Good day, and welcome to the Redfin Corporation Second Quarter 2019 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Elena Perron. Please go ahead, ma'am..

Thank you, Brad. Good afternoon, and welcome to Redfin's financial results conference call for the second quarter ended June 30, 2019. Joining me on the call today are Glenn Kelman, our CEO; and Chris Nielsen, our CFO. You can find the press release on our website at investors.redfin.com.

Before we start, note that some of our statements on today's call are forward-looking. We believe our assumptions and expectations related to these forward-looking statements are reasonable, but our actual results may turn out to be materially different.

Please read and consider the risk factors in our SEC filings together with the content of today's call. Any forward-looking statements are based on our assumptions today, and we don't undertake to update these statements in light of new information or future events.

During this call, the financial metrics will be presented on a GAAP basis and include stock-based compensation as well as depreciation and amortization expenses. In the event we discuss any non-GAAP measures today, we will post the most comparable GAAP measure and a reconciliation on our website.

All comparisons made in the course of this call are against the same period in the prior year unless otherwise stated. With that, let me turn the call over to Glenn..

Thanks, Elena, and hi everyone. Redfin's second quarter revenues were better than we projected in our last earnings call, up 39% from the second quarter of 2018 to $197.8 million. Our losses at $12.6 million were near the middle of the range we projected in May.

In the second quarter of 2018, we are in the $3.2 million profit but in 2019 we are advertising more and investing more in software for new businesses.

On our core business of brokering home sales through Redfin agents and through other firm’s agents working as our partners, revenues increased 17% year-over-year, and acceleration from last quarter's growth of 15% and the preceding quarter’s growth of 13%.

Our share gains continued with an 11 basis point gain from the second quarter 2018 to the second quarter of 2019. This is an acceleration from the 10 basis point gains we saw in the preceding two quarters.

RedfinNow, our business of buying and selling homes on our own account grew revenues from $9 million from the second quarter of 2018 to $39.9 million in the second quarter of 2019. Over that same time, our other businesses, primarily mortgage and title services grew 89%, an acceleration from last quarter's growth rate of 59%.

Up till now Redfin has taken a deliberate approach in expanding our new businesses. RedfinNow started in 2017, and is available in eight of our 92 markets. Our title business started in 2012 still only serves 23 markets. Redfin mortgage started in 2017, and now serves 40 markets. Now each is in a more aggressive phase of market expansion.

We expect these businesses which already contribute meaningfully to revenues today to contribute meaningful gross profits three to five years from now. The Redfin Mortgage and RedfinNow teams spent years building our own systems and processes for making loans and flipping houses.

At first sales from these new businesses went up and down as we experimented with different pricing to figure out which employees to base in a service center or in the field. Our title business bounced back and forth between the red and the black.

Our home grownloan origination software initially limited our productivity because of automated so few tasks. But now upgrade to that system regularly saves Redfin Mortgage employees’ hours per week, improving margins and pricing power.

We still have plenty to learn, our new businesses are preparing for more rapid expansion to other markets with strong demand and happy customers. Our goal is to be the first national provider of a complete real estate solution, which was a major premise of our 2017 public offering. The financial rationale of this strategy is obvious.

If we make more money per customer than any other real estate company, we can spend more than any other company on finding and serving that customer.

But we also believe that listing such brokerage service, mortgage, title, instant offers and renovations are more than the sum of their parts, and that we can over time combine these services in ways that let our customers buy and sell homes other people can’t.

For starters, each new step in the buying process where we can save customers’ money adds up to more customer buying power. Beyond that, the thesis behind Mortgage and RedfinNow is to give our customers access to capital more quickly than others can.

We believe that our renovations capabilities can one day transform listings nobody wants into one anybody would want. The homes listed by Redfin agents are already being promoted on our site directly to buyers in key markets, creating a more efficient marketplace for a faster sale at top dollar.

No one else has worked so long on so many different pieces to this puzzle.

The success of these new businesses is only compounded by accelerating growth in our core brokerage over the last two quarters, a trend we expect to continue because of the acceleration in traffic and the increase in brokerage awareness we saw in the first half of 2019, and also because of continued support from repeat customers.

Our primary challenge remains offering the on-demand home tours that drive so many homebuyers to give Redfin agents a shot while still investing in the personal service required to help each one succeed. We aren't just trying to improve the quality of the service, but also to identify better the customers most likely to buy a home.

We recently analyzed the customers we met in 2018 and their buying activity through June 2019, including net improvements to our service have been offset by a decline in the likelihood of our new customers to buy home at all from any brokerage, not just Redfin.

Of the people we signed up for a home tour on redfin.com in 2017, our estimates are that about a third likely bought a home by any brokerage within six months. The customers we met in 2018, this number was 3 to 5 percentage points lower.

We believe homebuyers fits and starts have been an industry-wide trend, unrelated to changes we made to our stay, but instead, driven by the housing affordability crisis and a more casual attitude about the services you can order from a phone.

We are still working hard to improve the quality of our home buying service but we are now also investing more in software to identify the customers most likely to buy a home, based on their browsing history and their answers to questions, about the service they seek and the reasons they may be moving.

In a world where some customers want simple property access and others an in-depth relationship with an agent, few other brokers will be able to pair different online customer profiles to different services from an agent.

This improved pairing will nonetheless take a gear more to rollout, which is why we expect homebuyer success rate to decline again in 2019. In the meantime, we have learned to deal with that decline better.

Agent productivity was up 6% in the second quarter of the same quarter last year, driven by an increase in the number of customers each agent serves and assists them for finding the most customers to agents with the best rates of customer engagement. If demand stays reasonably strong, this productivity should continue for the rest of the year.

