Alterations	10
	Section 8.5.	Compliance with Law; Environmental Compliance	10
	Section 8.6.	Payment of Impositions	11
	Section 8.7.	Adjustment of Impositions	13
	Section 8.8.	Utility Charges	13
	Section 8.9.	Litigation; Zoning; Joint Assessment	13
ARTICLE 9	INSURANCE		14
	Section 9.1.	Coverage	14
ARTICLE 10	RETURN OF PROPERTY TO LESSOR		15
	Section 10.1.	Return of Property to Lessor	15

1

ARTICLE 11	ASSIGNMENT BY LESSEE		16
	Section 11.1.	Assignment by Lessee	16
ARTICLE 12	LOSS; DESTRUCTION; CONDEMNATION OR DAMAGE		17
	Section 12.1.	Event of Loss	17
	Section 12.2.	Application of Payments Upon an Event of Loss When Lease Continues	19
	Section 12.3.	Application of Payments Not Relating to an Event of Loss	19
	Section 12.4.	Other Dispositions	19
	Section 12.5.	Negotiations	21
ARTICLE 13	INTENTIONALLY OMITTED		22
ARTICLE 14	SUBLEASE		22
	Section 14.1.	Subleasing Permitted; Lessee Remains Obligated	22
	Section 14.2.	Provisions of Subleases	22
	Section 14.3.	Assignment of Sublease Rents	22
ARTICLE 15	INSPECTION		23
	Section 15.1.	Inspection	23
ARTICLE 16	LEASE EVENTS OF DEFAULT		23
	Section 16.1.	Lease Events of Default	23
ARTICLE 17	ENFORCEMENT		25
	Section 17.1.	Remedies	25
	Section 17.2.	Survival of Lessee’s Obligations	27
	Section 17.3.	Remedies Cumulative; No Waiver; Consents; Mitigation of Damages	27
ARTICLE 18	RIGHT TO PERFORM FOR LESSEE		28
	Section 18.1.	Right to Perform for Lessee	28
ARTICLE 19	INDEMNITIES		28
	Section 19.1.	General Indemnification	28
ARTICLE 20	LESSEE REPRESENTATIONS AND COVENANTS		31
	Section 20.1.	Representations and Warranties	31
ARTICLE 21	LESSOR REPRESENTATIONS AND COVENANTS		32
	Section 21.1.	Representations and Warranties	32
ARTICLE 22	PURCHASE PROCEDURE		33
	Section 22.1.	Purchase Procedure	33
ARTICLE 23	TRANSFER OF LESSOR’S INTEREST		34
	Section 23.1.	Permitted Transfer	34
	Section 23.2.	Effects of Transfer	34
ARTICLE 24	PERMITTED FINANCING		35
	Section 24.1.	Financing During Term.	35
	Section 24.2.	Lessee’s Consent to Assignment for Indebtedness	35

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ARTICLE 25	MISCELLANEOUS		36
	Section 25.1.	Binding Effect; Successors and Assigns; Survival	36
	Section 25.2.	Quiet Enjoyment	37
	Section 25.3.	Notices	37
	Section 25.4.	Severability	37
	Section 25.5.	Amendments, Complete Agreements	37
	Section 25.6.	Headings	37
	Section 25.7.	Counterparts	37
	Section 25.8.	Governing Law	38
	Section 25.9.	Memorandum	38
	Section 25.10.	Estoppel Certificates	38
	Section 25.11.	Easements	39
	Section 25.12.	No Joint Venture	39
	Section 25.13.	No Accord and Satisfaction	39
	Section 25.14.	No Merger	39
	Section 25.15.	Lessor Bankruptcy	39
	Section 25.16.	Naming and Signage of the Property	40
	Section 25.17.	Expenses	40
	Section 25.18.	Investments	40
	Section 25.19.	Further Assurances	40
	Section 25.20.	[Intentionally omitted]	40
	Section 25.21.	Independent Covenants	41
	Section 25.22.	Lessor Exculpation	41
	Section 25.23.	Remedies Cumulative	41
	Section 25.24.	Holding Over	41
	Section 25.25.	Survival	42
	Section 25.26.	[Intentionally Omitted]	42
	Section 25.27.	Lease Subordinate	42
	Section 25.28.	Lessor Representation	42
	Section 25.29.	Leasehold Financing	42

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Schedule 3.1	C        Base Rent
Schedule 9.1	C        Insurance
Section 12.2	C        Condemnation Allocation
Exhibit A	C        Description of Land
Exhibit B	C        Form of Estoppel Agreement
Exhibit C	C        Form of Subordination, Non-Disturbance and Attornment Agreement

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THIS LEASE AGREEMENT (this “Agreement”) is made and entered into as of December 21, 2006, by and between INLAND RI HOLDING, LLC, a Delaware limited liability company, BRUNING HOLDING, LLC, a Delaware limited liability company, JM 55^TH HOLDING LLC, a Delaware limited liability company, 55^th HOLDING LLC, a Delaware limited liability company, ROCKFORD BRUNING HOLDING, LLC, a Delaware limited liability company, COMMONS HOLDING, LLC, a Delaware limited liability company, DEER PARK HOLDING, LLC, a Delaware limited liability company, BA WR HOLDING, LLC, a Delaware limited liability company, HARTLAND HOLDING, LLC, a Delaware limited liability company, as Lessor (“Lessor”), having its principal place of business at 2901 Butterfield Road, Oak Brook, Illinois 60523, and Cost Plus, Inc., a California corporation, (“Lessee”), having a place of business at 200 Fourth Street, Oakland, California 94607.

RECITALS

A. Lessee was the owner of the Property, which is now owned by Lessor;

B. Lessor and Lessee now desire to enter into this Agreement;

C. Lessor desires to grant and delegate to Lessee, and Lessee desires to accept and assume from Lessor, certain rights and duties as described in this Agreement;

TERMS

NOW THEREFORE, in consideration of the mutual agreements herein contained and other good and valuable consideration, the receipt of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows:

ARTICLE 1

DEFINITIONS; RESTATEMENT

Section 1.1. Definitions. The capitalized terms used herein and not otherwise defined shall have the meanings assigned thereto in Appendix A hereto for all purposes hereof.

ARTICLE 2

LEASE OF PROPERTY

Section 2.1. Demise and Lease. (a) Lessor hereby demises and leases the Property to Lessee, and Lessee does hereby rent and lease the Property from Lessor, for the Base Term and, subject to the exercise by Lessee of its renewal options as provided in Article 5 hereof, for the Renewal Terms.

(b) Lessee may from time to time own or hold under lease or license from Persons other than Lessor furniture, equipment and personal property, including Lessee’s Equipment and Personalty, located on or about the Property, which shall not be subject to this Lease.

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Lessor shall from time to time, upon the reasonable request of Lessee, promptly acknowledge in writing to Lessee or other Persons that Lessor does not own or, except as provided in Article 10, have any other right or interest in or to such furniture, equipment and personal property, including Lessee’s Equipment and Personalty, whether now owned or hereafter acquired, and Lessor hereby waives any such right, title or interest.

ARTICLE 3

RENT

Section 3.1. Base Rent. Lessee shall pay to Lessor Base Rent on each Rent Payment Date during the Base Term in the amount set forth on Schedule 3.1 attached hereto and incorporated herein, and shall pay to Lessor Base Rent on each Rent Payment Date during any Renewal Term as prescribed by Article 5. Each installment of Base Rent is payable monthly in advance.

Section 3.2. Supplemental Rent. Lessee shall pay to Lessor, or to such other Person as shall be entitled thereto in the manner contemplated herein or as otherwise required by Lessor, any and all Supplemental Rent as the same shall become due and payable. In the event of Lessee’s failure to pay when due and payable any Supplemental Rent, Lessor shall have all rights, powers and remedies provided for herein.

Section 3.3. Method of Payment. All Base Rent and Supplemental Rent (other than Excepted Payments) payable to Lessor shall, be paid to Lessor, or if Lessor directs (on at least ten (10) Business Days prior notice), to Lessor’s Lender in each case to the Rent Collection Account, as directed by Lessor or Lender as applicable, in immediately available funds as of the relevant payment date to the Rent Collection Account, or such other account or accounts in the continental United States as the Lender may from time to time designate (on at least ten (10) Business Days prior written notice) to Lessee. Upon payment in full of all amounts due to the Lender, as reasonably evidenced to Lessee, which evidence must include a written statement to that effect from the Lender, or evidence of release or assignment of the Lien of the Mortgage, or other similar evidence, Lessee shall accept instructions from Lessor (or its new lender, if so instructed by Lessor) as to the payment of Base Rent and Supplemental Rent. Each such payment of Rent shall be made by Lessee by wire or other transfer of funds consisting of lawful currency of the United States of America which shall be immediately available no later than 4:00 PM (New York City time) at the place of receipt on the scheduled date when such payment shall be due, unless such scheduled date shall not be a Business Day, in which case such payment shall be made at such time on the immediately following Business Day, with the same force and effect as though made on such scheduled dates. If any payment of Base Rent or Supplemental Rent is received after 4:00 PM (New York City time) on the dates when such rent is due, such rent shall be deemed received on the next succeeding Business Day.

Section 3.4. Late Payment. If any payment of Base Rent or any Supplemental Rent payable to Lessor shall be delinquent, Lessee shall pay interest thereon from the date such payment became due and payable to the date of receipt thereof by Lessor at a rate per annum equal to the Default Rate.

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Section 3.5. Net Lease, No Setoff, Etc. It is the intention of the parties hereto that the obligations of Lessee hereunder shall be separate and independent covenants and agreements, and that Base Rent, Supplemental Rent and all other sums payable by Lessee hereunder shall continue to be payable in all events, and that the obligations of Lessee hereunder shall continue unaffected, unless the requirement to pay or perform the same shall have been terminated pursuant to an express provision of this Lease. This Lease is a net lease and it is agreed and intended that Base Rent, Supplemental Rent and any other amounts payable hereunder by Lessee shall be paid without notice (except with respect to Supplemental Rent for which notice is specifically required herein), demand, counterclaim, setoff, deduction or defense and without abatement, diminution or reduction and that Lessee’s obligation to pay all such amounts, throughout the Base Term and all applicable Renewal Terms is absolute and unconditional. Under no circumstances shall Lessor be obligated to repay Lessee, refund to Lessee, or return to Lessee, any Base Rent.

This Lease shall not terminate and Lessee shall not have any rights to terminate this Lease, during the Base Term and any Renewal Terms (except as otherwise expressly provided in Article 12). Except to the extent otherwise expressly specified in this Lease, Lessee shall not take any action to terminate, rescind or void this Lease and the obligations and liabilities of Lessee hereunder shall in no way be released, discharged or otherwise affected for any reason, including without limitation: (a) any defect in the condition, merchantability, design, quality or fitness for use of the Property or any part thereof, or the failure of the Property to comply with all Applicable Laws, including any inability to occupy or use the Property by reason of such noncompliance; (b) any damage to, removal, abandonment, salvage, loss, condemnation (except as set forth in Article 12), theft, scrapping or destruction of or any requisition or taking of the Property or any part thereof, or any environmental conditions on the Property or any property in the vicinity of the Property; (c) any restriction, prevention or curtailment of or interference with any use of the Property or any part thereof including eviction; (d) any defect in title to or rights to the Property or any Lien on such title or rights to the Property; (e) any change, waiver, extension, indulgence or other action or omission or breach in respect of any obligation or liability of or by any Person; (f) any bankruptcy, insolvency, reorganization, composition, adjustment, dissolution, liquidation or other like proceedings relating to Lessee, Lessor or any other Person, or any action taken with respect to this Lease by any trustee or receiver of Lessee or any other Person, or by any court, in any such proceeding; (g) any right or claim that Lessee has or might have against any Person, including without limitation Lessor, the Lender, or any vendor, manufacturer, contractor of or for the Property; (h) any failure on the part of Lessor or any other Person to perform or comply with any of the terms of this Lease; (i) any invalidity, unenforceability, rejection or disaffirmance of this Lease by operation of law or otherwise against or by Lessee or Lessor or any provision hereof; (j) the impossibility of performance by Lessee or Lessor, or both; (k) any action by any court, administrative agency or other Governmental Authority; (l) any interference, interruption or cessation in the use, possession or quiet enjoyment of the Property; (m) the exercise of any remedy, including foreclosure, under the Mortgage, (n) any action with respect to this Lease (including the disaffirmance or rejection hereof) which may be taken by Lessor or Lessee under the Federal Bankruptcy Code or by any trustee, receiver or liquidator of Lessor or Lessee or by any court under the Federal Bankruptcy Code or otherwise, (o) the prohibition or restriction of Lessee’s use of the Property under any Applicable Laws or otherwise, (p) the eviction of Lessee from possession of the Property, by paramount title or otherwise, (q) any breach or default by the Lessor hereunder or under any

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other agreement between Lessor and Lessee; or (r) any other occurrence whatsoever, whether similar or dissimilar to the foregoing, whether foreseeable or unforeseeable, and whether or not Lessee shall have notice or knowledge of any of the foregoing. Except as specifically set forth in this Lease, this Lease shall be noncancellable by Lessee for any reason whatsoever and, except as expressly provided in this Lease, Lessee, to the extent now or hereafter permitted by Applicable Laws, waives all rights now or hereafter conferred by statute or otherwise to quit, terminate or surrender this Lease or to any diminution, abatement or reduction of Rent payable hereunder. Under no circumstances or conditions shall Lessor be expected or required to make any payment of any kind hereunder or have any obligations with respect to the use, possession, control, maintenance, alteration, rebuilding, replacing, repair, restoration or operation of all or any part of the Property, so long as the Property or any part thereof is subject to this Lease, and Lessee expressly waives the right to perform any such action at the expense of Lessor whether hereunder or pursuant to any law. Lessee waives all rights which are not expressly stated herein but which may now or hereafter otherwise be conferred by law (i) to quit, terminate or surrender this Lease or any of the Property; (ii) to have any setoff, counterclaim, recoupment, abatement, suspension, deferment, diminution, deduction, reduction or defense of or to Base Rent, Supplemental Rent, or any other sums payable under this Lease, except as otherwise expressly provided herein; and (iii) to have any statutory lien or offset right against Lessor or its property.

ARTICLE 4

INTENTIONALLY DELETED

ARTICLE 5

RENEWAL OPTIONS

Section 5.1. Renewal Options.

Lessor hereby grants to Lessee the option to extend the term of this Lease for the following periods (each, a “Renewal Term”):

(a) for four (4) consecutive terms of five (5) years each, the first commencing on the date that is the day after the expiration of the Base Term and ending on the fifth (5th) anniversary of the expiration of the Base Term (the “First Renewal Term”); the second (the “Second Renewal Term”) commencing on the day that is the day after the expiration of the First Renewal Term and ending on the fifth (5th) anniversary thereof; and the third (“Third Renewal Term”) commencing on the day that is the day after the expiration of the Second Renewal Term and ending on the fifth (5^th) anniversary thereof; and the fourth (the “Fourth Renewal Term”) commencing on the day that is the day after the expiration of the Third Renewal Term and ending on the fifth anniversary thereof, (collectively, the “Renewal Terms”).

In order to exercise its option to extend this Lease for any Renewal Term, the Lessee shall give Lessor written notice of its intent to exercise its option to extend the term of this Lease not less than twelve (12) months prior to the expiration of the Base Term or the then current Renewal Term, time being of the essence. If Lessee fails to provide such notice for any Renewal Term Lessee will be deemed to have waived its right to renew.

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(b) The monthly Base Rent for the Renewal Terms shall be as set forth on Schedule 3.1 hereof.

(c) The right of Lessee to extend the term of this Lease for any Renewal Term is contingent upon there not being any Lease Event of Default in existence on the date of Lessee’s exercise of such right or on the date that the Renewal Term commences.

5.2 Lease Provisions Applicable During Renewal. All the provisions of this Lease shall be applicable during each Renewal Term and the number of Renewal Terms shall be correspondingly reduced.

ARTICLE 6

LESSEE’S ACCEPTANCE OF PROPERTY, ENFORCEMENT OF WARRANTIES

Section 6.1. Waivers. The Property is demised and let by Lessor “AS IS” in its present condition, subject to (a) the rights of any parties in possession thereof (other than rights, if any, granted by Lessor), (b) the state of the title thereto existing at the time of the commencement of the Lease Term (other than defects in, or exceptions to, title, if any, created by Lessor, but including liens created by the Mortgage and related debt documents), (c) any state of facts which an accurate survey or physical inspection might show, (d) all Applicable Laws, (e) any violations of Applicable Laws which may exist at the commencement of the Lease Term and (f) the presence of any Hazardous Materials at or under the Property or at or under any property in the vicinity of the Property. NONE OF LESSOR, LENDER OR ANY AFFILIATE THEREOF HAS MADE OR SHALL BE DEEMED TO HAVE MADE ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, OR SHALL BE DEEMED TO HAVE ANY LIABILITY WHATSOEVER AS TO THE VALUE, HABITABILITY, COMPLIANCE WITH ANY PLANS AND SPECIFICATIONS, CONDITION, DESIGN, OPERATION, LOCATION, USE, DURABILITY, MERCHANTABILITY, CONDITION OF TITLE, OR FITNESS FOR USE OF THE PROPERTY (OR ANY PART THEREOF) FOR ANY PARTICULAR PURPOSE, OR ANY OTHER REPRESENTATION OR WARRANTY WHATSOEVER, EXPRESS OR IMPLIED, WITH RESPECT TO THE PROPERTY (OR ANY PART THEREOF) AND NONE OF LESSOR, ANY AFFILIATE THEREOF OR LENDER OR ANY DESIGNEE THEREOF SHALL BE LIABLE FOR ANY LATENT, HIDDEN, OR PATENT DEFECT THEREIN OR FOR THE FAILURE OF THE PROPERTY TO BE CONSTRUCTED IN ACCORDANCE WITH ANY PLANS AND SPECIFICATIONS THEREFORE, FOR THE COMPLIANCE OF THE PLANS AND SPECIFICATIONS FOR THE PROPERTY WITH APPLICABLE LAWS OR FOR THE FAILURE OF THE PROPERTY, OR ANY PART THEREOF, TO OTHERWISE COMPLY WITH ANY APPLICABLE LAWS. It is agreed that Lessee or an Affiliate of Lessee has occupied the Property as owner immediately prior to entering into this Lease, has inspected the Property, is satisfied with the results of its inspections of the Property and is entering into this Lease solely on the basis of the results of its own inspections and all risks incident to the matters discussed in the preceding sentence. The provisions of this Article 6 have been negotiated, and the foregoing provisions are intended to be

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a complete exclusion and negation of any representations or warranties by Lessor, any Affiliate thereof or a Lender, express or implied, with respect to the Property, that may arise pursuant to any law now or hereafter in effect, or otherwise and specifically negating any warranties under the Uniform Commercial Code.

Section 6.2. Lessee’s Right to Enforce Warranties.

(a) Lessor hereby assigns and sets over to, and Lessee hereby accepts the assignment of all of Lessor’s right, title and interest, and estate in, to and under, any and all warranties and other claims against dealers, manufacturers, vendors, contractors and subcontractors relating to the construction, use and maintenance of the Property or any portion thereof now existing or hereafter acquired (excluding from such assignment any such warranties and claims which by their terms are not assignable by Lessor without loss of some or all of the benefits of such warranties or claims); provided, however, that Lessor shall have no obligations under, or liabilities with respect to, any such warranties and claims.

(b) Lessor authorizes Lessee (directly or through agents) at Lessee’s expense to assert during the Lease Term, all of Lessor’s rights (if any) under any applicable warranty and any other claim that Lessee or Lessor may have against any dealer, vendor, manufacturer, contractor or subcontractor with respect to the Property or any portion thereof.

(c) Lessor agrees, at Lessee’s expense, to cooperate with Lessee and take all other action necessary as specifically requested by Lessee to enable Lessee to enforce all of Lessee’s rights (if any) under this Section 6.2, such rights of enforcement to be exclusive to Lessee, and Lessor will not, during the Lease Term, amend, modify or waive, or take any action under, any applicable warranty and any other claim that Lessee may have under this Section 6.2 without Lessee’s prior written consent.

ARTICLE 7

LIENS

Section 7.1. Liens. Lessee shall not directly or indirectly create, incur, assume or suffer to exist any Lien on or with respect to any and all of the Property, title thereto or any interest therein, to this Lease or the leasehold interest created hereby, or to Rent actually paid to Lessor, or the rentals payable with respect to the subletting of the Property (up to the amount of such rentals payable to Lessor hereunder), except Permitted Liens. Lessee shall promptly, but not later than sixty (60) days after receipt of notice of the filing thereof, at its own expense, take such action as may be necessary duly to discharge or eliminate or bond in a manner reasonably satisfactory to Lessor any such Lien (other than Permitted Liens); provided, however, Lessee may contest such Lien in good faith, upon satisfaction of the conditions contained in Section 8.6, below, and need not discharge or bond such Lien while so doing provided (i) Lessee has a long term unsecured debt rating equal to or above the Trigger Rating; (ii) no action to foreclose the Lien has been brought in any judicial or quasi-judicial action; and (iii) no Lease Event of Default is then continuing.

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NOTHING CONTAINED IN THIS LEASE SHALL BE CONSTRUED AS CONSTITUTING THE CONSENT OR REQUEST OF LESSOR, EXPRESS OR IMPLIED, TO OR FOR THE PERFORMANCE BY ANY CONTRACTOR, LABORER, MATERIALMAN, OR VENDOR OF ANY LABOR OR SERVICES OR FOR THE FURNISHING OF ANY MATERIALS FOR ANY CONSTRUCTION, ALTERATION, ADDITION, REPAIR OR DEMOLITION OF OR TO THE PROPERTY OR ANY PART THEREOF, WHICH WOULD RESULT IN ANY LIABILITY OF LESSOR FOR PAYMENT THEREFOR. NOTICE IS HEREBY GIVEN THAT LESSOR WILL NOT BE LIABLE FOR ANY LABOR, SERVICES OR MATERIALS FURNISHED OR TO BE FURNISHED TO LESSEE, OR TO ANYONE HOLDING AN INTEREST IN THE PROPERTY OR ANY PART THEREOF THROUGH OR UNDER LESSEE, AND THAT NO MECHANICS OR OTHER LIENS FOR ANY SUCH LABOR, SERVICES OR MATERIALS SHALL ATTACH TO OR AFFECT THE INTEREST OF LESSOR IN AND TO THE PROPERTY.

Notwithstanding the foregoing paragraph, Lessor agrees to reasonably cooperate with Lessee (without exposing its interest in the Property), at no cost to Lessor, to allow Lessee to perform alterations on the Property in accordance with Section 8.3.

ARTICLE 8

USE AND REPAIR

Section 8.1. Use. The Property may be used (“Permitted Use”) for any lawful purpose, except (a) for the operation of a public nuisance, or any other use that would materially increase the risk of Lessor incurring environmental liability, (b) for any use that would make it impossible to obtain or would invalidate any insurance policy of the Property, provided such policy is required to be maintained hereunder, (c) for any use that would involve the mining for, or removal of, any oil, gas or minerals, or (d) for any use that involves the storage, handling or processing of Hazardous Materials in violation of Applicable Law. Lessor agrees that Lessee may exercise the rights of Lessor under any property association now existing or hereafter existing, provided (i) Lessee takes no action which could result in either a violation of this Lease or a material adverse effect on the Property, and (ii) Lessee does not encumber the Property by any lien for the payment of money, which could survive expiration of the Lease, or execute documents on behalf of the Lessor unless such documents will not have a material adverse effect on the Property, or Lessor’s interest therein.

