Compass, Inc. (NYSE:COMP) Q3 2023 Earnings Call Transcript

Compass, Inc. (NYSE:COMP) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Thank you for standing by. And welcome to the Compass Inc. Third Quarter 2023 Earnings Call. I would now like to welcome Richard Simonelli, Vice President, Investor Relations to begin the call. Richard, over to you.

Richard Simonelli: Thank you, operator, and good afternoon, and thank you for joining the Compass third quarter 2023 earnings call today. 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 third 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 fourth 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 also our quarterly reports on Form 10-Q filed with the SEC and available on our Investor Relations website. You should not place undue reliance on any forward-looking statements. All information in this presentation today is as of today’s date November 6, 2023. We expressly disclaim any obligation to update this information. I will now turn the call over to Robert Reffkin. Robert?

Robert Reffkin: Thank you, Rich, and thank you everyone for joining us today for our third quarter results conference call. We achieved strong financial results in line with our guidance in a quarter that has seen mortgage rates increase over 100 basis points to 8%. I am pleased to share that in the third quarter, we grew quarterly market share 26, basis points year-over-year. We grew principal agents by 4% year-over-year and 3% sequentially. We had above 98% principal agents retention for the quarter, which is the second highest agent retention level since we went public. We launched several new exciting features on our technology platform that improved agent productivity and led to retention and recruitment. We moved closer to achieving our goal of bringing our operating expenses down to a run rate of $900 million in the fourth quarter.

And in the midst of a rapidly deteriorating market, we delivered positive free cash flow for the second quarter in a row. Kalani and Greg will walk you through the details later on this call. But I want to focus on the bigger picture. This downturn has given us opportunity to analyze every aspect of our business. And look for efficiencies to ensure that everything we are doing is dedicated towards delivering profitable top-line growth. We approach every day of accessibly looking for ways to smartly lower costs and increase the productivity and revenue of our agents. We have worked hard to position Compass to be able to ride out this period of macroeconomic uncertainty and position Compass for even greater success when the market recovery begins.

We are working from a position of strength. As the number one, brokerage by sales volume in the United States over the past two years, we have built an amazing business with the best agents serviced by a highly dedicated team of professionals at Compass that is laser-focused on delivering excellence at every level. Although the market has not improved over the past year, Compass is a much stronger company with a lower cost base, higher principal agent retention, a revitalized post-pandemic culture, enhanced technology platform in a larger agent to agent client referral network. I am proud of the fact that our team has thoughtfully and skillfully been able to reduce OpEx run rates by approximately $550 million since the second quarter of 2022.

We said we would do it and we did it. We expect to achieve our target $900 million OpEx run rate as we exit Q4 as planned. This is more than a $0.5 billion of expense cutting while still growing the number of agents, improving agent retention, and adding important new features to our technology platform. Our technology is clearly making a difference for agents. We have included a slide in our investor deck with quotes from agents who left campus and came back and cited technology as the reason. With their permission, we have also included their phone numbers, so you can call them directly. The reason we believe these agents’ opinions are so important is that they are doing a direct comparison of the current state of technology in the industry and as you will see Compass is the clear winner by far.

Here are a few examples. First quote, we missed the Compass technology. I’ve tried to make it work, but life is so much harder now. So much less efficient and my cost of doing business have increased. Property searching with clients without collections felt like going back in time five years. Next quote. Collections allows me to work with 3-5x the amount of buyers at any given point in time that I otherwise would not have the bandwidth to take on. Last quote. You never realize how valuable the Compass platform is until you don’t have it anymore. This is such a huge advantage to being at Compass. While I had indicated on prior calls, that we would hold our OpEx at $900 million in 2024 and 2025 given that 2024 could look a lot like 2023. We believe we should continue to drive more efficiencies in the business and are targeting $850 million in 2024, annualized non-GAAP operating expenses The bottom of our previously stated range of $850 million, to $950 million.

By continuing our expense reduction program, we are building in the potential for more free cash flow in 2024. But with the uncertainties surrounding ’24, and if marketing conditions get worse, we are getting out ahead of a continued downturn. I am happy to report that other firms are recognizing Compass’ leadership and strength. In the last two months, we have seen an increase in inbound inquiries of brokers looking to join Compass with our strong culture, technology platform, and agent-to-agents client referral network being leading reasons. We are looking to make the accretive transactions that will help us position for the inevitable market improvement that will come in the future. When you add companies and revenue, you are adding operating expenses, as well.

