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ZILLOW INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Statements containing words such as "may," "believe," "anticipate," "expect," "intend," "plan," "project," "projections," "business outlook," "estimate," or similar expressions constitute forward-looking statements. Our actual results may differ materially from those contained in or implied by any forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, including in the section titled "Note Regarding Forward-Looking Statements," and also those factors discussed in Part II, Item 1A (Risk Factors) in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2014. Overview Zillow operates the leading real estate and home-related information marketplaces on mobile and the Web, with a complementary portfolio of brands and products that help people find vital information about homes, and connect with local professionals. In addition to our living database of homes, accessible on Zillow.com, we also own and operate Zillow Mobile, our suite of home-related mobile applications, Zillow Mortgages, where borrowers connect with lenders to find loans and get competitive mortgage rates, Zillow Digs, our home improvement marketplace where consumers can find visual inspiration and local cost estimates, Zillow Rentals, a marketplace and suite of tools for rental professionals, Postlets, Diverse Solutions, Agentfolio, Mortech, HotPads, StreetEasy and Retsly. Zillow provides products and services to help consumers through every stage of homeownership - buying, selling, renting, borrowing and remodeling. We are transforming the way people make home-related decisions, and enabling homeowners, buyers, sellers and renters to find and connect with local professionals best suited to meet their needs. Our living database of more than 110 million U.S. homes-homes for sale, homes for rent and homes not currently on the market-attracts an active and vibrant community of users. Individuals and businesses that use Zillow have updated information on more than 50 million homes and added more than 275 million home photos, creating exclusive home profiles not available anywhere else. These profiles include detailed information about homes, including property facts, listing information and purchase and sale data. We provide this information to our users where, when and how they want it, through our industry-leading mobile applications that enable consumers to access our information when they are curbside, viewing homes, and through our websites. Using complex, proprietary automated valuation models, we provide current home value estimates, or Zestimates, and current rental price estimates, or Rent Zestimates, on more than 100 million U.S. homes. We generate revenue from local real estate professionals, mortgage professionals, rental professionals, and brand advertisers. Our revenue includes marketplace revenue, consisting primarily of sales to real estate agents based on the number of impressions delivered in zip codes purchased, and advertising primarily sold on a cost per click, or CPC, basis to mortgage lenders, as well as display revenue, which consists of advertising placements sold primarily on a cost per thousand impressions, or CPM, basis. During the three months ended September 30, 2014, we generated revenue of $88.6 million, as compared to $53.3 million in the three months ended September 30, 2013, an increase of 66%. This increase was primarily the result of a 36% increase in our Premier Agent advertisers to 60,877 as of September 30, 2014 from 44,749 as of September 30, 2013, as well as significant growth in traffic to our mobile applications and websites. There were approximately 86.0 million average monthly unique users of our mobile applications and websites for the three months ended September 30, 2014 compared to 61.1 million average monthly unique users for the three months ended September 30, 2013, representing year-over-year growth of 41%. In addition, mortgages revenue increased $1.4 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, or 24%. The increase was primarily a result of an increase in the number of loan requests submitted by consumers in Zillow Mortgages. There were approximately 7.0 million mortgage loan requests submitted by consumers for the three months ended September 30, 2014 compared to 5.9 million mortgage loan requests submitted by consumers for the three months ended September 30, 2013, an increase of 18%. During the three months ended September 30, 2014, sales and marketing expenses increased by $15.7 million compared to the three months ended September 30, 2013, primarily due to a $8.7 million increase in marketing and advertising expenses related to advertising spend to acquire shoppers across online and offline channels. We believe we have considerable opportunity to increase brand awareness and grow traffic through targeted advertising programs like our "Find Your Way Home" TV advertising campaign. As such, we have invested in selective advertisements to consumers and professionals in various online and offline channels that have tested well for us. As of September 30, 2014, we had 1,099 full-time employees, compared to 817 full-time employees as of December 31, 2013. 