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, 2007

OR

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

ZIPREALTY, INC.

DELAWARE		94-3319956
(State of incorporation)		(IRS employer identification number)
2000 POWELL STREET, SUITE 300
EMERYVILLE, CA		94608
(Address of principal executive offices)		(Zip Code)

(510) 735-2600

(Registrant’s telephone number)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

Large Accelerated Filer o      Accelerated Filer þ      Non-Accelerated Filer o

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

     We had 23,369,138 shares of common stock outstanding at November 1, 2007.

 

 

TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements			4
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006			4
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006			5
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006			6
Notes to Unaudited Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			13
Item 3. Quantitative and Qualitative Disclosures About Market Risk			29
Item 4. Controls and Procedures			30
PART II — OTHER INFORMATION			30
Item 1. Legal Proceedings			30
Item 1A. Risk Factors			31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			45
Item 5. Other Information			46
Item 6. Exhibits			46
SIGNATURE			47
EXHIBIT INDEX			48
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

Statement regarding forward-looking statements

     This report includes forward-looking statements. All statements other than statements of historical facts contained in this report, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “should,” “could,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “plan,” “potential,” “predict” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements contained in this report include, but are not limited to, statements relating to:

	•		our future financial results;
	•		our future growth and expansion into new markets;
	•		our future advertising and marketing activities; and
	•		our future investment in technology.

     We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors” in Item 1A of Part II. No forward-looking statement is a guarantee of future performance and you should not place undue reliance on any forward-looking statement.

     In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Except as otherwise required by law, we undertake no obligation to update or revise any forward-looking statement contained in this report.

Trademarks

     “ZipRealty,” “ZipAgent,” “ZipNotify,” “Your home is where our heart is” and “Real Estate Redefined” are our registered trademarks in the United States. We also own the rights to the domain name “www.Real-Estate.com.” “REALTOR” and “REALTORS” are registered trademarks of the National Association of REALTORS^® . All other trademarks, trade names and service marks appearing in this report are the property of their respective owners.

Internet site

     Our Internet address is www.ziprealty.com. We make publicly available free of charge on our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Information contained on our website is not a part of this quarterly report on Form 10-Q.

Where you can find additional information

     You may review a copy of this quarterly report on Form 10-Q, including exhibits and any schedule filed therewith, and obtain copies of such materials at prescribed rates, at the Securities and Exchange Commission’s Public Reference Room in Room 1580, 100 F Street NE, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as ZipRealty, that file electronically with the Securities and Exchange Commission.

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,
		2007				2006
Assets
Current assets
Cash and cash equivalents		$	7,740			$	8,575
Short-term investments			77,672				80,233
Accounts receivable, net of allowance of $32 and $30 at September 30, 2007 and December 31, 2006, respectively			2,085				1,781
Prepaid expenses and other current assets			2,964				3,151
Current and deferred income taxes			24				29
Total current assets			90,485				93,769
Restricted cash			90				90
Property and equipment, net			5,259				4,114
Investment in non-consolidated companies			13				17
Intangible assets, net			126				149
Other assets			209				218
Total assets		$	96,182			$	98,357
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable		$	2,810			$	2,184
Accrued expenses and other liabilities			10,301				7,791
Total current liabilities			13,111				9,975
Other long-term liabilities			501				513
Total liabilities			13,612				10,488
Commitments and contingencies (Note 8)
Stockholders’ equity
Common stock: $0.001 par value; 100,000 shares authorized; 23,279 and 21,627 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively			23				22
Additional paid-in capital			141,876				134,813
Common stock warrants			1,834				5,519
Deferred stock-based compensation			(13	)			(71	)
Accumulated other comprehensive loss			75				(157	)
Accumulated deficit			(61,225	)			(52,257	)
Total stockholders’ equity			82,570				87,869
Total liabilities and stockholders’ equity		$	96,182			$	98,357

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

ZIPREALTY, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

		Three Months ended September 30,								Nine Months ended September 30,
		2007				2006				2007				2006
Net transaction revenues		$	27,225			$	25,420			$	80,406			$	70,263
Referral and other revenues			804				765				2,286				2,048
Net revenues			28,029				26,185				82,692				72,311
Operating expenses
Cost of revenues			15,637				14,238				46,024				39,568
Product development			1,835				1,376				5,329				4,128
Sales and marketing			9,630				7,719				28,306				22,398
General and administrative			3,357				3,227				11,782				9,556
Litigation			3,550				—				3,550				—
Total operating expenses			34,009				26,560				94,991				75,650
Income (loss) from operations			(5,980	)			(375	)			(12,299	)			(3,339	)
Other income (expense), net
Interest income			1,147				1,086				3,329				2,782
Other income (expense), net			2				(8	)			2				(8	)
Total other income, net			1,149				1,078				3,331				2,774
Income (loss) before income taxes			(4,831	)			703				(8,968	)			(565	)
Provision for (benefit from) income taxes			—				81				—				(179	)
Net income (loss)		$	(4,831	)		$	622			$	(8,968	)		$	(386	)
Net income (loss) per share:
Basic		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)
Diluted		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)
Weighted average common shares outstanding:
Basic			22,629				20,410				22,421				20,356
Diluted			22,629				23,478				22,421				20,356

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

ZIPREALTY, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

		Nine Months ended September 30,
		2007				2006
Cash flows from operating activities
Net loss		$	(8,968	)		$	(386	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
Deferred income tax benefit			—				(179	)
Depreciation and amortization			2,118				1,744
Stock-based compensation expense			2,862				1,884
Provision for doubtful accounts			2				(4	)
Amortization of short-term investment premium (discount)			(323	)			(2	)
Amortization of intangible assets			23				—
Loss on disposal of property and equipment			8				15
Equity in net loss of non-consolidated companies			4				—
Changes in operating assets and liabilities
Accounts receivable			(306	)			(308	)
Prepaid expenses and other current assets			192				421
Other assets			9				(180	)
Accounts payable			626				(106	)
Accrued expenses and other liabilities			2,510				(1,614	)
Other long-term liabilities			(12	)			531
Net cash provided by (used in) operating activities			(1,255	)			1,816
Cash flows from investing activities
Purchases of short-term investments			(48,830	)			(51,102	)
Proceeds from sale and maturity of short-term investments			51,946				54,540
Purchases of property and equipment			(3,241	)			(3,038	)
Purchase of intangible asset			—				(150	)
Investment in non-consolidated companies			—				(28	)
Net cash provided by (used in) investing activities			(125	)			222
Cash flows from financing activities
Proceeds from stock option exercises			95				535
Proceeds from common stock warrant exercises			450				—
Net cash provided by financing activities			545				535
Net increase (decrease) in cash and cash equivalents			(835	)			2,573
Cash and cash equivalents at beginning of period			8,575				6,868
Cash and cash equivalents at end of period		$	7,740			$	9,441

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BACKGROUND AND BASIS OF PRESENTATION

     The accompanying unaudited interim condensed consolidated financial statements as of September 30, 2007 and 2006 and for the three and nine months then ended have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. In the opinion of the Company’s management, the unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s financial position for the periods presented. The results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the year ending December 31, 2007, or any other period. The audited condensed consolidated balance sheet at December 31, 2006 has been derived from the audited consolidated balance sheet at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

     In June 2006, the Company formed two wholly owned subsidiaries, ZipRealty Title Holdings, LLC, and Highline Insurance Services, LLC. These subsidiaries were formed for the purpose of offering services relating to the purchase, sale and ownership of a home, including services related to title insurance and property and casualty insurance. In June 2006, ZipRealty Title Holdings, LLC entered into a joint venture with an independent third party title company. There were no significant operations as of September 30, 2007 for any of these entities.

