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ZIPR > SEC Filings for ZIPR > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for ZIPREALTY INC



Quarterly Report

Item 2. 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 appearing elsewhere in this report. 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" in Item 1A of Part I of our annual report on Form 10-K for our fiscal year ended December 31, 2011. Those reasons include, without limitation, those described at the beginning of this report under "Statement regarding forward-looking statements," as well as those that may be set forth elsewhere in this report. Except as otherwise required by law, we do not intend to update any information contained in these forward-looking statements.


We are the most prominent online, technology-enabled real estate brokerage company that competes in the residential industry. Our company owned-and-operated real estate brokerage serves 19 metropolitan markets with nearly 1,600 real estate professionals. We serve an additional 12 markets through our Powered by Zip technology business, which provides our technology platform as a Software-As-A-Service, or SAAS, offering to third party brokerages with over 200 agents. We operate, the most visited brokerage website with approximately 2.4 million unique monthly visitors. We also provide consumers with highly rated mobile applications that offer all of the features of our website and optimize them for mobile phones and tablets.

Both our owned-and-operated brokerage and our Powered by Zip network share the same internal engine: the powerful proprietary technology, known as the Zip Agent Platform, or ZAP, and the online marketing capabilities that form the foundation of our business. We developed this internal engine over a 13-year period during which our engineers partnered with real estate professionals with the goal of producing the most innovative end-to-end technology platform in the residential real estate industry that would offer the most accurate, timely information on home listings available.

Our proprietary technology, established reputation as an owned-and-operated brokerage, and Powered by Zip network, as well as our prominence both online and in mobile, allow us to serve three main constituencies in the real estate industry:

· First and foremost, we serve serious consumers, by which we mean consumers that expect to purchase or sell a home within the next 12 months. These consumers increasingly demand control, choice and seamless, customized service. We offer Internet- and mobile-enabled, state-of-the-art technology and access to information that real estate professionals can combine with their own local knowledge and personal expertise to offer an exceptional start-to-finish experience to their clients. As a licensed brokerage company, the residential data available to us is more accurate than that of non-licensed companies, which gives our consumers an improved user experience as they search for the home that's right for them.

· 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 our fiercely competitive industry, we provide technology and online marketing tools to enhance their online sales channel, including the attraction, incubation and service of their clients.

· Third, we serve other real estate brokerages who seek a competitive edge in this new era in which consumers increasingly find homes and real estate professionals online. For these brokerages, we offer our technology platform through our Powered by Zip SAAS offering. All of these brokerages have access to all of the technology features and functionality available to our ZipRealty consumers and real estate professionals.

We conduct our owned-and-operated brokerage services in 19 markets nationwide, all of which were opened prior to May 2009: 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, the San Francisco Bay area, CA, Seattle, WA, Portland, OR, and Washington, DC. Our Powered by Zip network serves leading local brokerages in 12 markets where we do not otherwise conduct business, including Atlanta, GA, Jacksonville, FL, Nashville, TN, the Greater Philadelphia area, PA, Raleigh-Durham, NC, Salt Lake City, UT, Tucson, AZ, Westchester/Bronx, NY, Tampa, FL, Palm Beach, FL, Long Island, NY, and Brooklyn, NY. The markets in our owned-and-operated brokerage and Powered by Zip network are served by over 1,800 local, licensed real estate professionals, all of whom are independent contractors, and extends our services to approximately 42% of the U.S. domestic population and 41% of households.

All of our revenues derive from our core business of offering the best proprietary technology and online marketing capabilities available in our industry. We derive the 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 network. Brokerages in our Powered by Zip network typically pay a combination of a monthly subscription and transaction-based success fee for our full SAAS solution. This solution includes co-branded website, online visibility for their designated agents, high quality leads (as measured by lead to conversion rates) 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 marketing. Finally, we earn lead referral fees. For the third quarter and year-to-date, Powered by Zip and non-commission revenues represented less than 10% of our net revenues.