We are also working hard to improve the quality of our service, building on 2018’s programs for meeting customers more often with new incentives and performance standards for our agents, which should be fully in place as we start 2020.

If and when these efforts increase our homebuyer success rate, we can let agent productivity further which should have a compounding effect on profit and growth. Our website and mobile application continue to be an engine of our growth.

Monthly visitors to our website and mobile applications averaged nearly 37 million in the second quarter, an increase of 27% over the same quarter last year. This was a major acceleration compared to the first quarter's 20% year-over-year gain and a 18% gain we saw the quarter before that.

redfin.com has more than 4 times the traffic of the next nearest brokerage competitor. This brings Redfin agents new customers, but also new buyers for the homes we’ve been hired to sell. Our visitor growth will probably moderate some over the next six months, but some of those gains would still hold up.

Fortunately, Redfin has also made great strides in being recognized as a brokerage not a website. One of our biggest steps in 2019 has been our mass media ads which ran in 22 markets through the first five months of 2019, and for the first time.

As in past years, we are running ads from the second half of the year when people are less likely to buy or sell homes.

The cost to place the ads was nearly $36 million, triple what we spent 2018 and our last three earnings calls represented results from running mass media ads in test markets since 2015 showing that the ads are profitable over three years. But we also committed to tell you about the in-year returns from our 2019 campaign.

The ads have been effective at making homebuyers aware of Redfin and somewhat effective at driving 2019 sales. We measure mass media ad sales impact by comparing new customer growth in markets with and without ads. Demand across Redfin 92 markets has exceeded our projections.

And unsurprisingly, demand has been strongest in the markets where we've advertised. So we expected new customer growth in the markets with mass media ads to outpace the other markets by a modestly wider margin than it actually has so far.

This has been almost entirely because of smaller than expected gains in the 10 markets getting ads for the first time. In eight of those 10 markets at the start of 2019, our market share was below 0.7% and the percentage of homebuyers and sellers who listed us was one of the first three real estate brokerages to come to mind with 3% or lower.

And it was these eight markets where the gains in new customers attributable to mass media ads were most likely to fall short of our expectations. The ads were probably less credible with consumers who had never seen a yard sign or heard of our brokerage.

In the past, the magnitude of the customer response has been uneven from year-to-year but consistent across the years. We thus feel more confident about advertising’s long-term impact, especially because of the awareness gains we've seen in mass media markets.

In our 10 largest markets, unaided awareness of Redfin as a brokerage increased from 8% last November to 10% in June, and it also increased in nearly every market where the ads ran from 1% in November to 4% in June for the markets getting mass media for the first time, and from 15% to 19% in the market for we’ve run ads for the past five years.

The data on markets getting mass media for the first time excludes Hawaii and Rhode Island, which were too small to yield an accurate sample. The markets that have never gotten mass media ads were stuck at 4% awareness over that span.

We will continue to compare new customer growth in markets with and without mass media ads but we remained fundamentally confident about advertising. As we said in past calls, we plan to continue significant ad spending in 2020 and beyond, but as a declining percentage of revenue.

What will make our ads most effective is having the most innovative products to advertise. One of these products is Redfin Direct for unrepresented buyers to buy a Redfin listing via our website without their own agent. We first discussed this with you on our May earnings call after Redfin Direct’s March 28th launch in Boston.

On July 1st, we expanded Direct to Northern Virginia, which led to 15 offers in July, five of which have been accepted. This has been a good result especially for our listing customers, in a Redfin Direct sale the homeowner pays a total commission of 2%.

When the fee typically charged by a traditional broker is 4% to 5% in Boston, it's 5% or higher in Virginia. Because our agents use our own software to prepare offers for Redfin’s brokerage customers, we know how likely buyers are in Virginia or Boston, the way of contingencies or pay more than the asking price.

We know the average earnest money amount for the customer a number of days allow for an inspection to be completed.

This local data never serviced before to consumers but now embedded in the relevant pages of the Direct offer building tool, so it makes it possible for an unrepresented buyer to put together a credible offer using redfin.com, and homebuyers have put our data to good use.

While we expected many of the Direct offers to be ludicrous or [half paid], the Direct offers have in fact that more likely than our brokerage customers offers to be cash offers with no contingencies. Most Direct offers are within 5% of the asking price. In the second half of the year we will accelerate Direct’s expansion to other markets.

We will also begin optimizing the software so that more than one in five people who started off to finish one. The percentage of Redfin listings in Boston and Virginia that sell through direct buyers are now in the low single-digits.

But as we systematically improve the offer developmental tool and began using our site to educate consumers about self-service, we hope over time to be able to sell 10% of our listings to a direct buyer. We've also begun work on self-service property access, known as Direct Access.

First of the listings we own outright through RedfinNow but eventually for our brokerage clients. Using the Redfin mobile application would lead buyers to now verify their identity and unlock the door of a Redfin listing. Early returns are promising.

Since we launched Direct Access on June 26, the 15 listings in our San Diego pilot have averaged over five self-service towards the peak.

We launched Direct offers and Direct Access in different markets but over time the two will complement one another, with anyone tours the listings through Direct Access getting a notification to make a direct offering.

Even better the money we save the customer to sell their home to unrepresented buyer will benefit us directly when RedfinNow is the owner of the property. We expect to have all three capabilities, Now, offers and Access, available in the same market for the first time in the third quarter.

