Zillow Group, Inc. Q2 FY2020 Earnings Call

Good afternoon. My name is Abigail, and I will be your conference operator for today. I would like to welcome everyone to the Zillow Group Second Quarter 2020 Conference Call. All lines have been muted to prevent background noise. After the speakers’ remarks, there will be a question-and-answer session. Please note that this event is being recorded. Thank you. I would now like to turn the conference over to Brad Berning, Vice President of Investor Relations. Please go ahead.

Thank you, Abigail. Good afternoon and welcome to Zillow Group's second quarter 2020 conference call. Joining me today to discuss our Q2 results are Zillow Group's Co-Founder and CEO, Rich Barton; and CFO, Allen Parker. During the call, we will make forward-looking statements about our future performance and operating plans based on our current expectations and assumptions. These statements are subject to risks and uncertainties, and we encourage you to consider the risk factors described in our SEC filings for additional information. We undertake no obligation to update these statements as a result of new information or future events, except as required by law. This call is being broadcast on the Internet and is accessible on our Investor Relations website. A recording of the call will be available later today. During the call, we will discuss GAAP and non-GAAP measures, including adjusted EBITDA, which we refer to as EBITDA. We encourage you to read our shareholder letter and our earnings release, which can be found on our Investor Relations website, as they contain important information about our GAAP and non-GAAP results, including reconciliations of historical non-GAAP financial measures. In addition, please note, we will refer to our Internet, Media & Technology segment as our IMT segment. We will now open the call with brief remarks followed by a live Q&A. And with that, I'll turn the call over to Rich.

