Compass Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 6, 2023

Key Takeaways

  • Compass delivered positive free cash flow for the second consecutive quarter and reported $1.34 billion in Q3 revenue despite mortgage rates climbing over 8%.
  • Operating expenses have been reduced by over $550 million since Q2 2022, with a goal of a $900 million run rate exiting Q4 and a new target of $850 million for full-year 2024.
  • Principal agents grew 4% year-over-year and 3% sequentially, driving a 4.4% market share (+26 bps) and achieving over 98% agent retention, the second highest since the IPO.
  • The proprietary tech platform continues to set Compass apart with launches like Compass AI, Performance Tracker, and one-click title & escrow—features credited by returning agents as game-changers.
  • Compass completed accretive acquisitions of Realty Austin and DPP, reinforcing its leadership in key markets and adding approximately $14 million of annual OpEx to support future growth.
AI Generated. May Contain Errors.
Earnings Conference Call
Compass Q3 2023
00:00 / 00:00

There are 12 speakers on the call.

Operator

You for standing by, and welcome to the Compass Inc. 3rd Quarter 2023 Earnings Call. I would now like to welcome Richard Simonelli, Vice President, Investor Relations to begin the call. Richard, over to you.

Speaker 1

Thank you, operator, and Good afternoon, and thank you for joining the Compass Third Quarter 2023 Earnings Call today. Joining us will be Robert Refkin, our Founder and Chief Executive Officer Greg Hart, our Chief Operating Officer and Kalani Rilitz, our Chief Financial Officer. In discussing our company's performance, we will refer to to some non GAAP measures. You can find the reconciliation of these non GAAP measures to the most directly comparable GAAP measures in our Q3 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.

Speaker 1

And These statements include our guidance for the Q4 and full year 2023 and comments related to our operating C. Butler:] 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 ks 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.

Speaker 1

All information in this presentation 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 Refkin. Robert?

Speaker 2

Thank you, Rich, and thank you everyone for joining us today for our Q3 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 Q3, 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 Agent Retention for the quarter, which is the 2nd highest agent retention level since we went public.

Speaker 2

We launched several new exciting features on our technology platform that improve 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 $900,000,000 in the 4th quarter. And In the midst of a rapidly deteriorating market, we delivered positive free cash flow for the 2nd 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.

Speaker 2

We approach every day obsessively 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 2 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 5 and $50,000,000 since the Q2 of 2022.

Speaker 2

We said we would do it and we

Speaker 3

did it.

Speaker 2

We expect to achieve our target $900,000,000 OpEx run rate as we exit Q4 as planned. This is more than $500,000,000 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 Compass and came back in Citi Technology as the reason. With their permission, we have also included their phone numbers, So you can call them directly.

Speaker 2

The reason we believe these agents' opinions are so important is that they are doing a direct comparison of the current state of technology to 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 costs of doing business have increased.

Speaker 2

Property searching with clients without collections felt like going back in time 5 years. Next quote. Collections allows me to work with 3 to 5 times 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.

Speaker 2

While I had indicated on prior calls That we would hold our OpEx at $900,000,000 in 20 24 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 $850,000,000 in 2024 annualized non GAAP operating expenses, to the bottom of our previously stated range of $850,000,000 to $950,000,000 By continuing our expense reduction program, we are building in the potential for more free cash flow in 2024. So with the uncertainty surrounding 2024, if market 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 2 months, we have seen an increase in inbound inquiries of brokerages looking to join Compass with our strong culture, technology platform and agent to agent Client Referral Network being leading reasons.

Speaker 2

We are looking to make accretive transactions that will help us positioned for the inevitable market improvements that will come in the future. When you add companies and revenue, You are adding operating expenses as well. We're not going to pass up on accretive acquisitions just to beat the OpEx number. We acquired Realty Austin and DPG in September, marquee brokerages in their respective markets, because those acquisitions We're the right thing to do for the business as they further strengthen our position in Texas and California. Closed M and A activity adds approximately $14,000,000 of Annual OpEx in 2024.

Speaker 2

Clearly, the Compass value proposition relative to competitors is strengthening. Agents are coming to and staying 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 You're experiencing over 98% principal agent retention in the 3rd quarter, our 2nd highest retention level since we went public. This proves that our cost reductions are not compromising the agent's experience.

