Compass, Inc. (NYSE:COMP) Q2 2023 Earnings Call Transcript

Compass, Inc. (NYSE:COMP) Q2 2023 Earnings Call Transcript August 8, 2023

Operator: Good day, everyone, and welcome to the Compass Second Quarter 2023 Earnings Call. I would now like to turn the conference over to Richard Simonelli, VP of Investor Relations. Please go ahead.

Richard Simonelli: Thank you, operator, and we appreciate your time today, folks. Good afternoon, and thank you for joining the Compass second quarter 2023 earnings call. Joining us today will be Robert Reffkin, our Founder and Chief Executive Officer; and Greg Hart, our Chief Operating Officer; and Kalani Reelitz, our Chief Financial Officer. In discussing our company’s performance, we will refer to some non-GAAP measures. You can find the reconciliation of these non-GAAP measures to the most directly comparable GAAP measures in our second quarter 2023 earnings release posted on our Investor Relations website. We will make forward-looking statements that are based on our current expectations, forecasts and assumptions and involve risks and uncertainties.

These statements include our guidance for the third quarter and full year 2023 and comments related to our operating expenses and cash flow levels as well as our expectations for operational achievements. Our actual results may differ materially from these statements. You can find more information about risks, uncertainties and other factors that could affect our results on our most recent annual report on Form 10-K and quarterly reports on Form 10-Q filed with the SEC and available also on our Investor Relations website. You should not place undue reliance on any forward-looking statements, and all information in this presentation today is based upon our time at August 7, 2023. We expressly disclaim any obligation to update this information.

I’ll now turn the call over to Robert Reffkin. Robert?

Robert Reffkin: Thank you, Rich, and thank you for joining us today for our second quarter results conference call. I’m pleased to share that in the second quarter, we grew market share, grew agent count and grew margin, while delivering positive free cash flow and strengthening our cash position. We achieved strong financial results in line with guidance in the midst of a quarter that was impacted by mortgage rates increasing 100 basis points to 7% and unexpected market trauma resulting from the debt ceiling standoff in Congress. We will continue to take a disciplined approach to our operating expenses and run our business efficiently while still investing in our agents, platform and growth. We continue to launch new products into our platform, such as Performance Tracker, Compass GPT integration and one-click Title and Escrow.

We will be rolling out more team workflow functionality for agent teams over the next two quarters. And next year, we expect to launch our client portal, which over time will become the client’s single destination for everything home before, during and after the transaction for both buyers and sellers. We are seeing a positive trend on agent retention. Every month in the first half of the year, the number of principal agents we lost was less than the month before. July, while not yet closed, looks to continue the trend, and we believe this trend is being driven by fundamental changes in the competitive landscape where the Compass value proposition relative to competitors is strengthening. There is a critical shift happening in the brokerage industry that is resulting in structurally weakened competition and a key differentiator for Compass.

The Compass business model always has been and always will be focused on providing the best tools and services to agents, so they can best grow their businesses. We are seeing many traditional brokerages that historically competed for agents with value-added support and services, now significantly reducing investments in these areas, which, for the most part, was already much less than what Compass provided. We believe this is driven by competitors facing any combination of factors that Compass doesn’t face, specifically rising debt service costs, increases in agent departures, declining market share and margin, worsening free cash flow and, for some VC-backed companies, a pullback in the VC funding market. As an example, including equity compensation, we have invested over $1.5 billion in our technology platform over a 10-year period and continue to invest approximately $100 million in R&D a year, which makes it very challenging for competitors to catch up in a meaningful way.

In the peak of the pandemic real estate boom, many competitors were talking about investing significant dollars in R&D. But with the shift in the market, we are not seeing that come to fruition. The current pressure on competitors is resulting in two positive trends for Compass: one, we’re seeing competitors reduce the financial incentives, they were using to attempt to recruit Compass agents; two, a race to the bottom environment where many traditional brokerages that historically competed on value out of support and services, for example, support staff, training, coaching, in-person office culture, attempts to integrate third-party tech. We are now seeing them cut back on these areas, and in many cases, are adding themselves to the already crowded low-cost, low-value brokerage service landscape, a model that is defined by charging agents the lowest possible amounts and providing them the lowest possible amounts.

