##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark one)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission file number: 000-51002
 ZIPREALTY, INC.
 (Exact name of registrant as specified in its charter)
 DELAWARE
(State of incorporation)
    
    94-3319956
(IRS employer identification number)2000 POWELL STEET, SUITE 300
EMERYVILLE, CA
(Address of principal executive offices)
    
    94608
(Zip Code)
 (510) 735-2600
(Registrants telephone number)
 þ o
  o þ o
 o þ




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##### 



TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1. Unaudited Condensed Consolidated Financial Statements
    
    
    4Unaudited Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005
    
    
    4Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and 2005
    
    
    5Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005
    
    
    6Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    27Item 1A. Risk Factors
    
    
    27Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    40Item 6. Exhibits
    
    
    41SIGNATURES
    
    
    42EXHIBITS INDEX
    
    
    43EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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Statement regarding forward-looking statements
  
    
    our future financial results;
    
    our future growth and expansion into new markets;
    
    our future advertising and marketing activities; and
    
    our future investment in technology.
   Trademarks
 ®
 Internet Site
 www.ziprealty.com
 Where You Can Find Additional Information
  3




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PART I  FINANCIAL INFORMATION
 
 Item 1. Unaudited Condensed Consolidated Financial Statements:
 ZIPREALTY, INC.
 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands, except per share amounts)
 September 30,
    
    
    December 31,2006
    
    
    2005AssetsCurrent assetsCash and cash equivalents
    
    $
    9,441
    
    
    $
    6,868Short-term investments
    
    
    78,928
    
    
    
    82,041Accounts receivable, net of allowance of $38
and $42 at September 30, 2006 and December 31,
2005, respectively
    
    
    1,946
    
    
    
    1,634Prepaid expenses and other current assets
    
    
    2,717
    
    
    
    3,138Current and deferred income taxes
    
    
    679
    
    
    
    500Total current assets
    
    
    93,711
    
    
    
    94,181Restricted cash
    
    
    90
    
    
    
    90Property and equipment, net
    
    
    3,817
    
    
    
    2,538Investment in non-consolidated companies
    
    
    28
    
    
    
    Deferred tax assets, net
    
    
    17,053
    
    
    
    17,053Other assets
    
    
    421
    
    
    
    91Total assets
    
    $
    115,120
    
    
    $
    113,953Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    1,525
    
    
    $
    1,631Accrued expenses
    
    
    6,889
    
    
    
    8,503Total current liabilities
    
    
    8,414
    
    
    
    10,134Other long-term liabilities
    
    
    569
    
    
    
    38Total liabilities
    
    
    8,983
    
    
    
    10,172Commitments
and contingencies (Note 8)Stockholders equityCommon stock: $0.001 par value; 100,000 shares
authorized; 20,488 and 20,273 shares issued
and outstanding at September 30, 2006 and
December 31, 2005, respectively
    
    
    20
    
    
    
    20Additional paid-in capital
    
    
    132,331
    
    
    
    130,077Common stock warrants
    
    
    6,094
    
    
    
    6,094Deferred stock-based compensation
    
    
    (92
    )
    
    
    (257
    )Accumulated other comprehensive loss
    
    
    (167
    )
    
    
    (490
    )Accumulated deficit
    
    
    (32,049
    )
    
    
    (31,663
    )Total stockholders equity
    
    
    106,137
    
    
    
    103,781Total liabilities and stockholders equity
    
    $
    115,120
    
    
    $
    113,953
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ZIPREALTY, INC.
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share amounts)
 Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net transaction revenues
    
    $
    25,420
    
    
    $
    27,576
    
    
    $
    70,263
    
    
    $
    70,122Referral and other revenues
    
    
    765
    
    
    
    667
    
    
    
    2,048
    
    
    
    1,696Net revenues
    
    
    26,185
    
    
    
    28,243
    
    
    
    72,311
    
    
    
    71,818Operating expensesCost of revenues
    
    
    14,238
    
    
    
    15,565
    
    
    
    39,568
    
    
    
    39,467Product development
    
    
    1,284
    
    
    
    760
    
    
    
    3,838
    
    
    
    1,965Marketing and customer acquisition
    
    
    3,116
    
    
    
    3,637
    
    
    
    9,413
    
    
    
    9,729General and administrative
    
    
    7,922
    
    
    
    6,062
    
    
    
    22,831
    
    
    
    15,807Litigation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,164Total operating expenses
    
    
    26,560
    
    
    
    26,024
    
    
    
    75,650
    
    
    
    71,132Income (loss) from operations
    
    
    (375
    )
    
    
    2,219
    
    
    
    (3,339
    )
    
    
    686Other income (expense), netInterest income
    
    
    1,086
    
    
    
    715
    
    
    
    2,782
    
    
    
    1,967Other expense, net
    
    
    (8
    )
    
