Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For The Quarter Ended March 31, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

Commission File Number: 000-51032

 


HouseValues, Inc.

(Exact name of registrant as specified in its charter)

 


 

Washington   91-1982679

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

11332 NE 122nd Way, Kirkland, WA 98034

(Address of principal executive offices, including zip code)

(425) 952-5500

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of April 24, 2007, there were outstanding 24,577,046 shares of the registrant’s common stock, $0.001 par value, which is the only class of common stock of the registrant.

 



Table of Contents

HOUSEVALUES, INC.

FORM 10-Q

Index

 

         Page
PART I. FINANCIAL INFORMATION   
Item 1.   Condensed Consolidated Financial Statements (unaudited)   
  Condensed Consolidated Statements of Operations for the Three Months ended March 31, 2007 and 2006    3
  Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006    4
  Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2007 and 2006    5
  Notes to Condensed Consolidated Financial Statements    6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    10
Item 3.   Quantitative and Qualitative Disclosures about Market Risk    15
Item 4.   Controls and Procedures    15
PART II. OTHER INFORMATION   
Item 1.   Legal Proceedings    15
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    15
Item 6.   Exhibits    16
SIGNATURE    17

 

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Table of Contents
Item 1. Consolidated Financial Statements

HouseValues, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(unaudited)

 

     Three months ended March 31,  
     2007     2006  

Revenues

   $ 17,838     $ 23,234  

Expenses:

    

Sales and marketing (1)

     12,387       13,841  

Technology and product development (1) (2)

     2,790       2,836  

General and administrative (1) (2)

     3,552       3,102  

Depreciation and amortization of property and equipment (2)

     1,413       1,014  

Amortization of intangible assets

     395       213  
                

Total expenses

     20,537       21,006  
                

(Loss) income from operations

     (2,699 )     2,228  

Interest income, net

     586       604  
                

(Loss) income before income tax (benefit) expense

     (2,113 )     2,832  

Income tax (benefit) expense

     (945 )     797  
                

Net (loss) income from continuing operations

     (1,168 )   $ 2,035  

Discontinued operations:

    

Loss from operations of discontinued mortgage segment (1)

     (56 )     (408 )

Income tax benefit

     (20 )     (143 )
                

Loss on discontinued operations

     (36 )     (265 )
                

Net (loss) income

   $ (1,204 )   $ 1,770  
                

Net (loss) income per share—basic:

    

Continuing operations

   $ (0.05 )   $ 0.08  

Discontinued operations

   $ —       $ (0.01 )
                

Net basic (loss) income per share

   $ (0.05 )   $ 0.07  
                

Net (loss) income per share—diluted:

    

Continuing operations

   $ (0.05 )   $ 0.07  

Discontinued operations

   $ —       $ (0.01 )
                

Net diluted (loss) income per share

   $ (0.05 )   $ 0.06  
                

(1) Stock-based compensation is included in the expense line items above in the following amounts:

 

     Three months ended March 31,
     2007    2006

Sales and marketing

   $ 230    $ 318

Technology and product development

     115      141

General and administrative

     889      502

Discontinued operations

     19      91
             
   $ 1,253    $ 1,052
             

(2)    Depreciation and amortization of property and equipment is allocated as follows:

     2007    2006

Technology and product development

   $ 523    $ 522

General and administrative

     890      492
             
   $ 1,413    $ 1,014
             

See accompanying notes to condensed consolidated financial statements.

 

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HouseValues, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(unaudited)

 

    

March 31,

2007

  

December 31,

2006

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 40,124    $ 49,376

Short-term investments

     35,285      28,400

Accounts receivable, net of allowance of $203 and $161

     100      416

Prepaid expenses and other assets

     1,486      1,747

Deferred income taxes

     2,022      1,643

Prepaid income taxes

     947      2,254
             

Total current assets

     79,964      83,836

Property and equipment, net of accumulated depreciation of $10,065 and $8,803

     10,591      11,469

Goodwill

     3,605      3,605

Intangible assets, net of accumulated amortization of $2,830 and $2,439

     219      626

Deferred income taxes and other noncurrent assets

     1,627      1,826
             

Total assets

   $ 96,006    $ 101,362
             

Liabilities and Shareholders’ Equity

     

Current liabilities:

     

