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| ZIPR > SEC Filings for ZIPR > Form 10-Q on 7-Nov-2008 | All Recent SEC Filings |
7-Nov-2008
Quarterly Report
The following discussion should be read together with our financial statements and related notes appearing elsewhere in this report. This discussion contains forward-looking statements based upon current expectations that involve numerous risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including but not limited to those set forth in "Risk Factors" in Item 1A of Part II of this report and elsewhere in this report. Except as otherwise required by law, we do not intend to update any information contained in these forward-looking statements.
OVERVIEW
General
We are a full-service residential real estate brokerage firm, using our user-friendly website and employee real estate agents to provide homebuyers and sellers with high-quality service and value. Our website provides users with access to comprehensive local Multiple Listing Services home listings data, as well as other relevant market and neighborhood information. Our proprietary business management system and technology platform help to reduce costs, allowing us to pass on significant savings to consumers. We share a portion of our commissions with our buyer clients in the form of a cash rebate where permissible by law, and typically represent our seller clients at fee levels below those offered by most traditional brokerage companies in our markets. Generally, our seller clients pay a total brokerage fee of 4.5% to 5.0% of the transaction value, of which 2.5% to 3.0% is paid to agents representing buyers.
Our net revenues are comprised primarily of commissions earned as agents for buyers and sellers in residential real estate transactions. We record revenues net of rebate (or, in New Jersey, net of charitable donation) or commission discount, if any, paid to our clients. Our net revenues are principally driven by the number of transactions we close and the average net revenue per transaction. Average net revenue per transaction is a function of the home sales price and percentage commission we receive on each transaction and varies significantly by market. We also receive revenues from certain marketing arrangements, pursuant to which we receive compensation for the fair value of certain marketing services we provide. Generally, non-commission revenues represent less than 5% of our net revenues during any period. We routinely explore our options for entering into additional marketing arrangements or offering other services related to the purchase, sale and ownership of a home, including services related to title insurance, escrow, mortgage, home warranty insurance and property and casualty insurance (including auto insurance), which we refer to as core services. In October 2008, E-LOAN announced plans to shut down operations as a direct first mortgage lender and, as a result, our marketing relationship with E-LOAN terminated October 31, 2008. The marketing relationship with E-LOAN has been the primary source of our corporate referral income. We are actively pursuing other mortgage partners to replace this source of revenue.
We were founded in 1999, currently have operations in 35 markets, and as of September 30, 2008 employed 3,063 people, of whom 2,814 were ZipAgents. During 2007 we commenced operations in Naples and Tucson in March, Denver in April, Jacksonville in May, Salt Lake City and Richmond in July, Virginia Beach and Charlotte in August, Raleigh-Durham in September, and Westchester County in December. To date in 2008 we have commenced operations in Long Island in March and Hartford in July and do not expect to open additional markets during the remainder of 2008.
Trends in our business and financial and real estate markets
In the three months ended September 30, 2008 we generated $31.4 million in net revenues, compared to $28.0 million in the three months ended September 30, 2007. In the nine months ended September 30, 2008 we generated $82.4 million in net revenues, compared to $82.7 million in the nine months ended September 30, 2007. The year-over-year three month increase in net revenue is primarily attributable to higher transaction volume which outpaced a decrease in average net revenue per transaction for the period and a decrease in our referral fee revenue from our marketing agreement related to mortgage services. The year-over-year nine month decrease is primarily attributable to a decrease in our referral fee revenue from a mortgage services marketing agreement partially offset by an increase in net transaction revenue resulting from higher transaction volume outpaced by a decrease in average net revenue per transaction during this period. The number of our closed transactions increased to approximately 5,019 in three months ended September 30, 2008
from approximately 3,829 in the three months ended September 30, 2007, and our average net revenue per transaction decreased to approximately $6,130 in the three months ended September 30, 2008 from approximately $7,110 in the three months ended September 30, 2007, a decrease in average net revenue per transaction of approximately 13.8%. Our average net revenue per transaction decreased over these periods in existing markets and increased in new markets. The decrease in average net revenue per transaction was primarily attributable to a combination of factors including overall decreases in housing prices, an increase in the number of foreclosure, bank REO and short sale transactions, typically at further reduced sales prices, as well as a continued shift of our business into markets with lower average housing prices. The number of our closed transactions increased to approximately 12,821 in the nine months ended September 30, 2008 from approximately 10,927 in the nine months ended September 30, 2007, and our average net revenue per transaction decreased to approximately $6,299 in the nine months ended September 30, 2008 from approximately $7,359 in the nine months ended September 30, 2007.
