Zillow Group, Inc. Class C
Q3 2014 Earnings Call Transcript

Published: 6 Nov 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Zillow Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Raymond Jones, Investor Relations Officer for Zillow. Please go ahead.

[Raymond Jones:]

Thank you. Good afternoon, and welcome to Zillow's Third Quarter 2014 Earnings Conference Call. Joining me today to talk about our results are Spencer Rascoff, Chief Executive Officer; and Chad Cohen, Chief Financial Officer. Before we get started, as a reminder, during the course of this call, we will make forward-looking statements regarding the future financial performance of the company and future events, including our expectations regarding Zillow's proposed acquisition of Trulia. We caution you to consider the important risk factors that could cause the company's actual results to differ materially from those in the forward-looking statements made in the press release and on this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors in Zillow's quarterly report on Form 10-Q for the quarterly period ended June 30, 2014, and in our other filings with the SEC. In addition, please note that the date of this conference call is November 5, 2014, and any forward-looking statements that we make today are based on the assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release as well as posted on our Investor Relations website. In our remarks, the non-GAAP financial measure adjusted EBITDA will be referred to simply as EBITDA, which excludes share-based compensation and acquisition-related expenses. This call is being broadcast on the Internet and is available on the Investor Relations section of the Zillow website at investors.zillow.com. A recording of this call will be available after 8 p.m. Eastern Time today. Please note that the earnings press release is available on our website, and after the call, a copy of today's prepared remarks, along with exhibits of our business metrics, will also be available on our website. Today, we will deliver prepared remarks to start, then we will host a live question-and-answer session. During the Q&A, we will entertain questions asked via Twitter and Facebook, in addition to questions from those dialed into the call. Individuals may submit questions by tweeting @Zillow using the #ZEarnings hashtag or to the official Zillow Facebook page. After the call, Spencer will host a brief follow-up Q&A session via Twitter with the same #ZEarnings hashtag. I will now turn the call over to Spencer.

[Spencer M. Rascoff:]

Thank you all for joining us today. The third quarter of 2014 was another excellent one for Zillow and contributed to a transformational year. We hit our highest traffic point ever in July, with nearly 90 million unique users at the seasonal peak for home shopping, and the vast majority of our visits are continuing to come from a mobile device. Our belief that advertisers follow audience continues to be confirmed by our results, which show that our consumer-focused mobile first strategy is working. We achieved record revenue of nearly $89 million during the quarter, up 66% year-over-year, our 16th quarter in a row of greater than 65% year-over-year revenue growth. In our Premier Agent advertising business, we had record revenue and attained new highs in average revenue per advertiser and same advertiser sales growth. Due to our strong third quarter results, we're increasing our total revenue outlook to $323 million, at the midpoint of the range for 2014, which represents a 64% year-over-year growth rate for the full year. This revenue estimate is now over $30 million higher than the $291 million we initially guided to for full year 2014 revenue back in February. We're now in the home stretch of 2014, and things are progressing in our acquisition of Trulia, which we expect to close in the first half of 2015. We recently certified compliance with our second Request for Information and documentation from the FTC and are optimistic about the timing of the deal's closing. I remain confident this will be a phenomenal acquisition for Zillow and for Trulia shareholders. As we prepare for the closing and work on integration planning, we're becoming even more excited about how the combined company will operate a leading multi-brand real estate media portfolio. At closing, we will operate 4 consumer-facing real estate media brands on desktop and mobile

[Chad M. Cohen:]

