Zillow Group, Inc. Class A (ZG) Q2 2019 Earnings Report, Transcript and Summary

Good day. And welcome to the Zillow Group Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to RJ Jones, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon. And welcome to Zillow Group's second quarter 2019 financial results conference call. Joining me today to discuss our results are Zillow Group's Co-Founder and CEO, Rich Barton; CFO, Allen Parker; Zillow Brand, President and Co-Head of Zillow Offers, Jeremy Wacksman; and President of Media and Marketplaces, Greg Schwartz. During the call, we will make forward-looking statements regarding future financial performance, operations and events. Although, we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee these results. We caution you to consider the risk factors described in our SEC filings, which could cause actual results to differ materially from those in the forward-looking statements made on this call. The date of this call is August 7, 2019 and forward-looking statements made today are based on assumptions as of this date. We undertake no obligation to update these statements as a result of new information or future events, except as required by law. This call is being broadcast on the Internet and is accessible through the Investor Relations section of Zillow Group's Web site. A recording of the call will be available later today. During the call, we will discuss GAAP and non-GAAP measures. We encourage you to read our financial results press release, which can be found on our Investor Relations Web site, as it contains important information about our GAAP and non-GAAP results, including reconciliation of historical non-GAAP financial measures. In our remarks, the non-GAAP financial measure adjusted EBITDA is referred to as EBITDA, which excludes other income, depreciation and amortization expense, share-based compensation expense, acquisition-related costs, interest expense, and income taxes. We have posted our quarterly shareholder letter and financial tables on our Investor Relations Web site. We will open the call with brief remarks followed by live Q&A. I will now turn the call over to Rich.

Thanks, RJ. Greetings everyone. Thanks for joining us today. A few weeks ago, my wife and daughter were in DC, and their trip happened to coincide with the 50th anniversary of the Apollo 11 moon landing. They strolled out on to the mall that evening and discovered that the whole 555 feet of Washington Monument was being used as a screen for projecting images and video from that historic day. Tens and thousands of people were watching. The pictures they texted me were a reminder of what wondrous goals we humans can achieve through cooperation, cleverness, and big dreams. In our own slightly more mundane way, we at Zillow Group are dreaming about our own moon landing. We are in the early stages of a bold expansion from solely a residential real estate media company into the trillion-dollar TAM opportunity of streamlining and enabling the real estate transaction itself. It would be hard to find a more complicated snarl of a consumer experience than selling and buying a home, and all of the messy swirls around that transaction. We are finally bringing modern technology to this giant business, and the possibilities and our progress are exciting. There are many increasingly coordinated efforts underway across the company to drive this expansion, but the big new thing is Zillow Offers. July marked the one-year anniversary of when we sold our first Zillow owned home, and I'm really pleased to share today that we reported nearly $250 million in revenue for our Homes segment in Q2. I want to commend our whole team, not just the Zillow Offers team on going from zero to $1 billion run rate to $1 billion a year run rate in revenue, just in one year. The demand signal we are seeing for Zillow Offers continues to impress us. During the quarter, requests from sellers to receive a cash offer nearly doubled to almost 70,000. In the same period, we purchased more than 1,500 homes, up 71% from Q1. And we sold close to 800 homes, nearly twice the number of homes as last quarter and more than 4 times what we sold in all of 2018. In Q2, we stepped on the gas launching seven markets, a rate that we plan to match in Q3. On Monday, we launched Nashville, bringing our total live Zillow Offers markets to 15, giving another group of consumers a new way to sell their home without hassle and uncertainty. We are also increasing the number of markets we expect to be in to 26 adding Jacksonville, Cincinnati, Oklahoma City, and Tucson to our plans by early-to-mid 2020. With every new market, our team learns and applies the insights, lessons and data to move faster and gain efficiencies as we scale. In addition to participating directly in market making with Zillow Offers, we are pushing down funnel towards the transaction in our premier agent business. We are transitioning our lead generation model into one built-on partnership in which we deliver high touch customer service and seamless transactions where success is shared and mutually rewarded. The partnerships we're building with local brokers and agent teams in connection with Zillow Offers reflect the goodness that comes from aligning the Zillow customer with the highest-performing and client focused professionals in every market. We're applying these lessons to the future of Premier Agent. During our Q1 call, we announced plans to expand our Premier Agent Flex model to zip codes in Connecticut and Colorado. Under Flex, agents pay no upfront costs and only pays us a little success fee when they close a transaction with a Zillow lead. While still early, the signals we are receiving in these initial test markets are favorable. Our agents indicate they're receiving quality high intent connections, and Zillow consumers report high levels of engagement from their Flex agents. Given these positive indicators, we have decided to expand the Flex test in Q4 to two of our established Zillow Offers markets, Phoenix and Atlanta. We believe testing in these markets will allow us to increase our insights and learnings, while also experimenting with other lead monetization programs that can work in conjunction with Zillow Offers and Premier Agent. The evolution of our businesses and industry partnerships coincides with a tectonic shift in the industry at large driven by technology. Our optimal partners are the best of the best agents who combine their local expertise and professional smarts with advanced proprietary Zillow technology to anticipate and deliver on the high expectations of our shared customers in today's on -demand, always-on world. We're already moving in this direction. We're using data and customer feedback to select our broker partners in Zillow Offers markets, and our machine learning algorithms are already helping to identify the Flex agents most likely to close deals with the highest satisfaction levels. The future of these partnerships is key to our seamless real estate transaction experience vision. As you'll note in our quarterly letter, the Q4 Flex expansion into Zillow Offers markets is expected to shift some revenue and EBITDA from 2019 into future periods, which Allen will discuss in more detail. We confidently make these short-term trade-offs to accelerate our learnings about the long-term potential of Flex, but it's still early. We're spending this amount of time talking about Flex with you, because it is part of our strategic move towards the transaction and because it will affect revenue recognition and some expense recognition. Our core Premier Agent business continues to perform well. We're seeing positive feedback from agents and consumers on the new lead validation and distribution process, which is driving more connection and higher customer satisfaction. Let me switch gears to mortgages. It's been less than a year since we acquired Mortgage Lenders of America, which we rebranded as Zillow Home Loans during Q2. Our strong Q2 performance reflects our fulfillment of the pipeline that originated on the legacy MLOA platform. As we transition from MLOA to Zillow Home Loans, we are building new proprietary technology to streamline and integrate home loans as our payments platform for Zillow Offers. We're already testing the initial version of our digital mortgage software, but the full rollout is taking a bit longer than expected. As we continue to build out the test -- to build out and test our own platform, we slowed loan officer hiring until we feel we have the technology and operational infrastructure foundation that we need to scale, which you'll see reflected in our updated outlook. This in no way affects our excitement about the future of this segment. Loan originations are an essential part of our ability to deliver an integrated transaction experience for our customers. We're making solid progress and the long-term expectations for our Zillow Home Loans business, and other transaction-related adjacencies remains unchanged. So, we are on our way with our own exciting little moon mission to transform, streamline and integrate the Shelter transaction. Zillow is in a harder but lucky position relative to this massive opportunity. No other company and real estate comes close to our brand awareness, our audience size, technology, data science, industry partnerships and operational knowhow to get it done. No other company has all of the vertical businesses required to provide consumers with a seamless integrated transaction experience, woven together with technology and operations. We have the best team of inventurers, and every day we add people to the mission with more smarts and new skills to enable success. We are also lucky to have a group of supporters on the ground, you, our investors, who support and believe in the dream, but who hold us accountable. We treat your investment in our team and mission with respect and thank you for your support. I'm now going to turn the microphone over to Allen.