     The unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and reflect the elimination of intercompany accounts and transactions. Investments in business entities in which the Company does not have control, but has the ability to exercise significant influence over operating and financial policies, are accounted for using the equity method.

     The Company accounts for interests in variable interest entities (“VIEs”) in accordance with Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), as amended. The Company consolidates all VIEs for which the Company is deemed to be the primary beneficiary.

Reclassifications

     Effective January 1, 2007, for income statement presentation purposes, we have reclassified sales support and marketing expenses from general and administrative to sales and marketing (previously stated as marketing and customer acquisition). In management’s opinion, the reclassification to sales and marketing more appropriately reflects the nature of these activities, which include sales support and marketing activities of our district offices, regional services, ZipAgent and customer support services. In conjunction with this reclassification, we have also allocated headquarter occupancy costs to corporate departments based upon square footage to product development, sales and marketing and general and administrative; previously, all headquarter occupancy costs were recorded under general and administrative expenses. Comparative periods have been conformed to this presentation. The following is the change in classification of operating expenses for the three months and nine months ended September 30, 2006:

		Three Months Ended								Nine Months Ended
		September 30, 2006								September 30, 2006
		Previously								Previously
		Reported				Reclassified				Reported				Reclassified
		(in thousands)
Cost of revenues		$	14,238			$	14,238			$	39,568			$	39,568
Product development			1,284				1,376				3,838				4,128
Sales and marketing			3,116				7,719				9,413				22,398
General and administrative			7,922				3,227				22,831				9,556
Total operating expenses		$	26,560			$	26,560			$	75,650			$	75,650

Seasonality

     The Company’s net transaction revenues and income (loss) from operations have historically varied from quarter to quarter. Such variations are principally attributable to variations in home sales activity over the course of the calendar year. The Company has historically experienced lower net transaction revenues during the first quarter because holidays and adverse weather conditions in certain regions typically reduce the level of sales activity and listings inventories between the Thanksgiving and Presidents’ Day holidays. Net transaction revenues during the three months ended September 30, 2006 and 2005 accounted for approximately 27.4% and 30.3% of annual net transaction revenues in 2006 and 2005, respectively. Net transaction revenue during the nine months ended September 30, 2006 and 2005 accounted for approximately 75.8% and 77.0% of annual net transaction revenues in 2006 and 2005, respectively.

2. RECENT ACCOUNTING PRONOUNCEMENTS

     In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159 (“SFAS 159”), Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows and results of operations.

3. SHORT-TERM INVESTMENTS

     At September 30, 2007, short-term investments were classified as available-for-sale securities, except for restricted cash, and are reported at fair value as follows:

						Gross				Gross
		Gross Amortized				Unrealized				Unrealized				Estimated
		Cost				Gains				Losses				Fair Value
		(in thousands)
Money market securities		$	4,578			$	—			$	—			$	4,578
Asset backed			29,311				37				(40	)			29,308
Mortgage backed			11,763				60				—				11,823
Corporate obligations			23,763				11				(29	)			23,745
US Government and agency obligations			12,760				36				—				12,796
Total short-term investments		$	82,175			$	144			$	(69	)		$	82,250

		September 30,
		2007
		(in thousands)
Recorded as:
Cash equivalents		$	4,578
Short-term investments			77,672
		$	82,250

     At September 30, 2007, the fair value of the Company’s investments which had been in an unrealized loss position for over twelve months was $6.3 million and the related unrealized loss was approximately $18,000.

     The estimated fair value of short-term investments classified by date of contractual maturity at September 30, 2007 were as follows:

		September 30,
		2007
		(in thousands)
Due within one year or less		$	33,949
Due after one year through two years			16,068
Due after two years through four years			32,233
		$	82,250

4. NET INCOME (LOSS) PER SHARE

     The following table sets forth the computation of basic and dilutive net income (loss) per share for the periods indicated:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2007				2006				2007				2006
		(in thousands, except per share amounts)
Numerator:
Net income (loss)		$	(4,831	)		$	622			$	(8,968	)		$	(386	)
Denominator:
Weighted average common shares outstanding:
Basic			22,629				20,410				22,421				20,356
Diluted			22,629				23,478				22,421				20,356
Net income (loss) per share:
Basic		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)
Diluted		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)

     The 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,
		2007				2006				2007				2006
		(in thousands)
Stock options to purchase common stock			4,203				3,052				4,426				4,363
Warrants to purchase common stock			2,291				3				2,743				4,603
Nonvested common shares			42				—				14				—

5. STOCK-BASED COMPENSATION EXPENSE

     The impact on our results of operations of recording stock-based compensation for stock options and stock awards for the three and nine months ended September 30, 2007 and 2006 was as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2007				2006				2007				2006
		(in thousands, except per share amounts)
Cost of revenues		$	130			$	110			$	391			$	357
Product development			51				48				113				135
Sales and marketing			218				109				502				377
General and administrative			468				448				1,856				1,015
Total stock-based compensation expense			867				715				2,862				1,884
Tax effect on stock-based compensation			—				(286	)			—				(754	)
Net effect on net income		$	867			$	429			$	2,862			$	1,130
Effect on earnings per share:
Basic		$	0.04			$	0.02			$	0.13			$	0.06
Diluted		$	0.04			$	0.02			$	0.13			$	0.06

     There was no impact on cash flows from operating activities or financing activities during the three and nine months ended September 30, 2007 as a result of the adoption of SFAS 123(R). In the Company’s pro forma disclosures prior to the adoption of SFAS 123(R) the Company accounted for forfeitures upon occurrence. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. The Company estimated expected forfeitures based on various factors including employee class and historical experience. As of September 30, 2007, there was $9.4 million of unrecorded total stock-based compensation, after estimated forfeitures, related to unvested stock options. That cost is expected to be recognized over a weighted average remaining recognition period of 2.9 years. As of September 30, 2007, there was $1.4 million of unrecorded stock-based compensation related to unvested restricted stock. That cost is expected to be recognized over a weighted average remaining recognition period of 3.7 years.