Thank you, Spencer. Starting briefly with our traffic results, we again had record usage in the third quarter, attracting nearly 86 million average monthly unique users to Zillow's mobile applications and websites, representing growth of 41% year-over-year on a larger user base. Jumping now into our operating results. Total revenue for the third quarter increased 66% year-over-year to a record $88.6 million from $53.3 million in the same quarter last year. Total revenue in the third quarter exceeded the $87.5 million midpoint of our outlook by $1.1 million. With respect to our revenue mix, 82% of our revenue came from our Marketplace category and 18% from Display. Taking a deeper dive into our primary revenue category. Marketplace revenue grew 77% year-over-year to $72.7 million as we continued to see healthy growth across our real estate and mortgage subcategories. Going further into the real estate revenue subcategory, which includes Premier Agent, Rentals, StreetEasy and Diverse Solutions, our revenue accelerated sequentially for the fourth quarter in a row, growing 86% year-over-year to reach $65.6 million compared to $35.3 million last year, driven primarily by the largest component of this revenue category, our Premier Agent business. Premier Agent advertising revenue grew 87% year-over-year, similarly a fourth straight quarter of acceleration to $61.7 million. During the third quarter, we added 4,059 net new Premier Agents ending the period with 60,877 advertisers. Premier Agent monthly average revenue per advertiser, or ARPA, reached a new high mark in the third quarter at $349, 32% greater than the figure in the same period last year. As Spencer mentioned, 54% of our sales bookings in the quarter went to existing agents purchasing more impressions across mobile and web, up slightly from 50% a year ago. Same advertiser ARPA, which compares the average spend by Premier Agents who advertise with us in the same period last year, was 65% higher year-over-year. Consistent with prior trends, this result was primarily volume driven and reflects the favorable trade-off we make in our focus on the real estate agents of the future. Moving from real estate to mortgages, which consists of Zillow Mortgages and Mortech, revenue reached $7.1 million and grew 24% year-over-year despite continued mortgage industry headwinds. In Zillow Mortgages, roughly 7 million loan requests were submitted during the quarter versus 5.9 million requests submitted in the same period last year. Our purchased loan requests, which include pre-approval submissions, represented the vast majority of the mix. Looking at our Display category, revenue in the third quarter grew 30% year-over-year to $16 million. This result highlights the value we provide to our advertising partners and continued execution by our Display sales team in an increasingly challenging environment for premium CPM advertising. Of our endemic advertisers, financial institutions in particular are strategically reducing their advertising dollars across channels in light of industry headwinds. We will discuss the anticipated impact of these Display trends continuing in a moment. Shifting now from revenue to operating costs. Total operating expenses were $104.9 million compared to $58.8 million during the third quarter of 2013. Scrolling down the expense line items, comparing the third quarter results this year to last year, our cost of revenue during the quarter was $7.7 million or 9% of revenue compared to $5.1 million, which was 10% of revenue last year. Leverage was achieved by revenue growth in the period and absolute dollar increases continued to be driven by traffic and revenue growth, which impacted credit card fees and revenue sharing costs and, by addition to the IT team to support growth initiatives. Next, sales and marketing expense was $46.9 million or 53% of revenue versus $31.2 million last year, which is 59% of revenue. Absolute dollar increases were driven by significant headcount growth and increased advertising costs versus the prior year. Technology and development costs in the quarter were $21.3 million or 24% of revenue compared to $12.2 million or 23% of revenue in the third quarter of 2013. The increase in costs reflects higher depreciation and amortization as well as increased headcount-related expenses year-over-year. G&A costs in the third quarter were $15.8 million or 18% of revenue as compared to the third quarter of 2013 of $10.2 million or 19% of revenue. The increase in absolute dollars year-over-year is primarily attributed to higher headcount and service costs as well as higher facilities costs to support our growth. Noted as a separate line item in our income statement, our $13.2 million in acquisition-related cost in the third quarter related to our pending acquisition of Trulia. GAAP net loss was $16 million in the third quarter compared to GAAP net loss of $1.2 million in the third quarter of 2013. Third quarter 2014 GAAP basic and diluted loss per share was $0.40 based on 40.3 million basic weighted average shares outstanding. This result includes a $0.33 impact from the acquisition-related costs. On a non-GAAP basis, which excludes share-based compensation and acquisition-related costs, basic and diluted earnings per share were $0.15 and $0.13, respectively. EBITDA for the quarter was $14.6 million, slightly above the midpoint of our EBITDA outlook range, representing 17% of revenue. This compares to last year's third quarter EBITDA of $4.3 million or 8% of revenue. Our EBITDA calculation excludes acquisition-related costs. Turning briefly to our balance sheet. We ended the quarter with approximately $458 million in cash, cash equivalents and investments and we had no debt. Zillow ended with the -- Zillow ended the third quarter of 2014 with approximately 1,100 employees, an increase from nearly 800 a year ago. Now turning to our outlook for the fourth quarter 2014 and the full fiscal year. Our revenue for the fourth quarter of 2014 is expected to be in the range of $89 million to $90 million. This outlook represents growth of 53% year-over-year at the midpoint of the range. We anticipate revenue growth of approximately 20% year-over-year in our Display business, consistent with recent trends, resulting primarily from reduction in advertising by financial institutions. Taking more context to this, while terrific team execution has enabled us to go Display faster than the Display advertising category, we view this line item as less strategic than our marketplaces. So we continue to under-invest in Display and invest more heavily in products that improve our Premier Agent business. Looking at the fourth quarter EBITDA, we expect the range of $21.5 million to $22.5 million. And at the midpoint of the range, this represents a 25% margin. During the fourth quarter, our advertising ramps down in line with seasonal shopping trends. Note that our EBITDA range excludes approximately $5 million to $6 million in anticipated acquisition-related cost that results for our plans to acquire Trulia. Also for the quarter, we expect depreciation and amortization to be in the range of $9 million to $10 million and share-based compensation to be in the range of $8 million to $9 million. Although we are not providing a GAAP EPS outlook for the fourth quarter, we expect a basic and diluted weighted average share count of approximately 41 million and 44.5 million shares, respectively. Based on our performance to date, we are raising our full year 2014 revenue outlook by approximately $1 million at the midpoint of the range of $322.5 million to $323.5 million, representing 64% year-over-year growth at the midpoint, which is only a slight deceleration from the 69% last year. We expect to close out the year strongly with record revenue across our home-related marketplaces. Moving from the topline to the adjusted bottom line, our anticipated EBITDA range for the year is now $51 million to $52 million, which represents a 16% margin at the midpoint and 71% growth year-over-year. Regarding our expense categories, we will continue to make investments into our product, operating infrastructure and team that support our long-term strategic growth plans. Turning now to reconciling items and EBITDA for the year. We expect depreciation and amortization to be in the range of $35 million to $36 million, share-based comps to be in the range of $32 million to $33 million and $18 million to $19 million of acquisition-related costs. CapEx and capitalized purchased data content are expected to be in the range of $28 million to $29 million. We expect full year 2014 basic and diluted share counts to be approximately 40 million and 43 million weighted average shares outstanding, respectively. To conclude, Zillow had an excellent third quarter in executing on our strategic priorities of growing our audience, growing our Premier Agent business and growing our advancing marketplaces. As we finish up 2014, we remain focused on creating fantastic products that empower consumers, build our brand into a household name and drive the long-term growth for home-related marketplaces. With that, we'll open up the call for questions from the live call and from Twitter and Facebook with the hashtag #ZEarnings.

