Zillow Group, Inc. Q1 FY2023 Earnings Call

Good afternoon. My name is Hannah, and I will be your conference operator today. I would like to welcome everyone to the Zillow Group First Quarter 2023 Conference Call. I will now turn the conference over to Brad Berning, Vice President, Strategic Affairs and Investor Relations. Please go ahead.

Thank you. Good afternoon, and welcome to Zillow Group's First Quarter 2023 Conference Call. Joining me today to discuss our results are Zillow Group's Co-Founder and CEO, Rich Barton; CFO, Allen Parker; and COO, Jeremy Wacksman. During today's call, we will make forward-looking statements about our future performance and operating plans and the housing market based on 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. We will now open the call with remarks followed by live Q&A. And with that, I will turn the call over to Rich.

Thank you, Brad. And thank you, Hannah. Good afternoon, everyone. Thanks for dialing in today. We are excited to share our first quarter results and the progress we've made on our growth strategy since we last spoke in February. As I noted during our last earnings call, 2023 is critical for Zillow, and I'm pleased with how we've started the year. Total revenue of $469 million and EBITDA of $104 million surpassed the top end of our outlook. This outperformance is due to a combination of progress that we've made since reorienting the company in early 2022, along with favorable relative tailwinds in a tough housing environment. Since the beginning of 2022, we have made significant investments in improving our customer funnel, capturing more customer demand and connecting more of that demand to our strengthening partner network, resulting in increased conversion rates in Premier Agent. We have focused on many improvements in our customer funnel experience by offering clear calls to action that quickly and efficiently help solve customer needs. These numerous incremental changes collectively have been adding up to make a real impact on our business. The most tangible example we made over the last year is providing easier ways for buyers to request home tours on Zillow apps and sites. This has resulted in less drop-off in our funnel, which is a key driver behind improved expected lead volumes of higher intent customers, which does not yet even account for the benefits I'll discuss shortly from real-time touring. Overall, it has been nice to see our focus and investments begin to pay off, with our year-over-year residential revenue outpacing the broader real estate market by 1300 basis points and an expectation that we will see continued relative gains in Q2. Beyond our revenue gains relative to the industry, we are also pleased with the profit leverage in our business model. Our EBITDA outperformance for the quarter is a nod to how nicely revenue outperformance can flow through to the bottom line when we prudently manage costs. We couple these results with a strong balance sheet, ending the quarter with $3.4 billion in cash and investments even after buying back $86 million of stock in Q1. Interestingly and unexpectedly during the quarter, we have felt the first tremor of what we believe to be a coming earthquake in the broader technology landscape with the introduction of OpenAI's ChatGPT. We believe the arrival of conversational generative AI may well be a platform shift on par with the introduction of the graphical user interface or the touch interface on the first smartphones. Artificial intelligence, machine learning, computer vision and the use of data have been core to Zillow since our founding. Our AI journey began in 2006 with the invention of the Zestimate, which required massive amounts of data and the machine learning algorithm, albeit one that looks quite primitive compared to what we have deployed today. What started with AI and the Zestimate expanded to more parts of the product in the year as follows: advancements with our new neural Zestimate, computer vision-powered rich media experiences, AI-generated immersive floor plans and natural language search queries are four more recent examples of how these capabilities show up in our products and services today. The launch of ChatGPT and now new Bing and Bard have brought AI out of the basement and into life for all of us to interact with. We recognize that it is in its infancy, that it is evolving incredibly fast and that it is fraught with many levels of uncertainty. However, we are excited and confident in our ability to harness its power to drive growth. We believe this technology will improve our customer and partner experiences, meaningfully increase the productivity of our employees and the velocity of our output and ultimately drive growth for both Zillow and our partners' businesses. We are well positioned for this opportunity not only because we have understood and been early adopters of important new platforms as they emerged, like we did with iOS and Android, but also because we have the brand, the audience, and the access to large proprietary relevant data sets as well. There is another valid worry out there about how ChatGPT might disrupt the physics of the way people search, find and navigate the web itself. At Zillow, we are experimenting aggressively to understand this new paradigm. OpenAI's ChatGPT has a limited release alpha plug-in program that enables select app developers to have API-level platform access. We launched an alpha version Zillow plug-in yesterday, which operates in a small sandbox but with which we will learn and iterate rapidly. Again, I am confident that Zillow is well positioned for whatever disruption may come not only because we are leaning in hard, but because we own our own customer demand. The #1 core value at Zillow