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ZIPR > SEC Filings for ZIPR > Form 10-K on 10-Mar-2014All Recent SEC Filings

Show all filings for ZIPREALTY INC

Form 10-K for ZIPREALTY INC


10-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations:

The following discussion should be read together with our financial statements and related notes included in "Item 6. Selected Financial Data" and "Item 8. Financial Statements and Supplementary Data" of this annual report on Form 10-K. This discussion contains forward-looking statements based upon current expectations that involve numerous risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including but not limited to those described under "Risk Factors" and elsewhere in this annual report on Form 10-K. Except as otherwise required by law, we do not intend to revise or update any information contained in these forward-looking statements.

OVERVIEW

We are a leading online, technology-enabled residential real estate brokerage company. Our company owned-and-operated real estate brokerage serves 19 metropolitan markets with over 1,700 licensed REALTORS®. We serve an additional 20 markets through our Powered by Zip, or PbZ, business, which provides our technology platform for acquiring and incubating new customer relationships and for managing real estate transactions. We operate ZipRealty.com, which is consistently one of the most visited real estate brokerage websites in the nation according to reports generated with Google Analytics, a website traffic analysis service. ZipRealty.com attracts approximately 2.6 million unique monthly visitors. We also provide consumers with highly rated mobile applications that offer all of the key features of our website and optimize them for all major platforms and devices.

Both our owned-and-operated brokerage and our Powered by Zip client platform share the same internal engine: the powerful proprietary customer service technology, known as Zap, and the online marketing capabilities that form the foundation of our business. We developed Zap over a 15 year period during which our technology team partnered with REALTORS® across the country to collaboratively develop a customer service platform that empowers real estate professionals to deliver superior customer service using a significantly more efficient approach. We refer to this innovation feedback loop as our "innovation factory" and believe that our disciplined management of this process directly led to Zap's success in our brokerage and our Powered by Zip clients and also allows us to keep this application on the cutting-edge.

As the direct result of offering the most accurate, timely and comprehensive housing information, buyers using our services can quickly find relevant home listings that meet their search criteria and are well positioned when they are ready to interact with local REALTORS® affiliated with our owned-and-operated brokerage or our PbZ clients. At the same time, sellers using our system gain confidence in the pricing and marketing of their home to interested home buyers.

Who we serve

Our proprietary technology, established reputation as a full service online brokerage, and Powered by Zip business, as well as our prominence both online and in mobile, allow us to serve three main constituencies in the residential real estate industry:

· First and foremost, we serve serious consumers, which we define as those who expect to purchase or sell a home within the next six to eighteen months. We offer these consumers our technology and services to provide control, choice and seamless, customized service. Through ZipRealty.com and our award-winning mobile apps, we provide consumers with the most accurate and relevant data on homes currently for sale wrapped up in an easy-to-use interface and, when they are ready, connect them with knowledgeable local REALTORS® to assist them through every step of their real estate transaction.

· Second, we serve real estate professionals in our owned-and-operated brokerage business. For these professionals, who seek more productive ways to conduct business in the competitive residential real estate industry, we generate a large base of customer leads which, through an advanced algorithm developed over the course of 15 years, have been systematically matched to yield productive agent-client relationships. These leads are made even more valuable with Zap, which is a system that helps incubate customer relationships with the assistance of powerful prospecting tools and real-time data on client activity that enables agents to provide excellent anticipatory service. In October 2013, we launched a mobile Zap application, which allows agents to access the full functionality of the system via their smartphone or tablet while in the field. In the fourth quarter of 2013, 85% of our owned-and-operated brokerage agents accessed our mobile Zap application at some point. We also market ZipRealty-affiliated REALTORS® on ZipRealty.com by showcasing their local expertise and real estate transaction activity. We also provide these individuals with personalized agent profile pages accessible online and via mobile devices.