Our transaction volume is primarily driven by the number of ZipAgents we employ, their productivity, and market conditions. The number of ZipAgents we employ has increased to 2,814 at September 30, 2008 from 2,263 at September 30, 2007. The average productivity of our total agent force was 0.60 and 0.62 transactions per ZipAgent per month during the nine months ended September 30, 2008 and 2007, respectively. We calculate the average monthly productivity of our ZipAgents for the period by dividing the average monthly number of transactions closed during the period by the average number of ZipAgents employed at the beginning of each month during the period. As we introduce new initiatives to improve agent productivity, we may experience temporary declines in the total number of agents although, overall, we expect to continue to increase the number of agents.
We have increased our market share in many of our existing markets, resulting in an increase in net transaction revenues in existing markets (markets opened before January 1, 2007), to $27.6 million in the three months ended September 30, 2008 from $26.7 million in the three months ended September 30, 2007. Our net transaction revenues have increased due to higher transaction volume despite a decline in net revenue per transaction. New market net transaction revenues increased by $2.6 million resulting in an overall increase in net transaction revenues of approximately $3.5 million. Due to the general deterioration of market conditions, our new markets are taking longer to attain profitability.
We believe that customer acquisition is one of our core competencies, and while we anticipate that the difficulty of acquiring a sufficient number of leads online may increase over time, we expect that we can mitigate some of that impact with repeat and referral business, as well as by increasing our visibility and credibility to potential clients over time. Since our market share has averaged less than 1% over the past year in our existing markets in aggregate, we believe that there is an opportunity to increase further our market share, even if the overall level of sales continue to decline due to changing consumer sentiment, interest rate increases, credit tightening, or other economic or geopolitical factors.
Softness in the residential real estate market. Although our business has experienced increasing revenue growth on an annual basis since our inception in 1999, primarily as a result of increased transaction volume and increased average net revenue per transaction, recently revenue growth has slowed, and average net revenue per transaction has declined, due to a transition period in the housing market and the effects of recent changes in the mortgage lending business. Since the fall of 2005, the residential real estate market has been softening. As mortgages consequently went into default, lender underwriting criteria tightened. Credit standards continued to tighten even further in response to market changes, including the crisis in the financial markets and related banking shock caused by the declining value of mortgage-backed securities and the federal government's effective takeover of Fannie Mae and Freddie Mac in the late summer and fall of 2008. Non-conforming loans have become less available and, in some markets, almost nonexistent. Further, with the declining value of 401(k) savings accounts and other investment accounts created by plummeting stock values, fewer homebuyers have been able to meet the down payment and underwriting requirements to obtain even conforming loans, resulting in lower closing yields as transactions fail to close, and creating a further downward pressure on home prices. We believe that the recent increase in the unemployment rate, together with a further decline in consumer confidence on a macroeconomic level, have added additional downward pressure on home prices.
We have experienced increases in the available inventories of homes for sale in many of our markets, as well as increases in the amount of time listings take to sell. The National Association of REALTORS ® has reported that months of inventory levels in September 2008 decreased modestly from levels in September 2007. According to NAR, the national median home price decreased 9% year-over-year, while high inventories persist as the annual rate of existing home sales only increased 1.4% year-over-year in September 2008 to a seasonally adjusted rate of 5.18 million. In California, the California Association of REALTORS ® reported that the median home price decreased by 40.9%, but that inversely, home sales increased 96.7% year-over-year in September 2008. NAR further reported that the sales turnaround in California is broadening to other markets,
but the credit markets have not yet fully stabilized. The residential real estate market may continue to soften in the foreseeable future, particularly given the recent crisis in the financial and banking industries. We may continue to experience reduced growth rates versus our historical levels as buyers react cautiously to perceived changing market conditions.