Valuation assumptions

     SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period in the Company’s financial statements. In connection with the adoption of SFAS 123(R), the Company reassessed its valuation technique and related assumptions.

     The Company estimates 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 the Company’s common stock and consideration of other relevant factors such as the volatility assumptions of guideline companies. The expected life of options granted is estimated by taking the average of the vesting term and the contractual term of the option as provided by SAB 107.

     The assumptions used for the three and nine months ended September 30, 2007 and 2006 and the resulting estimates of weighted average fair value per share of options granted during those periods are as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2007				2006				2007				2006
Expected volatility			45	%			51	%			45-51	%			51-52	%
Risk-free interest rate			4.3	%			4.8-4.9	%			4.3-4.8	%			4.3-5.0	%
Expected life (years)			6.1				6.0-6.1				5.5-6.1				5.5-6.1
Expected dividend yield			0	%			0	%			0	%			0	%
Weighted-average fair value of options granted during the period		$	3.32			$	3.30			$	3.82			$	3.90

Stock option and stock award activity

     A summary of the Company’s stock option activity for the period indicated is as follows:

										Weighted
						Weighted				Average
						Average				Remaining
		Number of				Exercise				Contractual				Aggregate
		Shares				Price				Life (Years)				Intrinsic Value
		(in thousands)												(in thousands)
Outstanding at January 1, 2007			4,235			$	7.71				8.50			$	5,885
Options granted			976				7.37
Options exercised			(14	)			1.51
Options forfeited or expired			(347	)			9.81
Outstanding at March 31, 2007			4,850				7.51				8.56				4,929
Options granted			425				7.69
Options exercised			(37	)			1.36
Options forfeited or expired			(1,084	)			6.64
Outstanding at June 30, 2007			4,154				7.81				8.33				4,445
Options granted			543				6.68
Options exercised			(20	)			1.25
Options forfeited or expired			(170	)			8.85
Outstanding at September 30, 2007			4,507				7.66				8.30				2,881
Options exercisable at September 30, 2007			1,909			$	7.38				7.05			$	2,819

     Options generally vest over a four-year period with one-fourth (1/4) of the shares vesting one year after the vesting commencement date, and an additional one-forty eighth (1/48) of the shares vesting on the first day of each calendar month thereafter until all such shares are exercisable. Options expire after ten years.

     Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the fiscal period, which was $6.38 on September 28, 2007, and the exercise price for the options that were in-the-money at September 30, 2007.

The total number of in-the-money options exercisable as of September 30, 2007 was 925,000. Total intrinsic value of options exercised was $418,000 and $1,215,000 for the nine month periods ended September 30, 2007 and September 30, 2006, respectively.

     The Company settles employee stock option exercises with newly issued common shares.

     The Company’s 2004 stock plan also allows for the issuance of restricted stock. The restricted stock awards have the voting rights of common stock and the shares underlying the restricted stock awards are considered issued and outstanding. The Company expenses the cost of restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restriction lapse. Stock-based compensation expense related to restricted stock for the three and nine month periods ended September 30, 2007 was $122,000. A summary of the Company’s nonvested restricted stock for the period indicated is as follows:

						Weighted
						Average Grant Date
		Number of				Fair Value
		Shares				Per Share
		(in thousands)
Nonvested at June 30, 2007			—
Shares granted			225			$	6.68
Shares vested			—
Shares forfeited			—
Nonvested at September 30, 2007			225			$	6.68

Stock option plans

     Following the Company’s initial public offering, any shares that were reserved but not issued under the 1999 Plan were made available under the 2004 Plan, and any shares that would have otherwise returned to the 1999 Plan will be made available for issuance under the 2004 Plan. The 1999 Plan will continue to govern awards granted thereunder prior to the Company’s initial public offering. Our 2004 Equity Incentive Plan, or 2004 Plan, is an omnibus stock plan which provides for the grant of stock options, restricted stock, stock appreciation rights, performance units and performance shares to the Company’s employees, directors and consultants.

     The number of shares initially reserved for issuance under the 2004 Plan is 1,000,000 plus an increase to include the following: the number of shares that have been reserved but not issued under the 1999 Plan, any shares returned to the 1999 Plan, and an annual increase added on the first day of each fiscal year beginning in 2006 equal to the least of (a) 1,666,666 shares, (b) 4% of the outstanding shares on such date, or (c) an amount determined by the BOD. Pursuant to this requirement, on January 1, 2006 and 2007 respectively, an additional 810,932 shares and 864,905 shares respectively, were added to the plan, reserved for issuance and registered for sale under Form S-8.

Other stock options

     In September 2007, the BOD approved the issuance of 180,000 shares of common stock underlying options issued outside the Company’s stock option plans. The nonstatutory stock options (“NSO”) were granted in connection with the employment of the Company’s new Senior Vice President of Sales and Operations and the new Vice President and General Counsel. Subject to customary terms of a change in control agreement, these options vest over a four-year period with one-fourth (1/4) of the shares vesting one year after the vesting commencement date and an additional one-forty eighth (1/48) of the shares vesting on the first day of each calendar month thereafter until all such shares are exercisable. Options expire after ten years.

6. INCOME TAXES

     At the end of each interim period, the Company calculates an effective tax rate based on the Company’s best estimate of the tax provision (benefit) that will be provided for the full year, stated as a percentage of estimated annual pre-tax income (loss). The tax provision (benefit) for the interim period is determined using this estimated annual effective tax rate.

     We have recorded a full valuation allowance against our deferred tax assets at September 30, 2007, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of net operating loss carryforwards, before they expire. We regularly review deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we conclude that it is more likely than not that we will realize the benefit of all or some of our deferred tax assets, we will reduce or eliminate the valuation allowance and

will record a significant benefit to our results of operations. In the event we were to determine that we would be able to realize all of our deferred tax assets in the future, an adjustment to the valuation allowance would increase net income in the period such determination was made.

     Based on the full valuation allowance and the taxable loss for the nine months ended September 30, 2007, the Company has not recorded a tax provision or benefit.

     In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement 109 (“FIN 48”). As a result of the implementation of FIN 48, we recognized no material adjustment in the liability for unrecognized income tax benefits. We do not have any material accrued interest or penalties associated with any unrecognized tax benefits. We will account for any interest related to uncertain tax positions as interest expense, and for penalties as tax expense. Other than as discussed below, we do not believe it is reasonably possible that our unrecognized tax benefits will significantly change within the next twelve months. There were no material changes in the amount of unrecognized tax benefits as of September 30, 2007. We are subject to taxation in the US and various state jurisdictions. The tax years 2002-2006 remain open to examination by the federal and most state tax authorities.