    
    (8
    )
    
    
    (8
    )
    
    
    (11
    )Total other income, net
    
    
    1,078
    
    
    
    707
    
    
    
    2,774
    
    
    
    1,956Income (loss) before income taxes
    
    
    703
    
    
    
    2,926
    
    
    
    (565
    )
    
    
    2,642Provision for (benefit from) income taxes
    
    
    81
    
    
    
    76
    
    
    
    (179
    )
    
    
    76Net income (loss)
    
    $
    622
    
    
    $
    2,850
    
    
    $
    (386
    )
    
    $
    2,566Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    0.14
    
    
    $
    (0.02
    )
    
    $
    0.13Diluted
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    (0.02
    )
    
    $
    0.10Weighted average common shares outstanding:Basic
    
    
    20,410
    
    
    
    20,198
    
    
    
    20,356
    
    
    
    20,031Diluted
    
    
    23,478
    
    
    
    25,328
    
    
    
    20,356
    
    
    
    25,487
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ZIPREALTY, INC.
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Nine months ended September 30,2006
    
    
    2005Cash flows from operating activitiesNet income (loss)
    
    $
    (386
    )
    
    $
    2,566Adjustments to reconcile net income (loss) to net cash provided by operating activitiesDeferred income tax benefit
    
    
    (179
    )
    
    
    Depreciation and amortization
    
    
    1,744
    
    
    
    1,065Stock-based compensation expense
    
    
    1,884
    
    
    
    106Provision for doubtful accounts
    
    
    (4
    )
    
    
    13Amortization
of short-term investment premium (discount)
    
    
    (2
    )
    
    
    515Loss on disposal of property and equipment
    
    
    15
    
    
    
    Changes in operating assets and liabilitiesAccounts receivable
    
    
    (308
    )
    
    
    (975
    )Prepaid expenses and other current assets
    
    
    421
    
    
    
    (479
    )Other assets
    
    
    (180
    )
    
    
    (69
    )Accounts payable
    
    
    (106
    )
    
    
    (125
    )Accrued expenses
    
    
    (1,614
    )
    
    
    5,506Other long-term liabilities
    
    
    531
    
    
    
    (41
    )Net cash provided by operating activities
    
    
    1,816
    
    
    
    8,082Cash flows from investing activitiesPurchases of short-term investments
    
    
    (51,102
    )
    
    
    (26,650
    )Proceeds from sale and maturity of short-term investments
    
    
    54,540
    
    
    
    16,167Purchases of property and equipment
    
    
    (3,038
    )
    
    
    (1,954
    )Purchase of intangible asset
    
    
    (150
    )
    
    
    Investment in non-consolidated companies
    
    
    (28
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    222
    
    
    
    (12,437
    )Cash flows from financing activitiesProceeds from stock option exercises
    
    
    535
    
    
    
    448Proceeds from common stock warrant exercises
    
    
    
    
    
    
    11Net cash provided by financing activities
    
    
    535
    
    
    
    459Net increase (decrease) in cash and cash equivalents
    
    
    2,573
    
    
    
    (3,896
    )Cash and cash equivalents at beginning of period
    
    
    6,868
    
    
    
    11,525Cash and cash equivalents at end of period
    
    $
    9,441
    
    
    $
    7,629
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. BACKGROUND AND BASIS OF PRESENTATION
     Reclassifications
  Stock split
  Initial public offering
  7




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Seasonality
  2.
RECENT ACCOUNTING PRONOUNCEMENTS
 Accounting for Uncertainty in
Income Taxes Accounting for Income Taxes
 3. SHORT-TERM INVESTMENTS
  Gross
    
    
    GrossGross Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair Value(in thousands)Money market securities
    
    $
    6,076
    
    
    $
    
    
    
    $
    
    
    
    $
    6,076Repurchase agreements
    
    
    700
    
    
    
    
    
    
    
    
    
    
    
    700Asset backed
    
    
    24,209
    
    
    
    22
    
    
    
    (33
    )
    
    
    24,198Corporate obligations
    
    
    33,786
    
    
    
    40
    
    
    
    (97
    )
    
    
    33,729US Government and agency obligations
    
    
    21,100
    
    
    
    12
    
    
    
    (111
    )
    
    
    21,001Total short-term investments
    
    $
    85,871
    
    
    $
    74
    
    
    $
    (241
    )
    
    $
    85,704
 September 30,2006(in thousands)Recorded as:Cash equivalents
    
    $
    6,776Short-term investments
    
    
    78,928$
    85,704
   September 30,2006(in thousands)Due within one year or less
    
    $
    33,210Due after one year through two years
    
    
    31,668Due after two years through four years
    
    
    20,826$
    85,704
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4. NET INCOME (LOSS) PER SHARE
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands, except per share data)Numerator:Net income (loss)
    