If the current softness of the residential real estate market continues or worsens, we expect to see a further reduction in the number of licensed REALTORS® nationwide and in our largest markets. For example, the National Association of REALTORS ® has reported that its total membership of REALTORS® fell approximately 8.4% from September 30, 2007 to September 30, 2008. Further, according to the California Department of Real Estate, in December 2007, the total number of real estate licensees in California dropped by 0.1% month-over-month, the first decline in its agent rolls in over five years, and salesperson examinations in that state decreased by 85% from December 2006 to December 2007. We expect that overall declines in agent ranks will be comprised disproportionately of less skilled real estate agents, with the better agents continuing in the business. We also expect that the prolonged softening may deal a critical blow to some of our competitors. It is our hope that these events, if they occur, will increase the percentage of highly skilled real estate agents on the market, and reduce the competition for such agents, but we cannot know whether this result will occur, or whether the overall decline in the number of real estate agents will make it more difficult for us to employ qualified agents and grow our business.
Impact of availability of home loans on residential real estate market. The residential real estate market has been negatively impacted by the availability of home loans, which is critical to our business. As home prices have declined, lenders have increased lending standards to protect their positions. Throughout the first part of 2008, we observed a continued tightening in the availability of credit, and continued imposition of higher and more rigorous credit standards to obtain a mortgage.
In the first quarter of 2008, Federal legislation was enacted that, among other objectives, seeks to bolster the market for home loans by raising the loan amount that qualifies as a "conforming loan" up to a maximum of $729,750 in certain markets. There can be no assurance that this legislation will accomplish its desired objectives, or that it will have a positive impact on the residential real estate market. So far, we have seen little impact from this legislation, which will expire in December 2008 at which time the limit will decrease to $625,500.
In addition, at the end of July 2008, the President signed the Housing and Economic Recovery Act of 2008, which introduces several initiatives aimed at helping to shore up the real estate market, including an income tax credit of up to $7,500 for certain first-time homebuyers. Key aspects of this Act are provisions intended to strengthen Fannie Mae and Freddie Mac. During the third quarter of 2008, the government announced several steps taken with respect to Fannie Mae and Freddie Mac in order to shore up their capital positions and provide liquidity to the mortgage market, including placing Fannie Mae and Freddie Mac in conservatorship. A stable and liquid residential mortgage market is critical to the housing market, and, hence, our business. In early October 2008, the President signed the Emergency Economic Stabilization Act of 2008, which authorized the Treasury Secretary (Treasury) to establish the Troubled Assets Relief Program (TARP) to, among other things, purchase troubled assets. Later in October, Treasury announced a program pursuant to TARP to invest capital in certain banking institutions. It is too early to assess whether the Housing and Economic Recovery Act of 2008, the Emergency Economic Stabilization Act of 2008, and the actions taken with regard to Fannie Mae and Freddie Mac will have a positive and meaningful impact on the availability of credit, on spurring first-time homebuyers to purchase a home, and on the overall residential housing market.
Changes to our business model. Over time, we have made significant adjustments to our cost structure and revenue model in order to improve the financial results of our business, including to the compensation and expense reimbursement structure for ZipAgents. Currently, our ZipAgents earn a compensation package consisting of a percentage of the commissions they generate for us that ranges from 35% to 80% or more, based on their productivity, of our net revenues after deducting certain other items. We also provide our ZipAgents with health, retirement and other benefits, and pay for certain marketing costs and other business expenses. ZipAgents may also be granted equity incentives based on performance. We may choose or be required to make further modifications to our compensation structure in the future. For example, Nevada approved legislation that preempts the federal "outside sales exemption" from paying minimum wages in that state. That legislation took effect on November 1, 2007. Accordingly, on November 1, 2007 we began paying minimum wage and, where required, overtime pay, to our ZipAgents in Nevada. The minimum wage payments will be offset against future commissions earned, if any.