You’re not going to pass up on accretive acquisitions just to beat the OpEx number. We acquired Realty Austin and DPP in September marquee brokerages in their respective markets because those acquisitions were the right thing to do for the business as they further strengthen our position, in Texas, and California. Quote M&A activity adds approximately $14 million of annual OpEx in 2024. Clearly, the Compass value proposition growth of key competitors is strengthening. Agents are coming to and seeing at Compass during an unprecedented period of industry uncertainty. In Q3, we grew our average principal agent count by more than 400 agents versus the prior quarter. We also experienced – we are experiencing over 98% principal agent retention in the third quarter, our second highest retention level since we went public.

This proves that our cost reductions are not compromising the agents’ experience. At the same time, we have been able to deliver a number of technology advances such as performance tracker, Compass AI and One-Click Title and Escrow. So we’re actually seeing their technology mode while the vast majority of our competitors continue to not invest. I would like to take a moment to address the Sitzer/Burnett class-action lawsuit verdict against NAR and several brokerages. As you know Compass was not named in that lawsuit, but we were named in a new lawsuit last week that was filed by the same lawyers who represented the Sitzer/Burnett, as well as a second case in Illinois, which is a copy of the case already filed against NAR and other brokerages sometime ago.

Obviously, we have been closely watching the proceedings as we do with all things related to the residential real estate industry. We will respond in according to the complaints filed against us. I am not going to comment on the cases in this call or future calls. While there has been an enormous amount of speculation as to what this will mean for commissions, there are a few reasons why I felt confidence that Compass is positioned well, First, there is a market precedence for the changes being proposed in these lawsuits, as it relates to how commissions are displayed and shared with consumers and ultimately commission rates. The Northwest MLS, which covers all of Seattle in the majority of the State of Washington, including 83% of the population made these changes in October 2019.

And as of the end of 2022 the average Washington Realtor Commission rate is 5.3% with 2.67% going to the list agents and the remaining 2.63% going to the buyers’ agents. That aligns with the national average. So we have evidence in a major US market of what this change will look like that gives us confidence. Secondly, we believe we are positioned well, because we have a combination of some of the most productive agents in the only end-to-end technology platform in our industry. Our agents are able to use the Compass technology platform with their clients and deliver tangible value to clients through it, which will be a major advantage should things shift. For example, our collections product is a tool that makes the home buying experience easier for the buyer.

It is like a Pinterest board for real estate that provides buyers with a portfolio of properties that are automatically updated with new prices and statuses where it’s easy to share and communicate. When we launched our client portal in 2024, which will be a consumer interface for clients to manage their entire buying and selling products online through their agents. The bond between agents and buyer will be straightened further as we provide the clients one location to access everything related to their purchase. Given these products are unique to Compass, we are well positioned relative to others. Thirdly, we currently have agents that successfully answered buyers to sign buyer broker agreements in order to work with them. We’re in the process of launching training to all of our agents to empower them to successfully get buyer broker agreements signed with their buyers.

Lastly, we operate largely in the luxury segments everything buyers will still want to help. We also want to help of an advisor through their home buying journey. Overall, these are some of the reasons why we believe we are well positioned and prepared for any of these industry changes. So looking ahead to the future. 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 are confident that this approach ensures we can build 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.

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 has allowed us to make it through these difficult times 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. I echo your sentiment about the great team at Compass and want to also recognize our amazing agents who are working hard every day in a very difficult market to help their clients buy and sell homes. In the third quarter, we processed over 48,000 transactions a decline of 12% from a year ago, which compares favorably to the 20% decline in transactions for the entire residential real estate market in the third quarter, as reported by the National Association of Realtors. Our market share for Q3 2023 was 4.4%, up 26 basis points of year-over-year versus Q3 2022. The majority of agents tell us that Compass platform is the number one reason for coming to Compass and that contributed to another strong quarter of agent additions.

For Q3 2023, our average number of principal agents increased to 14,055 principal agents, up 4% year-over-year and up 3% quarter-over-quarter. Our technology platform, brand and agent network also contribute to our strong agent retention as agents continue to stay at Compass at very high rates. For Q3, we saw over 90% annualized retention of principal agents and as Robert mentioned, Q3 was our second highest quarterly retention rate of principal agents as a public company. And of the principal agents who did leave Compass in Q3, more than 80% of that attrition came from agents who are least productive in terms of both transaction count and gross transaction volume. And some agents have decided to leave the industry entirely during this prolonged market downturn.