Thanks, Brad. It's great to be on the line with you from Zillow Cloud HQ to discuss our results. I hope you're getting some downtime this summer and staying safe. Downtime matters now more than ever, so take care of yourselves and get some. Okay. The second quarter was one for our history books. We faced down fear and uncertainty and took prudent action to control costs, stopping short of layoffs or furloughs and extending the lifeline to our valued agent partners. We've refinanced, converted, and raised nearly $1 billion of capital for defense and for offense. Since the onset of COVID-19 for us here in the U.S., you've heard me speak several times on quarterly earnings and pop-up conference calls striking what was perhaps a more optimistic tone than you thought was warranted. This quarter's numbers are even better than we had hoped and firm up our belief that Zillow's business is experiencing powerful tailwinds in both real estate and technology. As I said before, I believe we are at the dawn of a great reshuffling. I'm sure I don't need to spell it out for you because we are all living it, spending an average of 9 hours more per day at home. Zoom meetings are changing the way families think about space and privacy. Home offices are in high demand. Backyards are more desirable than parks and gyms. Work-from-home policies are eliminating the commute for many. There's an endless list of considerations. Millions of people are currently considering upsizing, downsizing, getting closer to family, further from the office, et cetera. At Zillow, last week, we announced our intent to be a flexible employer, offering most of our employees the option to work remotely at least part of the time indefinitely. It’s something we never could have anticipated a year ago. New habits and norms are forming rapidly right now, in many cases, as with working from home; we have found better, more efficient, and healthier ways to live and work. We’re not going to just go back to the way things were. This is a tectonic shift that we expect to play out for years to come. Additionally, home turnover has been abnormally low since the global financial crisis, which means we entered the pandemic already carrying pent-up demand. These are the forces driving the real estate tailwind, supported by all signals we see and intuit. You see this reflected in our outperformance in Q2 in almost every measure, which sets us up well going into Q3 for which we have an outlook that now exceeds our pre-COVID estimates on most metrics. The great reshuffling is driving unusually high interest in home shopping. As the category leader, synonymous with real estate, we hit a record 218 million average monthly unique users this quarter. During the month of June, we grew users on Zillow Group sites and apps by more than 32 million year-over-year. Across every industry, we are seeing an acceleration in the preexisting online-to-offline customer migration, navigating from offline to online. In the absence of being able to do much in the physical world, folks have turned to digital delivery systems: Amazon, Netflix, Zoom, et cetera. These are the forces powering tailwind number two, the technology tailwind. We believe we are the outsized beneficiary of this tailwind. No company in our industry is better positioned than Zillow to deliver on seismic shifts in technology adoption. Zillow recreated what it meant to search and find real estate, and we are now investing to recreate and digitize the transaction itself. Three out of four U.S. adults said they want to use video or virtual 3D tour technology to shop for a home right now. Sellers are creating three times as many Zillow 3D home tours as they were in March. These two tailwinds, real estate and technology, are rapidly converging with Zillow at the nexus. The online-to-offline shift as it pertains to Zillow is, in part, what we've been talking about as real estate 2.0, and we're seeing years of adoption accelerate in these months. Real estate 2.0 will be an integrated transaction with virtual shopping, digital document routing, and one day, a trade-in button for your house. Zillow has the tech and R&D capabilities to enable this shift. We are best positioned to capture more transactions as more change the places they call home. These tailwinds paired with excellent execution this past quarter set us up well for the future. Let me recap a few highlights. In the haze of uncertainty, as the crisis began, we budgeted conservatively, but we planned aggressively to be ready to step on the gas when real estate bounced back. We avoided layoffs and other deep permanent cuts to our cost structure and set ourselves up to press advantages, ending Q2 with $3.5 billion in cash. This positions us well now that the real estate market is snapping back more quickly than many expected. Our Premier Agent business delivered its best sales and retention month on record in June. We expect this momentum to continue and are forecasting 15% year-over-year revenue growth in Q3. Regardless of the monetization model, we believe goodness flows from partnering with high-performing agents and teams to deliver high customer satisfaction and maximization of revenue and profit per customer. Q2's higher-than-expected revenue in our IMT segment, coupled with COVID-driven expense prudence, drove year-over-year margin expansion of 584 basis points that far exceeded our expectations. We continue to see top-line momentum in this segment, which informs a Q3 EBITDA margin outlook of close to 40%. Should we achieve this outlook, it will serve as a preview of profit leverage we can achieve in this business. However, we continue to see attractive growth opportunities in IMT and will invest appropriately. In Zillow Offers, we used enhanced selling strategies and differentiated data signals to manage our inventory. The fact that we were able to make it gracefully through the uncertainty of the past 5 months, continuing to sell inventory, is a testament to the team's agility. Our combination of machines and humans is getting smarter and more experienced. We have since reopened all 24 markets after our March pause, offering a certain, convenient, and safe way to sell. In the digital shopping experience of the future for buyers, this includes Zillow app’s 3D home tours from anywhere, virtual home tours with a Zillow Premier Agent by appointment, and in-person self-tours where buyers can unlock Zillow-owned homes with their mobile phones. A recent study by researchers at Stanford, Northwestern, and Columbia shared how Zillow Offers should increase liquidity and mobility by making it easier for people to move, especially those who are downsizing. Zillow Offers is likely helping grease the skids of the great reshuffling. Our Zillow Home Loans business is doing well, with June loan volume up 2.6 times versus a year ago; our best month ever. Zillow closing services is now up and running in all Zillow Offers markets after less than 12 months. It's still early, but these adjacent businesses are gaining traction, offering our customers value and convenience along the way. Real estate 2.0 is picking up steam, and we are leading the way. Going forward, we remain focused on driving more transactions across all business segments during this remarkable moment in time that we are all living through. People in all sorts of situations are rethinking their living space, and they're coming to Zillow for help to rent, buy, sell, finance, and close. We are continuing to invest heavily in technology and services that will allow more people to do more of their transactions with Zillow, whether that's through our Zillow branded transaction services or our best-in-class partners. The video we included in the shareholder letter of Seattle landlord Rahul Tela and his new tenants demonstrates the technology tailwind in action. Rahul is a local doctor and a Colombian immigrant whose fledgling real estate investment business is a piece of his American dream. When public health orders made it difficult to show his townhouse to potential renters this summer, he turned to Zillow and discovered a suite of virtual tools that made it possible for renters to take a 3D tour online, go on a personalized virtual tour, sign their lease, and pay their rent—all without ever meeting Tela in person. He went from nervous to relieved and surprised. He said, 'There's no other way I would have been able to do this without the Zillow platform.' Before I pass the mic over to Allen, I want to take a moment to acknowledge that we, at Zillow, recognize that the tailwinds we are experiencing are an advantage of being in the shelter business, which is at the base of Maslow's hierarchy of needs—a fortunate and lucky place to be in a pandemic. Our country is grappling with fear, loss, protest, and anger through a health crisis and a social reckoning. I'm proud of how our team at Zillow has responded. Our employees helped raise over $1 million for COVID-19 relief efforts in our communities. Additionally, our company has pledged at least $1 million to support equity and racial justice. Further, we have made a public comment that we can and will do more, starting with our own company, and helping to lead progress in the real estate industry, which has a troubled legacy of discrimination that has impacted generations. Recently deceased U.S. representative, John Lewis, wrote that 'Nothing can stop the power of committed and determined people to make a difference in our society.' We at Zillow are committed and determined to help shape a more equitable world. We appreciate your partnership in this journey. Okay. Allen?