Section 8.2. Maintenance. Lessee, at its own expense, shall at all times, (i) maintain the Property in good condition and repair appropriate for its use, reasonable wear and tear excepted, (ii) maintain the Property in accordance with the requirements of all insurance policies relating to the Property required to be maintained hereunder and in compliance with Applicable Laws and (iii) make repairs and Alterations of the Property necessary to keep the same in the condition required by the preceding clauses (i) and (ii), whether interior or exterior, structural or nonstructural, ordinary or extraordinary, foreseen or unforeseen and regardless of whether such expenditures would constitute capital expenses under GAAP if made by the owner of the Property; provided, if such repairs are structural and pursuant to Section 8.3 require the consent of the Lessor, Lessee shall obtain such consent before performing such repairs in accordance with the applicable provisions of Section 8.3 below. In no event shall Lessor be entitled to any management fee, supervisory fee, administrative fee, or any other fee payable by Lessee relating to its ownership of the Property.

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Section 8.3. Alterations. (a) At any time and from time to time, without Lessor’s consent, Lessee, at its sole cost and expense, may make (1) non-structural Alterations to the Property; (2) structural Alterations to the Property costing, for each scope of work, as reasonably determined by Lessee, less than the Threshold Amount without prior notice to Lessor; and (3) Structural Alterations in an amount, for each scope of work, as reasonably determined by Lessee, at or above the Threshold Amount after giving prior written notice to Lessor, and obtaining Lessor’s prior written consent, which shall not be unreasonably withheld, conditioned or delayed; provided that no Alteration (whether consent is necessary or not) shall (i) impair in any material respect the utility, remaining useful life, or fair market value of the Property, in each case assuming that the Improvements are then being operated and maintained in accordance with this Article 8, or (ii) create a violation of this Lease, or (iii) increase in any material respect the risk of liability to the Lessor including any material risk of liability under any Environmental Laws, or (iv) materially and permanently reduce the rentable square footage of the Improvements, or (v) materially weaken, temporarily (other than during construction or repair of the structure) or permanently, the structure of the Improvements or any part thereof, or (vi) reduce the permitted uses thereof under applicable zoning or land use laws so as to reduce the fair market value of the Property. Notwithstanding the requirements for notice and consent set forth above, Lessee may, in good faith, make any repairs (structural or non-structural) required by virtue of an emergency, without satisfying any otherwise applicable notice and/or consent requirement, provided Lessee notifies Lessor of such repair (to the extent otherwise required) as promptly as is reasonably practical, after the emergency and obtains Lessor’s consent in the manner required in Section 8.3(c), below, to the repairs made, and otherwise satisfies the provisions of this Section 8.3, all as promptly as practicable. Lessor shall consent to any work already performed or being performed unless such work either violates the terms of this Lease or violates Applicable Law.

(b) Every Alteration shall comply with the following terms (which compliance shall be at Lessee’s sole cost and expense): (i) except (unless required by Applicable Law) for Alterations costing less than $2,000,000 (or $500,000.00 if Lessee does not have a Required Rating equal to at least the Trigger Rating) for each scope of work, as reasonably determined by Lessee, the Alteration shall be made with plans prepared by a certified architect or civil engineer who shall be licensed in the appropriate jurisdiction to the extent required for the filing of any plans in connection with such Alteration (which architect may be an employee of Lessee or its Affiliates), and shall be done under the supervision of such architect or engineer, or other reasonably capable person, and copies of such plans and specifications shall be delivered to Lessor prior to construction, (ii) the structural integrity of the existing Improvements will not be impaired upon completion of such work, (iii) Lessee shall obtain any licenses, approvals or permits required (including final approvals), copies of which shall be delivered to Lessor upon written request by such party, and (iv) such Alterations will not encroach upon any adjacent premises. Lessor agrees to cooperate with Lessee (at no cost to Lessor) in signing permit applications and similar documents to the extent required for any Alteration. Lessee shall submit such applications or similar documents to Lessor to the extent Lessor’s approval is required for the subject Alteration. Lessee may execute such applications or similar documents on behalf of and (if necessary) in the name of, Lessor for all Alterations for which Lessor’s consent is not

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required, and for Alterations for which Lessor’s consent is required, has been granted, but Lessor does not execute such documents within ten (10) days of request therefore. Lessee shall promptly furnish Lessor with copies of all documents Lessee has signed on behalf of Lessor. Nothing herein shall be deemed to impose any liability or responsibility on Lessor for performance or payment of such Alteration. Any Claim asserted against or incurred by Lessor arising out of the foregoing shall be indemnified by Lessee pursuant to the terms of Section 19.1, below. In connection with any Alteration, Lessee shall perform and complete all work promptly and in a good, worker-like manner in compliance with Applicable Laws and the plans and specifications submitted to Lessor, if applicable. Lessee shall either (i) maintain or cause to be maintained at all times during construction builder’s all risks insurance and comprehensive general liability insurance required under this Lease naming Lessor and Lender as loss payees as their interests may appear under such property insurance, and as additional insureds under such liability insurance or (ii) self insure the risk otherwise insured by the policies required in subsection (i) hereof, which self insurance shall be subject to, and available only upon satisfaction of, the provisions of Section 9.1(b). In the event Lessor and Lessee cannot agree as to whether Lessor unreasonably withheld its consent to a proposed Alteration, the parties agree to submit such dispute to the American Arbitration Association in California for binding resolution in accordance with its expedited arbitration procedures.

(c) With respect to such structural Alterations for which Lessee must obtain the consent of Lessor pursuant to the terms of this Lease, Lessor shall have fifteen (15) days after Lessee’s delivery of its request for consent, together with preliminary drawings and specifications for such Alterations, within which Lessor, may grant or not grant Lessee’s request for consent. If Lessor, shall have not within such 15-day period responded to Lessee, Lessee may give a second notice which clearly shall state in bold-face type that the failure to respond within five (5) days shall be deemed consent. If Lessor, shall not, within five (5) days after such second notice, notify Lessee that such consent will not be granted, such consent shall be deemed to have been granted. All reasonable out-of-pocket costs of review incurred by Lessor (whether or not the Alteration is approved) shall be paid by Lessee within thirty (30) days of receipt of an invoice therefore.

Section 8.4. Title to Alterations. Title to Alterations shall without further act vest in Lessor and shall be deemed to constitute a part of the Property and be subject to this Lease in the following cases:

(a) such Alteration shall be in replacement of or in substitution for a portion of the Improvements as of the date hereof,

(b) such Alteration shall be required to be made pursuant to the terms of Section 8.2; or

(c) such Alteration shall be Nonseverable.

If an Alteration is not within any of the categories set forth in Section 8.4(a) through Section 8.4(c), then title to such Alteration shall vest in Lessee and shall be removed by Lessee to the extent required in accordance with Article 10 hereof. All Alterations to which title shall vest in Lessee as aforesaid, and all Lessee’s Equipment and Personalty, so long as removal

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thereof shall not result in the violation of any Applicable Laws or this Lease, may be removed at any time by Lessee, provided that Lessee shall, at its expense, repair any damage to the Property caused by the removal of such Alteration. Lessee shall provide “AS-BUILT” plans to Lessor for any structural Alterations within a single scope of work (as reasonably determined by Lessee) costing in excess of $2,000,000.00.

Section 8.5. Compliance with Law; Environmental Compliance.

(a) Lessee, at Lessee’s expense, shall comply, and shall cause its subtenants and other users of the Property to comply, in all material respects at all times with all Applicable Laws, including Environmental Laws. Such compliance includes, without limitation, Lessee’s obligation, at its expense, to take Remedial Action when required by Applicable Laws (in accordance with Applicable Laws, and this Lease) whether such requirement is now or hereafter existing, currently known or unknown to Lessee and/or Lessor, as and when such requirements are known to Lessee. Lessee shall not, however, be responsible to take Remedial Action in connection with a Release caused solely by the active (but not passive) actions of Lessor or its employees, agents or contractors. In the event that Lessee is required or elects to enter into any plan relating to a Material Remedial Action in connection with the Property with respect to any Environment Laws, Lessee shall periodically apprise Lessor of the status of such remediation plan and, upon Lessor’s request, provide copies of all correspondence, plans, proposals, contracts and other documents relating to such plan or proposed plan. Lessee may in good faith contest the applicability or alleged liability under any Environmental Law to the Property, provided (i) such contest will not result in a lien, encumbrance or judgment against the Property or Lessor, (ii) such contest satisfies the conditions set forth in subsections 8.6(c)(i), (ii), (iii), (iv), (v), (vi) and (vii), below, (iii) Lessee then has a Required Rating equal to or better than the Trigger Rating, and (iv) compliance with such Law will be satisfied as of the expiration date or earlier termination of the Lease, and if not completed by the expiration date, Lessee will continue to remain liable to comply with such Law and shall diligently prosecute such plan, and Lessor shall provide access to the Property to allow Lessee to finish its remediation plan. Lessee shall keep Lessor regularly apprised of the status of such contest. In all events Lessee must pay any cost, fine, penalty, assessment or other charge after the contest is either adversely decided or terminated voluntarily by Lessee or because it no longer has the right to contest pursuant to the terms of the Lease. In the event Lessee does not have a Required Rating equal to or in excess of the Trigger Rating, Lessee may nonetheless contest the applicability of any Environmental Law provided that Lessee and Lessor agree upon an Approved Environmental Consultant who shall, at Lessee’s sole cost and expense, prepare a report within sixty (60) days of being retained, which report shall state the costs the Approved Environmental Consultant reasonably believes is likely to be incurred by Lessee to comply with the Environmental Law in the event Lessee loses its contest. If, within thirty (30) days of receipt of said report, Lessee posts a letter of credit or other bond in a form reasonably acceptable to Lessor or deposits cash with the Proceeds Trustee an amount equal to 110% of the cost estimated by the Approved Environmental Consultant to comply with the Environmental Law, Lessee may continue the contest, provided the other terms of this Section 8.5 are met. In the event Lessee loses the contest and is forced to incur costs to comply with the Environmental Law, the Proceeds Trustee shall dispense the amount retained by it pursuant to this paragraph from time to time, in accordance with the provisions of Section 12.4

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below, with any balance remaining thereafter to be disbursed to Lessee provided no Lease Event of Default then exists and is continuing. Lessor and Lessee shall reasonably cooperate in selecting the Approved Environmental Consultant.

(b) Lessee shall notify Lessor promptly if (i) Lessee becomes aware of the presence or Release of any Hazardous Material at, on, under, emanating from, or migrating to, the Property in any quantity or manner, which could reasonably be expected to violate in any material respect any Environmental Law or give rise to any Material liability, or (ii) Lessee receives any written notice, claim, demand, request for information, or other communication from a Governmental Authority or a third party regarding the presence or Release of any Hazardous Material at, on, under, within, emanating from, or migrating to the Property or related to the Property which could reasonably be expected to violate in any material respect any Environmental Law or give rise to any Material liability. In connection with any actions undertaken by Lessee or at Lessee’s direction pursuant to this Lease, Lessee shall at all times comply with all applicable Environmental Laws and with all other Applicable Laws and shall use an Approved Environmental Consultant to perform any Remedial Action.

Section 8.6. Payment of Impositions.

(a) Lessee shall pay or cause to be paid all Impositions before any fine, penalty, premium, further interest (except as provided in the immediately succeeding sentence with respect to installments) or cost may be assessed or added for nonpayment, such payments to be made directly to the taxing authorities where feasible. If requested, Lessee shall deliver to Lessor copies of receipts, canceled checks or other documentation reasonably satisfactory to Lessor evidencing payment of Impositions to the extent Lessee maintains such documentation as part of its customary retention policy; provided, however, that Lessee shall maintain in its records evidence of payment of Taxes for a period of no less than four (4) years. If any such Imposition may, at the option of the taxpayer, lawfully be paid in installments (regardless whether interest shall accrue on the unpaid balance of such Imposition), Lessee may exercise the option to pay the same in installments, and in such event Lessee shall pay only those installments that become due and payable during the Lease Term or relate to the Lease Term, as the same become due and before any fine, penalty, premium, further interest or cost may be assessed or added thereto.

(b) Lessee shall pay to Lessor on each Rent Payment Date one-twelfth of the Taxes that Lessor estimates will be payable during the next ensuing twelve (12) months in order to accumulate with Lessor sufficient funds to pay all such Taxes at least thirty (30) days prior to their respective due dates and (said amounts are hereinafter called the “Tax Escrow Fund”). The Tax Escrow Fund and the other payments of Rent, shall be added together and shall be paid, monthly, as an aggregate sum by Lessee to Lessor. Lessor will apply the Tax Escrow Fund to payments of Taxes required to be made by Lessee pursuant to this Lease. In making any payment relating to the Tax Escrow Fund, Lessor may do so according to any bill, statement or estimate procured from the appropriate public office or from Lessee without inquiry into the accuracy of such bill, statement or estimate or into the validity of any tax assessment, sale, forfeiture, tax lien or title or claim thereof, provided, however, Lessor shall use reasonable efforts to pay such real property taxes sufficiently early to obtain the benefit of any available

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discounts of which it has knowledge. If the amount of the Tax Escrow Fund shall exceed the amounts due for Taxes, Lessor shall, in its sole discretion, return any excess to Lessee or credit such excess against future payments to be made to the Tax Escrow Fund. Any amount remaining in the Tax Escrow Fund in excess of the Taxes payable by Tenant hereunder shall be promptly returned to Lessee upon the expiration or earlier termination of the Lease. If at any time Lessor reasonably determines that the Tax Escrow Fund is not or will not be sufficient to pay Taxes by the dates set forth above, Lessor shall notify Lessee of such determination and Lessee shall increase its monthly payments to Lessor by the amount that Lessor estimates is sufficient to make up the deficiency at least thirty (30) days prior to delinquency of the Taxes.

(c) Notwithstanding the foregoing paragraphs (a) and (b), Lessee shall have the right to contest any Imposition, subject to the following: (i) such contest shall be at its sole cost and expense, (ii) if the Imposition being contested is in the amount of $2,000,000.00 or more, Lessee shall provide prompt notice to Lessor of such Imposition and contest and the grounds thereof, and either (A) have a Required Rating equal to the Trigger Rating or (B) post a letter of credit or other bond in a form reasonably acceptable to Lessor or deposit cash with the Proceeds Trustee in an amount equal to 110% of the amount contested, as reasonably determined by the Lender, to the extent such contested Imposition is not paid to the applicable Governmental Authority, (iii) such contest shall be by appropriate legal proceedings conducted in good faith and with due diligence, (iv) such contest will operate to suspend the collection of, or other realization upon, such Imposition, from any Property or other interest of Lessor or from any Rent (or otherwise affect Lessee’s obligation to pay, and Lessor’s right to receive, Rent), (v) such contest will not adversely affect the Lender’s lien on any Property, or Lessor’s right to any Property (for purposes hereof, “adversely affecting” being deemed to mean such lien or Lessor’s right is subject to reasonable likelihood of extinguishment), (vi) such contest will not materially and adversely interfere with the possession, use or occupancy or sale of any Property, (vii) such contest will not subject Lessor or the Lender to any civil (other than for the amounts being contested) or criminal liability, (viii) Lessee shall not postpone the payment of any Imposition for such length of time as shall permit the Property to become subject to a lien created by such item being contested that is prior to the lien of the Mortgage (other than a lien of real property taxes which are already a first lien) and (ix) no Lease Event of Default is existing. Lessee shall pay any Imposition (and related costs) promptly after forgoing any contest or after receipt of a final non-appealable adverse judgment.

Section 8.7. Adjustment of Impositions. Impositions with respect to the Property for a billing period during which Lessee’s obligation to indemnify Lessor pursuant to this Lease expires or terminates as to the Property shall be adjusted and prorated on a daily basis between Lessor and Lessee, whether or not such Imposition is imposed before or after such expiration or termination, and Lessee’s and Lessor’s obligation to pay its pro rata share thereof shall survive such expiration or termination (to the extent, with respect to Lessor, it is obligated to reimburse Lessee for Impositions paid by Lessee for periods after expiration of the Lease Term). Lessor acknowledges that Lessee may bring any tax certiorari or other actions for refunds of Impositions or adjustments of Impositions for which Lessee is liable under this Lease, or relating to periods prior to the commencement date of the Term and Lessee shall be entitled to all such refunds; provided Lessee shall take no such action which could increase any Imposition for a period after the expiration of the Lease. During the Term, Lessor agrees to cooperate with Lessee in such proceedings, at no cost to Lessor.

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Section 8.8. Utility Charges. Lessee shall pay or cause to be paid, directly to the party entitled, all charges for electricity, power, gas, oil, water, telephone, sanitary sewer services and all other utilities used in or on the Property prior to and during the Lease Term, and such obligation on the part of Lessee shall survive the expiration or earlier termination of this Lease until all such outstanding balances for services rendered prior to or during the term of this Lease have been paid. Any refunds of such charges attributable to the Term or the period prior to the commencement of the Term shall be the property of Lessee, and Lessor shall pay the same to Lessee promptly upon its receipt thereof. Lessee shall have the right to select all service providers for the Property. Lessor shall not be entitled to charge any fees associated with Lessee’s acquisition and/or use of utilities.

Section 8.9. Litigation; Zoning; Joint Assessment. Lessee shall give prompt written notice to Lessor of any litigation or governmental proceedings pending or threatened against Lessee or the Property of which Lessee has actual knowledge, which could reasonably be expected to materially adversely affect the condition or business of the Property. Without the prior written consent of Lessor, which consent shall not be unreasonably withheld, conditioned, or delayed, Lessee shall not initiate any zoning reclassification for the Property, or any portion thereof, or seek any variance under any existing zoning ordinances or use or permit the use of any portion of the Property in any manner that could result in such use becoming a non-conforming use under any zoning ordinance or any other Applicable Law. Lessee shall not initiate any proceeding to cause the Property to be jointly assessed with any other property or with any personal property of Lessee, or take any other action or initiate any proceeding which might cause the personal property of the Lessee to be taxed in a manner whereby such taxes or levies could be assessed against the Property.

ARTICLE 9

INSURANCE

Section 9.1. Coverage.

(a) Subject to Section 9.1(b), Lessee shall maintain insurance of the types and in the amounts set forth on Schedule 9.1 attached hereto and made a part hereof.

(b) So long as (i) no Lease Event of Default has occurred and is continuing and (ii) Lessee has a Required Rating at least equal to the Trigger Rating, Lessee shall be entitled to self-insure against any and all risks it would otherwise be required to insure against under Section 9.1(a), provided that such self-insurance program of this subsection (b) does not violate any Applicable Law. During any period that Lessee is self-insuring, Lessee shall not be required to deliver any policies, certificates or other evidence of insurance other than a certificate of self-insurance acknowledging Lessee’s insurance obligation under the Lease, and confirming Lessee’s decision to self-insure (to the extent Lessee is in fact self insuring). If Lessee does not, or is not permitted to, self-insure, then (i) Lessee shall maintain a policy or policies of commercial general liability insurance with respect to the Property, and shall cause Lessor and the Lender to be

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named as an additional insured on such policy or policies and (ii) Lessee shall maintain a policy or policies of property insurance with respect to the Property, and Lessee shall cause Lessor and the Lender to be named loss payee as their interests may appear on such policy or policies, all in forms and amounts as set forth in Schedule 9.1.

(c) Nothing in this Article 9 shall prohibit the Lessee from maintaining at its expense insurance on or with respect to the Property, naming the Lessee as insured and/or loss payee for an amount greater than the insurance required to be maintained under this Section 9.1, unless such insurance would conflict with or otherwise limit the availability of or coverage afforded by insurance required to be maintained under Section 9.1. Nothing in this Section 9.1 shall prohibit the Lessor from maintaining at its expense other insurance on or with respect to the Property or the operation, use and occupancy of the Property, naming the Lessor as insured and/or payee, unless such insurance would conflict with, cause the Lessor to be a coinsurer or otherwise limit or adversely affect the ability to obtain, or the cost of the insurance required to be maintained under Section 9.1.

(d) Copies of any certificates required to be delivered under Schedule 9.1 shall be delivered to Lessor at the same time delivered to the Lender.

(e) Irrespective of the cause thereof, Lessor shall not be liable for any loss or damage to any buildings or other portion of the Property resulting from fire, explosion or any other casualty. In the event of Lessee’s failure to obtain or maintain the insurance called for under this Lease after notice and applicable grace, Lessor shall have the right, together with Lessor’s remedies set forth herein, to obtain the policies of insurance required under this Lease and to bill Lessee for the premium payments therefor, together with interest at the Default Rate. Lessor shall have no obligation to maintain insurance of any nature or type whatsoever.

(f) In the event Lessee elects to self-insure, it shall be obligated to use or pay to third parties, all amounts that Lessor, or such third party, would have received had Lessee not self-insured. The foregoing shall not, however, act as a limit on Lessee’s liability. Sums due from Lessee in lieu of insurance proceeds because of Lessee’s self-insurance program shall be treated as insurance proceeds for all purposes under this Lease.

(g) Each policy required to be carried by Lessee under this Lease shall also provide that any loss otherwise payable thereunder shall be payable notwithstanding any act or omission of Lessor or Lessee which might, absent such provision, result in a forfeiture of all or a part of such insurance payment.

(h) Lessee shall comply with all insurance requirements applicable under any insurance policies required to be maintained under this Lease.

ARTICLE 10

RETURN OF PROPERTY TO LESSOR

Section 10.1. Return of Property to Lessor. Lessee shall, upon the expiration or termination of this Lease, and at its own expense, return the Property to Lessor by surrendering the same into the possession of Lessor:

(a) free and clear of all Liens (whether by payment or bonding), except that Lessee shall have no responsibility or liability in respect of (i) Lessor Liens, (ii) any Lien created by the Mortgage and related debt documents, and (iii) Liens for taxes not yet due and payable; and

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(b) in compliance in all material respects with all Applicable Laws and in compliance with the maintenance conditions required by this Lease. All Alterations and Lessee’s Equipment and Personalty not removed by Lessee by the last day of the Lease Term (but in the event of a termination other than upon the expiration of the Base Term or any Renewal Term, within thirty (30) days after said termination of this Lease), other than those Alterations as to which title shall vest in Lessor pursuant to Section 8.4, shall be deemed abandoned in place by Lessee and shall become the property of Lessor. Lessee shall pay or reimburse Lessor for any reasonable, actual, out-of-pocket costs incurred by Lessor in connection with the removal or disposal of such relinquished property, which obligation shall survive the expiration or termination of this Lease. In no event shall Lessee be required to remove or pay for the removal of any built in, permanent fixtures or improvements existing on, or within, the Property as of the date of this Lease or for any raised computer floors built during the Term or for any other Alterations made in compliance with the terms of this Agreement, or for any cabling or wiring (or similar property) now or hereafter located on or in the Property.

Upon the return of the Property, Lessee shall deliver therewith:

(i) all transferable licenses and permits pertaining to the Property by general assignment, without warranty or recourse;

(ii) as built-drawings including plans for HVAC, mechanical and electrical systems, to the extent in Lessee’s possession and not previously delivered to Lessor, without warranty or recourse;

(iii) keys to the Property; and

(iv) assignment of all maintenance contracts (to the extent required by Lessor) and existing warranties applicable to the Property by general assignment, without warranty or recourse to the extent assignable.

Lessee agrees to reasonably cooperate with Lessor and its representatives to effectuate a smooth transition of the operation and maintenance of the Property. Notwithstanding anything expressly to the contrary hereunder, providing Lessee surrenders the Property and all Alterations and Equipment upon the expiration or termination of this Lease in compliance with all Applicable Laws, the failure to remove any of Lessee’s Alterations or Equipment in accordance with the provisions hereof shall not result in Lessee being deemed a holdover tenant hereunder.