[Operator:]

[Operator Instructions] Our first question comes from the line of Ron Josey with JMP Securities.

[Ronald V. Josey:]

I'm wondering, Spencer, we've seen a lot of press releases over the past, call it, quarter just on additions to Zillow partnerships and zPro for Brokers partners added. I think Zillow now has around 3,200 partners now on zPro. I'm wondering at what point do you think you will have enough partners to have direct listing content? How long that would take? And then also if you could provide some other insight, some additional insight on the Retsly acquisition from, I think, July, that would be helpful.

[Spencer M. Rascoff:]

Sure. Thanks, Ron. So I mean, we've always had a multi-sourced listing strategy approach, where we get listings from brokerages, and that goes to at the franchisor level; and at the franchisee level; we get them for MLSs and we get them from listings aggregators. I think what you're detecting is over the last year or so, we've redoubled our focus on more directly sourced listing, and particularly from MLSs, and that's because we think it results in a better user experience, more high-quality listings. It's better for listing agents, it's better for the broker, it's better for the MLS, it's better for the seller and it's better for us, the web publisher because of the higher degree of accuracy in the listings when we get them directly from the source rather than through an intermediary or an aggregator. So what you're seeing is a focus of ours and it's clearly paying off. We have more and more of these direct relationships really every week. In terms of Retsly, we haven't talked very much about this acquisition. This is a small start-up that we acquired in Vancouver, BC a couple of months ago. And Retsly is building a software platform for innovation that sits on top of MLSs. So really, what it does is it allows multiple MLSs to connect to it and then it allows app developers to write software that connects to Retsly and then works across multiple MLSs. So it's a very powerful idea that can really accelerate innovation -- technology and innovation in the real estate industry. But it's a very early stage initiative. This company is less than a year old. And we're focused on it and excited about it, but I would describe it as extremely early stage.

[Operator:]

Our next question comes from the line of Robert Peck with SunTrust.

[Rodney A. Hull:]

It's Rodney Hull for Bob. Two quick questions, if I could. On the guidance itself, is there anything within the Marketplace business that you want to point out as the Q-over-Q decline is sort of more severe than we've seen in years past? And then secondly, as we think about you guys as more of a media property, as you guys have talked about over the past couple of months, new ad units or anything else that may be done on the desktop and mobile, similarly [ph] maybe there's some talk about your video ad product rolling out maybe to the Marketplace. If you could touch on that, that would be great.

[Chad M. Cohen:]

This is Chad, and I'll take that. So for the quarter, we are guiding up. So we are looking at a raise relative to last quarter, plus $1 million at the midpoint. We've been raising it all year long. Specifically in the Premier Agent business, which is our biggest driver of our Marketplace revenues, we saw a big quarter this year with acceleration from 82% last quarter to 87% this quarter. I think with respect to next quarter, even though we're not really breaking down our Marketplace businesses, what you're seeing is effectively the impact in the third quarter from selling through a lot of inventory and coming into a slower sort of seasonal period in the fourth quarter, which impacts our Premier Agent business. So we're not selling quite as much inventory in the third quarter as we did last quarter. So that has a direct flow-through to the fourth quarter. That said, we're very bullish on the business and that we're taking up our revenue guidance for the full year and remain committed to growing these marketplaces.

[Spencer M. Rascoff:]

And I'll take the second one, Rodney, and just say, yes, we launched -- at the Zillow Forum in Las Vegas, we unveiled a video ad unit product that we made available to existing Premier Agents initially and now it's been rolled out more broadly. And video is something that's been requested from our agents for a long time. That's a great opportunity for them to brand themselves. It's very new. It's just been a couple of weeks, or even less than that of selling it, so I definitely don't have any news to share. But we're always experimenting with different ad products and different ways to connect our audience with our advertisers. We test lots of different things, some of which we talked about and most of which we don't. I'll sort of tie this to a question that came through Twitter from Michael Graham at Canaccord Genuity, who asked, can we update on products targeting seller agents? So I'm sometimes asked this question of why don't we have a separate product that just focuses on generating listing leads. Doesn't the Premier Agent mostly focus on generating buyer leads? The Premier Agent product generates a lot of listing leads because Premier Agents appear on not for-sale homes. So if you go check your own home on Zillow if it's not on the market, you'll see a Zestimate but you also see Premier Agents there. And a lot of the people that are checking the Zestimate on their home and then choosing to contact an agent are doing so because they want to get a more accurate valuation of their homes in anticipation of potentially listing it. So we drive a lot of listing leads to Premier Agents, and it's an absolute part of the value proposition of being a Premier Agent. We haven't historically sold listing leads separately, and we have historically viewed that as a differentiator and something that we think creates simplicity for our advertisers where they just buy a fixed number of impressions and they get listing leads and buyer leads together. Now we're open-minded about that, and we've certainly seen some others in the space who have had success selling seller lead products recently but also even over the last 10 years or so of Internet lead generations. So I would say we're open-minded about whether that should be a separate product. Historically it's been bundled into the Premier product. Operator, we'll take the next question from the call, please.