Thank you, Rich. I'll summarize a few key financial results from Q2, followed by a discussion of our outlook for Q3. As Rich discussed, Zillow Group delivered a strong second quarter. We reported consolidated revenue of $768 million, up 28% year-over-year. Our revenue outperformance was primarily due to better-than-expected sales results in our Homes segment, with IMT and Mortgages also both outperforming our outlook. While our Zillow Offers home buying was paused temporarily at the beginning of Q2, our actions, improved housing market conditions, and low mortgage rates helped drive better revenue than expected for all three of our segments. Stronger revenue, combined with continued focus on managing costs, delivered consolidated EBITDA of $16 million, significantly outperforming our expectations of a loss of $61 million at the midpoint of our outlook range. IMT segment revenue of $280 million and the underlying Premier Agent revenue of $192 million was impacted by the Better Together discounts provided to our partners during Q2. These discounts were effective in retaining our partners and put us in a strong position to benefit from the faster-than-expected housing market recovery. While our IMT segment revenue declined 13% year-over-year, the decline was better than the 25% decrease at the midpoint of our Q2 outlook. As Rich mentioned, in June, we experienced record new Premier Agent monthly recurring revenue, and at the end of June, experienced our highest level of total MRR and retention since the inception of our Premier Agent MBP program. Given where the quarter started, this is a strong testament to our team's ability to manage through market volatility. IMT segment EBITDA margin was 25.6%, approximately 1,500 basis points above the midpoint of our Q2 outlook. This performance allowed us to grow EBITDA dollars 12% year-over-year, even with the declining revenue. While Homes segment revenue decreased sequentially due to the pause in home buying during the first half of the quarter, we sold 1,437 homes, or 80% of the inventory we had at the beginning of Q2, exceeding our expectations. Housing transactions proved resilient as we, our partners, and the broader industry participants found creative solutions to enable real estate transactions and customers to move forward safely. We restarted purchasing homes midway through the second quarter, and we are pleased with the initial inputs. We are seeing solid demand while driving continued operational improvements and safety measures. Our Q2 Mortgages segment revenue of $34 million increased 25% year-over-year, exceeding the high end of our outlook range. Increased loan officer productivity enabled us to participate in the refinance wave, driven by low mortgage rates. The Mortgages segment also delivered EBITDA of $5 million. As we stated on previous earnings calls, my focus as CFO continues to be establishing processes and mechanisms in support of three key priorities: scaling our new businesses; executing within our IMT segment to fund investments in our new segments, along with additional growth opportunities; and implementing focused cost discipline and operational rigor across the company as we scale. Last quarter, I also discussed that during this uncertain time, the team and I have been focused on liquidity preservation to protect the enterprise and ensure we are well positioned to execute on opportunities to lead the industry to real estate 2.0. We ended the quarter with $3.5 billion in cash and investments, the highest balance in our history. In May, we completed nearly $1 billion in capital raises with a combined convertible debt and equity offering, effectively refinancing a portion of our convertible debt due next year. Turning to our outlook, we are providing a one-quarter outlook for all segments. While we are pleased with the execution of our team coming out of Q2 and the strong current input trends that have informed our Q3 outlook, we do note that given the pandemic, there remains more of a macro uncertainty in our current environment than normal. Let me start with a few Q3 highlights. In Q3, we expect consolidated EBITDA at the midpoint of the guidance range to be $70.5 million, which is well above what we internally expected even pre-COVID. Accelerated revenue growth in our IMT and Mortgages segments are the primary factors driving top-line contribution. EBITDA margins are expected to improve meaningfully as we leverage this revenue growth with continued focus on operating expense discipline. We will begin to increase marketing and advertising investments in Q3 as compared to Q2 as we press our leadership position and drive growth. However, we do expect to see continued year-over-year operating leverage in Q3 for marketing and advertising. We also expect operating leverage in our people costs, technology and development, and other operating expenses. People costs are expected to be relatively flat year-over-year as we plan to cautiously manage headcount given the continued uncertain economic environment. Moving to each of our segments, within the IMT segment, we expect Premier Agent revenue to be $277 million, up 15% year-over-year at the midpoint of our outlook range. The sequential improvement from Q2 is driven by expected continued strong sales and partner retention in Q3, coupled with discontinuing our Better Together partner discounts. Other IMT segment revenue growth is also expected to improve in Q3, with further acceleration in rentals revenue growth and discontinued Better Together discounts. Partner hit marketplaces like New York City and display are expected to improve in Q3 from year-over-year declines in Q2 but still remained somewhat down year-over-year in Q3. In light of these factors, we expect IMT EBITDA margin to take a significant step upwards to 39% in Q3 at the midpoint of our outlook range, up nearly 1,200 basis points year-over-year from 27.2% in Q3 2019. In Q3, we expect our Homes segment revenue to be between $140 million and $160 million and an EBITDA loss to be between $80 million and $70 million. Revenue is expected to decline both sequentially and year-over-year due to the pause in purchasing homes that impacted Q2 and the resulting lower inventory balance coming into Q3. With regard to our Mortgages segment, our management team has successfully operationalized our move to conforming mortgages from FHA and VA loans, improved loan officer efficiency, and has successfully navigated the dynamic environment. We expect Q3 Mortgages revenue to be between $34 million and $37 million and EBITDA to be between a slight loss of $3 million and breakeven based upon capacity, current market conditions, and additional investments in operations. As our results demonstrate, Zillow has a strong foundation despite the ongoing complex and rapidly changing environment around us. Our actions in Q2 to accelerate our virtual tools, provide partner discounts to support and retain partners, and our reduced spending enabled us to extend our leadership position and deliver second-quarter results above expectations. Our balance sheet is strong. Our demand indicators have reached record highs, and our platform and partners are well positioned and ready to help our customers move safely into the next chapter of their lives. And with that, operator, we'll open the line for questions.