17-------------------------------------------------------------------------------- Table of Contents Proposed Acquisition Transaction On July 28, 2014, Zillow entered into a Merger Agreement with Trulia, Inc. and Zebra Holdco, Inc., a newly formed holding company ("HoldCo"), pursuant to which Zillow agreed, upon the terms and subject to the conditions set forth therein, to acquire Trulia. During the three months ended September 30, 2014, Zillow incurred a total of $13.2 million in acquisition-related costs related to the transaction, which includes $5.0 million of investment banking fees. If completed, the acquisition of Trulia will have a significant impact on our liquidity, financial position and results of operations. For additional information regarding the proposed transaction with Trulia, see Note 1 to our condensed consolidated financial statements. Unless otherwise noted, the following discussion and analysis of our results of operations and liquidity and capital resources focuses on our existing operations exclusive of the impact of the proposed acquisition of Trulia, and any forward-looking statements contained herein do not take into account the impact of such proposed acquisition. Key Growth Drivers To analyze our business performance, determine financial forecasts and help develop long-term strategic plans, we frequently review the following key growth drivers: Unique Users Measuring unique users is important to us because our marketplace revenue depends in part on our ability to enable real estate, rental and mortgage professionals to connect with our users, and our display revenue depends in part on the number of impressions delivered. Furthermore, our community of users improves the quality of our living database of homes with their contributions. We count a unique user the first time an individual accesses our mobile applications using a mobile device during a calendar month and the first time an individual accesses one of our websites using a web browser during a calendar month. If an individual accesses our mobile applications using different mobile devices within a given month, the first instance of access by each such mobile device is counted as a separate unique user. If an individual accesses our websites using different web browsers within a given month, the first access by each such web browser is counted as a separate unique user. If an individual accesses more than one of our websites in a single month, the first access to each website is counted as a separate unique user since unique users are tracked separately for each domain. We measure unique users with Google Analytics. Beginning in September 2013, the reported monthly unique users reflect the effect of Zillow's August 26, 2013 acquisition of StreetEasy, Inc. Average Monthly Unique Users for the Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands) Unique Users 85,979 61,118 41 % Premier Agent Advertisers The number of Premier Agent advertisers is an important driver of revenue growth because each agent pays us a fee to participate in the program. We define a Premier Agent advertiser as an agent with an active advertising contract at the end of a period. At September 30, 2013 to 2014 2014 2013 % Change Premier Agent Advertisers 60,877 44,749 36 % Basis of Presentation Revenue We generate revenue from local real estate professionals, mortgage professionals, rental professionals, and brand advertisers. Our revenue includes marketplace revenue and display revenue. Marketplace Revenue. Marketplace revenue consists of real estate revenue and mortgages revenue. Real estate revenue primarily includes revenue from impressions delivered under our Premier Agent program, as well as revenue generated by Zillow Rentals. Mortgages revenue primarily includes CPC advertising sold to mortgage lenders related to Zillow Mortgages, as well as revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform. Zillow's Premier Agent program offers a suite of marketing and business technology solutions to help real estate agents grow their businesses and personal brands. The Premier Agent program allows agents to select products and services that they can tailor to meet their business and advertising needs. The program has three tiers of participation including Premier Platinum, our flagship product, as well as Premier Gold and Premier Silver, to meet different marketing and business needs of a broad range of agents. All tiers of Premier Agents receive access to a dashboard portal on our website that provides individualized program performance analytics, as well as our personalized website service, and our customer relationship management, or CRM, tool that captures detailed 18 -------------------------------------------------------------------------------- Table of Contents information about each contact made with a Premier Agent through our mobile and web platforms. Our Premier Gold product also includes featured listings whereby the agent's listings will appear at the top of search results on our mobile and web platforms. Our Premier Platinum product includes the dashboard portal on our website, our personalized website service, our CRM tool, featured listings, and inclusion on our buyer's agent list, whereby the agent appears as the agent to contact for listings in the purchased zip code. We charge for our Platinum Premier Agent product based on the number of impressions delivered on our buyer's agent list in zip codes purchased and a contracted maximum cost per impression. Our Platinum Premier Agent product includes multiple deliverables which are accounted for as a single unit of accounting, as the delivery or performance of the undelivered elements is based on traffic to our mobile applications and websites. We recognize revenue related to our impression-based Platinum Premier Agent product based on the lesser of (i) the actual number of impressions delivered on our buyer's agent list during the period multiplied by the contracted maximum cost per impression, or (ii) the contractual maximum spend on a straight-line basis during the contractual period over which the services are delivered, typically over a period of six months or twelve months and then month-to-month thereafter. We charge a fixed subscription fee for our Premier Gold and Premier Silver subscription products. Subscription advertising revenue for our Premier Gold and Premier Silver subscription products is recognized on a straight-line basis during the contractual period over which the services are delivered, typically over a period of six months and then month-to-month thereafter. In Zillow Mortgages, participating qualified mortgage lenders make a prepayment to gain access to consumers interested in connecting with mortgage professionals. Consumers who request rates for mortgage loans in Zillow Mortgages are presented with personalized lender quotes from participating lenders. We only charge mortgage lenders