[Operator:]

Our next question comes from the line of Chris Merwin with Barclays.

[Christopher Merwin:]

I just had a couple. So you talked about the expected slowdown in the growth rate for display in the 4Q. Is that entirely a function of the demand environment that you're seeing and not any change in terms of the contribution that you're getting from the national deals? And then as it relates to the Mortgage business, you posted some really strong growth there. I think, you said up 24% in the 3Q for Trulia, yet they talked a bit about how they were negatively impacted in their quarter by the refi environment. I know you can't speak for Trulia on this, but what was really different for you all in the quarter? And then just keeping on the topic one more, did -- I mean, as it relates to the co-lending program, did you see sort of a commensurate pickup in ARPA from the co-lender program in the 3Q as you did in the 2Q?

[Spencer M. Rascoff:]

So Chris, I'll take the first two, and then Chad can take the co-marketing. So on Display, Display has nothing to do with national brokerage deals and everything to do with how much pixel space on the site and on mobile apps we decide to allocate to Display. Our Display revenue is totally in our control. If we want to add more display revenue and EBITDA, we could, but it would come at the expense of user experience. And so it doesn't have anything to do with broker deals or anything like that. On why Mortgage is relatively stronger than maybe others, it's because our mortgage revenue model is more tightly integrated into the user experience. Therefore, it's less susceptible to headwinds from a decline in the mortgage Display environment. I mean, the way we make money on mortgages is by getting purchase -- primarily over 80% now of our mortgagers is purchase mortgage shoppers through a search path when they're also looking to buy a home and then we monetize it on the cost-per-click basis. So it's really tightly integrated with the core real estate shopping experience, and so we're just less susceptible to macro Display issues on mortgages because of the way we monetize it. And Chad on the co-marketing?

[Chad M. Cohen:]

Yes. So on co-marketing, our Premier Agent Lender sponsorship platform, it's working really well, but it's just one element of the growth in our PA revenue and in growth in our ARPA for the period. Agents are deploying more of their out-of-pocket spend than the contribution that's made by Premier Agent Lender sponsors, so it's primarily dollars that are flowing out of actual agent pocketbooks that's driving that number. I mean, we provided some stats in the scripts. 54% of bookings went to existing agents who bought more, and we're seeing 65% growth in sort of same agent sales. I think the broader point to make is that Premier Agent Lender sponsorship and co-lending sponsorship is just one opportunity for agents to sort of increase and improve their ROI. There are a lot of them, as part of the Premier Agent platform, such as our CRM, our Tech Connect connection summits. And those all sort of contribute to overall healthy agent ROI of the platform.

[Spencer M. Rascoff:]

So operator, we'll take a couple from Twitter now. Neil Doshi asks, "Can you share the numbers on the rental side, revenue number of sales engineers dedicated to rentals, et cetera." And he asks also on Twitter, "As you get to scale on rentals, how big do you envision the rentals team? Will it be a similar sales team size as real estate?" So we started monetizing rentals about a year ago and when we did, we told investors, we reminded investors that it took 3 years for our Mortgages business to get to $10 million in revenue. And we said we felt we could get there faster on rentals for a variety of reasons. We are ahead of that plan. So I said, we'd do than 3 years, $10 million, we're going to do better than 3 year, $10 million. So I'm pleased with how rentals revenues is ramping. The TAM is absolutely there. The incumbents are absolutely vulnerable and the challenge is really only about rental sales team ramp and sales team productivity. I mean, not only but primarily that's a challenge for us. And this is something that we've done once before in another very related, vertical where we've grown the size of the real estate agent sales team and once we have the audience and build the Premier Agent business in short order. In terms of the total number of needed salespeople, it will definitely be less than the real estate side solely because there are fewer spenders. I mean, you're talking about tens of thousands of people, of decision-makers spending billions of dollars in advertising as compared with on the real estate side, where you're talking about hundreds of thousands of people spending 10-plus billion dollars. So fewer advertisers, smaller sales team for rentals. We don't break out where -- how many we have in terms of engineers or sales people right now, but at scale, that's where it will be relative to real estate. And we'll just knock off another one on Twitter really quick and go back to call. Mark Mahaney asks, "Any updated thinking on the costs and revenue synergies associated with the Trulia acquisition?” Nothing to report right now, about new numbers, I'd say. As we dig in, my confidence in the opportunity increases and, therefore, my confidence in the numbers that we did sort of disclosed at the time of the announcement, my confidence in those numbers becomes even greater, but nothing new to share about synergies, revenue or costs. And let's see. Okay, operator, why don't we go back to the call now, please?

[Operator:]

Our next question from the phone lines comes from the line of Heath Terry with Goldman Sachs.

[Heath P. Terry:]

I was wondering if you could just give us a sense of sort of where you're sitting, particularly in some of your major markets? I know you called out New York in terms of the amount of inventory that's available. And to the extent that here, sort of midway through November, you're getting a sense for what fourth quarter seasonality is looking like. How much of what we're seeing is kind of normal seasonality versus any sort of more macro changes in the housing environment?