is that the customer is our north star. Starting with the Zestimate, we have released a drumbeat of magical product innovations that empower, entertain and engage our customers throughout their home shopping journey. That has freed us to predominantly market Zillow through good old word of mouth boosted by great PR and brand marketing. We have always believed that the product itself is the most important part of the marketing mix. This has worked well for us. Our brand has grown to become the best known and trusted name in real estate. Zillow is the leading real estate app and site in the U.S. according to comScore. While we recognize and respect that SEO and SEM have a real and important place in the marketing mix, we have always been keenly aware that any vertical site's over-dependence on SEO and SEM makes it strategically fragile. Today, over 80% of our traffic comes to us directly. This is rare and very good. The direct branded relationship we have with our customers will help us well into the future. As you all know, a few years ago, we embarked on a new frontier to digitize the real estate transaction itself, to convert and monetize a small but increasing percentage of the 200 million average monthly unique users on our asset sites, turning them into transactors. Our growth investments are focused on improving the transaction experience so that we might not only help people search and find homes but also help them buy, sell, finance and rent and ultimately get into the next home with more ease, more transparency, and more efficiency than ever before. We've been laying the groundwork for our transaction strategy for quite some time and believe this is how we both differentiate and continue to grow our business and our brand, by being the destination for buyers, sellers, and renters' end-to-end housing transaction needs. This strategy of shifting our focus and efforts down funnel to the transaction is manifest in what we call our Housing Super App vision, an integrated end-to-end experience to help our customers move. Our goal is to increase engagement, customer transactions and revenue per customer transaction by investing across five growth pillars: touring, financing, seller solutions, enhancing our partner network, and integrating our services. The expected output of this strategy is to grow our share of customer transactions from 3% to 6% by the end of 2025. On our road map, 2023 is about execution, steadily rolling out products in constrained geographies across our five growth pillars and integrating them to create a seamless experience for our customers and partners. We are obviously excited about all the tech-enabled solutions we're building to improve the gnarly process of moving, but we are clear-eyed about the importance of connecting that technology to our critical partners in the physical world as well as the physical homes and apartments that are available for sale or rent. Rich, smart integration within our ecosystem is crucial to our Housing Super App vision, be it connecting with the Premier Agent partner that tours homes with you after you book it with showing time or working with the Zillow Home Loans Officer, who secures your mortgage. We are bringing this seamless, connected experience to various markets throughout the country with our first four in Raleigh, Denver, Atlanta, and Phoenix. I'll kick off our product roadmap progress report with touring; stepping into the home, whether virtually through a 3D Zillow 3D home interactive floor plan, where our computer vision technology makes it feel like you're walking through the home; or in person when you are actually physically touring the home with your Premier Agent partner brings the shopping experience to life. So when we talk about touring, we're talking about the point-of-sale moment when dreamers turn into customers. This means capturing the attention of the users who are currently dreaming and scrolling at the top of the funnel and providing them with a tangible step into the real-life home shopping experience of touring a home. This is one of our big bets and a critical piece of our product roadmap because our data shows that movers who requested to convert to buyers at 3x the rate of other actions on Zillow. And making improvements to the home tour process is critical to achieving the seamless, connected experience we envision. Enabled by showing time's integration with Zillow, real-time touring allows eligible buyers to get a tour confirmed in less than an hour with much less friction in the process. In February, we shared early results we were seeing with real-time touring in Atlanta. Connection rates were higher, and customers were more likely to work with our Premier Agent partners. That trend continued in Q1, leading to more tours being fulfilled and early indications of higher transaction rates. I'm pleased to share we have now rolled out real-time touring in our other three enhanced markets: Raleigh, Denver, and Phoenix. Combined with the other initiatives we're driving in our enhanced markets, real-time touring is improving our funnel, driving meaningful improvements in our ability to connect higher-intent customers to our Premier Agent partners. Beyond our improvements in tour, we are continuing to enhance our partner network. As we've discussed, our Premier Agent partners are critical to delivering integrated service and, therefore, growth. What's good for our customers is good for our agent partners. Helping customers find and win their homes also helps agents grow their businesses. We are holding ourselves accountable to connect higher-intent customers to our partners and are holding our Premier Agent partners accountable to higher performance standards as well. Across all four