Thanks Rich. I'm going to quickly summarize a few key financial results. Overall, we met or exceeded our revenue expectations for all segments and EBITDA with generally in line with our expectations for each segments. In Q2, we reported revenue of nearly $600 million, that's up 84% year-over-year, and exceeded the high-end of our outlook. Much of this growth in revenue was driven by our home segment, which was nearly $250 million, growing 94% sequentially. And as Rich noted, is continuing to outperform expectations. Internet, media and technology, or IMT segment, revenue grew 6% year-over-year to nearly $324 million and exceeded our Q2 guidance range. Premier Agent revenue was in line with our expectations at $232 million, up 50 basis points compared to a very strong Q2 2018. Before we take your questions, I want to take a moment to provide some comments on our outlook and highlight one item you will see in our results this quarter, as well as update you on my priorities as CFO. I'll start with the outlook. Zillow Offers' momentum is expected to continue. Demand for this service from consumers is strong. And we've accelerated our rollout into new markets throughout the year. We are anticipating Homes segment revenue to grow 44% sequentially at the midpoint of the guidance range for Q3. We have updated our IMT and Premier Agent full year 2019 revenue guidance ranges. At the midpoint of the guidance range, we expect IMT revenue growth of 5% in 2019 and Premier Agent revenue growth of 1% for the year. Our changes in outlook are primarily driven by the expected impact of our decision to expand the Flex test. This means that a portion of previously expected Premier Agent revenue from markets where we are expanding our tests is now expected to shift from Q4 in the future periods to correspondingly closing of Zillow attributed transactions. The impact of the Flex test on Q3 in full year 2019 EBITDA in our IMT segment is two-fold; first, closer to EBITDA from a portion of Premier Agent revenue that will shift from Q4 in the future period as I just described; second, we expect to recognize additional commission expense in Q3 and full-year 2019 due to the shortened estimated life related to the existing capitalized sales commissions. Additional details of the accounting treatments related to Flex are included in our shareholder letter. These adjustments do not have any reflection on the health of our Premier Agent marketplace, which has stabilized. As Rick mentioned, some of the integration of Zillow home loans and development of our mortgage software, will require more time than we originally anticipated. So we have slowed the pace of hiring loan officers until we have the operations and infrastructure in place to support scaling. As a result, we've adjusted our full year outlook accordingly. These changes position us well for 2020. Now, I would like to discuss an item that impacted the Homes segment cost of revenue included in our Q2 results. We recorded an inventory valuation adjustment for an immaterial amount during the quarter. This adjustment represented less than 1% of our inventory balance at period end, and was the primary driver of the increase in our Homes segment cost of revenue as a percentage of revenue in Q2 compared to Q1. Like any company that maintains physical inventory, we expect to incur these adjustments going forward as a regular course of business. This is anticipated as part of managing our portfolio of Homes, and the adjustment is well within our expectations. As of the end of Q2, only about 4% of homes held in our inventory were greater than 60 days past their underwritten hold time, with the vast majority of those homes under contract to be sold. Finally, during this time of transformation at Zillow Group my priorities as CFO are clear. I remain focused on establishing processes and mechanisms in supportive three things; scaling our new businesses; execution within our IMT segment in order to fund investments in our new segments, along with additional growth opportunities; and implementing discretionary cost disciplines and operational excellence across the company as we scale. It's exciting to be in the middle of such a significant evolution, both at the company and within the industry. And as we execute on our strategy to fundamentally change the home transaction for consumers, we are confident our long-term targets remain well within our reach. With that, operator, we'll open the line for questions.

