Zillow Group Inc (Z) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Zillow Group Q2 2018 Earnings Call.

(Operator Instructions) And as a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. RJ Jones, Vice President of Investor Relations.

Sir, you may begin.

Thank you.

Good afternoon, and welcome to Zillow Group's Second Quarter 2018 Financial Results Conference Call.

Joining me today to discuss our results are Zillow Group's Chief Executive Officer, Spencer Rascoff; and Interim Chief Financial Officer, Jennifer Rock.

During the call, we will make forward-looking statements regarding future financial performance, operations and events.

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee these results.

We caution you to consider the risk factors described in our SEC filings, which could cause actual results to differ materially from those in the forward-looking statements made on this call.

The date of this call is August 6, 2018, and forward-looking statements made today are based on assumptions as of this date.

We undertake no obligation to update these statements as a result of new information or future events, except as required by law.

During the call, we will discuss GAAP and non-GAAP measures.

We encourage you to read our financial results press release, which can be found on our Investor Relations website, as it contains important information about our GAAP and non-GAAP results, including reconciliation of non-GAAP financial measures.

Starting this quarter, we will communicate details of our financial results and other developments in a quarterly update letter, which we made available in the Quarterly Results section of our Investor Relations website.

We will notify the public via press release when the quarterly update is available for download, and we'll continue to host a live conference call and webcast dedicated primarily to answering your questions about the business and results.

We hope you like this change.

In our remarks, the non-GAAP financial measure adjusted EBITDA is referred to as EBITDA, which excludes other income, depreciation and amortization expense, share-based compensation expense, acquisition-related costs, interest expense and an income tax benefit.

We will open the call with brief remarks, followed by live Q&A.

In addition to taking questions from those dialed into the call, we will answer questions asked via Slido.

We encourage you to visit www.slido.com, where you may submit questions by entering the event code #ZEarnings.

On Slido, you may vote on which submitted questions you want us to answer.

This will ensure that we prioritize the questions that you consider most important.

You may begin submitting questions and voting now.

This call is being broadcast to the Internet and is accessible to the Investor Relations section of Zillow Group's website.

A recording of the call will be available later today.

I will now turn the call over to Jen.

Thanks, RJ.

For the second quarter of 2018, Zillow Group reported revenue of $325 million, which was in line with our expectations and up 22% year-over-year.

This growth was driven primarily by our Premier Agent, Rentals and New Construction marketplaces.

Second quarter Premier Agent revenue of $231 million came in just above the high end of our guidance range.

On a consolidated basis, GAAP net loss for the quarter was approximately $3 million or 1% of revenue, and EBITDA was in line with our expectations at $56 million or 17% of revenue.

Now turning to our outlook for the full year of 2018, I'll walk you through a few changes we've made, starting with revenue.

We now expect full year 2018 consolidated revenue to be in the range of $1.32 billion to $1.35 billion.

This outlook does not reflect any revenue related to the proposed acquisition we announced today.

The largest change in our revenue guidance is a result of adjusting our 2018 projections for the Homes segment.

We now expect full year Homes revenue to be in the range of $20 million to $40 million.

Home sellers are maximizing the flexibility that Zillow Offers provides them when selling their homes.

The adjusted outlook reflects the impact of the extended period of time between offer acceptance by sellers and closing of the sale to Zillow, which is longer than we originally anticipated.

For Premier Agent revenue, we raised the low end of our full year 2018 guidance range to $921 million while maintaining the high end of the range at $927 million.

For Rentals revenue, we have adjusted our guidance range for the year to $136 million to $138 million.

To adequately grow this marketplace, we need to increase listings as well as the size of our multifamily sales team.

We've also prioritized our focus to take us deeper down funnel in Rentals, including renter applications and rental payment processing.

Finally, we are adjusting our full year 2018 consolidated EBITDA outlook to $237 million to $253 million.

In addition to the revenue changes I've discussed, this change also reflects increases in headcount-related expenses, primarily due to higher costs to recruit talent, incremental headcount to support the expansion of our Homes business and initial projections for new hires associated with the integration and ramping up of the proposed acquisition we announced today as well as increased end-of-year brand advertising expenses.

These are a few key points we cover in more detail in the quarterly update letter.

I'll now turn the call over to Spencer.

Thanks, Jen, and thanks, everyone, for joining us.

If you read our quarterly update, you will know that we've got a lot to be excited about here at Zillow Group.

Our Premier Agent business is strong and undergoing exciting changes that position it for long-term growth.

We are moving beyond lead generation and actively evolving toward being a deeper funnel real estate industry partner.

Before the end of this year, our new consumer lead validation and distribution process will be rolled out nationwide and ahead of schedule.

This process has the potential to significantly increase the amount of commissions generated by our Premier Agents, as they successfully close more transactions with consumers who connected with them on our platform.

The second quarter of 2018 marked a major milestone in our company's history.

We launched our Homes business and began buying houses directly from homeowners in 2 cities through our Zillow Offers program.

We also announced today that we reached an agreement to acquire Mortgage Lenders of America or MLOA, a national mortgage lender.