    $
    622
    
    
    $
    2,850
    
    
    $
    (386
    )
    
    $
    2,566Denominator:Weighted average common shares outstanding:Basic
    
    
    20,410
    
    
    
    20,198
    
    
    
    20,356
    
    
    
    20,031Diluted
    
    
    23,478
    
    
    
    25,328
    
    
    
    20,356
    
    
    
    25,487Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    0.14
    
    
    $
    (0.02
    )
    
    $
    0.13Diluted
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    (0.02
    )
    
    $
    0.10The following table sets forth potential common shares that are not included in the diluted
net income (loss) per share calculation because to do so would be anti-dilutive for the periods
presented:Three Months Ended September 30,
    
    Nine Months Ended September 30,2006
    
    2005
    
    2006
    
    2005(in thousands)Stock options to purchase common stock
    
    
    3,052
    
    
    
    866
    
    
    
    4,363
    
    
    
    633Warrants to purchase common stock
    
    
    3
    
    
    
    3
    
    
    
    4,603
    
    
    
    3
 5. STOCK-BASED COMPENSATION
 Share-Based Payment
 Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services
 Prior to the adoption of SFAS 123(R)
 Accounting for Stock Issued to Employees Accounting for Certain Transactions Involving Stock Compensation  an
Interpretation of APB No. 25 Accounting for Stock-Based Compensation Accounting for Stock-Based
Compensation  Transaction and Disclosure
 9




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Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302005
    
    
    2005Net income as reported
    
    $
    2,850
    
    
    $
    2,566Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of tax
    
    
    (326
    )
    
    
    (827
    )Pro forma net income
    
    $
    2,524
    
    
    $
    1,739Net income per share, as reported:Basic
    
    $
    0.14
    
    
    $
    0.13Diluted
    
    $
    0.11
    
    
    $
    0.10Pro forma net income per share:Basic
    
    $
    0.12
    
    
    $
    0.09Diluted
    
    $
    0.10
    
    
    $
    0.07
  Impact of the Adoption of SFAS 123(R)
  
    
    compensation cost for all unvested stock-based awards as of January 1, 2006 that were
granted subsequent to the Companys filing of the registration statement for an initial
public offering in May 2004, and prior to January 1, 2006, that vested during the period
based on the grant date fair value estimated in accordance with the original provisions of
SFAS 123;
    
    compensation cost for stock-based awards granted subsequent to January 1, 2006, that
vested during the period based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R); and
    
    compensation cost for options granted prior to the Companys filing of the registration
statement for an initial public offering in May 2004, that vested during the period based on
the intrinsic value method.
  Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2006(in thousands)
    
    
    (in thousands)Cost of revenues
    
    $
    110
    
    
    $
    357Product development
    
    
    48
    
    
    
    135Marketing and customer acquisition
    
    
    (1
    )
    
    
    51General and administrative
    
    
    558
    
    
    
    1,341Total stock-based compensation
    
    
    715
    
    
    
    1,884Tax effect on stock-based compensation
    
    
    (286
    )
    
    
    (754
    )Net effect on net income
    
    $
    429
    
    
    $
    1,130Effect on earnings per share:Basic
    
    $
    0.02
    
    
    $
    0.06Diluted
    
    $
    0.02
    
    
    $
    0.06
  10




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Valuation Assumptions
    Three Months Ended September 30,
    
    Nine Months Ended September 30,2006
    
    2005
    
    2006
    
    2005Expected volatility
    
    
    51%
    
    
    
    40%
    
    
    
    51-52%
    
    
    
    33-40%Risk-free interest rate
    
    
    4.8-4.9%
    
    
    
    4.0%
    
    
    
    4.3-5.0%
    
    
    
    3.8-4.1%Expected life (years)
    
    
    6.0-6.1
    
    
    
    4
    
    
    
    5.5-6.1
    
    
    
    4Expected dividend yield
    
    
    0%
    
    
    
    0%
    
    
    
    0%
    
    
    
    0%Weighted-average fair
value of options
granted during the
period
    
    
    $3.30
    
    
    
    $5.11
    
    
    
    $3.90
    
    
    
    $4.88
 Stock Option Activity
  WeightedWeighted
    
    AverageAverage
    
    RemainingNumber of
    
    Exercise
    
    Contractual
    
    AggregateShares
    
    Price
    
    Life (Years)
    
    Intrinsic Value(in thousands)
    
    
    
    
    
    
    
    
    
    (in thousands)Outstanding at January 1, 2006
    
    
    3,652
    
    
    $
    7.01Options granted
    
    
    653
    
    
    $
    8.41Options exercised
    
    
    (45
    )
    
    $
    3.18Options forfeited or expired
    
    
    (82
    )
    
    $
    11.88Outstanding at March 31, 2006
    
    
    4,178
    
    
    $
    7.17
    
    
    