· Third, we serve other real estate brokerages and their affiliated agents who seek a competitive edge in this new era in which consumers are increasingly using online services for home buying and selling. Brokerages empowered with Zap enjoy online analytical metrics on consumer behavior, and real-time visibility on their leads, transaction pipeline and brokerage operations. With a wide array of analytics, brokerages can measure productivity by agent and allocate leads and resources in a targeted manner. Further, by utilizing our SaaS-based Zap technology platform, our PbZ brokerage clients benefit from our rapid innovation cycle without the burden of expensive IT maintenance and software upgrade costs.

Geographic reach

We conduct our owned-and-operated brokerage services in 19 markets nationwide:
Austin, TX; Baltimore, MD; Boston, MA; Chicago, IL; Dallas, TX; Denver, CO; Houston, TX; Las Vegas, NV; Los Angeles, CA; Orange County, CA; Orlando, FL; Phoenix, AZ; Richmond, VA; Sacramento, CA; San Diego, CA; San Francisco Bay Area, CA; Seattle, WA; Portland, OR; and Washington, DC.

Our Powered by Zip business serves leading local brokerages in 20 markets where we do not otherwise conduct business: Atlanta, GA; Brooklyn, NY; Charlotte, NC; Greater Hudson Valley, NY; Greater Philadelphia area, PA; Harrisburg, PA; Jacksonville, FL; Long Island, NY; Miami, FL; Minneapolis, MN; Nashville, TN; Palm Beach, FL; Pittsburgh, PA; Raleigh-Durham, NC; Salt Lake City, UT; Sarasota-Naples, FL; St. Louis, MO; Tampa, FL; Tucson, AZ; and Virginia Beach, VA.

Our Powered by Zip clients retain over 620 agents, bringing the total agent count in the markets served by our owned-and-operated brokerage and Powered by Zip clients to nearly 2,400 local, licensed real estate agents, all of whom are independent contractors.

In 2013, we continued to extend our Multiple Listing Service, or MLS, coverage to include several new markets where we do not yet have a full-scale owned-and-operated presence or a PbZ client. This expanded coverage also plays a role in facilitating expansion of our PbZ client base.

How we derive our revenues

We derive all of our revenues from our core business of offering the best proprietary technology and online marketing capabilities available in our industry. We derive the significant majority of our net revenues from commissions earned in our owned-and-operated brokerage representing buyers and sellers in residential real estate transactions. We record commission revenues net of any commission discount, transaction fee adjustment or, when applicable, rebate. Net transaction revenues are principally driven by our base of real estate professionals whose productivity leads to the number of transactions closed and the average net revenue per transaction. Average net revenue per transaction is a function of the home sales price and percentage commission received on each transaction and can vary significantly by market. We also derive revenues from net commission earned by brokerages in our Powered by Zip business. Brokerages in our Powered by Zip business typically pay a combination of a monthly subscription and transaction-based success fee for our full SaaS solution. This solution includes a co-branded website, online agent marketing, a steady stream of leads for their metropolitan area, the Zap brokerage operating system for managing the business, and the full agent functionality of the Zap platform for managing the client interaction, lead incubation and customer service. Additionally, we derive revenues from our website through marketing arrangements with residential mortgage service providers as well as the sale of online display advertising. Finally, we earn lead referral fees. Marketing and other revenues, which includes Powered by Zip revenues, represented approximately 7% of our net revenues for 2013.

RECENT DEVELOPMENTS

Expansion of the Powered by Zip business: We are a consistent technology innovator, known in the industry for testing and launching ground-breaking products, and using the live feedback of agents and consumers to improve those ideas and deliver even better, more relevant solutions over time. Our technology progress helped to drive success in our Powered by Zip business, which offers all of Zap's functionality to third party brokerages. In 2013, we added seven new clients to our Powered by Zip business, bringing the total number of brokerages served to 20. Additionally, two of our existing clients broadened the geographic footprint of our relationship in 2013. Our clients' brands include Coldwell Banker, Prudential/Berkshire Hathaway Home Services, Better Homes & Gardens, Century 21, and ERA as well as several independent brokerages with strong regional brands. Over the past year, we continued to gain experience serving our clients and their agents, which translated into increased adoption of our technology. Of the PbZ clients that we have served for more than 12 months, we grew agent count by 28% versus the prior year as additional agents signed on to PbZ teams. With the addition of new clients, we grew agent count to 620 at December 31, 2013 which was a 69% increase compared to the agent count at the prior year end.