7. COMPREHENSIVE INCOME (LOSS)

     Comprehensive income (loss) includes net income (loss) and unrealized gains (losses) on investments. Comprehensive income (loss) for the periods indicated is comprised of the following:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2007				2006				2007				2006
		(in thousands)
Net income (loss)		$	(4,831	)		$	622			$	(8,968	)		$	(386	)
Other comprehensive income (loss):
Change in accumulated unrealized gain (loss) on available-for-sale securities, net of tax			213				346				231				322
Comprehensive income (loss)		$	(4,618	)		$	968			$	(8,737	)		$	(64	)

8. COMMITMENTS AND CONTINGENCIES

     The Company leases office space under non-cancelable operating leases with various expiration dates through May 2013.

     Future minimum lease payments under non-cancelable operating leases at September 30, 2007 are as follows, in thousands:

		Operating
Year ending December 31,		Leases
2007		$	597
2008			2,172
2009			1,756
2010			1,655
2011			1,656
Thereafter			615
Total minimum lease payments		$	8,451

Legal proceedings

     On May 4, 2007, the Company was named in a class action lawsuit filed in United States District Court for the Central District of California, Lubocki, et al v. ZipRealty, case number CV 07 2959, by four former employee agents of the Company on behalf of themselves and others similarly situated. The complaint alleged, among other things, that the Company’s policies for expense allowances and expense reimbursement in place prior to October 2005, and its policy for commission payments to agents for transactions that do not close during the period of employment, violate applicable law. The Company has reached a proposed settlement which calls for a payment of $3,550,000 and, as a result, has recorded a charge in that amount during the quarter ended September 30, 2007. The proposed settlement is expected to include a full release from any further liability on the matters raised in the complaint, and is subject to the execution of a definitive settlement agreement and court approval.

     On May 18, 2007, the Company was named in a class action lawsuit filed in the Superior Court of California, County of Alameda, Crystal Alexander, et al. v. ZipRealty, case number RG 07326622, by one former employee agent of the Company. The complaint alleges, among other things, that the Company’s practices for compensating agents and reimbursing expenses violate applicable law regarding the payment for overtime. The Company is in the initial stages of investigation and discovery in this matter. However, at this time, management believes that its business practices at issue in this case are in compliance with applicable law, and therefore intends to vigorously defend this lawsuit.

     The Company has filed a claim for malpractice against the law firm which provided counseling in connection with certain employment matters in California Superior Court, County of San Francisco, ZipRealty Inc., v. Squire, Sanders & Dempsey, LLP, Michael W. Kelly Esq., et. al., Case No. CGC 06450765. While the Company believes it has a good case, it is too early to determine the likelihood of a recovery, or to estimate the amount of recovery, if any.

     The Company is not currently subject to any other material legal proceedings. From time to time the Company has been, and it currently is, a party to litigation and subject to claims incident to the ordinary course of the business. The amounts in dispute in these matters are not material to the Company, and management believes that the resolution of these proceedings will not have a material adverse effect on the business, financial position, results of operations or cash flows.

Indemnifications

     The Company has entered into various indemnification agreements in the ordinary course of our business. Pursuant to these agreements, the Company has agreed to indemnify, hold harmless and reimburse the indemnified parties, which include certain of the Company’s service providers as well as others, in connection with certain occurrences. In addition, the Company’s charter documents require the Company to provide indemnification rights to our directors and officers to the fullest extent permitted by the Delaware General Corporation Law, and permit the Company to provide indemnification rights to the Company’s other employees and agents, for certain events that occur while these persons are serving in these capacities. The Company has also entered into indemnification agreements with each of the Company’s directors and its officers with a title of Vice President or higher. Further, the underwriting agreement for the Company’s initial public offering requires the Company to indemnify the Company’s underwriters and certain of their affiliates and agents for certain liabilities arising from the Company’s offering and the related registration statement.

     The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unspecified. The Company is not aware of any material indemnification liabilities for actions, events or occurrences that have occurred to date. The Company maintains insurance on some of the liabilities the Company has agreed to indemnify, including liabilities incurred by the Company’s directors and officers while acting in these capacities, subject to certain exclusions and limitations of coverage.

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

     We are a full-service residential real estate brokerage firm, using the Internet, proprietary technology and efficient business processes to provide home buyers and sellers with high-quality service and value. Our solution includes a client-centric business approach, a sophisticated website that empowers home buyers and sellers with relevant information, a proprietary business management technology platform and significant financial savings for consumers. We share a portion of our commissions with our buyer clients in the form of a cash rebate, and typically represent our seller clients at fee levels below those offered by most traditional brokerage companies in our markets. Generally, our seller clients pay a total brokerage fee of 4.5% to 5.0% of the transaction value, of which 2.5% to 3.0% is paid to agents representing buyers.

     Our net revenues are comprised primarily of commissions earned as agents for buyers and sellers in residential real estate transactions. We record revenues net of rebate or commission discount, if any, paid or offered to our clients. Our net revenues are principally driven by the number of transactions we close and the average net revenue per transaction. Average net revenue per transaction is a function of the home sales price and percentage commission we receive on each transaction. We also receive revenues from certain co-marketing arrangements, such as our relationship with E-LOAN, Inc., which provides the mortgage center on our website and pays us a flat monthly fee that is established on a periodic basis. Generally, non-commission revenues represent less than 5% of our net revenues during any period. We are currently exploring our options for offering other services related to the purchase, sale and ownership of a home and have begun offering property and casualty insurance (including auto insurance) services through a subsidiary.

     We were founded in 1999, currently have operations in 32 markets, and as of September 30, 2007 employed 2,539 people, of whom 2,263 were ZipAgents. During 2006, we commenced operations in Tampa in February, Orlando in April, Minneapolis/St. Paul in May, Austin in July, Palm Beach in September, and the Greater Philadelphia area in December. To date in 2007 we have commenced operations in Naples and Tucson in March, Denver in April, Jacksonville in May, Salt Lake City and Richmond in July, Virginia Beach and Charlotte in August and Raleigh-Durham in September. We have announced plans to enter Long Island and Westchester County in the fourth quarter of 2007.

Trends in our business

     Although our business has experienced significant growth since our inception in 1999, primarily as a result of increased transaction volume and increased average net revenue per transaction, recently growth rates in transaction volume have decreased based on what we believe to be a transition period in the housing market and the effects of the recent changes in the mortgage lending business. In the three months ended September 30, 2007, we generated $28.0 million in net revenues, compared to $26.2 million in the three months ended September 30, 2006. In the nine months ended September 30, 2007 we generated $82.7 million in net revenues, compared to $72.3 million in the nine months ended September 30, 2006. The number of our closed transactions increased to approximately 3,829 in the three months ended September 30, 2007 from approximately 3,467 in the three months ended September 30, 2006, while our average net revenue per transaction decreased to approximately $7,110 in the three months ended September 30, 2007 from approximately $7,332 in the three months ended September 30, 2006. The number of our closed transactions increased to approximately 10,927 in the nine months ended September 30, 2007 from approximately 9,657 in the nine months ended September 30, 2006, and our average net revenue per transaction increased to approximately $7,359 in the nine months ended September 30, 2007 from approximately $7,276 in the nine months ended September 30, 2006.