ARTICLE 11

ASSIGNMENT BY LESSEE

Section 11.1. Assignment by Lessee. So long as no Lease Event of Default has occurred and is continuing, Lessee may, at Lessee’s sole expense, without the consent of Lessor, assign

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this Lease for a period that does not extend beyond the Lease Term, to any Person, provided, however, that any such Person or other Person is not a debtor or debtor-in- possession in a voluntary or involuntary bankruptcy proceeding at the commencement of the assignment. For purposes hereof, an assignment shall include a merger or consolidation of Lessee. Any assignee shall assume in writing any obligations of Lessee arising from and after the effective date of the assignment, provided, however, that no such assignment shall become effective until (i) a fully executed copy of an assignment and assumption agreement shall have been delivered to Lessor and the Lender, and (ii) such assignee shall have executed such instruments and other documents and provided such further assurances as the Lender shall reasonably request to ensure that such assignment is subject to the Mortgage and any related debt documents. Notwithstanding any such assignment, Lessee shall not be released from its primary liability hereunder and shall continue to be obligated for all obligations of “Lessee” in this Lease, which obligations shall continue in full effect as obligations of a principal and not of a guarantor, as though no assignment had been made. Lessee will have the right, subsequent to any assignment (a) to receive a duplicate copy of each notice of default sent by Lessor to any assignee (but such notice shall be effective as against the Lessee, as well as any subsequent assignees, even if a copy has not been delivered to such requesting assignee), and (b) to cure any default by any assignee under the Lease within the cure period provided for hereunder. Lessee’s liability hereunder shall continue notwithstanding the rejection of this Lease by an assignee or any sublease of this Lease pursuant to Section 365 of Title 11 of the United States Code, any other provision of the Bankruptcy Code, or any similar law relating to bankruptcy, insolvency, reorganization or the rights of creditors, which arises subsequent to such assignment. In the event Lessee assigns this Lease and it shall thereafter be rejected in a bankruptcy or similar proceeding, a new lease identical to this Lease shall be re-instituted as between Lessor and Lessee without further act of either party, provided Lessor shall not be obligated to deliver to Lessee possession of the Property free of any tenancy created or caused by Lessee or any entity holding by or through Lessee but Lessee may, in Lessor’s name, but at Lessee’s expense, take such action as it deems appropriate to have such assignee removed from the Property. Lessor shall reasonably cooperate with Lessee in such efforts. Nothing herein shall be construed to permit Lessee to mortgage, pledge, hypothecate or otherwise collaterally assign in any manner or nature whatsoever Lessee’s interest under this Lease in whole or in part. Lessee shall provide written notice to Lessor and the Lender of any assignment of this Lease within thirty (30) days after the effective date thereof and an executed copy of the approved agreement of assignment and assumption within thirty (30) days after the execution thereof. To the extent an assignee of this Lease fails to perform on behalf of Lessee the obligations of Lessee hereunder, and Lessee performs such obligations, then Lessee shall be subrogated to the rights of Lessor as against such assignee in respect of such performance.

ARTICLE 12

LOSS; DESTRUCTION; CONDEMNATION OR DAMAGE

Section 12.1. Event of Loss. If there shall occur an Event of Loss with respect to the Property (the “Affected Property (for purposes of this Lease, the Affected Property being the entire Property)”), Lessee shall give Lessor prompt written notice thereof and elect, within sixty (60) days after the occurrence of the Event of Loss, one of the following options:

(i) Offer to purchase the Affected Property from Lessor, on a Rent Payment Date, (the “Stipulated Loss Value Date”), and which Rent Payment Date shall be the first Rent Payment

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Date at least forty (40) days after Lessor accepts such offer, for a purchase price equal to the sum of (A) the Stipulated Loss Value for the Affected Property, determined as of such Stipulated Loss Value Date, plus (B) all unpaid Rent with respect to the Affected Property due but unpaid through such Stipulated Loss Value Date, plus (C) an amount equal to the reasonable out-of-pocket attorneys’ fees of Lessor relating to the purchase by Lessee as a result of such Event of Loss. Lessor (subject to the consent of the Lender), shall have sixty (60) days from the date of receipt of Lessee’s offer to decide whether to reject such offer. If Lessee has not received a response after forty (40) days, it may send a second notice to the foregoing parties, stating clearly in boldface that Lessor’s failure to reject such offer by the later of (i) the original sixty (60) day period, or (ii) ten (10) days after delivery of such second notice, shall be deemed Lessor’s acceptance of such offer; or

(ii) Restore and rebuild the Improvements damaged as a result of such Event of Loss (regardless of the availability of any insurance proceeds) so as to have a value, utility and remaining useful life as nearly as reasonably practicable equal to the value, utility and remaining useful life of the Affected Property immediately prior to such Event of Loss, and in all events as required by Section 8.2, such restoration to be done as expeditiously as is commercially reasonable and to be substantially completed, subject to force majeure, within twenty four months from the date of the Event of Loss, and in any event by the expiration of the Lease Term (and Lessee shall remain liable for the completion of such restoration beyond the expiration of the Lease Term to the extent not completed prior to such expiration but Lessee’s obligation to complete the Improvements shall not constitute a holdover by Lessee, who shall be granted access to the Property for such completion). In the event, due to force majeure events, restoration cannot be completed by the expiration of the Term, Lessee shall diligently complete the restoration thereafter and shall be liable to pay Base Rent (based on the Base Rent in effect on the day prior to the expiration of the Term (on a per diem basis)) and Supplemental Rent, until such restoration is complete.

Notwithstanding the options described in subsections 12.1(i) and (ii) if the Event of Loss occurs in the last of two (2) years of the Term, Lessee shall have the right to terminate the Lease effective as of the date of delivery of a notice of termination to Lessor not later than sixty (60) days following the Event of Loss. Upon such termination Lessor shall be entitled to all insurance proceeds and Lessee shall credit Lessor with all deductible amounts and Rent until the effective date of such termination. Lessee shall not have the right to terminate this Lease upon an Event of Loss if Lessee has exercised or intends to exercise its early termination right as provided for in the definition of Base Term. In other words Lessee does not, under any circumstances, have the right to exercise both rights of early termination and the right to terminate this Lease upon an Event of Loss pursuant to this paragraph.

If Lessee makes an offer to purchase pursuant to clause (i) above of this Section 12.1, and Lessor accepts such offer or is deemed to accept such offer within the sixty (60) day period referred to in the last sentence of clause (i) above, the conveyance shall occur, and Lessee shall pay to Lessor the Stipulated Loss Value and Rent described in said clause (i) on the Stipulated Loss Value Date; provided that any Net Proceeds related to the Affected Property then held by Lessor or the Lender shall be credited against the portion of such purchase price payable to Lessor and the balance of Net Proceeds, if any, shall be paid to or retained by Lessee. Concurrently with the payment in full of the amounts payable pursuant to said clause (i), the terms of Article 22 shall be complied with.

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In the event Lessor rejects the offer of Lessee to purchase the Affected Property as provided in clause (i) of this Section 12.1 (which it may not do without the Lender’s written consent unless it first pays to the Lender an amount sufficient to pay all amounts due Lender with respect to the Affected Property ), the following amount shall be paid to or retained by Lessor on such Stipulated Loss Value Date: (A) all Net Proceeds related to the Affected Property, provided that, if Lessee is self-insured (as permitted above) by means of deductibles, retained risks or no insurance whatsoever, Lessee shall pay such amounts or additional amounts so that Lessor receives in total (including any Net Proceeds) an amount that would have been paid by a third-party insurer under a customary commercial all-risk full replacement-value insurance policy substantially similar to that described in Schedule 9.01(a)(ii) without deductibles or retained risks (but in any case amounts paid to Lessor will not be in excess of the replacement value of the Improvements immediately preceding the Event of Loss, which replacement value shall be as mutually agreed between Lessee and Lessor and, failing such agreement within fifteen (15) days of the request of either party to do so, by the Appraisal Procedure), plus (B) unpaid Rent due with respect to the Affected Property on and through such Stipulated Loss Value Date.

Upon payment in full of the amounts set forth in clauses (A) and (B) of the preceding paragraph (in the event Lessor rejected Lessee’s offer) or upon payment in full of the amounts set forth in clause (i) of the first sentence of this Section 12.1 and consummation of the sale to Lessee (or its designee) (in the event Lessor accepted Lessee’s offer to purchase), (1) the Lease Term shall end, and (2) the obligations of Lessee hereunder (other than any obligations expressed herein as surviving termination of this Lease) shall terminate as of the date of such payment.

If Lessor elects to reject the offer of Lessee hereunder to purchase the Property pursuant to this Section 12.1 while a Mortgage encumbers the Property, any notice of rejection shall only be effective, and Lessor shall only be entitled to reject such offer, if such notice is in writing and either such rejection is concurrently consented to in writing by the Lender or Lessor concurrently with delivery of its rejection notice pays to the Lender all amounts secured by the Mortgage with respect to the Affected Property, and reasonably evidences such payment to Lessee, and absent such repayment or consent by the Lender within the period referred to in the last sentence of clause (i) above, Lessor shall be deemed to have accepted Lessee’s offer.

Section 12.2. Application of Payments Upon an Event of Loss When Lease Continues. Payments received at any time by Lessor or Lessee from any Governmental Authority or insurance carrier or other Person with respect to any Event of Loss in a case in which this Lease will not terminate (and there will occur no abatement or reduction of rent) because Lessee has elected to proceed under clause (ii) of Section 12.1, shall be paid to Lessee to be applied, as necessary, to the repair or restoration of the Property as described in clause (ii) of Section 12.1. Any excess insurance proceeds remaining thereafter shall be retained by Lessee. In the event of a condemnation which does not result in a termination of the Lease, the proceeds of the Condemnation award remaining after repair and restoration, to the extent the excess equals or exceeds $500,000.00, shall be paid to the Lessor. The first $500,000.00 of excess Condemnation proceeds shall be allocated between Lessor and Lessee as set forth on Schedule 12.2 attached hereto. In no event shall Rent be adjusted.

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Section 12.3. Application of Payments Not Relating to an Event of Loss. In case of a Condemnation or Casualty which is not an Event of Loss or which does not result in a termination of this Lease in accordance with the above provisions of Article 12, this Lease shall remain in full force and effect, without any abatement or reduction of Rent. Subject to Section 12.4, all Net Casualty Proceeds and all Net Condemnation Proceeds, as the case may be, shall be paid to Lessee to be applied, as necessary, to the repair or restoration of the Property so such Property shall have a value, utility and remaining useful life as close as reasonably practicable to the value, utility and remaining useful life existing immediately prior to such Casualty or Condemnation. Any excess insurance proceeds remaining thereafter shall be retained by Lessee and any excess condemnation award remaining thereafter in excess of $500,000.00 shall be paid to Lessor. The first $500,000.00 of excess condemnation proceeds shall be divided by Lessor and Lessee as set forth on Schedule 12.2.

Section 12.4. Other Dispositions. Net Casualty Proceeds or Net Condemnation Proceeds, as the case may be, in excess of the Threshold Amount (each, as applicable, the “Restoration Fund”) in respect of such Casualty or Condemnation, as the case may be, shall be paid to the Proceeds Trustee for release to Lessee as restoration progresses, subject to and in accordance with Section 12.4(a). Lessor and Lessee hereby authorize and direct (i) any insurer, to make payment in excess of the Threshold Amount under policies of casualty insurance required to be maintained by Lessee pursuant to Section 9.1(a) directly to the Proceeds Trustee instead of to Lessor and Lessee jointly, and (ii) any Governmental Agency to make payments of any Net Condemnation Proceeds in excess of the Threshold Amount directly to the Proceeds Trustee instead of to Lessor and/or Lessee; and each of Lessee and Lessor hereby appoints the Proceeds Trustee as its attorney-in-fact to endorse any draft therefor for the purposes set forth in this Lease after approval by Lessee of the Proceeds Trustee, if the Proceeds Trustee is other than the Lender. In the event that a Casualty shall occur at such time as Lessee shall not have maintained property or casualty insurance to the extent required by said Section 9.1(a) (i.e., Lessee is self-insuring in whole, or in part), Lessee shall be obligated to pay itself towards restoration the amount it self insures. Lessee shall be obligated to pay the Threshold Amount (or any amount it self-insured) towards restoration costs prior to the disbursement of any funds from the Restoration Fund.

(a) The Restoration Fund, if any, shall be disbursed by the Proceeds Trustee by wire transfer of immediately available funds within five (5) Business Days of the last submission made pursuant to and in accordance with the following conditions (provided that there shall be no more than one disbursement during each month):

(i) At the time of any disbursement, no Lease Event of Default shall exist and, subject to Article 7, no mechanics’ or materialmen’s liens shall have been filed and remain undischarged, unbonded or not insured over.

(ii) Disbursements (subject to the holdback in Section 12.4(a)(iv) below) shall be made from time to time in an amount not exceeding the hard and soft cost of the work and costs incurred since the last disbursement upon receipt of (1) satisfactory evidence,

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including architects’ certificates when required pursuant to Section 8.3, of the stage of completion, of the estimated cost of completion and of performance of the work to date in a good and workmanlike manner in accordance with the contracts, plans and specifications, (2) partial releases of liens from Lessee’s general contractor in respect of the disbursement made pursuant to the immediately preceding request, and (3) other reasonable evidence of cost incurred (whether or not paid) so that the Proceeds Trustee is able to verify that the amounts disbursed from time to time are represented by work that is completed in place or delivered to the site and free and clear of (subject to Article 7), mechanics’ and materialmen’s lien claims.

(iii) Each request for disbursement shall be accompanied by a certificate of Lessee (1) agreeing to use amounts disbursed for the costs described in Section 12.4(a)(iv), (2) describing the work, materials or other costs or expenses for which payment is requested, (3) stating the cost incurred in connection therewith, (4) stating that Lessee has paid costs and expenses for such work in an amount equal to the self insured and/or deductible amounts as permitted by Section 9.1(b) (and attaching thereto evidence thereof reasonable satisfactory to Lessor) and (5) stating that Lessee has not previously received payment for such work or expense and the certificate to be delivered by Lessee upon completion of the work shall, in addition, state that the work has been substantially completed and complies with the applicable requirements of this Lease.

(iv) The Proceeds Trustee shall retain ten percent (10%) of the amounts otherwise disbursable until the restoration is at least fifty percent (50%) complete, and thereafter five percent (5%) until the restoration is substantially complete.

(v) The Restoration Fund shall be kept by the Proceeds Trustee in a separate interest-bearing federally insured account or invested in Permitted Investments (as directed by, or on behalf of, Lessee).

(vi) Prior to commencement of restoration and at any time during restoration, if the estimated cost of restoration, as reasonably determined by the Proceeds Trustee, exceeds the then amount of the Restoration Fund, Lessee shall fund at its own expense the costs of such restoration until the remaining Restoration Fund is sufficient for the completion of the restoration. In the case of Casualty, any sum in the Restoration Fund which remains in the Restoration Fund upon the completion of restoration shall be paid to Lessee. In the case of Condemnation, any sum in the Restoration Fund which remains in the Restoration Fund upon the completion of restoration shall be applied as set forth in Section 12.2.

Section 12.5 Negotiations. In the event the Property becomes subject to condemnation or requisition proceedings, Lessee shall control the negotiations with the relevant Governmental Authority, unless: (i) a Lease Event of Default shall be continuing, or (ii) the Net Condemnation Proceeds will likely be in excess of the Threshold Amount (which determination shall be made in Lessor’s reasonable discretion), in which case Lessor may elect in writing to control such negotiations; provided that in any event Lessor may elect to participate in such negotiations. Lessee shall give to Lessor and the Lender such information, and copies of such documents, which relate to such proceedings and are in the possession of Lessee, as are reasonably requested

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by Lessor or the Lender. Lessor shall confer with Lessee as to any negotiations with Governmental Authorities material to Lessee’s operations and shall not agree to any act that would have a material adverse effect on Lessee’s business. Notwithstanding the foregoing, in jurisdictions where a separate award may be granted for Lessee’s Equipment and Personalty, moving and relocation expenses, business loss, business damages, loss of goodwill, unamortized costs of any Alterations title for which has not vested in Lessor pursuant to the terms of this Lease, and Lessee’s attorneys’ fees, costs and expenses in the proceedings, Lessee may assert claims for and control the negotiations pertaining to such interests, provided that the Lessor’s award in respect to the Property is not diminished by the award to Lessee. Lessee acknowledges that no payments shall be permitted hereunder other than on a Rent Payment Date.

ARTICLE 13

INTENTIONALLY OMITTED

ARTICLE 14

SUBLEASE

Section 14.1. Subleasing Permitted; Lessee Remains Obligated. Provided that no Lease Event of Default shall have occurred and be continuing at the time the sublease is entered into, upon fifteen (15) days’ prior written notice to Lessor (except for subleases to Affiliates, in which case no notice shall be required), Lessee may at any time and from time to time sublease the Property or any portion or portions thereof to any Person or permit the occupancy of the Property or any portion or portions thereof by any Person who is not a debtor or debtor-in-possession in a voluntary or involuntary bankruptcy proceeding at the commencement of the sublease term. Any such sublease, sub-sublease, license, occupancy agreement or similar agreement (each, a “Sublease”) shall not release Lessee from its primary liability for the performance of its duties and obligations hereunder, and Lessee shall continue to be obligated for all obligations of “Lessee” in this Lease, which obligations shall continue in full effect as obligations of a principal and not of a guarantor, as though no Sublease had been made. From time to time, but in no event more than once annually, upon Lessor’s request, Lessee shall forward to Lessor the names, businesses and square footage leased (or location) of all subtenants (other than Subleases to Affiliates).

Section 14.2. Provisions of Subleases. Each Sublease will:

(a) be expressly subject and subordinate to this Lease and any mortgage (including (the Mortgage) encumbering the Property;

(b) not extend beyond the Lease Term minus one (1) day; and

(c) terminate upon any termination of this Lease, unless Lessor elects in writing (which election must be consented to by the Lender), to cause the sublessee to attorn to and recognize Lessor as the lessor under such Sublease, whereupon such Sublease shall continue as a direct lease between the sublessee and Lessor upon all the terms and conditions of such Sublease (it being agreed that all Subleases with Affiliates of Lessee shall automatically terminate upon termination of this Lease).

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Section 14.3. Assignment of Sublease Rents. To secure the prompt and full payment by Lessee of the Rent and the faithful performance by Lessee of all the other terms and conditions herein contained on its part to be kept and performed, Lessee hereby absolutely, presently assigns, transfers and sets over unto Lessor, subject to the conditions hereinafter set forth in this Section 14.3, all of Lessee’s right, title and interest in and to all Subleases, and hereby confers upon Lessor, its agents and representatives, a right of entry in, and sufficient possession of, the Property to permit and ensure the collection by Lessor of the rentals and other sums payable under the Subleases, and further agrees that the exercise of the right of entry and qualified possession by Lessor shall not constitute an eviction of Lessee from the Property or any portion thereof; provided, however, that Lessee shall continue to have the right to collect, use, enjoy and distribute all Sublease revenue (a) except during the continuance of a Lease Event of Default, or (b) until this Lease and the Lease Term shall be canceled or terminated pursuant to the terms, covenants and conditions hereof, or (c) until there occurs repossession under a dispossess warrant or other judgment, order or decree of a court of competent jurisdiction and then only as to such of the Subleases that Lessor may elect to take over and assume. Notwithstanding the foregoing, if the events described in Section 14.3(b) and Section 14.3(c) herein above have not occurred and if the Lease Event of Default which caused such collection of revenue by Lessor shall have been cured by Lessee or otherwise not continue to exist, upon the written demand of Lessee, Lessor shall cease to exercise the rights granted hereunder to Lessor with respect to the Subleases, and amounts collected under the Subleases and not applied to Lessee’s obligations hereunder shall promptly be paid over to Lessee.

ARTICLE 15

INSPECTION

Section 15.1. Inspection. Upon at least five (5) Business Days prior written notice to Lessee (or immediately if a Lease Event of Default shall be continuing) Lessor or its respective representatives and agents (each, an “Inspecting Party”), may, in a commercially reasonable manner and at their own risk, inspect the Property, during normal business hours, to verify compliance with the provisions of this Lease. No Sublease shall contain any restrictions on inspection other than as set forth herein. The Inspecting Party shall repair any damage caused by any inspection performed pursuant to Section 15.1. Unless a Lease Event of Default is continuing, no intrusive tests are permitted. Lessee shall have the right during such inspection to have its representatives present at any such inspection, including security guards. In addition, Lessee may designate one or more reasonably sized “secure areas” to which Lessor or Lender shall have no access, except during the continuance of a Lease Event of Default. Each Inspecting Party agrees to hold in confidence all proprietary information and trade secrets of which it becomes aware during such inspection. All such inspections shall be at Lessor’s expense, unless a Lease Event of Default occurs and is continuing. Further, upon fifteen (15) Business Days prior notice to Lessee, but no more than once annually, the Inspecting Parties, at their expense, may inspect the books and records as they relate to the maintenance and care of the Property during the term of this Lease (other than Lessee’s Equipment and Personalty), that are in the possession of Lessee, which shall be made available at the Property or the headquarters of the Lessee. Such inspection shall be at the cost of the Inspecting Party unless a Lease Event of Default exists, in which event Lessee shall pay such costs.

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ARTICLE 16

LEASE EVENTS OF DEFAULT

Section 16.1. Lease Events of Default. The following events shall constitute a “Lease Events of Default”:

(a) Lessee shall fail to make any payment of Base Rent, within five (5) Business Days after notice that such amount is due and unpaid.

(b) Lessee shall fail to make any late payment and/or pay interest at the Default Rate within ten (10) days after notice that such amount is due and unpaid.

(c) Lessee shall fail to make any other payment of Supplemental Rent, other than any amount described in clause (a) or clause (b) of this Article 16, and such failure shall continue for a period of ten (10) days after notice of such failure to Lessee from Lessor or Lender.

(d) Lessee shall fail to timely perform or observe any covenant or agreement (not otherwise specified in this Article 16) to be performed or observed by it hereunder and such failure shall continue for a period of thirty (30) days after written notice thereof from Lessor or the Lender; provided that the continuation of such a failure for thirty (30) days or longer after such notice shall not constitute a Lease Event of Default if such failure can be cured, but cannot reasonably be cured within such thirty (30) day period, and Lessee shall commence to cure such failure within such thirty (30) day period and shall be diligently and continuously prosecuting the cure of such failure.

(e) except to the extent the Lessee is permitted to self-insure pursuant to Section 9.1(b) and Schedule 9.1, Lessee shall fail to carry or maintain in full force any insurance required hereunder, and such failure shall continue for ten (10) business days after such obligations arise, but not beyond the expiration date of any required policy of insurance.

(f) any representation or warranty made by the Lessee herein shall prove to have been incorrect in any material respect when such representation or warranty was made and shall remain materially incorrect at the time in question, and is not cured in all material respects within thirty (30) days of notice to Lessee of such breach; provided that the continuation of such a failure for thirty (30) days or longer after such notice shall not constitute a Lease Event of Default if such failure can be cured, but cannot reasonably be cured within such thirty (30) day period, and Lessee shall commence to cure such failure within such thirty (30) day period and shall be diligently and continuously prosecuting the cure of such failure.

(g)(A) Lessee makes any general arrangement or assignment for the benefit of creditors; (B) Lessee becomes a “debtor” as defined in 11 U.S.C. § 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within ninety (90) days); (C) the appointment of a trustee or receiver to take possession of substantially all of the assets of Lessee where possession is not restored to Lessee within ninety (90) days; (D) the attachment, execution or other judicial seizure of substantially all of the assets of Lessee where such seizure is not discharged within ninety (90) days; (E) Lessee admits in writing its inability

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to pay its debts generally as they become due; (F) Lessee files a petition or answer seeking reorganization or arrangement or other protection under the Federal bankruptcy laws or any other applicable law or statute of the United States of America or any State thereof; (G) Lessee is liquidated or dissolved, or placed under conservatorship or other protection under any applicable federal or state law; (H) any petition is filed by or against Lessee under Federal bankruptcy laws, or any other proceeding is instituted by or against Lessee seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, reorganization, arrangement, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for Lessee, or for any substantial part of the property of Lessee, and such proceeding is not dismissed within ninety (90) days after institution thereof, or Lessee shall take any action to authorize or effect any of the actions set forth above in this subsection (g).