Accounts payable

   $ 777    $ 3,201

Accrued compensation and benefits

     2,421      3,185

Accrued expenses and other current liabilities

     3,213      5,057

Deferred rent, current portion

     289      289

Deferred revenue

     711      1,141
             

Total current liabilities

     7,411      12,873

Deferred rent, less current portion

     1,001      1,094

Note payable

     1,774      1,742
             

Total liabilities

     10,186      15,709

Shareholders’ equity:

     

Common stock, par value $0.001 per share, stated at amounts paid in; authorized 120,000,000 shares; issued and outstanding 24,475,361 and 24,410,843 shares at March 31, 2007 and December 31, 2006, respectively

     64,586      63,215

Retained earnings

     21,234      22,438
             

Total shareholders’ equity

     85,820      85,653
             

Total liabilities and shareholders’ equity

   $ 96,006    $ 101,362
             

See accompanying notes to condensed consolidated financial statements.

 

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HouseValues, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

     Three months ended March 31,  
     2007     2006  

Cash flows from operating activities:

    

Net (loss) income

   $ (1,204 )   $ 1,770  

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

    

Depreciation and amortization of property and equipment

     1,413       1,014  

Amortization of intangible assets

     396       401  

Stock-based compensation

     1,253       1,052  

Tax benefit deficiency from exercises of stock options

     (74 )     —    

Deferred income tax benefit

     (589 )     (409 )

Changes in certain assets and liabilities

    

Accounts receivable

     316       36  

Prepaid expenses and other assets

     (45 )     341  

Prepaid income taxes

     1,307       209  

Accounts payable

     (1,601 )     28  

Accrued compensation and benefits

     (764 )     (571 )

Accrued expenses and other current liabilities

     (1,812 )     336  

Deferred rent

     (93 )     (74 )

Deferred revenue

     (430 )     (39 )
                

Net cash (used in) provided by operating activities

     (1,927 )     4,094  
                

Cash flows from investing activities:

    

Purchases of short-term investments

     (16,645 )     (5,000 )

Sales of short-term investments

     9,760       65  

Purchases of property and equipment

     (611 )     (3,748 )

Additions to intangible assets and other

     —         (41 )

Earn-out payments related to the SOAR Solutions acquisition

     —         (606 )
                

Net cash used in investing activities

     (7,496 )     (9,330 )
                

Cash flows from financing activities:

    

Proceeds from exercises of stock options

     142       115  

Tax benefit from exercises of stock options

     29       145  
                

Net cash provided by financing activities

     171       260  
                

Net decrease in cash and cash equivalents

     (9,252 )     (4,976 )

Cash and cash equivalents at beginning of period

     49,376       59,234  
                

Cash and cash equivalents at end of period

   $ 40,124     $ 54,258  
                

See accompanying notes to condensed consolidated financial statements.

 

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HouseValues, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands except per share amounts)

(unaudited)

Note 1: Summary of Significant Accounting Policies

Nature of Operations

Founded in 1999, HouseValues, Inc. provides consumers and real estate professionals with the information and tools they need for success throughout the home buying and selling process. Our flagship consumer products include HomePages.com, an Internet web site that combines aerial maps, in-depth neighborhood information and nationwide home listings in one integrated web site; HouseValues.com, a service that provides home sellers with market valuations of their current home; and JustListed.com, a service that alerts home buyers as soon as new homes that meet their criteria hit the market. These consumer sites are integrated with Market Leader, our real estate customer relationship management application that helps real estate agents structure and automate much of their online lead follow-up process. We derive the majority of our revenues from sales to real estate professionals that include media services, software tools and training that they need to be successful in serving internet-enabled consumers.

Basis of Presentation

The condensed consolidated financial statements are unaudited and include the financial statements of HouseValues, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Effective for the quarter ended March 31, 2007, we have segregated the results of operations related to the mortgage business and presented them as discontinued operations (see note 2). For consistent presentation, we also have restated amounts from the prior year for discontinued operations. As a further result of our exit from the mortgage business, HouseValues now operates as a single segment representing revenues from our real estate agent customers.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements included in our 2006 Annual Report on Form 10-K. All adjustments necessary for the fair presentation of our results of operations, financial position and cash flows have been included and are of a normal, recurring nature. Operating results for the quarter ended March 31, 2007 are not necessarily indicative of results to be expected for a full year.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates.