Recent advances in technology: We made several advancements in our consumer and agent facing technology during 2013. The most significant milestone was our development of Mobile Zap and its successful launch in October of 2013. Mobile Zap offers agents in both our owned-and-operated business and our PbZ business the full functionality of the desktop version, augmented with mobile-specific features such as geolocation and one-touch click to call functionality. Mobile Zap provides productivity enhancements over the desktop version with crisp data visualization designed to improve filtering and sorting capabilities for effective and efficient client platform management. Communication is improved with notifications now linked to SMS as well as email to enable an agent to respond more rapidly, which is a metric that we believe resonates well with consumers. The "Quick Add" feature of Mobile Zap allows agents to add new contacts, showing appointments, tasks and calendar items while in the field. The showings option includes a field to capture comments on the home during the visit. Data provided by Agent Comments highlights the agents' local insight, knowledge and experience to online consumers. We expect that the Mobile Zap launch will increase the number, timeliness and quality of Agent Comments.

We continued to drive innovation on our website to improve its SEO drawing power. Recognizing the increasing importance of social media to consumer behavior as well as to relevance with respect to search engine algorithms, we developed social sharing buttons on home detail pages, enabling agents to link to their social profiles from their profiles on ZipRealty.com, and opening up social sharing of Agent Reviews. These efforts resulted in social referral traffic that was up 94% year-over-year in the fourth quarter of 2013. In addition, Agent Comments continue to be a significant driver for SEO. Over 30% of all visit requests resulted in an Agent Comment in 2013. We expect that Mobile Zap will increase the volume of Agent Comments through increased participation by agents and a higher number of comments per agent.

All of these technology advances benefited from the close collaboration between our technology team and our agents. These continuing advances demonstrate our conviction that this innovation factory serves as one of our core competencies, helping us maintain our technology leadership in the residential real estate industry.

MARKET CONDITIONS AND TRENDS IN OUR BUSINESS

We compete in the domestic residential real estate market. Beginning in late 2005, the market was negatively impacted by a significant correction in the total value of homesale transactions and the deep economic recession that followed. The Federal Reserve responded to these events by implementing an extraordinary monetary accommodation policy, which helped to restore the country to economic growth beginning in 2011. Over the past three years, economic activity as measured by real Gross Domestic Product, or GDP, grew 1.8%, 2.2% and 1.9% in 2011, 2012 and 2013, respectively. The residential real estate market began showing signs of recovery between mid-2011 and early 2012, and since that time it has shown strong sales and price recovery. However, the deceleration of growth in GDP from 2012 to 2013 reflects an economy undergoing an uneven recovery.

Macroeconomic forces: The current Federal Reserve monetary policy is one of the most significant economic variables affecting the real estate market. For the past few years, the Federal Reserve has been pursuing an accommodative monetary policy designed to spur economic growth. In December 2013, in response to what was viewed as a "moderate" expansion of economic activity, the Federal Reserve announced that it planned to reduce the rate of treasury bond repurchases beginning in January 2014. The January 2014 meeting of the Federal Open Market Committee led to a further reduction in the pace of bond repurchases to $65 billion per month from $85 billion per month throughout 2013. The Committee also reaffirmed its commitment to an accommodative monetary policy as long as the unemployment rate exceeds 6.5% and the projected inflation continues to run below 2%.

The Federal Reserve's accommodative monetary policy depressed mortgage rates for several years, which reached a low point of 3.31% for a conventional 30-year fixed rate mortgage in November 2012, and which remained below 4.0% through the first half of 2013. Expectations of a change in Federal Reserve monetary policy pushed this rate up 53 basis points following the June 2013 Federal Open Market Committee meeting to above 4%, where it remained for the second half of 2013. Mortgage interest rates are still at historic lows and home affordability remains high, but if mortgage interest rates continue to rise, they could impair the housing recovery.