a fee when users click for more information regarding a mortgage loan quote. Mortgage lenders who exhaust their initial prepayment can then prepay additional funds to continue to participate in the marketplace. We recognize revenue when a user clicks on a mortgage advertisement or to obtain additional information about a mortgage loan quote. Display Revenue. Display revenue primarily consists of graphical mobile and web advertising sold on a CPM basis to advertisers primarily in the real estate industry, including real estate brokerages, home builders, mortgage lenders and home services providers. Our advertising customers also include telecommunications, automotive, insurance and consumer products companies. We recognize display revenue as impressions are delivered to users interacting with our mobile applications or websites. Growth in display revenue depends on continuing growth in traffic to our mobile applications and websites and migration of advertising spend online from traditional broadcast and print media. Costs and Expenses Cost of Revenue. Our cost of revenue consists of expenses related to operating our mobile applications and websites, including associated headcount expenses, such as salaries and benefits and share-based compensation expense and bonuses. Cost of revenue also includes credit card fees, ad serving costs paid to third parties, revenue-sharing costs related to our commercial business relationships, and data center operations costs. Sales and Marketing. Sales and marketing expenses consist of advertising costs and other sales expenses related to promotional and marketing activities, as well as headcount expenses, including salaries, commissions, benefits, share-based compensation expense and bonuses for sales, sales support, customer support, marketing and public relations employees. Technology and Development. Technology and development expenses consist of headcount expenses, including salaries and benefits, share-based compensation expense and bonuses for salaried employees and contractors engaged in the design, development and testing of our mobile applications and websites, equipment and maintenance costs, and facilities costs allocated on a headcount basis. Technology and development expenses also include amortization costs related to capitalized website and development activities, amortization of certain intangibles and other data agreement costs related to the purchase of data used to populate our mobile applications and websites, and amortization of intangible assets recorded in connection with acquisitions. General and Administrative. General and administrative expenses consist of headcount expenses, including salaries, benefits, share-based compensation expense and bonuses for executive, finance, accounting, legal, human resources, recruiting and administrative support. General and administrative expenses also include legal, accounting and other third-party professional service fees and bad debt expense. Other Income Other income consists primarily of interest income earned on our cash, cash equivalents and investments. 19 -------------------------------------------------------------------------------- Table of Contents Income Taxes We are subject to federal and state income taxes in the United States and in Canada. During the three and nine month periods ended September 30, 2014 and 2013, we did not have reportable taxable income, and we are not projecting reportable taxable income for the year ending December 31, 2014. Therefore, no tax liability or expense has been recorded in the consolidated financial statements. We have provided a full valuation allowance against our net deferred tax assets as of September 30, 2014 and December 31, 2013 because, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax asset will not be realized. We have accumulated federal tax losses of approximately $236.5 million as of December 31, 2013, which are available to reduce future taxable income. We have accumulated state tax losses of approximately $6.1 million (tax effected) as of December 31, 2013. We recorded an income tax benefit of $4.3 million for the three and nine month periods ended September 30, 2013 due to the use of the deferred tax liability generated in connection with Zillow's August 26, 2013 acquisition of StreetEasy, Inc. that can be used to realize certain deferred tax assets for which we had previously provided a full allowance. Results of Operations The following tables present our results of operations for the periods indicated and as a percentage of total revenue: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands, except per share data, unaudited) Statements of Operations Data: Revenue $ 88,646 $ 53,311 $ 233,564 $ 139,197 Costs and expenses: Cost of revenue (exclusive of amortization) (1) (2) 7,679 5,116 20,636 13,540 Sales and marketing (1) 46,934 31,195 129,907 83,913 Technology and development (1) 21,318 12,167 58,150 33,849 General and administrative (1) 15,757 10,156 44,968 27,367 Acquisition-related costs 13,200 201 13,384 201 Total costs and expenses 104,888 58,835 267,045 158,870 Loss from operations (16,242 ) (5,524 ) (33,481 ) (19,673 ) Other income 265 70 768 240 Loss before income taxes (15,977 ) (5,454 ) (32,713 ) (19,433 ) Income tax benefit - 4,265 - 4,265 Net loss $ (15,977 ) $ (1,189 ) $ (32,713 ) $ (15,168 ) Net loss per share - basic and diluted $ (0.40 ) $ (0.03 ) $ (0.82 ) $ (0.43 ) Weighted-average shares outstanding - basic and diluted 40,296 36,667 39,810 35,011 Other Financial Data: Adjusted EBITDA (3) $ 14,631 $ 4,322 $ 29,788 $ 14,720 20 -------------------------------------------------------------------------------- Table of Contents Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands, unaudited) (1) Includes share-based compensation as follows: Cost of revenue $ 489 $ 185 $ 1,280 $ 524 Sales and marketing 1,885 871 4,886 9,875 Technology and development 2,748 985 7,829 3,053 General and administrative 3,512 1,727 10,181 4,929 Total $ 8,634 $ 3,768 $ 24,176 $ 18,381 (2) Amortization of website development costs and intangible assets included in technology and development $ 7,472 $ 5,092 $ 21,113 $ 13,792 (3) See "Adjusted EBITDA" below for more information and for a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with U.S. generally accepted accounting principles, or GAAP. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (unaudited) Percentage of Revenue: Revenue 100 % 100 % 100 % 100 % Costs and expenses: Cost of revenue (exclusive of amortization) 9 10 9 10 Sales and marketing 53 59 56 60 Technology and development 24 23 25 24 General and administrative 18 19 19 20 Acquisition-related costs 15 0 6 0 Total costs and expenses 118 110 114 114 Loss from operations (18 ) (10 ) (14 ) (14 ) Other income 0 0 0 0 Loss before income taxes (18 ) (10 ) (14 ) (14 ) Income tax benefit 0 8 0 3 Net loss (18 %) (2 %) (14 %) (11 %) Adjusted EBITDA To provide investors with additional information regarding our financial results, we have disclosed Adjusted EBITDA within this Quarterly Report on Form 10-Q, a non-GAAP financial measure. We have provided a reconciliation below of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure. We have included Adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key metric used by our management and board of directors to measure operating performance and trends and to prepare and approve our annual budget. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis. Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: • Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; • Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; • Adjusted EBITDA does not consider the potentially dilutive impact of share-based compensation; • Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; 21 -------------------------------------------------------------------------------- Table of Contents • Adjusted EBITDA does not reflect acquisition-related costs; and • Other companies, including companies in our own industry, may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net loss and our other GAAP results. The following table presents a reconciliation of Adjusted EBITDA to net loss for each of the periods presented: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands, unaudited) Reconciliation of Adjusted EBITDA to Net Loss: Net loss $ (15,977 ) $ (1,189 ) $ (32,713 ) $ (15,168 ) Other income (265 ) (70 ) (768 ) (240 ) Depreciation and amortization expense 9,039 5,877 25,709 15,811 Share-based compensation expense 8,634 3,768 24,176 18,381 Acquisition-related costs 13,200 201 13,384 201 Income tax benefit - (4,265 ) - (4,265 ) Adjusted EBITDA $ 14,631 $ 4,322 $ 29,788 $ 14,720 Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Revenue Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Revenue: Marketplace revenue: Real estate $ 65,586 $ 35,254 86 % Mortgages 7,106 5,742 24 % Total Marketplace revenue 72,692 40,996 77 % Display revenue 15,954 12,315 30 % Total revenue $ 88,646 $ 53,311 66 % Three Months Ended September 30, 2014 2013 Percentage of Total Revenue: Marketplace revenue: Real estate 74 % 66 % Mortgages 8 % 11 % Total Marketplace revenue 82 % 77 % Display revenue 18 % 23 % Total revenue 100 % 100 % Overall revenue increased by $35.3 million, or 66%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. Marketplace revenue increased by 77%, and display revenue increased by 30%. Marketplace revenue grew to $72.7 million for the three months ended September 30, 2014 from $41.0 million for the three months ended September 30, 2013, an increase of $31.7 million. Marketplace revenue represented 82% of total revenue for the three months ended September 30, 2014 compared to 77% of total revenue for the three months ended September 30, 2013. The increase in marketplace revenue was primarily attributable to the $30.3 million increase in real estate revenue, which was primarily a result of growth in the number of advertisers in our Premier Agent program to 60,877 as of September 30, 2014 from 44,749 as of September 22 -------------------------------------------------------------------------------- Table of Contents 30, 2013, representing growth of 36%. Average monthly revenue per agent increased by 32% to $349 for the three months ended September 30, 2014 from $264 for the three months ended September 30, 2013. We calculate our average monthly revenue per agent by dividing the revenue generated by our Premier Agent products in the period by the average number of Premier Agent advertisers in the period, divided again by the number of months in the period. The average number of Premier Agent advertisers is derived by calculating the average of the beginning and ending number of Premier Agent advertisers for the period. The increase in average monthly revenue per agent was primarily driven by an increase in inventory which led to an increase in sales to existing Premier Agent advertisers looking to expand their presence on our platform. The increase in marketplace revenue was also attributable to growth in mortgages revenue, which increased $1.4 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, or 24%. The increase was primarily a result of an increase in the number of loan requests submitted by consumers in Zillow Mortgages. There were approximately 7.0 million mortgage loan requests submitted by consumers for the three months ended September 30, 2014 compared to 5.9 million mortgage loan requests submitted by consumers for the three months ended September 30, 2013, an increase of 18%. Display revenue was $16.0 million for the three months ended September 30, 2014 compared to $12.3 million for the three months ended September 30, 2013, an increase of $3.6 million. Display revenue represented 18% of total revenue for the three months ended September 30, 2014 compared to 23% of total revenue for the three months ended September 30, 2013. The increase in display revenue was primarily the result of an increase in the number of unique users to our mobile applications and websites, which increased to 86.0 million average monthly unique users for the three months ended September 30, 2014 from 61.1 million average monthly