Zillow Group, Inc. (ZG) Earnings Call Transcript & Summary

Good day and welcome to the Zillow Group Investor Update Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Brad Berning. Please go ahead, sir.

Good afternoon, and welcome to Zillow Group's Investor Update Conference Call. Joining me today to provide a business update are Zillow Group's Co-Founder and CEO, Rich Barton; and CFO, Allen Parker. During the call, we'll make forward-looking statements about our future performance and operating plans 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. The presentation is being broadcast on the Internet and is also available for download on our Investor Relations website. A recording of the call will be available later today. We'll open the call with brief remarks, followed by a brief live Q&A. And with that, I will turn the call over to Rich.

Thanks, Brad. Hi, everyone. Allen, Brad and I are dialing in from our respective homes, where I also expect many of you are currently. One thing is certain, home and the safe sanctuary it creates has never been as important as it is right now. It's hard to be productive when you and those who depend on you do not feel safe, so please make sure you are taking care. Thanks for joining our pop-up conference call today. We are pleased to have you here to talk about all of the very logical activities we are undertaking to protect our employees, our partners and you, our shareholders. It has been just 3 weeks to the day since Allen, Brad and I were dial-in presenters at the Morgan Stanley Tech Conference, while hundreds gathered for it in person in San Francisco. As a Seattle-headquartered company, we were understandably ahead of the curve on social distancing and already working from home at the time. That means we need haircuts and shaves right now too. A lot has happened since then, and we want to review what we are seeing and doing in order to ensure the success of Zillow today and tomorrow. First, we'll talk about our current business trends and where we stand on our outlook for Q1. Second, we'll review what you will likely agree are the logical actions we are taking to navigate these choppy waters, specifically to reduce expenses and preserve cash. Third, we will take a tour of our mid-quarter balance sheet, inventory levels and our convertible debt stack. Fourth, we will lay out a severe stress test scenario and what our estimated cash position would be in this scenario. I'll walk you through these actions, and I plan to reference a few slides from a supplemental deck that we just published on our IR website. Please go grab that deck if you haven't already or e-mail [email protected] for it, and he'll send it to you now. As I will be referring to it in my comments, I think we're going to try to broadcast it too on screen share, so maybe you'll be able to see it while we screen share. There may be a bit of a time lag there. I'll do that, and then Allen will -- and I will both take your questions. Okay. Before I turn to the business, I want to let you know that we are actively preparing for any and all scenarios and are choosing our path with the clear eyes that come from having led through major disruptions in the past. My co-founder and our Executive Chairman, Lloyd Frink, and I, along with many of our executive team, were leading Expedia as a public company when the planes hit the twin towers on 9/11. That's when many people thought that was going to be the end of capital T travel. We were also at the helm of Zillow during the global financial crisis, which started in our own industry and then spread mercilessly throughout the global economy. We successfully navigated these trying periods and emerged from both disruptions stronger than we entered them. We did this by making informed calls to use the brakes when appropriate and to use the accelerator when appropriate. In both of these cases and throughout my career, optionality was created with cash. You, as investors, understand this well right now. It is no different for a company. Lloyd and I were raised at Microsoft in the '80s and '90s. Part of the Microsoft lore is that Bill's dad told him he always should have enough money in the bank to be able to run the company for at least 1 year with 0 revenue. This is how I have managed every company I've founded and led, and this is how I have advised every company I have invested in or sat on the Board of. And though we certainly didn't contemplate a global pandemic in our 2020 business plan, this is the position Zillow is in today, strengthened by our decision last September to put another $1.1 billion on the balance sheet. Okay. Back to my outline. First, let's talk about the current state of the business. When we last spoke publicly 3 weeks ago, we shared we had not yet seen any signs that our customers and partners were changing behavior in response to the coronavirus. We also had not yet seen any local, state or federal actions at that time. Later, when counties started to issue stay-at-home orders, we started to see noticeable dips in shopping behavior and Premier Agent connection requests, most notably in those markets directly affected by the virus, while other markets still remained relatively healthy. These initial wobbles and subsequent deterioration came on the heels of a pretty remarkable January and February that delivered stronger-than-expected results, so we came into this period on solid ground. This performance early in the quarter is why I can report today somewhat ironically that we are reaffirming our outlook for the first quarter and that we expect to meet or beat our guidance ranges for each metric. That said, we can't know what lies ahead, and we're suspending our full year 2020 outlook. As concern for the virus has grown over the past 2 weeks, we've seen an increasing number of shelter-in-place orders, and many people are working from home and accommodating school closures. The pullback in home shopping and selling activity are closely correlated to these actions and virus concerns. But to be clear, despite the widespread uncertainty, people are still shopping for homes and rentals on our apps and sites and many sellers still need to sell. To give you an idea of the magnitude of the decline, visitor traffic is off from low double-digit year-over-year growth earlier in the quarter, so from low double-digit positive year-over-year growth early in the