The launch of our Homes business, coupled with the proposed acquisition of MLOA, are great examples of how we are executing strategically to become more of an end-to-end provider for housing-related services, with a focus on the massive opportunities ahead.

Moving further down funnel toward the transaction and beyond simple lead generation is both an exciting and challenging transformation.

When we complete this evolution, we expect to be operating a larger and stronger business that is integrated into the consumer's entire home life cycle.

To put everything in perspective, we'll be working closer with our industry partners to guide consumers as they, number one, buy or sell a home.

Note that housing annually generates $1.8 trillion in transaction value, with tens of billions of market opportunities in advertising and services; number two, finance the purchase of a home.

Mortgage lenders underwrite $1.1 trillion of purchase loans each year, which drives tens of billions of dollars in origination and advertising market opportunities; number three, rent a home.

Rental properties generate nearly $500 billion in rent payments annually, which drives tens of billions of dollars in advertising and services for property managers, landlords and tenants.

These are all large and expanding markets in which we will now be active participants, not simply a place to advertise.

We are shaping the way consumers buy, sell and rent homes.

Consumers desire a simpler and more flexible home buying, selling and renting process.

Zillow Group is committed to creating fantastic consumer experiences and developing innovative technologies and solutions like Zillow Offers and, with today's announcement, the potential for mortgage originations.

We're excited about the expanding long-term opportunities in front of us and our growth as we continue to innovate in the housing sector, one of the largest portions of our economy.

With that, Jen and I will open up the call to your questions.

Operator, please go ahead.

(Operator Instructions) And our first question comes from the line of Ron Josey with JMP Securities.

And our next question comes from the line of Mark Mahaney with RBC Capital Markets.

Two questions, please.

You talk about the closing taking longer than anticipated in the Homes segment.

Is that just the reflection of a tight housing market overall and just the challenge that people are facing in terms of buying the homes that they want at the right price?

So just explain that.

And then, secondly, you referred to -- in the letter to the -- in the last month, slightly greater agent advertiser churn in the markets where you've rolled out this new lead validation and distribution process.

Could you explain why you think that's happening and how long that could be happening for?

Sure.

Thanks, Mark.

To -- the first question is about the timing on the Zillow Offers business.

When we started this business a couple of months ago, we had lots of data, which helped us forecast seller interest in the product from consumer research and from our marketplace model, where we tested a third-party marketplace for about 1 year.

But, of course, we had no data on how long it would take from when a seller said yes to when a seller actually puts the house to us.

You can think about what we're really selling to sellers is a put option on their home.

And when we reach agreement with them, they then put the house to us when they're ready to close.

We have forecast that, that would be very brief, a matter of a couple of days from handshake with a seller to when we will close.

It's actually turning out to be more than a month, and that's delaying revenue because we don't get the keys for 4, 6, 8 weeks later than we expected.

And then the renovation starts later, and then the relisting starts later, and then the revenue generation for when we resell the home occurs later.

As I mentioned in the shareholder letter, all of this actually benefits the unit economics of the Zillow Offers business because it allows us to ready ourselves for the renovation in advance of even taking possession.

So we get a running start before we come up to the starting line.

And that's one of the reasons that we're selling the homes much faster than we originally forecast, because we're getting a head start because of the delayed closing on the initial purchase of the seller's house.

In terms of the reasons why that's happening, Mark, I think some of it is probably due to a tight inventory market, where a seller now has to go out and look for a home and it takes a while to find a home that matches her criteria and that she can get a mortgage originated for.

Note, it would be helpful if we could help originate that mortgage.

That would certainly facilitate her transaction more readily.

But part of it also is just the ease that we're providing to the seller, where the seller is now taking advantage of the fact that she can rest easy and choose to close anytime in the next month or 2, and that's just delaying the starting time.

So it's nothing fundamental about the Offers business.

It's just -- it pushes revenue out a little bit, but it actually improves the unit economics.

In terms of the Premier Agent question, when we think about what we're doing on this new lead distribution system, we're switching from a one-to-one concept to a one-to-many concept, wherein we call Premier Agents serially until we are sure that the consumer can get on the phone with a Premier Agent.

Remember, these are not -- these Premier Agents aren't just advertisers.

They're really small business owners that have built their business on our platform.

And every time we change the rules on them, even if it's well-intentioned and even if it's long-term beneficial for them and long-term beneficial for the consumer and long-term beneficial for Zillow Group, anytime we change the rules, that can cause pushback in the system.

When we first started rolling this out to the first couple of cities, we got that pushback because we weren't adequately explaining the benefits to Premier Agents of this new system.

We were instead focusing on the benefits to the consumer.

And the benefits to the consumer are clear, they are sure to get a Premier Agent on the phone.

The benefits to the agent are also quite clear.

They are that agents get more signal and less noise.

They are able to only answer the phone when they want to work a lead rather than answering the phone on every lead that is sent to them.

But we have gotten much better at articulating the benefit to Premier Agents, and so the last couple of markets that we've rolled out were received very, very well, much better than the first couple of markets.

When we roll out Florida later this week, I'm optimistic that it will be received well, and we're going to beat our goal.