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Angela Newell of Macquarie. Please go ahead.

Hey, guys. It's Ben Schachter. I just wanted to talk, there's a lot of issues in the near term to discuss, but really let's focus on the long term and the iBuyer market specifically. I just want to understand how you're framing the long-term TAM, specifically for the marketplace of buying and selling homes, and how that's changed or evolved over time. And then related to that, how are you thinking about the size of the long-term TAM for all these ancillary businesses, mortgage, title insurance, et cetera?

This is Jeremy, I'll take that one. I mean long term at scale, we think this is a really, really big market and that's why we're investing so aggressively. That's why we're accelerating our market rollouts we've announced in new markets. I think our buy box, as we talked about today, would cover half the homes in the country around, if we were available everywhere, and we seek to reach and expand the types of homes we buy over time. And ultimately at scale, when you're offering something like Zillow Offers, this really should be the way every homeowner starts to think about selling, not just requesting an offer from us but eventually looking at a standing offer we can make to them as a way to think about their selling options, whether with us or not. So, we've given a three- to five-year target, that's around 60,000 transactions a year run rate, that's a $20 billion business. That's just 1% of the market transactions today. We clearly see the opportunity as far, far bigger than that, that's a step along the way. And when we're able to deliver a service like this to those consumers, that opens up on top of the Zillow Offers business, all these adjacent opportunities, so mortgage, and title, and escrow and private transaction itself, as well as the knock-on services that you might get around the transaction.

Our next question comes from John Campbell of Stephens. Please go ahead.

I just wanted to touch back on the Flex pricing. We've obviously, -- I think we’ve heard a lot of positive feedback from agents just kind of doing the pilots. That seems like a pretty big opportunity for you guys. So, we're happy to see you lean on it, but my question first, could you guys talk a little bit more about the revenue impact? How is that accounted for in the backlog? And then any sense for the kind of estimated conversion rates in early stages of the pilots? And then secondly, are you guys starting to kind of mix in any of the sell side or listing leads into Flex yet?

It's Greg, I'll pick that up, the business part of that. And then Allen will take you through the modeling. So Flex, you're right, is looking pretty promising. We've got some leading indicators, right. So, it takes some time to mature a real estate lead, so the leading indicators that you're asking about that we're getting through here is first customer satisfaction. Our consumers are really pleased with the experiences they're getting by working with these Premier Agents, that's increasing in our Flex program. The second is the important appointment rate. Do consumers actually want to meet, and do they successfully meet with the real estate agents, the Premier Agents that we match them to, that's an important leading indicator to downstream transactions. That's looking really positive in these two-state tests we are doing right now in Connecticut and in a small area of Colorado, that's looking pretty good. And then we're getting our Premier Agents to engage in these. And we measure that by are they touching and interacting with these consumer connections in our app. And nearly every one of these connections is being touched in our Premier Agent app, and that is a very unique thing for real estate. So, so far the leading indicators are really good from these small scale tests. And I'll let Allen talk about that…

I mean, did you talk about [multiple speakers, Greg?

I did, yes.