In addition to our agent recruiting efforts, we completed two strategic acquisitions during the third quarter of brokerages in Texas and in California. Realty Austin, the number one independent brokerage in Texas, expands our presence in Austin, and San Antonio, nearly doubling our agent and transaction count in those markets, while DPP as a well-respected brokerage with a specific architectural focus that complements Compass well. Going forward, we will continue to be opportunistic in our approach to adding to our agent base via selective M&A for pursuing deal structures that allow us to minimize 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.

We continue to invest to make this platform better, and to launch new products into our platforms, such as performance tracker, Compass AI, and one-click title and escrow. Each of these products are generating rave reviews from agents and positive early adoption. Looking forward, we will continue to build more sophisticated team workflow functionality, and also plan to launch the first phase of our Compass client dashboard in 2024. We envision this as the single destination for both buyers and sellers for everything home before during and after the transaction. Our title and escrow 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.

We are now rolling this feature out in Philadelphia, Southern New Jersey, and the Washington DC area, including Maryland and Virginia as planned. As you know, we’ve been leveraging artificial intelligence across our platforms since 2020. Always for the expressed purpose of enhancing our agents’ workflow efficiency, and client service. We’ve done this through features like our likely to sell recommendations, search suggestions, similar homes, our CMA generation tool and in our video studio. Recently, we’ve further enhanced that offering by integrating the ChatGPT API into Compass AI, which has already proved to be a game changer for our agents. For those of you who have used AI, you know this technology has seemingly unlimited potential. But it is only as good as the data and you want to context from which it draws.

Compass As is custom built to support real estate agents and over time will be supercharged by a vast amount of proprietary Compass data drawn from our hundreds of thousands of transactions, which is a major competitive advantages over other brokerages. Right now, Compass AI is already augmented with smart, real estate-specific system prompts, as well as contacts taking directly from her proprietary platform data set. And in the future, Compass AI is poised to become a personalized solution trained to a proprietary data and customizable by our agent users. This is a significant advantage for Compass agents compared to agents at other brokerages who typically use general purpose solutions or otherwise search public databases for best practices.

We can create natural integration points for Compass AI directly into our agents’ platform workflows, rather than just as a standalone isolated tool. The more agents use our platform, the stronger the machine learning algorithms will be delivering better results for agents and producing a virtuous cycle. The agent response has been fantastic as thousands of agents have already integrated Compass AI into their workflow and our coaching classes featuring Compass AI typically has thousands of agents in attendance. I can’t wait to share the next round of improvements. This has been a challenging market for almost a year and a half. It has gone on longer than expected and immediate relief is not insight. In response,wWe’ve removed roughly $550 million in operating expenses from our business in the last 18 months.

And as Robert mentioned, we are continuing to drive our expenses downward. I’m working with an exceptionally strong team dedicated to looking for operating efficiencies in every corner of the business. Our leaders are united in their focus on finding ways to improve our processes and lower our costs. Our agents and our employees continue to demonstrate that they’re 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. Thanks, Greg. Today I’ll review our third quarter financial results in more detail and then I’ll provide an update on our guidance expectations for the fourth quarter. As a reoccurring theme we’ve been sharing with you over the past year, we continue to focus on controlling what we can control namely, our cause base and our ability to attract and retain the best agents.

The result of these efforts has allowed us to report another quarter of positive adjusted EBITDA and positive free cash flows despite this extremely challenging market. In particular our Q3 results reflected the fifth quarter in a row that we reduced our operating expenses over the prior quarter. Our third quarter revenue was $1.34 billion, falling slightly below the midpoint of our guidance range of $1.3 billion to $1.4 billion reflecting pressure from mortgage rates that have continued to rise since the time we put out our Q3 guidance back in August. Our Q3 revenue reflects a decline of 10% from the year ago period of $1.49 billion. Gross transaction volume was $50.9 billion in the third quarter, a decline of 11% from a year ago, reflecting a 12% reduction in total transaction, partly offset by an increase in average selling price.