Speaker 2

At the same time, we have been able to deliver a number of technology advances such as Print's performance tracker, Compass AI and one click title in escrow. So we're actually spinning our 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 represent the Sysor Burnett plaintiffs, as well as a second case in Illinois, which is a copy of the case already filed against NAR and other brokerages some time ago. Obviously, we have been closely watching the proceedings as we do with all things related to the residential real estate industry.

Speaker 2

We will respond accordingly to the complaints filed against us. I am not going to comment on the cases in this call for future calls. While there has been enormous amount of speculation as to what this will mean for commissions,

Speaker 4

There are a few reasons

Speaker 2

why I feel confident that Compass is positioned well. 1st, there is a market precedent 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 and 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 It's 5.3 percent with 2.67% going to the listing agents and the remaining 2.63% going to the buyer's agents. That aligns with the national average.

Speaker 2

So we have evidence in a major U. S. 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 And 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 to it, which will be a major advantage should things shift.

Speaker 2

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 launch our client portal in 2024, which will be a consumer interface for clients to manage their entire buying and selling process online through their agents. The bond between agent and buyer We'll be strengthened further as we provide the client one location to access everything related to their purchase. Given these products are unique to Compass, we are well positioned relative to others.

Speaker 2

Thirdly, We currently have agents that successfully ask their 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 agreement signed with their buyers. Lastly, we operate largely in the luxury segment, where we think buyers will still want to help We also want the 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.

Speaker 2

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.

Speaker 4

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 Q3, 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 3rd quarter As reported by the National Association of Realtors. Our market share for Q3 2023 was 4.4%, Up 26 basis points year over year versus Q3 2022. The majority of agents tell us Compass platform is their number one reason for coming to Compass and that contributed to another strong quarter of agent additions.

Speaker 4

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, brands 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 2nd 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.

Speaker 4

And some agents have decided to lead the industry entirely during this prolonged market downturn. In addition to our agent recruiting efforts, we completed 2 strategic acquisitions during the Q3 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 adds a well respected brokerage with a specific to a 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 and A While 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.

Speaker 4

We continue to invest to make this platform better and to launch new products into our platform such as Performance Tracker, Compass AI and OneClick 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.

Speaker 4

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 platform since 2020, always for the express 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 further enhanced that offering by integrating the Chat GPT 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 nuanced context from which it draws.

Speaker 4

Compass AI is custom built to support real estate agents And over time, we'll be supercharged by a vast amount of proprietary Compass data drawn from our 100 of 1000 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 context taken directly from our proprietary platform dataset. In the future, Compass AI is poised to become a personalized solution trained on 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.

Speaker 4

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 in sight.

Speaker 4

In response, We've removed roughly $550,000,000 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 are the best in the industry, which is why Compass is the number one brokerage in the country.

Speaker 4

I will now turn it over to our CFO, Kalani Realitz.

Speaker 3

Thanks, Greg. Today, I'll review our Q3 financial results in more detail and then I'll provide an update on our guidance expectation for the Q4. 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 cost base and our ability to attract and retain the best agents. The results of these efforts has allowed us to report another quarter of positive adjusted EBITDA and positive free cash flow despite this extremely challenging market. In particular, our Q3 results reflect the 5th quarter in a row that we've reduced our operating expenses over the prior quarter.

Speaker 3

Our 3rd quarter revenue was $1,340,000,000 falling slightly below the midpoint of our guidance range of $1,300,000,000 to $1,400,000,000 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 $1,490,000,000 Gross transaction volume was $50,900,000,000 in the 3rd quarter, 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 the 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 was the last year we offered the agent equity program, which allowed our agents to exchange a portion of their cash commissions for equity.

Speaker 3

Page 15 of the Q3 investor deck includes additional details on the agent equity program's impact on the commission line in the prior year period. You will continue to see this differential through each quarter in 2023 until we anniversary the sunset of the agent equity program in Q1 of Our total non GAAP operating expenses excluding commissions and other related expenses were $219,000,000 for the 3rd quarter. Our operating expense in the quarter benefited by a one time credit of $7,200,000 related to a favorable change in the way we provision 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 It would have been $226,000,000 or $904,000,000 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.

Speaker 3

However, due to our cost reduction initiatives implemented over the past year, the $226,000,000 of OpEx for the 3rd quarter Reflects a $140,000,000 reduction from OpEx of $366,000,000 in the Q2 of last year, Which was the quarter we began our cost reduction initiatives. On an annualized basis, this reflects a reduction of over $550,000,000 Our management team remains disciplined and 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 include the expense categories of sales and marketing, operation and support, Research and Development and G and A and excludes stock based compensation expense and other expenses that are excluded from adjusted EBITDA. We've included tables on Pages 13 and 14 in our Q3 investor deck that reconcile these amounts.

