Zillow Group, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial statements are unaudited. Unless indicated otherwise, dollar figures below are in millions.
Business context
Zillow Group operates consumer real estate and rental marketplaces and provides marketing, software and technology products to real estate, rental and mortgage professionals. Revenue is principally marketplace revenue—Premier Agent, other real estate and mortgages—and display advertising. Management reported 175.2 million average monthly unique users in Q3, up 6% year over year, and 1,667.1 million visits, up 19%.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $281.8 | $224.6 | $794.5 | $619.0 |
| Operating income (loss) | $14.7 | $7.8 | $(0.6) | $(195.6) |
| Net income (loss) | $9.2 | $6.8 | $(17.2) | $(196.9) |
| Adjusted EBITDA | $71.0 | $59.5 | $165.5 | $(39.9) |
| Operating cash flow | Not separately presented for the quarter | $176.9 | $(30.4) |
Q3 revenue increased 25%; operating margin was approximately 5.2% versus 3.5%, and net margin was 3.3% versus 3.0%. Nine-month revenue rose 28%; the operating loss narrowed substantially, while the prior-year period included a $130.0 million settlement payment to Move. Adjusted EBITDA is a non-GAAP measure; the filing cautions it excludes, among other things, capital expenditures, working-capital needs and share-based compensation.
- Revenue mix, Q3: Marketplace revenue was $262.7 million, up 27%; Premier Agent was $197.1 million, up 24%; other real estate was $44.8 million, up 55%; mortgages were $20.9 million, up 6%. Display revenue was $19.1 million, up 8%.
- Balance sheet at September 30: Cash and cash equivalents were $319.9 million; short-term investments were $361.0 million; current assets totaled $764.9 million and current liabilities $118.8 million. Cash, cash equivalents, restricted cash and investments totaled $682.0 million.
- Debt: Long-term debt carrying value was $380.8 million. The 2021 convertible notes had $460.0 million principal outstanding and a 2.00% coupon; the remaining 2020 notes had a $10.1 million carrying value and a 2.75% coupon. The notes are convertible subject to their terms.
- Cash flows, nine months: Investing activities used $180.2 million, including net investment purchases, capital spending, acquisitions and a $10.0 million cost-method investment. Financing activities provided $79.7 million, primarily from $80.0 million of option exercises. Cash and cash equivalents increased $76.4 million.
Material changes and management commentary
- Premier Agent revenue growth reflected higher visits, a 5% increase in Q3 revenue per visit, and the broad implementation of auction-based pricing in late 2016. Management cited increased sales to existing advertisers as well.
- Other real estate growth was led by Rentals, whose Q3 revenue increased 56%, and increased New Construction advertising. Mortgages revenue increased despite fewer loan information requests: requests declined 20% in Q3 and 30% year to date, which management attributed to requiring more consumer information to improve request quality.
- Management expects cost of revenue, sales and marketing, technology and development, and general and administrative expenses to rise in absolute dollars as the business grows. No full-year revenue or earnings guidance is stated in the provided filing text.
- Hurricane-related advertiser assistance and lost sales reduced Q3 Premier Agent revenue by more than $0.8 million; management expected approximately $1.0 million of impact in Q4. Traffic in affected areas also temporarily declined.
- The company acquired New Home Feed in September for an immaterial amount. It added approximately $3.8 million of goodwill and a $1.9 million identifiable intangible asset; the acquired business’s results were not significant.
- Management said cash from operations and existing cash and investments should cover operating, working-capital, capital expenditure and other capital needs for at least the next 12 months.
Risks, contingencies and unusual items
- The CFPB had concluded its investigation but invited settlement discussions and indicated it might pursue further action. Zillow recorded an immaterial accrual; a possible additional loss was considered reasonably possible but not estimable.
- Zillow recorded an estimated $4.1 million liability in the VHT copyright case after a reduced damages ruling and appealed the judgment in October 2017.
- A $6.0 million wage-and-hour class settlement received final court approval in October 2017 and was paid that month; the liability was recorded at September 30.
- Two purported securities class actions were pending, and a shareholder derivative suit was filed in October. The company had not accrued for these cases, stating loss was not probable.
- Contractual obligations totaled $822.3 million, including $460.0 million principal on the 2021 notes, $168.4 million of operating lease payments and $144.4 million of content purchase commitments. Separately, the filing warns adoption of the lease accounting standard is expected to materially affect the balance sheet.
- The company expects to adopt the new revenue recognition standard on January 1, 2018 and anticipates a significant impact from capitalizing certain sales commissions rather than expensing them as incurred; the total effect was still under assessment.
- Full valuation allowances were maintained against deferred tax assets. The filing identifies competition, user engagement, legal outcomes, regulation, privacy, technology scaling, acquisitions and employee retention among significant business risks.
Investor verification checklist
- Track whether traffic growth and auction-based Premier Agent pricing continue to translate into revenue and advertiser retention.
- Monitor the declining mortgage request volume and whether higher revenue per request offsets fewer requests.
- Review Q4 hurricane-related impacts and subsequent trends in user traffic and advertiser demand.
- Follow CFPB settlement or enforcement developments, the VHT appeal, and the securities and derivative lawsuits.
- Assess cash generation alongside capital spending, content commitments, lease obligations and convertible-note terms.
- Verify the eventual financial effects of commission capitalization under the 2018 revenue standard and lease accounting adoption.