    7.68
    
    
    
    13,778Options granted
    
    
    474
    
    
    $
    8.80Options exercised
    
    
    (77
    )
    
    $
    3.08Options forfeited or expired
    
    
    (113
    )
    
    $
    11.22Outstanding at June 30, 2006
    
    
    4,462
    
    
    $
    7.31
    
    
    
    7.66
    
    
    
    12,442Options granted
    
    
    1,462
    
    
    $
    6.05Options exercised
    
    
    (93
    )
    
    $
    1.66Options forfeited or expired
    
    
    (296
    )
    
    $
    11.71Outstanding at September 30, 2006
    
    
    5,535
    
    
    $
    6.84
    
    
    
    8.05
    
    
    
    11,475Options exercisable at September 30, 2006
    
    
    2,503
    
    
    $
    5.18
    
    
    
    6.38
    
    
    
    9,432
  11




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Stock Option Plans
      Other Stock Option
  6. INCOME TAXES
   12




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7. COMPREHENSIVE INCOME (LOSS)
  Three Months Ended September 30,
    
    

Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Net income (loss)
    
    $
    622
    
    
    $
    2,850
    
    
    $
    (386
    )
    
    $
    2,566Other comprehensive income (loss):Change in accumulated unrealized gain (loss) on
available-for-sale securities, net of tax
    
    
    346
    
    
    
    (156
    )
    
    
    322
    
    
    
    (392
    )Comprehensive income (loss)
    
    $
    968
    
    
    $
    2,694
    
    
    $
    (64
    )
    
    $
    2,174
 8. COMMITMENTS AND CONTINGENCIES
   OperatingYear ending December 31,
    
    Leases2006
    
    $
    3902007
    
    
    1,5502008
    
    
    1,2642009
    
    
    8162010
    
    
    739Thereafter
    
    
    781Total minimum lease payments
    $
    5,540
 Legal Proceedings
  Indemnifications
   13




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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 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
    Trends in our business
  14




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15




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Market seasonality, cyclicality and interest rate influences
      16




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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   Recent accounting pronouncements
 Accounting for Uncertainty in
Income Taxes Accounting for Income Taxes
 Revenue recognition
  Internal-use software and website development costs
 Accounting for the Cost of Computer Software Developed or Obtained for Internal Use Accounting for Website Development Costs
 Stock-based compensation
 Share-Based
Payment Accounting for Stock Issued to Employees
 17




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
    
    compensation cost for all unvested stock-based awards as of January 1, 2006 that
were granted subsequent to our filing of the registration statement for an initial public
offering in May 2004, and prior to January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS 123;
    
    compensation cost for stock-based awards granted subsequent, to January 1, 2006,
based on the grant date fair value estimated in accordance with the provisions of SFAS
123(R); and
    
    compensation cost for options granted prior to our filing of the registration
statement for an initial public offering in May 2004, based on the intrinsic value
method.
  Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services
   
    
    comparable values of similar companies and the pricing of recent rounds of financing;
    
    revenue growth and profitability milestones achieved and as measured to budget;
    
    continued growth in experience of our management team;
    
    marketplace activity and competition;
    
    barriers to entry; and
    
    status of capital markets.
 Income taxes
  18




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RESULTS OF OPERATIONS
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Statements of operations data (unaudited)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands, except per share data)Net transaction revenues
    
    $
    25,420
    
    
    $
    27,576
    
    
    $
    70,263
    
    
    $
    70,122Referral and other revenues
    
    
    765
    
    
    
    667
    
    
    
    2,048
    
    
    
    1,696Net revenues
    
    
    26,185
    
    
    
    28,243
    
    
    
    72,311
    
    
    
    71,818Operating expenses:Cost of revenues
    
    
    14,238
    
    
    
    15,565
    
    
    
    39,568
    
    
    
    39,467Product development
    
    
    1,284
    
    
    
    760
    
    
    
    3,838
    
    
    
    1,965Marketing and customer acquisition
    
    
    3,116
    
    
    
    3,637
    
    
    
    9,413
    
    
    
    9,729General and administrative
    
    
    7,922
    
    
    
    6,062
    
    
    
    22,831
    
    
    
    15,807Litigation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,164Total operating expenses
    
    
    26,560
    
    
    
    26,024
    
    
    
    75,650
    
    
    
    71,132Income (loss) from operations
    
    
    (375
    )
    
    
    2,219
    
    
    
    (3,339
    )
    
    
    686Other income (expense):Interest income
    
    
    1,086
    
    
    
    715
    
    
    
    2,782
    
    
    
    1,967Other expense, net
    
    
    (8
    )
    
    
    (8
    )
    
    
    (8
    )
    
    
    (11
    )Total other income (expense), net
    
    
    1,078
    
    
    