Our first question comes from Jason Kreyer with Craig-Hallum. Your line is now open.

Thank you, gentlemen. Congrats on the execution this quarter. Rich, there's been a lot of moving parts in the real estate industry, and it even sounds like it's been stronger recently. But with a lot of macro uncertainty lingering, just wanted to see if you could give us some perspective on how you're thinking about real estate going forward.

Yes. I mean it's not as hard to forecast as it was 4 months ago, but it's still pretty foggy. There's a ton of uncertainty, but here's what we're seeing, and I'm sure you're seeing it too. Demand is high. Supply is relatively low, okay? And mortgage rates are low, okay? So all of that is supporting prices and increasing prices should lead to increased inventory, but that's been a stubborn one. There are a couple of early leading indicators on inventory that are flashing yellow to green right now, though. So maybe that's changing. Rents are stable to up, and shopping is active. So I guess the question is why are we seeing this right now? I mean it really is those two big tailwinds I talked about that we are benefiting from here at Zillow. We're lucky to be benefiting from them. The more debatable tailwind is this great reshuffling that you heard me talk about. But literally, it’s math that we want that a lot of people want a new living space, whether they want to remodel it or move, and that is driving real estate demand everywhere, not just in the suburbs. The tailwind that is more powerful and advantage Zillow is the technology-driven online-to-offline tailwind—that retail to digital that's happening in every category, of course. But it's really happening in real estate now. And we're the digital leader, all the way from the top-of-funnel search and find right through 3D floor plans, deep down the shopping funnel. So, I guess, we're benefiting from this title shift up and down the funnel. And we're positioned really well going forward given our roots; really, our roots are as a tech company. So if it weren't for a pandemic and potential economic calamity, we could really get excited. Anyway, it's sort of exciting nonetheless. I hope that helps clarify things. But signals are looking pretty good.

That does. A lot of good color in there. Thank you.

And our next question comes from the line of Brad Erickson with Needham. Your line is now open.

Hi. Thanks. So, I guess, the IMT and Premier Agent business, in particular, the outlook you gave there for Q3 is ahead of what most of us were thinking. You talked about some of the factors that are driving that. Maybe, Rich, just talk about sustainability of those trends as we look out a bit beyond Q3. How should we think about that?

I mean it feels good, Brad. I mean it feels it's up and down the funnel. I mean at the top of the funnel, and it was driven by this online-to-offline shift. Just for instance, I think the stat I cited was that we increased new users in June by 32 million unique users. But the more interesting thing to sustain, we can't expect that kind of thing to continue. So we have to move down the funnel to find the levers to drive the business in a sustainable way, right? And we have these levers all the way down the funnel, these dials that we have all the way down the funnel that we are not yet maximizing or monetizing, and we've begun to turn them, and we're beginning to see action. So our focus— we began a year or a little over a year ago this focus on transactions. That focus on driving transactions is helping us drive more and better connections out of the same traffic flow. We got to increase traffic flow, but it's helping us drive more and better connections out of a similar traffic flow. We're getting them to better partners who are delivering better customer satisfaction and more transactions, so all of that results in more revenue and profit per customer for Zillow. So you're seeing that show up in our Q2 results, which are surprisingly good, and you're seeing that in our Q3 outlook. It's hard to know beyond that, but we sense plenty of road ahead for improvement in these dials and optimization of them given the amounts—just the sheer amount of blue ocean that's off our bow.