Reclassifications

Prior period financial statement amounts have been reclassified to conform with current period presentation. In 2007, we reclassified our credit card fees to sales and marketing from general and administrative, as management believes this to be a more appropriate classification of these costs.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the difference between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. In determining tax bases and evaluating tax positions taken in our filings, we determine that a tax position will more likely than not be sustained upon examination by taxing authorities before any benefit is recognized in our financial statements. To the extent that we do not meet this standard, benefit recognition is reduced accordingly and any related interest and penalties also are included in income tax expense.

Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when it is more likely than not that deferred tax assets will not be realized.

 

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Recent Accounting Pronouncements

In January 2007, we adopted the Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (FIN 48). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. It also provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. We did not recognize any adjustments to our financial statements as a result of our implementation of FIN 48.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157), which provides guidance on how to measure assets and liabilities that use fair value. SFAS 157 will apply whenever another U.S. GAAP standard requires assets or liabilities to be measured at fair value but does not expand the use of fair value to any new circumstances. This standard also will require additional disclosures in both annual and quarterly reports. We will adopt SFAS 157 when required, currently January 1, 2008. We are currently evaluating the potential impact this standard may have on our financial position and results of operations, but do not believe the impact of the adoption will be material.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (SFAS 159). Under SFAS 159, entities may elect to measure eligible items at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. We will adopt SFAS 159 in 2008. We are currently evaluating the potential impact this standard may have on our financial position and results of operations.

Note 2: Discontinued Operations – Mortgage Business

In 2005, we launched the JustListed Connect product and acquired The Loan Page product, both targeted at mortgage professionals. Since then, this highly competitive market has faced increasing economic and competitive challenges, especially for new market entrants like HouseValues. While we believe the underlying synergies between mortgage professionals and our real estate customers continue to exist, we decided in January 2007 to exit the mortgage business. With that announcement, we implemented a plan to eliminate headcount associated with the mortgage operation as well as an overall reduction in force.

Results of operations for the quarter ended March 31, 2007 related to the mortgage business have been segregated from continuing operations and presented separately, net of related income taxes, on the statement of operations. We also have restated the comparative period from the prior year for discontinued operations. Included in discontinued operations are revenues of $715 and $3,637, including revenues from our JustListed Connect product of $422 and $2,482, for the three month periods ended March 31, 2007 and 2006, respectively. Continuing revenues from our JustListed Connect product are not considered significant, and there is not significant continuing involvement with the discontinued operations of the mortgage business.

During the first quarter of 2007 we paid severance costs of $63 related to the discontinued operations.

Note 3: Earnings per Share

Basic earnings per share is computed using the weighted average number of shares outstanding during the period. Diluted earnings per share uses the weighted average common shares outstanding plus dilutive stock options.

 

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The following table sets forth the computation of basic and diluted earnings per share:

 

     Three months ended March 31,  
     2007     2006  

Net (loss) income from continuing operations

   $ (1,168 )   $ 2,035  

Net loss from discontinued operations

     (36 )     (265 )
                

Net (loss) income

   $ (1,204 )   $ 1,770  
                

Weighted average common shares outstanding

     24,428       25,810  

Dilutive effect of stock options

     —         1,543  
                

Diluted Shares

     24,428       27,353  
                

Net (loss) income per share—basic:

    

Continuing operations

   $ (0.05 )   $ 0.08  

Discontinued operations

   $ —       $ (0.01 )
                

Net basic (loss) earnings per share

   $ (0.05 )   $ 0.07  
                

Net (loss) income per share—diluted:

    

Continuing operations

   $ (0.05 )   $ 0.07  

Discontinued operations

   $ —       $ (0.01 )
                

Net diluted (loss) earnings per share

   $ (0.05 )   $ 0.06  
                

Antidilutive stock options

     2,570       1,696  
                

Note 4: Income Taxes

We adopted the provisions of FIN 48 on January 1, 2007. We did not recognize any adjustments to our financial statements as a result of our implementation of FIN 48. Both at the adoption date of January 1, 2007 and at March 31, 2007, we did not have any unrecognized tax benefits, nor did we have any interest or penalties accrued. We have concluded all U.S. federal income tax matters for years through 2003 and state and local taxes for years through 2002.

Our effective tax rate for continuing operations was 45% for the quarter ended March 31, 2007, compared to 28% for the quarter ended March 31, 2006. Our effective tax rate increased due to the increase in our tax-exempt interest income relative to operating results. The effective tax rate for discontinued operations approximates the statutory rate as those results are not impacted by investment income.

Note 5: Stock-based Compensation Plans

Stock-based compensation cost is measured at grant date, based on the fair value of the award, over the requisite service period.