    707
    
    
    
    2,774
    
    
    
    1,956Income (loss) before income taxes
    
    
    703
    
    
    
    2,926
    
    
    
    (565
    )
    
    
    2,642Provision for (benefit from) for income taxes
    
    
    81
    
    
    
    76
    
    
    
    (179
    )
    
    
    76Net income (loss)
    
    $
    622
    
    
    $
    2,850
    
    
    $
    (386
    )
    
    $
    2,566Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    0.14
    
    
    $
    (0.02
    )
    
    $
    0.13Diluted
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    (0.02
    )
    
    $
    0.10Weighted average common shares outstanding:Basic
    
    
    20,410
    
    
    
    20,198
    
    
    
    20,356
    
    
    
    20,031Diluted
    
    
    23,478
    
    
    
    25,328
    
    
    
    20,356
    
    
    
    25,487The following table presents our historical operating results as a percentage of net revenues for
the periods indicated:Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Statements of operations data (unaudited)
    
    2006
    
    2005
    
    2006
    
    2005Net transaction revenues
    
    
    97.1
    %
    
    
    97.6
    %
    
    
    97.2
    %
    
    
    97.6
    %Referral and other revenues
    
    
    2.9
    
    
    
    2.4
    
    
    
    2.8
    
    
    
    2.4Net revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Operating expenses:Cost of revenues
    
    
    54.4
    
    
    
    55.1
    
    
    
    54.7
    
    
    
    55.0Product development
    
    
    4.9
    
    
    
    2.7
    
    
    
    5.3
    
    
    
    2.7Marketing and customer acquisition
    
    
    11.9
    
    
    
    12.9
    
    
    
    13.0
    
    
    
    13.5General and administrative
    
    
    30.3
    
    
    
    21.5
    
    
    
    31.6
    
    
    
    22.0Litigation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.8Total operating expenses
    
    
    101.5
    
    
    
    92.2
    
    
    
    104.6
    
    
    
    99.0Income (loss) from operations
    
    
    (1.5
    )
    
    
    7.8
    
    
    
    (4.6
    )
    
    
    1.0Other income (expense):Interest income
    
    
    4.1
    
    
    
    2.5
    
    
    
    3.8
    
    
    
    2.7Other expense, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total other income (expense), net
    
    
    4.1
    
    
    
    2.5
    
    
    
    3.8
    
    
    
    2.7
 19




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Statements of operations data (unaudited)
    
    2006
    
    2005
    
    2006
    
    2005Income (loss) before income taxes
    
    
    2.6
    
    
    
    10.3
    
    
    
    (0.8
    )
    
    
    3.7Provision for (benefit from) income taxes
    
    
    0.3
    
    
    
    0.3
    
    
    
    (0.2
    )
    
    
    0.1Net income (loss)
    
    
    2.3
    %
    
    
    10.0
    %
    
    
    (0.6
    )%
    
    
    3.6
    %
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Other operating data
    
    2006
    
    2005
    
    2006
    
    2005Number of ZipAgents at end of period
    
    
    1,747
    
    
    
    1,383
    
    
    
    1,747
    
    
    
    1,383Total value of real estate transactions closed during period (in billions)
    
    $
    1.20
    
    
    $
    1.36
    
    
    $
    3.35
    
    
    $
    3.42Number of transactions closed during period (1)
    
    
    3,467
    
    
    
    3,689
    
    
    
    9,657
    
    
    
    9,407Average net revenue per transaction during period (2)
    
    $
    7,332
    
    
    $
    7,475
    
    
    $
    7,276
    
    
    $
    7,454
 
 (1)
    
    The term transaction refers to each representation of a buyer or seller in a real estate
purchase or sale.(2)
    
    Average net revenue per transaction equals net transaction revenues divided by number of
transactions with respect to each period. Comparison of the three months ended September 30, 2006 and 2005
 Net revenue
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Net revenue
    
    $
    26,185
    
    
    $
    28,243
    
    
    $
    (2,058
    )
    
    
    (7.3
    )%
   Cost of revenues
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Cost of revenues
    
    $
    14,238
    
    
    $
    15,565
    
    
    $
    (1,327
    )
    
    
    (8.5
    )%
   20




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##### Table of Contents



Product development
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Product development
    
    $
    1,284
    
    
    $
    760
    
    
    $
    524
    
    
    
    69.0
    %
    Marketing and customer acquisition
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Marketing
and customer acquisition
    
    $
    3,116
    
    
    $
    3,637
    
    
    $
    (521
    )
    
    
    (14.3
    )%
    General and administrative
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)General and administrative
    
    $
    7,922
    
    
    $
    6,062
    
    
    $
    1,860
    
    
    
    30.7
    %
  21




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Interest income
 Three Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Interest income
    
    
    $1,086
    
    
    