Quite simply, Compass is going the other direction. We are strengthening our in-person culture and investing heavily in tools and technology for agents, capitalizing on the downturn to widen our competitive advantages, as the high-value brokerage space is becoming much less crowded. It would not surprise me to see in the years to come, Compass as the only major national brokerage competing to serve agents with high-value products and services and universally known for creating more tangible value for agents than any other company. Our financial results demonstrate that our aggressive stance in cost discipline and a reset of operating expense levels throughout 2022 and continued into 2023 is working. In a moment, Kalani will discuss the details of our second quarter results, but here are some important highlights.

We generated our second best quarter of adjusted EBITDA in company history with adjusted EBITDA of $30 million. We delivered on our commitment to be free cash flow positive in the second quarter with $51 million of free cash flow. This almost completely makes up for the first quarter of free cash flow deficit and positions us to achieve our goal of being free cash flow positive for all of 2023. We ended the second quarter with $335 million in cash and cash equivalents. Given our ability to generate strong free cash flow, ongoing improvement in operating expenses and positive free cash flow outlook, we repaid the $150 million draw on our revolving credit facility in July. With the exception of the $30 million used to fund our very successful Compass Concierge program, we have no corporate debt.

The business is on extremely solid footing with over $450 million of liquidity today. For the third quarter in a row, we improved market share. Our market share is now 4.6%, an increase of 45 basis points over the last three quarters. I want to emphasize that we have successfully improved operating expenses by $500 million on a run rate basis in the last 12 months. We said we would cut OpEx from an annualized run rate of over $1.4 billion to $950 million, and we did it. We said we would be free cash flow positive in Q2, we did it. We are very strong, and we are still investing in growth and the platform. We are excellently positioned for the cyclical upturn that will come when the market normalizes. And when the market returns, we will work to ensure that our OpEx does not.

Specifically, we expect to exit 2023 at a $900 million OpEx run rate and are committed to a path we have outlined to maintain our OpEx at $900 million in 2024 and are focused on maintaining that level in 2025 as well. We are confident that this approach ensures ongoing operating discipline, while enabling us to continue to invest in the future growth of our business, growing and retaining agents and building upon our competitive advantage with the only proprietary end-to-end technology platform for agents in the industry. When the market improves in the future, we believe the company will be well positioned to generate substantial free cash flow over the long term. We continue to be laser-focused on what we can control and remain diligent in our desire to achieve positive free cash flow in 2023.

I remain incredibly excited about the future, and I want to end by thanking the entire Compass team of employees and agents. Their incredible dedication in these difficult times has allowed us to make it through the first half of 2023 with the confidence that we have a strong foundation for future success. I’ll now turn it over to Greg.

Greg Hart: Thank you, Robert. We believe Compass has the best, most experienced connected and supported agents in the industry. As a result, they have been able to capitalize in a tight inventory environment, allowing Compass to continue to outperform our competitors by growing market share for the third consecutive quarter. In the second quarter, we processed just over 54,000 transactions, a decline of 19% from a year ago, which compares favorably to the 21% decline in transactions for the entire residential real estate market in the second quarter as reported by the National Association of Realtors. Although many agents have left the industry, as evidenced by declining NAR membership since its peak in October 2022, our market share for Q2 2023 was 4.63%, up 13 basis points versus Q1 2023 and up 45 basis points from Q3 2022.

Our growth team is having increasing success, and we continue to grow our principal agent count since we eliminated cash and equity sign-on incentives last summer. The vast majority of agents tell us the Compass platform is their number one reason for coming to Compass. For Q2 2023, our average number of principal agents increased to 13,633 principal agents, up 3% year-over-year and an acceleration from Q1. We also saw more agents returning to Compass from other brokerages than in Q1. We call these win backs, and the primary reasons these agents cite for returning to Compass are our technology platform, our culture and the caliber of our agent network and the referrals it drives. These factors also contribute to our strong agent retention as agents are staying at Compass at higher rates.