     Our transaction volume is primarily driven by the number of ZipAgents we employ, which increased to 2,263 at September 30, 2007 from 1,747 at September 30, 2006. Our average net revenue per transaction increased over this period of time in both existing and new markets, as well as in California markets and in markets outside of California. As we introduce new initiatives to improve agent productivity, we may experience a temporary decline in the total number of agents. However we expect to end 2008 with more agents than we will end with in 2007. As we add additional ZipAgents, we believe long term we will continue to increase our transaction volume and grow our business, although this may not be the case if the market continues to soften. In addition, we believe that customer acquisition is one of our core competencies, and while we anticipate that the difficulty of acquiring a sufficient number of leads online may increase over time, we expect that we can mitigate some of that impact with repeat and referral business, as well as by increasing our visibility and credibility to potential clients over time. Since our market share has averaged less than 1% over the past twelve months in our existing markets in aggregate, we believe that there is an opportunity to increase our market share, even if the overall level of sales decline due to changing consumer sentiment, interest rate increases, credit tightening, or other economic or geopolitical factors.

     As we end 2007 and develop our business plan for 2008 a key area of focus will be be on existing markets, and driving their efficiency, productivity and profits. Nevertheless, our losses are likely to continue into 2008, albeit we expect they will be reduced from that we expect to incur in 2007.

     Since early September of 2005 we have experienced a significant increase in the available inventory of homes for sale in many of our markets, as well as an increase in the amount of time listings are taking to sell. For example, average inventories in our existing markets increased approximately 23%, and months of inventory increased approximately 64%, in the quarter ended September 30, 2007 from the quarter ended September 30, 2006. Pricing increases have also slowed, and some markets have shown declines in median selling prices over this period. According to NAR, nationally sales of existing homes fell 19.1% year-over-year in September 2007 to a seasonally adjusted annual rate of 5.04 million. In the State of California, the California Association of REALTORS reported that sales of existing homes declined 38.9% year-over-year during the month of September 2007. In our opinion, these data points suggest the housing market is in a period of transition, with more power shifting to buyers from sellers, and that the residential real estate market may continue to soften in the foreseeable future. While over the long-term we believe a more balanced market will be beneficial to our model, which relies primarily on representing buyers, during this period of transition we may continue to experience reduced growth rates and agent productivity versus our historical levels as buyers react cautiously to perceived changing market conditions.

     Over time, we have made significant adjustments to our cost structure and revenue model in order to improve the financial results of our business. We have modified the compensation and expense reimbursement structure for ZipAgents over time, and we most recently changed our commission and/or expense structure in April 2007. Currently, our ZipAgents earn a compensation package consisting of a percentage of the commissions they generate for us that ranges from 35% to 80% of our net revenues after deducting certain other items. We also provide our ZipAgents with health, retirement and other benefits, and pay for certain marketing costs and other business expenses. ZipAgents may also be granted equity incentives based on performance. We may choose or be required to make further modifications to our compensation structure in the future.

     For example, Nevada recently approved legislation that preempts the federal “outside sales exemption” from paying minimum wages in that state. That legislation took effect on November 1, 2007. Accordingly, on November 1, 2007 we begin paying ZipAgents minimum wage and, where required, overtime, to our ZipAgents in Nevada. The minimum wage payments will be offset against future commissions earned, if any.

     We have lowered our buyer rebate percentage several times to improve our revenue model. In March 2004, we reduced our buyer rebate to 20% of our commission from 25% of our commission, up to a maximum of 1% of the home sales price. The effect of the buyer rebate reduction was recognized over a phase-in period of approximately two to four months as the reduction only affected new clients immediately while existing clients continued under the prior rebate policy for transactions already in progress and for transactions opened within a short period after the reduction was announced. We implemented these buyer rebate percentage reductions for several reasons, including our determination that our growing reputation for superior service allowed us not to compete solely on price, our efforts to improve our revenue model and agent compensation model, and our desire to offer a simplified rebate structure to our clients.

     In connection with entry into the Greater Philadelphia area, we entered the New Jersey market, where the payment of cash rebates is currently not permitted by law. Consequently, in New Jersey, in lieu of offering a cash rebate to our buyers, we make a donation to a local charity through United Way equal to 20% of our commission in cash upon closing.

     We achieved profitability in the first quarter of 2005, the first time in our seasonally slow first quarter, primarily as a result of higher average net transaction revenues and increased transactional volume. We experienced a net loss in the second quarter of 2005 as a result of a one-time charge relating to the settlement of a class action lawsuit; we would have been profitable excluding the effect of this settlement. We achieved profitability in the third and fourth quarters of 2005, but because of seasonality and new market expansion as well as softening in the residential real estate market, we experienced a net loss in the first and second quarters of 2006. We achieved profitability in the third quarter of 2006, but experienced a net loss in the fourth quarter of 2006 as a result of decreased transaction volume due to our seasonally slow fourth quarter and continued market softness. We reported a loss in the first quarter of 2007 primarily due to seasonality, new market expansion and ongoing market softness. We reported losses in the second and third quarters of 2007 due to new market expansion and further market softness. The third quarter loss was also impacted by tightening in the availability of home mortgage credit and the proposed litigation settlement described in Part II, Item 1 Legal Proceedings.

     Over the past several years there has been a decline in average commissions charged in the real estate brokerage industry, in part due to companies such as ours exerting downward pressure on prices with a lower commission structure, as well as by what, in our view, appears to be an increase in consumer willingness to negotiate fees with their agents. We believe that many consumers are focusing on absolute commission dollars paid to sell their home as opposed to accepting a traditional standard market commission percentage. According to REAL Trends, while the average commission percentage decreased from 5.44% in 2000 to 5.18% in 2006, total commission revenues increased from $42.6 billion to $59.7 billion during that same period, influenced by steadily increasing

sales volumes and higher median sales prices. In the event that commissions continue to decline, we have designed our business model around an attractive cost structure and operational efficiencies which we believe should allow us to continue to offer our services at prices less than those charged by the majority of our competitors.

     In addition, the competitive landscape in the residential real estate industry is in the midst of significant changes as new business models enter the marketplace. For example, Redfin Corporation has introduced a discount brokerage model (currently in five states and the District of Columbia) that allows clients to make offers to purchase homes and to list homes for sale directly online, while receiving a two-thirds rebate of their commission. BuySide Realty, another discount brokerage, employs agents who are paid salaries and bonuses based on customer service, not commissions, while offering a 75% rebate of their commission. RealEstate.com, which is owned by LendingTree, LLC, acts as a lead generator for real estate brokers and agents, and has opened a direct to consumer brokerage service. Trulia, Inc. operates a residential real estate search engine to connect consumers directly to listings on agent and broker web sites. These companies have limited operating histories upon which to evaluate their operations and future prospects. However, in order to be successful, our business model must remain attractive to consumers so that we can compete successfully with these newer models as they expand into our marketplaces. In addition, to remain economically viable, we will need to be able to compete effectively with these new entrants for the acquisition of agents and leads.