quarter, to down nearly 20% from last year in recent days. The markets that have seen traffic drop the most have been New York City and Chicago, down 36% and 27%, respectively, over the prior year. It's somewhat surprising that in Seattle, we have seen visitor traffic rebound a bit, although it is still down 19% year-over-year, in line with the current national average. During the past week, we have also seen some government restrictive orders that have impacted activity we see online and in our field operations. Many of these orders have specifically called out real estate showings and other activities as nonessential. As traffic has fallen, we've also seen requests for connections with agents decline in some markets more than traffic, but not as much as one might expect. Interestingly, while connection volumes are down 30% from peak levels nationally, they are down only 40% in the shelter-in-place markets. This could mean that, at least for now, people are still considering moves. We also see our agents creatively navigating fast-changing circumstances to respond quickly and service our mutual customers as best they can, given the circumstances. The lower consumer activity means our partners have been deriving less value from Zillow leads of late. We understand this, and last week, we announced we would offer all Premier Agents a 50% credit on their next bill beginning today. We want to demonstrate we are all in this together. This week, we are extending additional support and financial credit to our partners in StreetEasy, Rentals, mortgage lead gen and New Construction. The support varies by marketplace and the impact thus far falls within the $40 million to $50 million 1-month impact that we disclosed last week. While anecdotal, we have indications that these proactive actions have helped support Premier Agent retention during this unsettling time. As of late last week, our monthly recurring revenue or MRR for Premier Agent had declined 2% nationally from its all-time peak a couple of weeks ago and are down about 5% in shelter-in-place markets so far. Okay. Now that we talked about the business trends and shared some metrics, let's turn to expense reduction. You have heard Allen talk about getting fit internally. Over the past year, we have done a lot of hard work to infuse operational rigor into our company and it's serving us well right now. We will continue to take costs out of our operations to preserve jobs and put us on solid ground to reaccelerate as we turn the corner. We said last week that we will take steps to offset anticipated revenue loss with logical and obvious expense reductions. The short version is that we will cut 25% of our quarterly expense run rate versus our 2020 budget. Specifically, to this end: one, we have paused all hiring across the company; two, we have paused most marketing spend; three, we are cutting other discretionary spending as you may have seen in our press release this morning; and as you may have seen in our press release this morning, we have, four, paused acquisitions in our Zillow Offers business. All right. So these are all really logical mechanisms we're using. We'll monitor this level of reduction and make changes if conditions warrant. Let me talk a bit about our decision to pause home acquisitions in Zillow Offers. We did this to preserve capital to help protect the enterprise, while it also became increasingly difficult to navigate the local ordinances while trying to ensure the safety of our team, our customers and our partners. We will also temporarily pause new market openings, but we will continue to market and sell Zillow-owned homes wherever possible. We intend to unpause acquisitions under Zillow Offers as soon as the health situation stabilizes and we feel the housing market is functioning. Our decision to pause buying came on the heels of intentionally slowing our rate of home purchases over the past month as uncertainty rose, which followed seasonal adjustments to our pricing that corresponded to lower home acquisitions already. On resale, Zillow Offers had a great January and February, with the fastest sales pace since we launched this business, which was driven by applying past learnings that have sharpened our resale strategies. As a result, our inventory balance has significantly reduced since the end of the year, which we'll discuss in more detail in a moment. I know a lot of our tech shareholders have been concerned about inventory risk, but the reality is this risk is very manageable on our balance sheet. While we certainly don't expect it, we could fund our entire inventory and our balance sheet ourselves and it would not impact our capital levels from operating the business. Okay. I'm going to dig into this more now. And I got to switch my view here. I can. I'm going to try. All right. Here we go. I'm jumping to Slide 4 of the supplemental right now. Okay? I'm having trouble bringing up my Google Sheet, however. Hold on 2 secs. All right. I'm going to have to pull up my iPad as backup. All right. Let's take a look at the balance sheet. It was interesting. My friend, Bill Gurley, who many of you, I know, know or know of, called me the other day and did a Zoom. We did a Zoom, and we were just talking about what's going on in the business. And he did a screen share, and on his screen share was Zillow Group's balance sheet. And he quizzed me for about 10 minutes on what each line item was. Interestingly, I found it incredibly comforting for myself to explain to Bill what all these -- about the balance sheet. It was comforting to me. All right. I got people texting me. All right. So let's start with cash, okay? As you can see, what we're doing on this balance sheet, on Slide 4, we have our December 31 audited balance sheet from 2019 in the left column. In the right column, we have come up with an unaudited balance sheet as of February 29. Okay? The first 2 line items are cash and cash equivalents and short-term investments, $1.35 billion, $1.36 billion and $1.15 billion. Okay, if we flip, if you -- we're going to take a little detour on cash by going to Slide 5, and we'll look at what that cash actually is and how it's grown over time. So go to Slide 5 in the supplemental, and you'll see that our cash balance has been increasing over time and in fact has gone up mainly of late because we have been reducing our Zillow Offers-owned homes inventory. So we have $2.5 billion in cash as of 2/29. So the next question is what is that cash, what's it made up of, is it safe? 89% of it is in actual cash or government-backed securities, short-term government-backed securities, okay? So we're in good shape there. All right. Let me go look and see if I missed anything on the cash. No, I think those are the key points. All right. Let's go back to the balance sheet now and let's do a little inventory tour. So the next line -- 2 lines down is inventory. You can see actually, just by comparing these 2 numbers, that the value of our inventory that we're carrying is -- has been in decline from $836 million, $837 million at the end of the year to $645 million right now. That tells most of the story. If you want, you can go to Slide 6 and see how that plot has actually changed over time. We don't need to go do that right now. All right. Now we're going to take a little tour of the debt, and I want to break the debt into 2 categories, asset-backed -- home asset-backed debt and then corporate convertible debt that we're carrying. So let's jump to the liability side and look at this line item, borrowings under credit facilities, these are the -- this is the asset-backed debt, these are the bilaterals that we have with several banks. Currently, we have $563 million in those bilaterals. That roughly matches as the offloaded nonrecourse debt portion of the inventory of that $645 million in inventory that we have above, so those match fairly well right there. Okay, so that's the story of the asset-backed debt. If you go down one line item, you see our corporate debt. Our corporate debt is all convertible notes, okay? And let us go look at -- that is $1.6 billion. Let us go look at Slide 7 to get a little double-click down on those converts. Okay? First thing you'll notice is that, that number I cited, $1.6 billion, it shows up as $2 billion total. That is simply the carrying value versus the face value. So it's $2 billion of face value. You can see how they -- when they mature over time in the chart down below. So it's stretched out over as close as 2 years out for the first meaningful chunk, to 3 to 4 years out, July 2023, for the next big chunk, September 2024 for the next big chunk and then September 2026 for the final $500 million. Okay? So it plays out over time. And it's worth noting that these converts are repayable at our option in stock or cash, okay? So this is not a hard cash obligation. So in the worst of circumstance, we can actually pay it back in stock. And note, we have a low cash coupon rate on all of those converts. Okay. So our strong balance sheet, combined with the expense actions I discussed also protect the enterprise in a severe stress test scenario, what we believe is a highly unlikely worst-case scenario. So I'm going to walk you through that scenario right now. So I'm not explicitly looking at the supplemental slides anymore. Okay. First, in this scenario, first, let's assume our IMT and mortgage revenue drops by 75% for the remainder of the year, okay? That is a severe assumption. So 75% drop in revenue for the remainder of the year. Next, let's assume we execute only 25% of the -- only the 25% cost reduction that we've already announced but we don't take additional cost savings actions, okay? This is far-fetched, but it's a hyper-conservative scenario. Next, assume we sell 0 homes that are currently on the market or in renovation and that 75% of our owned homes currently under contract don't actually sell. Buyers just can't get it done. Again, a hyper-conservative scenario. And finally, assume we are forced to put all of these homes on our balance sheet at 100% equity and we have to carry them through the end of the year, okay? So we -- but this is a worst case. Basically, we own all the homes outright that we have. We don't have any debt on those -- asset-backed debt on those homes. Okay. In the unlikely event that all of these things become true at once, our current $2.5 billion of cash and short-term investments would be reduced to approximately $1.35 billion at the end of 2020. We'd obviously take further cost action if this scenario did play out, but wanted to really stress our balance sheet to understand what would happen. As Zillow's largest individual shareholder, this gives me personally great comfort. Okay. My hope is this also gives you real comfort and confidence that we are in a strong position to navigate what may come. There is no coronavirus playbook, but we are actively writing ours based on the signals we are seeing and our past experience running extended plays during market disruptions at Expedia and Zillow that ultimately propelled us to category leaders. There is nothing to change our fundamental belief that there is a huge opportunity to replatform the real estate transaction, and we are in the pole position. In fact, this crisis very well could accelerate a technology-driven replatforming as we have seen happen in multiple other industries in our experience set. This current situation has illuminated just how antiquated systems and paper-driven processes weigh down this sector and how technology can ultimately make exchanges with our customers and partners more seamless and the entire market more efficient. For instance, with social distancing, we're seeing evidence that our proprietary 3D home technology is already helping partners and customers. Over the past 2 weeks, we've seen a surge in the number of 3D tours created and published compared to February. Our team is also rapidly innovating on new features and technology to help the virtual shopping and transaction experience. For example, we will soon be rolling out a remote online notary solution with other technologies under development. And finally, just earlier today, the Federal Housing Finance Authority directed Fannie and Freddie to provide alternative options for home appraisals, and we are actively exploring how Zillow can help using our free 3D homes tech and other solutions. This would be major. These are examples of opportunity areas we can go deeper on another day. Right now, our top priority remains on keeping our people, customers and partners safe as we protect the Zillow Group enterprise on this unexpected but navigable journey. All right. Allen will now be joining me as we're going to take just a few questions. [Operator Instructions] Operator, please open the lines for questions.