ARTICLE 17

ENFORCEMENT

Section 17.1. Remedies. Upon the occurrence of any Lease Event of Default and at any time thereafter so long as the same shall be continuing, Lessor may, at its option, by notice to Lessee do one or more of the following as Lessor in its sole discretion shall determine:

(a) Lessor may, by notice to Lessee, terminate this Lease as of the date specified in such notice; provided (i) no reletting, reentry or taking of possession of any or all of the Property by Lessor will be construed as an election on Lessor’s part to terminate this Lease unless a written notice of such intention is given to Lessee, (ii) notwithstanding any reletting, reentry or taking of possession, Lessor may at any time thereafter elect to terminate this Lease with respect to any or all of the Property, and (iii) no act or thing done by Lessor or any of its agents, representatives or employees and no agreement accepting a surrender of any or all of the Property shall be valid unless the same be made in writing and executed by Lessor. If Lessor shall have terminated the Lease, Lessor may demand that Lessee pay to Lessor, and Lessee shall pay to Lessor, the amounts set forth in subparagraphs (c) or (e) below.

(b) Lessor may whether or not the Lease is terminated (i) demand that Lessee, and Lessee shall upon the written demand of Lessor, return the Property promptly to Lessor in the manner and condition required by, and otherwise in accordance with all of the provisions of, Article 10 as if the Property were being returned at the end of the Lease Term, and Lessor shall not be liable for the reimbursement of Lessee for any costs and expenses incurred by Lessee in connection therewith, and (ii) without prejudice to any other remedy which Lessor may have for possession of the Property, enter upon the Property and take immediate possession of (to the exclusion of Lessee) the Property and expel or remove Lessee and any other person who may be occupying the same (subject to the terms of any nondisturbance agreements with Lessor in favor of any subtenants), by summary proceedings or otherwise, all without liability to Lessor for or by reason of such entry or taking of possession, whether for the restoration of damage to property caused by such taking or otherwise and, in addition to Lessor’s other damages, Lessee shall be responsible for the reasonably necessary costs and expenses of reletting actually incurred.

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(c) Lessor may sell the Property at public or private sale, as Lessor may determine, free and clear of any rights of Lessee and without any duty to account to Lessee with respect to such action or inaction or any proceeds with respect thereto (except to the extent required by the next succeeding sentence if Lessor shall elect to exercise its rights thereunder), in which event Lessee’s obligation to pay Base Rent hereunder for periods commencing after the Stipulated Loss Value Date next succeeding the date of such sale shall be terminated. If Lessor shall have sold any of the Property pursuant to the above terms of this Section 17.1(c), Lessor may demand that Lessee pay to Lessor, and Lessee shall promptly pay to Lessor, on the date of such sale, as liquidated damages for loss of a bargain and not as a penalty (the parties agreeing that Lessor’s actual damages would be difficult to predict, but the liquidated damages described below represent a reasonable approximation of such amount), in lieu of Base Rent in respect of the Property due for the period commencing on the Stipulated Loss Date next succeeding the date of sale, an amount equal to the sum of:

(1) all unpaid Rent with respect to the Property due but unpaid through such Stipulated Loss Date; plus

(2) an amount equal to the present value of the amount of the Base Rent payments payable on the Business Day before the date preceding the remaining scheduled Rent Payment Dates, discounted monthly at the Reference Rate;

(3) interest at the Default Rate on all of the foregoing amounts from the date due until the date of actual payment;

to the extent such amount exceeds the net proceeds of such sale.

(d) Except as Lessor may otherwise be required by Applicable Laws, Lessor may hold, keep idle or lease to others the Property as Lessor in its sole discretion may determine, free and clear of any rights of Lessee and without any duty to account to Lessee with respect to such action or inaction or for any proceeds with respect to such action or inaction, except that Lessee’s obligation to pay Base Rent from and after the occurrence of a Lease Event of Default, but prior to the termination of the Lease or the foreclosure of the Lien of the Lender, shall be reduced by the net proceeds, if any, received by Lessor from leasing the Property to any Person, or allowing any Person to use the Property, other than Lessee for the same periods or any portion thereof,

(e) Lessor may, whether or not Lessor shall have exercised or shall thereafter at any time exercise any of its rights under Section 17.1(b) or 17.1(d), but only if the Property shall not have been sold under Section 17.1(c), demand, by written notice to Lessee specifying a Stipulated Loss Value Date (the “Final Payment Date”) not earlier than twenty (20) days after the date of such notice, that Lessee pay to Lessor, and Lessee shall pay to Lessor, on the Final Payment Date, as liquidated damages for loss of a bargain and not as a penalty (the parties agreeing that Lessor’s actual damages would be difficult to predict, but the aforementioned liquidated damages represent a reasonable approximation of such amount), in lieu of Base Rent for periods commencing after the Final Payment Date, an amount equal to the sum of:

(1) all unpaid Rent with respect to the Property due but unpaid through such Stipulated Loss Value Date; plus

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(2) an amount equal to the present value of the amount of the Base Rent payments payable on the Business Day before the dates preceding the remaining scheduled Rent Payment Dates, discounted monthly at the Reference Rate;

(3) interest at the Default Rate on all of the foregoing amounts from the date due until the date of actual payment.

(f) Lessor may retain and apply against Lessor’s damages all sums which Lessor would, absent such Lease Event of Default, be required to pay to, or turn over to, Lessee pursuant to the terms of this Lease; or

(g) Lessor may exercise any other right or remedy that may be available to it under Applicable Laws or in equity, or proceed by appropriate court action (legal or equitable) to enforce the terms hereof or to recover damages for the breach hereof. A single or separate suits may be brought to collect any such damages for any period or periods with respect to which Rent shall have accrued, and such suits shall not in any manner prejudice Lessor’s right to collect any such damages for any subsequent period, or Lessor may defer any such suit until after the expiration of the Base Term or the then current Renewal Term, in which event such suit shall be deemed not to have accrued until the expiration of the Base Term, or the then current Renewal Term.

Section 17.2. Survival of Lessee’s Obligations. Except to the extent prohibited by Applicable Laws, no repossession of any or all of the Property or exercise of any remedy under this Lease, including termination of this Lease, shall, except as specifically provided herein, relieve Lessee of any of its liabilities and obligations hereunder, including the obligation to pay Rent. In addition, except as specifically provided herein, Lessee shall be liable for any and all unpaid Rent due hereunder before, after or during the exercise of any of the foregoing remedies, including all reasonable legal fees and other costs and expenses incurred by Lessor by reason of the occurrence of any Lease Event of Default or the exercise of Lessor’s remedies with respect thereto, and including all costs and expenses incurred in connection with the return of the Property in the manner and condition required by, and otherwise in accordance with the provisions of, Article 10 as if the Property were being returned at the end of the Lease Term. At any sale of any or all of the Property or any other rights pursuant to Section 17.1, Lessor or the Lender may bid for and purchase the Property.

Section 17.3. Remedies Cumulative; No Waiver; Consents; Mitigation of Damages. To the extent permitted by, and subject to the mandatory requirements of, Applicable Laws, each and every right, power and remedy herein specifically given to Lessor or otherwise in this Lease shall be cumulative and shall be in addition to every other right, power and remedy herein specifically given or now or hereafter existing at law, in equity or by statute, and each and every right, power and remedy whether specifically herein given or otherwise existing may be exercised from time to time and as often and in such order as may be deemed expedient by Lessor, and the exercise or the beginning of the exercise of any power or remedy shall not be construed to be a waiver of the right to exercise at the same time or thereafter any right, power or remedy. No delay or omission by Lessor in the exercise of any right, power or remedy or in the pursuit of any remedy shall impair any such right, power or remedy or be construed to be a

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waiver of any default on the part of Lessee or to be an acquiescence therein. Lessor’s consent to any request made by Lessee shall not be deemed to constitute or preclude the necessity for obtaining Lessor’s consent, in the future, to all similar requests. No express or implied waiver by Lessor of any Lease Event of Default shall in any way be, or be construed to be, a waiver of any future or subsequent Lease Event of Default. Lessor shall use reasonable efforts to mitigate any damages suffered by Lessor that result from a Lease Event of Default.

ARTICLE 18

RIGHT TO PERFORM FOR LESSEE

Section 18.1.Right to Perform for Lessee. If Lessee shall fail to perform or comply with any of its agreements contained herein, following applicable notice and cure periods, Lessor may perform or comply with such agreement, and Lessor shall not thereby be deemed to have waived any default caused by such failure, and the amount of payment required to be made by Lessee hereunder and made by Lessor on behalf of Lessee, and the reasonable out-of-pocket third-party costs and expenses of Lessor (including reasonable attorneys’ fees and expenses) incurred in connection with the performance of or compliance with such agreement, as the case may be, together with interest thereon at the Default Rate, shall be deemed Supplemental Rent, payable by Lessee to Lessor upon demand. In addition, during the continuance of a Lease Event of Default in respect of Lessee’s obligations under Section 8.2 and/or Section 8.5, then, in addition to the rights above and at the cost of Lessee, (a) Lessor shall have the right to hire Persons (as selected by Lessor in its reasonable discretion) to cure such Lease Event of Default, and to take any and all other actions necessary to cure such Lease Event of Default, and (b) Lessee shall cooperate with Lessor, and the Persons hired by Lessor, in the performance of such cure, including, without limitation, (i) providing access to the subject Property at reasonable times every day of the week, (ii) making available water, electricity and other utilities existing at or on the subject Property, and (iii) restricting or closing the Property, but only if such restriction or closure is reasonably necessary for the performance of such cure and provided that such closure shall be done for and during a time period and in such manner that balances the need for the maintenance or repair of the Property (and doing so in a safe manner) and the continuing operations of the Property.

ARTICLE 19

INDEMNITIES

Section 19.1. General Indemnification.

(a) Lessee agrees to indemnify, defend, and keep harmless each Indemnitee, from and against any and all Claims arising out of acts, or failures to act, prior to the expiration or earlier termination of the Term (whether during the Lease Term, or prior to the Closing Date), whenever they may be suffered, imposed on or asserted against any Indemnitee, to the extent arising out of (i) the ownership, leasing, subleasing, assignment, financing, refinancing, renewal, return, operation, possession, use, non-use, maintenance, modification, alteration, reconstruction, restoration, or replacement of the Property or the Lease, or from the granting by Lessor at Lessee’s request of easements, licenses or any similar rights with respect to all or any part of the Property, or from the construction, design, purchase or condition of the Property (including any

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Claims (whether by Governmental Authority or other Person) arising, directly or indirectly, out of the actual or alleged presence, use, storage, generation, Release or threat of Release of any Hazardous Materials, and any Claims for patent, trademark or copyright infringement and latent or other defects, whether or not discoverable), including any liability under Applicable Laws (including, without limitation, any Claims arising directly or indirectly out of any actual or alleged violation, now or hereafter existing, of any Environmental Laws), (ii) this Lease or any modification, amendment or supplement thereto, to the extent arising out of the operation, maintenance, use or possession of the Property whether before or after the Closing Date, (iii) the non-compliance of the Property with Applicable Laws (including because of the existence of the Permitted Liens), (iv) without limiting any other indemnities herein, any other matters relating to the Property or any operations thereon, and not already covered by this Section 19.1(a), to the extent such matters arise out of the operation, maintenance, use or possession of the Property by Lessee, whether before or after the Closing Date, including matters relating to Environmental Laws or Hazardous Materials, the breach by Lessee of its representations, warranties, covenants and obligations in this Lease whether or not such Claim arises or accrues prior to the date of this Lease, (v) the business and activities of Lessee, except to the extent arising out of relationships not related to this transaction, (vi) the cost of any Remedial Action, assessment, containment, monitoring, treatment and/or removal of any and all Hazardous Materials from all or any portion of the Property or any surrounding areas over which Lessee has responsibility, the cost of any actions taken in response to a release or threat of release of any Hazardous Materials on, in, under, relating to or affecting any portion of the Property or any surrounding areas over which Lessee has responsibility to prevent or minimize such release or threat of release so that it does not migrate or otherwise cause or threaten danger to present or future public health, safety, welfare or the environment, and costs incurred to comply with Environmental Laws in connection with all or any portion of the Property or any surrounding areas over which Lessee has responsibility, (vii) a Lease Default or a Lease Event of Default, (viii) any litigation, suit, cause of action, writ, decree, injunction, order, judgment, proceeding or Claim now or hereafter asserted against the Property, Lessor (by virtue of its ownership of, leasing or financing of the Property), or Lessee with respect to the Property or this Lease, and (ix) any defects in title caused, created or permitted by Lessee, or anyone acting by, through or under Lessee. Lessee acknowledges that the foregoing includes any costs incurred by Lessor, or the Lender in performing any inspections of any Property if such inspection reveals a violation by Lessee of Section 8.5. Lessee shall not be required to indemnify any Indemnitee under this Section 19.1 for any Claim to the extent resulting from (A) the willful misconduct or negligence or breach of representation or warranty of such Indemnitee or a member of such Indemnitee’s Group, (B) any amounts payable to Lender unless such amounts are payable by Lessee under this Lease, (C) any acts or events to the extent first occurring after the expiration of the Lease Term and return of the Property to Lessor in the condition required in this Lease (but any indemnification first arising after the expiration of the Term (and not otherwise covered hereby) shall include only those matters relating to Lessee’s failure to return the Property in the condition required), (D) any taxes, except to the extent covered in Sections 8.6 of this Lease, (E) any voluntary transfers of the Property made by Lessor (other than arising out of a Lease Event of Default by Lessee), and (F) any voluntary transfer made by the Lender. Lessee shall be entitled to credit against any payments due under this Section 19.1 any insurance recoveries or other reimbursements received by the Indemnitee to be indemnified in respect of the related Claim under or from insurance paid for, directly or indirectly, by Lessee or assigned to Lessor by Lessee, to the extent such insurance recoveries exceed such Indemnitee’s costs and expenses incurred in recouping such insurance recovery.

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(b) In case any Claim shall be made or brought against any Indemnitee, such Indemnitees shall give prompt notice thereof to Lessee, provided that failure to so notify Lessee shall not reduce Lessee’s obligations to indemnify any Indemnitee hereunder unless and only to the extent such failure results in additional liability on Lessee’s part. Lessee shall be entitled, at its expense, acting through counsel selected by Lessee (and reasonably satisfactory to such Indemnitee), to participate in, and, to the extent that Lessee desires, to assume and control, the negotiation, litigation and/or settlement of any such Claim (subject to the provisions of the last sentence of subparagraph (c) of this Section 19.1). Such Indemnitee may (but shall not be obligated to) participate in a reasonable manner at its own expense (unless Lessee is not properly performing its obligations hereunder) and with its own counsel in any proceeding conducted by Lessee in accordance with the foregoing. If Lessee shall defend the Indemnitee in any such suit or proceeding, then, unless such Indemnitee shall determine (in its reasonable discretion) that a conflict of interest exists between Lessee and such Indemnitee, Lessee shall not be obligated to reimburse the Indemnitee for the cost of such Indemnitee’s attorneys’ fees or expenses incurred in connection with such suit or proceeding.

(c) Each Indemnitee shall at Lessee’s expense supply Lessee with such information and documents reasonably requested by Lessee in connection with any Claim for which Lessee may be required to indemnify any Indemnitee under this Section 19.1. Unless a Lease Event of Default is continuing, no Indemnitee shall enter into any settlement or other compromise with respect to any Claim for which indemnification is required under this Section 19.1 without the prior written consent of Lessee. Lessee shall have the authority to settle or compromise any Claim against an Indemnitee hereunder, provided that no admission of wrongdoing shall be required of such Indemnitee and such Indemnitee shall be released of all liability in connection with any such Claim.

(d) Upon payment in full of any Claim by Lessee pursuant to this Section 19.1 to or on behalf of an Indemnitee, Lessee, without any further action, shall be subrogated to any and all claims that such Indemnitee may have relating thereto, and such Indemnitee shall execute such instruments of assignment and conveyance, evidence of claims and payment and such other documents, instruments and agreements as may be necessary to preserve any such claims and otherwise reasonably cooperate with Lessee to enable Lessee to pursue such claims.

(e) Prior to paying any amount otherwise payable to an Indemnitee pursuant to this Section 19.1, Lessee shall be entitled to receive from such Indemnitee (i) a written statement describing the amount so payable, (ii) a general release from Indemnitee upon such payment with respect to the claim made and (iii) such additional information as Lessee may reasonably request and which is reasonably available to such Indemnitee to properly substantiate the requested payment.

(f) Subject to the penultimate sentence of Section 19.1(a) above, Lessee’s liability hereunder shall in no way be limited or impaired by any act, including, without limitation, (i) any amendment or modification to the Lease, (ii) any waiver of any Lease Event of Default, default, or extension of time or any failure to enforce any remedies or rights of either Lessor or Lender, (iii) any sale or transfer of the Property, or (iv) any assignment of the Lease.

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Section 19.2 Lessor’s Indemnification Obligation. Lessor agrees to indemnify, defend, and hold harmless the Lessee, from and against any and all loss incurred by Lessee resulting from Claims arising out of active actions prior to the expiration or earlier termination of the Term, to the extent arising solely out of Lessor’s (or its employees’ agents’ or contractors’) willful misconduct or gross negligence.

ARTICLE 20

LESSEE REPRESENTATIONS AND COVENANTS

Section 20.1. Representations and Warranties. Lessee represents and warrants to Lessor that the following are true and correct as of the Closing Date:

(a) Due Organization. Lessee is a corporation duly organized, validly existing and in good standing in the State of California and qualified to do business in, and in good standing, in the Commonwealth of Virginia. Lessee has the corporate power and authority to conduct its business as now conducted, to lease the Property and to enter into and perform its obligations under the Lease. Lessee is duly qualified to do business and is in good standing as a foreign corporation in any jurisdiction where the failure to so qualify would have a material adverse effect on its ability to perform its obligations under the Lease.

(b) Due Authorization; No Conflict. The Lease has been duly authorized by all necessary corporate action on the part of Lessee and has been duly executed and delivered by Lessee, and the execution, delivery and performance thereof by Lessee will not, (i) require any approval of the stockholders of Lessee or any approval or consent of any trustee or holder of any indebtedness or obligation of Lessee, other than such consents and approvals as have been obtained, (ii) contravene any Applicable Law binding on Lessee or (iii) contravene or result in any breach of or constitute any default under Lessee’s charter or by-laws or other organizational documents, or any indenture, judgment, order, mortgage, loan agreement, contract, partnership or joint venture agreement, lease or other agreement or instrument to which Lessee is a party or by which Lessee is bound, or result in the creation of any Lien upon any of the property of Lessee.

(c) Governmental Actions. All Governmental Action required in connection with the execution, delivery and performance by Lessee of the Lease, has been or will have been obtained, given or made.

(d) Enforceability. The Lease constitutes the legal, valid and binding obligation of Lessee, enforceable against Lessee in accordance with the terms thereof, except as enforceability may be limited by bankruptcy, moratorium, fraudulent conveyance, insolvency, equitable principles or other similar laws affecting the enforcement of creditors’ rights in general.

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(e) Bankruptcy. No bankruptcy, reorganization, arrangement or insolvency proceedings are pending, threatened or contemplated by Lessee, and Lessee has not made a general assignment for the benefit of creditors.

(f) Tax Filings. All tax returns and reports of Lessee required by law to be filed with respect to the Property have been duly filed, and all taxes, interests and penalties assessed by any Governmental Authority upon the Property or Lessee (with respect to the Property), which are due and payable, have been paid, except to the extent being contested in good faith by the Lessee.

(g) Condition of Property: Condemnation. The Property is, to the Lessee’s knowledge, free and clear of any damage that would materially and adversely affect its value. The Lessee has not received notice of any proceeding pending for the total or partial condemnation of or affecting the Property, such that such proceeding would have a material adverse effect on the Property. To the Lessee’s knowledge, as of the Closing Date, all of the material Improvements lie wholly within the boundaries and building restriction lines of such Property, except for encroachments that are insured against by the Title Policy or that do not materially and adversely affect the value or marketability of the Property, and no improvements on adjoining properties materially encroach upon the Property so as to materially and adversely affect the value or marketability of the Property.

(h) Environmental Conditions. To the Lessee’s knowledge, there are no circumstances or conditions with respect to the Property that render the Property in violation (other than to a de minimis effect) of any applicable Environmental Laws.

(i) Legal Proceedings. There are no pending or to the Lessee’s knowledge, threatened actions, suits or proceedings by or before any court or governmental authority against or affecting the Lessee with respect to the Property that, if determined adversely to such Lessee or Property, would materially and adversely affect the value of the Property.

(j) Licenses and Permits. To the Lessee’s knowledge, (i) it possesses all material licenses, permits and authorizations required by applicable law for the operation of the Property and (ii) all such licenses, permits and authorizations are valid and in full force and effect.

The phrase “the Lessee’s knowledge” and other words and phrases of like import shall mean the actual state of knowledge of Jane Baughman, Vice President – Financial Planning and Treasurer. Lessee represents that the foregoing individuals are the people who are likely to know of any matters covered by these representations and warranties.

ARTICLE 21

LESSOR REPRESENTATIONS AND COVENANTS

Section 21.1. Representations and Warranties. Lessor represents and warrants to Lessee that the following are true and correct as of the Closing Date:

(a) Due Organization. Lessor is a limited liability company duly organized, validly existing and in good standing in the State of Delaware and qualified to do business in, and in

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good standing, in the Commonwealth of Virginia. Lessor has the corporate power and authority to conduct its business as now conducted and to enter into and perform its obligations under the Lease. Lessor is duly qualified to do business and is in good standing as a foreign limited liability company in any jurisdiction where the failure to so qualify would have a material adverse effect on its ability to perform its obligations under the Lease.

(b) Due Authorization; No Conflict. The Lease has been duly authorized by all necessary corporate action on the part of Lessor and has been duly executed and delivered by Lessor, and the execution, delivery and performance thereof by Lessor will not, (i) require any approval of the members of Lessor or any approval or consent of any trustee or holder of any indebtedness or obligation of Lessor, other than such consents and approvals as have been obtained, (ii) contravene any Applicable Law binding on Lessor or (iii) contravene or result in any breach of or constitute any default under Lessor’s charter or by-laws or other organizational documents, or any indenture, judgment, order, mortgage, loan agreement, contract, partnership or joint venture agreement, lease or other agreement or instrument to which Lessor is a party or by which Lessor is bound.

(c) Governmental Actions. All Governmental Action required in connection with the execution, delivery and performance by Lessor of the Lease, has been or will have been obtained, given or made.

(d) Enforceability. The Lease constitutes the legal, valid and binding obligation of Lessor, enforceable against Lessor in accordance with the terms thereof, except as enforceability may be limited by bankruptcy, moratorium, fraudulent conveyance, insolvency, equitable principles or other similar laws affecting the enforcement of creditors’ rights in general.

(e) Bankruptcy. No bankruptcy, reorganization, arrangement or insolvency proceedings are pending, threatened or contemplated by Lessor, and Lessor has not made a general assignment for the benefit of creditors.

ARTICLE 22

PURCHASE PROCEDURE

Section 22.1. Purchase Procedure. In the event of the purchase of Lessor’s interest in the Property by Lessee pursuant to any provision of this Lease, the terms and conditions of this Section 22.1 shall apply.

(a) On the closing date fixed for the purchase of Lessor’s interest in the Property, which shall be a Rent Payment Date:

(i) Lessee shall pay to Lessor, in lawful money of the United States, at Lessor’s address hereinabove stated or at any other place in the United States which Lessor may designate, in immediately available funds, the applicable purchase price or Stipulated Loss Value, and all other costs due as of such Closing, including, without limitation, any applicable prepayment premium; and

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(ii) Lessor shall execute and deliver to Lessee a special warranty deed with covenants against grantor’s acts, assignment and/or such other instrument or instruments as may be appropriate, which shall transfer Lessor’s interest in the Property, subject to, (A) Permitted Liens (except for any mortgage indebtedness of Lessor if the sale is pursuant to Article 12), (B) all liens, encumbrances, charges, exceptions and restrictions attaching to the Property after the Closing Date which shall not have been created or caused by Lessor (unless consented to by Lessee), and (C) all applicable laws, rules, regulations, ordinances and governmental restrictions then in effect.

