Good day, and welcome to the Redfin Corporation Q2 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Meg Nunnally. Please go ahead, ma'am..

Thanks, Cody. Good afternoon, and welcome to Redfin's financial results conference call for the second quarter ended June 30, 2022. I'm Meg Nunnally, Redfin’s Head of Investor Relations. Joining me on the call today is Glenn Kelman, our CEO; and Chris Nielsen, our CFO.

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. On this call, we will present non-GAAP measures when discussing our financial results.

We encourage you to review today's earnings release, which is available on our website at investors.redfin.com, for more information relating to our non-GAAP measures, including the most directly comparable GAAP financial measure and related reconciliation.

All comparisons made in the course of this call are against the same period in the prior year, unless otherwise stated. Lastly, we will be providing a copy of our prepared remarks on our website by the conclusion of today's call and a full transcript and audio replay will be also available soon after the call.

With that, I’ll turn the call over to Glenn..

beautiful homes on corner lots still sell readily, but the homes with funky layouts now don’t sell at all. In lieu of publicly reported price drops, builders are funding lower mortgage rates, paying closing costs, doubling agent commissions, buying washers and dryers, and upgrading kitchen finishes.

One reason prices are falling fast is the fraction of inventory now being sold by iBuyers, builders and other institutions, which has increased from about 27% in 2017 to nearly 35% in 2022. Redfin knows from our experience as a broker that people who’ve lived their whole lives in a home just aren’t going to mark it down after a few weeks.

But iBuyers price the listing below every current comparable, and price it even lower if it doesn’t get an offer in the opening weekend; builders also respond to market downturns quickly. This makes market corrections sharper, but maybe also shorter too. The good news is that buyers are already responding to drops in prices and mortgage rates.

The market-wide data on sales closed in July and August will reflect how far demand fell in June, but now demand has modestly improved in the second, third and fourth weeks of July. It may improve further, as mortgage rates dropped this week to around 5% from a peak north of 6% in June.

If the housing market and the overall economy can stabilize, many, many Americans still want to move, and we’re here to help them, with low fees and the best service in the brokerage industry. Take it away Chris..

Thanks, Glenn.

This was a volatile quarter, and we’re being responsive to the changing macro environment and taking actions to manage towards profitability, including reducing the number of homes we purchase through our properties segment, laying off employees in our headquarters, real estate services and mortgage businesses, and limiting backfills for voluntary attrition.

Second-quarter revenue was $607 million, up 29% from a year ago and below the low end of our $613 million to $650 million guidance range. The difference was due to a quicker than anticipated decline in refinancing and purchase-home volumes for Bay Equity.

Real estate services revenue, which includes our brokerage and partner businesses, generated $252 million in revenue, which was flat year-over-year and in-line with guidance. Brokerage revenue, or revenue from home sales closed by our own agents, was up 1%, driven by home price appreciation, while transaction volume was down 2%.

Revenue from our partners was down 23%, on a 13% decrease in transactions and mix shift to lower value houses. Overall, real estate services revenue per transaction was up 4% year-over-year.

The properties segment, which consists primarily of homes sold through RedfinNow, generated $263 million in revenue, up 52% from a year ago and driven by a 45% increase in homes sold. Our rentals business generated $38 million, down 10% from a year ago, but up slightly from the first quarter of 2022.

As Glenn mentioned, this marks the first quarter of sequential revenue growth for this business in many years. Our mortgage segment generated $53 million in revenue in the second quarter. This was below our guidance range as discussed above, but we’re thrilled with how Bay Equity loan officers have been serving Redfin customers.

Our other segment, which now includes title, and other services, contributed revenue of $6 million, an increase of 72% year-over-year, driven by increased attach rates for our title and closing services. Total gross profit was $118 million, down 6% year-over-year, with a total gross margin of 19.4%.

Total operating expenses were up $36.2 million, or 23% year-over-year. $23.6 million of the increase was attributable to the acquisition of Bay Equity, our mortgage business, as well as restructuring expenses incurred in the quarter. As a percentage of revenue, total operating expenses represented 32%, down from 33% one year ago.