With or without Direct, RedfinNow has continued to grow quickly with second quarter revenues up 344% year-over-year and purchases up more than that. Our entire three year experience continues to confirm RedfinNow foundational premise. Running a brokerage is crucial to competing effectively as an institutional buyer.

More than 60% of the homeowners requesting an instant offer are seeking to move up, which creates opportunities for our brokerage and RedfinNow to work together on the sale of one home and the purchase of another.

One day, [indiscernible] that America entered a period where low inventory and restrictive consumer credit made it nearly impossible for many families to move from one home to another, without lenders or the government moving a muscle. But that is what has created today's buying market and its favors Redfin’s integrated approach.

This integration not only benefits customers selling one home in order to buy the next, but those customers who just want to compare brokerage sales to our RedfinNow offer. In April, we changed our website to let homeowners ask for a RedfinNow offer and a listing consultation in one meeting, training our listing agent to present the RedfinNow offer.

Previously a separate RedfinNow employee presented the offer in a separate appointment. Asking the listing agent to present the RedfinNow offer alongside Redfin's listing pitch can lower our costs and let us expand more quickly.

Since RedfinNow employees more than 500 sellers agents, that’s better for consumers who can discuss our cash offer with a local Redfin agent and compare it to the proceeds from listing their home. Among homeowners comparing RedfinNow to a sale brokered by Redfin almost 3 times as many chose to list with Redfin overtaking the cash offer.

But what's most important is that more overall chose Redfin in one form or another, we can offer both choices in one meeting. It’s important to offer both choices because these complications are often competitive. We've been eager to learn this year how we compete on price with other institutional buyers.

So far, our sales growth has been strongest in markets with large competitors. We compete against Opendoor in Denver, Dallas and Southern California's Inland Empire and we just opened door in LA and Austin. Now, there are Opendoor nor Zillow by homes and the remaining RedfinNow markets, San Diego and Orange County.

What we've learned so far is that each buyer’s appetite for risk varies so much from home-to-home, and also from market-to-market that no one company consistently pays more than another.

The other measure of our pricing accuracy is our margins, gross margins were down 1.4 percentage points compared to the second quarter of 2018 but were largely consistent with our expectations. Margins declined as we staffed up our team to buy and renovate the homes to claim to sell in the second half of 2019.

We also hired more folks to open new markets faster and to manage the people and programs of a much larger business. Our competitors are getting homes on the market faster. But because we invest more in renovations our homes sell faster, with a smaller percentage unsold after 90 days on the market.

Over time, we expect our renovation costs to decline both from efficiency gains but also due to more discipline about the scope of renovations we undertake. Because we can't expand RedfinNow fast enough to handle iBuying interest from website visitors and brokerage customers alike.

We launched an Opendoor partnership this July in Phoenix and Atlanta, in which Redfin earns a referral fee for every Opendoor purchase. The two companies have worked nicely together so far, and the partnership has been well received by Redfin agents. Demand has been strong.

Some of us whether Redfin still plans compete all out with Opendoor in markets where we overlap. The answer is yes. For years to come, we plan to compete with Opendoor and we remain partners.

There's ample precedent to this, as Redfin is referred brokerage customers to partner agents to competing firms for more than a decade, generating the referral fees that constitute 5% of this quarter's revenue from real estate services. We send homebuyers to other lenders where Redfin mortgage doesn't have the best loans for their needs.

We learned long ago that online demand fluctuates due to interest rates in season, acts of god and Google. The only way to give employees and customers alike a consistent Redfin experience is either to pay for idle capacity most of the year or to refer excess demand to a trusted partner like Opendoor.

Even when RedfinNow expands to nearly every Opendoor market in the U.S., there will be times when we don't have the money or staff to buy and sell another home, and we hope a partner will take our place.

For now we aren't too worried about the markets ups and downs even if the overall economy weakens just a bit, housing demand is strong and likely getting stronger. Mortgage rates approached 5% in November 2018, but are now well below 4% Keeping buyers in the market at a time last year when they were headed to the exits.

The number of homes for sale began declining in mid June for the first time since August 2018. So sellers see prices rising more than likely they saw on to the market. That was more of a nervous really about the market to me but our data shows home sales will be strong in the second half of 2019.

With that, let’s dig into Redfin's financial statements with Chris. .

Thanks Glenn. Our year continue to play out as we expected. We again posted healthy top-line trends with second quarter revenue of $198 million, up 39% from last year. Real Estate Services revenue which includes our brokerage and partner businesses grew 17% year-over-year.

Brokerage revenue or revenue from home sales closed by our own agents was 18% on a 20% growth in brokerage transactions. Brokerage revenue per transaction was down 2% year-over-year reflecting continued mixed shift towards our listing business and lower home price appreciation as compared with the second quarter of 2018.

Revenue from our partner agents was down 1% on a 2% increase in partner transactions as we continue to shift our transaction mix more toward our own agents. Revenue per partner transaction was down 3% year-over-year.

The property segment, which consists of homes sold through our RedfinNow program generated nearly $40 million in revenue, up from $9 million from the second quarter of 2018.

In July 2019 to support continued growth in investment in RedfinNow, we put in place and asset-backed credit facility, which will provide up to an additional $100 million of borrowing capacity with an initial term of 18 months.

We continue to expect that over time more of the capital to buy homes will come from lenders, using the homes we purchase as collateral. Going forward with this facility in place, we won't be updating you each quarter as to our RedfinNow capital commitment.

Our other segment, which includes mortgage, title and other services, contributed revenue of $5.3 million a year-over-year increase of 89%. Total gross profit was $48.3 million, up 7% year-over-year.