    $715
    
    
    $
    371
    
    
    
    51.8
    %Interest income relates to interest we earn on our money market deposits and short-term
investments. Interest income will fluctuate as our cash equivalents and short-term investment
balances change and applicable interest rates increase or decrease. The increase in interest income
for the three months ended September 30, 2006 compared to the three months ended September 30, 2005
was due primarily to higher interest rates earned on marginally lower average balances.Other income (expense), netThree Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Other income (expense), net
    
    
    $(8)
    
    
    
    $(8)
    
    
    $
    
    
    
    
    (6.4)
    %Other income (expense), net consists of non-operating items, which have not been significant
to date.Provision for income taxesThree Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Provision for income taxes
    
    
    $81
    
    
    
    $76
    
    
    
    $5
    
    
    
    6.8
    %We recorded a provision for income taxes in the three months ended September 30, 2006 and 2005
related to our net book profit based on our best estimate of the tax provision (benefit) that will
be provided for the full year. At September 30, 2005, we maintained a full valuation allowance
against our deferred tax assets based on the determination that it was more likely than not that
the deferred tax assets would not be realized.Comparison of the nine months ended September 30, 2006 and 2005Net revenuesNine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Net revenues
    
    $
    72,311
    
    
    $
    71,818
    
    
    $
    493
    
    
    
    0.7
    %
  22




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Cost of revenues
 Nine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Cost of revenues
    
    $
    39,568
    
    
    $
    39,467
    
    
    $
    101
    
    
    
    0.3
    %
   Product development
 Nine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Product development
    
    $
    3,838
    
    
    $
    1,965
    
    
    $
    1,873
    
    
    
    95.3
    %
   Marketing and customer acquisition
 Nine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Marketing and customer acquisition
    
    $
    9,413
    
    
    $
    9,729
    
    
    $
    (316
    )
    
    
    (3.2
    )%
  23




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General and administrative
 Nine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)General and administrative
    
    
    $22,831
    
    
    
    $15,807
    
    
    
    $7,024
    
    
    
    44.4
    %General and administrative expenses consist of compensation and benefits costs of our
corporate employees, field support and management personnel, occupancy costs, legal and accounting
fees, and other general operating support costs.The increase in general and administrative expenses in the nine months ended September 30,
2006 compared to the nine months ended September 30, 2005 was due to growth in our business and
consisted primarily of approximately $1.5 million related to increased salaries and benefits, $0.2
million of travel, $0.2 million of depreciation and $0.6 million of related occupancy,
communication and operating costs for our additional management and support personnel in our
existing and new district sales offices. These costs were partially offset by a decrease of
approximately $0.3 million related to recruiting and training expenses. Corporate office expenses
increased for the same period due to approximately $2.2 million of salaries and benefits,
approximately $0.7 million of outside accounting and other professional costs relating primarily to
operating as a public company including Sarbanes-Oxley section 404 compliance costs and
approximately $0.6 million of depreciation, occupancy and other operating costs related primarily
to the relocation of our corporate office. Additionally, stock-based compensation increased $1.2
million in general and administrative expense resulting from the adoption of SFAS No. 123(R). As a
percentage of net revenues, general and administrative expenses increased 9.6 percentage points for
the same period.LitigationNine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Litigation
    
    $
    
    
    
    
    $4,164
    
    
    $
    (4,164
    )
    
    
    (100.0
    )%Litigation expense in 2005 is related to a class action lawsuit. We settled this claim in
exchange for our payment of $4.164 million.Interest incomeNine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Interest income
    
    
    $2,782
    
    
    
    $1,967
    
    
    
    $815
    
    
    
    41.4
    %Interest income relates to interest we earn on our money market deposits and short-term
investments. Interest income will fluctuate as our cash equivalents and short-term investment
balances change and applicable interest rates increase or decrease. The increase in interest income
for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005
was due primarily to higher interest rates earned on marginally lower average balances.Other income (expense), netNine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Other income (expense), net
    
    
    $(8)
    
    
    
    $(11)
    
    
    
    $3
    
    
    
    27.1
    %
 24




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Provision for income taxes
 Nine Months EndedSeptember 30,
    
    Increase
    
    Percent2006
    
    2005
    
    (Decrease)
    
    Change(in thousands)Provision for income taxes
    
    $
    (179
    )
    
    $
    76
    
    
    $
    (255
    )
    
    
    (336.8
    )%
  LIQUIDITY AND CAPITAL RESOURCES
   Operating activities
    Investing activities
  25




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Financing activities
   Future needs
  CONTRACTUAL OBLIGATIONS AND COMMITMENTS
  Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More than1 year
    