Speaker 3

Our adjusted EBITDA for the 3rd quarter was $21,800,000 slightly below the midpoint of our guidance range, reflecting the challenging market conditions. Our GAAP net loss for the Q3 was $39,000,000 Compared to a loss of $154,000,000 in the same period a year ago. Included in the GAAP net loss for the quarter are non cash charges, which included $38,000,000 of non cash stock based compensation expense and $21,000,000 of depreciation and amortization expense. Free cash flow during the Q3 was a positive $12,200,000 which compared favorably to negative $69,100,000 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 $2,800,000 in the current quarter compared to $15,500,000 a year ago, driven by our cost cutting measures and the intentional slowing of expansion to new markets and new offices.

Speaker 3

We have meaningfully improved our free cash flow position compared to last year. When comparing the 1st 9 months of 2023 to the same period of 2022, our free cash flow improved by $235,000,000 on $1,100,000,000 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 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 had $220,000,000 of cash and cash equivalent on our balance sheet at the end of September, which reflects the previously Payback of $150,000,000 of our revolver drawn in July. Also during the quarter, we completed the acquisition of certain assets of a Canadian real estate PropTech entity He called properly, which we've accounted for the financing transaction whereby we received cash of $32,000,000 in exchange for 9,000,000 shares of Compass stock for an effective issuance price of $3.62 per share.

Speaker 3

We thought this transaction was an effective way to add strength to our balance sheet given the challenging macroeconomic environments We have access to liquidity of over $500,000,000 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 1st 3 quarters of 2023 confirm that our operating expense discipline creates meaningful performance improvement. And as we look forward to Q4, we continue to see market risks. For Q4 of 2023, we expect revenue in the range of $1,100,000,000 to $1,200,000,000 We are reaffirming our expectation that our OpEx will be in the range of $850,000,000 to $950,000,000 with the Q4 run rate around the midpoint of $900,000,000 Excluding the impact of the additional OpEx we expect in Q4 from our 2 adjusted EBITDA positive brokerage acquisitions completed at the end of September.

Speaker 3

The OpEx from those two deals is expected to be just shy of $4,000,000 per quarter. Despite our cost control and discipline given the revenue softness driven by continued market pressure the second half of twenty twenty three, we expect adjusted EBITDA to be in the range of negative $35,000,000 to negative $20,000,000 in the 4th quarter. We anticipate free cash flow to trend in line with adjusted EBITDA and be negative in the Q4 as well. And as a result, while we have made significant improvement in our free cash flow and cash 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 to free cash flow is seasonally stronger in the earlier quarters of the year and seasonally weaker in the later quarters of the year.

Speaker 3

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 1st year here at Compass. The market conditions over the last year have truly challenged our agents and our teams.

Speaker 3

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, 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. Would now like to turn the call over to the operator to begin Q and

Operator

Our first question comes from the line of Foham Bonzel with BTIG. Please go ahead.

Speaker 5

Hey, guys. Good evening. Thanks for taking my 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.

Speaker 5

But let's just say hypothetically that buy side commissions do come under pressure in the Sure. How does that change, I guess, Compass' ability to hold uphold the eightytwenty split model longer term? Right. Do you think you have to adjust split hires, 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 NPN platform.

Speaker 5

Thanks. Yes. First, thanks

Speaker 2

for asking the question. Maybe a few things. 1, I don't think there's any evidence to suggest that there'll be pressure on the commission. When you look at the state of Washington, In addition to what I mentioned earlier, in the Northwest MLS, which covers 80% of the state, In 2019, they discontinued requiring sellers to make a minimum offer of compensation. Since that point in time, 99.75% of sellers in Those markets continue to offer compensation to buyer brokers.

Speaker 2

In 95% of the time, these fees exceed 2% to the buy side as quoted by The Wall Street Journal. 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 a buyer. They personally decide they're going to ask that buyer to sign a buyer broker agreement. And in that buyer broker agreement, they will negotiate independently, of course, what the commission is that they require.

Speaker 2

And let's just say hypothetically, it says 2.5%. Then what would happen if the seller To contribute 2.5%. The buyer doesn't have to do anything and the seller doesn't contribute anything to buyers to 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.