For Q2, we continue to maintain high levels of retention of principal agents with over 90% annualized retention in the second quarter of 2023. And when agents have left Compass, most of this attrition has come from agents who are less productive in terms of both transaction count and gross transaction volume, as some agents have decided to leave the industry entirely during this prolonged market downturn. Going forward, we will continue to be opportunistic in our approach to adding to our agent base via selective M&A, while pursuing deal structures that allow us to utilize minimum upfront cash and limit equity dilution. We are proud of the fact that the majority of the agents coming to Compass tell us that one of the primary reasons they are doing so is for the platform, and we continue to invest to make this platform better.

We recently released Compass Performance Tracker, a powerful addition to our integrated platform that helps agents and team leaders to be more productive by allowing them to better monitor their activity and how that translates to business performance. This comprehensive but simple-to-use dashboard helps agents to set goals and create activity targets for actions like texts made, calls placed and e-mails sent to achieve those goals. They can then monitor that activity and track production in one place. This enables agents to use data-driven insights to help them make more efficient decisions and take more intentional action to improve their business performance. Like the rest of our platform, Performance Tracker is fully integrated with the other tools within the platform, which increases efficiency and accuracy by eliminating the need for agents to pay for third-party tools or manually enter redundant data on their production.

Our Title and Escrow business has been outpacing our internal targets throughout the first half of 2023 as the business is generating positive adjusted EBITDA and increasing attach rates after our successful launch of Title and Escrow integration in the Compass platform in Southern California. Since that March launch, platform integration has delivered new and repeat users, resulting in an acceleration in our attach rate at Chartwell Escrow and Consumer Title, our two T&E entities in Southern California. At Chartwell Escrow, the platform is driving increased users and contributing to the highest attach rate on record in Q2. And since launching, 28% of Chartwell’s Compass transactions opened in Southern California originated on the Compass platform.

At Consumer Title, 48% of their Compass orders originated on the platform, resulting in a significant increase in our attach rate. We continue to focus on strategically expanding market coverage for our Compass platform integration to accelerate the margin accretion driven by our T&E portfolio. We expect to add Title and Escrow integrations in Philadelphia, Washington, D.C., Virginia and Maryland by the end of the year. The Compass platform is built to save our agents’ time and to help them achieve better business results, and we leverage AI to help accomplish both objectives. As the leading technology-enabled brokerage and the number one brokerage in the U.S., our agents have been benefiting from our investments in artificial intelligence for a number of years.

This isn’t a new area for us. As I mentioned on our Q1 call, we’ve been leveraging AI across our platform since 2020 through features like our likely to sell recommendations, search suggestions, similar homes, our CMA generation tools and in our video studio. We recently launched the beta for our integration of OpenAI’s ChatGPT-4 capabilities directly into the Compass platform to help agents save substantial time with tasks such as writing listing descriptions, creating marketing collateral and automating outreach with clients. We have seen tremendous interest in this technology from our agents and have had very positive response to our beta. We’re excited to roll these capabilities out to all our agents over the coming months. We believe that we’ll see an outsized return on our AI investments because of our integrated platform that AI tools can build upon and enhance.

By its nature, all artificial intelligence depends on data to drive its performance. Our end-to-end platform provides more touch points where we can apply machine learning to improve the tools our agents use and our platform delivers more data to help us enhance the performance of those machine learning models. This, in turn, drives more usage as agents see better results, which then generates more data to improve the models. Compass is unique in this regard. Brokerages that don’t offer their agents an integrated platform won’t benefit from this virtuous cycle. In June, we launched a global affiliate referral program with BARNES International Realty. This will enable our agents to place luxury listings in front of a global affluent audience.

We’ve seen strong interest in this program from Compass agents across the country and dozens of referrals have already been made, ranging from a $25 million referral to a $20,000 monthly rental. I am proud of the major strides we’ve taken in the transformation of Compass in what has been a very challenging market over the past 12 months. Our agents and our employees continue to demonstrate that they are the best in the industry, which is why Compass is the number one brokerage in the country. I will now turn it over to our CFO, Kalani Reelitz.