Market seasonality, cyclicality and financing influences

     The residential real estate brokerage market is influenced both by annual seasonality factors, as well as by overall economic cycles. While individual markets vary, transaction volume nationally tends to progressively increase from January through the summer months, then gradually slows over the last three to four months of the calendar year. Revenues in each quarter are significantly affected by activity during the prior quarter, given the typical 30- to 45-day time lag between contract execution and closing. While we believe that, until fairly recently, seasonality has been somewhat masked by our overall growth, we have been, and believe we will continue to be, influenced by overall market activity and seasonal forces. We generally experience the most significant impact in the first and fourth quarters of each year, when our revenues are typically lower relative to the second and third quarters as a result of traditionally slower home sales activity and reduced listings inventory between Thanksgiving and Presidents’ Day.

     We believe that the overall market activity, macroeconomic environment, and periodic business cycles can significantly influence the general health of the residential real estate market at any given point in time. Generally, when economic times are fair or good, the housing market tends to perform well. If the economy is weak, interest rates dramatically increase, or there are market events such as terrorist attacks or threats, the outbreak of war or geopolitical uncertainties, the housing market could be negatively impacted. Recently, changes in the mortgage market, including the subprime market, have negatively effected the buying and selling of real estate, as financing and credit standards have tightened. These factors have tended to depress the real estate activity. Also, there have been numerous reports about the effects of subprime mortgages on the general real estate market. These reports also tend to have a dampening effect on the general real estate market.

     Over the past several decades, the national residential real estate market has demonstrated significant growth, with annual existing home sales volume growing from 1.6 million in 1970 to approximately 7.1 million in 2005 and median existing home sales prices increasing every year during that period. While the volume of existing home sales has declined for at least two consecutive years only twice since 1970, namely 1979 through 1982 and 1989 through 1990, sales did fall from their 2005 peak to approximately 6.5 million in 2006 and are forecasted to fall again in 2007, and there are forecasts that predict sales will continue their decline in 2008. Sales volume changes are sensitive to, but do not always follow interest rate changes. The declines in sales volumes in the 1979 through 1982 period occurred while interest rates were at historic highs, with long-term U.S. Treasury rates exceeding 10%. However, with rates remaining at similarly high levels, sales increased during the period from 1983 through 1986. Average interest rates were lower during the second period of consecutive year declines, 1989 through 1990, than they had been in the expansion period ending in 1988.

     Many factors influence an individual’s decision to buy or sell a home, and we believe that no one factor alone determines the health of the residential real estate market. For example, a rise in interest rates, tighter lending standards and/or disruptions in the availability of mortgage funds could lead to lower demand for housing or put downward pressure on prices because, all else being equal, it should increase monthly housing payments or reduce the amount an individual can pay for a home. However, it is also our experience that lifestyle influences, such as job relocation, changes in family dynamics or a desire to change neighborhoods, significantly impact the demand for residential real estate. In addition, periods of interest rate increases are often characterized by improving economic fundamentals, which can create jobs, increase incomes and bolster consumer confidence, all of which are factors that positively influence housing demand. It is difficult to predict which influences will be strongest, and ultimately whether the housing market will be affected positively or negatively when faced with numerous influences.

     While it is difficult to isolate the cause of recent transaction volume declines and pricing growth slowing in the residential real estate market, such softening has been occurring since the Fall of 2005 as interest rates and inventories have been increasing and credit standards, and financing have tightened. Other factors have likely contributed to the slowdown as well, such as high fuel prices, persistent press coverage about residential real estate potentially being poised for a correction, and the fact that prices had until that time been increasing at historically high rates. This rapid price appreciation, which was well ahead of household income growth, along with increasing interest rates has made housing less affordable, which has manifested itself in declining home ownership rates, which peaked in 2004. With overall transaction activity declining and sales price increases slowing, overall commissions generated in the industry could decline as well, potentially causing the roughly $59.7 billion in annual commissions generated in 2006 to decline. However, should the addressable market for our services decline somewhat in the near term due to decreasing sales volume or prices, we believe the overall size of the market on an absolute basis will remain very large, providing ample addressable opportunity for us to continue to grow our business through increasing our market share.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Accordingly, our actual results may differ from these estimates under different assumptions or conditions.

     Our significant accounting policies are described in Note 1 of the notes to our consolidated financial statements contained in our Form 10-K for the year ended December 31, 2006, and of those policies, we believe that the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to understand and evaluate our financial condition and results of operations.

Income statement reclassification

     Effective January 1, 2007, for income statement presentation purposes, we have reclassified sales support and marketing expenses from general and administrative to sales and marketing (previously stated as marketing and customer acquisitions). In management’s opinion, the reclassification to sales and marketing more appropriately reflects the nature of these activities which include sales support and marketing activities of our district offices, regional services and ZipAgent and customer support services. In conjunction with this reclassification, we have also allocated headquarter occupancy costs to corporate departments based upon square footage to product development, sales and marketing and general and administrative; previously all headquarter occupancy costs were recorded under general and administrative expenses. Comparative periods have been conformed to this presentation.

Revenue recognition

     We derive the substantial majority of our revenues from commissions earned as agents for buyers and sellers in residential real estate transactions. We recognize commission revenues upon closing of a sale and purchase transaction, net of any rebate or commission discount, or transaction fee adjustment, as evidenced by the closure of the escrow or similar account and the transfer of funds to all appropriate parties. We recognize non-commission revenues from our other business relationships, such as our E-LOAN marketing relationship, as the fees are earned from the other party typically on a monthly fee basis. Revenues are recognized when there is persuasive evidence of an arrangement, the price is fixed or determinable, collectibility is reasonably assured and the transaction has been completed.

Internal-use software and website development costs

     We account for internal-use software and website development costs, including the development of our ZipAgent Platform, in accordance with the guidance set forth in Statement of Position 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use and Emerging Task Force Issue No. 00-02, Accounting for Website Development Costs. We capitalize the payroll and direct payroll-related costs of employees who devote time to the development of internal-use software. We amortize these costs over their estimated useful lives, which is generally 15 to 24 months. Our judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. The estimated life is based on management’s judgment as to the product life cycle.

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. Deferred tax amounts are determined by using the tax rates expected to be in effect when the taxes will actually be paid or refunds received, as provided under current tax law. 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 plus or minus the change during the period in deferred tax assets and liabilities.