(b) Lessee shall pay all costs, charges and expenses of incident to such transfer, including, without limitation, all recording fees, transfer taxes, title insurance premiums, and federal, state and local taxes, except for any net income taxes and the grantor’s tax due under Section 58.1-802 of the Code of Virginia of 1950, as amended, if the sale is pursuant to Section 12.1, otherwise, such costs shall be as set forth in the terms.

(c) In the event Lessor and Lessee enter into a purchase agreement for the sale of the Property, Lessor agrees to cause the entity that owns the Property to be sold to Lessee, in lieu of a sale of the Property to Lessee, in the event (i) Lessee requests Lessor so to do; and (ii) the sale of the interests in Lessor (rather than the Property) to Lessee shall not impose any obligations on Lessor that would not be imposed had Lessor sold the Property, will not decrease any rights Lessor would have had Lessor sold the Property, and will not create any increased possibility of additional liability to Lessor (including without limitation, for ongoing corporate acts, taxes, etc.), all as shall be reasonably evidenced to Lessor by certificates, affidavits, opinions or otherwise. Lessor agrees to cooperate with Lessee in effectuating such a transfer of equity interests, subject to the terms hereof.

ARTICLE 23

TRANSFER OF LESSOR’S INTEREST

Section 23.1. Permitted Transfer. Subject to Article 4, Lessor may transfer all, or any part of, its right, title and interest in and to any Property and its rights under this Lease and the other documents relating thereto with respect to such Property on the following terms and conditions, each of which shall be satisfied prior to the effective date of the transfer (other than a transfer by a deed-in-lieu of foreclosure or similar transfer made in connection with an exercise of remedies under the Mortgage):

(a) such transfer shall be in compliance with the Mortgage and related documents,(if still in place), and with Applicable Laws and shall not create a relationship which would violate Applicable Laws;

(b) the transferor shall have given or at closing give to Lessee, notice of such transfer, if of the entire Property, which notice shall contain such information and evidence as shall be reasonably necessary to establish compliance with this Article 23 and the name and address of the transferee for notices.

Section 23.2. Effects of Transfer. From and after any transfer effected in accordance with this Article 23, the transferor shall be released, to the extent of the interest transferred and

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the obligations assumed, in writing, by the transferee, from its liability hereunder and under the other documents to which it is a party relating to, the interests being transferred. Such release shall be in respect of obligations (that are assumed, in writing, by the transferee) arising on or after the date of such transfer. Upon any transfer by Lessor of the Property as above provided, any such transferee shall be deemed the “Lessor” for all purposes of such documents and each reference herein to Lessor shall thereafter be deemed a reference to such transferee for all purposes, except as provided in the preceding sentence. Lessee agrees to execute any and all documents reasonably appropriate to effectuate the contemplated transfer by Lessor, including, without limitation, an amendment to this Lease providing that the new Lessor shall be Lessor and the existing Lessor shall be released from its liabilities.

ARTICLE 24

PERMITTED FINANCING

Section 24.1. Financing During Term.

Lessee hereby expressly consents to the Lien imposed in favor of any first mortgage indebtedness. With respect to any financing or refinancing during the Base Term and during any Renewal Term, Lessor shall be free to encumber the Property, provided that under no circumstances shall any such financing adversely affect the rights and privileges of Lessee under this Lease in any material respect, or increase in any material respect the nature, scope or amount of any obligations or liabilities (including any contingent liabilities) of Lessee in excess of those existing prior to any such further encumbrances by Lessor. Lessee and its Affiliates will have no obligation to amend this Lease to facilitate such financing; but shall execute and deliver a subordination and attornment agreement to any lender to Lessor permitted by the above terms of this Section 24.1 if such lender shall in turn deliver a nondisturbance agreement to Lessee, in each case with terms reasonably acceptable to the parties. Lessee agrees to cooperate with any refinancing by Lessor permitted hereunder. Such cooperation shall include, without limitation, (i) naming such new lender(s) as additional insureds; and (ii) making payments of Base Rent and/or Supplemental Rent to or at the direction of such lender(s).

Section 24.2. Lessee’s Consent to Assignment for Indebtedness. Lessee acknowledges that in order to secure Lessor’s obligations to a Lender, Lessor may agree, among other things, to the assignment (to the extent provided therein) to the Lender of Lessor’s right, title and interest to this Lease. While the Mortgage or any replacements thereof are in effect, Lessee hereby:

(a) consents to such assignment in this Lease;

(b) covenants to make in full, in funds that are immediately available, to Lender or its designee in accordance with the terms of this Lease:

(i) each payment of Base Rent and Supplemental Rent payable to Lessor (except under Article 19 hereof); and

(ii) all purchase prices, termination amounts, and other sums payable to Lessor under this Lease;

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(c) agrees:

(i) that it shall not, except as provided under Applicable Law, seek to recover from the Lender any moneys paid to the Lender by virtue of the foregoing provisions; provided, however, that the foregoing provisions shall not limit Lessee’s right to recover (A) any duplicate payment made to the Lender whether due to computational or administrative error or otherwise, if the Lender has received such payment, (B) all or any portion of a payment in excess of the amount then due under this Lease or otherwise owed by Lessor to Lessee under this Lease, and (C) any amounts that have been paid to or are actually held by the Lender that is required to be refunded to, repaid, or otherwise released to or for the benefit of Lessee under this Lease;

(ii) that Lessee shall not pay any Rent more than thirty (30) days prior to such payment’s scheduled due date except as provided in this Lease;

(iii) that Lessee shall not enter into any agreement subordinating or (except as expressly permitted by the terms of this Lease as in effect on the date hereof) surrendering, canceling, or terminating this Lease without the prior written consent of the Lender, and any such attempted subordination or termination without such consent shall be void;

(iv) that Lessee shall not enter into any amendment or modification of this Lease without the prior written consent of the Lender, and any such attempted amendment or modification without such consent shall be void;

(v) that if this Lease shall be amended, it shall continue to constitute collateral under the Mortgage without the necessity of any further act by Lessor, Lessee or the Lender; and;

(vi) that except as expressly provided in this Lease, Lessee shall not take any action to terminate, rescind or avoid this Lease, notwithstanding, to the fullest extent permitted by law, the bankruptcy, insolvency, reorganization, composition, readjustment, liquidation, dissolution or other proceeding affecting Lessor or any assignee or Lessor and notwithstanding any action with respect to the Lease which may be taken by an assignee, Lender or receiver or Lessor or of any such assignee or by any court in any such proceedings.

Nothing herein shall be construed as Lessee’s agreement to be bound and perform the obligations of Lessor under any Mortgage or other debt documents. If Lessee receives conflicting direction from Lessor and the Lender, or is in good faith uncertain as to whether it should comply with a direction from either Lessor or the Lender, Lessee shall be permitted to seek written confirmation from Lessor and the Lender, or if the matter in dispute regards the payment of money by Lessee, pay the same into a court and provide Lessor and the Lender with reasonably prompt notice of such payment.

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ARTICLE 25

MISCELLANEOUS

Section 25.1. Binding Effect; Successors and Assigns; Survival. The terms and provisions of this Lease, and the respective rights and obligations hereunder of Lessor and Lessee, shall be binding upon their respective successors, legal representatives and assigns (including, in the case of Lessor, any Person to whom Lessor may transfer the Property) and inure to the benefit of their respective permitted successors and assigns, and the rights hereunder of the Lender shall inure (subject to such conditions as are contained herein) to the benefit of its permitted successors and assigns.

Section 25.2. Quiet Enjoyment. Lessee shall have the right to peaceably and quietly hold, possess and use any and all of the Property hereunder during the Lease Term, so long as no Lease Event of Default has occurred and is continuing.

Section 25.3. Notices. Unless otherwise specifically provided herein, all notices, consents, directions, approvals, instructions, requests and other communications required or permitted by the terms hereof to be given to any Person shall be in writing sent to either that Person’s Address, and a copy thereof shall be sent to each Person to receive a copy pursuant to the definition of “Address”, by (i) a prepaid nationally recognized overnight courier service, and any such notice shall be deemed received one (1) Business Day after delivery to a nationally recognized courier service specifying overnight delivery, or (ii) U.S. certified or registered mail, return receipt requested, postage prepaid, and such notice shall be deemed received when actually received, as evidenced by the return receipt, or when delivery is first refused. From time to time any party may designate a new Address for purposes of notice hereunder by giving fifteen (15) days’ written notice thereof to each of the other parties hereto. All notices given hereunder shall be irrevocable unless expressly specified otherwise. Lessor shall endeavor to label any envelope which contains a notice of default with the legend: “Default Notice,” but its failure to do so shall not invalidate or affect in any way such notice.

Section 25.4. Severability. Any provision of this Lease that shall be prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction, and each party hereto shall remain liable to perform its obligations hereunder except to the extent of such unenforceability. To the extent permitted by applicable law, Lessee hereby waives any provision of law that renders any provision hereof prohibited or unenforceable in any respect.

Section 25.5. Amendments, Complete Agreements. Neither this Lease nor any of the terms hereof may be terminated, amended, supplemented, waived or modified orally, but may be terminated, amended, supplemented, waived or modified only by an instrument in writing signed by the party against which the enforcement of the termination, amendment, supplement, waiver or modification shall be sought and, as required by the Mortgage or related documents, by the Lender. This Lease is intended by the parties as a final expression of their lease agreement and as a complete and exclusive statement of the terms thereof, all negotiations, considerations and representations between the parties having been incorporated herein. No representations, undertakings, or agreements have been made or relied upon in the making of this Lease other than those specifically set forth herein.

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Section 25.6. Headings. The Table of Contents and headings of the various Articles and Sections of this Lease are for convenience of reference only and shall not modify, define or limit any of the terms or provisions hereof.

Section 25.7. Counterparts. This Lease may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute but one and the same instrument.

Section 25.8. Governing Law. This Lease shall be governed by, and construed in accordance with, the laws of the State in which the Property is situated.

LESSOR AND LESSEE HEREBY SUBMIT TO NON-EXCLUSIVE PERSONAL JURISDICTION IN THE COUNTY OF ALAMEDA, STATE OF CALIFORNIA AND THE FEDERAL COURTS OF THE UNITED STATES OF AMERICA LOCATED IN THE COUNTY OF ALAMEDA, STATE OF CALIFORNIA (AND ANY APPELLATE COURTS TAKING APPEALS THEREFROM) FOR THE ENFORCEMENT OF SUCH PERSON’S OBLIGATIONS HEREUNDER AND WAIVES ANY AND ALL PERSONAL RIGHTS UNDER THE LAW OF ANY OTHER STATE TO OBJECT TO JURISDICTION WITHIN SUCH STATE FOR THE PURPOSES OF SUCH ACTION, SUIT, PROCEEDING OR LITIGATION TO ENFORCE SUCH OBLIGATIONS OF LESSEE OR LESSOR. LESSOR AND LESSEE HEREBY WAIVE AND AGREE NOT TO ASSERT, AS A DEFENSE IN ANY ACTION, SUIT OR PROCEEDING ARISING OUT OF OR RELATING TO THIS LEASE (A) THAT IT IS NOT SUBJECT TO SUCH JURISDICTION OR THAT SUCH ACTION, SUIT OR PROCEEDING MAY NOT BE BROUGHT OR IS NOT MAINTAINABLE IN THOSE COURTS OR THAT IT IS EXEMPT OR IMMUNE FROM EXECUTION, (B) THAT THE ACTION, SUIT OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM OR (C) THAT THE VENUE OF THE ACTION, SUIT OR PROCEEDING IS IMPROPER. LESSEE AND LESSOR EACH HEREBY EXPRESSLY WAIVES ANY AND ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING RELATED TO THE ENFORCEMENT OF THIS LEASE.

Section 25.9. Memorandum. Lessee and Lessor agree that a memorandum of this Lease (and any amendment hereof) shall be executed and recorded, at Lessee’s expense, in the land records of the jurisdiction in which the Property is situate.

Section 25.10. Estoppel Certificates. Each party hereto agrees that at any time and from time to time during the Lease Term (but on no more than two occasions during each Lease Year), it will promptly, but in no event later than ten (10) days after request by the other party hereto, execute, acknowledge and deliver to such other party a certificate in the form of Exhibit B attached hereto. In addition, each party agrees to include in such certificate such other items as may be reasonably requested under the circumstances giving rise to the delivery of such certificate. Such certificate may be relied upon by any bona fide, permitted purchaser of, or mortgagee together with its successors and assigns with respect to, Lessor’s or Lessee’s interest in the Property (direct or indirect), or any prospective sublessee of Lessee in respect of all or a portion of the Property.

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Section 25.11. Easements. So long as no Lease Event of Default has occurred and is then continuing, and provided that no such action could in either the Lender’s or Lessor’s reasonable judgment be expected to have a material adverse effect upon Lessee’s ability to perform its obligations under the Lease, or on the Fair Market Rental Value or Fair Market Sales Value of the Property, Lessor will join with Lessee from time to time at the request of Lessee (and at Lessee’s sole cost and expense) to:

(a) subject to the terms of Article 12, sell, assign, convey or otherwise transfer an interest in any or all of the Property to any Person legally empowered to take such interest under the power of eminent domain, and dedicate or transfer unimproved portions of any or all of the Property for road, highway or other public purposes;

(b) upon approval by Lessor, which approval may not be unreasonably withheld: (i) grant new (or release existing) easements, servitudes, licenses, rights of way and other rights and privileges in the nature of easements, with respect to the Property, and (ii) execute amendments to any covenants and restrictions affecting the Property; and

(c) execute and deliver any instrument, in form and substance reasonably acceptable to Lessor, necessary or appropriate to make or confirm the grants, releases or other actions described above in Section 25.11(a) and Section 25.11(b).

Lessor agrees that it shall not grant any easements, licenses or other possessory interests in the Property to any party without Lessee’s prior written consent, which shall not be unreasonably withheld or delayed, provided, however, Lessee’s consent shall not be required (i) during the continuation of a Lease Event of Default, and (ii) to the extent such easement, license or other possessory interest is required by law.

Section 25.12. No Joint Venture. Any intention to create a joint venture or partnership relation between Lessor and Lessee is hereby expressly disclaimed.

Section 25.13. No Accord and Satisfaction. The acceptance by Lessor of any sums from Lessee (whether as Rent or otherwise) in amounts which are less than the amounts due and payable by Lessee hereunder is not intended, nor shall be construed, to constitute an accord and satisfaction, or compromise, of any dispute between such parties regarding sums due and payable by Lessee hereunder, unless Lessor specifically deems it as such in writing.

Section 25.14. No Merger. In no event shall the leasehold interests, estates or rights of Lessee hereunder, or of the Lender, merge with any interests, estates or rights of Lessor in or to any and all of the Property, it being understood that such leasehold interests, estates and rights of Lessee hereunder, and of the Lender, shall be deemed to be separate and distinct from Lessor’s interests, estates and rights in or to the Property, notwithstanding that any such interests, estates or rights shall at any time or times be held by or vested in the same person, corporation or other entity.

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Section 25.15. Lessor Bankruptcy. During the Lease Term the parties hereto agree that if Lessee elects to remain in possession of any and all of the Property after the rejection of the Lease by Lessor under Section 365(h) of the Bankruptcy Code, all of the terms and provisions of this Lease shall be effective during such period of possession by Lessee, including the Renewal Terms and Lessee’s purchase rights hereunder, even if Lessor becomes subject to a case or proceeding under the Bankruptcy Code prior to the commencement of any such Renewal Term or the exercise by Lessee of such purchase rights.

Section 25.16. Naming and Signage of the Property. So long as Lessee (or a sublessee) is the occupant of, at least, a majority of the Improvements located on the Property Lessee shall have the sole and exclusive right, at any time and from time to time, to select the name or names of the Property and the Improvements, and the sole and exclusive right to determine not to use any name in connection with the Property, as well as all rights in respect of signage for or in connection with the Property. Lessor shall not have or acquire any right or interest with respect to any such name or names used at any time by Lessee, or any trade name, trademark service mark or other intellectual property of any type of Lessee. Lessor shall cooperate with Lessee to effectuate Lessee’s sign rights hereunder, at no cost to Lessor. Lessee may install any sign or signs on the Property as it elects, at its sole cost and in compliance with Applicable Laws. Any signs installed by Lessee (other than those existing as of the Commencement of the Term) shall be removed by Lessee at the expiration or earlier termination of the Term, and Lessee shall repair any damage caused by such removal.

Section 25.17. Expenses. Whenever this Lease provides for the reimbursement by Lessee of costs and expenses of Lessor or any other party, then such reimbursement obligation shall be limited to actual, out-of pocket third-party costs and expenses including, but not limited to, reasonable attorneys’ fees. In addition to any other costs payable hereunder by Lessee, Lessee acknowledges and agrees that whenever (i) it seeks Lessor’s consent to an Alteration, (ii) it makes a rejectable offer, (iii) Fair Market Sales Value, Fair Market Rental Value or Base Rent during a Renewal Term need to be calculated, (iv) Lessee assigns its lease (if such assignment requires Lessor’s consent, (v) Lessor is asked to sign a landlord waiver with respect to Lessee’s personal property, or (vi) a casualty or condemnation (or an Event of Loss) occurs, Lessee shall pay all reasonable costs incurred by Lessor, arising out of the foregoing.

Section 25.18. Investments. Any moneys held by Lessor (or by the Lender or Proceeds Trustee) pursuant to this Lease, including Section 12.4, shall, until paid to Lessee, be invested by Lessor or the Proceeds Trustee, or by the Lender (if there is one), in Permitted Investments. Any gain (including interest received) realized as a result of any such investment shall be retained with, and distributed and re-invested in the same manner, as the original principal amount. Lessor (and the Lender) shall have no liability for any losses arising from any such investments or reinvestments. At such time as there no longer exists a requirement under this Lease for the Proceeds Trustee to hold such amounts, such amounts, together with any income thereon, shall be disbursed to Lessee.

Section 25.19. Further Assurances. Lessor and Lessee, at the cost and expense of the requesting party (except as otherwise set forth in this Lease to the contrary), will cause to be promptly and duly taken, executed, acknowledged and delivered all such further acts, documents

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and assurances as any of the others reasonably may request from time to time in order to carry out more effectively the intent and purposes of this Lease. Nothing herein shall obligate Lessee to provide to Lessor or the Lender any proprietary or confidential information relating to the manner, method and procedures of Lessee’s business operations, or relating to Lessee’s business plan. Lessee also agrees to cooperate with Lessor in determining how to allocate the purchase price paid for the Property for purposes of depreciation, including review of the applicable portions of Lessee’s books applicable to Lessee’s depreciation of the Property, as prior owner and as Lessee.

Section 25.20. [Intentionally omitted]

Section 25.21. Independent Covenants. The covenants of Lessor and Lessee herein are independent and several covenants and not dependent on the performance of any other covenant in this Lease.

Section 25.22. Lessor Exculpation. Anything to the contrary in this Lease notwithstanding, the covenants contained in this Lease to be performed by Lessor shall not be binding on any member of Lessor in its or his or her individual capacity, but instead said covenants are made for the purpose of binding only all of Lessor’s right, title and interest in and to the Property, and none of Lessor or any of its Affiliate or any of its successors and assigns shall have any liability under this Lease in excess of, and Lessee shall have no recourse under this Lease against Lessor or any Affiliate of it except for Lessor’s interest (to the extent not pledged or assigned), the Property, Net Proceeds and Rent.

Section 25.23. Remedies Cumulative. To the extent permitted by, and subject to the mandatory requirements of, Applicable Laws, each and every right, power and remedy herein specifically given to the Lessor or otherwise in this Lease shall be cumulative and shall be in addition to every other right, power and remedy herein specifically given or now or hereafter existing at law, in equity or by statute, and each and every right, power and remedy whether specifically herein given or otherwise existing may be exercised from time to time and as often and in such order as may be deemed expedient by Lessor. No delay or omission by Lessor in the exercise of any right, power or remedy or in the pursuit of any remedy shall impair any such right, power or remedy or be construed to be a waiver or any default on the part of Lessee or to be an acquiescence therein. Lessor’s consent to any request made by Lessee shall not be deemed to constitute or preclude the necessity for obtaining Lessor’s consent, in the future, to all similar requests. No waiver by Lessor of any default shall in any way be, or be construed to be, a waiver of any future or subsequent default.

Section 25.24. Holding Over. Subject to Section 12.1 and the last sentence of Section 10.1(b) Lessee covenants that if for any reason Lessee or any subtenant of Lessee shall fail to vacate and surrender possession of a Property or any part thereof, in the condition required herein, on or before the expiration or earlier termination of this Lease and the Term, then Lessee’s continued possession of the Property shall be as a tenant at sufferance, during which time, without prejudice and in addition to any other rights and remedies Lessor may have hereunder or at law, Lessee shall pay to Lessor an amount equal to: (a) one hundred twenty-five percent (125%) of the total monthly amount of Rent payable hereunder immediately prior to such

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termination (the “Existing Rent”) for the first ninety (90) days during which Lessee holds over, and (b) one hundred fifty percent (150%) of the Existing Rent thereafter. The provisions of this Section shall not in any way be deemed to (i) permit Lessee to remain in possession of the Property after the expiration date or sooner termination of this Lease, or (ii) imply any right of Lessee to use or occupy the Property upon expiration or termination of this Lease and the Term and no acceptance by Lessor of payments from Lessee after the expiration date or sooner termination of the Term shall be deemed to be other than on account of the amount to be paid by Lessee in accordance with the provisions of this Section. Lessee’s obligations under this Section shall survive the expiration or earlier termination of this Lease.

Section 25.25. Survival. The following provisions shall survive the termination of this Lease: (i) Sections 3.5, 6.1, 8.4, 8.5, 8.6 (only with respect to Impositions arising during the Term) 8.7, 8.8, 17.2, 22.1, Articles 7, 10, 19 and 25 to the extent relating to unfulfilled obligations of Lessee arising or occurring prior to the date of termination of this Lease, and (ii) any provision of this Lease pursuant to which the Lessor or Lessee had an existing obligation which was unsatisfied at the time of termination of this Lease and remains unsatisfied, including, without limitation, to the extent there was any unsatisfied obligation under, Sections 12.1, and Article 3, provided, however, that nothing in this Section 25.25 shall be deemed to extend any applicable statute of limitations.

Section 25.26. [Intentionally Omitted]

Section 25.27. Lease Subordinate. This Lease, the leasehold estate of Lessee created hereby and all rights of Lessee hereunder are and shall be subject and subordinate to the Mortgage and to all renewals, modifications, consolidations, replacements and extensions of the Mortgage, subject to the parties executing a subordination, non-disturbance and attornment agreement in the form attached hereto as Exhibit C. Such agreement shall provide that, so long as no Lease Event of Default has occurred and is continuing, Lessee’s occupancy and use of the Property pursuant to the terms of this Lease shall not be disturbed and Lessee’s rights under this Lease are and shall always be subordinate to the Mortgage and to all renewals, modification, consolidation, replacements and extension of the Mortgage.

Section 25.28. Lessor Representation. The Lease has been duly authorized by all necessary action on the part of Lessor and has been duly executed and delivered by Lessor, and the execution, delivery and performance thereof by Lessor will not, (i) require any consent or approval of any Person, other than such consents and approvals as have been obtained, (ii) contravene any Applicable Law binding on Lessor or the organizational documents of Lessor or (iii) contravene or result in any breach of or constitute any default under Lessor’s organizational documents, or any indenture, mortgage, loan agreement, contract, partnership or joint venture agreement, lease or other agreement or instrument to which Lessor is a party or by which Lessor is bound.