Speaker 2

I think the actual effect of it will be 2 things. 1, 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 their value will get the required buyer broker Agreement. And of course, when that agreement is in there, their value as in their compensation will be clearly outlined. The second thing that it will do is it 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 It's the listing presentation.

Speaker 2

That's where the agent goes into a listing appointment. It's 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, 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 where the agent independently negotiates the commission. And that is considered very valuable For an agent, any almost any agent that is going to move companies wants 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 agreement.

Speaker 2

So when you need the buyer sorry, your buyer presentation, it walks through All the reasons why you want to work with me as your buyer agent, but also why you want to work with Compass as your buyer brokerage, because we have collections, Which is we saw in the quotes multiple agents say that's the reason why they came back to Compass, because we have Off market listings and coming soon and the largest network of top agents across the country in the major markets in the country because they're number 1 In every in more top markets in the country than anyone else. And so the reason I bring that up is now ConBiz is going to and other brokers are going to create an even stronger reason why you need to be affiliated with a top brokerage firm, 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 Broker firms agree on with agents. I think we'll just reinforce that value.

Speaker 5

Got it. Thank you. And then second one, I guess, Klein, the $850,000,000 expense target. I just want to make sure I understand. So First, is the 850 now the target for 2024 and 2025 given that you were looking to stay flat in both those years previously?

Speaker 5

Then can

Speaker 3

you just talk about some of

Speaker 5

these specific actions that will get you to the new run rate? Thanks.

Speaker 3

Yes, sure. Thanks, A few things. I think we definitely are targeting $850,000,000 for 2024. And I think, As you mentioned consistently, we want to make sure we are working to drive even more efficiency to maintain that level in 2025. We think there's just A tremendous value, if we are able to do that.

Speaker 3

I think as we think about where we're going, we're going to continue to drive Operating efficiencies. I think one of the things over the last year and a half is we created a real operating discipline across the company to really drive out efficiency and We will continue to look to take advantage of our platform and scale. We'll continue to focus on low cost labor to drive To drive our cost of service down, we'll continue to look at extracting savings from vendors. And so we'll just continue To drive that operating discipline, so we can allow our cost base to flex with both the market, but also just to make sure one of the things we continue to learn Where we can be more efficient, and I think not only to react to the market, but also just to allow ourselves to continue to drive more value, more EBITDA, more cash We won't stop making sure we are servicing our agents with the best service, but also the most efficiently.

Speaker 5

I guess just a quick follow-up, then move from 900 to 850 like what's the delta? What's the biggest delta that's getting you there?

Speaker 3

Yes. So, a few things. 1, I think we continue to look at our operating model. So we continue to look at, kind of how we lower the transact the cost per transaction. We do that through just our operating model, some of the low cost labor.

Speaker 3

We continue to think we have tremendous opportunities with vendors, especially now as the market sits. And so a lot of the same Actions we've taken will continue to drive, we continue to learn more and we'll continue to push on those. All right, great guys. Thanks a lot.

Operator

Our next question comes from the line of Bernie MacTiernan with Needham and Company. Please go ahead.

Speaker 6

Great. Thanks for taking the questions. Maybe just to start, revenue guidance for 4Q flat to up. Just given the macro, can you talk about some of the moving pieces and then maybe how the brokerage acquisitions impacts revenue growth in the 4th quarter?

Speaker 2

Maybe I'll just give just some high level context of what we're seeing in the market and I'll let Clonnie go into more detail. I think we have modestly less inventory, so 4% less inventory than we did a year ago when he's already record low inventory, but it's not getting worse. So the week over week is really following last year now. In terms of pricing, price is still higher than a year ago and is recently at an all time high. And in terms of demand, demand at 8% mortgage rates definitely slowed down.

Speaker 2

And I would say it was almost Instead of being more buyers and sellers, it almost felt like for the first time in many, many months, it was as many buyers and sellers. It was almost a balanced market, although a depressed one. I think it was the mortgage rates going down 70 basis points over the last week is a very, very good thing for Compass and for the market. There is a lot of evidence out there that consumers respond more to the change in The mortgage rates more than the absolute number. And so, 8% at this moment in time is almost a great marketing It's almost great marketing to buyers to say 7.4% is very attractive.