Determining Fair Value—Assumptions

The value of each employee option granted during the quarters ended March 31, 2007 and 2006 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

     Three months ended March 31,  
     2007     2006  

Expected life (in years)

     3.0       3.0  

Weighted average expected volatility

     80 %     90 %

Weighted average risk-free interest rate

     4.83 %     4.55 %

Expected dividend yield

     0 %     0 %

Weighted average fair value

   $ 2.82     $ 8.51  

Stock-based Compensation under FAS 123R

The following table summarizes stock-based compensation expense related to stock-based awards:

 

    

Three months ended

March 31, 2007

 

Total cost of share-based payment plans

   $ 1,274  

Amounts capitalized in internally developed software

     (21 )
        

Amounts charged against income, before income tax benefit

   $ 1,253  
        

Amount of related income tax benefit recognized in income

   $ 430  

Amounts recognized in income for amounts previously capitalized in fixed assets

   $ 5  

As of March 31, 2007, we had $8,852 of unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans. We expect to recognize this cost over a weighted average period of 1.54 years.

 

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Stock Option Activity

As of March 31, 2007, we had reserved 1.7 million shares for future issuance under our stock option plans. We issue new shares for option exercises.

Options granted, exercised, canceled and expired under all of our stock option plans are summarized as follows:

 

     Options     Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Life
   Aggregate
Intrinsic
Value

Outstanding at December 31, 2006

   4,037,756     $ 6.63      

Options granted

   426,100       5.16      

Options exercised

   (64,518 )     2.20      

Options canceled

   (343,795 )     9.68      

Options expired

   (9,323 )     14.51      
                  

Outstanding at March 31, 2007

   4,046,220     $ 6.27    8.0 years    $ 4,298
                        

Exercisable at March 31, 2007

   1,884,155     $ 5.52    6.6 years    $ 4,026
                        

The total intrinsic value of options exercised and the total fair value of options that vested and were forfeited are included in the following table.

 

    

Three months ended

March 31,

     2007    2006

Intrinsic value of options exercised

   $ 185    $ 632

Fair value of options vested

   $ 1,745    $ 864

Fair value of options forfeited

   $ 2,318    $ 1,239

Note 6: Supplemental Disclosure of Cash Flow Information

 

    

Three months ended

March 31,

     2007    2006

Cash paid during the period for income taxes

   $ 311    $ 708

Income tax refunds received during the period

   $ 1,949      —  

Non-cash investing and financing activities:

     

Accrued earn-out payments in connection with acquisitions

     —      $ 681

Change in payables for property and equipment

   $ 97    $ 1,977

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this Quarterly Report on Form 10-Q contain forward looking statements relating to the Company’s anticipated plans, products, services, and financial performance. The words “believe,” “expect,” “anticipate,” “intend” and similar expressions identify forward-looking statements, but their absence does not mean the statement is not forward looking. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially from those anticipated in the forward looking statements. Factors that could affect the Company’s actual results include, but are not limited to, those discussed under the heading “Risk Factors” in our Annual Report on our Form 10-K for the period ended December 31, 2006 and in our other Securities and Exchange Commission filings. Given these risks and uncertainties, you should not place undue reliance on our forward looking statements. The forward looking statements are made as of the date of this report and the Company assumes no obligation to update any such statements to reflect events or circumstances after the date hereof.

Overview

Results for the quarter ended March 31, 2007 continued to reflect broader real estate market conditions. Revenue from continuing operations for the first quarter was $17.8 million, down 23% from the comparative period last year driven by lower average revenue per customer and a decline in the customer base. In the first quarter of 2007, the National Association of Realtors reported that seasonally adjusted U.S. existing home sales were 5% lower than in the first quarter of the prior year. We believe this is creating financial pressure on real estate agents that is reflected in our key operating metrics. We have responded to the changing economic conditions by reducing our cost structure while continuing to improve our existing product offerings and to develop new product offerings that are intended to drive success for our real estate agent customers.

In January 2007, we announced our exit from the mortgage lead generation business and our intention to scale back or eliminate initiatives that are not critical to our real estate agent customers. These reductions resulted in an overall reduction of our workforce by about 12% or 60 employees. We plan to work with strategic and advertising partners to monetize organic mortgage demand originating on our web sites and will continue to facilitate cooperation between real estate agents and their mortgage partners. As a result of our decision to exit the mortgage business, we have presented results of operations related to the mortgage business as discontinued operations, including prior periods. In connection with the discontinuation of our mortgage operations and the reduction in workforce, discontinued operations incurred cash severance costs of $0.1 million, while continuing operations incurred cash severance costs of $0.3 million and additional stock compensation expense of $0.5 million. In the fourth quarter of 2006, we recorded a $6.2 million impairment charge for goodwill and intangible assets related to the mortgage business.