Section 25.29. Leasehold Financing. During the entire Lease Term as such Lease Term may be extended Lessee shall not be permitted to obtain a loan using this Lease or Lessee’s interest in the Property as collateral therefore.

[SIGNATURE PAGES SHALL FOLLOW]

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IN WITNESS WHEREOF, Lessor and Lessee have duly authorized, executed and delivered this Lease as of the date first hereinabove set forth.

LESSOR:

INLAND RI HOLDING, LLC
a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
BRUNING HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
JM 55TH HOLDING LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
55TH HOLDING LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
ROCKFORD BRUNING HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager

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COMMONS HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
DEER PARK HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
BA WR HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
HARTLAND HOLDING, LLC a Delaware limited liability company
By:	/s/ Sherwin Jarol	[SEAL]
Name:	Sherwin Jarol
Title:	Manager
LESSEE:
COST PLUS, INC., a California corporation
By:	/s/ Tom Willardson	[SEAL]
Name:	Tom Willardson
Title:	Executive Vice President And Chief Financial Officer

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APPENDIX A

[Definitions]

Unless otherwise specified or the context otherwise requires:

(a) any term defined below by reference to another instrument or document shall continue to have the meaning ascribed thereto whether or not such other instrument or document remains in effect;

(b) words which include a number of constituent parts, things or elements, shall be construed as referring separately to each constituent part, thing or element thereof, as well as to all of such constituent parts, things or elements as a whole;

(c) references to any Person include such Person’s successors and assigns and in the case of an individual, the word “successors” includes such Person’s heirs, devisees, legatees, executors, administrators and personal representatives;

(d) words importing the singular include the plural and vice versa;

(e) words importing a gender include any gender;

(f) the words “consent”, “approve”, “agree” and “request”, and derivations thereof or words of similar import, mean the prior written consent, approval, agreement or request of the Person in question;

(g) a reference to a part, clause, party, section, article, exhibit or schedule is a reference to a part and clause of, and a party, section, article, exhibit and schedule to, the document referenced;

(h) a reference to any statute, regulation, proclamation, ordinance or law includes all statutes, regulations, proclamations, ordinances or laws varying, consolidating or replacing them, and a reference to a statute includes all regulations, proclamations and ordinances issued or otherwise applicable under that statute;

(i) a reference to a document includes an amendment or supplement to, or replacement or novation of, that document;

(j) a reference to a party to a document includes that party’s successors and permitted delegees and/or assigns,

(k) the words “including” and “includes,” and words of similar import, shall be deemed to be followed by the phrase “without limitation”;

(l) the words “hereof” and “hereunder,” and words of similar import, shall be deemed to refer to the Lease as a whole and not to the specific section or provision where such word appears;

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(m) unless the context shall otherwise require, a reference to the “Property” or “Improvements” shall be deemed to be followed by the phrase “or a portion thereof”;

(n) the Schedules and Exhibits of the Lease are incorporated herein by reference;

(o) the titles and headings of Articles, Sections, Schedules, Exhibits, subsections, paragraphs and clauses are inserted as a matter of convenience and shall not affect the construction of the Lease;

(p) all obligations of the Lessor under the Mortgage and any related documents shall be satisfied by the Lessor at Lessor’s sole cost and expense;

“Actual Knowledge” with respect to any Person, shall mean the present, conscious, actual knowledge of, or receipt of notice by, (i) senior officers of such Person or the officers or employees of such Person charged with the oversight on its behalf of the Overall Transaction or (ii) with respect to a matter covered by a representation and warranty, the property or asset manager having responsibility for the matters covered by such representation and the person to whom such manager reports. Actual Knowledge of Lessee as of the Closing Date shall be as set forth in Section 20.1 of the Lease with respect to the matters represented in the Lease as of the Closing Date.

“Address” shall mean, subject to the rights of the party in question to change its Address in accordance with the terms of the Lease:

(i)	with respect to Lessee:	Cost Plus, Inc. 200 Fourth Street Oakland, California 94607
	with a copy to:	Cost Plus, Inc. 200 Fourth Street Oakland, California 94607
		Attention:	Tom Willardson, Chief Financial Officer and
			Executive Vice President
	with a copy to:	Cooper, White & Cooper LLP 201 California Street, 17th Floor San Francisco, California 94111 Attention: Beau Simon
	with a copy to:	Williams Mullen 222 Central Park Ave., Suite 1700 Virginia Beach, Virginia 23462 Attention: William W. Harrison, Jr.

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(ii)	with respect to Lessor:	The Inland Real Estate Group, Inc. 2901 Butterfield Road Oak Brook, Illinois 60523 Attention: Roberta Matlin
	with a copy to:	The Inland Real Estate Group, Inc. 2901 Butterfield Road Oak Brook, Illinois 60523 Attention: Robert H. Baum, General Counsel

“Affected Property” shall have the meaning specified in Section 12.1 of the Lease.

“Affiliate” of any Person shall mean any other Person directly or indirectly controlling, controlled by or under common control with, such person and shall include, if such Person is an individual, members of the Family of such Person and trusts for the benefit of such individual or Family members. For purposes of this definition, the term, “control” (including the correlative meanings of the terms “controlling” “controlled by” and “under common control with”), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management policies of such Person, whether through the ownership of voting securities or by contract or otherwise.

“Alterations” shall mean alterations, improvements, installations, demolitions, modifications, changes and additions to the Property, but shall not include Lessee’s Equipment and Personalty.

“Applicable Laws” shall mean (i) all existing and future applicable laws (including common laws), rules, regulations, statutes, treaties, codes, ordinances, permits, certificates, orders and licenses of and interpretations by, any Governmental Authorities, and applicable judgments, decrees, injunctions, writs, orders or like action of any court, arbitrator or other administrative, judicial or quasi-judicial tribunal or agency of competent jurisdiction (including those pertaining to the environment and those pertaining to the construction, use or occupancy of the Property), and (ii) any reciprocal easement agreement, covenant, other agreement or deed restriction or easement of record affecting the Property as of the date hereof or subsequent hereto pursuant to the terms of the Lease (but excluding for purposes of this definition the Mortgage and related debt documents). Applicable Laws include Environmental Laws.

“Appraisal Procedure” shall mean the following procedure for determining any one or more of the Fair Market Sales Value of the Property, the Fair Market Rental Value of the Property or any other amount which may, pursuant to any provision of this Lease, be determined by the Appraisal Procedure: one Qualified Appraiser shall be chosen by the Lessor and one Qualified Appraiser shall be chosen by Lessee. If the Lessee or Lessor fails to choose a Qualified Appraiser within twenty (20) Business Days after written notice from the other party of the selection of its Qualified Appraiser followed by a second notice (which notice shall specifically state that failure to select a Qualified Appraiser within ten (10) Business Days shall prohibit appointment of a Qualified Appraiser by the addressed party) given at least ten (10) Business Days prior to the expiration of such twenty-day period, then the appraisal by such

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appointed Qualified Appraiser shall be binding on the parties. If the two Qualified Appraisers cannot agree on a value within twenty (20) Business Days after the appointment of the Second Qualified Appraiser, then a third Qualified Appraiser shall be selected by the two Qualified Appraisers or, failing agreement as to such third Qualified Appraiser within thirty (30) Business Days after the appointment of the Second Qualified Appraiser, by the American Arbitration Association office in San Francisco, California. The appraisals of the three Qualified Appraisers shall be given within twenty (20) Business Days of the appointment of the third Qualified Appraiser and the appraisal of the Qualified Appraiser most different from the average of the other two shall be discarded and such average of the remaining two Appraisers shall be binding on the parties; provided that if the highest appraisal and the lowest appraisal are equidistant from the third appraisal, the third appraisal shall be binding on the parties. The fees and expenses of the Qualified Appraiser appointed by a party shall be paid by such party (such fees and expenses not being indemnifiable by Lessee); the fees and expenses of the third Qualified Appraiser shall be divided equally between the two parties, except that all fees and expenses of all the Qualified Appraisers shall be paid by Lessee in the case of an appraisal or determination under Article 17 of the Lease.

“Approved Environmental Consultant” shall mean any environmental consultant to Lessee of national standing and reasonably approved by Lessor.

“Authorized Officer” shall mean with respect to a Person if the Person is not an individual, any officer or principal of the Person, any trustee of the Person (if the Person is a trust), any general partner or joint venturer of the Person (if the Person is a partnership or joint venture) or any manager or member that is a manager of the Person (if the Person is a limited liability company) who shall be duly authorized to execute the Lease.

“Bankruptcy Code” shall mean the Bankruptcy Reform Act of 1978 as amended and as may be further amended.

“Base Rent” shall mean, for the Base Term, the rent payable pursuant to Section 3.1 of the Lease and, for any Renewal Term, the rent payable pursuant to Article 5 of the Lease as such amounts may be adjusted from time to time.

“Base Term” shall mean the period commencing on the Closing Date and ending on the last day of the calendar month in which the twenty (20) year anniversary of the Closing Date occurs, or such shorter period as may result from earlier termination of the Lease as provided therein. At any time prior to the commencement of the tenth (10^th) Lease year, Lessee shall have the one time right to terminate the Lease upon, delivery of, at least, eighteen (18) months prior written notice to Lessor for no termination provided in no event shall the Base Term be less then ten (10) years. The failure of Lessee to exercise its one time right to terminate the Lease prior to the commencement of the tenth (10) Lease Year in the manner set forth above, shall be deemed a waiver of Lessee’s rights of early termination hereunder.

“Business Day” shall mean any day other than a Saturday, Sunday or other day on which banks are authorized to be closed in the State of California or the Commonwealth of Virginia.

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“Casualty” shall mean any damage or destruction caused to the Property by any reason, whether or not constituting an Event of Loss.

“Claims” shall mean Liens (including, without limitation, lien removal and bonding costs) liabilities, obligations, damages, losses, demands, penalties, assessments, payments, fines, claims, actions, suits, judgments, settlements, costs, expenses and disbursements (including, without limitation, reasonable, actually-incurred legal fees and expenses and costs of investigation and Remedial Action) of any kind and nature whatsoever.

“Closing Date” shall mean December 21, 2006.

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

“Condemnation” shall mean any condemnation, requisition or other taking or sale of the use, occupancy or title to any or all of the Property, by or on account of any eminent domain proceeding or other action by any Governmental Authority or other Person under the power of eminent domain or otherwise or any transfer in lieu of or in anticipation thereof.

“Default Rate” shall mean three percent (3%) above the annual rate of interest set by Citibank, N.A. (or any successor thereto) as its “Prime Rate” from time to time.

“Environmental Laws” shall mean all federal, state or local laws, ordinances, rules, orders, statutes, decrees, judgments, injunctions, codes, regulations and common law (a) relating to the environment, human health or natural resources; (b) regulating, controlling or imposing liability or standards of conduct concerning Hazardous Materials; (c) relating to the remediation of the Mortgaged Property, including investigation, response, clean-up, remediation, prevention, mitigation or removal of Hazardous Materials; or (d) requiring notification or disclosure of releases of Hazardous Materials or any other environmental conditions on the Mortgaged Property, as any of the foregoing may have been or may be amended, supplemented or supplanted from time to time, including the Resource Conservation and Recovery Act of 1976 (“RCRA”), 42 U.S.C. §§ 6901 et seq., as amended by the Hazardous and Solid Waste Amendments of 1984, the Comprehensive Environmental Response, Compensation and Liability Act, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C. §§ 9601 et seq. (“CERCLA”), the Hazardous Materials Transportation Act of 1975, 49 U.S.C. §§ 1801-1812, the Toxic Substances Control Act, 15 U.S.C. §§ 2601-2671, the Clean Air Act, 42 U.S.C. §§ 7041 et seq., the Federal Insecticide, Fungicide and Rodenticide Act, 7 U.S.C. §§ 136 et seq., as any of the foregoing may have been or may be amended, supplemented or supplanted from time to time.

“ERISA” shall mean the Employee Retirement Income Security Act of 1974.]

“Event of Loss” shall mean (y) the damage, by fire or otherwise, and whether total or partial, that (A) the Lessee in its reasonable discretion shall determine that as a result of such damage the Property is no longer useful for its intended purpose, and (B) the cost of repair or restoration would exceed twenty-five percent (25%) of the appraised value for the Improvements on the Closing Date, (z) the permanent or material taking by Condemnation effecting (A) title to all or substantially all of the Property, or (B) the principal points of ingress or egress of the

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Property to public roadways, or (C) such a material part of the Land or the Improvement so as to have a material and adverse effect on the business of the Lessee as conducted from the Property. Any decision regarding whether the Property is no longer useful for its intended purpose shall be made by Lessee in good faith and evidenced by an Officer’s Certificate of Lessee delivered to Lessor and the Lender.

“Excepted Payments” shall mean and include (i) the amount by which Base Rent exceeds all amounts then due and payable under any debt documents, any amount payable to Lessor as a reimbursement for losses suffered by Lessor pursuant to Section 12.1 above and any other amounts payable directly to Lessor under Article 18 or 19 as set forth in the Lease, (ii) proceeds of public liability or property damage insurance maintained under the Lease solely for the benefit of any Person other than the Lender, and (iii) any payment required under the Lease to be made directly by Lessee to a third party such as taxes, utility charges, ground rent, if any, and similar payments.

“Existing Rent” shall have the meaning specified in Section 25.24 of the Lease.

“Fair Market Rental Value” with respect to any Property shall mean the fair market monthly rental value that would be obtained in an arm’s-length transaction between an informed and willing lessee and an informed and willing lessor, in either case under no compulsion to lease, and neither of which is related to Lessor or Lessee, for the lease of such Property on the terms set forth in the Lease, and taking into consideration the fact that no brokerage commission will be payable, and that Lessee will not be receiving any tenant improvement allowance, period of free rent, or other economic concession. Such fair market rental value shall be calculated as the value for the use of such Property assuming that such Property is in the condition and repair required to be maintained by the terms of the Lease, including, without limitation, in compliance with all Applicable Laws and assuming no Hazardous Materials present in, on, under or about the Property.

“Fair Market Sales Value” with respect to any Property shall mean the fair market sales value that would be obtained in an arm’s-length transaction between an informed and willing buyer and an informed and willing seller, under no compulsion, respectively, to buy or sell, and neither of which is related to Lessor or Lessee, for the purchase of the Property. Such Fair Market Sales Value shall be calculated as the value for such Property using the same methodology as used in the appraisal delivered on or before the Closing Date and assuming that the Property is in the condition and repair required to be maintained by the terms of the Lease, including, without limitation, in compliance with all Applicable Laws and assuming no Hazardous Materials present in, on, under or about the Property.

“Family” shall mean, as to any Person, such Person’s grandparents, all lineal descendants of such Person’s grandparents, Persons adopted by, or stepchildren of, any such grandparent or descendant and Persons currently married to, or who are widows or widowers of, any such grandparent, descendant, adoptee or stepchild.

“Final Payment Date” shall have the meaning specified in Section 17.1(e) of the Lease.

“Fixtures” shall have the meaning specified in the term “Property”.

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“GAAP” shall mean generally accepted accounting principles in the United States, as in effect from time to time, consistently applied.

“Governmental Action” shall mean all permits, authorizations, registrations, consents, approvals, waivers, exceptions, variances, orders, judgments, decrees, licenses, exemptions, publications, filings, notices to and declarations of or with, or required by, any Governmental Authority, or required by any Applicable Laws, and shall include, without limitation, all citings, environmental and operating permits and licenses that are required for the use, occupancy, zoning and operation of the Property.

“Governmental Authority” shall mean any federal, state, county, municipal or other governmental or regulatory authority, agency, board, body, commission, instrumentality, court or quasi governmental authority (or private entity in lieu thereof).

“Hazardous Material” shall mean any substance (whether solid, liquid or gas), pollutant, contaminant, waste or material (including those that are toxic, explosive, corrosive, flammable, infectious, radioactive, carcinogenic, mutagenic or otherwise hazardous or considered pollutants including petroleum, its derivatives, by-products and other hydrocarbons and asbestos), in each case that is or becomes regulated by any Governmental Authority, including any agency, department, commission, board or instrumentality of the United States and/or each State in which the Property is situated, or that may form the basis of liability under any Environmental Law.

“Impositions” shall mean, collectively, all real estate taxes on the Property, all ad valorem, sales and use, gross receipts, transaction privilege, rent or similar taxes levied or incurred with respect to the Property, or the use, lease, ownership or operation thereof, personal property tax on any property covered by the Lease that is classified by government authorities as personal property, assessments (including all assessments for public improvements or benefits, whether or not commenced or completed within the Lease Term) (collectively “Taxes”), water, sewer, utilities or other rents and charges, excises, levies, fees and all other governmental charges of any kind or nature whatsoever, general or special, foreseen or unforeseen, ordinary or extraordinary, with respect to the Property or any part thereof and/or the Rent, including all interest and penalties thereon, which at any time prior to, during or with respect to the Lease Term may be assessed or imposed on or with respect to or be a Lien upon Lessor or the Property or any part thereof or any rent therefrom or any estate, title or interest therein. Impositions shall exclude, however, and nothing contained in the Lease or any debt documents or related Mortgage shall be construed to require Lessee to pay, (i) any tax imposed on Lessor, or the Lender based on the net income of Lessor, or the Lender or any transfer tax imposed on Lessor, the Lender or any other Person, except to the extent that any tax described in this clause (i) is levied, assessed or imposed as a total or partial substitute for a tax, assessment, levy or charge upon the Property, the Rent or any part thereof or interest therein which Lessee would otherwise be required to pay thereunder; (ii) any tax imposed with respect to the sale, exchange or other disposition by (A) Lessor of the Property or (B) the Lender of its debt; or (iii) any gross receipts, transaction privilege, rent or similar tax, assessment, levy or charge upon Lessor, the Property, the Rent or any part of any thereof or interest therein, but solely to the extent that the same is levied, assessed or imposed as a total or partial substitute for a tax, assessment, levy or charge described in clause (i) or clause (ii) which Lessee would otherwise not be required to pay hereunder.

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“Improvements” shall have the meaning specified in the term “Property”.

“Indemnitee” shall mean the Lessor, its member, the Lender, any trustee under a Mortgage which is a deed of trust, and each of their Affiliates and their respective officers, directors, employees, shareholders, members or partners.

“Indemnitee’s Group” shall mean, with respect to a particular Indemnitee, such Indemnitee (including its Affiliates and their respective officers, directors, employees, agents, shareholders, trustees, members or partners) and their successors and assigns.

“Inspecting Parties” shall have the meaning specified in Article 15 of the Lease.

“Land” shall have the meaning specified in the term “Property”.

“Lease” shall mean the Lease Agreement dated as of the Closing Date between Lessor, as lessor, and Lessee, as lessee.

“Lease Default” shall mean any event, condition or failure which, with notice or lapse of time or both, would become a Lease Event of Default.

“Lease Event of Default” shall have the meaning specified in Article 16 of the Lease.

“Lease Term” shall mean the full term of the Lease, including the Base Term and any Renewal Terms as to which Lessee exercises a renewal option pursuant to Article 5 of the Lease, or such shorter period as may result from earlier termination of the Lease as provided therein.

“Lease Year” shall mean each consecutive period of twelve (12) full calendar months occurring after the Closing Date, provided, however, that, if the Closing Date shall not be the first day of a month, then the first Lease Year shall also include the partial month in which the Closing Date occurs.

“Lender” shall mean, from time to time, the holder of the first lien Mortgage on the Property. During periods when there is no Lender, references herein to Lender shall have no force or effect.

“Lessee” shall mean the Lessee named in the Lease to which this Appendix is attached.

“Lessee’s Equipment and Personalty” shall mean all furniture, equipment and personal property of Lessee, which includes, without limitation, inventory, racking, shelving, conveyer equipment, lifts, cabling, antennae, machinery, air compressors, battery chargers, communication equipment, data cabinets, automated teller machines, hoist equipment, lockers, plug-in light fixtures, propane tanks, storage racks, trash compactors, signs, desks, movable partitions, vending machines, computer software and hardware, movable storage and utility rooms and removable trade fixtures and equipment, even if bolted or otherwise affixed to the floors, including, without limitation, telecommunication switches, in each case, as now or may hereafter

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exist in or on any of the Improvements and any other personal property owned by Lessee or a sublessee of Lessee or other occupant of the Property. In no case shall Lessee’s Equipment and Personalty include fixtures or built-in heating, ventilating, air-conditioning, and electrical equipment (including power panels) to be utilized in connection with the operation of the Property.

“Lessor” shall mean the Lessor named in the Lease to which this Appendix is attached.

“Lessor Liens” shall mean Liens on or against the Property or the Lease or any payment of Rent (a) which result from any act of, or any Claim against, Lessor, or which result from any violation by Lessor of any of the terms of the Mortgage or any related debt documents, other than a violation due to a default by Lessee under the Lease, (b) which result from Liens in favor of any taxing authority by reason of any tax owed and payable by Lessor, except that Lessor Liens shall not include any Lien resulting from any tax for which Lessee is obligated to indemnify Lessor until such time as Lessee shall have already paid to or on behalf of Lessor the Tax or the required indemnity with respect to the same, or (c) which result from any expenses owed, caused or occasioned by Lessor or any of its employees, contractors or agents which are not indemnified by Lessee pursuant to Section 19.1 of the Lease, but shall exclude Permitted Liens and any Liens created by the Mortgage and any other debt documents, except to the extent any such Lien arises by the Lender’s payment of any of the foregoing.

“Lien” shall mean any lien, mortgage, pledge, charge, security interest or encumbrance of any kind, or any other type of preferential arrangement that has the practical effect of creating a security interest, including, without limitation, any thereof arising under any conditional sale agreement, capital lease or other title retention agreement.

“Material” as used to describe Lessee’s compliance requirement in Section 8.5 of the Lease shall mean that the failure to so comply may reasonably be expected to result in material risk of (i) physical injury or illness to any individual, (ii) criminal liability, or (iii) fines or Remedial Action or compliance costs in excess of $500,000.00.

“Moody’s” shall mean Moody’s Investors Service, Inc. and its successors.

“Mortgage” shall mean a first lien deed of trust or mortgage (together with any related assignment of rents) between the Lessor, as mortgagor or trustor, and the Lender, as mortgagee or beneficiary, and as the same may be renewed, amended, modified, consolidated, replaced or extended from time to time. During periods when there is no Mortgage, references in the Lease to the Mortgage shall have no force or effect.

“Mortgaged Property” shall mean the Mortgaged Property or Trust Property, as defined in the Mortgage.

“Net Casualty Proceeds” shall mean the compensation and/or insurance payments (whether received from a third party insurance company or from Lessee because it has self-insured) net of the reasonable expenses of collecting such amounts incurred by the Lessor and Lender if a Lease Event of Default exists, received by the Lender, the Lessor or the Lessee in respect of the Property by reason of and on account of an Event of Loss described in clause (y) of the definition thereof or a casualty.

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“Net Condemnation Proceeds” shall mean any award or compensation net of the reasonable expenses of collecting such amounts incurred by the Lessor and the Lender if a Lease Event of Default exists, received by the Lender, the Lessor or the Lessee in respect of the Property by reason of and on account of a Condemnation.

“Net Proceeds” shall mean Net Casualty Proceeds and Net Condemnation Proceeds.

“Nonseverable” shall describe an Alteration or part of an Alteration which cannot be removed from the existing Improvements or the Land without causing material damage to the Property; provided that Lessee’s Equipment and Personalty shall not be construed as Nonseverable.

“Officer’s Certificate” of a Person or any Person signing on behalf of a Person shall mean a certificate signed, in the case of a partnership, by a general partner of such partnership, or in the case of a corporation, by an Authorized Officer of such Person, or, in the case of a limited liability company, by the manager of such limited liability company.

“Overall Transaction” shall mean all the transactions and activities referred to in or contemplated by the Lease.