unique users for the three months ended September 30, 2013, representing growth of 41%. The growth in unique users increased the number of graphical display impressions available for sale and advertiser demand for graphical display inventory. Although there is a relationship between the number of average monthly unique users and display revenue, there is not a direct correlation, as the Company does not sell its entire display inventory each period and some of the inventory is sold through networks and not directly through our sales team which impacts the cost per impression we charge to customers. Cost of Revenue Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Cost of revenue $ 7,679 $ 5,116 50 % Cost of revenue was $7.7 million for the three months ended September 30, 2014 compared to $5.1 million for the three months ended September 30, 2013, an increase of $2.6 million, or 50%. The increase in cost of revenue was attributable to increased headcount-related expenses of $0.9 million, including share-based compensation expense, driven by growth in headcount, increased credit card and ad serving fees of $0.7 million, a $0.5 million increase in revenue share costs, and a $0.5 million increase in various miscellaneous expenses, including data center costs and royalties. We expect our cost of revenue to increase in absolute dollars in future years as we continue to incur more expenses that are associated with growth in revenue. Sales and Marketing Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Sales and marketing $ 46,934 $ 31,195 50 % Sales and marketing expenses were $47.0 million for the three months ended September 30, 2014 compared to $31.2 million for the three months ended September 30, 2013, an increase of $15.7 million, or 50%. The increase in sales and marketing expenses was primarily due to an $8.7 million increase in marketing and advertising expenses, primarily related to advertising spend to attract users across online and offline channels, which supports our growth initiatives, and a $0.7 million increase in consulting costs to support our marketing and advertising spend. We believe we have considerable opportunity to increase brand awareness and grow traffic through targeted advertising programs. As such, we plan to continue to selectively advertise to consumers and professionals in various online and offline channels that have tested well for us to drive traffic and brand awareness for Zillow. In addition to the increases in marketing and advertising expense, we incurred a $5.9 million increase in headcount-related expenses, including share-based compensation expense, driven by growth in headcount, and a $0.4 million increase in various miscellaneous sales and marketing expenses. We expect our sales and marketing expenses to increase in absolute dollars in future years as we continue to expand our sales team and invest more resources in extending our audience through marketing and advertising initiatives. 23-------------------------------------------------------------------------------- Table of Contents Technology and Development Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Technology and development $ 21,318 $ 12,167 75 % Technology and development expenses, which include research and development costs, were $21.3 million for the three months ended September 30, 2014 compared to $12.2 million for the three months ended September 30, 2013, an increase of $9.2 million, or 75%. Approximately $4.7 million of the increase related to growth in headcount-related expenses, including share-based compensation expense, as we continue to grow our engineering headcount to support current and future product initiatives. Approximately $2.4 million of the increase was the result of increased amortization of intangible assets, including website development costs, purchased content, and acquired intangible assets. The increase in technology and development expenses was also attributable to a $0.6 million increase in software costs, a $0.5 million increase in depreciation expense, a $0.4 million increase in consulting costs, and a $0.6 million increase in various miscellaneous expenses, including connectivity costs and travel. Amortization expense included in technology and development for capitalized website development costs was $4.8 million and $3.2 million, respectively, for the three months ended September 30, 2014 and 2013. Amortization expense included in technology and development related to intangible assets recorded in connection with acquisitions was $1.6 million and $1.2 million, respectively, for the three months ended September 30, 2014 and 2013. Amortization expense included in technology and development for intangible assets related to purchased data content was $1.0 million and $0.7 million, respectively, for the three months ended September 30, 2014 and 2013. Other data content expense was $0.2 million and $0.1 million, respectively, for the three months ended September 30, 2014 and 2013. We expect our technology and development expenses to increase in absolute dollars over time as we continue to build new mobile and website functionality. General and Administrative Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) General and administrative $ 15,757 $ 10,156 55 % General and administrative expenses were $15.8 million for the three months ended September 30, 2014 compared to $10.2 million for the three months ended September 30, 2013, an increase of $5.6 million, or 55%. The increase in general and administrative expenses was a result of a $2.8 million increase in headcount-related expenses, including share-based compensation expense, driven primarily by growth in headcount and increases in compensation, a $1.3 million increase in building lease-related expenses including rent, utilities and insurance, a $0.5 million increase in travel and meals expense, a $0.4 million increase in consulting costs, and a $0.6 million increase in various other miscellaneous expenses. We expect general and administrative expenses to increase over time in absolute dollars as we continue to expand our business. Acquisition-Related Costs Three Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Acquisition-related costs $ 13,200 $ 201 6,467 % Acquisition-related costs were $13.2 million for the three months ended September 30, 2014 compared to $0.2 million for the three months ended September 30, 2013, an increase of $13.0 million. Acquisition-related costs for the three months ended September 30, 2014 were a result of the proposed acquisition of Trulia, including investment banker, legal, accounting, tax, and regulatory filing fees. Acquisition-related costs for the three months ended September 30, 2013 were a result of the acquisition of StreetEasy, Inc. We expect our acquisition-related costs to increase in future periods in connection with our proposed acquisition of Trulia. 