Speaker 2

And so Hopefully, things stay around these levels. But the good news is The fall market is not falling off a cliff, and we are seeing in contract listings over the recent weeks either at or above the prior weeks the same levels the prior weeks prior year. And we're all holding tight to hope that the mortgage rate outlook is reasonable. But with that, Kailani, maybe a bit more detail for Q4.

Speaker 3

Yes. The only thing I'd add is just to remind Bernie of the equation, right. I think market first, which Robert said is Slightly down, but obviously lapping Q4 of last year, which was historically low. Added to that, agent adds, Which as you heard Greg mentioned, we continue to add agents and so the lift from there will be additive. And then obviously our M and A, we haven't provided formal guidance on the lift there, But those are the 3 big kind of components to the equation.

Speaker 6

Understood. And then just on the agent adds, Just any color in terms of how organic agent ads are tracking versus the acquired ones from brokerages? I guess asking the same question in a different way, if I could.

Speaker 4

Yes. It's a good question, Bernie. So agent adds organically in Q3 were actually almost Identical to what we did in Q2. And I'd just remind you and everybody on the call about the way that we report. Our average principal agent count is calculated by taking the end of month average for each month in the quarter and then just dividing by 3.

Speaker 4

And so the end of the month total rather for each month and then dividing by 3. And we closed the Realty Austin DPP deals in September. So those The impact of those on our average principal agent count is, deleted a little bit because it's really only a third The actual total principal agents that they have are going to be reflected in Q3. But we had a strong quarter from an agent recruiting perspective In Q3, normally Q2 is our best agent recruiting quarter. It's historically been that.

Speaker 4

But this year, we saw Q3 be Almost identical, slightly above Q2 on an organic basis. And then you'll see in Q4 the full impact of the Two acquisitions flow through in the numbers and so we're expecting to see healthy growth in Q4 as well.

Speaker 7

Understood. Thank you all.

Operator

Our next question comes from the line of Mike Nisch with Goldman Sachs. Please go ahead.

Speaker 8

Hey, good afternoon. Thanks for the question. I just have 2. First, I was just wondering if you could talk a little bit about Compass' GTV and market share performance in the context of whether geography Contributed to it or the acquisitions, either on a year over year or quarter on quarter basis. And then 2nd, I was just wondering if you could talk a little bit about Compass' mix of buy side versus sell side transactions.

Speaker 8

Is that Evenly split and are there any factors to consider as you think about things that impact that Whether by market or brokerage size or target customer otherwise. Thank you.

Speaker 4

I'll speak to Mike, this is Greg. I'll speak to the market share. One of the things that we've seen for the last three years Is that our Q3 market share tends to be sequentially lower than Q2. So Q3 was up year over year, a little bit down sequentially. We've seen that the last 3 years in a row.

Speaker 4

We believe that's primarily just Geo mixed across the entire country. The markets that Compass is in playing a smaller role in overall transactions in Q3 versus the rest of the country than they do in Q2. And so we believe that's one of the factors that's playing out in our market share in the quarter. In terms of buy side versus sell side, they're pretty evenly split. I'll defer to Robert, so that he had some thoughts he wanted to share on that.

Speaker 2

Yes. I'm pretty sure that we're around 55% buy side versus sell side. It has changed over time as the markets change, That's the most recent number that I have.

Speaker 8

Great. Thanks, Greg. Thanks, Robert.

Operator

Our next question comes from the line of Matthew Bouley with Barclays. Please go ahead.

Speaker 9

Hey, good evening, everyone. Thank you for taking Questions. Wanted to touch on commission splits. I think even excluding the equity comp Adjustments, it looked like they went the splits went 50 basis points or so in favor of the agent this quarter. I'm curious if there's Anything driving that?

Speaker 9

Any mix in there to be aware of? And if this is the direction of commission splits that we should assume, kind of as we model 2024?

Speaker 6

Thank you.

Speaker 3

Yes. Thanks, Matt. It's Kehlani. Just a couple of things. I think when we Think about our Q3 margin, you're right, it's unfavorable kind of year over year, driven mainly by 2 big buckets.

Speaker 3

First, Q3 of last year was one of the 2 best margin percentage quarters in our history. So, we're facing tough prior year comps. I think second, We did see year over year margin change primarily due to mix shift, both regional mix shift as well as production mix shift And then also some impact from select number of agent split changes. So those are the 2 big kind of in quarter drivers. I think as you as we think about and go We continue to believe we have opportunity in our commission space.