Got it. That’s great. Thanks.

And our next question comes from the line of Ron Josey with JMP Securities. Your line is now open.

Great. Thanks for taking the question and, yes, really great to see everything coming back here. And Rich, I wanted to stick with the Premier Agent business. Two questions here: you mentioned a comment around regardless of the revenue model, the focus is on revenue maximization. I'm curious if the pandemic accelerated Flex or how you're thinking about that, and then maybe, Allen, with EBITDA margins guiding to around 39%, 40% in the IMT business, advertising is coming back, which you talked about, despite strong user growth. So that's one thing. But just wondering how sustainable that margin is for the IMT business and what's driving that? Thank you.

Yes. The only—hey, Ron, thanks for the questions. I can take the second, and then we can talk about Flex. So, with respect to our Q3 guide on our IMT margins, our margin outlook in Q3 is reflective of how our marketplace business models can perform when top-line growth is combined with cost discipline. Our focus is providing a great customer experience by improving connections, customer satisfaction, and conversion for our customers through technology and partnering with high-performing agent partners. This focus is working, as evidenced by the strong trends we're experiencing exiting Q2, and has informed the accelerating revenue growth incorporated into our Q3 outlook. But we control the cost levers, and we'll continue to focus on cost discipline. I would call out, though, that we'll also invest strategically and opportunistically to press our leadership position where warranted. So given the uncertainty and lack of clarity, we're not providing any guidance or target updates outside of the Q3 outlook, but we feel really good about where we are and the business models that we're operating with.

Okay. I see your first one, Ron. Thanks for jumping in there, Allen. I started talking, and I did the classic Zoom mute error. Sorry about that. So, yes, on the Flex question, certainly early in the pandemic, you heard us comment that we were certainly happy that we had the Flex arrow in our quiver. We had to Flex entree on our dinner menu of stuff that we can offer our partners as we move to get these better partners who are better at converting and are focused on customer satisfaction and transactions. We're willing to delay gratification from revenue in order to do that, so it was certainly nice to have, especially at an uncertain time. It's still uncertain, but a decent amount of fog has cleared. The way we're thinking about this really, Ron, is as the menu I described. We have these different business models, these different ways we interact with different partners in different geographies—not just in Premier Agent, but also on the businesses that surround Zillow Offers. What we're finding is that having a flexible menu of things that we can figure out how to make them work the best with different partners has offered us a really interesting optimization opportunity. That's really what's going on now. We continue to test and roll out this and other models, but we think about this just in a much broader context of continuing to get more dollars to drop out the bottom of this customer funnel. So you're going to probably hear less specific stuff about Flex, I think, going forward. And that's not to say we don't love it. We do. It's just become part of the way we do business. The only reason we started talking about it as a separate thing initially was because of this revenue recognition issue. I think we've kind of— that's just not as necessary anymore to focus on. I hope that helps, Ron.

It does. Thank you, Rich. Appreciate it. Thank you, Allen.

And our next question comes from the line of Naved Khan with SunTrust. Your line is now open.

Hi. This is Robert Zeller for Naved. Thank you for taking the question. Following the pause and subsequent resumption of purchasing homes, how aggressive do you expect to be with Zillow Offers going forward in Q3 and the rest of the year? I'm just curious how consumers' interest in this offering has evolved throughout the pandemic. In the shareholder letter, you mentioned that you agreed to repurchase homes, but sometimes the closing can take weeks or months to close, which is why some won't be added to inventory until Q3 or later. I'm just wondering— I just want to clarify whether or not that's— these homes are reflected in the 86 homes sold in the quarter. And then separately, how long do you expect it to take for these homes to close? How much volatility do you expect in closing times? Thank you.