[Chad M. Cohen:]

This is Chad. I don't have any specific inventory numbers to sort of walk you through on a market basis. But I'd say this is a pretty normal seasonality with the business. And just to bring you back again to what happened in the second quarter, which was we pulled forward a lot of inventory to sell through there, which had the impact of really growing our monthly recurring revenues in the third and fourth quarter. So this is inventory that we normally probably would've sold in the third quarter and had the direct impact of probably a bigger lift in the fourth quarter as we're guiding, but that inventory itself was sold through already. And so we're saying that seasonality comes into play because we've already taken up those impressions and sold those to agents, which gives us less inventory to sell in the third quarter, and the impact on the fourth quarter is such that there's not as much of a lift as you would tend to expect period-to-period.

[Operator:]

Our next question comes from the line of Tom White with Macquarie.

[Thomas Cauthorn White:]

Just back to guidance. So I think you beat the third quarter revenue outlook by about $1 million and you're taking up the full year by about $1 million. Sort of the tailwind in the PA business seemed very strong, particularly on the ARPA side. Is the fact that you're not kind of taking up the full year by more, is that just a function of Display weakness? Is that how we should be reading it? And then, on the unaided awareness, 31%, is there like a set threshold that you guys sort of envisioned, after which you hit maybe you can kind of meaningfully sort of scale down marketing spend? Or is the market just too dynamic to kind of think like that?

[Chad M. Cohen:]

Tom, this is Chad, I'll take the first question and then hand it over to Spencer. So on Display, we just never had fantastic visibility into that business. It's really hard to predict more than a quarter out, and so we've always been challenged by that. I think if you bought us back to the last call in August, we were way more bullish on Display looking at the numbers then and probably had a few million dollars, low single digits in display revenue that we thought was going to materialize in the quarter, primarily related to the credit and financial verticals that we're now seeing as not there. I think what's happening broadly as the financial services are moving away from Display and moving more towards sort of direct response, which I think long-term bodes really well for us as we build out our Mortgage Marketplaces, but in the short term hits us on revenue with respect to fourth quarter. So we're still predicting 20% growth in Display in the fourth quarter. I think that's sort of higher than what the rest of the category is doing. But yes, to answer your question, it's primarily Display.

[Spencer M. Rascoff:]

And Tom, on unaided awareness. It's too early for us to think about when we might change strategy, change the strategic direction with respect to our advertising because we're still seeing such good returns on our spend. I think what you see though, if you look at other companies when they start advertising, usually, once they figure out the right messaging, the first -- I don't know, the first tens of millions of dollars in advertising are quite efficient and it becomes harder to eke out more efficiencies later once you increase your levels of awareness. So tieing it back to the target model, which I still feel good about, of 40-plus-percent EBITDA margins at greater revenues scale when revenue growth stops being hypergrowth, 65% plus, and it becomes something along the lines of a more mature looking business, I still feel good about that target model, and obviously, that assumes some -- getting some leverage in the sales and marketing line, both on advertising as well as sales team headcount. We'll do 2 from Twitter now. So Brian Bolan asks, “ARPA really jumped this quarter compared to last year. What was driving that?” Chad, let's talk about ARPA.

[Chad M. Cohen:]

Yes, again, just going back to the comments I made about the second quarter. So the impact of those additional bookings, and we gave you some visibility into some of those metrics on a one-time basis, was that they really impacted the quarter such that we had accelerating revenue growth to 87% in our Premier Agent business. That incremental inventory drove ARPA to $349 for the period per month and that represented a 32% growth year-over-year. That's the highest growth period that we've had probably in 2 or 3 years. So that's primarily what was driving that.

[Spencer M. Rascoff:]

And operator, we'll go to the next question from the call, please.

[Operator:]

Our next question comes from the line of Mark May with Citi.

[Mark May:]

Sorry if this has been addressed already, but it looks like that your marketing spend in the quarter, the growth rate decelerated a decent amount. Can you help us -- help me think a little bit about where that came from? Is that primarily throttling back a little bit on the marketing budget? Or is that more headcount or salary and benefit related? And then secondly, I know this isn't the first time you've mentioned this, but really pointing to volumes as opposed to pricing being the predominant driver of growth in the PA side of the business. Do you expect at any point in the future that the price will become a more meaningful driver of the growth?

[Chad M. Cohen:]

Mark, this is Chad. On marketing spend, I think when I look at the figures and look at the seasoning and the comments that I've made on prior calls, it's pretty consistent, which is that we front-loaded some of that marketing spend to the beginning of the year to get a head start. And so when I look at delivering $48 million in S&M in Q2, 47-ish in Q3, that's just consistent with how we planned the cadence of our marketing spend throughout the year. And in terms of your second question on the primary driver, I think we continue to see volume being the primary driver of growth in our Premier Agent business in the near term.

[Operator:]

Our next question comes from the line of Neil Doshi with CRT Capital.

[Neil A. Doshi:]

Just a quick question, Chad, on the free cash flow. It looks like that slumped to the negative. It was one of the bigger negatives we've seen. Anything you could call out there? And how should we think about free cash flow going forward? And then...