Kalani Reelitz: Thanks, Greg. Today, I will review our second quarter financial results in more detail, and then I’ll provide an update on our guidance expectations for the third quarter. We continue to perform with focus and discipline in the midst of this historical low housing market. We continue to be focused on controlling what we can control, namely our cost base and our ability to attract and retain the best agents. As our Q2 results show, the strong focus on controlling our cost base resulted in the generation of adjusted EBITDA and strong free cash flow despite this extremely challenging market. For the fourth quarter in a row, we continue to reduce our operating expenses. Turning to our detailed financial results. Our second quarter revenue was $1.5 billion, falling within our guidance range of $1.45 billion to $1.6 billion.

This compares to $2 billion of revenue in the prior-year period, representing a 26% reduction year-over-year. Revenue came in on the lower end of our expectations as we saw pressure from continued increases in mortgage rates since the time we put out our guidance back in May. Gross transaction value was $56.8 billion in the second quarter, a decline of 26% from a year ago, reflecting a 19% reduction in total transactions as well as a decrease in average selling price of about 9%. Our non-GAAP commission expense as a percent of revenue improved by approximately 38 basis points from Q2 of last year to 81.93% when excluding the impact of the Agent Equity Program on the year-ago period. As a reminder, 2022 was the last year we offered the Agent Equity Program, which allowed our agents to exchange a portion of their cash commission for equity.

Page 14 of the Q2 investor deck includes additional details on the Agent Equity Program’s impact on the commission line in the prior-year periods. You will continue to see this differential through each quarter in 2023 until we anniversary the sunset of the Agent Equity Program in Q1 2024. Our total non-GAAP operating expense, excluding commissions, were $238 million for the second quarter or $953 million on an annualized basis. As we talked about previously, many of our noncommission-based operating expenses are somewhat fixed in nature and have historically increased sequentially from quarter-to-quarter as opposed to varying in line with revenue. However, due to our cost reduction initiatives implemented over the past year, the $238 million of OpEx for the second quarter reflects a $128 million reduction from our OpEx of $366 million in the second quarter of last year.

On an annualized basis, this reflects a reduction of over $0.5 billion compared to the same quarter just one year ago. Our management team remains disciplined and focused on our operating expenses. And as Robert mentioned, we are focused on maintaining our operating discipline that allows us to sustain our new cost base. As a reference point, the non-GAAP operating expenses we refer to include the expense categories of sales and marketing, operations and support, research and development and G&A, and excludes stock-based compensation expense and other expenses that are excluded from adjusted EBITDA. We’ve included tables on Page 12 and 13 in our Q2 investor deck that reconcile these amounts. Our adjusted EBITDA for the second quarter was $30.1 million.

While within our guidance range, it was at the low end of our expectations, primarily due to the challenging market conditions, which negatively impacted our second quarter revenue and the resulting flow-through effect to adjusted EBITDA. Our GAAP net loss for the second quarter was $48 million compared to a loss of $101 million in the same period a year ago. Included in the GAAP net loss for the quarter are non-cash charges, which include $39 million of non-cash stock-based compensation expense and $22 million of depreciation and amortization expense. Additionally, during the second quarter, we incurred a restructuring charge of $16 million related to continued efficiency improvements. Free cash flow during the second quarter was positive $50.7 million, which compares favorably to a negative $29.9 million of free cash flow a year ago, driven primarily by the improvements in adjusted EBITDA, lower capital expenditures and other favorable changes in working capital.

In particular, capital expenditures were just $2.6 million in the current quarter compared to $20.6 million a year ago, driven by our cost [indiscernible] and the intentional slowing of expansion to new markets and new offices. Cash flow can be impacted by the timing of cash collections from our clients and the payments of cash to our agents and vendors and the timing of our payroll cycles in relation to the calendar quarter-end. We had $335 million of cash and cash equivalents on our balance sheet at the end of June, which reflects the payback of $75 million of our revolver during the quarter. And therefore, as of June 30, the outstanding balance on our revolver was $150 million. Given the continued relative stability in the market and our strong cash flow during the second quarter, we made the decision to repay this remaining outstanding balance of our revolver of $150 million in July to save on interest costs.