enhanced markets, we meaningfully consolidated our partner network with a focus on Premier Agent partners, who convert leads into transactions best, treat our customers best, and are motivated to grow their businesses alongside us. And we are seeing the operational benefits from working with a tighter set of partners. First, we're able to work more closely to deliver a brand-aligned experience to our shared customers. And second, it has allowed us to quickly test new products and services and evaluate in real-time how things are going before we scale. Most importantly, we are seeing improvements in customer satisfaction and engagement as we connect customers with our strongest partners in each market. For our next product roadmap update, I'll cover financing. This is an important investment for us because 87% of homes purchased are financed for mortgage, 40% of all homebuyers start their journey shopping for a mortgage, and 80% of those don't yet have an agent. We told you before that we've turned our attention towards building the foundation for a substantial first-party, direct-to-consumer purchase mortgage origination business. Our top priorities include building overall awareness for Zillow Home Loans, building a better digital mortgage experience, bolstering our loan officers' tools and capabilities, and working closely with our Premier Agent partner base to build integrated processes. And we're making progress on all fronts. You may recall last quarter, we spoke about the two broad ways in which customers connect with Zillow Home Loans, property first and financing first, though aimed based on whether our customer entered their transaction journey through a property inquiry or through a mortgage inquiry. I'll start with property first, which is when our Zillow Home Loans lead comes back to us from a Premier Agent partner who is working with a home shopping customer we had previously sent them. We are now seeing roughly 1 in 3 Premier Agent partners in our enhanced markets introduce customers to Zillow Home Loans, up from roughly 1 in 5 last quarter. Continue to drive conversion here, we focused on making it much easier for Premier Agent partners to connect customers with Zillow Home Loans, which makes for a more seamless connection process that generates a better customer experience. First, it provides our customers optionality. For customers who may have sought financing advice elsewhere, our management partners can give them the choice to speak with the Zillow Home Loans Officer if they want to seek a second opinion. Second, our Premier Agent partners can connect a customer to a Zillow Home Loans officer with confidence because they can choose the loan officer who specializes in their market and who can provide a more knowledgeable, personalized financing experience. Let's now switch over to financing first, the other entry point, which is when a customer starts their moving journey by getting pre-qualified before they are connected to an agent. We've made some very good progress here. We've begun turning the dial on a number of different strategies to build overall awareness of Zillow Home Loans, including recently rolling out an update on the Zillow app to put financing at the forefront of the customer experience. We've rolled out a central hub for financing on the navigation bar at the bottom of the app, which gives the customer multiple options, including Calculate What You Can Afford tool and a direct connection to Zillow Home Loans via a Get Prequalified button. We began rolling this out in early April and expect it to be available to customers nationally by the end of Q2. We've also shipped an affordability search filter that gives home shoppers the ability to customize the home details page only showing them homes that fit within their monthly mortgage payment budget. These are two examples of how we're putting financing at the forefront, working to improve awareness of Zillow Home Loans and shipping features of the Housing Super App as we strive to solve our customers' complicated problems. As we've said before, we think there is a big prize for us in purchase mortgage originations, and extending Zillow's umbrella over mortgages is a critical part of our transformation. As a result of all of our efforts across our mortgage investments, purchase loan origination volumes in Q1 doubled year-over-year. So I feel quite good about progress against that which we can control. But of course, we continue to live in a very challenging housing macro environment with no clear indications of a turn. Transactions continue to be low. High demand to move supports a stable pricing environment, but high rates have somewhat locked sellers into their existing low-rate mortgages. So we see record combined new home and new apartment inventory on the way; it will take quite some time to balance demand with supply and to normalize the market. And while we may see rates come down at any time, we are certainly not counting on it. Meanwhile, we are well capitalized, generating positive operating cash flow and staying focused on making progress on our growth plan, converting traffic into transactions with the help of our rapid product innovation and our increasingly intertwined relationships with our terrific partners and loan officers. To close, I am pleased with how we started the year, as evidenced by our solid Q1 results. That said, we have a lot of work to do to drive outsized gains in our share of customer transactions moving forward, and our team is focused on delivering on our product roadmap in service of our customers. We appreciate you all being on the journey with us and look forward to connecting with you in the days and weeks ahead. With that, I'll pass it over to Allen. Allen?