We have told you that we would finish this rollout by the end of the year.

We're going to beat that.

And I think when all of it is said and done, we're going to be in a much better position than we were previously.

And our next question comes from the line of Tom White with D.A. Davidson.

Just one on Instant Offers and agent commissions.

I guess, could you talk a bit about the role of the agent in the product and how that may evolve over time?

Some of the other kind of iBuyers out there kind of rely on not having to pay agent commissions.

How important is it to the profitability of your Homes segment to maybe not have to pay full agent commission when you resell homes?

And then on the acquisition, maybe just talk a little bit about how it integrates, maybe more color about how it integrates with the Homes segment and how it may impact the model and profitability of that segment over time.

Thanks, Tom.

We think we can make a lot of money in the buying and selling of Homes business by charging sellers a fee, doing a light remodel, paying agent commissions in the transaction and turning our capital 4 or more times a year, so having a pretty short hold time.

So we're very comfortable having agents in the transaction.

We think most other iBuyers are also paying agent commissions in the transaction.

But I can also speak to our unit economics, which are attractive at, albeit at a low margin, high-volume game.

The mortgage business provides an opportunity to monetize the Zillow Offers business even further.

So just what we intend to do here is, on a Zillow-owned home, when we're reselling that to a consumer, we will provide mortgage origination for a homebuyer of a Zillow-owned home through MLOA, which we'll rebrand post closing as Zillow Mortgages.

So just to give you some napkin math for a second.

About 400,000 homes sell a month in the United States.

If Zillow Offers is buying and selling, say, 10,000 homes a month, that's about 2.5%, 2% or so of the market.

If we're doing that type of home buying and selling volume, homebuilders typically have a 75% attach rate on their in-house mortgage of homes that they're selling.

At a 75% attach rate on 10,000 homes a month at 9,000 in revenue per mortgage origination, that's $67 million a month of mortgage origination revenue or about $800 million a year.

So for anybody who is wondering why we just bought a mortgage lender, just to hit some of those numbers again, at a mere 10,000 homes sold a month from Zillow Offers, a 75% attach rate gets to over $800 million a year of revenue opportunity for mortgage origination.

In addition, it allows you to sell the home faster, which, as we've talked about extensively with investors, that's critical to improving the return on equity of the Zillow Offers business.

And then the final piece I just want to point out on Zillow Offers is the opportunity to create a listing lead generation business for our Premier Agent is significant.

So take a step back.

We think the core Zillow Offers business can be profitable with commissions.

We think the mortgage origination opportunity is large.

We think the sell-side listing lead generation for Premier Agent opportunity is large as well.

And I'm very, very pleased with the progress we've made so far in Zillow Offers after just a couple of months.

And our next question comes from the line of Heath Terry with Goldman Sachs.

Just, Spencer, a little bit on the -- I know we're spending a lot of time on Zillow Offers, but a little bit on the core business.

How do you -- how should we think about the 4% visit growth -- or user growth that we saw this quarter and the low teens visit growth that we saw?

How indicative of that is sort of what you're seeing in the top of the funnel or I know you guys referenced the mid-funnel?

And how much of an impact do you think you -- or will be able to have on that kind of growth with marketing?

How much of this is penetration, which you sort of alluded to in the letter versus just sort of where we are in your marketing budgeting?

It's a little both.

As you point out, I expanded on this a little bit more in the letter where I said, look, at some point, we're going to hit a unique user max in the United States, where there's only a certain number of people and machines and phones that will go to a real estate website every month.

I don't know what that number is.

I'm not satisfied with 4% user growth at the top of the funnel, and we're working very hard to improve that, and I think we can, especially Trulia and HotPads, which had just okay unique user numbers this quarter.

Mid-funnel and deep funnel, I think I am much more confident that there's a lot more opportunity there than even top funnel, and I am optimistic that some of our personalization, reengagement, database marketing initiatives and other product improvements across a couple of our different brands are going to be able to allow visits and commerce out the bottom of the funnel to continue to grow faster than unique users at the top.

So I'm not satisfied with 4% user growth at the top, but it's definitely healthier at mid-level and down funnel, and there's a lot more opportunity down funnel than there is up funnel.

And our next question comes from the line of Ron Josey with JMP Securities.

Just 2, please.

Spencer, I think you touched about this earlier in the call.

But when you talk about the number of homes that you're seeing in Phoenix, in Vegas and the other markets, I'm curious if you can maybe break down the percentage of homes that Zillow passes on and specifically maybe when a user asked for a bid or you declined to offer one.

And what happens there in terms of an opportunity on the sell side?

And then also, there remains a lot of debate around just the Homes business in general, I think some press recently about it.

I wonder if you can just provide any comments on that.

Yes.

So we're getting a lot of looks.

I think in the shareholder letter, I mentioned that in Phoenix, for example, we are seeing about 15% of all dollar value that's being sold in Phoenix any given month, and that's just after 2 months or so.

So we're -- yes, we're passing, obviously, on -- or, I should say, we're not buying most of that real estate.