We have lowered our buyer rebate percentage several times to improve our revenue model. We implemented these buyer rebate percentage reductions for several reasons, including our determination that our growing reputation for superior service allowed us not to compete solely on price, our efforts to improve our revenue model and agent compensation model, and our desire to offer a simplified rebate structure to our clients.
In connection with entry into the Greater Philadelphia area in December 2006, we entered the New Jersey market, where the payment of cash rebates is currently not permitted by law. Consequently, in New Jersey, in lieu of offering a cash rebate to our buyers, we make a donation to a local charity through United Way equal to 20% of our commission after closing.
Historically, most of our business has been derived from representing buyers in their home purchases. One of our growth strategies is to increase the portion of our business that is composed of representing sellers in their home listings. In addition, a general softening in the residential real estate market, as well as other factors, may cause an increase in the percentage of our business that is composed of representing home sellers rather than home buyers. As the portion of our listings business increases, and as listings take longer to sell in a market with higher inventory levels, marketing costs generally increase, and commissions can decrease as buyers demand more last-minute concessions in price before closing. If the softened market persists, we may incur greater listing marketing costs and achieve lower commissions and lower profit margins.
Fluctuations in quarterly profitability. Since first achieving profitability in the first quarter of 2005, we have experienced fluctuations in profitability from period to period. Our profitability has been impacted by various factors including seasonality, new market expansion, legal settlements, ongoing market softness and tightening in the availability of home mortgage credit.
Industry declines in commission percentages. Over the past several years there has been a decline in average commissions charged in the real estate brokerage industry, in part due to companies such as ours exerting downward pressure through a lower commission structure, as well as by what, in our view, appears to be an increase in consumer willingness to negotiate fees with their agents. We believe that many consumers are focusing on absolute commission dollars paid to sell their home as opposed to accepting a traditional market commission percentage. According to REAL Trends, while the average commission percentage decreased from 5.44% in 2000 to 5.25% in 2007, total commission revenues increased from $42.6 billion to $49.4 billion during that same period, influenced by steadily increasing sales volumes and higher median sales prices. In the event that commissions continue to decline, we have designed our business model around an attractive cost structure and operational efficiencies which we believe should allow us to continue to offer our services at prices less than those charged by the majority of our competitors.
Changes in competitive landscape. In addition, the competitive landscape in the residential real estate industry is in the midst of significant changes as new business models enter the marketplace. For example, Redfin Corporation has introduced a discount brokerage model that allows clients to make offers to purchase homes and to list homes for sale directly online, while receiving a two-thirds rebate of their commission. BuySide Realty, another discount brokerage, employs agents who are paid salaries and bonuses based on customer service, not commissions, while offering a 75% rebate of their commission. RealEstate.com, which is owned by LendingTree, LLC, acts as a lead generator for real estate brokers, and has opened a direct to consumer brokerage service. Trulia, Inc. operates a residential real estate search engine to connect consumers directly to listings on agent and broker websites. These companies have limited operating histories upon which to evaluate their operations and future prospects. However, we believe these companies, as well as ours, reflect that the real estate industry is experiencing, and will continue to experience, significant changes due, in part, to the introduction of new technologies, new businesses, and new business models. In order to be successful, our business model must remain attractive to consumers so that we can compete successfully with these newer models as they expand into our marketplaces. In addition, to remain economically viable, we will need to be able to compete effectively with these new entrants for the acquisition of agents and leads.