     Historically, we have recorded a valuation allowance on our deferred tax assets, the majority of which relate to net operating loss tax carryforwards generated before we achieved profitability. During the fourth quarter of 2006, the Company concluded that a full valuation allowance should be reinstated, a significant portion of which had originally been released in 2005, against its net deferred tax assets at December 31, 2006 as available evidence, including recent historical results and management’s expectations for the future, supported a more likely than not conclusion that the related deferred tax assets will not be realized.

Stock-based compensation

     SFAS 123 (Revised 2004), Share-Based Payment (“SFAS 123(R)”) requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. Under the fair value recognition provisions for SFAS 123(R), 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.

     The Company estimates 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 the Company’s common stock and consideration of other relevant factors such as the volatility assumptions of peer companies. The expected life of options is estimated by taking the average of the vesting term and the contractual term of the option as provided by SAB 107. The Company estimates expected forfeitures based on various factors including employee class and historical experience.

     The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123(R) and Emerging Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (“EITF 96-18”).

     The accounting for and disclosure of employee and non-employee equity instruments, primarily stock options and preferred and common stock warrants, requires judgment by management on a number of assumptions, including the fair value of the underlying instrument, estimated lives of the outstanding instruments, and the instrument’s volatility. Changes in key assumptions will impact the valuation of such instruments.

Recently issued accounting pronouncement

     In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows and results of operations.

RESULTS OF OPERATIONS

     The following table summarizes our operating results for the three and nine months ended September 30, 2007 compared to the same period in the prior year:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Statements of operations data (unaudited)		2007				2006				2007				2006
		(in thousands, except per share amounts)
Net transaction revenues		$	27,225			$	25,420			$	80,406			$	70,263
Referral and other revenues			804				765				2,286				2,048
Net revenues			28,029				26,185				82,692				72,311
Operating expenses:
Cost of revenues			15,637				14,238				46,024				39,568
Product development			1,835				1,376				5,329				4,128
Sales and marketing			9,630				7,719				28,306				22,398
General and administrative			3,357				3,227				11,782				9,556
Litigation			3,550				—				3,550				—
Total operating expenses			34,009				26,560				94,991				75,650
Income (loss) from operations			(5,980	)			(375	)			(12,299	)			(3,339	)
Other income (expense):
Interest income			1,147				1,086				3,329				2,782
Other expense, net			2				(8	)			2				(8	)
Total other income, net			1,149				1,078				3,331				2,774
Income (loss) before income taxes			(4,831	)			703				(8,968	)			(565	)
Provision for (benefit from) income taxes			—				81				—				(179	)
Net income (loss)		$	(4,831	)		$	622			$	(8,968	)		$	(386	)
Net income (loss) per share:
Basic		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)
Diluted		$	(0.21	)		$	0.03			$	(0.40	)		$	(0.02	)
Weighted average common shares outstanding:
Basic			22,629				20,410				22,421				20,356
Diluted			22,629				23,478				22,421				20,356

     The following table presents our operating results as a percentage of net revenues for the periods indicated:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Statements of operations data (unaudited)		2007				2006				2007				2006
Net transaction revenues			97.1	%			97.1	%			97.2	%			97.2	%
Referral and other revenues			2.9				2.9				2.8				2.8
Net revenues			100.0				100.0				100.0				100.0
Operating expenses:
Cost of revenues			55.8				54.4				55.7				54.7
Product development			6.5				5.3				6.4				5.7
Sales and marketing			34.4				29.5				34.2				31.0
General and administrative			12.0				12.3				14.2				13.2
Litigation			12.7				—				4.3				—
Total operating expenses			121.4				101.5				114.8				104.6
Income (loss) from operations			(21.4	)			(1.5	)			(14.8	)			(4.6	)
Other income (expense):
Interest income			4.1				4.1				4.0				3.8
Other expense, net			—				—				—				—
Total other income, net			4.1				4.1				4.0				3.8
Income (loss) before income taxes			(17.3	)			2.6				(10.8	)			(0.8	)
Provision for (benefit from) income taxes			—				0.3				—				(0.2	)
Net income (loss)			(17.3	)%			2.3	%			(10.8	)%			(0.6	)%

Comparison of the three months ended September 30, 2007 and 2006

Net transaction revenues

     Net transaction revenues and statistical data are presented below for comparable existing and new markets (1):

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands, except statistical data)
Net transaction revenues
Comparable existing markets		$	23,659			$	24,594			$	(935	)			(3.8	)%
New markets			3,566				826				2,740				331.9	%
Total		$	27,225			$	25,420			$	1,805				7.1	%
Statistical data
Number of markets
Comparable existing markets			17				17				—
New markets			15				5				10
Total			32				22				10
Number of transactions closed during the period (2)
Comparable existing markets			3,167				3,304				(137	)			(4.1	)%
New markets			662				163				499				306.1	%
Total			3,829				3,467				362				10.4	%
Average net revenue per transaction (3)
Comparable existing markets		$	7,471			$	7,444			$	27				0.4	%
New markets			5,387				5,066				321				6.3	%
All markets		$	7,110			$	7,332			$	(221	)			(3.0	)%

Tampa, FL		February 2006
Orlando, FL		April 2006
Minneapolis, MN		May 2006
Austin, TX		July 2006
Palm Beach, FL		September 2006
Greater Philadelphia Area, PA		December 2006
Naples, FL		March 2007
Tucson, AZ		March 2007
Denver, CO		April 2007
Jacksonville, FL		May 2007
Salt Lake City, UT		July 2007
Richmond, VA		July 2007
Virginia Beach, VA		August 2007
Charlotte, NC		August 2007
Raleigh-Durham, NC		September 2007

     The increase in our net transaction revenues of $1.8 million for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 was primarily due to a decrease in net transaction revenues of $0.9 million in our existing markets offset by an increase in net transaction revenues of $2.7 million from our new markets.

     The decrease in our existing markets was driven primarily by the decrease of 4.1% in the number of transactions closed during the period. We had 1,752 ZipAgents in existing markets at September 30, 2007 compared to 1,590 at September 30, 2006.

     The increase from our new markets was driven primarily by a 6.3% increase in average net revenue per transaction combined with a 306.1% increase in the number of transactions closed during the period as we opened ten new markets since September 30, 2006 and added new ZipAgents. We had 511 ZipAgents in new markets at September 30, 2007 compared to 157 at September 30, 2006.

Referral and other revenues

     Referral and other revenues consist primarily of certain co-marketing agreements and transaction referrals.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Referral and other revenues		$	804			$	765			$	39				5.0	%

     The absolute dollar increase in referral and other revenues was not significant.

     We expect that our referral and other revenues for 2007 will be flat and remain relatively consistent as a percentage of net revenues.

Cost of revenues

     Our cost of revenues for existing and new markets consists principally of commissions, related payroll taxes, benefits and expense allowances and reimbursements paid to our ZipAgents, and the amortization of internal-use software and website development costs which relate primarily to our ZAP technology.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Cost of revenues
Comparable existing markets		$	13,712			$	13,818			$	(106	)			(0.8	)%
New markets			1,925				420				1,505				357.8	%
Total		$	15,637			$	14,238			$	1,399				9.8	%

     The increase in cost of revenues for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 was primarily related to the overall increase in transaction revenue on which we pay agent commissions.