24-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Revenue Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Revenue: Marketplace revenue: Real estate $ 168,232 $ 92,000 83 % Mortgages 20,800 16,465 26 % Total Marketplace revenue 189,032 108,465 74 % Display revenue 44,532 30,732 45 % Total revenue $ 233,564 $ 139,197 68 % Nine Months Ended September 30, 2014 2013 Percentage of Total Revenue: Marketplace revenue: Real estate 72 % 66 % Mortgages 9 % 12 % Total Marketplace revenue 81 % 78 % Display revenue 19 % 22 % Total revenue 100 % 100 % Overall revenue increased by $94.4 million, or 68%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Marketplace revenue increased by 74%, and display revenue increased by 45%. Marketplace revenue grew to $189.0 million for the nine months ended September 30, 2014 from $108.5 million for the nine months ended September 30, 2013, an increase of $80.6 million. Marketplace revenue represented 81% of total revenue for the nine months ended September 30, 2014 compared to 78% of total revenue for the nine months ended September 30, 2013. The increase in marketplace revenue was primarily attributable to the $76.2 million increase in real estate revenue, which was primarily a result of growth in the number of advertisers in our Premier Agent program to 60,877 as of September 30, 2014 from 44,749 as of September 30, 2013, representing growth of 36%. Average monthly revenue per agent increased by 24% to $321 for the nine months ended September 30, 2014 from $260 for the nine months ended September 30, 2013. The increase in average monthly revenue per agent was primarily driven by an increase in inventory which led to an increase in sales to existing Premier Agent advertisers looking to expand their presence on our platform. The increase in marketplace revenue was also attributable to growth in mortgages revenue, which increased by $4.3 million, or 26%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in mortgages revenue was primarily a result of an increase in the number of loan requests submitted by consumers in Zillow Mortgages. There were approximately 18.3 million mortgage loan requests submitted by consumers for the nine months ended September 30, 2014 compared to 15.8 million mortgage loan requests submitted by consumers for the nine months ended September 30, 2013, an increase of 16%. Display revenue was $44.5 million for the nine months ended September 30, 2014 compared to $30.7 million for the nine months ended September 30, 2013, an increase of $13.8 million. Display revenue represented 19% of total revenue for the nine months ended September 30, 2014 compared to 22% of total revenue for the nine months ended September 30, 2013. The increase in display revenue was primarily the result of an increase in the number of unique users to our mobile applications and websites, which increased to 86.0 million average monthly unique users for the three months ended September 30, 2014 from 61.1 million average monthly unique users for the three months ended September 30, 2013, representing growth of 41%. 25 -------------------------------------------------------------------------------- Table of Contents Cost of Revenue Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Cost of revenue $ 20,636 $ 13,540 52 % Cost of revenue was $20.6 million for the nine months ended September 30, 2014 compared to $13.5 million for the nine months ended September 30, 2013, an increase of $7.1 million, or 52%. The increase in cost of revenue was attributable to increased headcount-related expenses of $2.2 million, including share-based compensation expense, driven by growth in headcount, increased credit card and ad serving fees of $2.0 million, a $1.5 million increase in data center operations and connectivity costs, a $1.0 million increase in revenue share expense, and a $0.4 million increase in various miscellaneous expenses. Sales and Marketing Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Sales and marketing $ 129,907 $ 83,913 55 % Sales and marketing expenses were $129.9 million for the nine months ended September 30, 2014 compared to $83.9 million for the nine months ended September 30, 2013, an increase of $46.0 million, or 55%. The increase in sales and marketing expenses was primarily due to a $30.9 million increase in marketing and advertising expenses, primarily related to advertising spend to attract users across online and offline channels, which supports our growth initiatives, and a $2.1 million increase in consulting costs to support our marketing and advertising spend. We believe we have considerable opportunity to increase brand awareness and grow traffic through targeted advertising programs. As such, we plan to continue to selectively advertise to consumers and professionals in various online and offline channels that have tested well for us to drive traffic and brand awareness for Zillow. In addition to the increases in marketing and advertising expense, headcount-related expenses, including share-based compensation expense, increased by $10.6 million, driven primarily by growth in the size of our sales team. We also incurred a $0.9 million increase in depreciation expense, a $0.8 million increase in tradeshow and conference expenses, including related travel costs, and a $0.7 million