I'll start, Allen, with the first half of the question, and then you can hop in to help out. So starting with your question, Robert, about how aggressive we want to be with Zillow Offers, well, we've now, as of today, actually opened up all 24 of the markets that we had open before COVID hit. And how aggressively we've reopened markets tells you we feel good about it. The supposition is that this price certainty, this time certainty, and the convenience and safety associated with— if you're a seller, not having to have a lot of people go through your house; and if you're a buyer, letting yourself into a home with a Zillow app with nobody there—those both feel like good things in the midst of a health crisis, and we're seeing that play out. So we feel that in a way, the pandemic highlights some of the benefits of working with Zillow Offers. The reopening is early days, so we're watching carefully, but we're feeling good about kind of the post-COVID Zillow Offers. On the repurchase question, I think what you're asking is—maybe a little confusion is just basically us highlighting that, of course, pausing the factory for 8 weeks or so is going to cause an air gap of products coming out of the factory, then it just takes the cycle time for getting a home all the way through the factory to sell. So you're going to see that, basically, in our guidance for Homes next quarter. Allen, do you want to take that?

Yes. I think it's exactly right, Rich. Just trying to add a little color to that. So we purchased 86 homes in Q2. We disclosed that in the shareholder letter. We unpaused—we started up again our Zillow Offers. We were only in 15 markets when we came out of Q2. We're now in all 24. That's exactly what Rich mentioned. Our revenue guidance of $140 million to $160 million, down 61% year-over-year and 67% sequentially, is really due to this air pocket. We have not seen any substantial increases in the cycle time from when we agreed to an offer with one of our customers who's selling their home to when we close, but it does take time. And so what we have here is because of the pause and we were actually paused up to 21 weeks before we were open in all 24 markets, it's just going to take a little time as we restart the factory. The air gap that Rich mentioned is reflected in that outlook.

Okay, that’s very helpful. Thank you. I appreciate it.

And our next question comes from the line of Brian Nowak with Morgan Stanley. Your line is now open.

Brian?

Brian Nowak with Morgan Stanley, your line is now open. Again, Brian Nowak with Morgan Stanley, your line is now open.

You can maybe go to the next one, Abigail.

Our next question comes from the line of Maria Ripps from Canaccord. Your line is now open.

Great. Thanks for taking my questions. I just wanted to follow up on Homes. Now that you have resumed your home buying across all of your markets, can you comment on what you are seeing in terms of pricing and homes availability? Are you finding good undervalued homes to buy? Any updated thinking on targets for average return on homes sold now that your data models are getting better?

Maybe I'll take the first half, Allen. You take the second? So just as—thanks for your question, Maria. Just as a reminder, what we're doing in our Zillow Offers Homes business is not looking for distressed situations, deep discounting, or taking advantage of a seller's situation to make a profit. We're really going for a high-volume, scaled service that offers anyone within our buy box a fair price and the ability for them to choose a convenient date to affect the transaction, so it doesn't interfere with their lives. I'm just saying that because embedded in your question was a little inference that we have a house flipping type of business. What we are finding is that it's early in the reopening, and we're feeling good about the product refining. I want to see inventories build, and inventories are beginning to build now, and that's good. When it was scary, and we couldn't see the future, I wanted to see the inventories go down, and they did. Now inventories are rising. So it's reinforcing that lots of sellers in our 24 markets are seeing the value of the convenience, certainty, and safety of the Zillow Offers service. Allen?

Yes. The second part of your question on the average return, again, we're still in the very early stages in Zillow Offers in 24 markets. So we're not adjusting our guardrails of the plus or minus 200 basis points. We still believe that we've got a lot of testing and iteration to do across many areas. We are very excited as we start up operations again with opportunities to improve our cost structure. But for right now, the plus or minus 200 basis points are still the guardrails we have in place as we test and iterate. I will call out that given our pause and our restart, we do expect some increased volatility near term in metrics as we refill our factory across all 24 markets. This is going to be driven by what would have been a normal operating cycle curve and a normal distribution of aged inventory when we were in normal operations, skewed a little bit to older inventory as the pause works its way through our factory.

All right. Thank you for the color.

And our next question comes from the line of Brian Nowak with Morgan Stanley. Your line is now open.

Can you guys hear me now?

He was there. The mute problem.

Yes. I'm bad at technology. Thanks for the call again. I have two questions. The first one on the Agent discounts. I appreciate the color about Better Together. I guess I was curious to hear about the order of magnitude of how much that was in the second quarter. As you look at your third quarter guide, what are you assuming for discounting? Are you sort of assuming that those go away given the strength of underlying demand? And then the second one: curious to hear about your discussions with agents have evolved throughout a shelter-in-place and now the reopening. There are a lot of other real estate platforms trying to compete for your agents. How has that discussion changed around their asks of you to provide value for them? Thanks.