The decline in our transactions of 12% from a year ago period compares favorably to the decline in transactions in the overall market of 20%. Our non-GAAP commission expense as a percent of revenue was 81.97%, an increase of 50 basis points from Q3 of last year, when excluding the impact of the agent equity program on the year ago period. As a reminder, 2022 is the last year we offered the agent equity program, which allowed our agents to exchange a portion of their cash commissions to our equity. Page 15 of the Q3 Investor deck includes additional details on the agent equity programs impact on the commission line in the prior year periods. You will continue to see this differential through each quarter in 2023, so we anniversary the sunset of the agent program in Q1 of 2024.

Our total non-GAAP operating expenses excluding commissions and other related expenses were $219 million for the third quarter. Our operating expense in the quarter benefited by a one-time credit of $7.2 million related to a favorable change in the way we provisioned for certain state franchise taxes, resulting in a tax refund for taxes paid in prior years. Adjusting for this one-time credit, our operating expense in the quarter would have been $226 million or $904 million on an annualized basis. As we talked about previously, many of our non-commission-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 $226 million of OpEx for the third quarter reflects a $140 million reduction from OpEx of $366 million in the second quarter of last year, which was the quarter we began our cost reduction initiatives.

On an annualized basis, this reflects a reduction of over $550 million. Our management team remains disciplined focused on our operating expenses and as Robert and Greg 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 included the expense category of the sales and marketing, operation, and support, research and development, and G&A and excludes stock-based compensation expenses, other expenses that are excluded from adjusted EBITDA. We’ve included tables on pages 13 and 14 on our Q3 investor deck that reconciles these amounts. Our adjusted EBITDA for the third quarter was $21.8 million, slightly below the midpoint of our guidance range reflecting the challenging market conditions, Our GAAP net loss for the third quarter was $39 million, compared to a loss of $154 million in the same period a year ago.

Included in the GAAP net loss for the quarter are non-cash charges, which included $38 million of non-cash stock-based compensation expense and $21 million of depreciation and amortization expenses. Free cash flow during the third quarter was a positive $12.2 million, which compares favorably to negative $69.1 million of free-cash flow in the year ago quarter, driven primarily by the improvement in adjusted EBITDA, lower capital expenditures, and other favorable changes in working capital. In particular, capital expenditures were just $2.8 million in the current quarter, compared to $15.5 million a year ago, driven by our cost-cutting measures and the intentional slowing of expansion into new markets and new offices. We have meaningfully improved our free cash flow position, compared to last year when comparing the first nine months of 2023, to the same period of 2022, our free cash flow improved by $235 million or $1.1 billion less revenue.

While cash flow can be impacted by the timing of cash collections from transaction closing and the payment of cash to our agents and vendors, and the timing of our payroll cycles in relation to the calendar quarter end, the magnitude of improvement in free cash flow is directly attributed to the impact of our cost discipline over the past year. We have $220 million of cash and cash equivalents on our balance sheet at the end of September, which reflects the previously disclosed payback of $150 million of our revolver drawn in July. Also during the quarter, we completed the acquisition of certain assets of a Canadian real estate prospect entity called Properly, which we’ve accounted for the financing transaction whereby we received cash of $32 million in exchange for nine million shares of $compass stock for an effective issuance price of $3.62 per share.

We thought this transaction was an effective way to add strength to our balance sheet during the challenging macroeconomic environments ahead of us. We have access to liquidity of over $500 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 three quarters of 2023 confirmed our operating expense discipline creates meaningful performance improvements and as we look forward to Q4, we continue to see market risks. For Q4 of 2023, we expect revenue in the range of $1.1 billion to $1.2 billion and we are reaffirming our expectation that our OpEx will be in the range of $850 million to $950 million with the Q4 run rate around the midpoint of $900 million excluding the impact of the additional OpEx we expect in Q4 from our two adjusted EBITDA positive brokerage acquisitions completed at the end of September.

The OpEx from those two deals is expected to be just shy of $4 million per quarter. Despite our cost control and discipline given the revenue softness driven by continued market pressure in the second half of ‘23, we expect adjusted EBITDA to be in the range of negative $35 million to negative $20 million in the fourth quarter. We anticipate free cash flow to trend in line with adjusted EBITDA and be negative in the fourth quarter, as well, and as a result, while we have made significant improvement in our free cash flow and cash position we do not anticipate being free cash flow positive for the full year 2023. As we’ve discussed in the past the conversion of adjusted EBITDA and free cash flow is seasonally stronger in the earlier quarters of the year and seasonally weaker in the later quarters of the year.