Real Estate Services gross margin was 32.2%, down 260 basis points year-over-year, primarily driven by a 90 basis point increase in home touring and field costs, a 70 basis point increase in occupancy and office expenses and a 50 basis point increase in listing expenses, each as a percentage of revenue.

Properties gross margin was minus 2.5%, down 140 basis points from a year ago, primarily due to an increase in personnel costs including stock-based compensation, as Glenn mentioned. Other segment had a gross margin of 2.2%, an improvement of 960 basis points from year ago, as our mortgage and title businesses continue to scale.

Total operating expenses increased 42% year-over-year and represented 31% of revenue, up from 30% one year ago, primarily driven by marketing. Marketing expenses increased by 87% year-over-year, driven by our brand advertising campaign that ramped through May. We do not plan to run any additional brand advertising for the remainder of the year.

Technology and development, and general and administrative expenses both grew slower than revenue, increasing by 23% and 15% year-over-year, respectively. Our net loss including stock-based compensation and depreciation was $12.6 million, compared to $3.2 million net income in the second quarter of 2018.

Diluted net loss per common share was $0.14, compared with the $0.04 diluted net income per common share one year ago. Now turning to our financial expectations for the third quarter 2019. Revenue is expected to be between $223 million and $233 million, representing year-over-year growth between 59% and 66%.

We expect our Properties segment to account for $67 million to $72 million of that revenue.

We don't typically provide guidance on gross margin components, because those are subject to a variety of business and market factors, but we wanted to comment to what we expect for Real Estate Services gross margin in third quarter 2019, given the headwinds we've seen so far this year.

We anticipate that agent productivity will continue to increase year-over-year in the third quarter. We believe, however, the third quarter real estate gross margin will be down slightly to flat year-over-year, given we're seeing strong touring and other customer activity that may not pull through to revenue during the quarter.

Net income is expected to be between $3.4 million and $6.4 million, compared with the $3.5 million net income in the third quarter of 2018. Our guidance includes approximately $6.6 million of stock-based compensation and $2.5 million in depreciation and amortization.

It assumes, among other things that no additional business acquisitions, investments, restructurings, or legal settlements are included, and that there are no further revisions to stock-based compensation estimates. And with that, we will open up to your questions..

Thank you. [Operator instructions]. And our first question comes from Jason Helfstein from Oppenheimer..

So great color Glenn, thank you very much. So kind of two questions, maybe dinging a bit more on the Opendoor partnership? I mean, it would seem you would kind of save a lot on fixed cost to do that. It totally makes sense why you would still compete in markets. Well, it’s still offering markets where they -- where you both don't compete.

But I guess everything about that. So the point of getting your agents to present those offers, really like that idea. But again, there's significant cost savings if you partner with Opendoor.

So maybe just kind of rationalize that a bit more, because I think people like the idea of the synergy with Opendoor? And then, one of the things that we all struggle with is how to think about margins long-term and apologize long with a question, you talk agents productivity improving.

How are you thinking about agent hiring for the rest of the year and maybe into next year? And yet, we saw marketing, G&A was lower this quarter.

Just help us give us some more color on your thoughts about how to think about, I don't know, margins next year, and maybe longer term, if you want to give us color by business line that'd be better? But I'll stop there. .

Yes, Jason, we always laugh because the operator says one question and then you immediately say only two questions. But they're both good ones. So first of all, the Opendoor partnership is not a replacement for RedfinNow in any market. And the reason is, is because there's too much demand for that business, to let us outsource it to anyone else.

We want to understand it better. We want to own that inventory. We want to be responsible for selling it. We have 14 years of history selling homes better than anyone else. We think we can build a better marketplace for those listings, if we own those listings. So there's plenty of good, bad between those two companies. We really like one another.

And we know that we're going to need one another for a long time to come. But we've got to be in this properties business. And we're making a long-term commitment too to that business because it's so strategic and because it works so well with all the pieces of the puzzle.

And I can't even believe you started trying to get us to talk about 2020 because you know, we avoid forward-looking guidance like crazy. We are happy with the increase in agent productivity, but we're also seeing significant increases in demand.

We are not ready to talk about how many agents we're going to hire in the fourth quarter of this year, or the first quarter of next year to prepare for 2020 just because we don't see how much demand there will be next year. And because we just want to avoid forward-looking guidance on this call..

Just one other color commentary piece related marketing expenses that in the second half of the year on a year-over-year basis those marketing expense will not be increasing significantly.

We talked a little bit earlier about the fact that we won't be running offline advertising in the second half of the year and so we provided just that one additional piece of information relative to the marketing..

Thank you. Our next question comes from Mark Mahaney with RBC..

Alright. Thanks. So I think I countered three questions by Jason so I'm going to do three questions too.

Glenn, bigger picture, what percentage of homes in 10 years do you think will be bought via iBuying? Secondly, I got the point about what you're not going to grow brand advertising in the back half year, but did you explained the why, it seems like that was relatively successful for you in terms of traffic, it gives a couple of really good brand awareness data points so why not in the back half year? Is that just purely for seasonal reasons? And third is, can you just talk about the attach rate you think you could get for these things like title and insurance or that you are seeing in your best markets, what percentage of sales you think have you been able to attach those services or customers that wanted those services attached so we could think about how big that opportunity could be long-term? Thanks a lot..

Wow! That was fast. Well done, Mark in rapid fire.

I think it’s between 10% and 20% of all sales will be through iBuying but that is a wild guess in part because we don't know what the cost of capital will be as such and a historical cost of capital today that is created this market, Middle Eastern money, Far East money, all sorts capital coming in at almost no cost, so we can easily provide liquidity to a consumer who has no other way to get it.