In 2014, we believe that the health of the residential housing market will continue to be significantly affected by the availability of credit, inventory levels, and interest rates, as well as any significant change in unemployment levels. We cannot predict any changes in those macroeconomic forces, nor can we predict the combined impact of those changes on the residential real estate market nationally or in the markets we serve.

Federal action: The federal government, state governments and related agencies have acted to address the decline in the residential real estate market and the availability of home mortgage credit. The most significant lending-related legislation in effect was mandated by The Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the Consumer Financial Protection Bureau and mandated it to develop rules that discourage risky home mortgage lending practices. The resulting regulations, referred to as Regulation Z, which implement the Truth in Lending Act, or TILA, became effective January 10, 2014 and prohibit a creditor from making a higher-priced mortgage loan without regard to the consumer's ability to repay the loan. Because TILA is a new regulation, there can be no assurance that it will have a positive, meaningful and lasting impact on the housing market, or that it will not result in unintended consequences.

Current residential real estate market conditions: Recent indicators of national residential real estate market include the following:

· Volume: According to the NAR, total existing-home sales in 2013 were the highest since 2006. NAR's preliminary annual total for existing-home transactions in 2013 was 5.09 million, up 9.1 percent from 4.65 million in 2012, marking the third consecutive year of volume increases. However, the volume increase tapered off by the end of 2013, with existing home sales increasing just 0.8% year-over-year for the fourth quarter of 2013, and down 0.6% year-over year for December 2013. Low mortgage interest rates, particularly through the first half of 2013, seem to have played a large role in affecting sales volume, although inventory shortages and tight lending criteria may be limiting buying opportunities.

· Price: NAR's preliminary estimate of median existing-home price for the full year 2013 was $197,100, up 11.5 percent from $176,800 in 2012. This year-over-year increase represented the strongest annual price gain since 2005, when the median price rose 12.4 percent. Year-over-year price growth continued through the end of 2013, increasing 10.1% for the fourth quarter and 9.9% for December 2013. The price increase may have been due, in part, to a decrease in the percentage of national home sales that represented distressed properties, as well as inventory shortages.

· Inventory: NAR reported a December 2013 housing inventory level of 1.86 million homes, which it stated was approximately a 4.6-month supply at its estimated current sales pace. This inventory level is slightly higher than the December 2012 level, which had not been that low since May of 2005. The sharp decrease in housing inventory experienced in 2012, during which inventory fell by 22%, moderated somewhat in 2013. However, NAR noted that inventory continued to be tight at the end of 2013, particularly in the Western United States. Tight inventory can distort the market by causing sharp price increases that favor sellers and that are typically only sustainable over a short period of time.

Fluctuations in quarterly profitability: We have experienced fluctuations in profitability from period to period. Our profitability has been impacted by various factors, including ongoing market challenges, government intervention, seasonality, market expansions and closures, and legal settlements.

Industry seasonality and cyclicality: The residential real estate brokerage market is influenced both by seasonal factors and by overall economic cycles. While individual markets vary, transaction volume nationally tends to increase progressively from January through the summer months, then to slow gradually 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 longer. 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.

The impact of seasonality can be masked by the general health of the residential real estate market at any given point in time, whether affected by macroeconomic events, periodic business cycles or other factors. Generally, when economic conditions are fair or good, the housing market tends to perform well. If the economy is weak, if interest rates dramatically increase, if mortgage lending standards tighten, or if there are disturbances such as terrorist attacks or threats, the outbreak of war or geopolitical uncertainties, the housing market likely would be negatively impacted.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. 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 Consolidated Financial Statements under Item 8, and of those policies, we believe that the following accounting policies are the most critical to understand and evaluate our financial condition and results of operations.

Revenue recognition

Revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service has been delivered and collectability of the resulting receivable is reasonably assured.