Speaker 3

Again, just a reminder, both in mix, So we continue to drive the overall book of our agents through the top 50%. Obviously, the bottom side of that has better economics. We continue to think that we can drive also Incentives as they come off, if you think about the last 3 or 4 years as we recruited, we I think we stopped about a year ago with incentives So those burn off and improve. And then obviously, if you think about total, I think we have some more opportunity on Adjacent Services. So I think this quarter has comping and some mix more than anything, but it shouldn't be indicative of future modeling.

Speaker 2

Yes. I just want to double down on that point that this is not be indicative of the future. This is always an area of focus, but The bigger areas of focus over the last year are bringing our expenses down in a number of ways, and we are very focused on this to ensure that it's not A trend that we see in the future.

Speaker 9

Got it. Okay. Super helpful. Thank you for that detail. And then Back on the topic of commissions, certainly the kind of worry out there is that There would be additional changes compelled beyond what happened in the Northwest MLS there.

Speaker 9

For example, A scenario where homebuyers kind of have to pay their agent out of pocket, as one possibility. From your perspective and really great color around all the proactive efforts you're making, you mentioned something around kind of consolidation. I mean, so Robert, I mean, is this the type of thing where you are hearing from acquisition targets out there? Do you find that this is a type of thing that could drive Brokerages to want to join Compass and just kind of what's your thoughts on how that kind of overall industry market and consolidation may take shape here?

Speaker 2

Yes. So, Ian, one, I just want to reiterate that there's no evidence today that the commissions will be under pressure. And also want to Make the point that for the likely thousands of agents out there, dozens that I know personally, that only work with buyers where they highlight With the commission that they command independently, and there's a buyer broker agreement there. Any of those agents don't are not worried about this present about this, lawsuit in any way at all, because it's not going to change anything for them. They're going to sign the same they're going to buy your broker agreement in 2 years, 3 years, 4 years, they have for the last 2, 3, 4 years, and it's going to outline what they charge independently.

Speaker 2

And so I just use that as an example to just reiterate that there is an evidence that Commissions, particularly for any good agents, maybe for the worst agents, yes, but for any good agents who really focus on and the best agents here at Compass that it won't create pressure. On your question around what's happening, I think, in the real estate industry And why there's an unprecedented number of brokerage firm CEOs that are open to selling. I think that they are I think for the average brokered firm CEO, They can be exhausted financially because of the real estate market has been difficult. I think the average broker firm CEO can be exhausted culturally Because their agents and their employees haven't come back to the office with the same energy and the same Yes, present as they did before the pandemic. I think that they are exhausted competitively, as they increasingly see That is the Compass technology platform that we have built with $1,500,000,000 of investment behind it and A greater than 500 person team, technology team still, making it better every single day that they won't be able to rebuild what Compass has.

Speaker 2

And then I think to your point, The unknown around what the trials will lead to And the headache around them of just lawyers and litigation. It has, I think, led to More people are saying, is this really what I want to sign up for the next couple of years? And so I think it has contributed to adding an additional layer of exhaustion that makes people reevaluate. Is this a good time to double down or is it a good time to partner with Compass?

Speaker 9

Got it. Well, thank you for that, Robert. Thanks, everyone, and good luck.

Speaker 4

Thank you.

Operator

Our next question comes from the line of Jason Helfstein with Oppenheimer and Company. Please go ahead.

Speaker 6

Hey, thanks. This is Chad on for Jason. Quick one for me. Robert, could you maybe just talk about what new product or feature launch you're most excited about for 24, either to increase agent productivity or consumer conversion?

Speaker 7

Can I give 2?

Speaker 2

All right. Well, one would be it would be solving the majority of team functionality requests That have come from our agents as agents are really small business owners and many of them work in teams with Highly complex multiparty workflows, and we have done a level of that. But I think over the course of 2024, We will do it to a level that satisfies the majority of the key agent team needs, and I'm really excited by that. The second is the client dashboard. It will there'll be a client dashboard over time for buyers, Another one for sellers, another one for multiple homeowners.

Speaker 2

It will be the one stop shop for everything home. We'll have the time the transaction timeline there. All of the tools that we built for agents, where you can send a CMA or Tour sheet or collection to client will all live in one place. And so, if you just want to send it by email, it will be in one place for them Before, during and after the transaction for the client and we believe will be a repeat and referral gold mine with the agent's branding on front and center in the client dashboard and it will reinforce the relationship as the real estate advisor with their clients, strengthen relationship, which is really important in this time to show your value. And that's probably those are 2 things I'm most excited about.