I'm not sure that will always be the case. So, we need to see the margins of this business that allow and understand the true cost to the consumer, because right now there is so much money been thrown around but it’s hard to say what the value proposition will be two years from now. No brand advertising in 2019. For the remainder it is seasonal.

You pay a lot to advertising in Q4 especially because there's so much holiday shopping and people forget the ads that you ran and home buying comes around the next year.

I would comment that we think most of our traffic growth is unrelated to advertising because the ads focus so much on the brokerage, but also because we don't see significant traffic lift in the markets that run ads. It is a broader phenomenon on the net. And then the final question was about attach rates for title and mortgage.

We feel a little cagey about that. But I would think of them separately because title is something where consumers have almost no preference. They don't do much price shopping. We do offer the best deal of course, because of our consumer advocacy.

So we think that attach rates can be above 50% whereas mortgages it really depends on how efficient we can get because we have to compete on price. We have seen encouraging results there, but nowhere near 50% for mortgage and none of our models have that baked in..

Thank you. Our next question comes from Brent Thill with Jefferies..

[Shyamal] on for Brent.

Just on the market share gains in the quarter, anything specific to call out as to what drove the acceleration there, mostly driven by the marking campaign or may be an improvement in agent efficiency? And then Glenn just wanted to get your thoughts on the recent partnership between Amazon and Realogy whether you think that signifies a bigger push by Amazon into real estate may be how those dynamics may play out?.

Sure, I don’t think our market share gains are driven by efficiency. I think they're driven by increased demand. So we're having more people come to our website and more of those people signing up for home tours, the only challenge we really have is getting them to stick with the brokerage and buy a house because there's an affordability crisis.

And because people just hit a button on their phone and see a property without thinking a thing of it. So the market share gain just has to do with our increasing presence online and an increasing affinity for the service.

I wouldn't attribute much to mass media, it's sort of like a Delayed Blast Fireball, if you've ever played Dungeons and Dragons, we get more of the benefit in following years. We get some now, but really, there was just a very broad lift in mass media markets and outside those markets.

So the Amazon and Realogy deal, nobody is more afraid of Amazon than me. I mean, those guys are animals. What they're doing here I'm not sure is a really serious move into the real estate market. They're giving away merchandise that some people will want that some people won't care much about.

I don't think a senior executive who is really involved in that deal. I don't think there are major demand channel for people seeking real estate services. You see deals like this from USAA and Costco or big retailers, or insurance companies, they will save you a few bucks if you sign up their real estate agent through us.

And I see this deal is similar to that. If Amazon were to get out of putting goods in boxes and shipping them to your doorstep to deliver soft services like real estate, I think that would be a different kind of challenge. But it is well outside their strikes zone..

Our next question comes from Keith Terry with Goldman Sachs..

Great, thanks. I was wondering if you give me a sense here, as we look at the declines in gross profit this quarter in the core business, any expectation or anything that you can sort of give us in terms of what's driving that particularly as we see the improvements in agent efficiency, just feel like those two things are potentially a bit counter.

And as we look towards the second half, obviously see the leverage coming out of the changes in marketing spend but wondering if we should expect to see anything on the growth line as well there?.

So on the gross margin line, if you're looking at the second quarter, the biggest headwind was related to home touring and field costs.

And the way to think about that is that we do have a lot of top of the funnel customer demand, people who are interested in particular in purchasing homes, that has us incurring an expense, the two of those customers through homes. And as Glenn mentioned on the call, we're still not seeing the kind of close rate improvement we would like over time.

So we're incurring the expense of not getting all of the revenue that we would like to over time. And so that's the biggest, single headwind that we have in the second quarter as it relates to gross margin, specifically in the Real Estate Services portion of the business.

And then I did provide a little bit of commentary on the call as it relates to what to expect in the third quarter. We do expect to see some of that continued headwind.

And what we would like investors to think about and our best view on the third quarter is that real estate gross margin will be slightly down to flat year-over-year as we get into the third quarter..

And I just want to add that there's two components for that. And Chris has described the main one, which is that it’s harder for people to buy a house, they have to see more properties than they did before and some of them get turned off by the high prices.

I think also when you have some acceleration and demand, you're paying it forward, where you're paying more for tours one quarter and hoping it closes in the other quarter, but we want to temper some of those expectations around how many closes we'll get, usually we’re very happy to pay high touring cost because those chickens are going to come home to route.

It is just the every year we are seeing it gets harder and harder especially in coastal cities for people to pull the trigger..

Thank you. Our next question comes from John Campbell with Stephens..

Hey guys. Congrats on a great quarter. Glenn, thanks for updates on Redfin Direct that seems like one of the kind of more compelling long-term opportunities for you guys.

But you made some comments around I guess just further expansion, I'm curious about the pace of expansion and maybe if you could one or two key metrics you guys are going to tracking in this pilot markets that help influence or kind of drive the expansion pace?.

Sure, we think we can expand this business much more quickly than other businesses, because we don't have to hire people to do it. This is technology that can easily scale across the country.

We do have to train the system to understand the vagaries of different markets because we have different data sets and different offer forms about whether to include this contingency or that contingency, but we can scale it pretty fast.

And all we are looking for is, a homeowner who has hired us to sell a house being absolutely thrilled that they got an unrepresented buyer. And therefore, we're able to put more money in their pocket. We have just begun to fight on optimizing the forms.

If you have got a 55 question form that you haven't optimized, I guarantee you the drop-off is going to get much better over time, avoid words like guaranteeing future results, let me temper that. I'm pretty damn confident anything can happen. But I just feel like, we put something up to see if they would work.