And this is Allen Parker. With respect to the impact on revenue, as we've called out in the shareholder letter, the impact of accelerator increasing the number of tests in the Phoenix and Atlanta area, has the effect of taking revenue we previously thought we would recognize in Q4 and pushing that out in future periods. So, our outlook now reflects the impact of increasing the size of our Flex testing. And so, when you think about that range, it's the primary -- it's the significant change, our primary change to our revenue outlook as it is related to this Flex testing. And not only does it affect revenue as we push out from Q4 to future periods, that revenue falls through to EBITDA. And then we also have to accelerate our capitalized sales commission costs, accelerate the amortization, which has an impact of increasing costs in Q3, and the rest of 2019 for those two new markets.

This is Rich. The accounting for this is unfortunate, but not why we're making these decisions. We're making these decisions, because this is a better customer experience, and it's a better -- it's at least in our testing so far, it looks to be a better business model. And so we are making these decisions, because we think it's the right thing for customers and for the business for the long term.

Our next question comes from Mark Mahaney of RBC Capital Markets. Please go ahead.

This is Mike Chen on for Mark. I was just wondering if you could expand a little bit about Flex in Phoenix and Atlanta. In the shareholder letter, you mentioned about the lead monetization opportunities and programs that you're working on. So any color on how that dynamic would work between Zillow Offers and Premier Agent? Thanks.

So, you're right. We're optimizing to Phoenix and we're optimizing to another really strong Zillow Offers market, of course Atlanta. There's a few things that it allows us to do. It allows us to experiment with additional lead types and lead distribution. And lead distribution part is super important. We've just launched what we are calling the performance pacing algorithm, the PPA. And what that is, is using an autonomous model to make optimal matches between buyers and real estate agents that are able at that moment and familiar with that particular type of home in that particular area. And we expect to see some pretty significant conversion gains from that.

As the quality of those agents factors into the algorithm too.

Yes, you bet. So the algorithm is driven by expertise in the market, past transaction history and then customer experience score, CSAT score. And then if you're engaged at that moment inaccessible to us. So we're going to see some pretty awesome wins in customer experience, which we believe will flow through to gain some transaction volume and conversion rates. Again, the tests we're doing in a few smaller metros in Connecticut and Colorado are low scale. That's the reason why we're going to be to the two strong Zillow Offers markets so we can get a big strong signal to work off both, and we're feeling pretty good.

Our next question comes from Ryan McKeveny of Zelman. Please go ahead.

So I have a question on the valuation adjustment to inventory. And I guess just thinking about the possible adjustments going forward? Can you talk about that process of managing, so called tail or the relative underperformers in inventory? I guess those homes that are sitting longer than the underwritten hold times. And outside of just kind of commentary on that process that you look at. I'm curious if you look at the finished goods inventory on the balance sheet, so I think it was $379 million in the Q. Is there a way to break apart what percent of that was acquired maybe in 1Q '19 versus 2Q '19 just to a better sense of that aging process within the inventory that'd be very helpful. Thank you.

This is Jeremy, I'll take that. So I mean a couple of things. You're right. It's a way to think about the tail and it's a good marker of how we think about pricing the portfolio. As we price, there can be distribution of homes in each market and across Zillow Offers, some are going to outperform and ahead, some are going to take a little longer in the tail. And so you'll see the value adjustment as a reflection of that. Allen gave you a stat less than 4% of our inventory is late by 60 days, as a way to think about the sizing of it. That's probably the best way for you to actually think about the age too, we're not breaking out the age of inventory by segment, or -- sorry, by market, or by timeframe.

And I guess the follow up. I mean, so the 60 days past underwritten hold time of the 4%. I mean is there a way to frame what percent is any time late relative to the hold period? Or maybe said another way, what is the average underwritten hold period?

I mean, the best way to think about that is it's going to vary by market by price point. That's why relative to underwriting it's probably the cleanest metric. And thinking about the value adjustment as a reflection of any changes to the inventory on balance is the way we'll reflect it. Our underwriting will have a unique target of appreciation costs and hold time for each home. And then the pricing will balance the portfolio in a market and across the markets to solve for our financial performance results. So each home is unique in what it's -- and what's expected to do and then obviously where we see it flow through and actually do.

Our next question comes from Lloyd Walmsley of Deutsch Bank. Please go ahead.

This is Greg Vlahakis on for Lloyd. Two if I may. So I think Allen had mentioned that a majority of the Premier Agent guide down was attributed to the Flex. But just curious what were some of the other factors that were the cause there? And then I guess continuing on Flex? Since it seems like things are going better than expectations, and it's a better business decision. How should we think about this in the context of the long term IMT guide that you provided? And I guess if things are going better than expected, why not raise this long term guide for IMT? Thanks.