Speaker 3

Thanks.

Speaker 2

And completing title and escrow integration of the platform in every market as well as number 3.

Operator

Our next question comes from the line of Lloyd Walmsley with UBS. Please go ahead.

Speaker 7

Thanks. In terms of just the operating costs, Are there plans perhaps on the shelf where if we don't see any relief in mortgage rates, like if they just keep marching forward, where you can take more operating costs out of the business to ensure you remain at free cash flow positive. I think None of it well, I speak for myself. I did not think rates would be where they are today a year ago. So if we keep seeing them march up higher, What do you guys contemplate reacting?

Speaker 7

And then I guess going back to the industry structure question, How do you think a full an injunction from the judge in the Citrus case preventing Sellers from paying buyers at all, like is that would that surprise you? And if the industry moved in that Do you think that would be more perhaps more problematic than what the case study we're looking at In the Seattle region where it's simply they're not required to offer

Speaker 2

higher compensation. Maybe I'll start with the second and then I'll pass on to Connie for the first part of your question. So the settlements That Realigent REMAX had still allow sellers to pay a buyer commission. It just doesn't make it a requirement. And to my understanding, the requirement was only a penny.

Speaker 2

And so That's why when you take a penny to 0, which I believe is what they said on just bring the penny to a 0. That's why the market norm prevailed, because taking a pain to 0 wouldn't change the market norm, which kind of highlights What's going on here and the different people's different motivations. But bringing his penny to a 0 is What they settle on and that brings you to Washington State, kind of the Northwest MLS, which is 80% of the population. Not allowing sellers to pay the buyer commission It'd be really challenging for buyers because right now, because then they would not be able to finance it in the mortgage. So, it actually increased costs for buyers, to my knowledge.

Speaker 2

But again, there isn't Evidence that, that is going to be the clear path versus what has been settled on. And again, for the agents who are who know how to successfully get buyer broker agreements, Which outlined their commission, it shouldn't be a risk for those people, which is why we're making training along those lines a key priority for our agents to empower them. But with that, Kony?

Speaker 3

Yes, sure. Thanks, Lloyd. I think and we mentioned, I think we've had what we've seen our success is Being able to look ahead and making sure that our OpEx is ahead of market conditions. I think that's again for 2 things. 1, to make sure we are Ahead of market conditions also to make sure we're maximizing profit and value.

Speaker 3

I think as we think about our path to 900 down to 8 I think we do have room. If we need to, we'll continue to monitor. Where we go is going to be kind of a continued Our operational efficiencies we've already extracted as part of it. So I think about lowering costs So looking at continued efficiencies in our kind of transaction based cost, obviously, if the market continues, looking at variable cost as revenue declines. Low cost labor, we've done a tremendous job so far, but I think we still have opportunity.

Speaker 3

I think about our back office Efforts and continuing to look at low cost labor and efficiencies there as well as our technology we've done and Greg and team have done A really nice job of ensuring that we have a great portfolio, but doing it with low cost labor. And then vendors, I think we'll continue to rationalize, we'll Look at lower usage, licensing, etcetera, and then obviously procurement and lowering rates. So I think we have a bunch of Opportunities are at our disposal, and we'll continue to monitor it. But again, I think we're doing it both to make sure we react to the market, but also just to continue to drive profit, To drive free cash flow, the more we can optimize through our kind of discipline of efficiencies, I think the more profit we're focused on. So I hope that helps.

Speaker 7

All right. Thank you.

Operator

Our next question comes from the line of Ryan McKeveny with Zelman and Associates. Please go ahead.

Speaker 10

Hey, thanks a lot guys. Two questions that are kind of the same, so I'll ask them at the same time. So on the client dashboard and on the T and E side, both Seem very interesting opportunities to expand those. I guess, we'll in both cases, will that require much Incremental investment or expense to kind of get where you want to go, let's say, on the dashboard or with the T and E integrations into more markets? Or Maybe on the T and E side, is that more of driving revenue opportunity without adding much cost?

Speaker 10

And same thing on the client dashboard, is there much Incremental tech spend or whatever expenses they are that need to get that to the point of launch and expansion into next year.

Speaker 2

Yes. I'm going to pass it on to Greg to answer that. No, there is no incremental text. And also, I thought it'd be helpful if Greg is really spearheading Combus AI. If you can just maybe chat about Why?