Marketing relationships: During the second and third quarters of 2012, we signed non-exclusive marketing agreements with two residential mortgage service providers, New American Mortgage and Citibank N.A, a subsidiary of Citigroup, to replace our terminated agreement with Bank of America, a mortgage lender that paid us a flat marketing fee. According to the terms of our new marketing agreements, we are paid either a flat marketing fee or on a cost-per-click basis. We launched our Citibank marketing relationship mid-quarter in the third quarter of 2012, and in the fourth quarter we expect to receive the first full quarter benefit of this relationship. We expect these combined arrangements to offset fully the revenues we received previously from Bank of America. We are seeking to enter into other such non-exclusive agreements with participants in the mortgage lending and related fields, and we routinely explore opportunities to grow our non-commission revenues through marketing and other business arrangements for offering services related to the purchase, sale and ownership of a home.

Restructuring and realignment: In early 2011, we began restructuring our business to heighten our focus on our core strengths in technology, online marketing and our most attractive local real estate markets. Since then, we closed our offices in sixteen markets, while transitioning six of them to eight third-party brokerages in our Powered by Zip network. We have also reorganized local management responsibilities and significantly reduced our corporate sales support and administration. Also, our President of Brokerage Operations, Van Davis, implemented new initiatives in agent recruiting and retention in the third quarter of 2012, and in the fourth quarter of 2012 he is planning to complete the restructuring of our field operations staffing to support growth in the brokerage business. Key initiatives in the field operations restructuring plan include consolidation of district-level leadership roles and a shift in our agent recruiting function from a centralized approach to district-level execution. The latter initiative requires the hiring of 17 district-level recruiters and the closing of our central recruiting services. While we believe that district recruiters will be more effective in driving growth in agent count, we may experience disruption in our recruiting process until these positions are filled and the recruiters are executing on their hiring plans. Overall, we believe that the net result of our restructuring and cost containment will be an increase in our district office profitability and a sustainable corporate overhead that would support an increase in transaction volume nearly double that of our current seasonally adjusted annual rate of transaction revenue.

Legal settlement: On September 28, 2012, we signed a settlement agreement with the State of California's Department of Labor Standards Enforcement, or DLSE, for a release of all its claims that we failed to pay our California real estate agents, who were at the time in question classified as employees, minimum wage and overtime mandated by California laws. Pursuant to that settlement, in the fourth quarter of 2012, we paid $0.2 million to the DSLE for attorney's fees and costs and $4.8 million to a trust for disbursement to our former employees as back wages. As this trust disburses funds to our former employees, we will be required to pay the employer's shares of F.I.C.A. taxes and other employer tax responsibilities on back wages on those disbursements, as well as the administrative costs of the claims administrator for the trust, which could total up to $1 million if all former employee claimants participate. Given the unique qualitative test that applies under California law in evaluating the outside sales exemption and the deference afforded the DLSE in the context of a law enforcement action, we believed that this settlement was a reasonable resolution in this case. Further, by agreeing to settle this issue, which relates to an employee agent model that we discontinued in 2010 and early 2011, we were able to avoid potentially millions of dollars in future litigation costs and the diversion of excessive time and attention of our management and employees from key business initiatives.

End of buyer rebates: On July 1, 2011, we announced that we were discontinuing our commission rebate program, with some limited eligibility exceptions that allowed buyers to receive a rebate through the end of 2011. We believe that the termination of our rebate program had a modest positive impact on our financial results for the first three quarters of 2012 and will have a negligible year-over-year impact for the fourth quarter of 2012.

Powered by Zip and our SAAS offering: In 2011, we developed a Software-As-A-Service (SAAS) offering to provide third party real estate brokerages with all of the technology tools of our proprietary end-to-end technology solution. Since then, we have built a network of 12 independent brokerages that use our SAAS offering, which we refer to as our Powered by Zip network. Over the past year, we have gained significant experience serving our Powered by Zip customers with our SAAS offering. The terms on which we offer SAAS vary among these brokerages because we are still developing, testing and building our business model, and because each brokerage is at a different stage of adoption and incorporation of the technology and services into their business. We currently evaluate each individual brokerage's performance with our SAAS offering by using the same metrics as we use for our brokerages services business as well as subjective measures such as the agents' experience with the use of our technology.

We are developing new pricing schedules for our current SAAS offering, which is currently offered on an exclusive basis in any one metropolitan area. Additionally, our technology and product teams are developing new versions of the SAAS offering, including a version designed to serve multiple customers in the same metropolitan area nonexclusively, and a subscription model for individual real estate professionals who are not associated with ZipRealty or one of the Powered by Zip network brokerages. We are also in the process of developing a formal organizational structure for the Powered by Zip business and, within the next several quarters, we expect to hire managers and staff in sales, account management, operations and integration, and product development.