So with respect to the -- we took the top and down from 930 to 915. As I mentioned, significantly all of that was due to the revenue effect of Flex and moving Q4 into future periods. So there's not really much of anything to talk call out there. All of the key input metrics for the premier agent business continues to stabilize, and we're excited about that. And so there's no real story other than Flex with respect to Premier Agent and IMT. And I'm sorry, the second part of your question?

How does it affect our long-term -- how do we feel about IMT through the period…

So three to five-year targets remain -- we still feel very confident. As I mentioned in my opening remarks, that they're well within reach.

Yes, we don't think we were -- what was the IMT, three to five year guide, $2 million?

Yes, $2 billion with $600 million of EBITDA. It still feels appropriate.

Our next question comes from Ron Josey of JMP Securities. Please go ahead.

Just wanted to ask on two things really, first on just Premier Agent retention. I think you said in the letter return to historic norms. Can you just update us on how you're doing with acquiring perhaps those agents that might be have lost during the transition last year, and then overall just conversion rates with PA forward? And then on homes, just with service fee I think in the 7.5% in the quarter, I think that compares maybe 7% prior. Just talk about what's driving that fee? I know it's a range. But is it maybe going into newer markets, consumer perhaps willing to pay more for the convenience. Any insights on the fee would be helpful. Thank you very much.

It's Greg. I will pick up the first half of that. So as we noted on Premier Agent, we run forecast. So we returned to exactly where we thought we would be now, so we're pleased about that. The real driver of this and again the normal retention, we're right on it, is the step we made on connections that fewer higher quality connections between these great real estate professionals and consumer that need to be served, that was a big bet we made. And it's flowed through. Our premier agents are now covering high-quality live connections, so we're please about that. The other big bet we made -- and both of these are important for our Flex transition is best of Zillow. The best of Zillow that was we would make this a selective group of the finest real estate professionals down to anywhere. We'd have a measure that's incredibly high scale, millions and millions of consumer -- elements of consumer feedback now on this thing. And a reminder of best of Zillow is it's a five star rating system that happens at multiple times during the relationship between consumer and professional, and we're holding agents -- our Premier Agent's too high standards. So that's fully implemented and positions us wonderfully for Flex, and that's been our focus to-date. On returning customers, these folks come and go based on their lives, because these are small business people. And so we've always been pretty consistent once these connections were recognized as valuable with folks flowing back to us, but we feel pretty good about that. But the team is focused on Flex and what they had. Allen, do you want to take the second half of that, there was a financial question there?

Yes, it is. It's market and buy box and home mix. So we're getting into more markets. Each market and even zips within market and home types have different underwriting input from carrying holding costs, to taxes and fees and those all get rolled up into the fee. So you will see that vary as we go, especially as we're opening in more markets and as we spread.

Our next question comes from Jason Helfstein of Oppenheimer. Please go ahead.

This is Hoffman on for Jason Helfstein. As you are entering all these iBuyer markets. How should we think of inventory and economics for iBuyer trending throughout the rest of the year? We saw slight uptick from 1Q to 2Q. But how should we think about that in 3Q and 4Q, if you don't mind?

This is Jeremy. So the unit economics we're targeting continues to be the same, so plus or minus 200 basis points return before interest. And so you saw a similar performance between Q1 and Q2, and well within that range and you'll see us -- we expect to continue to performance at that level.

And this is Allen Parker. I'm just going say, in terms of economics overall, we have talked about we expect to see trending improvement in our EBITDA margin as a percentage of revenue, that may not be linear. But if you look at our range, we were at negative 22.7 in Q2 and we have a range of negative 18.9 and negative 23 in Q3, based on our guidance ranges.

Our next question comes from Jason Deleeuw of Piper Jaffray. Please go ahead.

Great, thanks for taking the question. Just wondering on the seller fee. How much of a factor is that on the home seller acceptance rate? And then there's also been more talk about I buyers offering the instant offer and then plus a traditional agent listing price what they think the home seller to get through traditional sale for the house? How important do you think that would be to the iBuying process? And is that something that Zillow is taking a look at? Thank you.

This is Jeremy. So I mean consumers are super sensitive to the fees. So as the fee varies, you'll see acceptance rate change but that's relative to their alternative, right. So when we're pricing in the fee, many of those costs are cost they would incur no matter how they sold. And having that conversation, having explain that to them is something that we're still working through and they're still learning as they get into the selling process. So when fee moves, it moves but it's about what does it mean relative to in terms of alternatives. And then, Greg, I don't know if you want to take the listing to…

Certainly, it's been a topic of some interest. We think we have a good long term opportunity in developing a business adjacent to Zillow offers. But there's some adventure to happen here. Of course, it's confined it to the Zillow Offers' footprint, which is still a pretty compact footprint. And the thing we have to get sorted out in our product iteration is focused covet of beautiful, amazing Zillow Offers' instant experience. And we have to figure out how to cross sell them when they don't fit or buy box typically, cross sell them into the listing with the premier agent. We're working our tails off on that and there's promise, but it's not this year.