Allen, do you want to take the first bit, at least?

Yes. I'll take the first bit. So, Brian, I think that we spoke about the Better Together as one of the many actions we took late in Q1 to manage our business, and we're really excited we did. We think those, along with other actions, helped retain our partners and respond. So we were able to respond when the industry came back faster than expected, is the right thing to do. We’re seeing the benefits in record sales, high retention, higher connections, and improved customer satisfaction. With respect to how I would look at the business, I think the best way for you guys to think about the business is to look at our Q3 outlook for PA with a guide range on revenue of 272 to 282. That's year-over-year growth of about 15% at the midpoint. That is the best barometer of where we kind of feel the business is going into the quarter. The discounts were heavily weighted toward early in the quarter. A number over the quarter wouldn't really help you too much. I look to our Q3 guide; there are no discounts implied in that range as kind of where we are trending coming out of Q2 into Q3 and onward.

I guess, Brian, for the second part, how have the agent discussions changed during shelter-in-place and the reshuffling? I would characterize it as we feel like we are the outsized beneficiary of agent retention right now as they hunt for new customers simply because people have fewer places to go to shop, and agents have fewer places to get visibility where customers are. We are finding more inbound interest or general interest. We've been working our way towards finding better, more productive, more transaction and customer satisfaction-focused agents. I don't think I'd be going too far to say that we've accelerated those trends during COVID. As Allen was saying, we bought a lot of goodwill with the Better Together discount. We're seeing that play out in some numbers but feeling it play out in just general partnership sentiment, which is really good. Finally, I'd say we've seen attitudes towards technology adoption amongst the agent community to be quite different during COVID than pre-COVID. Put it that way. When everything was going fine, doing things the old way, it's just don't bother me with the new way stuff. Don't bother me with the 3D tours; don't bother me with the virtual stuff. It was just fine, so we could do it the old way. But now they need to do it safely. We are getting all kinds of adoption and usage of the tools we've had in place for a while during this period. I hope that gives you some texture.

That’s really helpful. Yes, thank you both. Thanks.

And our next question comes from the line of John Campbell with Stephens Inc. Your line is now open.

Hey, guys. Good afternoon. Phenomenal results and good guidance. Good work. On the closing revenue, you guys kind of tucked that in that new revenue line item under the recovery in the last quarter. But just doing the math on the homes that you sold thus far this year, it’s small potatoes. It’s $0.30 or so per home sold, but I'm guessing that you guys— the closing services that you have in there with title and escrow and some of the other settlement services here, that could probably get you somewhere up to, I don't know, $5,000, $6,000, maybe $7,000 per transaction. Is that the right way to think about it?

Allen, you're on mute, and I'm waiting for you to reply.

Yes. So this is title and escrow. And yes, we reported $436 million in Q2, and we had $761 million—that's so not just everyone knows in other revenue within our Homes segment. What this really is, is more of a play on integrated transaction. I believe it's about 100 basis points is what we're talking about, and it saves us on cost when we use VCS services, our own internal services and a transaction that we're closing with Zillow Offers. There are other times we're able to use that for non-Zillow Offers transactions, but more like 100 basis points, so you may be a little high on your number for the escrow services we provide now. We believe we can scale that. We're open in all 24 markets, and we were not open throughout the entire year in all 24 markets. But we're really excited to see how quickly this team has built up and supported our customers. But again, what we really like is in partnering with our actual Zillow Offers business, these two services can make the transaction painless, fast, and it's actually a cost structure reduction for us when we do it ourselves versus pay a third party. Does that answer your question?

Yes, that makes sense. And then second question for me. On the reduction in sales and marketing, I imagine you guys are going to see a little bit of lift there over the next couple of quarters, but how much of that is driven by deemphasizing Trulia, or are there other pieces helping offset some of that marketing spend?

Yes. We talked about our pause in marketing for Q2. We announced that even prior to our Q2 guidance. It was incorporated in our Q2 guidance. We are starting to at least sequentially in Q3 look for opportunities where it makes sense to support our brand and to increase spending. We continue to support both Trulia and Zillow, but our priority is on the Zillow brand. We'll continue to look, assess, monitor, measure, and adjust the spend as appropriate to support our brand and continue to support growth. But the guide for Q3 incorporates a sequential increase while still providing year-over-year leverage, and that's coming both on the Trulia brand and the Zillow brand.

Okay, very helpful. Thank you.