We derive the significant majority of our net revenues from commissions earned in our owned-and-operated residential real estate brokerage. We recognize this commission based revenue upon closing of a sale and purchase transaction, net of any rebate, commission discount or transaction fee adjustment. These transactions typically do not have multiple deliverable arrangements.

We derive marketing and other revenues primarily from marketing agreements with residential mortgage service providers, the sale of online advertising, and other referral revenue including revenue from brokerages who are clients of our Powered by Zip business. Marketing service revenues are recognized over the term of the agreements as the contracted services are delivered. Advertising revenues on contracts are recognized as impressions are delivered or as clicks are provided to advertisers. Advertising and marketing contracts may consist of multiple deliverables which generally include a blend of various impressions or clicks as well as other marketing deliverables. Other referral revenues related to revenue sharing arrangements are recognized based on reports received from our partners, provided that collectability is reasonably assured.

Internal-use software and website development costs

We account for internal-use software and website development costs, including the development of our customer service platform which we refer to as Zap, in accordance with the guidance set forth in the related accounting standards. We capitalize internal costs consisting of payroll and direct payroll-related costs of employees who devote time to the development of internal-use software, as well as any external direct costs. We amortize these costs over their estimated useful lives, which typically is 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. We periodically evaluate the carrying value of capitalized internal-use software and website development costs for impairment when events and circumstances warrant such a review. As of December 31, 2013, we have not recorded any charges for impairment of capitalized internal-use software and website development costs to date.

Stock-based compensation

We follow the provisions of accounting standards for share-based payments, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees, consultants and directors, including employee stock options and employee stock purchases, based on estimated fair values. Under the fair value recognition provisions of the accounting standards, stock-based compensation cost is estimated at the grant date based on the fair value of the awards expected to vest and recognized as expense using the straight-line method over the requisite service period of the award.

We estimate the fair value of stock options using the Black-Scholes option pricing model, which incorporates various assumptions including volatility, expected life and interest rates. The expected volatility is based on the historical volatility of our common stock. The expected life of options is estimated by taking the average of the vesting term and the contractual term of the option. We estimate expected forfeitures based on various factors including employee class and historical experience. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period the estimates are revised.

Income taxes

Deferred tax assets and liabilities arise from the differences between the tax basis of an asset or liability and its reported amount in the financial statements as well as from net operating loss and tax credit carry forwards. The measurement of current and deferred tax assets and liabilities is based on provisions of enacted tax laws; the effects of future changes in tax laws or rates are not anticipated. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable, respectively, for the period adjusted for the change during the period in deferred tax assets and liabilities.

The accounting guidance for income taxes requires that deferred tax assets be evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent historical results and our expectations for the future. Historically, we have recorded a valuation allowance on our deferred tax assets, the majority of which relate to net operating loss carryforwards and we maintain that a full valuation allowance should be accounted for against our net deferred tax assets at December 31, 2013.

Restructuring charges

In connection with our cost reduction initiatives, we record restructuring charges for employee termination costs, costs related to leased facilities to be abandoned or subleased, fixed asset impairments and other exit-related costs. Formal plans are developed and approved by management. Restructuring costs related to employee severance and related expenses are recorded when probable and estimable. Fixed assets impaired as a result of restructuring are typically accounted for as assets held for sale or abandoned. The recognition of restructuring charges requires us to make judgments and estimates regarding the nature, timing, and costs associated with the planned restructuring activity, including estimating sublease income and the fair value, less selling costs, of fixed assets being disposed of. Estimates of future liabilities may change, requiring us to record additional restructuring charges or to reduce or reverse the amount of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued liabilities to ensure their adequacy, that no excess accruals are retained and that the utilization of the provisions is for the intended purpose in accordance with the approved restructuring plan. In the event circumstances change and the provision is no longer required, the provision is reversed.

Litigation

We are involved in legal proceedings on an ongoing basis. Based upon our evaluation and consultation with outside counsel handling our defense in these matters and an analysis of potential results, we accrue for losses related to litigation if we determine that a loss is probable and it can be reasonably estimated. If only a range of estimated losses can be determined, then we record . . .

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