[Chad M. Cohen:]

Yes. One of the -- yes, sure, so I think obviously, this quarter, we had one-time acquisition cost of $13.2 million. I think that's driving a large portion of the free cash flow sort of moving down in the direction that's different than what you've seen in the past. Probably some puts and takes on the balance sheet, I'll have to just go through those. But I can get back to you on the specific details. But I would say the majority of it really has to -- is really driven by those acquisition costs.

[Neil A. Doshi:]

Great. And then just another quick question on the mortgage business. It looks like traffic grew pretty nicely, but the mortgage leads grew a little bit slower than the traffic. So is there any way to kind of bridge the big difference in that? And I think you guys launched a fairly new product where you can get preapproved right away. And you track -- any update on how that product is tracking as well?

[Spencer M. Rascoff:]

So early -- just to answer your second question first, pre-approval is still very early. It's gaining great traction. In terms of sort of the conversion from total uniques down to overall loan requests, I would say that there's some sensitivity in the model with respect to the impact on interest rates. So that's probably the primary driver. That said, we're still really happy with generating 7 million loan requests in the quarter, that's up 24% year-over-year. Revenues were up 18-ish-percent year-over-year and that's in face of some pretty strong headwinds with 30-plus-percent deceleration in mortgage loan originations sort of at a macro level.

[Operator:]

Our next question comes from the line of Lloyd Walmsley with Deutsche Bank.

[Lloyd Walmsley:]

Sorry if I missed this, but if you can just clarify some of the comments on I think you're trying to pull forward, it looks like backing out Display, the guide implies like 3% sequential growth at the high end in the fourth quarter Marketplace revenue versus '12 last year in the fourth quarter. Given it's a subscription business like walk us through how the pull forward results in slower incremental growth in the fourth quarter. And I didn't quite catch that.

[Chad M. Cohen:]

Yes. I think it's -- hey, Lloyd, it's Chad. So inventory that we normally would've sold as bookings in the third quarter, we pulled that inventory forward to the second quarter. So effectively, inventory that we would've sold through, we sold through in the second quarter. What you saw in the third quarter are the benefits of that, which is it's impacting revenue, accelerating revenue to 87% growth, growing ARPA as we deliver that revenue in the third quarter to $349 million. And what I'm basically saying is that the lift that you would've normally associated with a more normalized growth in bookings period-over-period, a lot of that was taken up in the second quarter and you're seeing that delivery in the third quarter. So the incremental lift for the fourth quarter isn't as high as you normally would have seen had we not had sold that impression inventory in the second quarter. So we're also entering a slower seasonal period in the fourth quarter. So there's just less shoppers, therefore less impressions to sell. So those dynamics -- to serve, those dynamics put a little bit of a ceiling on the overall impressions that we have to sell.

[Lloyd Walmsley:]

Okay. And then for Spencer, if I can. Any reaction to the regulator's decision to try to pseudo block National CineMedia and Screenvision's merger? Is there any reason to be -- to think that's different enough so that it's not a concern? Any thoughts there?

[Spencer M. Rascoff:]

Not -- haven't focused on that particular situation. I'm still confident in our situation. And I mean, you've heard the numbers, Lloyd, that it's 2% of agent ad spend on Zillow, 2% of agent ad spend on Trulia. There are lots of alternatives, lots of other places they choose to advertise. And I think that's what the government is going to be looking at for us, and so that's why I'm confident.

[Operator:]

Our next question comes from the line of Jason Helfstein with Oppenheimer.

[Jason S. Helfstein:]

Most of the questions have been answered. Just maybe one about the outlook for marketing. Again, it was just -- you discussed about the this amount of operating leverage or improved leverage we saw in sales and marketing this quarter and then kind of implied in the fourth quarter. Any kind of commentary about the outlook for marketing next year kind of pre-Trulia?

[Spencer M. Rascoff:]

No. We're not giving out any sort of guidance with respect to 2015 or anything sort of post combination. We're confident that we're going to close in the first half of next year, but I don't think we have anything more to say beyond that. Maybe we might have some more comments on our next call.

[Operator:]

Our next question comes from the line of John Campbell with Stephens.

[John Campbell:]

Just a quick question. Again, just back on the marketing expense, not looking for any type of like real guidance there, but just generally speaking, I know you guys like to see good growth in traffic. That helps the incremental leads in the PA side. But with the pressure on the Display side, I'm assuming that, that -- that the return of the marketing dollars probably has to decline a good bit. So just generally speaking, if we were to see that negative trend kind of continue on the Display side into '15, I mean, would we see a coinciding decline in marketing expense from that?

[Spencer M. Rascoff:]

It's really unrelated. I mean, remember, the reason that we are advertising at all is to grow brand awareness. It's not drive near-term revenue either from Display or from Premier Agent. So as long as we feel that advertising is continuing to grow Zillow's brand awareness, Zillow's audience, Zillow's relevance to home shoppers and really set us up for a future, a couple of years from now when most of the $12 billion of ad spend is online and, therefore, we're in a great position to have a lot of revenue from it, and that's why we're advertising today. So display, what happens to Display or even frankly, Premier Agent, is not relevant to our advertising decisions in 2015.

[John Campbell:]

Okay. And then just, Spencer, just generally, just talk a little bit about the conversations you are having with some agents. I mean, I know the landscape has shifted quite a bit over the last, call it, year or so with you guys getting Trulia and the News Corp with Move. Is there fear or excitement maybe with agents or maybe just some thinking that the world just really doesn't change for them?

