Zillow Group, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Comparisons are with Q1 2017 unless noted. Zillow Group operated one reportable segment during the quarter and announced that it would begin reporting Internet, Media & Technology and Homes segments in Q2 2018.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $299.9 million | $245.8 million |
| Operating income (loss) | $(11.4) million | $1.2 million |
| Net income (loss) | $(18.6) million | $(4.6) million |
| Diluted net loss per share | $(0.10) | $(0.03) |
| Adjusted EBITDA | $46.3 million | $54.8 million |
| Cash provided by operating activities | $24.7 million | $67.0 million |
- Revenue grew 22%. Premier Agent remained the largest source at $213.7 million, or 71% of revenue. Rentals rose 35% to $29.1 million; Other rose 33% to $38.1 million; Mortgages fell 6% to $19.0 million.
- Operating margin was approximately negative 3.8%, versus positive 0.5% a year earlier; net margin was approximately negative 6.2%, versus negative 1.9%.
- Costs and expenses rose 27% to $311.2 million, outpacing revenue growth. Sales and marketing increased 30% and technology and development 29%. Share-based compensation expense was $30.7 million, up from $26.4 million.
- Adjusted EBITDA decreased approximately 15%. Operating cash flow fell about 63%; the company cited working-capital outflows, including increased prepaid expenses and contract cost assets.
- At March 31, cash and cash equivalents were $397.4 million and short-term investments were $425.6 million, totaling $823.0 million. Long-term debt carrying value was $389.6 million. Current assets were $922.2 million and current liabilities $120.7 million.
- Investing activities used $32.2 million; financing activities provided $52.9 million, primarily from employee stock-option exercises. Capital expenditure and intangible-asset purchases totaled approximately $16.9 million.
Changes, outlook, and notable items
- Growth was driven by higher traffic and monetization in Premier Agent, greater rental listings, and new-construction advertising. Average monthly unique users increased 5% to 175.5 million and visits increased 15% to 1.765 billion. Premier Agent revenue per visit rose 6% to $0.121.
- Mortgages revenue declined amid fewer leads from product changes and initial testing of the Connect lead-distribution model, as well as lower-than-expected refinance activity associated with rising mortgage rates. Loan-information requests nevertheless rose 8% to 7.1 million.
- In April 2018, Zillow announced it would buy homes through Instant Offers, beginning purchases in May. Management expected to hold approximately 300–1,000 homes at year-end 2018 and said the Homes business would materially affect 2018 balance sheets, results, and cash flows. It expected higher costs and planned initially to use balance-sheet cash, with possible future debt financing; financing availability and terms were not assured.
- The company began testing a revised Premier Agent lead-distribution approach in April, with broader adoption expected by year-end. Management could not predict its financial impact. It also expected operating costs to rise as it expands, including costs associated with the Homes segment.
- Management stated that cash, cash equivalents, and investments, together with operating cash flows, should cover operating, working-capital, capital-expenditure, and other needs for at least 12 months, while warning that home buying is cash- and inventory-intensive.
- Adoption of new revenue-recognition guidance on January 1, 2018 resulted in a $40.3 million opening accumulated-deficit adjustment and capitalization of certain sales commissions. Q1 contract-cost amortization was $9.3 million. Under prior guidance, Q1 net loss would have been $21.4 million rather than $18.6 million.
- Tax Act accounting remained provisional; clarification of executive-compensation rules could affect financial position and results by an estimated $2–$5 million. The company had approximately $1.014 billion in federal net operating loss carryforwards as of December 31, 2017, whose use may be limited.
Risks, contingencies, and debt
- Key risks include dependence on advertising—particularly Premier Agent, which generated 71% of revenue—competition, real-estate and mortgage-market conditions, and the ability to retain advertisers and sustain user engagement.
- The Homes initiative adds valuation, resale-price, renovation-cost, inventory, financing, property-condition, regulatory, and reputational risks; Zillow disclosed limited experience buying, upgrading, and selling homes.
- The CFPB had concluded its investigation into the co-marketing program but invited settlement discussions and indicated further action could follow. A loss beyond the immaterial accrual was reasonably possible, but not estimable.
- The company accrued approximately $4.1 million for the VHT copyright matter and appealed. Securities class-action and shareholder derivative lawsuits were also pending; no accrual was recorded for those cases because management did not consider loss probable.
- Debt included $460.0 million principal of 2.00% convertible notes due 2021 and $9.6 million principal of 2.75% notes due 2020. There were no financial covenants associated with either note issuance.
- Management reported effective disclosure controls as of March 31, 2018. The company also disclosed approximately $3.7 million of surety bonds and a new Seattle office lease with $13.1 million in future minimum payments.
Important facts for investors to verify
- Whether revenue growth can translate into improved operating profitability, given expense growth, lower Adjusted EBITDA, and weaker operating cash flow.
- Early Homes-segment purchase volumes, inventory, resale proceeds, renovation and transaction costs, financing arrangements, and cash-flow effects versus the 300–1,000-home year-end expectation.
- The revenue and advertiser-retention effects of the revised Premier Agent lead distribution and the Connect mortgage-lead model.
- Progress and potential financial exposure in the CFPB matter, VHT appeal, securities class action, and derivative litigation.
- Effects of the new commission-capitalization accounting, provisional Tax Act estimates, and expected lease-standard adoption on reported results and balance-sheet comparability.
- Debt maturities, dilution or cash-settlement exposure from convertible notes, and the availability and cost of financing for home purchases.