Results of Operations

Our discussion of operating results addresses results from continuing operations, our real estate business. Our former mortgage business has been presented in our financial statements as discontinued operations.

Revenues

 

     Three months ended March 31,
     2007    2006

Revenues

   $ 17,838    $ 23,234

Real estate revenues for the first quarter of 2007 decreased 23% over the same quarter in 2006 due to a 16% decline in our average real estate revenue per customer and a 9% decline in average core real estate customer base. We believe that slower existing home sales are creating financial pressure on real estate agents that are reflected in the lower average revenue per customer and decreased customer base.

Revenue in the first quarter of 2007 decreased 7% over the fourth quarter of 2006. On a sequential quarter basis, we experienced a 9% decrease in average real estate core customer count, partially offset by a 2% increase in average real estate revenue per customer during the first quarter. More information about the sequential change in real estate revenue and customers is included in the “Key Operational Metrics – Real Estate Products” section of Management’s Discussion and Analysis.

 

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Sales and Marketing

 

     Three months ended March 31,  
     2007    % of Revenue     2006    % of Revenue  

Sales and marketing expense before stock-based compensation

   $ 12,157    68 %   $ 13,523    58 %

Stock-based compensation

     230    1 %     318    2 %
                          

Total sales and marketing expense

   $ 12,387    69 %   $ 13,841    60 %
                          

Sales and marketing expense in the first quarter of 2007 increased as a percentage of revenue driven primarily by comparable advertising costs on lower revenue. In total, expenses decreased from the same quarter in 2006 primarily due to reduced payroll and related expenses as we have scaled back headcount during 2006 and reduced our workforce in January 2007.

Technology and Product Development

 

     Three months ended March 31,  
     2007    % of Revenue     2006    % of Revenue  

Technology and product development expense before stock-based compensation

   $ 2,675    15 %   $ 2,695    11 %

Stock-based compensation

     115    1 %     141    1 %
                          

Total technology and product development expense

   $ 2,790    16 %   $ 2,836    12 %
                          

Technology and product development expense decreased slightly in total dollars, but increased as a percentage of revenue for the quarter ended March 31, 2007 as compared to the same period in 2006, primarily due to lower revenues. The reduction in payroll and related expenses resulting from the reduction in workforce in January 2007, as well as reduced contractor expense were partially offset by severance costs related to the reduction in force.

General and Administrative

 

     Three months ended March 31,  
     2007    % of Revenue     2006    % of Revenue  

General and administrative expense before stock-based compensation

   $ 2,663    15 %   $ 2,600    11 %

Stock-based compensation

     889    5 %     502    2 %
                          

Total general and administrative expense

   $ 3,552    20 %   $ 3,102    13 %
                          

General and administrative expenses increased in total dollars and as a percentage of revenues for the quarter ended March 31, 2007 when compared to the same period last year, primarily due to severance costs resulting from our reduction in workforce in January 2007. General and administrative expense included severance of approximately $0.2 million in cash compensation and $0.5 million of stock-based compensation resulting from the acceleration of stock options. These increases were mostly offset by reduced salaries and related expenses, including stock-based compensation aside from the impact of stock option acceleration related to severance packages, as well as reduced state taxes.

Depreciation and Amortization of Property and Equipment

Depreciation and amortization of property and equipment increased year-over-year primarily due to additional depreciation expense on capitalized software development, workstations and equipment. Additionally, in the first quarter of 2007 we recognized the remaining $0.1 million of accelerated depreciation on a technology investment in HomePages that was retired upon the launch of the next major release of the product at the end of the first quarter of 2007.

Amortization of Intangible Assets

Amortization of intangible assets increased for the quarter ended March 31, 2007 when compared to the same period in 2006 primarily due to $0.3 million acceleration of the remaining amortization on a technology investment in HomePages that was retired upon the launch of the next major release of the product at the end of the first quarter of 2007.

Interest Income

Interest income for the first quarter of 2007 was consistent with the first quarter of 2006. At March 31, 2007, we held $75.4 million in cash, cash equivalents and short-term investments, compared to $84.8 million at March 31, 2006. Overall lower cash and investment balances were largely offset by increased market rates.