increase in various miscellaneous sales and marketing expenses. Technology and Development Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Technology and development $ 58,150 $ 33,849 72 % Technology and development expenses, which include research and development costs, were $58.2 million for the nine months ended September 30, 2014 compared to $33.8 million for the nine months ended September 30, 2013, an increase of $24.3 million, or 72%. Approximately $12.0 million of the increase related to growth in headcount-related expenses, including share-based compensation expense, as we continue to grow our engineering headcount to support current and future product initiatives. Approximately $7.3 million of the increase was the result of increased amortization of intangible assets, including website development costs, purchased content, and acquired intangible assets. The increase in technology and development expenses was also attributable to a $1.5 million increase in software costs, a $1.4 million increase in depreciation expense, a $0.7 million increase in consulting costs, a $0.4 million increase in loss on disposal of property and equipment, and a $0.8 million increase in various miscellaneous expenses, including data acquisition costs, connectivity costs, and travel. Amortization expense included in technology and development for capitalized website development costs was $13.3 million and $8.6 million, respectively, for the nine months ended September 30, 2014 and 2013. Amortization expense included in technology and development related to intangible assets recorded in connection with acquisitions was $4.7 million and $3.2 million, respectively, for the nine months ended September 30, 2014 and 2013. Amortization expense included in technology and development for intangible assets related to purchased data content was $3.1 million and $2.0 million, respectively, for the nine months ended September 30, 2014 and 2013. Other data content expense was $0.5 million and $0.3 million, respectively, for the nine months ended September 30, 2014 and 2013. 26 -------------------------------------------------------------------------------- Table of Contents General and Administrative Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) General and administrative $ 44,968 $ 27,367 64 % General and administrative expenses were $45.0 million for the nine months ended September 30, 2014 compared to $27.4 million for the nine months ended September 30, 2013, an increase of $17.6 million, or 64%. The increase in general and administrative expenses was a result of an $8.9 million increase in headcount-related expenses, including share-based compensation expense, driven primarily by growth in headcount and increases in compensation, a $2.9 million increase in building lease-related expenses including rent, utilities, and insurance, a $1.5 million increase in professional services fees, including legal and accounting, a $1.2 million increase in travel and meals expense, a $0.9 million increase in city and state taxes, a $0.6 million increase in consulting costs, a $0.5 million increase in bad debt expense, a $0.4 million increase in software costs, and a $0.7 million increase in various other miscellaneous expenses. Acquisition-Related Costs Nine Months Ended September 30, 2013 to 2014 2014 2013 % Change (in thousands, unaudited) Acquisition-related costs $ 13,384 $ 201 6,559 % Acquisition-related costs were $13.4 million for the nine months ended September 30, 2014 compared to $0.2 million for the nine months ended September 30, 2013, an increase of $13.2 million. Acquisition-related costs for the nine months ended September 30, 2014 were primarily a result of the proposed acquisition of Trulia, including investment banker, legal, accounting, tax, and regulatory filing fees. Acquisition-related costs for the nine months ended September 30, 2013 were a result of the acquisition of StreetEasy, Inc. Liquidity and Capital Resources As of September 30, 2014 and December 31, 2013, we had cash, cash equivalents and investments of $458.5 million and $437.7 million, respectively. Cash and cash equivalents balances consist of operating cash on deposit with financial institutions, money market funds and U.S. government agency securities. Investments as of September 30, 2014 and December 31, 2013 consisted of fixed income securities, which include U.S. government agency securities, certificates of deposit, commercial paper, corporate notes and bonds, and municipal securities. Amounts on deposit with third-party financial institutions exceed the applicable Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation insurance limits, as applicable. We believe that cash from operations and cash, cash equivalents and investment balances will be sufficient to meet our ongoing operating activities, working capital, capital expenditures and other capital requirements for at least the next 12 months. We have executed a standby letter of credit of $2.0 million in connection with the lease of our Seattle, Washington office space and a standby letter of credit of $1.1 million in connection with the operating lease of our New York office space. The letters of credit are secured by our investments and are effective until 60 days after the expiration date of the lease. On July 28, 2014, Zillow, HoldCo, and Trulia entered into the Merger Agreement, pursuant to which Zillow agreed, upon the terms and subject to the conditions set forth therein, to acquire Trulia. If the Merger Agreement is terminated in certain circumstances, Zillow or Trulia, as applicable, would be required to pay the other a termination fee of $69.8 million. In addition, the Merger Agreement provides that, in certain other circumstances, Zillow would be required to pay Trulia a termination fee of $150 million. If completed, the acquisition of Trulia will have a significant impact on our liquidity, financial position and results of operations and, as a result of the acquisition, HoldCo (as the resulting parent entity in the acquisition) will enter into a supplemental indenture in respect of