Thanks, Rich. In Q1, we delivered results above our outlook for both revenue and EBITDA. Residential revenue also outperformed the tough housing industry, and we expect that trend to continue into Q2. Residential revenue was $361 million, down 14% year-over-year, outperforming the high end of our outlook range and the industry's total transaction dollar decline of 27% according to data from the National Association of Realtors. The relative outperformance was driven by a combination of the strength of our brand, a better-than-expected number of customer connections provided to our Premier Agent partners from the investments we have made that Rich has already discussed, and favorable tailwinds relative to the industry that we've discussed before. New construction revenue was also strong during Q1, growing 16% year-over-year as customers turned to new construction given tight housing inventory. Rentals revenue increased 21% year-over-year as rental traffic on Zillow grew 16% year-over-year to 29 million average monthly unique visitors in Q1 for comScore despite industry headwinds in multifamily demand. Our industry-leading rental traffic helped us drive accelerated year-over-year growth in the number of multifamily partners on our apps and sites when compared to Q4 2022. We also continue to see industry tailwinds with occupancy rates declining from historically high levels and lower rental customer demand, combined with new supply coming onto the market, driving an increased need for advertising for landlords. Mortgages revenue was $26 million, with purchase loan origination volumes growing 9% sequentially and more than 100% year-over-year. We continue to make progress building our Zillow Home Loans-purchased mortgage business. We began to assign our centralized team of loan officers to specific geographic areas and enhance the ability for Premier Agent partners and their buyers to choose their loan officer. We also made changes to our apps and sites to show Zillow Home Loans to more customers. Given this progress and to meet customer demand, we plan to increase our number of loan officers in the coming months while we closely monitor operational efficiencies. Our EBITDA expenses totaled $365 million in Q1, roughly flat from $362 million in Q4 and meeting the midpoint of the range implied in our outlook for Q1. We grew planned investments in our key growth initiatives with active cost management of other discretionary and non-people-related costs, such as direct advertising and marketing expenses, which were down both sequentially and year-over-year. On a GAAP basis, the net loss was $22 million in Q1, and the net loss margin was 5%. EBITDA was $104 million, above the midpoint of our outlook range by $48 million in Q1. EBITDA margin was 22%. This outperformance demonstrates the inherent profit leverage in our business model and how quickly revenue outperformance can flow through to the bottom line. We ended Q1 with $3.4 billion of cash and investments, flat from the end of 2022, which includes the benefit of net cash provided by operating activities as well as the impact of $86 million in share repurchases during Q1. Convertible debt was $1.7 billion at the end of Q1. Turning to our outlook for Q2, we expect total revenue to be $451 million to $479 million, implying a year-over-year decline of 8% at the midpoint of our outlook range. We expect residential revenue to be in the range of $341 million to $361 million, down 10% year-over-year at the midpoint of our outlook range, compared to our estimate for an industry transaction dollar decline between 18% and 28% year-over-year in Q2. This implies four consecutive quarters of outperformance relative to the industry. For Premier Agent, we estimate revenue will decrease 9% to 13% year-over-year. We expect the investments we have made in our funnel will continue to deliver benefits into Q2. As the macro backdrop remains choppy, we continue to focus on the inputs we can control, adding value to our customers and shipping great products while actively managing costs. For Q2, we expect EBITDA to be in the range of $61 million to $81 million, implying a 15% margin at the midpoint of our outlook range. Our outlook implies a planned increase in EBITDA expenses from $365 million in Q1 to a range of $390 million to $398 million for Q2, driven primarily by a sequential increase in marketing and advertising expenses, which is the largest driver. This is a combination of typical seasonal spending in Q2 and a pull forward of previously planned second half marketing as we are ready to test additional initiatives in our enhanced markets earlier than expected. We also have a small amount of advertising that we pushed from Q1 to Q2. In addition, we expect a modest increase in planned hiring investments as we continue to support our growth strategy. Part of the increase includes some hiring timing that was moved from Q1 to Q2 and staffing up to support product and market launches during the remainder of the year. We also expect to add variable resources for increased activity levels, such as the hiring of additional loan officers, which is evidence that our growth strategy is gaining traction. Taken as a whole, we believe Q2 EBITDA expenses will be close to the run rates we expect in the second half based on what we know today. We are currently willing to look through the macroeconomic environment as we balance prudent investments while constantly seeking operating efficiencies across the business. We are making progress on reducing friction in our funnel, and we feel good about the progress we are making towards our growth pillars. We believe investing against our growth targets while managing costs is the right thing to do to drive customer transaction share and grow revenue per transaction. We have a high incremental margin business, where we expect to see operating leverage as we grow revenue across the housing industry cycle. In closing, we remain in a strong position to invest against our strategy to better serve more customers, resulting in share growth and more revenue per transaction. As we look forward, our priorities remain focused on innovating and executing on behalf of our customers and partners. We plan to continue to grow our customer engagement through compelling dream and shop experiences; deliver a more integrated customer transaction experience to drive customers to choose to transact with us and our partners; invest in sustainable top-line growth opportunities across the company, including new integrated services that are more scalable, less subject to earnings volatility, and more capital-efficient; and manage our cost structure and improve productivity, including continued prioritization of our investments that we expect will drive a profitable, scalable, and positive operating cash flow company. And with that, operator, we'll open the line for questions.