[Operator Instructions] And our first question will come from Ron Josey with JMP Securities.

Great. Thank you, Rich, thank you, Allen, for the update. I think it's very valuable and helpful during these times. I just wanted to maybe ask a little bit more, given the events and the speed at which these events are taking place. Is there any change to how you view Offers maybe longer term as part of the Zillow business? And then tactically speaking, as part of Offers, it's sort of the same question. Inventory's at 1,859 homes or so. What are you doing with homes that are currently under contract? So is that something that will add to the balance? Or is that -- just curious what you're doing with that to think about balance.

Yes. Hey, Ron. Yes, I mean, this doesn't change how we think about Zillow Offers. We really -- we feel like we know that this is a really interesting consumer innovation and that demand and interest in it is really high. And we are keeping the apparatus in place and the people in place and -- while we pause and getting ready to accelerate out of this because we think demand is going to be really high. We are working with existing customers to cancel our existing contracts to the greatest extent we can. We'll do this in a humane way. This is clearly a material adverse change, so we'll be taking that position and then evaluating, on a case-by-case basis, what we actually do and using some financial incentives to largely extricate -- to hopefully largely extricate ourselves from those transactions. I guess I would also say that it's really good that -- I guess it's good to be Zillow right now and that we have all of these different business lines that do feed each other and support each other. And so we can pause this business, keep the apparatus in place and still run our other business and keep progressing forward, and it's good to have this cash position that we have. So no change in how we feel about the Zillow Offers opportunity long term, and we're really happy that we have this optionality and flexibility.

And our next question will come from Mark Mahaney of RBC.

Yes. Just a question on the Premier Agent business. So these numbers down in traffic, substantial and then the connections, but the MRR down 2% and even down 5% in the shelter-in-place areas. I'm surprised by the fact that it's down so little. So just walk through that, why it hasn't corrected more? Or is that kind of -- is that a lagging indicator and we should expect MRR to decline a lot more over the next 3 to 6 months?

I mean it's a little -- hey, Mark, it's a little bit of a lagging indicator. It's also kind of a big denominator effect. But mainly, what we're seeing is we believe these kind of early actions we took to give relief to these customers was a churn deterrent, okay? And we're really expressing -- we're really getting down there with these partners, and we say, look, we want to partner with you, we want to be -- we want to be part of the solution here long term, we want to emerge from this crisis more closely bonded to our partners than we went into it, and this is part of it. And so it's impossible to quantify how much churn reduction actually happened as a result of our kind of partner relief actions that we've taken. But anecdotally, we hear that it's been meaningful.

And our next question will come from Justin Patterson with Raymond James.

Great. I hope everyone is healthy and safe. And Rich, if it makes you feel better, I was also told I need to shave this morning, so you're not alone there. I appreciate the detail that you shared around the actions you've taken around the -- and the liquidity position. To step back, you were targeting breakeven amid normal times. This is clearly a unique situation here. How do you think about which areas to invest in as these headwinds persist while maintaining the ability to meet that need going forward?

