ZILLOW GROUP, INC. quarterly report, Q2 FY2019

Full document

Zillow Group, Inc. — Q2 2019 Form 10-Q

Reporting period: Three and six months ended June 30, 2019. Unaudited results. Zillow reports three segments: Internet, Media & Technology (IMT), Homes (Zillow Offers), and Mortgages.

Financial performance

  • Revenue: Q2 revenue was $599.6 million, up 84% year over year; first-half revenue was $1.054 billion, up 69%. Homes contributed $248.9 million in Q2 and $377.4 million for the first half; the comparable 2018 periods had no Homes revenue. IMT revenue rose 6% in Q2 to $323.7 million, while Mortgages revenue rose 40% to $27.0 million.
  • Profitability: Q2 operating loss was $62.5 million and net loss was $72.0 million, versus net loss of $3.1 million a year earlier. Q2 diluted loss per share was $0.35 versus $0.02. First-half net loss was $139.5 million versus $21.7 million. Q2 operating margin was approximately -10.4% and net margin approximately -12.0%.
  • Segment results: Q2 IMT operating income was $13.2 million; Homes operating loss was $65.2 million; Mortgages operating loss was $10.6 million. Homes revenue less cost of revenue was about $8.2 million before selling, marketing, holding, and other segment costs.
  • Adjusted EBITDA: $2.3 million in Q2 versus $56.0 million in Q2 2018; $26.2 million for the first half versus $102.3 million. This is a non-GAAP measure; the filing cautions it should be considered alongside GAAP results and cash flows.
  • Cash flow: First-half operating cash use was $373.8 million, compared with $73.1 million provided in 2018. The main working-capital driver was a $390.0 million inventory increase tied primarily to Zillow Offers home purchases. Investing activities provided $197.8 million, largely from net investment maturities; financing provided $323.1 million, including $293.1 million of revolving-facility borrowings.
  • Liquidity and balance sheet: At June 30, cash and cash equivalents were $766.7 million, short-term investments $673.0 million, and restricted cash $43.9 million—$1.484 billion combined. Inventory rose to $552.8 million from $162.8 million at year-end 2018. Total assets were $4.826 billion; total liabilities $1.548 billion.
  • Debt: Zillow Offers revolving borrowings were $409.8 million against $1.0 billion maximum capacity; mortgage warehouse borrowings were $30.1 million against $100 million capacity. Convertible notes had $843.4 million aggregate principal outstanding. Management said the company was in compliance with financial covenants. Revolving and warehouse facilities carry floating-rate interest.

Changes and management commentary

  • Growth in revenue chiefly reflects Zillow Offers, which began selling homes in July 2018, and the addition of Zillow Home Loans, acquired in Q4 2018. The filing cautions that the changed business model makes prior-period comparisons less indicative of future performance.
  • Zillow Offers sold 786 homes in Q2 at an average selling price of $316,700; it sold 1,200 homes in the first half at an average $314,500. The service operated in 11 metropolitan areas at June 30.
  • Traffic increased: average monthly unique users rose 4% to 194.3 million and Q2 visits rose 14% to 2.181 billion. Premier Agent revenue was nearly flat in Q2; management attributed slower growth and a 12% decline in revenue per visit partly to 2018 program and lead-distribution changes. Management said advertiser churn normalized in the first half of 2019.
  • Management expects Homes and Mortgages operating expenses to increase in absolute dollars as those businesses expand; it also expects technology and development costs to rise over time. No numerical revenue, profit, or cash-flow guidance is provided in the supplied filing text.
  • Q2 included $293,000 of integration costs. First-half share-based compensation included a $26.4 million charge related to modifications to former CEO Spencer Rascoff’s equity awards. CEO Richard Barton’s appointment took effect February 21, 2019.

Risks, commitments, and contingencies

  • Zillow Offers is cash- and inventory-intensive. Homes under contract but not yet closed totaled $266.2 million at June 30; aging limits and borrowing-base requirements can require repayment of advances. Management stated available cash, investments, and operating cash flows should cover needs for at least the next 12 months.
  • A 1% increase in LIBOR was estimated to increase annual interest expense by approximately $4.1 million on revolving facilities and $0.3 million on warehouse lines, assuming balances were unchanged.
  • Operating lease liabilities totaled $230.4 million; the filing also reports $16.9 million of letters of credit securing certain lease obligations and $9.7 million of surety bonds.
  • Legal matters include the VHT copyright case, for which an estimated immaterial liability was recorded, and securities class-action and derivative litigation. No accrual was recorded for the securities class action or derivative cases because management did not consider a loss probable; the filing says loss estimates for certain proceedings are not meaningful at this stage.
  • The company identifies risks including real-estate market conditions, competition, execution and scaling of Zillow Offers, consumer engagement, regulation, privacy, technology, and legal outcomes. It reported disclosure controls were effective as of June 30, 2019 and no material change in internal control during the quarter.

Most important facts for investors to verify

  • Whether Zillow Offers can improve per-home economics after acquisition, renovation, resale, selling, and holding costs, and manage inventory and borrowing-base constraints.
  • Whether operating cash use and inventory growth moderate as Homes expands, and whether liquidity remains adequate under different housing-market conditions.
  • How segment operating losses, Adjusted EBITDA, and share-based compensation evolve; reconcile non-GAAP measures to GAAP results.
  • Whether Premier Agent monetization and advertiser retention recover, and whether Flex pricing affects revenue quality or timing.
  • Updates to legal proceedings, debt capacity and maturities, floating-rate exposure, and the July 2019 extension of a $50 million mortgage warehouse line to October 15, 2019.