Technology and development expenses increased by $10.0 million, or 24% year-over-year. Included in the increase was $0.7 million from Bay Equity. The remaining increase was primarily attributable to an $8.7 million increase in personnel costs due to increased headcount.

Total technology and development expenses represented 8% of revenue, down from 9% one year ago. Marketing expenses increased by $1.3 million, as compared with the same period in 2021. Included in the increase was $1.8 million from Bay Equity.

The remaining decrease was primarily attributable to a $1.9 million decrease in outside services and recruiting, offset by a $1.5 million increase in personnel costs. Total marketing expenses represented 9% of revenue, down from 12% one year ago.

General and administrative expenses increased by $12.2 million, or 20%, as compared with the same period in 2021. Included in the increase was a $8.4 million from Bay Equity, a $3.2 million increase in legal expenses, largely due to a settlement offer, and a $3.1 million increase in personnel costs due to increased headcount.

This was partially offset by a $4.2 million decrease in acquisition-related expenses. Total G&A expenses represented 12% of revenue, down from 13% one year ago. Restructuring expenses included in total operating expenses were $12.7 million, and there were no such expenses in the same period in 2021.

These expenses were attributable to $2.4 million in severance and other costs associated with our mortgage restructuring, and $10.3 million in severance costs associated with our June 2022 workforce reduction. Turning to segment level profitability, real estate services gross margin was 29.4%, down 550 basis points year-over-year.

This was driven by a 670 basis point increase in personnel costs and transaction bonuses. This increase was offset by a 210 basis point decrease in tour and field costs and 50 basis point decrease in listing expenses. Total net loss for real estate services was $18.8 million, down from net income of $7.8 million in the prior year.

The decrease was attributable to lower revenue and margins, as well as a $12.5 million year-over-year increase in operating expenses. These expenses were added during a period of rapid growth in our real estate services business, and we have begun to pare back with the restructuring announced in June.

Properties gross margin was 2.6%, down 30 basis points year-over-year. This was driven by an 80 basis point increase in purchase, maintenance and capital improvement costs. This was partially offset by a 50 basis point decrease in personnel costs as the business scaled.

Total net loss for properties was $3.2 million, down from a net loss of $1.4 million in the prior year, with the increase in operating expenses slightly exceeding the increase in gross profits. Rentals gross margin was 79.3%, down 290 basis points year-over-year.

This was driven by a 180 basis point increase in personnel costs as we sold more marketing services that require personnel to fulfill. Total net loss for rentals was $19.2 million, down from a net loss of $14.1 million.

Declining profitability was primarily attributable to year-over-year declines in revenue as discussed earlier, while operating expenses remained roughly flat at $49.8 million compared to the $49.3 million in the prior year. Mortgage gross margin was 12.8% for the second quarter, below our implied guidance of 31% to 36%.

This was driven by lower refinancing and purchase volume from Bay Equity's historic business. Total net loss for mortgage was $6.5 million. We acquired Bay Equity on April 1 of this year and completed the wind-down of our legacy mortgage business during the second quarter of 2022.

Wind-down activities contributed approximately $4.9 million to the segment's net loss. $1.6 million is attributable to day equity. Other segment gross margin was negative 0.1%, an improvement from the negative 6.1% a year ago. Total net loss was $2.1 million compared to a net loss of $1.1 million in the prior period.

Turning back to consolidated results. Total net loss of $78 million was below the low end of our $72 million to $60 million guidance range. Our guidance didn't include $10.3 million of restructuring expenses for our June payoff.

Diluted loss per share attributable to common stock was $0.73 and compared with the diluted loss per share attributable to common stock of $0.29 per share one year ago. Now, turning to our financial expectations for the third quarter of 2022.

We Consolidated revenue is expected to be between $590 million and $627 million, representing year-over-year growth between 9% and 16%. We expect our real estate services segment to account for $200 million to $208 million of that revenue and the property segment to be between $305 million and $330 million.