Yes. Yes, we were -- we had said previously for our kind of full year guide that we were targeting roughly EBITDA breakeven for the business overall. As I said during the call, Justin, we're not -- we're retracting basically our full year guidance at this point, and we'll come back and potentially revisit that soon when we report. But things are pretty foggy and uncertain right now. I'm really focused on cash, not EBITDA right now. As you can tell by the subject of the call here, we're really focused on the balance sheet. And we feel really good that we have our hands on the expense levers. We're turning them down the appropriate amount in a very logical way that is easy to explain to our employees, easy to explain to our partners. And my acid test is always, can I explain it to my wife and kids? Which I've just done. So these make sense. We think -- we hope this will be enough. But we've been through things like this before. We're clear-eyed. We'll watch carefully. And if we need to control expenses more than we already have, we certainly will do that and do what's necessary to preserve the enterprise long term and to make sure we come out of this really, really strong.

And our next question will come from Lloyd Walmsley with Deutsche Bank.

Just wondering if you can give us a sense of the 25% run rate expense reduction, how much of that is oriented towards just the -- halting homes acquisitions versus operating expenses and then just sort of operating expenses across IMT versus the home segment. I know you guys have been really, really disciplined over the past year on IMT. Are there more costs that will come out of that side of the business, or most of this is coming through home segment?

Yes. Okay. Hey, Lloyd, we didn't actually break down the expense reduction, the savings by segment. But I will tell you that the bulk of it is not -- we're looking at this from a cash perspective. If I switch to cash for a sec, we believe Zillow Offers, from inventory declines, we know it's been cash-generative for us as we've reduced inventories. We don't know what will happen with inventories going forward, but to the extent they're reduced, they will be cash-generative. For the rest of the business, IMT, Mortgages, et cetera, what we are seeing is a fairly balanced, I guess, savings that we're seeing from pausing headcount, pausing marketing and cutting other nonessential expenses.

Yes, Rich, I would probably add that the marketing is probably going to provide more benefit to our IMT businesses just given the nature of some of the marketing spend that's not committed to what we're going to do. But they will -- all of those actions, discretionary spend, pausing hiring and pausing our marketing spend is going to benefit all 3 segments and a little differently across just depending on where they are in the hiring ramps.

Hey, Allen is part of our call.

I am. Thank you.

Sorry, I forgot you were there, Allen. You saved me. Any -- are there any other questions?

Our next question will come from Naved Khan with SunTrust.

Maybe a couple of questions. So Rich, and maybe Allen, you can maybe -- can you explain to us this 25% run rate expense reduction? Should we think about it as a 25% reduction in the expense basis you have currently or you had at the end of last year? How should we think about the baseline or the 25% off of what base? And then, Rich, you kind of drew a worst-case scenario for us, but what do you think, at least in your mind, what is the more sort of a base case outcome?

I'll take it, Allen.

Okay.

Yes, it's 25% off of our budgeted 2020, which was a number we didn't publish. I realize that's a little -- it's a little difficult for you to pin down exactly. But from our perspective, it's 25% reduction from our internal expense budget, Naved. I can't remember the second part of the question.

Base sales versus maybe a worst case that you can detail for us.

Sorry, yes. Okay, right. We're focused on the worst case right now to make sure we're safe and secure, make sure you're safe and secure. It's very difficult to predict what we actually think is going to happen right now. We are running lots of different scenarios and updating them constantly, as you might imagine, using all the inputs that you're looking at but all the ones that we're looking at as well. But we haven't -- things are not stable enough yet for us to have a predicted case. We're going to talk to you in a couple -- in a few weeks, several weeks, when we actually report on Q1, and hopefully, we'll have a clearer picture at that point. Yes.

This concludes our question-and-answer session. I would now like to turn the conference back over to Rich Barton for any closing remarks. Please go ahead, sir.

I was getting questions in, in text as that was happening. All right, closing remarks. Thank you, guys. Really, thank you. Thanks for joining us today. We're all in this together and we're doing the best we can. I am finding that communications more and more -- the more communications we can do with our people and with our investors and with our partners and our employees and everybody, even if we don't know the answers, it's better to be communicating. So thank you for joining us. We know this is a difficult time for everybody. In referencing the wise Warren Buffett and perpetuating our ocean metaphor as to what can happen when the tide goes out, I want to assure you, Zillow Group is not swimming naked. We have wetsuits, navigational instruments and safety gear, all supported by a highly experienced crew who will keep us moving forward until the calm waters return. We look forward to connecting again in a few weeks. In the meantime, please stay safe and calm in the sanctuary of your homes. We are doing the same. Talk to you soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.