Zillow Group, Inc. — Q3 2016 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. Financial statements are unaudited; amounts below are in U.S. dollars. Zillow Group operates real estate, rental, mortgage and home-related marketplaces and professional tools, including Zillow, Trulia, StreetEasy, HotPads and Naked Apartments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $224.6 million | $176.8 million | $619.0 million | $475.3 million |
| Operating income (loss) | $7.8 million | ($27.7 million) | ($195.6 million) | ($123.2 million) |
| Net income (loss) | $6.8 million | ($26.0 million) | ($196.9 million) | ($123.2 million) |
| Diluted earnings (loss) per share | $0.04 | ($0.15) | ($1.10) | ($0.74) |
| Adjusted EBITDA (non-GAAP) | $59.5 million | $29.5 million | ($39.9 million) | $67.2 million |
| Operating cash flow | Not presented separately | Not presented separately | ($30.4 million) | $38.6 million |
Q3 net margin was approximately 3.0% and operating margin approximately 3.5%. Revenue increased 27% in Q3 and 30% year to date. For the first nine months, net loss widened despite revenue growth, chiefly reflecting the $130.0 million settlement payment and increased operating costs. Adjusted EBITDA is a non-GAAP measure and excludes, among other items, share-based compensation, acquisition and restructuring costs, and the divestiture gain or loss.
Revenue mix and operating trends
- Q3 marketplace revenue increased 35% to $206.9 million, while display revenue declined 25% to $17.7 million. Marketplace accounted for 92% of Q3 revenue, versus 87% a year earlier.
- Q3 Premier Agent revenue rose 33% to $158.3 million; other real estate revenue rose to $28.8 million from $10.2 million; mortgage revenue rose 57% to $19.8 million. Display revenue fell as the company deemphasized display advertising in favor of marketplace growth.
- Average monthly unique users increased 16% to 164.5 million. Management attributed Premier Agent growth to audience expansion and a sales focus on higher-performing advertisers. Agent advertisers declined to 89,147 from 96,965, while average monthly revenue per advertiser increased to $585 from $402.
- Mortgage revenue grew even as loan information requests fell 46% in Q3 to 6.1 million. Management cited a 191% increase in average revenue per request, product changes intended to improve lead quality, and greater adoption of higher-yield products.
- Q3 sales and marketing expense rose 13% to $92.8 million and technology and development expense rose 29% to $69.2 million. General and administrative expense declined 12% to $37.7 million, partly due to lower legal and professional fees compared with the prior-year quarter.
Cash, debt and liquidity
- At September 30, 2016, cash and cash equivalents were $190.8 million and short-term investments were $253.8 million; restricted cash was $1.1 million. Combined cash, cash equivalents, restricted cash and investments totaled $445.7 million, down from $523.3 million at December 31, 2015.
- Long-term debt was $230.0 million, consisting of 2.75% convertible senior notes due December 2020. Their estimated fair value was $346.4 million; carrying value was $230.0 million.
- Nine-month investing cash outflow was $27.9 million, including property/equipment and intangible purchases and acquisition payments. Financing cash inflow was $20.0 million, primarily from stock-option exercises. Cash and cash equivalents decreased $38.4 million over the period.
- Management stated that operating cash flow and cash, cash equivalents and investments should be sufficient for operating needs, working capital and capital requirements for at least the next 12 months.
Material changes, outlook and risks
- Comparability: Trulia was acquired in February 2015, so the 2015 nine-month comparison includes Trulia only after the acquisition date. Market Leader revenue was included through its September 2015 divestiture. These factors limit comparability with 2016.
- Unusual item: Zillow paid $130.0 million in June 2016 to settle the Move, Inc./National Association of Realtors-related litigation; the settlement included no admission of liability and resolved the claims. The payment was recorded in general and administrative expense.
- Pricing and spending: The company began meaningful testing of dynamic, demand-based impression pricing for Platinum Premier Agent. Management said the revenue impact was not yet predictable. Management expected cost of revenue, sales and marketing, technology and development, and general and administrative costs to rise in absolute dollars over time as the business grows.
- Acquisitions and divestitures: Zillow acquired Naked Apartments for approximately $13.2 million in cash and acquired Bridge Interactive in 2016; both businesses had immaterial reported results to date. It also sold Diverse Solutions in August 2016, recording a $1.3 million gain.
- Contingencies: A Department of Labor wage-and-hour compliance review remained ongoing. A related employee class-action settlement was contingent on resolution of that review and court approval; the company reported an immaterial accrual. Zillow reported no material changes to its previously disclosed risk factors.
- Other risks: Management highlighted competition, user engagement and revenue growth, acquisition integration, technology scaling, talent retention, regulation, intellectual property and customer privacy. The company reported effective disclosure controls as of September 30, 2016.
Most important facts for investors to verify
- Whether marketplace growth, particularly Premier Agent and mortgages, can continue and offset declining display revenue and a lower agent-advertiser count.
- How the dynamic Premier Agent pricing test affects revenue, advertiser demand and consumer experience as it expands.
- The cash-flow and earnings effects of the $130.0 million settlement, ongoing investment and operating-expense growth; distinguish GAAP results from Adjusted EBITDA.
- Liquidity and dilution implications of the $230.0 million convertible notes, including their 2020 maturity and conversion terms.
- Resolution of the Department of Labor review and conditions on the related class-action settlement.
- Comparability of reported growth given Trulia’s acquisition and Market Leader’s divestiture, and the integration and returns of recent acquisitions.