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ZipRealty Conference Call Notes 11/7/07


I'll leave most of the numbers for the SEC filings, and just take notes on the general comments. I will try to put my comments in (parens).

Overall net revenues +7% growth, slight decline per transaction, increase in new markets. While they outperformed the market, the market stinks.

Generally, inventories are high, and both buyers and sellers are paralyzed.

Interest in real estate is high, scheduled visits are up and site visits and registrations are up. (This suggests to me that there is a substantial quantity of pent up demand as people wait out the uncertainty.)

For new markets they accelerated growth in 07, and have almost completed their goal. They're switching to cost reduction efforts now, so they plan on fortifying existing markets with money that was going to be used for more expansion to bolster their 2008 balance sheet.

(Talking about Pro Forma... Blah, blah. They focused heavily on the pro forma revenue numbers. This had me worried. Pro forma can bite my pickle. I want this company to break even on GAAP and hold it's cash position steady. Looks like they'll need to cut costs and increase productivity heavily, especially in their new markets to get their numbers up for next year.)

Existing market revenues decreased due to number of trans dropping YOY. Cost of revenues increased. (Cost hikes were designed to motivate and retain agents, however it seems to me that they were paying out too much to keep their existing agents happy to make break-even. Hopefully, better times will allow them to drop this compensation structure back down, or that productivity will increase so the the percentage of G&A will drop, increasing margins. This is my main worry about this company -- can it scale into profitability? Is it the Netflix of real estate companies, making money off of their brand and low cost structure, or the Blockbuster, giving away $1 for just $0.85? At this point, I'm not convinced.)

New Market results (new means less than 1 year old) include 15 markets. Revenues were 3.6MM, and we should expect costs of doing business in new markets rise as agents do better. (Hopefully revenues should expand as well. Again, this creates a system where the more transactions happen, the more their agents make, and the less the company profits. It makes sense from a motivational standpoint, but from a profit standpoint? I don't know.)

ZipRealty outperformed the overall transaction trends and are stealing market share from others. (This makes sense as they are a low cost provider and have a great web tool.)

They added 516 new agents YOY, with 162 of those added in existing, and the rest in new markets.

They believe they can leverage G&A costs in better times.

Class action lawsuit was for non-CA expenses for employees (CA lawsuit was already paid out). Court fast-tracked and they learned their exposure was greater than they thought and reached a settlement for $3.55MM. This is not 100% yet, but will seek court approval during Q1 08. They took the hit now and will pay later.

((missed a few minutes))

GAAP loss this year should be $14-17MM.

4MM cost savings announced in Oct:
mostly 40 positions (half in corp, half in field)
some changes in support. Most should hit G&A line. (Nothing new here.)

Plans for 2008: they will continue to invest in their 17 new markets from 06 and 07, and plan on perhaps opening only 2-4 next year.

They pointed out that 2007 was an investment year and they fulfilled their goal of expanding their business and reducing risk exposure by working in more markets. They are progressing "according to plan," and looking forward to the NY market opening soon.

Four Company Priorities

1)Maximize ROI in new markets, working on productivity and tech enhancements there.
2)Improve overall agent productivity, agent accountability. (Produce and get rewarded or slack off and get the boot.) Will only accept and keep agents who are willing to embrace the new zip model. (Sounds like they've had parasites and people who probably aren't comfortable with technology oriented sales that they've had to ax. Good.)
3) Efficiencies, constant goal.
4) Expansion, but secondary to expanding productivity.

Two New Online Tools
Offer evaluator, seller dashboard.

Evaluator -- will evaluate what percent of offers get accepted in their area, great tool for sellers. (Good idea!)
Dashboard -- didn't get this one. Something about 24 hour access to everything and not having to wait for an agent to get back to you.

(One thing I noticed is that they did not comment on their customer satisfaction metrics, which they have in past calls. I may have to call investor relations if it's not in the 10Q.)

Answers and Comments during Q&A Session

Predicting low Q4 this year due to credit crisis and weak real estate market.
New market rampups were slower due to macroeconomic factors, and they expect signigicant upside in those areas in 2008.
Expect to continue to outperform the general market.

When asked what percentage of customers were not getting loans they said that loan criteria are more strict now, and they're seeing 20% or more of clients that are having problems from pre-approvals differing from final requirements, and having to drop out. Home pricing is going to have to drop to take this into account (unless wages go up, Hahahah!).

Here's a little rundown on their Agent commission structure:
Compensation - They have a stepped system, where as you do more deals, you get a higher percentage of the take. This rewards those who perform the best with highest payment. Additionally they can earn their way into expense reimbursement and other stipends.

Gerneral Productivity fell to 0.59trans/agent/month, down from 1 year ago, due primarily to a weak sales environment. This is higher than the industry, but the statistic is dragged down by the less experienced agents from the very new group. (As this company matures, I expect this number to rise higher and stabilize around .8 to 1.2 during a normal real estate environment.)

The ZipRealty agent may make less than others, however the amount that they take home is higher because the company paying more expenses.
Agents have to work very hard, and fly-by-night agents are leaving the industry quickly as they discover this.
Agents that have left for other companies are coming back to Zip because they can't replicate their success in other companies, they attribute this to Zip's backbone and web presence.

Recruiting is difficult, but they are more competitive than most other companies.

My Commentary:
Well, this quarter had lack-luster written all over it. I wanted to see a much smaller loss or break even on GAAP. The $3.5MM hit due to the lawsuit settlement is unfortunate. They discontinued the practice that caused that suit in 2005, so that's good. However, their cash will be reduced when they have to pay that out later.

I think that their strategy of shoring up existing operations with operational cash is a good one given their trend toward loss. Better to nip that trend in the bud than to let it run and lose cash faster due to unnecessary expansion.

As for the overall business, I'm concerned that the business model will not scale well, as I said in my notes above. However, I know that they pay fairly high salaries, and these will not scale up at the same rate as they increase revenues during good times. During bad times, they protect their agents by giving them a nice stable income cushion. The question is: will those agents stay during good times, or will they churn out looking for the greener pasture across the fence? I think this group of folks is traditionally very trend sensitive. People jump in when times are good and jump out at the first sign of decline. Hopefully this company will be able to create more career agents, folks who work hard and are willing to accept less upside potential for less downside pain. I believe that among agents this is a popular although uncommonly available job preference.

Well, here's to the eventual turn around. I'll continue to buy this puppy until I have a full position. I believe that the credit markets will turn around for the better eventually, and that home prices will come down to earth a little. I believe that people will continue to wait to move for several more quarters, but when they finally do start, the existing home market will see a boom as the pent up demand hits hard and pops prices of companies who have strong presence in the industry and are cost efficient. At that point, ZipRealty should shine.

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