“Permits” shall mean as to the Property all licenses, authorizations, certificates, variances, concessions, grants, registrations, consents, permits and other approvals issued by a Governmental Authority now or hereafter pertaining to the ownership, management, occupancy, use or operation of such Premises, including certificates of occupancy.

“Permitted Encumbrances” shall mean the easements, rights of way, reservations, servitudes and rights of others against the Property which are listed in the title policy issued to the Lessor by the Title Insurance Company on the Closing Date.

“Permitted Investments” shall mean any one or more of the following obligations or securities having (a) a predetermined fixed dollar of principal due at maturity that cannot vary or change, (b) bearing interest that may either be fixed or variable but which is tied to a single interest rate index plus a single fixed rate spread (if any) and move proportionately with that index, and (c) having the required ratings, if any, provided for in this definition:

(i) direct obligations of, and obligations fully guaranteed as to timely payment of principal and interest by, the United States of America or any agency or instrumentality of the United States of America, the obligations of which are backed by the full faith and credit of the United States of America that mature in thirty (30) days or less after the date of issuance and that does not have a “r” highlighter affixed to its rating;

(ii) time deposits, unsecured certificates of deposit, or bankers’ acceptances that mature in thirty (30) days or less after the date of issuance and are issued or held by any depository institution or trust company (including the Lender) incorporated or organized under the laws of the United States of America or any State thereof and subject to supervision and

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examination by federal or state banking authorities, so long as the commercial paper or other short-term debt obligations of such depository institution or trust company are rated at least “A-1” and “P-1” by Standard & Poor’s and Moody’s, respectively, or such other rating as would not result in the downgrading, withdrawal or qualification of the then current rating assigned by the Rating Agencies to the Pass-Through Certificates, as evidenced in writing and that does not have a “r” highlighter affixed to its rating;

(iii) repurchase agreements or obligations with respect to any security described in clause (i) above where such security has a remaining maturity of thirty (30) days or less and where such repurchase obligation has been entered into with a depository institution or trust company (acting as principal) described in clause (ii) above;

(iv) debt obligations bearing interest or sold at a discount issued by any corporation incorporated under the laws of the United States of America or any state thereof which mature in thirty (30) days or less from the date of issuance, which debt obligations have ratings from Moody’s and Standard & Poor’s in the highest category possible, or such other rating as would not result in the downgrading, withdrawal or qualification of the then-current rating assigned by the Rating Agencies to any Pass-Through Certificate as specified in writing by the Rating Agencies and that does not have a “r” highlighter affixed to its rating; provided, however, that securities issued by any particular corporation will not be Permitted Investments to the extent that investment therein will cause the then-outstanding principal amount of securities issued by such corporation and held in the accounts established hereunder to exceed 10% of the sum of the aggregate principal balance and the aggregate principal amount of all Permitted Investments in such accounts; and

(v) commercial paper (including both non-interest-bearing discount obligations and interest-bearing obligations) payable on demand or on a specified date maturing in thirty (30) days or less after the date of issuance thereof and which is rated in the highest category possible by Moody’s and Standard & Poor’s and that does not have a “r” highlighter affixed to such rating.

“Permitted Liens” shall mean:

(a) the respective rights and interests of the Lessee, the Lessor and the Lender under the Lease and any Mortgage,

(b) Liens for Taxes either not yet due or being contested in good faith and by appropriate proceedings, so long as such proceedings shall not involve any danger of the sale, forfeiture or loss of any part of the Property, title thereto or any interest therein (other than to a de minimis extent) and are undertaken in accordance with the terms of any documents securing the Lender’s loan to Lessor, (including, without limitation, posting of any bonds or other collateral to the extent required by such documents),

(c) materialmen’s, mechanics’, workers’, repairmen’s, employees or other like Liens for amounts either not yet due or being contested in good faith and by appropriate proceedings so long as such proceedings shall not involve any danger of the sale, forfeiture or loss of any part of the Property, title thereto or any interest therein (other than to a de minimis extent), provided

Lessee agrees that it shall pay, discharge or record or bond any such lien within sixty (60) days after Lessee receives notice thereof, if Lessee does not have a Required Rating equal to or greater than the Trigger Rating, or if a Lease Event of Default under Section 16.1(a), (b) or (c) exists,

A-11

(d) Liens arising out of judgments or awards with respect to which at the time an appeal or proceeding for review is being prosecuted in good faith and either which have been bonded or for the payment of which adequate reserves shall have been provided to Lessor’s reasonable satisfaction, provided that if the long-term unsecured debt of Lessee shall not have a Required Rating of at least the Trigger Rating, then any such amount in excess of $500,000.00 (unless Lessee is insured therefor), shall be bonded or discharged by Lessee within thirty (30) days after Lessee’s knowledge thereof,

(e) easements, rights of way, reservations, servitudes and rights of others against the Property which are granted pursuant to Section 25.11 of the Lease and which could not reasonably be expected to have a material adverse effect on the Property,

(f) Permitted Encumbrances, and

(g) Assignments and subleases expressly permitted by the Lease.

No lien, judgment, charge or other agreement shall be deemed to be Permitted Lien if such lien, judgment, charge or other agreement, individually or in the aggregate with other liens, judgments, charges or agreements, materially and adversely affect (i) the value of the Property, (ii) Lessee’s ability to pay all Rent, as and when due hereunder, or (iii) Lessee’s right to use and operate the Property.

“Permitted Use” shall have the meaning given to such term in Section 8.1 of the Lease.

“Person” shall mean individual, corporation, partnership, joint venture, association, joint-stock company, trust, limited liability company, non-incorporated organization or government or any agency or political subdivision thereof.

“Proceeds Trustee” shall mean the Lender or, if the Property shall not at the time in question be encumbered by a Mortgage, a federally insured bank or other financial institution, selected by Lessor and reasonably satisfactory to Lessee.

“Property” shall mean the real property whose parcel or parcels of land are described on Exhibit A to the Lease (the “Land”); together with all buildings, structures, and other improvements of every kind situated on the Land (collectively, the “Improvements”); together with all easements, rights and appurtenances relating to the Land or the Improvements; and together with all fixtures, including all components thereof, on and in respect to the Improvements, including, without limitation, all built-in refrigeration and freezer equipment used in the operation of the Property, together with all replacements, modifications, alterations and additions thereto (collectively, the “Fixtures”), provided that in no event shall “Property” include Lessee’s Equipment and Personalty.

“Qualified Appraiser” means an independent nationally recognized appraiser who shall be a member of The Appraisal Institute (or its successor organization) with not less than five (5) years experience appraising properties similar to the Property in the market in which the Property is located.

“Rating Agencies” shall mean Moody’s and Standard & Poor’s.

“Reference Rate” shall mean on any day, the rate at which prepayments would be discounted under any note secured by a Mortgage (or if no Mortgage is in effect, the rate at which prepayments would by discounted under the note secured by the Mortgage in effect on or promptly following the Closing Date).

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“Release” shall mean the release or threatened release of any Hazardous Material into or upon or under any land or water or air, or otherwise into the environment, including, without limitation, by means of burial, disposal, discharge, emission, injection, spillage, leakage, seepage, leaching, dumping, pumping, pouring, escaping, emptying, placement and the like.

“Remedial Action” means the investigation, response, clean-up, remediation, prevention, mitigation or removal of contamination, environmental degradation or damage caused by, related to or arising from the existence, generation, use, handling, treatment, storage, transportation, disposal, discharge, Release (including a continuous Release), or emission of Hazardous Materials, including, without limitation, investigations, response, removal, monitoring and remedial actions under CERCLA; corrective action under the Resource Conservation and Recovery Act of 1976, as amended, the investigation, removal or closure of any underground storage tanks, and any related soil or groundwater investigation, remediation or other action, and investigation, clean-up or other actions required under or necessary to comply with any Environmental Laws.

“Renewal Term” shall have the meaning specified in Section 5.1 of the Lease.

“Rent” shall mean Base Rent and Supplemental Rent, collectively.

“Rent Collection Account” shall mean the account established by the Lender from time to time, and to which Lessee is directed to make all payments of Rent due to the Lender.

“Rent Payment Dates” shall mean the 1st day of each month during the Lease Term, commencing December 21, 2006, provided, however, in the event such date is not a Business Day, the Rent Payment Date shall be the immediately following Business Day; provided further, however that Base Rent for the period commencing on the Closing Date and terminating on December 31, 2026 shall be payable in advance on the Closing Date.

“Required Rating” shall mean a rating of the Lessee at the level set forth in the Lease as required for Lessee to have the benefit conferred, issued by Standard & Poors and Moody’s (or any replacement of either of them made by the Lender (in which case the rating shall be the equivalent)).

“Restoration Fund” shall have the meaning specified in Section 12.4(a) of the Lease.

“Sale and Purchase Agreement” shall mean the Purchase and Sale Agreement dated as of October 26, 2006 between Lessee’s as Seller and Inland Real Estate Acquisitions, Inc. as Purchaser.

“Standard & Poor’s” shall mean Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies, Inc., and its successors.

“Stipulated Loss Value” shall mean $57,502,500.

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“Stipulated Loss Value Date” shall have the meaning specified in Section 12.1(i) of the Lease, and after expiration of the Base Term shall mean the first day of each month during a Renewal Term.

“Sublease” shall have the meaning given such term in Section 14.1 of the Lease.

“Subsidiary” shall mean any corporation whose assets and liabilities are consolidated with that of Lessee.

“Supplemental Rent” shall mean any and all amounts, fees, expenses, liabilities, obligations, late charges, Taxes and Impositions other than Base Rent which Lessee assumes or agrees or is otherwise obligated to pay under the Lease, including, without limitation, to the Lessor, the Lender or any other party, including Fair Market Sales Value payments, Stipulated Loss value payments, and indemnities and damages for breach of any covenants, representations, warranties or agreements; provided that, when Supplemental Rent is used with respect to the Property, then Supplemental Rent shall be such amounts determined in respect of the Property.

“Term” shall mean the Base Term and Renewal Term (if any).

“Terms” shall have the meaning specified in Section 4.1 of the Lease.

“Threshold Amount” shall mean $2,000,000.00, but if the Lessee does not have a credit rating (as calculated under the definition of Trigger Rating) at least equal to the Trigger Rating, Threshold Amount shall mean $500,000.

“Title Insurance Company” shall mean Chicago Title Insurance Company.

“Trigger Rating”, with respect to any Person, shall mean that the senior unsecured obligations of such Person shall have a rating, (or if the senior unsecured obligations of such Person shall not be rated, such Person shall have a confidential debt rating) of BBB by Standard & Poor’s, and of Baa2 by Moody’s.

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SCHEDULE 3.1

Rental Payments

Years	Rent Per Annum
	The Base Rent for each Renewal Term shall Be increased to an amount which is 1.5% of The immediate preceding Base Rent.
1	$3,980,000.00
2	$4,039,000.00
3	$4,100,295.50
4	$4,161,799.50
5	$4,224,226.50
6	$4,287,590.00
7	$4,351,903.85
8	$4,417,182.40
9	$4,483,440.10
10	$4,550,691.70
11	$4,618,951.70
12	$4,688,235.95
13	$4,758,559.45
14	$4,829,937.85
15	$4,902,386.85
16	$4,975,922.65
17	$5,050,561.45
18	$5,126,319.85
19	$5,203,214.65
20	$5,281,262.85

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SCHEDULE 9.1

Insurance Requirements

(a) Lessee covenants and agrees that it will at all times keep in full force and effect the following insurance coverage:

(i) A broad form commercial general liability insurance policy or its then current industry acceptable equivalent (unamended except for amendments increasing coverages or adding additional insured parties)), including but not limited to premises, operations, automobile liability (which may be carried by separate policy) and products liability, personal injury liability, contractual liability, and property damage liability coverage at the Property and the business conducted by Lessee thereon. The policy shall provide coverage limits of not less than One Million Dollars ($1,000,000) per occurrence Two Million Dollars ($2,000,000) aggregate. Lessee shall also provide a commercial excess or umbrella liability of Ten Million Dollars ($10,000,000) insuring Lessor and the Lender and its successors and assigns as additional insureds, as their interest may appear. Lessor may reasonably require other types of general liability insurance, based upon (A) the loss history at the Property, and (B) industry standards, and taking into account Lessee’s (or its parent’s, if applicable) insurance program, and other types of coverage being obtained in similar transactions. To the extent commercially available, such policy shall contain a deductible of not more than Twenty-Five Thousand Dollars ($25,000.00) per occurrence, (One Hundred Thousand Dollars ($100,000.00) per occurrence so long as Lessee maintains a net worth of, at least, One Hundred Million Dollars ($100,000,000.00)). In the event Lessee maintains a deductible in excess of $25,000 or $100,000 as required above (but not more than $250,000) Lessee may provide a letter of credit in form approved by Lessor which approval shall not unreasonably be withheld in the amount of the difference between the actual deductible and the applicable limits to the deductible as described above.

(ii) A comprehensive all risk “special form” policy of standard 100% replacement cost insurance with agreed amount endorsements and no coinsurance against physical loss or damage by fire, lightning, flood, windstorm and other risks and supplementary perils from time to time included under all risk policies, with standard and extended coverage or all risk endorsement, including without limitation, vandalism and malicious mischief and also including against terrorist acts based upon the relevant provisions of the Terrorist Risk Insurance Act of 2002 (“TRIA”) or if TRIA is no longer applicable against foreign terrorist acts (to the extent commercially available) of all building and other facilities and improvements constructed on the Property and all tenant finish and leasehold improvements and fixtures and loss of rents for actual loss sustained for a period of at last twenty-four (24) months. This policy shall name Lessor and the Lender its successors and assigns as loss payees and mortgagee as their interest may appear. To the extent commercially available, such policy shall contain a deductible of not more than Twenty Five Thousand Dollars ($25,000.00) per occurrence (One Hundred Thousand Dollars ($100,000.00) per occurrence if Lessee maintains a net worth of at least, One Hundred Millions Dollars ($100,000,000.00) unless Lessee has a Required Rating at least equal to the Trigger Rating, in which case the deductible may be no more

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than five percent (5%) of the replacement cost of the Improvements, excluding footings and foundation, as reasonably evidenced to Lessor and Lender upon request of Lessor on behalf of the Lender. Lessee shall be responsible for all deductibles.

(iii) Workers’ compensation or other such insurance in accordance with applicable state law requirements covering all of Lessee’s employees.

If Lessee is self-insuring, its obligations shall be that of an insurer under the form of policy delivered to Lessor as of the Closing.

(iv) To the extent the use of the Property is legal, but nonconforming to existing zoning laws from time to time, Lessee shall also provide law and ordinance insurance.

(b) If the Lessee fails to satisfy the condition necessary to maintain a program of self-insurance adequate to satisfy the requirements set forth herein, Lessee shall have a period of five (5) days in which to obtain the necessary insurance coverage and deliver to Lessor and the Lender a certificate of insurance evidencing compliance with the requirements set forth in Section 9.1.

(c) All policies of insurance described in this Schedule which Lessee is required to procure and maintain shall be issued by one or more primary insurers having a Standard & Poor’s rating equal to A- or better.

(d) Unless Lessee elects (and is permitted) to self-insure as provided in Section 9.1(b), certificates of such insurance will be delivered to Lessor and the Lender, and any additional insureds upon execution of this Lease and any renewals or extensions of said policies or certificates of insurance shall be delivered to Lessor and the Lender at least ten (10) days prior to the expiration or termination of such policies. Upon request of Lessor or Lender, Lessee shall provide certified copies of those portions of any policy requested covering all aspects of how a claim can or may be made under such policy, within thirty (30) days of request. In the alternative, Lessee may provide a certificate from its insurance broker setting forth all of the foregoing, in form and substance reasonably satisfactory to Lessor and the Lender. Unless Lessee elects (and is permitted) to self-insure as provided in Section 9.1(b), all liability and property damage policies will contain the following provisions:

(i) The company writing such policy will agree to give the insured and additionally named insured parties or loss payees not less than thirty (30) days (ten (10) days for nonpayment of premium) notice in writing prior to any cancellation, reduction, or material modification of such insurance;

(ii) Lessor and the Lender shall be named as additional insured or loss payees, as their interests may appear, for each insurance policy required to be maintained by Lessee (except (a)(iv) above), with all proceeds under any policy under (a)(ii) and (iii) to be paid in accordance with the provisions of the Lease.

(e) Any insurance required by the Lease (excluding, however, the coverage identified in Section (a)(ii) above) may be brought within the coverage of a so-called blanket policy or policies of insurance carried by and maintained by the insuring party insuring the combined

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operations at the Property with other premises leased or owned by Lessee, so long as the insured party and the additional insureds required hereunder are named under such policies as their interest may appear with coverage at least as good as required herein.

(f) If Lessee fails to acquire or maintain the insurance required pursuant to this Schedule and Article 9 or to pay the premiums for such insurance and deliver the required certificates, Lessor may, in addition to other rights and remedies available to Lessor, acquire such insurance and/or pay the requisite premiums therefor. Such premiums so paid by Lessor will be reimbursable and payable by Lessee immediately upon written demand therefor made to Lessee by Lessor, plus interest at the Default Rate from the date paid by Lessor until reimbursement by Lessee.

(g) Except to the extent otherwise provided in the Lease, the parties hereto release each other, and their respective representatives, agents, contractors and employees from any claims for damage to the Property and all improvements located in the Property, and to the fixtures, personal property, improvements, and alteration of either Lessor or Lessee in or upon the Property, that are caused by or result from risks insured against under any property insurance policies carried by the parties (or which should have been carried by the parties pursuant to the terms hereof) or, in the case of Lessee’s self-insurance, all risks that would otherwise be insured against under the property policies identified herein; provided, however, the foregoing shall not impair any claim against Lessee in its capacity as self insurer. Each party shall cause each property insurance policy obtained by it (recognizing that Lessor may not in fact obtain any insurance) to provide that the insurance company waives in writing all right of recovery by way of subrogation against the other party in connection with any damage covered by such policy. Neither party shall be liable to the other for any damage caused by fire or any of the risks insured against (or to be insured against) under any property insurance policy required by the Lease or self-insurance maintained in lieu of any such required insurance.

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SCHEDULE 12.2

The first $500,000.00 of any excess Condemnation shall be divided between the Lessor and Lessee as follows:

If the taking takes place in:	The Lessor receives:		The Lessee receives:
2006	8.3	%	91.7	%
2007	16.7	%	83.3	%
2008	25	%	75	%
2009	33.3	%	66.7	%
2010	41.7	%	58.3	%
2011	50	%	50	%
2012	58.3	%	41.7	%
2013	66.7	%	33.3	%
2014	75	%	25	%
2015	83.3	%	16.7	%
2016	91.7	%	8.3	%
2017	100	%	0	%

During any Renewal Term the proceeds shall be allocated 100% to the Lessor.

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EXHIBIT A

LEGAL DESCRIPTION OF PROPERTY

ALL THAT certain parcel of land lying, situate and being in Windsor District, Isle of Wight County, Virginia, being designated as Parcel 4 containing 81.852 acres as shown on that certain plat entitled, “PLAT SHOWING A CONSOLIDATION OF PARCELS 2A AND 3, SHIRLEY T. HOLLAND INDUSTRIAL PARK AND 34.520 ACRES OF LAND FORMING PARCEL 4, SHIRLEY T. HOLLAND INDUSTRIAL PARK, WINDSOR DISTRICT, ISLE OF WIGHT COUNTY, VIRGINIA”, dated May 3, 2004, and recorded May 14, 2004, in the Clerk’s Office of the Circuit Court of Isle of Wight County, Virginia in Plat Cabinet 2, Slide 119, Pages 8 and 9.

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EXHIBIT B

Form of Estoppel Agreement

                    , the                      of [Lessee][Lessor] hereby certifies that as of                      (the “Certification Date”), the following is true and correct:

(a) the Lease dated as of                          , 2006 is unmodified and in force and effect [(or if there have been modifications, that the Lease is in force and effect as modified, and identifying the modification agreements];

(b) the date to which Base Rent has been paid is                     ,     ,             ;

(c) to the best of Lessee’s knowledge there is no default by Lessee in the payment of Base Rent or any other Rent payable to Lessor hereunder, and there is no other existing default by either party with respect to which a notice of default or notice of termination (by Lessor) has been served, [and, if there is any such default, specifying the nature and extent thereof], and, to the actual knowledge of the property or asset manager of Lessee having responsibility for the Lease and Property, and the officer to which he or she reports, there are no acts under the Lease that have occurred that would constitute a Lease Event of Default with notice, and the passage of time;

(d) to the knowledge of the signer, there are no setoffs, defenses or counterclaims against enforcement of the obligations to be performed hereunder existing in favor of the party executing such certificate.

(e) the term of the Lease and the payment of rent commenced on                     , 2006, and is scheduled to expire on                     , 20    , unless renewed or terminated in accordance with the terms of the Lease. Pursuant to the Lease, Lessee is entitled to renew the Lease for four (4) terms of five (5) years each.

[(f) Lessee is not the subject of any filing for bankruptcy or reorganization under any applicable law.]¹

[LESSOR/LESSEE]

¹ Only if Lessee is delivering estoppel certificate.

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EXHIBIT C

SUBORDINATION, NONDISTURBANCE AND ATTORNMENT AGREEMENT

THIS SUBORDINATION, NON-DISTURBANCE AND ATTORNMENT AGREEMENT (the “Agreement”) is made as of the          day December 2006 by and between                                         , having an address at                                                                       (“Lender”) and Cost Plus, Inc., a California corporation (“Tenant”).

RECITALS:

A. Tenant is the holder of a leasehold estate in a portion of the property known as Cost Plus Facility located at 12300 Windsor Blvd., Isle of Wright County, Virginia as more particularly described on Schedule A (the “Property”) under and pursuant to the provisions of a certain lease dated                     , 200     between                                         , as landlord (“Landlord”) and Tenant or its predecessor in interest, as tenant (as amended through the date hereof, the “Lease”);

B. The Property is or is to be encumbered by one or more mortgages, deeds of trust, deeds to secure debt or similar security agreements (collectively, the “Security Instrument”) from Landlord, or its successor in interest, in favor of Lender; and

C. Tenant has agreed to subordinate the Lease to the Security Instrument and to the lien thereof and Lender has agreed to grant non-disturbance to Tenant under the Lease on the terms and conditions hereinafter set forth.

AGREEMENT:

NOW, THEREFORE, the parties hereto mutually agree as follows:

1. Subordination. The Lease shall be subject and subordinate in all respects to the lien and terms of the Security Instrument, to any and all advances to be made thereunder and to all renewals, modifications, consolidations, replacements and extensions thereof.

2. Nondisturbance. So long as Tenant is not in default (beyond applicable notice and cure periods) of any of its obligations and covenants pursuant to the Lease, Lender agrees for itself and its successors in interest and for any other person acquiring title to the Property through a foreclosure (an “Acquiring Party”), that Tenant’s possession of the premises as described in the Lease will not be disturbed during the term of the Lease, as said term may be extended pursuant to the terms of the Lease or as said premises may be expanded as specified in the Lease, by reason of a foreclosure. For purposes of this agreement, a “foreclosure” shall include (but not be limited to) a sheriff’s or trustee’s sale under the power of sale contained in the Security Instrument, the termination of any superior lease of the Property and any other transfer of the Landlord’s interest in the Property under peril of foreclosure, including, without limitation to the generality of the foregoing, an assignment or sale in lieu of foreclosure.

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3. Attornment. Tenant agrees to attorn to, accept and recognize any Acquiring Party as the landlord under the Lease pursuant to the provisions expressly set forth therein for the then remaining balance of the term of the Lease, and any extensions thereof as made pursuant to the Lease. The foregoing provision shall be self-operative and shall not require the execution of any further instrument or agreement by Tenant as a condition to its effectiveness. Tenant agrees, however, to execute and deliver, at any time and from time to time, upon the request of the Lender or any Acquiring Party any reasonable instrument which may be necessary or appropriate to evidence such attornment.