Industry seasonality and cyclicality. The residential real estate brokerage market is influenced both by annual seasonality factors, as well as by overall economic cycles. While individual markets vary, transaction volume nationally tends to progressively increase from January through the summer months, then gradually slows over the last three to four months of the calendar year. Revenues in each quarter are significantly affected by activity during the prior quarter, given the typical 30- to 45-day time lag between contract execution and closing for traditional home purchases. For non-traditional sales, the time lag from contract execution to closing can be a few months. We have been, and believe we will continue to be, influenced by overall market activity and seasonal forces. We generally experience the most significant impact in the first and fourth quarters of each year, when our revenues are typically lower relative to the second and third quarters as a result of traditionally slower home sales activity and reduced listings inventory between Thanksgiving and Presidents' Day.
We believe that the overall market activity, macroeconomic environment, and periodic business cycles can significantly influence the general health of the residential real estate market at any given point in time. Generally, when economic times are fair or good, the housing market tends to perform well. If the economy is weak, interest rates dramatically increase, or there are market events such as terrorist attacks or threats, the outbreak of war or geopolitical uncertainties, the housing market likely would be negatively impacted.
Recently, changes in the mortgage market, including the subprime market, have negatively affected the buying and selling of real estate. The tightening of financing and credit standards has depressed real estate activity. Also, there have been numerous reports about the effects of subprime mortgages on the general real estate market. These reports also tend to have a dampening effect on the general real estate market.
Historical variations in volume of home sales and interest rates. Over the past several decades, the national residential real estate market has demonstrated significant growth, with annual existing home sales volume growing from 1.6 million in 1970 to approximately 7.1 million in 2005 and median existing home sales prices increasing every year during that period. Between 1970 and 2005, the volume of existing home sales had declined for at least two consecutive years only twice since 1970, namely 1979 through 1982 and 1989 through 1990. We are currently in such a period of decline. Sales have fallen from their 2005 peak to approximately 6.5 million in 2006 and fell again in 2007 to approximately 5.7 million, and there are forecasts that predict sales will continue their decline in 2008. Sales volume changes are sensitive to, but do not always follow, interest rate changes. The declines in sales volumes in the 1979 through 1982 period occurred while interest rates were at historic highs, with long-term U.S. Treasury rates exceeding 10%. However, with rates remaining at similarly high levels, sales increased during the period from 1983 through 1986. Average interest rates were lower during the second period of consecutive year declines, 1989 through 1990, than they had been in the expansion period ending in 1988.
While it is difficult to isolate the initial cause of recent transaction volume declines and downward pressure on prices in the residential real estate market, we believe such softening has been occurring since the fall of 2005 as interest rates have generally increased (subject to some recent fluctuations and reductions), inventories have generally increased (but with significant variations in inventory market to market), and credit standards and financing have tightened, as previously discussed above. Other factors have likely contributed to the slowdown as well, such as high fuel prices, job insecurity, and the fact that prices had until that time been increasing at historically high rates, well ahead of household income growth.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Accordingly, our actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are described in Note 1 of the notes to our consolidated financial statements contained in our Form 10-K for the year ended December 31, 2007, and of those policies, we believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to understand and evaluate our financial condition and results of operations.
Revenue recognition
We derive the substantial majority of our revenues from commissions earned as agents for buyers and sellers in residential real estate transactions. We recognize commission revenues upon closing of a sale and purchase transaction, net of any rebate (or, in New Jersey, charitable donation) or commission discount, or transaction fee adjustment, as evidenced by the closure of the escrow or similar account and the transfer of these funds to all appropriate parties. We recognize non-commission revenues from our other business relationships, such as our mortgage marketing relationships, as the fees are earned from the other party typically on a monthly fee basis. Revenues are recognized when there is persuasive evidence of an arrangement, the price is fixed or determinable, collectibility is reasonably assured and the transaction has been completed.
Internal-use software and website development costs
We account for internal-use software and website development costs, including the development of our ZipAgent Platform, in accordance with the guidance set forth in Statement of Position 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, and Emerging Task Force Issue No. 00-02, Accounting for Website Development Costs. We capitalize the payroll and direct payroll-related costs of employees who devote time to the development of internal-use software. We amortize these costs over their estimated useful lives, which range between 15 to 24 months. Our judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. The estimated life is based on management's judgment as to the product life cycle.
Stock-based compensation
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