    1 to 3 years
    
    3 to 5 years
    
    5 years
    
    Total(in thousands)Operating lease commitments
    
    $
    1,551
    
    
    $
    2,290
    
    
    $
    1,458
    
    
    $
    241
    
    
    $
    5,540
 OFF-BALANCE SHEET ARRANGEMENTS
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk:
 Interest rate sensitivity
  26




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Exchange rate sensitivity
  
 Item 4. Controls and Procedures:
 Disclosure controls and procedures
 Changes in internal control over financial reporting
 
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings:
  
 Item 1A. Risk Factors:
  RISKS RELATED TO OUR BUSINESS AND INDUSTRY
 We have been profitable in only nine quarters and may incur losses in the future, and our limited
operating history makes our future financial performance difficult to assess.
  27




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##### Table of Contents



Our business model requires access to real estate listing services provided by third parties that
we do not control, and the demand for our services may be reduced if our ability to display
listings on our website is restricted.
     ®
 28




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Our business could be harmed by transitions in the real estate markets and economic events that
are out of our control and may be difficult to predict.
   Interest rates were at historic lows for the past several years, and increases in interest rates
have the potential to negatively impact the housing market.
  Our business model is new and unproven, and we cannot guarantee our future success.
  If we fail to recruit, hire and retain qualified agents, we may be unable to service our clients
and our growth could be impaired.
 29




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Our failure to effectively manage the growth of our ZipAgents and related technology could
adversely affect our ability to service our clients.
  Our failure to effectively manage the growth of our control systems could adversely affect our
ability to maintain legal compliance.
  If we fail to comply with real estate brokerage laws and regulations, we may incur significant
financial penalties or lose our license to operate.
  30




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##### Table of Contents



We may have liabilities in connection with real estate brokerage activities.
  We may have liabilities if any of our employees violates laws concerning settlement procedures.
  If any of our core services fails to comply with applicable federal and state law and regulations,
we may incur significant financial penalties or lose licenses require to provide these services.
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We may have liabilities in connection with our performance of core services.
  If our arrangements for providing core services become impaired, we may lose sources of revenue
that may be difficult to replace and we may be less likely to engage in related transactions with
our clients.
  If consumers do not continue to use the Internet as a tool in their residential real estate buying
or selling process, we may be unable to attract new clients and our growth and financial results
may suffer.
  Our success depends in part on our ability to successfully expand into additional real estate
markets.
  32




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##### Table of Contents




    
    the economic conditions and demographics of a market;
    
    the general prices of real estate in a market;
    
    Internet use in a market;
    
    competition within a market from local and national brokerage firms;
    
    rules and regulations governing a market;
    
    the ability and capacity of our organization to manage expansion into additional
geographic areas, additional headcount and increased organizational complexity;
    
    the existence of local MLSs; and
    
    state laws governing cash rebates and other regulatory restrictions.
  Unless we develop, maintain and protect a strong brand identity, our business may not grow and our
financial results may suffer.
   We have numerous competitors, many of which have valuable industry relationships, innovative
business models and access to greater resources than we do.
  33




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##### Table of Contents



Trends
   Changes in federal and state real estate laws and regulations, and rules of industry organizations
such as the National Association of REALTORS could adversely affect our business.
  We derive a significant portion of our leads through third parties, and if any of our significant
lead generation relationships are terminated, impaired or become more expensive, our ability to
attract new clients and grow our business may be adversely affected.
  34




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##### Table of Contents



Our ability to expand our business may be limited by state laws governing cash rebates to home
buyers.
  We may be unable to integrate our technology with each MLS on a cost-effective basis, which may
harm our operating results and adversely affect our ability to service clients.
  We may be subject to liability for the Internet content that we publish.
  We monitor and evaluate the use of our website by our registered users, which could raise privacy
concerns.
  35




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##### Table of Contents



We may need to change the manner in which we conduct our business if government regulation of the
Internet increases.
    Our operating results are subject to seasonality and vary significantly among quarters during each
calendar year, making meaningful comparisons of successive quarters difficult.
   
    
    timing of widely observed holidays and vacation periods and availability home buyers and
sellers, real estate agents and related service providers during these periods;
    
    a desire to relocate prior to the start of the school year;
    
    inclement weather which can influence consumers desire or ability to visit properties;
    
    timing of employment compensation changes, such as raises and bonuses;
    
    the time between entry into a purchase contract for real estate and closing of the transaction; and
    
    the levels of housing inventory available for sale.
  Our reputation and client and agent service offerings may be harmed by system failures and
computer viruses.
  36




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Our business is geographically concentrated, which makes us more susceptible to business
interruption and financial loss due to natural disasters, inclement weather, economic or market
conditions or other regional events outside of our control.
  Our intellectual property rights are valuable and our failure to protect those rights could
adversely affect our business.
  We may in the future be subject to intellectual property rights disputes, which could divert
management attention, be costly to defend and require us to limit our service offerings.
   