4. No Liability. Notwithstanding anything to the contrary contained herein or in the Lease, it is specifically understood and agreed that neither the Lender, any receiver nor any Acquiring Party shall be:

(a) liable for any act, omission, negligence or default of any prior landlord (other than to cure defaults of a continuing nature with respect to the maintenance or repair of the demised premises or the Property); provided, however, that any Acquiring Party shall be liable and responsible for the performance of all covenants and obligations of landlord under the Lease accruing from and after the date that it takes title to the Property; or

(b) except as set forth in (a), above, liable for any failure of any prior landlord to construct any improvements;

(c) subject to any offsets, credits, claims or defenses which Tenant might have against any prior landlord; or

(d) bound by any rent or additional rent which is payable on a monthly basis and which Tenant might have paid for more than one (1) month in advance to any prior landlord; or

(e) liable to Tenant hereunder or under the terms of the Lease beyond its interest in the Property or

(f) liable or responsible for or with respect to the retention, application and or/return to the Tenant of any security deposit paid to Landlord or any prior landlord, unless and until Lender or such Acquiring Party has actually received for its own account as landlord the full amount of such security deposit.

Notwithstanding the foregoing, Tenant reserves its rights to any and all claims or causes of action against such prior landlord for prior losses or damages and against the successor landlord for all losses or damages arising from and after the date that such successor landlord takes title to the Property.

5. Rent. Tenant has notice that the Lease and the rents and all other sums due thereunder have been assigned to Lender as security for the loan secured by the Security Instrument. In the event Lender notifies Tenant of the occurrence of a default under the Security Instrument and demands that Tenant pay its rents and all other sums due or to become due under the Lease directly to Lender, Tenant shall honor such demand and pay its rent and all other sums due under the Lease directly to Lender or as otherwise authorized in writing by Lender. Landlord hereby irrevocably authorizes Tenant to make the foregoing payments to Lender upon such notice and demand.

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6. Lender to Receive Notices. Tenant shall notify Lender of any default by Landlord under the Lease which would entitle Tenant to cancel the Lease, and agrees that, notwithstanding any provisions of the Lease to the contrary, no notice of cancellation thereof shall be effective unless Lender shall have received notice of default giving rise to such cancellation and shall have failed within thirty (30) days after receipt of such notice to cure such default, or if such default cannot be cured within thirty (30) days, shall have failed within thirty (30) days after receipt of such notice to commence and thereafter diligently pursue any action necessary to cure such default.

7. Notices. All notices or other written communications hereunder shall be deemed to have been properly given (i) upon delivery, if delivered in person with receipt acknowledged by the recipient thereof, (ii) one (1) Business Day (hereinafter defined) after having been deposited for overnight delivery with any reputable overnight courier service, or (iii) three (3) Business Days after having been deposited in any post office or mail depository regularly maintained by the U.S. Postal Service and sent by registered or certified mail, postage prepaid, return receipt requested, addressed to the receiving party at its address set forth above, and:

if to Tenant, to the attention of:	Cost Plus, Inc.
	200 4th Street Oakland, California 94607
	Attn:	Tom Willardson, Chief Financial Officer and Executive Vice President
and
if to Lender:

or addressed as such party may from time to time designate by written notice to the other parties. For purposes of this Paragraph 7, the term “Business Day” shall mean any day other than Saturday, Sunday or any other day on which banks are required or authorized to close in New York, New York.

Either party by notice to the other may designate additional or different addresses for subsequent notices or communications.

8. Successors. The obligations and rights of the parties pursuant to this Agreement shall bind and inure to the benefit of the successors, assigns, heirs and legal representatives of the respective parties. In addition, Tenant acknowledges that all references herein to Landlord shall mean the owner of the landlord’s interest in the Lease, even if said owner shall be different than the Landlord named in the Recitals.

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9. Duplicate Originals; Counterparts. This Agreement may be executed in any number of duplicate originals and each duplicate original shall be deemed to be an original. This Agreement may be executed in several counterparts, each of which counterparts shall be deemed an original instrument and all of which together shall constitute a single Agreement. The failure of any party hereto to execute this Agreement, or any counterpart hereof, shall not relieve the other signatories from their obligations hereunder.

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IN WITNESS WHEREOF, Lender and Tenant have duly executed this Agreement as of the date first above written.

LENDER:
By:
Name:
Authorized Signatory
TENANT:
COST PLUS, INC.
A California corporation
By:
Name:	Tom Willardson
Title:	Chief Financial Officer and
	Executive Vice President
The undersigned as the Landlord named in the Recitals or as successor thereto hereby accepts and agrees to be bound by the provisions of Paragraph 5 hereof.
By:
By:
Name:
Title:

H-6

STATE OF	)
	)
COUNTY OF	)

I, the undersigned, a Notary Public of the County and State aforesaid, certify that                                          personally came before me this day and acknowledged that he/she is the                                          of                                                               and that he/she as its                                         , being duly authorized to do so, executed the foregoing instrument on behalf of the corporation.

WITNESS my hand and official seal, this          day of                     , 200    .

Notary Public

My commission expires:                                          

[NOTARIAL SEAL]

H-6

STATE OF	)
	)
COUNTY OF	)

I, the undersigned, a Notary Public of the County and State aforesaid, certify that                                          personally came before me this day and acknowledged that he/she is the                                          of                                                              , a                                                                                   and that he/she as its                                         , being duly authorized to do so, executed the foregoing instrument on behalf of the corporation.

WITNESS my hand and official seal, this          day of                     , 200    .

Notary Public

My commission expires:                                          

[NOTARIAL SEAL]

H-6

STATE OF                                          

COUNTY OF                                     

I, the undersigned, a Notary Public of the County and State aforesaid, certify that                                          personally came before me this day and acknowledged that he/she is the                                          of INLAND RETAIL REAL ESTATE TRUST, INC., a Maryland corporation, which is the general partner of INLAND RETAIL REAL ESTATE LIMITED PARTNERSHIP, an Illinois limited partnership, which is the sole member and manager of INLAND SOUTHEAST                                         , L.L.C., a Delaware limited liability company and that he/she as its                                         , being duly authorized to do so, executed the foregoing instrument on behalf of the corporation.

WITNESS my hand and official seal, this          day of                     , 200    .

Notary Public

My commission expires:                                          

[NOTARIAL SEAL]

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EX-10.23

Exhibit 10.23

EMPLOYMENT SEVERANCE AGREEMENT

This Employment Severance Agreement (the “Agreement”) is made and entered into effective as of December 11, 2006 (the “Effective Date”), by and between George Whitney (the “Executive”) and Cost Plus, Inc. (the “Company”).

R E C I T A L S

A. Cost Plus desires to retain the services of the Executive, and the Executive desires to be employed by Cost Plus, on the terms and subject to the conditions set forth in this Agreement.

B. The Board of Directors of the Company (the “Board”) believes the Company should provide the Executive with certain severance benefits should the Executive’s employment with the Company terminate under certain circumstances, such benefits to provide the Executive with enhanced financial security and sufficient incentive and encouragement to remain with the Company.

C. Certain capitalized terms used in the Agreement are defined in Section 6 below.

AGREEMENT

In consideration of the mutual covenants herein contained, the parties agree as follows:

1. Duties and Scope of Employment. The Company shall employ the Executive in the position of Senior Vice President, Merchandising, with such duties, responsibilities and compensation as in effect as of the Effective Date. The Board and the Chief Executive Officer of the Company (the “CEO”) shall have the right to revise such responsibilities and compensation from time to time as the Board or the CEO may deem necessary or appropriate. If any such revision constitutes “Involuntary Termination” as defined in Section 6(d) of this Agreement, the Executive shall be entitled to benefits upon such Involuntary Termination as provided under this Agreement.

2. At-Will Employment. The Company and the Executive acknowledge that the Executive’s employment is and shall continue to be at-will, as defined under applicable law. If the Executive’s employment terminates for any reason, the Executive shall not be entitled to any payments, benefits, damages, awards or compensation other than as provided by this Agreement, or as may otherwise be available in accordance with the Company’s established employee plans and practices or in accordance with other agreements between the Company and the Executive. This Agreement shall remain in effect until the earlier of (i) the date that all obligations of the parties hereunder have been satisfied or (ii) the date upon which this Agreement terminates by consent of the parties hereto.

3. Severance Benefits.

(a) Benefits upon Termination. Unless the Executive is entitled to benefits under Section 3(b) of this Agreement, if the Executive’s employment terminates as a result of Involuntary Termination prior to June 15, 2007 and the Executive signs and does not revoke a Release of Claims, then the Company shall pay the Executive’s Base Compensation on a salary continuation basis in accordance with the Company’s normal payroll practices to the Executive for twelve (12) months from the Termination Date. The Executive shall not be entitled to receive any payments if the Executive voluntarily terminates employment other than as a result of an Involuntary Termination.

(b) Benefits upon Termination After a Change of Control. If after a Change of Control the Executive’s employment terminates as a result of Involuntary Termination prior to June 15, 2007 and the Executive signs and does not revoke a Release of Claims, then the Company shall pay the Executive’s Base Compensation on a salary continuation basis in accordance with the Company’s normal payroll practices to the Executive for eighteen (18) months from the Termination Date. The Executive shall not be entitled to receive any payments if the Executive voluntarily terminates employment other than as a result of an Involuntary Termination.

(c) Stock Options. Unless otherwise provided in the Company’s stock option plans or in the Executive’s stock option agreements, the Executive shall not be entitled to acceleration of any unvested stock options upon the termination of the Executive’s employment for any reason, including an Involuntary Termination.

(d) Miscellaneous. In addition to the benefits described in Section 3(a) or Section 3(b) of this Agreement, upon the termination of the Executive’s employment, (i) the Company shall pay the Executive any unpaid base salary due for periods prior to the Termination Date; (ii) the Company shall pay the Executive all of the Executive’s accrued and unused vacation through the Termination Date; (iii) following submission of proper expense reports by the Executive, the Company shall reimburse the Executive for all expenses reasonably and necessarily incurred by the Executive in connection with the business of the Company prior to the Termination Date; and (iv) if benefits will be paid under Section 3(a) or Section 3(b) of this Agreement, the Company shall pay the Executive a pro-rata portion of his fiscal year bonus, if any, under the Company’s Management Incentive Plan in effect for the fiscal year in which the Termination Date occurs. Such amount shall be paid at the time bonuses for the completed fiscal year are paid to other executives (but no later than the period of time required to fit within the short-term deferral rule of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”)), shall be pro-rated for the period of time during the fiscal year that the Executive was an employee of the Company and shall only be paid if, and to the extent, that the relevant performance targets have been achieved by the Company. Except for any bonus payment under clause (iv) of the preceding sentence, these payments shall be made promptly upon termination and within the period of time mandated by applicable law.

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4. Limitation on Payments.

(a) Code Section 409A. If the Company reasonably determines that Section 409A will result in the imposition of additional tax to an earlier payment of the severance and other benefits provided in this Agreement or otherwise payable to the Executive, then the first six (6) months of the Executive’s severance benefits under Section 3 of this Agreement will accrue during the six (6)-month period following the Executive’s termination and will become payable in a lump sum payment on the date that is six (6) months and one (1) day following the date of the Executive’s termination of employment. The remaining severance benefits will be payable as provided in Section 3 of this Agreement.

(b) Code Section 280G. In the event that the severance and other benefits provided for in this Agreement or otherwise payable to the Executive (i) constitute “parachute payments” within the meaning of Section 280G of the Code and (ii) but for this Section 4, would be subject to the excise tax imposed by Section 4999 of the Code, then the Executive’s severance benefits under Section 3(b) of this Agreement shall be either:

(i) delivered in full, or

(ii) delivered as to such lesser extent which would result in no portion of such severance benefits being subject to excise tax under Section 4999 of the Code, whichever of the foregoing amounts, taking into account the applicable federal, state and local income taxes and the excise tax imposed by Section 4999 of the Code, results in the receipt by the Executive on an after-tax basis, of the greatest amount of severance benefits, notwithstanding that all or some portion of such severance benefits may be taxable under Section 4999 of the Code. Unless the Company and the Executive otherwise agree in writing, any determination required under this Section 4 shall be made in writing by the Company’s independent public accountants immediately prior to Change of Control (the “Accountants”), whose determination shall be conclusive and binding upon the Executive and the Company for all purposes. For purposes of making the calculations required by this Section 4, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of Sections 280G and 4999 of the Code. The Company and the Executive shall furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make a determination under this Section. The Company shall bear all costs the Accountants may reasonably incur in connection with any calculations contemplated by this Section 4.

5. Non-Solicitation. In consideration for the mutual agreements as set forth herein, the Executive agrees that the Executive shall not, at any time, within twelve (12) months following termination of the Executive’s employment with the Company for any reason, directly or indirectly solicit the employment or other services of any individual who at that time shall be or within the prior twelve (12) months shall have been an employee of the Company.

6. Definition of Terms. The following terms referred to in this Agreement shall have the following meanings:

(a) Base Compensation. “Base Compensation” means the Executive’s monthly base salary paid by the Company for services performed calculated as the average base salary for the six (6) months completed prior to the Termination Date. If the Executive has not been employed by the Company for six (6) complete months prior to the Termination Date, Base Compensation shall be calculated as the average base salary for the period of the Executive’s employment.

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(b) Cause. “Cause” means the Executive’s (i) intentional failure to perform reasonably assigned duties, (ii) dishonesty or willful misconduct in the performance of duties, (iii) engaging in a transaction in connection with the performance of duties to the Company or any of its subsidiaries which transaction is adverse to the interests of the Company or any of its subsidiaries and which is engaged in for the Executive’s personal enrichment or (iv) willful violation of any material law, rule or regulation in connection with the performance of duties.

(c) Change of Control. “Change of Control” means the consummation of any of the following events:

(i) The acquisition by any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) of the “beneficial ownership” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the total voting power represented by the Company’s then outstanding voting securities;

(ii) A change in the composition of the Board of Directors of the Company occurring within a two (2)-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. “Incumbent Directors” shall mean directors who either (A) are directors of the Company as of the date hereof, or (B) are elected, or nominated for election, to the Board of Directors of the Company with the affirmative votes of at least a majority of the Incumbent Directors at the time of such election or nomination (but shall not include an individual not otherwise an Incumbent Director whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company);

(iii) A merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the approval by the stockholders of the Company of a plan of complete liquidation of the Company or of an agreement for the sale or disposition by the Company of all or substantially all the Company’s assets;

(iv) The sale of all or substantially all of the assets of the Company determined on a consolidated basis; or

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(v) The complete liquidation or dissolution of the Company.

(d) Involuntary Termination. “Involuntary Termination” means:

(i) termination of the Executive’s employment by the Company for any reason other than Cause;

(ii) a material reduction in the Executive’s salary, other than any such reduction which is part of, and generally consistent with, a general reduction of officer salaries;

(iii) a material reduction by the Company in the kind or level of employee benefits (other than salary and bonus) to which the Executive is entitled immediately prior to such reduction with the result that the Executive’s overall benefits package (other than salary and bonus) is substantially reduced (other than any such reduction applicable to officers of the Company generally);

(iv) any material breach by the Company of any material provision of this Agreement which continues uncured for thirty (30) days following notice thereof; or

(v) a material reduction in the Executive’s titles, duties, responsibilities or authority;

provided that none of the foregoing shall constitute Involuntary Termination to the extent the Executive has agreed thereto. Any purported Involuntary Termination pursuant to Section 6(d)(ii) through 6(d)(v) will not be effective until the Executive has delivered to the Company a written explanation which describes the basis for the Executive’s belief that the Executive should be permitted to terminate his employment and have it treated as an Involuntary Termination and the Company has been given thirty (30) days to cure any curable violation.

(e) Release of Claims. “Release of Claims” shall mean a waiver by the Executive, in a form satisfactory to the Company, of all employment-related obligations of and claims and causes of action against the Company.

(f) Termination Date. “Termination Date” shall mean the date on which an event that would constitute Involuntary Termination occurs, or the later of (i) the date on which a notice of termination is given, or (ii) the date (which shall not be more than thirty (30) days after the giving of such notice) specified in such notice.

(g) Management Incentive Plan. “Management Incentive Plan” shall mean the Company’s bonus program, as implemented by the Company’s board of directors from time to time and pursuant to which the Executive may receive incentive-based compensation at fiscal year end.

7. Confidentiality. The Executive acknowledges that during the course of the Executive’s employment, the Executive will have produced and/or have access to confidential information, records, notebooks, data, formula, specifications, trade secrets, customer lists and secret

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inventions, and processes of the Company and its affiliated companies. Therefore, during or subsequent to the Executive’s employment by the Company, the Executive agrees to hold in confidence and not directly or indirectly to disclose or use or copy or make lists of any such information, except to the extent authorized by the Company in writing. All records, files, drawings, documents, equipment, and the like, or copies thereof, relating to the Company’s business, or the business of an affiliated company, which the Executive shall prepare, or use, or come into contact with, shall be and remain the sole property of the Company, or of an affiliated company, and shall not be removed from the Company’s or the affiliated company’s premises without its written consent, and shall be promptly returned to the Company upon termination of employment with the Company.

8. Successors.

(a) Company’s Successors. Any successor to the Company (whether direct or indirect and whether by purchase, lease, merger, consolidation, liquidation or otherwise) to all or substantially all of the Company’s business and/or assets shall assume the obligations under this Agreement and agree expressly to perform the obligations under this Agreement in the same manner and to the same extent as the Company would be required to perform such obligations in the absence of a succession. For all purposes under this Agreement, the term “Company” shall include any successor to the Company’s business and/or assets which executes and delivers the assumption agreement pursuant to this subsection (a) or which becomes bound by the terms of this Agreement by operation of law.

(b) Executive’s Successors. The terms of this Agreement and all rights of the Executive hereunder shall inure to the benefit of, and be enforceable by, the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees.

9. Notice.

(a) General. Notices and all other communications contemplated by this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by U.S. registered or certified mail, return receipt requested and postage prepaid. In the case of the Executive, mailed notices shall be addressed to the Executive at the home address that the Executive most recently communicated to the Company in writing. In the case of the Company, mailed notices shall be addressed to its corporate headquarters, and all notices shall be directed to the attention of its CEO.

(b) Notice of Termination. Any termination by the Company for Cause or by the Executive as a result of a voluntary resignation or an Involuntary Termination shall be communicated by a notice of termination to the other party hereto given in accordance with Section 9(a) of this Agreement. Such notice shall indicate the specific termination provision in this Agreement relied upon, shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination under the provision so indicated, and shall specify the termination date (which shall be not more than thirty (30) days after the giving of such notice). The failure by

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the Executive to include in the notice any fact or circumstance which contributes to a showing of Involuntary Termination shall not waive any right of the Executive hereunder or preclude the Executive from asserting such fact or circumstance in enforcing the Executive’s rights hereunder.

10. Miscellaneous Provisions.

(a) Non-Disparagement. The Executive agrees to refrain from any defamation, libel or slander of the Company and its respective officers, directors, employees, investors, shareholders, administrators, affiliates, divisions, subsidiaries, predecessor and successor corporations, and assigns or tortious interference with the contracts and relationships of the Company and its respective officers, directors, employees, investors, shareholders, administrators, affiliates, divisions, subsidiaries, predecessor and successor corporations, and assigns. The Executive acknowledges and agrees that any breach of this paragraph shall constitute a material breach of the Agreement and shall entitle the Company immediately to recover all consideration paid under this Agreement, including, but not limited to the consideration described in Section 3.

(b) No Duty to Mitigate. The Executive shall not be required to mitigate the amount of any payment contemplated by this Agreement, nor shall any such payment be reduced by any earnings that the Executive may receive from any other source.

(c) Waiver. No provision of this Agreement shall be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by the Executive and by an authorized officer of the Company (other than the Executive). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party shall be considered a waiver of any other condition or provision or of the same condition or provision at another time.

(d) Whole Agreement. No agreements, representations or understandings (whether oral or written and whether express or implied) which are not expressly set forth in this Agreement have been made or entered into by either party with respect to the subject matter hereof.

(e) Severance Provisions in Other Agreements. The Executive acknowledges and agrees that the severance provisions set forth in this Agreement shall supersede any such provisions in any other agreement entered into between the Executive and the Company.

(f) Choice of Law. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of California.

(g) Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision hereof, which shall remain in full force and effect.

(h) No Assignment of Benefits. The rights of any person to payments or benefits under this Agreement shall not be made subject to option or assignment, either by voluntary or involuntary assignment or by operation of law, including (without limitation) bankruptcy, garnishment, attachment or other creditor’s process, and any action in violation of this subsection shall be void.

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(i) Employment Taxes. All payments made pursuant to this Agreement will be subject to withholding of applicable income and employment taxes.

(j) Code Section 409A. This Agreement will be deemed amended to the extent necessary to avoid imposition of any additional tax or income recognition prior to actual payment to the Executive under Section 409A of the Code and any temporary, proposed or final Treasury Regulations and guidance promulgated thereunder and the parties agree to cooperate with each other and to take reasonably necessary steps in this regard.

(k) Assignment by Company. The Company may assign its rights under this Agreement to an affiliate, and an affiliate may assign its rights under this Agreement to another affiliate of the Company or to the Company; provided, however, that no assignment shall be made if the net worth of the assignee is less than the net worth of the Company at the time of assignment. In the case of any such assignment, the term “Company” when used in a section of this Agreement shall mean the corporation that actually employs the Executive.

(l) Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument.

[Signature Page to Follow]

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IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by its duly authorized officer, as of the day and year first above written.

COMPANY:		COST PLUS, INC.
	By	/s/ Barry J. Field
	Title	Director, Chief Executive Officer and President (Principal Executive Officer)
EXECUTIVE:		/s/ George Whitney
		George Whitney

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EX-21

Exhibit 21

Cost Plus, Inc.

List of Subsidiaries

Name	State of Incorporation
Cost Plus of Idaho, Inc.	Idaho
Cost Plus of Texas, Inc.	Texas
Cost Plus Management Services, Inc.	California

EX-23

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement Nos. 333-27739, 333-56975, 333-67441, 333-83561, 333-45710, 333-68322, 333-96899, 333-118819, 333-03456 and 333-137944 on Form S-8 of (i) our report dated May 4, 2007 relating to the financial statements of Cost Plus, Inc. (which report expresses an unqualified opinion and includes explanatory paragraphs relating to the Company’s adoption of a new accounting standard and a restatement) and (ii) our report dated May 4, 2007 on internal control over financial reporting (which report expresses an adverse opinion on the effectiveness of the Company’s internal control over financial reporting because of material weaknesses) appearing in this Annual Report on Form 10-K of Cost Plus, Inc. for the year ended February 3, 2007.

/s/ DELOITTE & TOUCHE LLP

San Francisco, California

May 4, 2007

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Barry J. Feld, certify that:

1. I have reviewed this annual report on Form 10-K of Cost Plus, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 4, 2007

/s/ Barry J. Feld

Barry J. Feld

Chief Executive Officer, President

(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Thomas D. Willardson, certify that:

1. I have reviewed this annual report on Form 10-K of Cost Plus, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 4, 2007

/s/ Thomas D. Willardson

Thomas D. Willardson

Executive Vice President, Chief Financial Officer

(Principal Financial and Accounting Officer)

EX-32.1

Exhibit 32.1

Certification of the Chief Executive Officer

and the Chief Financial Officer

Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of Cost Plus, Inc. (the “Company”) on Form 10-K for the fiscal year ended February 3, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Barry J. Feld, Chief Executive Officer and President of the Company and Thomas D. Willardson, Executive Vice President and Chief Financial Officer, hereby certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Barry J. Feld

Barry J. Feld

Chief Executive Officer and President

(Principal Executive Officer)

May 4, 2007

/s/ Thomas D. Willardson

Thomas D. Willardson

Executive Vice President,

Chief Financial Officer

(Principal Accounting Officer)

May 4, 2007