     Cost of revenues decreased in our existing markets by approximately $0.1 million related to the decrease in transaction revenue in our existing markets during the period. The cost of revenues as a percentage of existing market net transaction revenues increased by 1.8% primarily due to the mix of agent commissions paid as well as increased agent expense reimbursements. Additionally we made certain adjustments to our agent compensation plan to better motivate and retain our agents under the current market conditions.

     Cost of revenues increased in our new markets by approximately $1.5 million related to the increase in the transaction revenue closed in our new markets during the period. The cost of revenues as a percentage of new market net transaction revenues increased by 3.1% primarily due to the mix of agent commissions paid. This increase in the cost of revenues percentage in new markets is expected as increasing numbers of ZipAgents achieve higher commission splits as the new markets mature.

     We expect that our cost of revenues for 2007 will increase in absolute dollars because of the overall increase in transaction revenue, primarily from our new markets, and that they will increase modestly as a percentage of net revenues.

Product development

     Product development expenses, net of capitalized costs of internally developed software, include our information technology costs, primarily compensation and benefits, depreciation of equipment and software, communications expenses and other operating costs relating to the maintenance of our website, proprietary technology systems and general information technology services.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Product development		$	1,835			$	1,376			$	459				33.4	%

     The increase in product development expenses for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 was primarily due to ongoing website development and to support new market expansion and consisted primarily of increases in salaries and benefits of $0.2 million and general technology expenses (including depreciation) of $0.2 million. As a percentage of net revenues, product development costs were 6.5% in the period compared to 5.3% in the three months ending September 30, 2006.

     We expect our product development expenses to increase in 2007 in absolute dollars and as a percentage of net revenues as we continue to grow our business and enhance our proprietary consumer website and agent platform.

Sales and marketing

     Sales and marketing expenses consist primarily of compensation and related costs for personnel engaged in sales and sales support functions and customer service as well as promotional, advertising and client acquisition costs. These expenses have been categorized below between those incurred in the comparable existing and new markets offices and those expenses which are incurred by the regional and corporate support functions across all markets.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Sales and marketing
Comparable existing markets		$	5,536			$	5,311			$	225				4.2	%
New markets			2,466				898				1,568				174.7	%
Regional sales support and marketing			1,628				1,510				118				7.8	%
Total		$	9,630			$	7,719			$	1,911				24.8	%

     The increase in sales and marketing expenses for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 was primarily related to the overall growth in our business as a result of the expansion into new markets.

     Sales and marketing expenses increased in our existing markets by approximately $0.2 million principally attributable to increased spending on customer acquisition leads. As a percentage of existing market net transactions revenues, existing market sales and marketing expenses were 23.4% in the current period compared to 21.6% in the prior year.

     Sales and marketing expenses increased in our new markets by approximately $1.6 million principally attributable to opening ten new market offices since September 30, 2006. The increased expenses consisted primarily of salaries and benefits of $0.4 million, customer acquisition costs of $0.5 million, occupancy and related expenses of $0.3 million and recruiting/training expenses of $0.2 million. As a percentage of new market net transactions revenues, new market sales and marketing expenses were 69.1% in the current period compared to 108.7% in the prior year.

     Regional sales support and marketing expenses increased by approximately $0.1 million principally attributable to the costs of our new market expansion personnel. As a percentage of total net transactions revenues, regional sales support and marketing expenses were 6.0% in the current period compared to 5.9% in the prior year.

     We expect that our overall sales and marketing expenses for 2007 will increase in absolute dollars and as a percentage of net revenues primarily because of our new market expansion

General and administrative

     General and administrative expenses consist primarily of compensation and related costs for personnel and facilities related to our executive, finance, human resources, facilities and legal organizations, and fees for professional services. Professional services are principally comprised of outside legal, audit and outsourcing services.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
General and administrative		$	3,357			$	3,227			$	130				4.0	%

     The increase in general and administrative expenses for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 was principally due to increased professional fees of $0.2 million. As a percentage of net revenues, general and administrative expenses were 12.0% in the period compared to 12.3% in the three months ended September 30, 2006.

     We expect our general and administrative expenses for 2007 to increase in absolute dollars and to increase modestly as a percentage of net revenues.

Litigation

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Litigation			$	3,550			$	—			$	3,550			100.0	%

     Litigation relates to a class action lawsuit filed by four former ZipAgents. The plaintiffs allege, among other things, that our expense allowance policies violate applicable law. There is a proposed settlement involving a payment of approximately $3.6 million, and a full release from any further liability on the matters raised in the lawsuit. See the description under Legal Proceedings in Part I.

Interest income

     Interest income relates to interest we earn on our money market deposits and short-term investments.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Interest income		$	1,147			$	1,086			$	61				5.7	%

     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, 2007 compared to the three months ended September 30, 2006 was due primarily to higher interest rates and modestly higher average balances for our cash equivalents and short-term investments.

Other income (expense), net

     Other income (expense), net consists of non-operating items, which have not been significant to date.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Other income (expense), net		$	2			$	(8	)		$	10				120.4	%

Provision for (benefit from) income taxes

     The provision for income taxes relates to our net book profit based on our best estimate of the tax provision (benefit) that will be provided for the full year.

		Three Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands)
Provision for income taxes			$	—			$	81		$	(81	)			100.0	%

     We continue to record a full valuation allowance against our deferred tax assets at September 30, 2007, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of net operating loss carryforwards, before they expire.

Based on the full valuation allowance and the taxable loss for the three months ended September 30, 2007, the Company has not recorded a tax provision or benefit.

Comparison of the nine months ended September 30, 2007 and 2006

Net revenues

     Net transaction revenues and statistical data are presented below for comparable existing and new markets (1):

		Nine Months Ended
		September 30,								Increase				Percent
		2007				2006				(Decrease)				Change
		(in thousands, except statistical data)
Net transaction revenues
Comparable existing markets		$	72,269			$	69,228			$	3,041				4.4	%
New markets			8,137				1,035				7,102				686.7	%
Total		$	80,406			$	70,263			$	10,143				14.4	%
Statistical data
Number of markets
Comparable existing markets			17				17				—
New markets			15				5				10
Total			32				22				10
Number of transactions closed during the period (2)
Comparable existing markets			9,441				9,456				(15	)			(0.2	)%
New markets			1,486				201				1,285				639.3	%
Total			10,927				9,657				1,270				13.2	%
Average net revenue per transaction (3)
Comparable existing markets		$	7,655			$	7,321			$	334				4.6	%
New markets			5,476				5,146				330				6.4	%
All markets		$	7,359			$	7,276			$	83				1.1	%