Some of it we're choosing to bid on, some of it we're bidding on and the bids are not getting accepted.

The buy box right now that we're bidding on opens us up to about 2.75 million transactions a year in the top 200 cities.

What I mean by that is because most homes are at or near the midpoint or the median home value at any given city, if we took our buy box rules of what we're willing to bid on and expanded that to, say, the top 200 cities, that would open us up to about half the homes that sell 2.75 million.

So what happens to the homes that we choose not to bid on or the homes that the seller chooses not to sell to us, well, we're passing those to Premier Agents as listing lead opportunities.

And a lot of those Premier Agents are turning those into listings.

We're not monetizing that today.

We will monetize that in the future.

To address the investor concern or media concern about this overall business expansion, I think it is a gross mischaracterization and misunderstanding to call this a flipping business.

Flipping requires distressed homes and distressed sellers, people that are selling their home under duress, and it only applies to a very small segment of the market.

Most people are not willing to sell their home to a flipper because their home doesn't meet that type of criteria.

They're not desperate.

They're not willing to sell it for 20% or 30% below market.

What we're doing at Zillow Group appeals to a much, much broader segment of the market.

It appeals to anybody that values speed, certainty, ease, convenience, the ability to sync up the timing of the sale of their home and the purchase of the next home.

That is appealing to a much broader swath of consumers.

Arguably, most people need to lighten up the sale of their home with the purchase of the next home.

So you can think of it as a service for which we charge a fee.

It is not a flipping business.

And the early stats that we've seen are providing the data, hopefully, for skeptics to start to wrap their minds around this, things like the 10,000 home sellers coming through our funnel in just the first couple of months representing over $2.5 billion of total real estate.

It's broadly appealing.

So we're comfortable with people misunderstanding this for a long period of time, as I say, but we have conviction on it.

We think it's a service that is very appealing to home sellers and can be very profitable for us in its core but also profitable in its attached mortgage business and its attached listing lead generation business for a Premier Agent.

Our next question comes from the line of Deepak Mathivanan with Barclays.

So, first of all, of the 9 homes that you have sold already so far, I know it's a small sample set, but can you talk about the realized gross margin that you're seeing with these homes?

And then the $30 million revenue at midpoint from the Homes business that you're now expecting for the full year, how should we think about the number of transactions that you kind of expect to get from that?

Sure.

Jen?

Sure.

So, yes, this is Jen.

I'll take the second question first.

The $30 million midpoint, that basically assumes that we'll sell somewhere between, I think, 100 and 150 homes for the remainder of this year, but again, you will see that ramp very quickly, given there's the -- our anticipated 90-day hold time.

So even though we've only sold 9 homes thus far, you'll see that start to ramp.

And, in fact, by the time we reach December, we should be on pace where we're selling around 100 homes a month.

On profitability so far, Spencer, do you want to cover that one?

Yes.

I mean, we've been more profitable than we put in our original model when we first started this business a couple of months ago and discussed it with investors.

We're testing different levels of profitability.

We know that we can choose to be very profitable on a per unit basis at a smaller scale if we charge a high fee, and we can be less profitable at a much higher -- a much larger scale business if we charge sellers a lower fee.

And we're still finding that sweet spot in terms of matching seller demand and seller throughput with the size of our renovations and resell teams.

At this point, we're clearly biased towards scale over profitability, but because we've been selling the houses so much faster than we anticipated, the return on equity has been better than originally forecasted, and gross margin has also been better than originally forecast.

But don't get used to that because we are more interested in scale than profitability for now.

And, of course, as I've already said, the mortgage opportunity allows us incremental revenue -- or will eventually allow us incremental revenue, which can help subsidize the fee, the profitability of the core buying and selling and the fee charging business.

And then, of course, listing lead generation to our Premier Agents also provides another revenue opportunity, which allow us to charge a lower fee and increase scale.

Operator, I think we'll take the next question from Slido.

And let's see.

Dennis, can you just read it?

The first question is, how does Zillow hope to leverage the Mortgage Lenders of America acquisition?

Sure.

I mean, I touched on it a little bit, but let me just describe the user experience.

Post closing, which will be late this year, post, let's call it, preparation, which will take several months to get MLOA ready for scale post rebranding, so at this point, we're some time in 2019, just to be realistic.

What I imagine will happen is a homebuyer of a Zillow-owned home will get a stable financing from us.

Think of it as they can originate their mortgage on a home that they're buying from us digitally.

And the goals of that are to sell the home a lot faster by originating it ourselves and to make money in the actual origination.

So today, MLOA makes around $12,000 per origination that they're quite profitable on a -- in terms of revenue per origination because of the types of loans they originate.

As they move more towards the types of loans that Zillow Offers will originate, that 12,000 number will come down a little bit, somewhere in the $7,000, $8,000, $9,000 revenue per origination, and that obviously creates more revenue from each Zillow Offers homes.

So we're trying to create a digitized purchase expense, including origination.

And it starts with the Zillow-owned homes, and maybe someday, it moves into other types of transactions as well.

And this is Jen.

I can take the next question from Slido, which is about the long-term expectations and the scalability of the Homes business.