 

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Income Taxes

We recognized an income tax benefit for the first quarter of 2007 as a result of our pre-tax loss from continuing operations. Our first quarter 2007 effective tax rate for continuing operations was 45% compared to an effective tax rate from continuing operations of 28% for the first quarter of 2006 due to the increase in our tax-exempt interest income relative to operating results.

Because tax-exempt interest income represents a significant contribution to operating results, changes to forecasted operating income could have a significant impact on our effective tax rate and the related tax expense for the remainder of 2007.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Accordingly, our actual results may differ from these estimates under different assumptions or conditions.

In the first quarter of 2007, we announced our exit from the mortgage lead generation business. As a result of our decision to exit the mortgage business, we have presented results of operations related to the mortgage business as discontinued operations, including prior periods. Significant judgment and analysis was used to determine support costs classified as continuing operations and discontinued operations. Other critical accounting policies that involve significant judgments and estimates used in the preparation of our consolidated financial statements are disclosed in our 2006 Annual Report on Form 10-K.

Quarterly Consolidated Statements of Income and Operational Data

The following tables present unaudited operational data pertaining to both our continuing operations and our discontinued operations for the five quarters ended March 31, 2007. This quarterly information has been prepared on the same basis as our audited consolidated financial statements and, in the opinion of our management, reflects all adjustments necessary for a fair representation of the information for the periods presented. This data should be read in conjunction with our audited consolidated financial statements and the related notes included in our 2006 Annual Report on Form 10-K. Operating results for any quarter apply to that quarter only and are not necessarily indicative of results for any future period.

 

    

Mar. 31,

2007

   

Dec. 31,

2006

   

Sept. 30,

2006

   

June 30,

2006

  

Mar. 31,

2006

Continuing Operations Data, in thousands:

           

Revenues

   $ 17,838     $ 19,148     $ 21,091     $ 22,351    $ 23,234

Expenses:

           

Sales and marketing

     12,387       13,463       14,463       13,709      13,841

Technology and product development

     2,790       3,311       2,700       2,528      2,836

General and administrative

     3,552       3,064       3,188       2,951      3,102

Depreciation and amortization of property and equipment

     1,413       1,488       1,559       1,116      1,014

Amortization of intangible assets

     395       70       68       213      213
                                     

Total expenses

     20,537       21,396       21,978       20,517      21,006
                                     

(Loss) income from operations

     (2,699 )     (2,248 )     (887 )     1,834      2,228

Interest income, net

     586       642       717       690      604
                                     

(Loss) income before income tax expense

     (2,113 )     (1,606 )     (170 )     2,524      2,832

Income tax (benefit) expense

     (945 )     (896 )     351       —        797
                                     

Net (loss) income from continuing operations

   $ (1,168 )   $ (710 )   $ (521 )   $ 2,524    $ 2,035
                                     

 

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Mar. 31,

2007

   

Dec. 31,

2006

   

Sept. 30,

2006

   

June 30,

2006

   

Mar. 31,

2006

 

Discontinued Operations Data, in thousands:

          

Revenues from discontinued operations

   $ 715     $ 2,373     $ 2,894     $ 3,515     $ 3,637  

Loss from discontinued operations

     (56 )     (7,122 )     (1,450 )     (970 )     (408 )

Income tax benefit

     (20 )     (2,493 )     (508 )     (340 )     (143 )
                                        

Net loss from discontinued operations

   $ (36 )   $ (4,629 )   $ (942 )   $ (630 )   $ (265 )
                                        

Key Operational Metrics

The following table presents operational data related to our real estate products for the five quarters ended March 31, 2007:

 

    

Mar. 31,

2007

   

Dec. 31,

2006

   

Sept. 30,

2006

   

June 30,

2006

   

Mar. 31,

2006

 

Operational Data:

          

Components of revenue (in thousands):

          

Real estate core revenue (1)

   $ 17,514     $ 18,735     $ 20,623     $ 21,953     $ 22,747  

Other real estate revenue (2)

     324       413       468       398       487  
                                        

Net real estate revenue (3)

   $ 17,838     $ 19,148     $ 21,091     $ 22,351     $ 23,234  

Core real estate customers, end of period

     13,508       14,596       16,184       15,993       15,825  

Average monthly churn rate (4)

     10.4 %     9.3 %     7.6 %     7.4 %     6.6 %

Average core real estate customers in the quarter (5)