We have access to liquidity of over $450 million to the cash on our balance sheet and the capacity on our revolving credit facility, and therefore, we believe we are well positioned to react to continued market challenges. Now turning to our financial guidance. Our results for the first half of 2023 confirmed that our operating expense discipline creates meaningful performance improvement. As we look forward to Q3, we continue to see mixed signals in the market. And while some trends have improved, we’ve also seen additional market risks. For Q3 of 2023, we expect revenue in the range of $1.3 billion to $1.4 billion, and positive adjusted EBITDA of $15 million to $35 million. We do expect a revenue lift from the impact of net new agent additions over the last year, however, similar to the first half, we anticipate this will be offset by mix drag, particularly from declines in California, which is our largest market and experienced record sales last year.

Importantly, we are on schedule to be free cash flow positive again in the third quarter, given our continued cost discipline, assuming transactions stay in line with industry expectations for the year, we remain on schedule to be free cash flow positive for the full year. Additionally, we are reaffirming our expectations for our full year non-GAAP operating expenses to be in the range of $850 million to $950 million. We expect to be at the midpoint of this range on a run rate basis by year-end. For the last year, we’ve spoken about our commitment to reduce our cost base and have proven that commitment through our results. It is clear to us that our strong commitment to cost control is working and led directly to our solid adjusted EBITDA results in Q2, despite declining revenue.

And we expect our continued commitment to cost control to drive favorable results over the remainder of the year and beyond. While we are excited with the results to date, we are even more committed today to our cost discipline as we maintain our operating expense levels over the next couple of years. Thank you again to our agents and team members for all you do for Compass. I would now like to turn the call over to the operator to begin Q&A.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question from Bernie McTernan with Needham.

Bernie McTernan: Great. Thank you for taking the questions. Maybe to start, we’d just love to get your thoughts in terms of what the guidance contemplates to the broader real estate market in 3Q? And when you think the industry can get back to positive year-over-year growth?

Robert Reffkin: Yes. In terms of the overall market, we continue to see more buyers and sellers. We see buyers have accepted these mortgage rates at 7% as a new normal. I think the evidence that there’s more buyers and sellers, every month this year the prices have increased relative to the month before. And when — we’re all seeing more cash offers in places like Manhattan 65% of offers are all cash. In the country, it’s around 40%, which historically is around 25%. That said, is of course, as you know, there is not enough inventory. And so, we still believe that the market over the course of this year will be down approximately 20%. And we shared down 15% to 20% in the past, I’d say, more towards the 20% now than the 15%, given the inventory to sales and coming to market at the pace that we would have liked.

Bernie McTernan: Understood. Helpful commentary. Thanks, Robert. And then just on — you provided some helpful commentary on agent retention, agent churn. It seems like you guys had some meaningful agent acquisition towards the end of the second quarter and early third quarter. But just love to get your comments in terms of how you guys are thinking about gross adds for the remainder of the year?

Greg Hart: Yes. We did see some positive momentum. I sort of referenced that in my scripted remarks, and we’ve been really encouraged by the team’s performance in the second quarter. It was one of our most productive quarters we’ve ever seen in terms of the number of principal agents that we recruited per recruiter, strategic growth manager. And we hope to continue that. And so the challenge for the team is to how to not just continue at that level, but to take that up over time. In terms of net agent adds on a go-forward basis, we don’t have a formal and haven’t ever provided a formal forecast for net agent adds, but we definitely expect the trends that we’ve seen to continue, and we’re trying to use them to be even more positive, and that’s the challenge we’ve set for the team.

Bernie McTernan: Great. And maybe last one for Kalani. As we think about OpEx seasonality, should there be OpEx seasonality? You said, we’re sharpening our pencils for 2024. If you guys are able to hit the $900 million run rate in — by the end of the year, should we just expect quarterly OpEx just to be $900 million divided by four? Or is there some seasonality we should be taking to account?

Kalani Reelitz: Yes. Thanks for the question. We are a business that kind of move sequentially by quarter versus, say, that variable kind of in line with revenue. So I would expect, Bernie, there’d be some small seasonality aspects to it, but overall, we should keep relatively the same amount of OpEx. So materially, I think it should look the same. There might be some give and take, especially with Q2 as a kind of a higher revenue quarter. But overall, we tend to be more of a kind of straight line through the year versus a variable in line with revenue.

Bernie McTernan: Understood. Thank you all.

Operator: We’ll take our next question from Soham Bhonsle with BTIG.