Rentals revenue is expected to be between $37 million and $38 million. Mortgage revenue is expected to be between $45 million and $48 million. Total net loss is expected to be between $87 million and $79 million compared to total net loss of $19 million in the prior year. Adjusted EBITDA loss is expected to be between $47 million and $39 million.

We expect real estate services gross margin to decrease in the third quarter compared to the same period in 2021. In prior earnings calls, we discussed operational changes we were making that were intended to increase real estate services gross margins in the second half of 2022.

However, deteriorating macroeconomic conditions have overshadowed these operational changes, and we now expect gross margin compression. With respect to properties, we expect gross margins to be negative in the third quarter as we work through selling inventory that we purchased earlier in the year. We expect inventory to peak in August.

We want to continue to offer a choice to customers, but we're being more conservative on offer prices right now. With respect to mortgage, we expect gross margins to be roughly flat to slightly down quarter-over-quarter.

On a consolidated basis, this guidance includes approximately $37 million in total company marketing expense, $19 million of stock-based compensation, $6 million of depreciation and amortization and $5 million of interest expense. In addition, we expect to pay a quarterly dividend of 30,640 shares of common stock to our preferred stockholder.

This guidance assumes, among other things, that no additional business acquisitions, investments, restructurings or legal settlements are concluded that there are no further revisions to stock-based compensation estimates. And now let's take your questions..

Thank you. [Operator Instructions] We'll take our first question from Brian Mecke with Selman & Associates. Please go ahead..

Hey, thank you very much. Glenn and Chris, appreciate all the detail and commentary on the levers in the business. And certainly, the comment about the potential impact to the real estate gross margins next year for removing the buyer refund is encouraging. I wanted to ask one more on the real estate gross margin and some of the levers.

So a comment you guys have in your filings in the 10-K is that, the real estate gross margin is generally higher in some of the top markets and generally lower in smaller markets.

So, I guess, I'm curious on kind of the levers that you guys can pull, how do you think about those smaller markets that maybe are subscale or lower margin and pushing for growth in actual brokerage business versus potentially leaning more into the partner channel to potentially kind of grow through less brokerage specific growth and brokerage specific costs, and then maybe more so leaning into the partner business, which I believe is kind of a higher-margin lead gen business.

So again, just curious if you can talk about the balance there between kind of brokerage and partner, and if there are additional levers that you guys can pull and maybe how that compares between the bigger markets and some of the smaller markets? Thank you..

Well, we're going to manage the business to maximize gross profit dollars per customer. So, as these smaller markets grow, their prices are also increasing, which will increase both the gross profit contribution and their gross margin.

The reason that, we often want to serve customers through our employees is because our employee agents have higher close rates to have higher loyalty rates.

I mean, they generate more gross profit per customer, but we are going to be financially disciplined about it if we feel like a partner can serve the customer well and generate more gross profit, we'll do that.

We've been raising thresholds throughout the month of July, just because demand has been stronger than we expected immediately following our layoff. So there will be a modest shift toward the partner business, at least in the first part of the third quarter..

Got it. Okay. Thanks very much, Glenn, that's helpful. And then, Chris, one just kind of big picture on the cash flows. I guess looking ahead and thinking about the convertible debt, I guess maybe, if you can just give us a big picture sense of how you guys are thinking of ultimately managing the cash flow side of things.

And obviously, the maturities are quite a ways away, but I think to some degree, people are just curious how you think about managing the cash from now in the coming years with those maturities on the horizon? Just any big picture thoughts there would be helpful..

Yeah. I think that, the commentary on our capital matches with Glenn's commentary and our march to profits here, the way we think about continuing to drive the business forward is increasing our profitability into 2023, into 2024 reaching net income positive in 2024.

And that sets the stage then for us to feel really good about the capital position that we'll have start to become mature. So I do think of these things as naturally matched up that way and not separate topics..

Thank you. We'll take our next question from Mark Mahaney with Evercore..

Thanks, Brian..

And we’ll take our next question from Mark Mahaney with Evercore ISI..