So really there, I would just emphasize that there is no change in our long-term expectations.

In fact, if you were to take our Homes revenue guidance that we put out back in April, we should achieve that revenue level by the end of the first quarter.

So really, it's just a matter of timing of when we expect those first sales to come through.

Nothing long term.

Really, we're seeing great performance throughout the funnel.

Really solid request for offers.

Everything is on target, except that slight delay that we talked about between when the seller accepts our offer and when Zillow actually closes on the home.

Our next question comes from the line of Maria Ripps with Canaccord.

Spencer, it seems like rentals were a little softer in the quarter.

Could you talk a little bit about what caused that and what are some initiatives to address that?

And then, secondly, I think you turned on StreetEasy rental monetization about a year ago.

Can you talk about your progress there?

Do you think that the total number of listings is now at the optimal level?

And how much pricing upside can you achieve over time?

Thanks, Maria.

Good questions.

So on rentals, you're right, rentals was a little softer this quarter, and guidance revenue was quite a bit softer.

There are 2 things happening with rentals.

Number one, because rentals is cost per lead, a cost per lead business model, any rentals traffic weakness is -- becomes a rentals revenue issue.

And so the reduced rentals guidance for the full year is due to softness in rentals traffic.

What we're doing about it, obviously, is trying to grow rentals traffic faster.

A lot of that comes down to product, which is the second thing worth mentioning in the rentals space.

We've been focused from a products development standpoint, and by product on rentals, I mean, a couple of hundred people across our different offices that work on rentals.

We've been focused on digitizing the rentals transaction for single-family and multifamily.

So creating a digitized scheduling, applications, leasing and payments, these are initiatives that we think are very important to renters and landlords.

We think it's the direction that the consumer and landlord expectations have moved.

It's going to take several years to gain widespread adoption for our digital rental transaction services.

And so in 2018, we prioritize building those features out, launching them and getting in that race, which will be a multiyear race.

But those product resources focused on digitizing the rental transaction could otherwise have focused on rentals, multifamily lead generation initiatives that would grow revenue in the near term.

We think that trade-off is the right one, focusing on building out long-term product differentiation for digitized real estate and rental transactions, but it undoubtedly comes at a cost, which is near-term rentals revenue growth.

In terms of StreetEasy monetization, I don't have data to support the -- your question about, are we maxed out on listings?

I would say that -- anecdotally, I'd say that I'd be sort of surprised if there was a lot of rental inventory in Manhattan at least that's not on StreetEasy already, given -- just given how widely used StreetEasy is.

So further rentals revenue growth on StreetEasy would likely have to come from price, not unit, and other business models in and around rentals.

The $3 per listing per day pricing that we launched with StreetEasy was well-received by the market.

That's a screaming deal for a rental broker or a property manager.

We haven't changed that price.

We have no plans to change it in the near term.

But it is a terrific deal and very ROI-positive for anybody that advertises rental listings on StreetEasy.

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

So, I guess, to the extent that it's taking longer for a seller to accept your offer, just how does that impact, though, your ability to sell that lead?

Is it just simply you can't sell until they say no?

Or what's -- or do they match out?

In other words, does the revenue from selling the lead also get the delayed as well?

No.

Good question, Jason.

No, it does not.

Well, to be clear, there's no revenue yet from selling the lead because we're just giving them gratis to Premier Agents.

But when we monetize that, no, it doesn't affect the timing on the listing lead generation monetization opportunity.

So the way the funnel works is a homeowner comes to the site, answers a couple of questions, uploads photos, hit submit, and then within a couple of hours, we make an offer to them, most of the time or actually -- well, some portion of the time.

Some portion of the time, that homeowner's home is outside our buy box, either it's more than -- it's at a higher price point than we bid on, it's in the ZIP Code that we don't bid on or whatever.

There's something about the home that doesn't match our purchase criteria.

In that case, we pass it off to a Premier Agent immediately.

In the case where it is in our buy box and we make an offer, what we do is we quote the homeowner the price that we think the home is worth and would sell for conventionally.

We quote them a fee of what they would be paying us to -- in exchange for the convenience and ease that they would get from selling it through us.

And then we give them a couple of days to accept that offer.

If they don't accept it at the end of those couple of days, then we ask if they want to be connected with a Premier Agent.

The delay that I've been talking about is what -- when they say, yes, I accept, we then give them between 1 and 2 months to actually close.

So at that point, we've got a signed purchase and sale agreement, but we haven't closed with them yet.

And during that time, they have this lottery ticket in hand, which is the sale price of their home fixed, all cash from Zillow Group

(technical difficulty)

they know will close with certainty.

And with that lottery ticket, they go out and shop for their own home.

So it doesn't affect the listing lead gen opportunity because I'm only referring to homeowners that have accepted our offer.

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

I have 2 questions.

First, just the 15% statistic from the Phoenix market, a big number.

Wondering if you can give us a sense for how much of that you think will actually come to market in the near term versus people who may just be feeling you out for price.

And, I guess, what I'm trying to get at is, as you start to scale up, do you think a 15% share is the right number from which you grow your market share?