     14,052       15,390       16,089       15,909       15,398  

Average monthly revenue per core real estate customer (6)

   $ 415     $ 406     $ 427     $ 460     $ 492  

(1) Real estate core revenue consists of revenue for our primary real estate service offerings, HouseValues, JustListed, and agent advertising products. The customers from these primary service offerings are referred to as “core real estate customers.”
(2) Other real estate revenue includes revenue related to ancillary services, such as sales of surplus leads to brokers with no minimum commitment, monthly fees for use of our tools, the sales of branded marketing collateral, seminar attendance fees, and advertising.
(3) Real estate core and other revenues have been revised from amounts previously reported by immaterial amounts.
(4) Average monthly customer churn is calculated by dividing the number of core real estate customers who canceled during the quarter by the average core customers in the quarter, divided by the number of months in the quarter. Core real estate customers are customers from whom we collect fees for our core revenues. One minus our average monthly churn rate equates to our average monthly retention rate. Our annualized customer retention rate is calculated as average monthly retention raised to the power of 12. Other companies may calculate churn and retention differently, and their churn and retention data may not be directly comparable to ours.
(5) Average core real estate customers in the quarter are calculated as the average of core real estate customers at the beginning and at the end of the quarter.
(6) Average revenue per core real estate customer is calculated as core real estate revenue for the quarter divided by the average number of core real estate customers in the quarter.

Our core real estate customer count decreased by 1,088 customers during the first quarter of 2007, compared to a net decrease of 1,588 customers in the fourth quarter of 2006. Ending core real estate customers at March 31, 2007 had decreased 15% compared to March 31, 2006.

Average monthly churn for our real estate business was 10.4% for the first quarter of 2007, up from 9.3% in the fourth quarter of 2006. Monthly churn of 10.4% equates to 89.6% monthly retention which represents a 27% annualized retention rate. Churn increased as a result of a higher number of cancellations which was partially offset by seasonally stronger new customer acquisition. We believe that the high rate of cancellations partially reflects new customers acquired in prior periods consistent with a peak in cancellations that has been historically seen twelve to fourteen months into the customer lifecycle.

 

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Additionally, we believe that slower existing home sales continued to contribute to the high number of cancellations in the first quarter of 2007. While we expect to experience fluctuations in our churn rate from quarter to quarter, we believe that both of these factors may continue to drive high cancellation levels in the near term.

Average monthly revenue per real estate customer for the first quarter of 2007 increased 2% compared to the fourth quarter of 2006. Average revenue per customer will fluctuate from quarter to quarter based on the number of customers, the mix of sales for products priced differently across lower and higher priced geographies, the demand for existing services and the acceptance of new offerings.

Liquidity and Capital Resources

The following table presents summary cash flow data:

 

     Three months Ended March 31,  
     2007     2006  
     (dollars in thousands)  

Cash (used in) provided by operating activities

   $ (1,927 )   $ 4,094  

Cash used in investing activities

     (7,496 )     (9,330 )

Cash provided by financing activities

     171       260  

Cash equivalents and short-term investments consist of money market funds and highly liquid, short-term, adjustable-rate insured municipal notes. These municipal notes are classified as short-term investments available for sale and are reported at fair value, which approximates cost.

Our principal sources of liquidity are our cash, cash equivalents and short-term investments, $75.4 million at March 31, 2007, as well as the cash flow that we may generate from our operations.

Operating Activities

Net cash from operating activities primarily consists of our net operating results adjusted for certain non-cash items, including depreciation, amortization, stock-based compensation, deferred income taxes and the effect of changes in working capital. Cash flow used in operations for the first quarter of 2007 was $1.9 million, a decline of $6.0 million from the same period in 2006 primarily due to a $4.4 million reduction in our current liabilities, as well as lower operating profits.

Investing Activities

Cash used in investing activities for the first quarter of 2007 decreased by $1.8 million compared to the same period last year. During the first three months of 2007 lower capital expenditures were partially offset by the net increase in short-term investments. Our capital expenditures in 2007 were generally investments in our customer-facing infrastructure and the development costs related to new products and features.

Financing Activities

Cash provided by financing activities remained relatively consistent.