Zip Agent Platform (ZAP):ZAP is the proprietary technological engine that drives our business. We continually upgrade ZAP in response to feedback from consumers, real estate professionals, field leadership, and corporate management and staff. This year, we embarked upon an aggressive program to develop and deliver the most transformational change to ZAP in over five years. We are in the final user testing stages and plan to launch the ZAP upgrade in December of this year. We believe that adoption of the upgraded ZAP in our owned-and-operated and Powered by Zip businesses will help improve agent productivity in 2013.


We compete in the domestic residential real estate market. For the past few years, this market has been negatively impacted by the significant correction in home prices that began in 2005 and the deep recession that followed. The Federal Reserve responded to these events by implementing an extraordinary accommodation policy designed to improve economic activity. Through September 30, 2012, economic activity has increased, driving favorable changes in the residential real estate market. However, we continue to observe that an unusually large number of economic variables are creating statistically significant distortions in the real estate market, both on the national and local markets.

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. At the Federal Open Market Committee (FMOC) meeting on September 13, 2012, the Federal Reserve noted that this policy has been successful in driving moderate economic activity, as recently evidenced by the advance estimate from the U.S. Department of Commerce, Bureau of Economic Analysis (BEA) that third quarter 2012 real GDP growth was 2.0% on an annualized basis. The BEA also reported increases in personal income and consumer spending. The National Association of REALTORS® reported September 2012's existing-home sales at a seasonally adjusted annual rate of 4.75 million, which was 11.0% above the 4.28 million-unit pace in September 2011. Still, the FMOC expressed its concern that the current rate of economic growth would not be strong enough to improve employment and that turmoil in the global markets continues to pose a risk to domestic growth. As a result, the Federal Reserve anticipates that an accommodative monetary policy would "be warranted at least through mid-2015". According to the Summary of Economic Projections released with the FOMC minutes, 12 of the 19 FOMC participants believe that the current monetary policy should be maintained into 2015.

This accommodative monetary policy continues to depress mortgage rates. According to the Federal Housing Finance Agency (FHFA) Primary Mortgage Market Survey, the September 2012 30-year fixed rate was 3.47%, which is the lowest rate in the agency's forty-two year history. These low rates make housing more affordable for new entrants and existing homeowners who are able to refinance their mortgages. However, these low rates also encourage investors to purchase residential real estate for resale or rental. A sudden rise in rates could put these investors at risk. Purchase of homes by consumers who intend to reside in those homes would be more indicative of a healthier economy.

Additionally, low mortgage rates encourage tight lending criteria. The Federal Reserve July 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices, found that, "With respect to loans to households, a majority of the banks reported that lending standards for all five categories of residential mortgage loans included in the survey (prime conforming mortgages, prime jumbo mortgages, subprime mortgages, nontraditional mortgages, and HELOCs) were at least somewhat tighter than the middle of the range that those standards have occupied since 2005, while smaller but still significant fractions of domestic banks also reported that standards were tighter than the midpoint for prime credit card, subprime credit card, auto, and other consumer loans." This survey also found:
"On balance, domestic banks continued to report little change in lending standards for prime mortgages and having tightened standards somewhat for nontraditional mortgages over the past three months." More recently, the September 2012 Ellie Mae Origination Insight Report shows that the average FICO score for all closed loans in September was 750, up from August 2011 when the average FICO score was 741 for these loans. These tighter lending standards may pose a challenge for individuals who experienced a foreclosure or short-sale, and those who might otherwise qualify in a different environment, to purchase a residence.

For the remainder of 2012, we believe that the health of the residential housing market will continue to be significantly affected by the availability of credit, inventory and shadow inventory levels, the pace at which banks process their foreclosure pipelines, 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.