Our first question comes from John Campbell with Stephens.

A question here on touring, and then I had a quick follow-up on mortgage. You guys have talked pretty consistently about the touring leads, converting at 3x the rate. You guys have obviously moved more and more of that mix towards touring in recent quarters. But with a little bit more time under the belt, I'm curious how those touring lead conversions are looking in the test markets. Rich, you talked to more leads and a higher rate of connections. But specifically for those under flex, could you maybe talk to the degree of uplift in actual conversions you're seeing? And would you characterize it as maybe modest improvements or something closer to step function improvements?

John, this is Jeremy Wacksman. I'll take that one. Yes, as Rich talked about, in general, the touring customer converts at a higher rate than a non-touring customer. And in our enhanced markets where we're piloting this real-time touring, right, this ability to really kind of book your tour nearly instantly, we see less friction, which plugs the holes in the funnel and increases both the customers' ability to get the tour when they want. It also increases the ability for those customers to connect with our Premier Agent partners, and they report a higher propensity to work with those Premier Agents. So all those things lead to a higher tour fulfillment rate. If you ask those customers, do they get to see the home when they want to see it, they're able to more often, and they end up liking working with the agents they're working with more often. So all of those mid-funnel metrics are really good indicators of higher transaction rates. As you know, transaction cohorts take a long time to mature. That's why we're giving you all kind of early indicator data on what historically looks like higher transaction rates. And as we get that data in those markets, we'll share more.