Recent Accounting Pronouncements

In January 2007, we adopted the Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (FIN 48). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. It also provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. The adoption of this Interpretation did not have a material impact on our financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157), which provides guidance on how to measure assets and liabilities that use fair value. SFAS 157 will apply whenever another U.S. GAAP standard requires assets or liabilities to be measured at fair value but does not expand the use of fair value to any new circumstances. This standard also will require additional disclosures in both annual and quarterly reports. We will adopt SFAS 157 when required, currently January 1, 2008. We are currently evaluating the potential impact this standard may have on our financial position and results of operations, but do not believe the impact of the adoption will be material.

 

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In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (SFAS 159). Under SFAS 159, entities may elect to measure eligible items at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. We will adopt SFAS 159 in 2008. We are currently evaluating the potential impact this standard may have on our financial position and results of operations.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The primary objective of our investment activities is to preserve principal and liquidity without incurring significant risk. To achieve this objective, we invest in short-term, high-quality, interest-bearing securities. Our investments in debt securities are subject to interest rate risk. To minimize our exposure to an adverse shift in interest rates, we invest in short-term securities and maintain an average maturity of one year or less.

 

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2007.

(b) Changes in internal controls. We have made no changes in internal control over financial reporting during the first fiscal quarter of 2007 that materially affected or are reasonably likely to materially affect our internal control over financial reporting. We intend to continue to refine our internal control on an ongoing basis as we deem appropriate with a view towards continuous improvement.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we may become involved in litigation relating to claims arising from the ordinary course of our business, including actions relating to employment issues. We believe that there are no claims or actions pending or threatened against us, the ultimate disposition of which would have a material adverse effect on us.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On December 9, 2004, the Securities and Exchange Commission declared effective our registration statement on Form S-1 (SEC File No. 333-118740) in connection with our initial public offering of common stock. We sold 4,166,667 shares of common stock at $15.00 per share, for aggregate gross proceeds of $62.5 million, and selling shareholders sold 2,083,333 shares of common stock at $15.00 per share, for aggregate gross proceeds of $31.2 million. We received net proceeds of approximately $56.1 million after underwriters’ discounts and commissions of approximately $4.4 million and other expenses related to the offering of approximately $2.0 million. None of the proceeds of the offering that we received were used as payments to our directors or officers (or their associates), or to our affiliates or 10% shareholders. All of the expenses of the offering were direct or indirect payments to others and not payments to our directors or officers (or their associates) or to our affiliates or 10% shareholders. Credit Suisse First Boston LLC and J.P. Morgan Securities Inc. acted as joint book-running managers of the offering, with Piper Jaffray & Co., Thomas Weisel Partners LLC and Pacific Crest Securities Inc. acting as co-managers of the offering.

Through March 31, 2007, we have used approximately $24.1 million of the proceeds to purchase property and equipment, intangible assets, and to complete acquisitions. The remaining proceeds have been invested in money market funds and highly liquid, short-term, adjustable-rate insured municipal notes. Our current and planned use of the proceeds does not represent a material change from the use of proceeds described in the prospectus relating to the Registration Statement.

 

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Item 6. Exhibits

 

Exhibit

Number

  

Description of Document

10.1*

   Description of 2007 Management Bonus Incentive Plan, filed herein.

10.2*

   Amendment to Employment Agreement by and between the registrant and John Zdanowski, dated May 20, 2004, filed herein.

10.3*

   Employment Agreement by and between the registrant and Gregg Eskenazi, dated January 5, 2004, filed herein.

10.4*

   Employment Agreement by and between the registrant and Clayton Lewis, dated August 23, 2004, filed herein.

10.5*

   Employment Agreement by and between the registrant and Tom Romary, dated October 14, 2005, filed herein.

10.6*

   Separation Agreement and Release by and between the registrant and Tom Romary, dated August 9, 2006, filed herein.

31.1

   Certification of Ian Morris, Chief Executive Officer and President of HouseValues, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of Regulation S-K.

31.2

   Certification of R. Barry Allen, Chief Financial Officer and Executive Vice President of Operations for HouseValues, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of Regulation S-K.

32.1

   Certification of Ian Morris, Chief Executive Officer and President of HouseValues, Inc. and R. Barry Allen, Chief Financial Officer and Executive Vice President of Operations for HouseValues, Inc., Pursuant to 18 U.S.C. Section 1350 of Item 601 of Regulation S-K.

* Management contract or compensatory plan

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

HOUSEVALUES, INC.
By:  

/s/ JACQUELINE DAVIDSON

 

Jacqueline Davidson

Authorized Officer and Principal Accounting Officer

May 7, 2007

 

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