Zillow Group, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results. Zillow Group operates real estate and home-related marketplaces and technology services; it began purchasing homes through Zillow Offers in May 2018. The filing reports two segments: Internet, Media & Technology (IMT) and Homes.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $325.2m | $266.9m | $625.1m | $512.6m |
| Operating loss | $(9.6)m | $(16.6)m | $(21.0)m | $(15.4)m |
| Net loss | $(3.1)m | $(21.8)m | $(21.7)m | $(26.5)m |
| Adjusted EBITDA (non-GAAP) | $56.0m | $39.7m | $102.3m | $94.5m |
- Q2 revenue grew 22%. Premier Agent generated $230.9m (+22%), Rentals $33.3m (+40%), Mortgages $19.3m (-8%), and Other $41.8m (+29%). Homes generated no revenue.
- Q2 operating margin was approximately -3% versus -6% a year earlier; net margin was approximately -1% versus -8%. The Q2 net result included a $10.6m income tax benefit; no tax benefit was recorded in Q2 2017.
- Q2 average monthly unique users rose 4% to 186.1m and visits increased 14% to 1,920.6m. First-half visits increased 15% to 3,685.4m.
- First-half operating cash flow was $73.1m, down from $84.9m. Investing cash outflow was $93.7m and financing cash inflow was $99.6m, mainly from employee stock-option exercises. Cash and cash equivalents ended at $431.0m.
- At June 30, cash, cash equivalents and short-term investments totaled $899.6m, versus $762.5m at December 31, 2017. Current assets were $1,007.5m and current liabilities $123.2m.
- Long-term debt carrying value was $394.4m; principal outstanding was $460.0m on 2021 convertible notes and $9.6m on 2020 notes. The notes bear fixed coupons of 2.00% and 2.75%, respectively.
Changes and notable items
- Premier Agent remained 71% of revenue. Management attributed growth to higher traffic, increased revenue per visit, and the auction-based pricing model. Rentals growth reflected more listings, including StreetEasy, while revenue per listing declined. Mortgage revenue fell amid lead-distribution changes and lower refinance activity associated in part with higher interest rates.
- The Homes segment recorded $12.2m of Q2 operating expenses and no home-sale revenue; inventory was $5.7m at quarter-end. Zillow said home resales and related costs were expected to begin affecting results in subsequent quarters.
- Adoption of the new revenue standard effective January 1, 2018 led to capitalization of eligible sales commissions. The company recorded $43.4m of contract-cost assets at June 30 and a $40.3m opening reduction to accumulated deficit; the new accounting lowered first-half operating expenses by $3.1m relative to prior guidance.
Outlook, risks and contingencies
- The filing provides no quantified revenue or earnings guidance. Management expected broader, nationwide adoption of a revised Premier Agent lead-validation and distribution model by year-end 2018, but could not predict its financial effect. It also expected the Homes segment to have a material impact on consolidated results, balance sheet and cash flows during the remainder of 2018.
- Management stated existing cash, investments and operating cash flows were expected to fund operating needs, working capital and capital expenditures for at least 12 months. It cautioned that Zillow Offers is cash- and inventory-intensive and expected to use debt financing for part of home purchases.
- Subsequent to quarter-end, Zillow issued $373.8m of 1.50% convertible notes due 2023 and sold Class C shares for approximately $360.3m net proceeds. A July 2018 revolving facility provides up to $250m borrowing capacity, initially $20m, subject to conditions and secured by equity of certain Zillow Offers subsidiaries.
- Also after quarter-end, Zillow agreed to acquire Mortgage Lenders of America, with closing then expected in Q4 2018. The filing does not state a purchase price.
- The CFPB informed Zillow in June that it had completed its investigation and did not intend to take enforcement action. The VHT copyright case remained on appeal; approximately $4.1m was accrued. Securities class-action and shareholder derivative suits remained unresolved, with no accrual recorded because management did not consider a loss probable.
- Potential risks include execution and resale economics of Zillow Offers, housing-market conditions, mortgage rates and lead monetization, competitive pressures, legal matters, and tax uncertainty. Possible effects of further IRS guidance on executive-compensation tax rules were estimated at $2m–$5m. The company also anticipated a material balance-sheet impact from adopting lease accounting in 2019.
Investor verification priorities
- Track Zillow Offers purchase volumes, inventory valuation, resale margins, cash requirements and borrowing under the new facility.
- Assess whether lead-distribution changes sustain Premier Agent growth and whether mortgage monetization stabilizes.
- Reconcile reported GAAP results with Adjusted EBITDA and consider the effect of commission capitalization and substantial share-based compensation.
- Review post-quarter financing, potential dilution, acquisition terms when disclosed, and the unresolved litigation and tax matters.