As Robert mentioned, our commitment to cost discipline has driven significant improvement in our free cash flow, compared to the same period last year. It is clear to us that our strong commitment to cost control is working and led directly to our adjusted EBITDA results in Q3, despite declining revenue. We remain committed to our cost discipline to drive favorable results in 2024 and beyond. As I finish my prepared remarks, November marks the end of my first year here at Compass. The market conditions over the last year have truly challenged our agents and our teams. The commitment of our agents and team members to support each other and provide world-class service to our clients has been nothing short of inspiring. We are a significantly stronger company today than when I started a year ago and we are well positioned to create tremendous value for our employees, agents, and shareholders going forward.

Thank you again to our agents and team members for all that 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] Our first question comes from the line of Soham Bhonsle with BTIG. Please go ahead.

Soham Bhonsle: Hey guys. Good evening. Thanks for taking our questions. Robert, I guess, first one for you. So I know you’re not commenting on the lawsuits, but just thinking through the potential impact, it still seems pretty unclear to us. But let’s just say hypothetically that buy sell commissions do come under pressure in the future. How does that change, I guess Compass’ is ability to hold – uphold the 80/20 split model longer term, right? Do you think you have to adjust splits higher to maybe entice agents that want to keep more of their commissions going forward? Or do you think you can still make the pitch based on the value that you provide on the MPN platforms? Thanks.

Robert Reffkin: Yeah. First, thanks for asking the question. I mean, a few things. One, I don’t think there’s any evidence to suggest that there will be pressure on the commission. When you look at the State of Washington in addition to what I mentioned earlier the Northwest MLS which covers 82% of the state, in 2019, they discontinued requiring sellers to make a minimum offer of compensation. Since that point in time, 99.7% – 99.75% of sellers in those markets continue to offer compensation to buyer brokers and 95% of the time these fee is exceed 2% to the buying side as quoted by the Wall Street Journal. And so I just think one is that there’s no evidence from any market that it would create pressure on commissions. Also, there are likely thousands of agents in the country that are – that already require to work with the buyer.

They personally decide that they’re going to ask that buyer to sign a buyer broker agreement. And in that buyer book agreement, they will negotiate independently, of course what the commission is that they require. And let’s just say hypothetically, it says two and a half percent. Then what happen if the seller contributes to 2.5% the buyer doesn’t have to do anything. If a seller doesn’t contribute anything to buyers, do 2.5%, but that’s already a practice that exists out there in the world. And so, what I mentioned early on the call is we’re going to train how to do that in a compliant way to our agents across the country. And I think the actual effect of this will be two things. One, it has the potential to further professionalize the industry, because agents that don’t know how to sell their value will leave the business and agents that do know how to sell the value will get the buck that required by broker agreements.

And of course, when that agreement is in there, they’re valued. I think their compensation will be clearly outlined. The second thing that it will do, is they will force Compass and other companies to create a buyer presentation at the same level that we’ve created listing presentations. Arguably, the most important thing a brokerage firm can give an agent is the listing presentation. That’s where you agent goes in to list an appointment is the moment of truth where the agent says, here’s why you want to work with me and here’s why you want to work with the company. Yeah. The all the different reasons on both fronts. And that’s the moment where you either, get the listing or you don’t. That’s where you negotiate when the agent independently negotiates, the commission, and that is considered very valuable for an agent.

Any – almost any agent that’s going to move companies want to see, what would the listing presentation look like before they move. So now we’re going to create – we are launching over the next week, our buyer agreements. So when you need a buyer – so your buyer presentation that walks through all the reasons why you want to work with me as it your buyer agent, but also I want to work with Compass as your buyer brokerage, because we have collections, which is as you saw in the quotes, mostly didn’t say that that’s the reason why they came back to Compass because we have off market listings and coming soons and the largest network of toppings across the country in the major markets and countries. Number one in every and more top markets in the country than anyone else.

And so the reason I bring that up is now Compass is going to and other brokerages are going to create an even stronger reason why you need to be affiliated with the top brokerage firms because we have a buyer presentation that helps you communicate your value in that important moment to buyers just like we have for sellers. So, as we think about, the split that brokerage firms agree on the agents, I think it will just reinforce that value.

Soham Bhonsle: Got it. Thank you. And then second one I guess, Kalani the 850 expense target, I just want to make sure I understand. So first is the 850 now the target for our 2024 and 2025 given that you are looking to stay flat in both those years previously. And then can you just talk about some of these specific actions that will get you to the new runrate? Thanks.