Federal action: The federal government, state governments and related agencies have acted repeatedly to address the decline in the residential real estate market and the availability of home mortgage credit. Currently, under the Dodd-Frank Wall Street Reform Act, federal regulators must develop rules to discourage risky home mortgage lending practices by requiring lenders to retain 5% of the risk in the mortgages they originate, other than qualified residential mortgages, also known as QRMs, and other than mortgages that are backed by federally insured mortgage programs. Mortgages that do not meet these exemptions could carry higher interest rates or be less available to home buyers, which could dampen the housing market, particularly if the definition of a QRM is drawn narrowly. It is too soon to tell what the final rules will require. To the extent that governments and related agencies take actions to address the residential real estate market or the home mortgage market, there can be no assurance that those activities will have a positive, meaningful and lasting impact on either market, or that they will not result in unintended consequences.

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

• Volume: According to the National Association of REALTORS®, or NAR, existing home sales nationwide in September 2012 were up 11.0% year-over-year. September 2012 represented the fifteenth consecutive month of year-over-year volume increases nationwide. The year-over-year volume increase may have been due, in part, to historically low mortgage interest rates, as well as a reduction in the national home-price-to-rent ratio to its lowest level in over a decade. However, inventory shortages may be limiting buying opportunities, as discussed below.

• Price: According to NAR, the national median existing home sales price increased year-over-year in each of July, up by 9.4%, August, up by 9.5%, and September, up by 11.3%, with increases in all major regions. September 2012 represented the seventh consecutive month of national year-over-year price increases. The price increases in the third quarter of 2102 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, as discussed below.

• Inventory: According to NAR, the nationwide inventory of existing homes available for sale in September 2012 decreased by 20.0% year-over-year, most notably in parts of the West. Inventory shortages may be impairing homes sales volume and, conversely, pushing up prices in the affected regions.

• Distressed Properties: Currently, a significant percentage of our sales transaction volume is composed of distressed properties. Distressed properties are homes that are in foreclosure, are real estate owned, or REO, by the lending bank, government agency or government loan insurer after an unsuccessful sale as a foreclosure auction, or are "short sales," meaning a sale where the sale price is less than the loans or debt secured by the home listed for sale. In the third quarter of 2012, the percentage of our sales transactions composed of distressed properties in our owned-and-operated markets was approximately 27%, which was down from 35% in the third quarter of 2011 for those same markets. Distressed properties not only tend to sell at reduced prices, but they also tend to put downward pressure on the values of other homes for sale in the same and nearby neighborhoods. We expect distressed properties to continue to represent a significant portion of the residential real estate market and of our business for the foreseeable future.

• Shadow Inventory: "Shadow inventory" refers to distressed and other properties that have not yet been listed for sale, as well as properties that homeowners wish to sell, but will not sell at current market prices. For July 2012, CoreLogic, a leading provider of consumer, financial and property information, analytics and services to business and government, estimated shadow inventory at 2.3 million properties, which consisted of 1.0 million properties backed by loans classified as seriously delinquent, 900,000 properties with loans that were in some stage of foreclosure, and 345,000 properties that were REO. The CoreLogic report estimated that the July 2012 shadow inventory number fell by 10.2% year-over-year.

Shadow inventory is problematic because it represents properties that would negatively impact the housing market if placed on the market for sale. The timing and volume of such action is driven by a wide range of variables including the financial health of the lender that holds the title, an owner's financial income, federal and state regulations on foreclosure and local government foreclosure moratoriums. It is impossible to accurately assess the current volume of shadow inventory and its future impact on the residential real estate market, particularly given the uncertainty surrounding the foreclosure processing delays instituted by many major mortgage lenders as they settle their disputes with regulators concerning their lending practices.

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 such as the September 2012 settlement with the California DLSE discussed above.

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.


Our 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. 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 Consolidated Financial Statements contained in our Form 10-K for the year ended December 31, 2011, 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

We derive the majority of our net revenues from commissions earned in our owned-and-operated residential real estate brokerage, and from commission referrals earned from brokers in our Powered by Zip network. We recognize commission based revenues 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.

Non-commission based revenues are derived primarily from marketing agreements with residential mortgage service providers, the sale of online advertising, lead referral fees and other revenues. We classify these revenues as marketing and other revenues. 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. Revenues related to revenue sharing arrangements are recognized based on revenue reports received from our partners, provided that collectability is reasonably assured.

Revenue is recognized only when the price is fixed or determinable, persuasive evidence an arrangement exists, the service has been delivered and collectability of the resulting receivable 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 ZipRealty Agent Platform ("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, . . .

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