Our next question comes from Brent Thill of Jefferies. Please go ahead.

It's Alex Giaimo on for Brent. Just based on the color you provided in the letter, it seems as if recent premier agent feedback has been positive. But the full year guide still implies just 2% growth. So if you can just remind us what you think the TAM is for that business that would be helpful? And how much runway you think is still available in the PA business? Thanks.

So this is Allen Parker. I'll take that. I mean, I guess what I would say is that with the guidance that we gave, the implied -- at the top end of the guidance, the implied growth rate for premier agent in Q4 is about just under 3%. But that is impacted by this Flex adjustment that we described. I think that we expected with this recurring revenue and in turn that we saw last year that we would have to build that back up. We would see more significant growth had we not done the flex transaction. As rich mentioned, it's the way we recognize revenue. But in terms of long term TAM and growth, I would just look through our long term progress. We still believe that within three to five years, IMT can be $2 billion business at a 30% EBITDA margin.

And the frame to apply to this is we're moving to a transaction model. We're doing the transaction model with the finest real estate professionals in the land. And we've got a much larger TAM to address with this new Flex program as we get to it. So there's a bunch of upside on the bids. We just got to get everything lined up and we got to get some full data back from these higher scale tests in these important Zillow markets, and then we will good.

Our next question comes from Brad Berning of Craig-Hallum. Please go ahead.

Just to follow up a little bit more further on that thought process, maybe you can touch a little bit upon the flex TAM of how you see it versus the traditional advertising Premier Agent TAM? And what is the margin profile on Flex likely look at versus the historical PA business? Just curious if you could help us think that through?

I will talk to you about like the top line economics of it and then Allen can hit the margin profile, if you want to. The way to think about this is we've been limited by the advertising budgets, which is -- by advertising budgets of the credit cards of these great small business people, these agents. Who've had to pay upfront, who've had to pay upfront, take the financial risks, and so they were looking for pretty strong economics in return. And even when they were wildly profitable, multiples profitable, they de-risked those decisions when prices went up on them, when we moved towards -- when we move to Flex. Let's be clear, the economics, the take on an average transaction improved for our company. So we take a bit more, because we're capitalizing the transaction. And we think by providing better lead distribution or connections to the right professional and a better experience with best of Zillow where we can drop folks that aren't providing amazing experiences to consumers, we drive well more transactions. The economics on a per transaction basis improved for us, and you know we've talked of this roughly to 35% referral fee is the industry standard, we will see where we sell in. So that's great and then we will drive more transactions. So this should have really good leverage for us, and it aligns us with the incentives for both consumer and those real estate professionals.

And it doesn't appear on the income statement. But once again, I'll bring up customer satisfaction. It's a better -- we think it's a customer experience this way, and that matters. That is an input to growth.

And with respect to the margin profile, we're not currently giving any guidance outside of our current outlook we got a lot to learn about flex. But again, as Rich mentioned, we're super excited about a lot of the elements starting with the customer. And we think the rest will work itself out to the positive. And I would just still direct you to our long-term targets with respect to the curves over the next three to five years.

Our next question comes from Tom Champion of Cowen. Please go ahead.

Maybe one more on Flex. I just am curious if you could close the loop on why Phoenix and Atlanta, and why it's important that those were offers markets as well. Can you just clarify that? And then maybe switching gears to offers, really impressive markets growth and transaction volumes. I'm just curious if you could share any thoughts around scale and maybe volumes where individual markets become profitable. Any comments around that would be really helpful? Thank you.

Yes, I will pick up the first. This is Greg. Why Phoenix, Atlanta. The brand is pretty hot there. We've got great agents working with us there, and partnered with us there. And we're iterating on the seller lead opportunity and the buyer lead opportunity there.

It's a more controlled laboratory for testing…

Yes, you bet. So that's why those two important markets -- and they've large enough markets that it's going to give us strong enough signal. And in on this signal, the strong signals we're seeing from the data that we've created leading indicators are based on a few midsize metros in Connecticut and Colorado. And these two big areas will give us a really strong signal. Jeremy, you want…

Yes, I mean on offers and how we think about markets as we go. Yes, we're scaling quickly and we're adding more, and we're just now starting to come up on even being able to see year-over-year on the first couple of markets. So it's still early and it's going to be a while before we can really think about market composition and market-by-market dynamics. The only thing I can say is obviously scale is an input to that long term target on profitability too. So the scale platform that we get, both in each market and across the markets and being able to grab the data, get the best demand signal, provide stronger offers and drive costs down are what going to drive the whole business. That's going to be true in our big markets and it's going to be true across the platform.

Our next question comes from Brian Nowak of Morgan Stanley. Please go ahead.