We got a better response than we expected. We're scaling it fairly quickly. But at the same time, we are going to go back and put a bunch of data science to figure out exactly where people drop off, what they're getting nervous about and how we can comfort them, so that more and more folks feel comfortable buying a house over our website.

Not everybody is going to do that. I want to be clear on that point but more and more people will..

Thank you. Our next question comes from our Ygal Arounian with Wedbush securities..

Hey guys. Thanks for taking the question. I just wanted to parse into revenue guidance for next quarter little bit. It's up, the revenue growth is up meaningfully over 2Q and looks like the RedfinNow revenue is also stepping up meaningfully.

So is the strength in overall revenue coming more from RedfinNow revenue? Is it strength from both -- Glenn you’ve always given really detailed commentary on the overall market strength or weakness, may be just how we could think about where the overall strength is coming from? And then kind of related as RedfinNow is getting traction and you're seeing a lot of demand for it, you've talked about being a little more afraid of stepping deep into the iBuyer business and you've been more measured there I think most certainly than some of the biggest players.

How do you think about that plan, accelerating that business as we go forward and particularly as it relates to the Opendoor partnership that you can accelerate and step into it more or kind of lean back and work the Opendoor partnership as you continue to steadily rollout….

Sure. So this is Chris. With regards to revenue guidance I really would think about it as two pieces. One is the set of businesses excluding RedfinNow.

And there are really the years playing out the way we expected it to, which is the contributions from the mass media that Glenn talked about, continued traffic growth, those things would set up a period of time in the second half of the year where our revenue growth would accelerate.

And that's exactly what we're seeing as we're getting to that moment. So we're really pleased to see things pulling through on that chunk of the business in the way we had planned for it to happen.

And then the second piece is it relates to RedfinNow Glenn can comment more but what this reflects in terms of our guidance is the kind of pickup that we're seeing from the combination of having purchased homes and then turn around and put those back on the market, but it seems really just across the whole set of markets where we're operating that business have seen good customer involvement in both sets of activities and service reflected in the numbers.

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And I just wanted to talk about my attitude or our attitude towards iBuying. As we tried to make clear over the past six months, the demand is real, and it's very strong. So we are quite committed to this business, but anyone in this business should be scared.

And if they aren't scared, you should be scared, because we are taking significant capital risk. And most of the folks in the space are losing tons of money.

And you have to have a clear path to profit, you have to know exactly how scale is going to let you renovate homes more efficiently, you have to know exactly how you're going to be able to market those homes more directly to the buyer. And it's hard to pull apart.

Because when you're growing really fast, you're paying forward some of your growth, and that limits your margins. But you're also trying to get more efficient. And whenever you're trying to get more efficient and grow at the same time it’s just a real challenge. And so we're just trying to be eyes wide open about those risks.

And I think that's the way you would want us to be. And what drives me crazy about this space is that almost everybody in the space accounts for their margins differently, which makes it harder for you to get an apples-to-apples comparison of who's really making money and who's losing money and how much money they're losing.

That's the reason we invented accounting principles. I wish we would use them more consistently. .

Okay, but just as follow up as you think about expanding into new markets, do you see the pace of that accelerating as kind of see the demand pick up?.

Yes, so we're expanding as fast as we can. That isn't as fast as we would like. And what's limiting this is how operationally intensive business is. So clearly being able to use our own sales force from the brokerage to present RedfinNow offers makes it easier to expand faster.

We already have 500 listing agents in 50 plus markets and we're going to put them to work presenting these offers. But there's also a renovations capability that I think is probably the toughest not for us to crack.

We started using third-party software and switched over to homegrown systems so that we can really have someone walk through the property and say exactly what's wrong with it using an iPhone, and then have a centralized call center, manage all the vendors to have to get replaced fixed up. And just getting that right has been hard.

But the primary signal you should have heard from the call I just probably wasn't as clear about it is that we're trying to hit the gas in almost all these businesses that mortgage was really in purgatory late last year where we couldn't figure out what our margins were going to be and where we should price the product.

We couldn't figure out whether to have centralized mortgage advisors or people out in the field and now we've got good product market fit. With RedfinNow, we really have been questions about margin. We haven't answered all of those but we've answered more and more and we've figured out a really good distribution system through our own agents.

So, we're going to tried to expand more quickly than we have before and what’s going to be gating it isn't by courage or anything like that but our operational capacity. We know the demand is there..

Thank you. [Operator Instructions]. Our next question comes from Naved Khan from SunTrust..

Thank you for the time. This is Robert on for Naved.

Where do you guys think you are in your efforts to optimize lead agent efficiency, to specify you guys mentioned the benefit of increasing customer loads but that conversion rates may be negatively impacted? So, just how should we be thinking about agent efficiency by total transactions or any more color on conversion rates would be greatly appreciated? Thank you..

I think we are in the middle of it. I wish we were at the end of it, but in all candor this is a problem we have been working on for a long time. It affects everyone in the industry. How take someone off a website, click the button and deliver them into the right home, six months later efficiently, has just become a challenge of our times.

And we're much better at it we think than anyone else. But we still need to get even better, because the consumer is changing over the past few years.

She's much more fickle, more worried about prices, struggling harder to be able to buy the home, but also just more casual about ordering a service where you don't have to pay to get a real estate agent to show up.

So, I think we are going to be building significant new systems over the next year and half to make that better that there is some opportunity for leverage in 2020, you've already seen a little bit here, up to 6% productivity increase.