And then, I guess, second one would just be, looking at the illustrative model for the Homes segment, how much of that detail will you all be disclosing as we start to see that segment hit revenue?

And why wouldn't all the costs associated with buying and selling a home, like closing costs and commissions and stuff like that, get loaded into the COGs there to get a true sense of unit economics on gross margin?

Curious just the rationale between COGs and operating expense there.

Yes, this is Jen.

I'll take that second question first.

So had we -- keep in mind that we're now operating 2 segments.

We have our IMT segment and our Homes segment.

And as an SEC filer, we report our results on a consolidated Zillow Group basis.

So when we think about where costs need to land in our P&L, similar-typed costs need to be classified similarly across the segments.

So for example, on our Premier Agent business, when we pay sales commission, that gets recorded in sales and marketing.

Much like when we sell a home in the Homes business, that will get recorded also in sales and marketing.

We certainly do intend to provide ample disclosure.

For example, the amount of sales commissions related to home sales, including sales and marketing, so our intent is to make it very easy for analysts and investors to do the math and determine what unit economics are.

Lloyd, I wanted it in COGs.

Spencer tried very hard, but the SEC won out.

The SEC did not.

It's not my decision.

So we'll do our best to provide clarity for you.

And I would say, keep in mind also that the commission that we pay on the buy side, that does get capitalized in inventory and then subsequently relieved through COGS once we sell the home.

So it really is just on the sale side of the home, on the revenue side, that you won't see that come through COGS.

On the market -- sorry.

Go ahead.

What?

I was just going to say that's helpful.

It sounds like you're going to give a lot of disclosure beyond what you're required to.

So that will be helpful, I think.

But, yes, on the first one?

[The one that sits there].

Yes.

So the -- I am sort of mixing apples and oranges here.

I want to be clear about what I'm saying.

So what we compared over the last 2 months was the number -- or the dollar value of all homes that asked us to bid on them is the numerator and the denominator is the dollar value of all homes that sold in Phoenix during that 1- or 2-month period.

And so the point I'm trying to make is that this is much more broadly appealing to your average home seller than a flipping business would be.

So I'm not saying that 15% of the homes that sold last month, we bid on, the specific 15% of homes.

In terms of what portion of the homes that we do offer price on end up selling eventually through one means or another, I don't have data on that.

So I don't have a good sense for that.

I do think that -- I mean, having listened to many, many of these calls and spoken with a decent number of the sellers myself, I think people are pretty serious when they go through this funnel.

So I don't know what portion of them who turned down our offers end up selling conventionally anyway.

But I think it's a fairly serious home seller that goes through this process.

And our next question comes from the line of Matthew Brooks with Macquarie.

I've got a couple here.

Firstly, can you tell us a little bit about the city rollout plan?

You've already announced 4 cities.

Can you give any thoughts about whether you're adding any more this year, maybe there are some implied in guidance already, or any early thoughts about next year?

Nothing further than what we've announced so far.

I think -- except to say, to sort of reiterate the scope of our ambition here, Matthew, you and I have talked about this a lot, we intend eventually to be in many, many more cities than we're in today.

But yes, today, 2, 4 certainly by the end of the year, we already announced markets 3 and 4, nothing beyond that.

But the team is ramping quickly, and we have no shortage of seller demand.

Clearly, this is something -- this is a service that's very interesting to sellers.

People want to get an all-cash offer on their homes from Zillow.

Right.

Second one, can you tell us an update maybe on the percent of sellers who come direct to your website to get an offer rather than come through an agent?

I don't know if we have disclosed that.

RJ, have we?

No.

Yes, sorry, I don't think we've shared that.

Okay.

Lastly then, I guess.

Can you just make any comments about Canada?

It's -- in the commentary in your release, that it's an opportunity.

Maybe you can talk a little bit about how much that could add value to Zillow.

Yes.

So we're going to launch Canadian listings on Zillow in the next couple of weeks, probably in -- well, sometimes the next couple of weeks.

Initially, we're not monetizing those -- that traffic or those consumers at all.

Eventually, the Premier Agent business model, we think, will extend to Canada as well as some of the other business models that we have in the U.S., including multifamily, rental listings, new construction listings and probably mortgages through display advertising more so than origination.

So before we can build out businesses, we need audience and consumers.

Of course, in the case of early Zillow, it took 3 or 4 years of building audience before we start to focus on monetization.

In the case of Canada in 2018, unlike Zillow in 2006, we think we'll have audience a lot sooner than that.

It's 12% of the size of the United States in terms of most metrics population, real estate transaction value, real state commissions, real estate advertising.

It's in the 10% to 12% range.

So that's our bogey longer term, but it will take time, of course, to grow into that opportunity.

And our next question comes from the line of Brent Thill with Jefferies.

Spencer, when you look at the 5 businesses that you're in, you basically took down guidance for 3 of the 5 and took the Premier Agent business up.

I think there are just a number of questions.

It doesn't sound like you're retreating from your long-term economic value in those businesses.

But is this just the case of just getting too overzealous on guidance as it relates to some of these other businesses?