Trulia's Convertible Senior Notes due in 2020 in the aggregate principal amount of $230.0 million, which will provide, among other things, that, at the Trulia Merger Effective Time, (i) each outstanding Convertible Senior Note will no longer be convertible into shares of Trulia common stock and will be convertible solely into shares of HoldCo Class A Common Stock, pursuant to, and in accordance with, the terms of the indenture governing the Convertible Senior Notes, and (ii) HoldCo will guarantee all of the obligations of Trulia under the Convertible Senior Notes and related indenture. The aggregate principal amount of the 2020 Notes is due on December 15, 2020 if not earlier converted or redeemed. Interest is payable on the 2020 Notes at the rate of 2.75% semi-annually. The 2020 Notes cannot be redeemed prior to December 20, 2018. For additional information regarding the proposed acquisition of Trulia, see Note 1 to our condensed consolidated financial statements. 27 -------------------------------------------------------------------------------- Table of Contents The following table presents selected cash flow data for the nine months ended September 30, 2014 and 2013: Nine Months Ended September 30, 2014 2013 (in thousands, unaudited) Cash Flow Data: Cash flows provided by operating activities $ 33,357 $ 12,536 Cash flows used in investing activities (133,296 ) (114,167 ) Cash flows provided by financing activities 20,944 270,479 Cash Flows Provided By Operating Activities For the nine months ended September 30, 2014, net cash provided by operating activities was $33.4 million. This was driven by a net loss of $32.7 million, adjusted by depreciation and amortization expense of $25.7 million, share-based compensation expense of $24.2 million, an increase in the balance of deferred rent of $3.2 million, amortization of bond premium of $2.6 million, bad debt expense of $1.7 million, and a loss on disposal of property and equipment of $0.5 million. Primarily due to the increase in accounts payable and accrued expenses since December 31, 2013, which, in turn, were primarily a result of increased advertising spend and related consulting costs, changes in operating assets and liabilities increased cash provided by operating activities by $8.2 million. For the nine months ended September 30, 2013, net cash provided by operating activities was $12.5 million. This was primarily driven by a net loss of $15.2 million, adjusted by share-based compensation expense of $18.4 million, depreciation and amortization expense of $15.8 million, a $4.3 million non-cash change in the valuation allowance related to a deferred tax liability generated in connection with our acquisition of StreetEasy, Inc., bad debt expense of $1.2 million, and loss on disposal of property and equipment of $0.9 million. Changes in operating assets and liabilities decreased cash provided by operating activities by $4.4 million. Cash Flows Used In Investing Activities Our primary investing activities include the purchase and maturity of short-term and long-term investments, including U.S. government agency securities, certificates of deposit, commercial paper, corporate notes and bonds, and municipal securities, as well as the purchase of property and equipment and intangible assets, and cash paid in connection with acquisitions. For the nine months ended September 30, 2014, net cash used in investing activities was $133.3 million. This was the result of $102.3 million of net purchases of investments, $27.4 million of purchases for property and equipment and intangible assets, and $3.5 million paid in connection with an acquisition. For the nine months ended September 30, 2013, net cash used in investing activities was $114.2 million. This was the result of $52.5 million of net purchases of investments, $42.6 million paid in connection with the acquisition of StreetEasy, Inc., and $19.1 million of purchases for property and equipment and intangible assets. Cash Flows Provided By Financing Activities For the nine months ended September 30, 2014, our financing activities resulted entirely from the exercise of employee stock options. The proceeds from the issuance of Class A common stock from the exercise of stock options for the nine months ended September 30, 2014 was $20.9 million. For the nine months ended September 30, 2013, net cash provided by financing activities was approximately $270.5 million, which was primarily the result of $253.9 million in net proceeds to us from the public offering of our Class A common stock that closed in August 2013. In addition, we received approximately $16.6 million in proceeds from the issuance of Class A common stock from the exercise of stock options for the nine months ended September 30, 2013. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of September 30, 2014. 28 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table provides a summary of our contractual obligations as of September 30, 2014: Payment Due By Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years (in thousands) Operating lease obligations $ 93,876 $ 8,869 $ 22,001 $ 22,181 $ 40,825 Purchase obligations 10,300 4,632 5,668 - - Total $ 104,176 $ 13,501 $ 27,669 $ 22,181 $ 40,825 Our operating lease obligations consist of various operating leases for office space and equipment. We also have purchase obligations for content related to our mobile applications and websites. For further discussion of our operating lease and purchase obligations, see Note 11 and Note 13 in Part I, Item 1 (Notes to Condensed Consolidated Financial Statements). Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. For information on our critical accounting policies and estimates, see Part II, Item 7 (Management's Discussion and Analysis of Financial Condition and Results of Operations) of our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material changes to our critical accounting policies and estimates as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. 29-------------------------------------------------------------------------------- Table of Contents |