That's helpful. Regarding mortgage, it's a key long-term growth driver for you. It's also a crucial part of the super app, but I understand you're still in the development phase, so the strategy might still be evolving. Looking ahead, I'm interested in how you plan to leverage the significant customer acquisition cost advantage. At a broad level, are you considering using that to target industry average margins with competitive pricing, or perhaps lower pricing to gain market share? Alternatively, do you see the potential for achieving above-average margins in mortgage with better pricing?

Yes. It's a great question on mortgage in the long term. And as Rich also talked about, very early and very focused on getting the machine, the factory, the partners and the customer experience all right and all working well together. You're right to point out, we do believe we have a great CAC advantage in mortgage. The two hardest things, I think, for a stand-alone mortgage company to work through are how to acquire customers and how to find a great referral network of agent partners, and those are the two advantages that we have at Zillow with our fantastic brand and audience. As Rich talked about, many customers on Zillow today are starting with that financing question, and so starting to explore ways to connect them with our own offering as well as have our agent partners refer those customers back to us who want to start with a property inquiry. So you're correct in that, that CAC advantage, which, in some cases, is 25% of industry cost is one for us. I think it's too early to say how we might look to structure the business long term. I guess the only comment I'll make is that as we've been growing this business carefully with our great loan officers, our great agent partners, the feedback we get is what folks care most about is closing on time and having a great and high level of service. So of course, they want great value. But as we're building the technology and the people operations to make this go, the real value to a customer and to their agent is, is the loan going to close on time, do I have transparency on when that's going to happen, and do I get a great level of service? And so that's really what we're focused on. And we think if we can deliver that, that's a great business with great margins.

Congratulations on the results. I wanted to explore real-time touring further. The feedback from Atlanta and other test markets seems positive, and the goal of tripling conversions is clearly significant. What should we consider regarding the speed and extent of your plans to expand real-time touring beyond the test markets? When do you envision transitioning from the test phase in these enhanced markets to a more widespread rollout across the country?

Yes. This is Jeremy. I'll take that one, too. Thanks. Nothing to share yet other than, as Rich talked about, we're really excited that we went from one market to four markets in the last quarter. And of course, as we continue to see the signals of better customer experience, better funnel performance and also better agent feedback, we're excited to figure out how we can bring that to more customers and more partners in more markets. I will just caution the complexity of that and the reason we're doing this market by market is because it is a new workflow. So to the customer, it may look invisible that you click this button on Zillow and something better happens and there's less friction, but it's an entirely different way for agent teams to connect with those customers than what they've done before. And so that's why we've been very methodical in working closely with these great, optimized partners we're working with to help them figure out how to retrain their agent teams to go meet these customers where they are. Part of the benefit of it is the less friction on the digital side. Part of the other benefit is less friction on the operational side, and making sure we get that right with each partner is something we're really focused on.

I lose you?

No. We hear you, Allen.

Okay. Yes. Thanks, Ryan. So what I describe is we gave some guidance kind of on our EBITDA OpEx to tick up in Q2, and we believe the guide we have for Q2 is pretty representative of what we expect in run rate as we close out the year. Obviously, as we see success and to the extent mortgage would be a great example, if volume were to tick up, there would be some variable resources that we'd hire to support that volume, but that would come also with the increase in revenue.

Yes, yes. Sure, Brad.

So the existing home sale forecast that we talked about is we're talking about down 18% to down 28% in total transaction dollar volumes for Q2, and so our residential outperformance we talked about is versus that existing home market. That does not include, obviously, the new home market. The new home market is a smaller part of our overall business. So the part that more closely correlates with our business is the existing home sales, so that's why you see us reference that and correlate. And as we called out, the things that are driving the benefits that we see in Q1, we expect to continue into Q2.

Well, great chatting with everybody. Thanks for taking the time on this busy earnings day. You can see we feel really good about a bunch of incremental improvements adding up to good relative results, good results relative to the industry. We look forward to chatting with you soon. Thanks a lot.

This concludes today's conference call. You may now disconnect.