But already thinking about 2021, 2022, it's a long-haul [baby] and I’m really confident that we're going to make progress on this, but I don't want you expect overnight miracle..

Thank you. Our next question comes from Tom White with D. A. Davidson..

A quick on guidance and then a bigger picture one for Glenn. So, may be a question and a half.

Just on third quarter net income, the midpoint implies a low increase year-over-year despite I guess homes and Properties business kind of ramping up pretty quick, and now it sounds like real estate gross margins are sort of flattish to down maybe a little bit versus your prior expectations of maybe up.

So, could you maybe just help to kind of bridge what are the other factors that are contributing to that uptick in net income? Is it other OpEx et cetera? And then just a bigger picture thing, Glenn, I was hoping you could share your current thinking on kind of the positioning of the real estate brokerage space or maybe the vulnerability from lawsuits like the Moerhl versus NAR lawsuit around anti-competition and stuff like that? And then specifically, how do you think you guys are sort of positioned there? Thanks..

I am not sure they will provide a whole lot more in terms of the segregate in the guidance. As we indicated we do think that the chunk of business excluding RedfinNow will continue to grow pretty significantly year-over-year. The gross margin on the Real Estate Services business may be slightly down to flat.

And I think maybe just the third component to call out is that in the second half of the year, we don't believe that marketing expenses will be meaningfully up from the dollar values that were in the second half of 2018. And when we put all those things together, you end up with a mix that looks a lot like our guidance.

So, I think that's probably, the best information to provide there. .

And the lawsuits that you referenced are going to have one effect, which is the websites like Redfin are going to be able to publish how much the homeowner is offering to pay a buyer's agent.

And this has been a battle we've been fighting for a long time, because we refund part of our commission, and it only confuses consumers who think the buyer's agent is free. So we're offering a refund of the service that they think is free, and it limits the appeal of our pricing power.

And so our hope is that once people realize how much a buyer's agent is paying, they're going to think twice about how much they should get from that buyer's agent. And also, I think it's going to increase the number of people who consider buying a home unrepresented.

So just showing where the money goes will always help the people who save the customer money. .

Thank you. Our next question comes from Jason Deleeuw with Piper Jaffray. .

So on the RedfinNow business have you expanded the buybacks at all or is the demand just strong and you kind of kept your buying criteria of the types of homes that's still the same? And then in terms of home sellers that turned down the RedfinNow offer.

How many were -- what percentage or any help you can give us in thinking of what percentage of them then want to use the Redfin agents? And then also, who are the typical sellers to RedfinNow? Are there any categories that you can kind of call out? Thank you..

Got it. So we haven’t expanded the box much. We're fairly disciplined about the kind of homes that we buy and sell, the name of the game here is to make sure you can flip it. Once we get margins right, then we can start experimenting with [wacky] properties.

But the best way to really make money in this business is to know the kind of homes you can sell for more. As for the upsell question, it's such a good question. We know that most people turn down an offer and end up listing the property.

The only challenge we have is that we come in with a low offer from RedfinNow, we told them their baby is ugly, and they're less likely to turn that baby over to us for any other reason. So, I think that we have to get better in that area. They often choose another broker instead of Redfin to list the house.

And today, we don't have many returns from this integrated listing consultation, it used to be that the RedfinNow offer would with and then a few days later we talk about listing the property.

But now it should be one meeting where we can say, look, this is what we will give you for the house now in cash, but we think we can sell this house for more money and put more of it in your pocket. And that should be a more complicated conversation. And I think the customer should view it as a benefit.

Certainly it has already helped RedfinNow offer acceptance to have a real estate agent present that offer and say look, I know the market is a good offer or it’s not. Oh! And then you asked about the typical RedfinNow seller. Most of them are move-up buyers.

We came into this business with the premise that there was more distress or investors where people had gone through a divorce or had a death in the family and they just didn't care about the proceeds or it was an investor who wanted to sell the property from 12 states away.

That happens but more of them are move-up buyers, and that particularly suits us well because we have a lot of buyers agents that are helping people to buy houses and then we see the home of their dreams and say, oh my gosh I got to sell my other place right now so I can have the cash to win this bidding war and then RedfinNow suits them and gives them a liquidity to compete..

Thank you. Our next question comes from Jack Micenko with SIG..

I guess maybe one question for each of you.

Chris, the sort of delta between the $3.4 million and the $6.4 million, what are the swing factors there that would drive that differential? And then, Glenn, in the past, we have seen a lot of commentary from you publicly that talks about how iBuyer is maybe not a lead generation tool and just thinking on the call it sounds like your mind has changed a bit.

Am I interpreting that correctly? Thanks..

The variation on the net income guidance is primarily related to volume, related to the revenue that we would earn in the quarter. We do have a set of fixed costs associated with our agents and our staff. And so as we have different volume levels that’s placed through to the bottom-line..

As for RedfinNow is lead generation tool, I think if you are offering to buy someone's house, you can't bluff. You actually got true intent to buy the house and you have to able to deal with the consequences. So, I would never be so cynical as to say it’s a lead generation tool.

We earnestly when we make an offer want the customer to accept it if it’s in the customer's best interest. But we think that every customer should have a choice and to make an informed choice.

If we're just pitching one product to the other -- I have met too many homeowners who list their property and can't get the place cleaned because they got a dog and three kids because they've anxiety disorder and they worry about where it’s going to sell today or tomorrow and they should not just listing.

They should take an instant offer but I have also -- got also with the people who need the money and you don’t want to be taking advantage of anyone with an offer, unless it's really in their best interest. So my real position on this is that everybody is going to want to know before listing our house what they could get from a cash offer.