    
    pay damages;
    
    stop using the technology found to be in violation of a third partys rights;
    
    seek a license for the infringing technology; or
    
    develop alternative non-infringing technology.
 37




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##### Table of Contents



If we fail to attract and retain our key personnel, our ability to meet our business goals will be
impaired and our financial condition and results of operations will suffer.
  We intend to evaluate acquisitions or investments in complementary technologies and businesses and
we may not realize the anticipated benefits from, and may have to pay substantial costs related
to, any acquisitions or investments that we undertake.
  
    
    our inability to successfully integrate acquired technologies or operations;
    
    diversion of managements attention;
    
    problems maintaining uniform standards, procedures, controls and policies;
    
    potentially dilutive issuances of equity securities or the incurrence of debt or contingent liabilities;
    
    expenses related to amortization of intangible assets;
    
    risks associated with operating a business or in a market in which we have little or no prior experience;
    
    potential write offs of acquired assets;
    
    loss of key employees of acquired businesses; and
    
    our inability to recover the costs of acquisitions or investments.
 Accounting for employee stock options using the fair value method could significantly reduce our
net income in future periods.
  The value of our services could be diminished if anti-spam software filters out an increasing
portion of the emails we send.
  38




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##### Table of Contents



OTHER RISKS RELATED TO OUR STOCK PRICE
 Our stock price may be volatile.
  
    
    variations in our quarterly results of operations;
    
    announcements by us or our competitors or lead source providers;
    
    the relatively low level of public float and average daily trading volumes of our common stock;
    
    changes in estimates of our performance or recommendations, or termination of coverage by securities analysts;
    
    inability to meet quarterly or yearly estimates or targets of our performance;
    
    the hiring or departure of key personnel (such as the recent departure of our former
Chief Executive Officer, Eric A. Danziger), including agents or groups of agents or key
executives;
    
    changes in our reputation;
    
    acquisitions or strategic alliances involving us or our competitors;
    
    changes in the legal and regulatory environment affecting our business; and
    
    market conditions in our industry and the economy as a whole.
  Our share price could decline due to the large number of outstanding shares of our common stock
eligible for future sale.
    39




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Our principal stockholders, executive officers and directors own a significant percentage of our
stock, and as a result, the trading price for our shares may be depressed and these stockholders
can take actions that may be adverse to your interests.
  Our charter documents and Delaware law could prevent a takeover that stockholders consider
favorable and could also reduce the market price of our stock.
  
    
    providing for a classified board of directors with staggered, three-year terms;
    
    not providing for cumulative voting in the election of directors;
    
    authorizing the board to issue, without stockholder approval, preferred stock with rights senior to those of common stock;
    
    prohibiting stockholder action by written consent;
    
    limiting the persons who may call special meetings of stockholders; and
    
    requiring advance notification of stockholder nominations and proposals.
   
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds:
  40




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Item 6. Exhibits:
  41




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SIGNATURE
  ZIPREALTY, INC.By:
    
    /s/ Gary M. Beasley

Gary M. BeasleyPresident and Chief Financial Officer
  42




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Exhibit Index
 Exhibitnumber
    
    Description3.1(a)(1)
    
    Amended and Restated Certificate of Incorporation3.2(a)(1)
    
    Bylaws4.1(1)
    
    Form of Common Stock Certificate10.13(a)(2)*
    
    ZipRealty, Inc. Amended and Restated Management Incentive Plan  Fiscal Year 200610.16(3)*
    
    Offer Letter to Richard F. Sommer dated August 24, 200610.17(4)*
    
    Form of Stock Option Award Agreement between Company and Richard F. Sommer to be dated September 6, 200631.1
    
    Certification of Chief Executive Officer, as required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 193431.2
    
    Certification of Chief Financial Officer, as required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 193432.1
    
    Certification of Chief Executive Officer, as required by Section 1350 of Chapter 63 of Title 18 of the
United States Code (18 U.S.C. 1350)32.2
    
    Certification of Chief Financial Officer, as required by Section 1350 of Chapter 63 of Title 18 of the
United States Code (18 U.S.C. 1350)
 
 (1)
    
    Incorporated by reference to the exhibit of the same number to the Registrants Registration
Statement on Form S-1(File No. 333-115657) filed with the Securities and Exchange Commission
on May 20, 2004, as amended.(2)
    
    Incorporated by reference to the exhibit of the same number to the Registrants Current
Report on Form 8-K (File No. 000-51002) filed with the Securities and Exchange Commission on
October 27, 2006.(3)
    
    Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K
(File No. 000-51002) filed with the Securities and Exchange Commission on August 30, 2006.(4)
    
    Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K
(File No. 000-51002) filed with the Securities and Exchange Commission on August 30, 2006.*
    
    Identifies a management contract or compensatory plan or agreement required to be filed as an
exhibit of this report. 43