I know that you also mentioned the construction, new construction market business is off, but that business seems pretty hot.

The rental market seems very strong.

And so I'm just -- I think I was just trying to reconcile what's actually happening versus what you're actually guiding for.

Yes.

So, I mean, if you take -- you have to take each -- unfortunately, I have to take each individual -- business individually.

So in the case of Premier Agent, increased bottom end of the range, kept top end flat.

And a lot of it -- a lot of the current Premier Agent success or challenges is predicated in the rollout of this new lead distribution system.

I feel good about where we are.

I feel like we're going to beat our goal, which was end of the year.

But it was bumpy.

Just like it's always bumpy when we make these changes.

Rentals is about rental traffic and the product team focusing on digitizing rental transactions, not driving more paid multifamily leads in the short term.

New Construction is about -- it's a little bit of traffic, a little bit of listings count from inventory because -- just from homebuilders not having enough inventory.

And Zillow Offers is about timing of the seller pushing out the closing date.

So it probably -- when you take a step back, it probably -- it looks challenged when you dive in and focus on the particulars of each of these business.

I think they're good explanations of what's happening underneath each of them.

And we're very excited about the MLOA acquisition, which we think dramatically expands the TAM and when combined with the Zillow Offers business, which is actually doing great, despite the sort of weird appearance of reducing guidance because of the timing of revenue recognition.

So it's a bit of a tricky quarter to understand.

I totally get that.

But I think for those that take the time to understand it, I think they'll realize that the long-term opportunity is as large or larger as ever.

It's just there's a lot going on at the business sort of underneath.

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

I had two, if I could.

I'm very intrigued by the move in the mortgage origination.

And my question is, as Zillow becomes more of a full service real estate provider, are there other aspects of the service offering that you can do that like MLOA is doing, which seems at a high level to be increasing your profit per transaction while, at the same time, streamlining the user experience?

So are there other aspects that you can sort of absorb or add to that will give you some more opportunity?

I don't know if anything comes to mind.

And then, secondly, I'm not familiar with all the legal aspects of the real estate industry.

But as the business morphs and you become principal in some of these areas, just curious what impact it could have on how you operate in the other aspects of your business.

For instance, has the Premier Agent business any way impacted in situations where you're providing the mortgage for a home that you're then working with a third-party agent to close the sale?

Or any other elements of -- I know your business is complex.

Is there -- are there any other follow-on effects as you're becoming a principal in some areas?

Yes, Mark, good question.

There are a lot of follow-on effects.

Let's just say our legal, regulatory and compliance bill is going up as we move into these other businesses.

So let's see.

Where to begin?

For example, making sure that when -- that once we've vertically integrated into mortgages, making sure that the appropriate disclosures and the appropriate regulations are being followed is critical from a reputational standpoint, obviously, from a legal standpoint.

As Jen mentioned, one of the things weighing on our balance of year costs is the incremental cost of that compliance.

We have opened today 40 -- I think you said 40, Jen, I think it's 46 incremental heads in Kansas City and in Seattle.

Most of those are around compliance and other shared services to ready MLOA for being part of Zillow Group.

So, yes, it's -- the stakes are higher, and it's -- and that's -- and it's costly for us to ready ourselves for that.

In terms, Mark, of other businesses -- other business opportunities that present themselves as we go deeper funnel, there's a lot more around mortgages long term.

So in our -- a lot more opportunity.

We're focused obviously on the Zillow Offers opportunity, which I already gave you some napkin math, which shows what a large opportunity that is.

But we connect many borrowers with mortgage originators and real estate agents who have mortgage originators, and that presents opportunity for us long term as we go deeper funnel in mortgages.

There are other ancillary services that other companies such as homebuilders attach to their principal business, whether it's title escrow and other businesses in the rental side, property management as well.

So none of that is -- we're not -- don't worry, we're not pursuing any of that right now.

But you are right.

In pursuit of a better consumer experience, more of an on-demand customer experience where she expects to be able to press a button on a smartphone and have something magical happen, we'll undoubtedly move into other businesses that put us as more of a principal.

That increases complexity, but it dramatically expands the total addressable market of the opportunity.

And it's going to be a complicated transition and evolution to that, but we think the opportunity merits that increased complexity.

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

Just staying on the regulatory front.

It's obviously never a dull day with you guys in the NAR.

But I saw where you guys exchanged comments, I guess, on the final day, the FTC and DOJ comment period.

Maybe if you guys could just [give] us an update on what they were looking at, what they were examining with the workshop and if you guys expect any type of positive or negative kind of turn of events come from that.

Sure.

The DOJ and FTC were refreshing their analysis of the real estate industry from 10 years ago.

As you probably know, they had a consent decree against the real estate industry issued 10 years ago, which was getting ready to expire, which had certain requirements on how the industry was expected to act, in particular, with respect to discount brokerages.

Of course, Zillow Group hardly existed 10 years ago when the last time the FTC and the DOJ looked at the industry.

This time, our comment is focused on the ways in which Zillow Group empowers consumers and the ways in which Zillow Group helps real estate agents and other real estate professionals succeed.