And our next question comes from the line of Heath Terry with Goldman Sachs. Your line is now open.

Great. Thanks for that. Rich, you've mentioned a few times the increased pace of adoption you're seeing from brokers of new technology. You've never been one to shy away from leaning into the development of that technology. Seeing this, what are you doing? How are you using this opportunity to push Zillow's investment in that technology? How much more do you want to spend, and need to spend, and to the extent that there is a roadmap of priorities for the biggest opportunities for you in that technology investment? I would appreciate those insights.

Yes. Heath, I think if I broaden out, if I could at least choose to hear your question in a broad framework, I'd say there's no greater priority. It's weird, but real estate has been a laggard in the adoption of modern technology even before COVID. For a lot of legacy regulatory complexity, fragmentation, distribution reasons, it's been pretty stubborn in its resistance to technology adoption. I really believe we are at the beginning of a cycle of complete re-platforming and near gear being escorted out, and a new foundation for the industry is being built. So unlike—this is it. We are really excited about this. We're excited that we're in a position to be able to just have the talent and hire the talent that can dream up what that looks like. We can make it all work together and do so in a way with the ultimate customer in mind, not necessarily the legacy industry user in mind. But the industry user matters a lot; it's really the customer experience that we need to fix. It’s a broken process, and we’re at the early stages of that. So broadly speaking, I would say it's the top development platform that we have. Specifically, I think you're asking more about kind of the virtual touring stuff and the stuff we've been talking about. Yes, we're leaning into that, too. It's pretty clear that people want to shop this way. Even as we ask them about shopping post-pandemic, would you still want to take virtual tours? Yes. Would you still want to let yourself into a home so that you can tour it yourself? Yes, et cetera. So we do think that these are rapidly becoming industry norms. So we're leaning into that. We have some competition there, no doubt, that is investing in this, but I think our collective—our R&D expenditure and capabilities in this area really give us an advantage.

Great. Thanks a lot, Rich.

And our next question comes from the line of Lloyd Walmsley with Deutsche Bank. Your line is now open.

Great. Thanks. Two if I can. First, just what is the latest update on seller leads and fact converting sales inquiries from Zillow Offers where you don't make an offer to seller leads for Premier Agent? And then second, can you talk about whether you're seeing any signs of increased moving activity, in the sense of people looking to move out of cities or tolerating longer commutes? Is there any real signal in search activity that this notion of potentially unlocking like a multiyear trend of elevated moves could be real? Anything you could share there would be great. Thanks.

You want to start, Allen, and I'll finish?

Yes. On—we call it partner leads—but on partner leads, what I'd say is that Zillow Offers buying pause was an opportunity for us to look at and refine our partner lead generation channel. We're continuing to enhance our processes to better support our customers. We're providing them with multiple options now early in the pipeline, whether they want to sell to Zillow Offers or sell traditionally with our Premier Agent partners. We're very excited. It's still very early. We're seeing some positive trends, but we're still iterating, and we're excited about the opportunity here.

Hey, Lloyd, thanks for your question. Yes, it's a tricky one. It's a really popular story to tell this deurbanization story. Everybody seems to want to tell it. The real story is that shopping is up everywhere, and that's what our data says. We're speculating beyond what we're seeing as is everybody. COVID has accelerated many pre-existing trends—pick your trends, social, political, and in business. COVID has accelerated these trends. There was a preexisting trend that was kind of an affordability crisis in some coastal urban—high-density urban areas, and we were already seeing a deceleration of migration; we actually expect logically to have COVID be an accelerant of that. The longer we go on with companies—I think I said that the longer we go on working—having many companies not all but those lucky companies be able to have people working from home, the more the concrete sets and the more habits get formed. The less likely companies are to go back. We are pretty confident that this is going to be a lasting, multiyear meaningful trend. We can't call exactly how it's going to play out from our data yet, but from an intuition supported by some data, it seems like something real.

All right. Thank you.

And this completes the allotted time for questions. I will now turn the call back over to Rich Barton for any closing remarks.

Thanks, Abigail. Thanks, everybody. This quarter is just further evidence that Zillow is in a strong position to lead the industry through the tech transformation ahead that I've been talking about. In the short and long term, we're committed to bringing our customers a safe, convenient, seamless way to move forward. We feel like the wind is at our backs, and we're in a great position. I really appreciate your partnership in this journey. Stay safe, and carry on. Again, make sure you take a break and enjoy the summer. It's more important now than ever. Good talking to you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.