Zillow Group, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Comparisons are with Q1 2016 unless noted. Zillow Group operates real estate and home-related consumer marketplaces and sells advertising and software to real estate, rental and mortgage professionals.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $245.8 million | $186.0 million; up 32% |
| Operating income (loss) | $1.2 million | $(48.1) million |
| Net income (loss) | $(4.6) million; $(0.03) per share | $(47.6) million; $(0.27) per share |
| Operating margin | About 0.5% | About (25.9)% |
| Adjusted EBITDA (non-GAAP) | $54.8 million | $1.9 million |
| Operating cash flow | $67.0 million | $18.9 million |
| Cash, cash equivalents, restricted cash and investments | $560.1 million at March 31 | $507.5 million at December 31, 2016 |
| Total assets | $3.20 billion at March 31 | $3.15 billion at December 31, 2016 |
| Total liabilities | $628.1 million at March 31 | $616.1 million at December 31, 2016 |
| Long-term debt, carrying value | $371.8 million at March 31 | $367.4 million at December 31, 2016 |
Revenue growth substantially exceeded expense growth. Total costs and expenses were $244.6 million, up 5% year over year. Sales and marketing rose 7% to $105.9 million and technology and development rose 21% to $72.9 million; general and administrative fell 21% to $45.5 million, primarily because of lower professional-services costs after the 2016 Move, Inc. litigation settlement. Q1 2017 interest expense increased to $6.7 million from $1.6 million, chiefly reflecting the 2021 convertible notes and related discount and issuance-cost amortization.
Cash and investments totaled $560.1 million. Operating activities provided $67.0 million; investing activities used $59.8 million, including net investment purchases, capital and intangible asset purchases, and an acquisition; financing activities provided $10.8 million, mainly from employee option exercises. Management said available cash, investments and operating cash flows should cover operating, working-capital, capital-expenditure and other requirements for at least 12 months.
Revenue drivers and changes from prior year
- Marketplace revenue grew 36% to $230.3 million and represented 94% of total revenue, versus 91% a year earlier. Premier Agent revenue rose 30% to $175.3 million; other real estate revenue increased 93% to $34.8 million; and mortgages revenue increased 23% to $20.3 million.
- Premier Agent growth reflected 18% more visits and the broad rollout of auction-based pricing. Premier Agent revenue per visit increased 10% to $0.114. This was the first full quarter of broad implementation; management said the long-term revenue effect remained uncertain.
- Other real estate growth was primarily driven by Rentals, whose revenue increased 111%. Mortgage revenue benefited from higher average revenue per loan information request, while requests declined 38% to 6.6 million after product changes intended to improve request quality.
- Display revenue fell 9% to $15.4 million. Management said it was deemphasizing display advertising in favor of marketplace revenue and expected display revenue to continue to decline.
- Average monthly unique users grew 7% to 166.6 million; visits rose 18% to 1.533 billion.
- The company acquired HREO, a Hamptons-focused real estate portal, in January 2017. Its reported operating results were not significant.
For context, prior-year expense categories were reclassified to conform to the current presentation; management characterized the reclassifications as immaterial and said total costs were unaffected.
Debt, outlook, risks and unusual items
- The company had $460 million principal amount of 2.00% convertible notes due 2021, with an initial conversion price of about $52.36 per Class C share. Their March 31 carrying value was $361.6 million; quarterly interest expense included $4.4 million of discount and issuance-cost amortization. The notes are convertible and may be settled in cash, shares or a combination, at the company’s election.
- Remaining 2020 convertible notes had a carrying value of $10.1 million and a 2.75% coupon. The balance sheet reports total long-term debt at $371.8 million carrying value.
- No numerical full-year revenue or earnings guidance is stated in the provided filing text. Management expected several expense categories to increase in absolute dollars over time, including cost of revenue, sales and marketing, technology and development, and general and administrative costs. It also cited seasonal peak advertising expenditure in Q2.
- Legal matters include a VHT copyright-infringement jury verdict awarding approximately $8.2 million in statutory damages plus actual damages. Zillow was pursuing post-trial motions, recorded no accrual, and disclosed a possible loss range of $0 to approximately $8.3 million.
- The CFPB was investigating the company’s co-marketing program under RESPA and related law. Zillow had received a further information demand; it recorded no accrual, said a loss was reasonably possible but not estimable, and could not predict whether enforcement action would follow.
- A wage-and-hour settlement of up to $6.0 million was accrued, remained subject to court approval, and was expected to be paid in 2017. The related Department of Labor review had been resolved under an agreement requiring the contemplated payments and compliance procedures.
- Management identified competition, acquisition integration, growth and engagement, legal outcomes, regulation, technology scaling, talent retention, intellectual property and privacy as business risks. It reported no material change to the risk factors in its 2016 annual report.
- The company expected lease accounting guidance to have a material balance-sheet impact when adopted, primarily from recognizing office lease assets and liabilities. It expected to adopt the new revenue-recognition standard in 2018 and anticipated a significant effect related to capitalizing sales commissions rather than expensing them as incurred.
Important facts for investors to verify
- Whether auction-based Premier Agent pricing can sustain revenue growth and how it affects advertiser demand, pricing and retention.
- Whether strong reported operating cash flow and Adjusted EBITDA translate into durable profitability; Adjusted EBITDA is non-GAAP and excludes, among other items, share-based compensation, interest and capital expenditures.
- The outcome and financial exposure from the VHT litigation and CFPB investigation, and final court approval and payment of the wage-and-hour settlement.
- Debt terms, future interest expense, potential conversion dilution and the cash or share settlement choices for the 2021 notes.
- The sustainability of Rentals and mortgage growth, including the impact of fewer but potentially higher-quality mortgage requests, and the expected decline in display revenue.
- Whether higher operating and investment spending, lease obligations and upcoming accounting changes affect margins, liquidity or reported results.