Thanks for taking my questions -- I have to just to throw another one at Flex. So I just kind of want to make sure we understand. So if you look at your initial markets where you're testing this. Are you saying that your per home transaction monetization, so the revenue you're generating per home is actually sold to the platform is actually better through Flex than the old PA? Just to kind of -- to clear that up. And then just so we understand how that trends over time. And then you talked about the idea that you'll be able to send more leads and more home sales to higher quality agents. If Flex is successful over time, then do you see a world where you have more leads and more transactions going through higher quality agents, so the agent count could fall further over time? Is that kind of the way you're thinking about Flex changing the business model?

Yes, so the two good questions. So the economics I would point out, we're early yet. We just launched the program in those areas in June. So what we believe will occur -- and what occurs. We've got to let this stuff mature a little bit, so we're going to plant a flag on that issue.

You just said to me the take rate was going to go up. I just heard that on the call. And I took a note. So at the end, it's still pretty small.

Yes, the end is pretty small but it's working pretty positive. It is looking like on a per transaction basis, it should be positive. And then the question on agent account. We intend to have a selection of the most productive agents in the business. Connections allow them to pick up the phone and have a live customer who's been vetted, who wants to talk to them and to get appointment, go out and see a house, get connected to them. This is a really important efficiency driver for them. So we expect that the best get bigger. You asked if that's the question. We certainly expect that to occur. And the team model is very well suited to this, which we've invested in now for many, many years. A lot of wonderful individual practitioners have now become businesses, hiring buyers' agents, hiring showing agents, hiring listing agents, hiring transaction coordinators on top of our platform. We expect that to accelerate. And so the total customer count may decline early but the number of agents working the volume that we send downstream will probably grow, and each of them will get more of their business from us, but it's early…

Our next question comes from Ygal Arounian of Wedbush Securities. Please go ahead.

So a little bit more on Flex. I just want to make sure maybe understand all the ins and outs. And in the markets that you are in, is it often right now are you pushing to -- or is it only Flex. What's kind of the mix in those markets? And so I understand that you're seeing some early positive signals. Anyway to give ballpark framework around how many transactions have actually closed through the Flex model? And then as we look out to the three to five-year targets, understanding that you're still confident and those numbers are more confident today. How much of that -- there is a big step up in growth between this year and then the following years, that's the assumption if we get to the targets. How much of that is based on Flex working and how much of it is based on the traditional core PA returning back to the double-digit growth rate that you've seen?

There are a few questions in there, so I will pick off one at a time and then you will help me out. So the first question is what's the actual dynamics in the market that are live today and how we roll it out? It's the entire market. So we get on there. We put our teams on the market. We train up our customers. They go ahead in accretive shift from a prepay model to a post pay model, that hasn't been real hard to stop doing their credit card to move into a post pay model. We typically run the changes, but per month or two and we frame the same share voice they had. And then we left it to algorithm that I mentioned, the performance facing algorithm start to scale up, because it has the input needs from this maturing set of data appointment rates, customer satisfaction and then the performance facing algorithm starts to do the allocations, overweight or heavy up the best performers. And so that's how these typical market launches go. That is how Atlanta and Phoenix were launched. And there's a whole lot of dialog with our Premier Agents before we launch, and they've been very welcoming of this change. So that's been a highlight so far. Question on transactions is we just launched this in June, and so it too early in the maturity for me or the team to be comfortable sharing a metric.

So we're not being -- we just -- it takes a while for these transactions to happen. We have to close…

It hasn't been six months yes, and that's the typical window. So we're not going to plant a flag in yet on what that looks like. And again it's small scale and that's why we're going to these larger scale markets to get a stronger signal.

And it's a test, so it wasn't -- the two to five year model was not predicated on, yes. Okay. I mean with success or failure of this…

Yes, we don't have enough information on the test yet to really roll in what we exactly to think in the three to five year. We feel comfortable that the three to five-year targets are achievable. But we will learn more with this and we will come back and explain what we think the impact could be if it affects it.

Our next question comes from Naved Khan of SunTrust. Please go ahead.

Just looking at the amount of inventory, number of homes, that's around 1,500. And I think there are a few things been on your ramping across, and you're opening new markets and then there is seasonality, because obviously we are in the peak season. So how should we understand on a like-for-like basis, how the inventory increased because of seasonal factors versus it going up, because you're in more markets?

This is Jeremy. I mean, it's both market expansion and just raw growth, maybe even less seasonality. So yes, we're opening more markets and therefore every month is an increasing amount of volume in the business. And so you're going to see that continue to build. So we'll -- the inventory will continue to grow while we're scaling, because we'll be buying more in every month than we were able to sell from the previous cohort. And we expect that to not just continue but to continue across the markets that we open as well.