We also discussed the ways in which the California Association of Realtors stifles competition by prohibiting their forms from being licensed by companies like dotloop.

We discussed that in our public remarks.

So you can see our point of view on that in print there.

And we also discussed our perspectives on Project Upstream.

And you can see our thoughts on that initiative discussed in the published remarks where we laid them out for all to see.

In terms of what happens next, I don't know.

And that's not up -- I have no idea.

So -- but -- yes.

So it's all there.

Anything to add from anyone here in the room?

No?

Okay.

And our next question comes from the line of Justin Patterson with Raymond James.

Spencer, I wanted to revisit the earlier theme of moving down the funnel.

Conceptually, many companies struggle to move from the top of the funnel.

And lead generation, they're further down toward the transaction.

I get that you're doing a lot via technology, new products, Zillow Offers in today's acquisitions.

Could you talk about what you're doing more so on changing consumer behavior and that of the real estate industry?

Didn't do anything differently than you're doing today on the marketing side?

Sure.

The good news is that much of the consumer expectation has already changed, because real estate has been slow to adapt to changing consumer expectations of the on-demand economy.

Other parts of the economy from transportation to food delivery, to package delivery have already trained the consumer to expect that she can press a button, and within minutes or hours, a car can arrive, food can arrive, a package can arrive, et cetera.

So real estate is pretty slow.

If you take each of our businesses in turn, you can get a better sense of how we're approaching this on-demand expectation.

In that case of home shoppers, the new Premier Agent, one-to-many lead distribution system helps a consumer press a button and get a real estate agent on the phone.

Now I know that may not sound particularly cutting edge, but in our industry, that actually is quite cutting edge.

There are very few places that you can press a button and get a real estate agent on the phone, including a real estate agent's own website.

And so the new lead distribution model really is adapting to changing consumer expectations of the on-demand economy by switching to a one-to-many lead distribution system and then just to pick one more business.

In the case of rentals, pressing a button and scheduling a showing, pressing a button, filling out a rental application, pressing a button, paying for your rent, these are all things that landlords and tenants have come to expect from other services but have been slow to come to real estate.

Are there challenges to consumer expectations here?

I think will come probably around the logistics of home buying.

I think that's what might be slow to catch up, not so much on the consumer front but on the regulatory front.

The days of pressing a button and buying a home are -- it's -- there's a lot that has to happen between here and there in terms of readying the industry and readying regulators for that type of on-demand consumer expectation.

We'll clearly be at the forefront of catering to consumer and real estate agents' needs, as all of these aspects of home buying, selling, renting and financing become digitized.

And the next question comes from the line of Brad Erickson with KeyBanc.

Just a couple of follow-ups.

First, on the Premier Agent side.

Just curious if you can comment on any discernible trends you noticed in Phoenix and Vegas and how those cities performed Premier Agent-wise relative to the rest of the business.

And then second, you mentioned maybe a bit higher churn in that business associated with the shifting model that raised the bottom end of the guide there.

Can you just help us reconcile that?

Sure.

There's been no discernible impact to our Premier Agent business in Las Vegas or Phoenix since we launched Zillow Offers in those markets or no quantifiable impact.

I would say, qualitatively, the -- there is a lot more -- there's a lot of positivity in those areas because of Zillow Offers and because agents are excited either to be in our Zillow Offers transactions or start taking our listing leads from the homes that we don't buy or both.

But it's not -- it hasn't impacted our economics for our Premier Agent business.

And, sorry, what was the second question?

[To] PA [for] and the impact in our guidance.

I think I can take that.

This is Jen.

So typically, as we go throughout the year, we narrow the band of our guidance ranges.

That's really -- that's mostly what you're seeing with our revised PA guidance in pulling up the bottom end.

But, again, as we've discussed at length, we just aren't comfortable pulling up the top end of the range at this point in time given the transition of the new lead validation and distribution method.

So we feel like based on all the data that we have, we've made our best attempt at coming up with what our guidance is for the year, and this is where we are.

Yes, if I could just squeeze in one last kind of housekeeping question, and maybe you guys have his this already.

But just wanted to understand the loss on the home is proving, obviously, to be a little bit bigger than earlier.

But that business apparently is going to be a little smaller.

Maybe just a quick reconciliation of that and then I'm all good.

Yes.

Really, all you're seeing there is -- it's not so much inventory constraints or anything like that.

Really, what you're just seeing is us investing in headcount costs on the expense side.

As we continue to ramp the business, we approve incremental headcount.

And, of course, a lot of that initial headcount will be, I hate to say fixed, but it should become fixed as we scale the business.

And you'll be able to spread that across more of the markets.

But as we're ramping and scaling the business, you will see in our results just higher costs.

And that does conclude today's Q&A session.

And I'd like to return the call to Spencer for any closing remarks.

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towards a deeper funnel, it gives us the opportunity to delight the consumer and expand our addressable market.

We're taking our huge advantages, which are our audience and our brand and our resources, and expanding into different businesses, vertically growing our TAM.

Thanks very much for the questions.

We'll talk to you next quarter.

Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.