[Spencer M. Rascoff:]

Well, the real estate industry is undergoing an important transformation where the type of agent that was successful in 2005 will not be the type of agent that will be successful in 2015 or 2020. And so agents are changing their business plans to adapt to the Internet. They're becoming more sophisticated about Internet marketing and those that aren't are losing share and leaving the business. And so that's where you find the real estate industry today. And I mean, I love this question because this is actually what I spend most of my day worrying about and thinking about and positioning us for. There will be a time, 5 years from now when most of this ad spend is online and it's wherever the mobile shopper is. And most of the commissions are earned by agents who are tech savvy and understand Internet lead generation and take control of their online reputation and use software to run their business and are part of the team and are sophisticated about Internet marketing. And that is the type of agent that in 2020 is going to be doing most of the business. And we are really well positioned to benefit from and cause that transition that's happening in the industry. So every investment that we make today from whether it's having local events or investing in advertising through our audience or building out account management teams or connecting to other software platforms like the 42 companies we connect with, with Tech Connect, or acquiring Retsly, I mean, all of these investments that we're making today all position ourselves for that inevitability of when that agent of the future has most of the $60 billion in commissions and spend most of the $10 billion in advertising. It's changing. It's changing quickly.

[Operator:]

Our next question comes from the line of Brian Nowak with SIG.

[Brian Nowak:]

Spencer, on the heels of the recent agent conference in Vegas, where I'm sure you spoke to a lot of agents, can you talk to the agent lead-to-close or lead-to-home sale conversion trends that they're seeing? Is the average lead-to-close conversion improving at this point? And if not, what do you have to do to improve that trend to really provide more value to your agents?

[Spencer M. Rascoff:]

So we've historically talked about how we think 3% of the total leads that we send to agents get closed into an actual commission check, into a transaction. But we've always known that there a lot of agents that have much higher lead-to-close conversion rates, upwards of 20-plus-percent in some cases. We've been very focused on making sure more of our impressions are being sold to the top producing agents that understand our [ph] lead conversion, and that has driven ARPA growth and that's also improved lead conversion rate as just more of our leads go these agents that have a higher conversion rate. And then we made a lot of investments in our own CRM, like the ones that I mentioned, where our mobile app now has CRM features that help agents convert these leads into transactions. And then we've made investments in connecting to other CRMs. So we've done a lot to improve the lead conversion rates, which speak directly to the ROI that the agents get from their ad spend with us. And then that drives more impressions and drives ARPA growth. It's very hard for us to measure lead conversion rate. It's very hard for agents to measure lead conversion rate. So we don't have good data on what impact all of these initiatives have had, but my gut tells me that agents are converting Zillow leads at a higher rate than ever before, and partly that's because more of the leads are going to the higher-producing agents and that drives higher ROI and grows impression count and drives ARPA growth. So it's definitely part of a concerted strategy of ours.

[Operator:]

Our next question comes from the line of Brad Safalow with PAA Research.

[Bradley G. Safalow:]

The first question, can you guys comment on what percentage of Premier Agents are participating in the lender comarketing program at this point?

[Spencer M. Rascoff:]

Brad, we don't disclose that for competitive reasons, so, sorry.

[Bradley G. Safalow:]

Okay, and then it seems implicit in your comments, Chad, what you're saying on the inventory that prospectively, as the business matures into this impression-based model that your ARPA will be commensurate with the traffic in any given quarter, so there'll be more pronounced seasonality. Is that fair to say?

[Chad M. Cohen:]

No, not at all. I think, the comments that I've made on prior calls, I still believe them, which is I think when we look to the future, ARPA is going to continue to grow. What I'm saying is that there's a specific anomaly that you have to look to with respect to the seasoning of ARPA between this quarter and whatever you're projecting in your model and we're it's been historically. It will have to do with pulling forward that impression inventory in the second quarter.

[Bradley G. Safalow:]

I guess essentially, I think you have less impressions in the fourth quarter just because of what goes on in real estate. How are you not going to have lower ARPA? Are you going to be charging agents more per impression? I mean, is that the implication?

[Chad M. Cohen:]

I'm just saying that we believe longer term that ARPA is going to continue to grow and we don't have any thoughts with respect to seasonality of ARPA right now. That's just -- it's what we're looking at right now is ARPA for the third quarter at 32% growth year-over-year. The reason that it grew so much is because we pulled forward a lot of that inventory, so we're at $349 for the period. And that -- had we had additional impressions to sell and had not sold all of the impressions in the second quarter, there would probably be a more pronounced lift relative to next quarter. But we really don't provide ARPA and it's not the way we view the business.

[Spencer M. Rascoff:]

Let me give an example, though, so we all understand how the business operates. So if an agent buys 10,000 impressions and pays $100 a month, and in July, 10,000 impressions served, they get charged $100 a month and in August, 10,000 impressions gets served and they get charged $100, et cetera. In December, hypothetically, if they only served 50,000 or half of the impressions they bought, it's true, we would have lower revenue from that individual agent. But the way that we model the number of impressions that we sell is we model to the trough, and so we don't tend to underserve. So in that example, there is seasonality on the number of impressions that are served, but as long as we don't serve fewer impressions than we've sold, there's no seasonality in the revenue. So that's why there isn't pronounced revenue seasonality despite the fact that there's impression seasonality.