If you've got an envelope with a cheque inside of it, in the middle of the a listing consultation, you're not going to able to talk about anything else until people said, what's inside that envelope.

And usually what's inside that envelope is a discount to it because of all the risk that we're taking and some people are going to want to take that risk down themselves and some people are going to grab the money..

Thank you. Our next question comes from Brad Erickson with Needham & Company..

Just a couple. I guess Glenn and I apologize I know you’ve been over this a few times already, I just think it still needs some clarification. You made some comments on the impact of the marketing. It seemed a little bit odd with itself.

So, can you clarify which piece wasn't as good as what you thought versus some of the more positive comments you seem to be describing looking at the next year? And then second for Chris.

Just as we evaluate cash burn, can you help us the impact what's going out with the cash flows in the quarter relative to the core business versus the investments being made in the Properties business? Thanks..

Sure. So, there are three phenomena. Number one, Redfin generally somewhat unrelated to the marketing is growing traffic. It's growing traffic in markets with media, in markets without media, we generally have more demand than we would have hoped for. Number two, the marketing has increased customer demand in year.

But it has not increased it as much as we could have hoped. It's been good but not great. And then number three, the awareness gains have been wonderful. And the whole way we tried to set up the marketing investment, we're not selling an ab cruncher where we're trying to get you to pick up the phone right now and order three of them.

We know that most people think a long time about whether to buy a house. And so we have a multi-year model for ads being profitable, where awareness is extremely important. So we wanted to be candid with you and say the in-year contributions, the first response from some customers has been good, but not great. And the awareness gain has been great. .

And just in terms of cash, you do see us using our cash in the second quarter to buy homes, to buy inventory recorded on the balance sheet. As I mentioned on the call, we do now have a facility in place that we will use for funding some of those purchases going forward. And so that should reduce our cash utilization there.

There's just one more call out I wanted to make related to the cash flow statement in the second quarter. And that's that we did set up a set of investments that are recorded as short and long-term assets, where we have funds that were previously in cash invested.

And so you see that influencing the way that statement looks?.

And just maybe just a quick follow if I could. Is there any disclosure in terms of like the homes you bought and sold or held in the quarter? Thanks. .

There's no further disclosure on details on the numbers associated without beyond the inventory dollar values. .

Our next question comes from Brad Berning with Craig Hallum..

Can you compare and contrast the factors that are driving in markets where you're gaining market share faster than the company average? And what are the key attributes that drive the inflection points when markets start to accelerate?.

So I think the factor that we haven't completely addressed is just operational excellence. And we have someone running that market really well with a crackerjack team of agents. There's no way to really characterize that in the earning scripts, but it makes a difference. Other than that, it's traffic, media and conversions.

And there are markets where we do better in terms of traffic, there are markets where we're spending more on media, conversion is fairly consistent. So it's just a combination of things. And of course, you have to understand the vantages of our markets, the places where we've been the longest have the highest share.

But because it's a retail business combined with an online business, the markets that we opened five to 10 years after other markets that have lower share, and I'm assuming that most folks on the call understand that. .

Yes, no, I mean, the pace of share gains, I think some of the markets have been in the longest not just have the largest share but they're also growing the fastest share.

So I'm just wondering if there's a repeat and referral component to an inflection point of time in a market, if that's part of the factor, as well?.

Yes, I think there is two components to critical mass and one is that, you get credit for time served as a brokerage. It can be hard business to cold start unless you're doing a rollup of some kind.

So, eventually you have customers who bought a home from you five or six years ago who come back and certainly you have customers to refer and that has been a major driver of our growth.

The second part of critical mass is just brokerages are intrinsically viral that you cannot sell one customer’s house without that customer running an ad for your brokerage to sell other houses, that's the yard sign. And what we have seen is that the media is more effective.

Once there is some validation, you see the billboard or hear the radio jingle, but then notice the yard sign in the neighbourhood or hear from friends that she went on a tour and it was fantastic.

So, we do think that there's some compounding effects that have been the reason that instead of kind of growing really fast and then tailing off, we've been able to sustain strong share growth even in markets where people are sort of feeling or reach some kind of asymptote we haven't..

One more question. This is it. You get to close the show..

Ladies and gentleman, as we are out of time, we will take our final question from Tom Champion with Cowen..

Thanks guys. I guess the question is around agent productivity and the 6% increase year-over-year that's really positive but falls below I think it was 12% or 13% increase in the customer aging cap.

And I'm just curious if that delta represents something that's kind of structural or the declining success rate that you've talked about or whether or not you can kind of chip away that delta going forward.

Any thoughts on that would be really helpful?.

I should be clear just because we are candid about our challenges doesn't mean we are confident about addressing them. We think that agent productivity gross margins are on inexorable march up. There will be some bumps in the road that we think they are going out.

And you're right, the challenge is that there is a change in the homebuyer, and that homebuyer is more fickle. They’re having hard time affording the house. They have a different relationship with any kind of service that they order online, where they just kind of shrug and hit the button.

And that's the reality that we're working we are going to better each year. So, it won't be a short journey, it will be a long journey, but it is a journey headed up.

And the fact that agent loads have increased more than agent productivity it’s indicative of the fact that you’ve just got more and more people clicking this button to go see a house and more of them realizing holy-molly, I don't have to go to buy it. .

So, that's it. Guys I just wanted thank you, they are brilliant questions. It was so fun answering them. We are going to go work our fanny off to kill it in Q3. Thank you, everyone..

Ladies and gentleman, this concludes today's presentation. You may now disconnect your phone lines..