And then maybe a related question, so in the markets that you're in already with Zillow Homes. How much effort are you spending on brand advertising? And what's the plan? Is that going to ramp up or do you think you're in a good place?

So I mean the story for Zillow Offers is that we have all the demand we can handle, and this big amazing brand that we have spent decades building in concert with the IMC business and the other businesses for our customers is paying great dividends as a place to all of our homebuyers to come and start with Zillow Offers. So we do a little testing here or there to try and figure out how to start to get the marketing machine we have dialed in across these businesses. But by enlarge, the traffic that we have coming already is the source for Zilllow Offers. And frankly, we've been inundated with the demand every time we went up a market. And so our big goal is trying to figure out how to open these markets efficiently, quickly and effectively to actually satisfy that demand.

And that of course makes sense, not just because we have $194 million you use for the quarter is what we just announced…

Something like that, yes…

Okay, so not just because we have a ton of you use, but a lot of those are coming because this estimate is for a stop on the way to thinking about selling your home. And so we haven't had to exhibit a tremendous amount of cleverness in merchandising. In fact, we haven't exhibited a certain amount -- that much cleverness honestly, but we haven't had to in trying to get them to raise their hand and say they like the Zillow Offer.

Our next question comes from Deepak Mathivanan of Barclays. Please go ahead.

Somewhat related to question -- the prior one. So on the 3Q guide for the Homes business, the $80 million EBITDA loss at the high end. How much of the cost is associated with city level expansion and all the fixed costs, a non-variable cost associated with it compared to your expectations for contribution margin on a per home basis related to the volume that you're looking to sell? And then second one also on the Homes business, now that you've been active in Phoenix and Vegas markets for a while. Os the inventory growth continuing to happen on a similar pace where you think market share gain is still very easily achievable in these markets? Or are we now at a point where the iBuying market in itself has reached a reasonable level in these early adopting city? So it's going to be a little bit more market share dynamic that plays out there? Thank you.

So Allen, I guess I'll take the first one. I guess the way I would describe it is when you think about our growth and our revenue range, the Homes cost of revenue has fluctuated between 95% to 97% of revenue, as a percent revenue, and the 97 high was in Q2 and that related to this inventory value assessment. So I think that what you'll see over time is that that number will move back down closer to the 95, and the rest would be the fixed costs associated with building the business and infrastructure that's not part of the cost of revenue of the Homes. So I think you can use a range of around 95 that will fluctuate, but that maybe a good estimate, at least in the near term, on the variable costs related to the Homes versus the fixed costs to build. And then on the second one market share gains versus steady state. I mean, I think it's important to remember just how early it is. So even though this segment has been around for a couple of years and people have been starting to experiment with trying to sell our home this way. The vast majority of consumers we talk to don't know what this is. And as we said, we're not really getting that clever yet about trying to teach them, because frankly we don't have to and we're inundated with the demand of people coming up for Web site. But there is a ton…

We're busy building out markets…

But overtime, you will see market share gains come from more homeowners and home sellers understanding what this offering is, learning about it, trying it out and hopefully converting to it. And we're in the very, very early innings of consumer awareness and understanding of this.

And our last question comes from Heath Terry of Goldman Sachs. Please go ahead.

This is Adam Schukantz on for Heath. Thanks for the question. When we think about just the turnover in the Homes business, we saw roughly a thousand homes on the balance sheet at the end of 1Q. And you guys sold roughly 80% of that in 2Q. You've previous talked about the 90 day threshold. How has that evolved over time, particularly as you've entered new market, the thought process around balance sheet turnover? And then when we talk to agents, we hear a lot about the value that, particularly those who are representing homeowners in markets with Zillow offers and other instant offers businesses that it's a value of essentially using that as a way to create more opportunities and more value for the homeowner. When we think about you being proactive with agents versus agent sort of coming to you in some of these newer markets. How do you think about how those relationships evolved?

So on the hold time, I mean I will point you back to our unit margin targets. So we get into more market. We get into more type of homes. We're underwriting each home to a specific hold time and cost to sell, all solving for that plus or minus 200 basis points before interest. So as market vary in season, you are going to see hold times vary across that, but it's really about solving for that unit margin. And we continue to hit that target as we go, and feel good about that target. In terms of -- I think your second question was just around agent in markets where there are, things like Zillow Offers, talking about Zillow Offers as an option to sell. I think that's what your question was. At least from our standpoint, we have a great agent partner in each one of these market that we're working with. They have that conversation well. And we think that choice is super important, whether they end up selling to us, or traditionally hopefully with one of our partners. I think that will help contribute to growing awareness of what this is. As Rich said earlier, most folks are starting their home selling journey on Zillow think about those estimates, and that button right next to them as a way to think about how to start, we think becomes a really primarily way for them to get their hands and their head around what selling looks like, regardless of which path they go down.

This concludes our question-and-answers session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.