[Chad M. Cohen:]

And also, so much of it, Brad, has to do with the percentage of the impressions that are actually sold to existing agents and that's what triggers a growth or deceleration in the ARPA number.

[Bradley G. Safalow:]

Right, I understand. That's helpful. Last question. Why did you guys reduce the number of featured listings for Platinum, and I think Gold, Premier Agents from 25 to 10 in the quarter?

[Spencer M. Rascoff:]

We do that because the number of impressions that other Premier Agents serve is, of course, reduced when there are impressions that are taken up by existing listing agents or other Premier Agents. And so the way we price Premier Agent impression is we try to model how many total leads they're going to get. And then we have an ROI target that the agents -- that we try to solve for, for the agent. So most listing agents or most Premier Agents, rather, only had a few listings. So it doesn't move the needle much. But we don't like seeing situations, where a Premier Agent has -- what's appearing is the only listing -- the only agent on their listing, have a low monthly spend. So that's why we reduced it.

[Operator:]

Our next question comes from the line of Aaron Kessler with Raymond James.

[Aaron M. Kessler:]

Just a couple of questions. First, just going back to the Display spend quickly. Besides the reasons you've stated, any headwinds you're seeing kind of from shift to mobile or maybe through kind of advertisers using a programmatic channel more? I guess, that would maybe go along with your direct response comments. And is there any update on kind of rental listings numbers? I know initially you kind of talk about kind of 500,000 going to maybe $1 million range over the next couple of years? Any updates there?

[Spencer M. Rascoff:]

Why don't you start with the Display one? I'm going to pass it over to you.

[Chad M. Cohen:]

So with respect to programmatic, that is a larger headwind, I would say, that's impacting the Display business longer term. When we look out many years from now at the relative contribution of Display, we see that probably coming down with respect to the mix. And I think programmatic ad buying is going to be part of that, and that's an overall headwind specifically in the quarter and for the rest of the year. We're looking at specific headwinds in specific verticals. I would say with respect to mobile, I don't think there are really that many Display ad buys that are happening today across our platform, where there isn't a mobile component. So it's becoming more and more just part of what we're selling on a day-to-day basis.

[Spencer M. Rascoff:]

I mean, Display revenue can be what we want Display revenue to be. It depends how many Display ads you want to have on the site. And so every quarter, we try to strike the right balance between having high margin revenue from Display, but not impacting the user experience too much. And that's -- yes, that's where the Display line nets out that quarter. On rental count, Aaron, the postage team and the listing -- the rental listings team has focused much more on listings quality than quantity because we think that's a differentiator. Companies like craigslist are full of fraudulent and duplicated listings and our research has shown, that's incredibly frustrating and has opened up a real weak flank in their offering. And so we believe that we now have the most accurate listing -- rental listings, on the web, but in terms of raw listing count, most of the initiative has been focused on improving listing quality than quantity. That said, listing -- rental listings were up significantly year-over-year. I'm not sure if we've released them, although you could probably poke around the site and figure it out. But it's more about quantity -- quality than quantity over the last 6 months focus area for us.

[Operator:]

Our next question comes from the line of Chad Bartley with Pacific Crest.

[Chad Bartley:]

Just curious if there's anything else you can add in terms of kind of the changes you anticipate in the competitive landscape, particularly with the acquisition of Move and how they might look to work with agents and address the consumers. And then any update or any incremental comments on how you might differentiate Zillow and Trulia brands with agents or consumers later in mid to late 2015?

[Spencer M. Rascoff:]

Thanks, Chad. So first on the News Corp acquisition of Realtor.com, I think that has accelerated our ability to get more direct listings because the industry realizes that there's really no reason why you should have a direct relationship with News Corp's website, Realtor.com, but not Zillow Corp's website, zillow.com. So given our sizable audience lead I think we are very well positioned to take advantage of the News Corp acquisition of Realtor.com as we explained to the industry that they ought to have direct relationships with us, and you see that in the announcements that we make almost every week. In terms of the competitive landscape with respect to advertising, throughout the course of 2014, all of our competitors in this space spent tens of millions of dollars on advertising, and yet, we grew our leadership in the category. We really benefited from that rising tide of ad spend and we continued to extend our lead through the course of 2014. So I'm not overly concerned about the competitive landscape with respect to advertising and its impact on 2015. With respect to differentiating the brands between Zillow and Trulia, I think you specifically said to agents. To agents, they will be represented by one entity. So from an agent relations, agent sales, it will be the combined company that they are working with. To consumers, the brands will be differentiated and we're not -- I'm not ready to discuss just yet how the brands will be differentiated to consumers. That'll become more apparent when the deal closes in the first half of next year. So with that, thanks, everyone, for your time. We're very pleased with the Q3 results and excited about 2015. I think it's going to be a fun and exciting year as we close the Trulia acquisition and we move forward to this next stage of real estate media. As a reminder, we're going to keep this conversation going on Twitter for a couple more minutes. If you're interested, we'll be using the hashtag #ZEarnings and answer some questions that we didn't get to on the call on Twitter. Thanks very much, and we'll talk to you next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a good day.