This is Jan Lee [ph] for Mark Mahaney. Thanks for the question. I just wanted to -- the one thing to clarify, sorry if I misheard that. But was I buying the gross margin you're expecting to be negative in Q3 with some mentioned some headwinds.

But on a full year basis, you're still expecting it to maintain positive gross margin, did I hear that right? And if you can just talk through the leverage in the business to support margins, especially if the current trends persists. Thanks..

Well, we're assuming that prices will continue to decline and the business will still generate significant gross profit for the full year. So the levers for the business are making sure that we react quickly to the market, lowering our bids on the homes that we're buying now.

Obviously, we also want to convince the customers who ask us about a Redfin, now offer and decide that the offer is too low to instead list the home with Redfin, which is working out better than it ever has, at least in June. So mostly, we just want to sell the homes quickly, renovate them well.

Sometimes we've been backlogged in 2020 and 2021 and haven't been able to get the properties on the market because we can't just get somebody out there to fix it up. But now we've got good capacity. The homes are selling quickly. We're going to reach peak inventory next week.

And then we know it's downhill from there just because we already have so many homes under contract, so I think we've got good visibility here. It would take a fairly apocalyptic price drop for us to swing into negative territory for Redfin nw. We've already factored in significant price declines..

Got it. That's helpful. And if I may, one more on just the marketing spend this quarter. I saw some leverage here. So if you can -- is that like a kind of a pullback in marketing spend, if you can talk through kind of the efficiencies of the brand campaign..

Yes..

Okay..

It's more seasonal. We probably stepped back a month early from our TV campaign because just the tone of the campaign didn't match the mood to the American consumer. It was just about a frenzy housing market coming into 2022. And that market has become less frenzy.

But other than that, we've been advertising fairly aggressively, actually shifting some dollars toward the 1% campaign, which is resonating well. Mostly that we just planned in the advertising campaign in the summer, we've done that every year..

Okay. Thanks a lot, guys..

Thank you [Operator Instructions] We'll take our next question from Jason Helfstein with Oppenheimer..

It's [indiscernible] on for Jason Helfstein. So two quick questions. If we were thinking about real estate as a top of the funnel driver for the rest of the business, how do you think about long-term gross margins and EBITDA margins for real estate, assuming other segments will limit spending amount on marketing.

And the second question is, are you making any further changes to the way you compensate agents. Thanks..

So the brokerage has been an engine of profit for the company. It generated significant adjusted EBITDA last year, as you can see in this new segment reporting, and it should remain that way.

So we had too many agents in the second quarter that swung us to an adjusted EBITDA loss of that business, but we view that as an intolerable situation long-term. So we're not going to think about the brokerage is a loss leader for getting a loan or a loss leader for doing the title.

We want that business to have its own high gross margins north of 30%. And then we just want to monetize that customer again and again through mortgage and title, we'll deliver more value to the customer, we'll offer them a great rate on the loan. And because we have employees, I think we're more capable of selling a complete real estate solution.

So we don't want to back off at all on brokerage gross margins just because we have these ancillary businesses.

And that's evidenced by the price increase where we're eliminating the commission refund in 22 markets and possibly extending that further? And then on the second question I don't know, Chris, do you want to answer that first? I'd be more in your wheelhouse?.

I'd like to go ahead, Glenn. Can you just rephrase the question? I want to make sure I understand it..

Yeah. No, totally. So given like the recent layoffs, are you like incrementing any more changes on the way you pay your agent.

Oh, on agent pay. Yeah, yeah. Not really, we adjusted how much we pay our agents at the beginning of the year because we were lowering loads in anticipation of having better close rates. We've seen that of the customers who buy, they are sticking with us at a higher rate. So that's been encouraging.

We have been waiting for two years to get a result from that effort. And now we have one. But other than that, we aren't making major changes to agent pay..

Thank you. That's helpful..

Thank you..

Thank you. [Operator Instructions] All right. With no additional questions in the queue, that does conclude today's question-and-answer session. It also does conclude today's conference. We thank you all for your participation. You may now disconnect..