Zillow Group, Inc. — Q3 2019 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2019. Zillow reports three segments: Homes (Zillow Offers home purchases and resales), Internet, Media & Technology (IMT), and Mortgages. Zillow Offers and Zillow Home Loans make current results and cash needs materially different from prior periods.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $745.2m | $343.1m | $1,798.9m | $968.2m |
| Operating loss | $48.4m | $10.3m | $173.7m | $31.3m |
| Net loss | $64.6m | $0.5m | $204.2m | $22.2m |
| Diluted loss per share | $0.31 | Less than $0.01 | $0.99 | $0.11 |
| Adjusted EBITDA, non-GAAP | $15.8m | $66.2m | $42.1m | $168.5m |
| Operating cash flow | Nine months: $(670.3)m | Prior-year nine months: $102.5m |
Revenue and margins: Q3 revenue rose 117%; nine-month revenue rose 86%. Homes generated $384.6m of Q3 revenue from 1,211 home sales, and $762.0m for nine months from 2,411 sales. Homes cost of revenue was $370.8m in Q3, leaving a narrow gross spread of $13.8m before selling, marketing, holding and other costs. Consolidated cost of revenue was 54% of revenue in Q3 versus 11% a year earlier, reflecting the shift toward home resale revenue. IMT revenue rose 7% in Q3 to $335.3m; Mortgages revenue rose 37% to $25.3m. Premier Agent revenue grew 3%, Rentals 19%, and Other IMT revenue 15%.
Balance sheet and liquidity: At September 30, cash and cash equivalents were $1,791.9m, short-term investments $531.7m, and restricted cash $75.0m. Together these totaled $2,398.6m, compared with $1,567.3m at year-end 2018. Inventory increased to $879.4m from $162.8m. Current assets were $3,458.8m and current liabilities $907.6m. Management said available cash, investments and operating cash flows should cover operating, working-capital and capital needs for at least 12 months.
Debt: Outstanding convertible notes had aggregate principal of $1,943.4m; balance-sheet long-term debt was $1,478.7m after discounts and issuance costs. Zillow also had $698.3m drawn on up to $1.0bn of revolving facilities financing Zillow Offers and $30.1m drawn on $100m of mortgage warehouse lines. Revolving and warehouse borrowings have floating LIBOR-based rates. A 1% LIBOR increase was estimated to add about $7.0m and $0.3m, respectively, to annual interest expense, assuming balances unchanged.
Material changes and notable items
- Homes revenue drove most of the year-over-year increase as Zillow Offers scaled; it accounted for 52% of Q3 revenue versus 3% in the prior-year quarter. Zillow Offers operated in 19 metropolitan areas.
- Operating cash use was primarily associated with the $716.5m increase in inventory, reflecting home purchases. Cash from financing was $1,554.8m, including $1,085.7m net proceeds from September convertible-note issuance and $581.6m of revolving-facility borrowings.
- In September, Zillow issued $600m of 0.75% notes due 2024 and $500m of 1.375% notes due 2026. It spent approximately $150.5m on capped-call transactions intended to reduce potential dilution or offset certain conversion cash payments, subject to caps.
- Q3 segment results before tax: Homes loss $87.9m, IMT income $42.1m, and Mortgages loss $12.3m. IMT remained profitable, while Homes and Mortgages losses widened.
- Share-based compensation was $151.9m for the nine months, including $26.4m of expense from modifications of former CEO Spencer Rascoff’s equity awards. The company appointed Richard Barton CEO in February 2019.
- Subsequent to quarter-end, Zillow issued an additional $73m of 2024 notes; entered a Zillow Offers credit agreement with capacity up to $500m; and Zillow Home Loans entered a mortgage repurchase agreement with capacity up to $75m, of which $25m is committed. The filing says the repurchase agreement’s financial-statement impact had not yet been determined.
Outlook, risks and contingencies
- No specific company-wide revenue or earnings guidance is provided. Management expects Homes-related cost of revenue, sales and marketing, technology and development, general and administrative, and interest expense to rise in absolute dollars as Zillow Offers expands. It also expects Mortgages costs to increase as Zillow Home Loans grows.
- Management said advertiser churn in Premier Agent had normalized during 2019. Premier Agent revenue per visit nevertheless fell 7% in Q3 to $0.114. Zillow planned to extend Flex pricing tests to two additional regions in Q4 2019.
- Key exposures include housing-market and home-price changes, inventory valuation and resale timing, the capital-intensive nature of Zillow Offers, availability and cost of financing, interest-rate movements, competition, customer and listing-data relationships, regulatory requirements, and execution of growth plans.
- IBM sued in September 2019 alleging infringement of seven patents and seeking unspecified damages, including potentially trebled damages, and injunctive relief. Zillow said a loss was reasonably possible but the amount or range was not estimable. Securities class and derivative actions remained pending; management did not believe a loss was probable. No material accruals were recorded for the discussed cases.
- Management reported disclosure controls were effective as of September 30, 2019, and no material changes to internal control over financial reporting occurred during the quarter.
Most important facts for investors to verify
- Whether Zillow Offers can improve per-home economics and manage the $879.4m inventory balance, purchase commitments of $221.1m, and resale exposure.
- How operating cash use, revolving-facility utilization and borrowing availability evolve as Homes scales; also verify subsequent credit-facility terms and maturities.
- Whether IMT growth and profitability can offset Homes and Mortgages losses, including the effects of Premier Agent pricing, churn and Flex testing.
- The dilution, cash-settlement and interest-cost implications of convertible notes, capped calls, and unrecognized equity compensation.
- Updates on the IBM patent matter and other litigation, and any quantified loss estimates if they become available.