Speaker 2

I know I've heard from you say that that's one of the areas you're most excited by. Maybe just share why that is.

Speaker 4

Sure. So, first just to answer the question, no, there's no incremental expense. We're not Increasing the investment in technology to be able to either integrate D and E into the platform or to work on Client Dashboard or Compass AI for that matter. We've continued over time to reduce Our investment in technology both on an absolute basis, but also obviously as a percentage of revenue, yet we still feel Very confident in our ability even with less investment in the area to continue to build for our agents. Compass AI is a great example of that and we certainly believe that we are in a different position than any of our competitors with respect to our ongoing investment In tech being a much more impactful one for us than what anybody else is doing in this space.

Speaker 4

In terms of Compass AI, Robert mentioned that. One of the reasons that I am a big believer in The impact that Compass AI has already had, but will also have for our agents is that it takes some of the tasks What agents do all the time, and it makes them much, much, much easier. So, it doesn't do their job for them completely, but it does 80% to 90% of the job in one second, writing a listing description, creating a marketing email, Creating a social post. You can use CampusAI, type in a few things that you want to do for a new listing. Give me a new listing at 123 Main Street, 3 Bedroom, Faces West, 3rd Floor, and then nearly come back to you with a great description.

Speaker 4

You can then tweak it or you can Use the prompts to refine what the AI gives you. When we've done coaching sessions and training sessions on Compass AI with agents, we'll have Thousands of agents in attendance are by far our best attended training sessions that we ever had. And agents Rave about it. It's a huge time saver for them and it's also one of those things that gets them over The cold start problem when they're sitting down to do that. And so one of the best things about all the investment we've made in our technology platform to date is it gives us a lot of Surface area to use AI across, and so Compass AI is the latest example of that and someone something that we're continuing to be excited about Expanding over time, but that won't require any incremental investment to do so.

Speaker 10

Great. Thank you very much.

Operator

Our final question comes from the line of Matthew Kos with Morgan Stanley. Please go ahead.

Speaker 3

Hi, everybody. Thanks for squeezing me

Speaker 11

in here. I guess, you've had a pretty clear roadmap that you've laid out for the market that we're in where Transaction volume is really, really low. Prices have not gone down, and you're managing costs As much as

Speaker 3

you can, I think you've

Speaker 11

been clear about your goals there? What happens if we tip into a recession scenario from here? Do you look to cut costs even further? You've already taken a lot of costs out of the model. You kind of stay on the path that you're on.

Speaker 11

And then at what point do you lean back in to reinvesting, because obviously if we do end up in that scenario then that's Kind of the darkest moment before things start to recover. Thank you.

Speaker 3

Well, I think

Speaker 2

There's a lot of the number of people that would say that if A recession would be good for the real estate at some levels. A recession at some level would be good for the real estate market because It would lead to the Fed lowering rates, which would bring down, obviously the mortgage rate. And that's the that is the biggest thing that's governing The transaction volume in the country, where 60% of homeowners are locked in at 4% mortgage rates or below. And so rolling something from 4 into 8 is just too much or 3 into 8 is just too much. By the way, it's a better number now than it was 9 months ago.

Speaker 2

9 months ago, It was 70% was locked in at 4%. So it looks like over the last 9 months, it moved from 70% to 6% that have that significant Rate lock issue. So, yes, I think a modest recession would be helpful to the mortgage rate. A deeper one Would be more could potentially be more problematic. And in terms of when are we turn the investment back on, I think it's important to be clear that we believe This isn't a temporary moment or we're going to just bring expenses back when the mark comes back.

Speaker 2

This is we are thinking of this as the new normal for a cost base, of course, increasing with inflation over time. But we're even at these levels, we have a technology team that's over 500 people strong, which is likely larger than every other The value that we create, it's all relative to our competitors. And I think the distance between us and our competition has widened every year over the last 3 years. And so for that reason, We don't need to put on massive dollars to invest. We can just continue being the company at these new levels Yes, and taking advantage of efficiencies to be able to earn the right to invest by creating more profit over time.

Speaker 2

But I don't think that's going to be the area of focus as in creating more investment right now.

Speaker 3

Great. Thank you.

Operator

I would now like to turn the call over to Robert Rathkin for closing remarks.

Speaker 2

Look, thank you everyone for joining today's call. I just want to take these final moments On the call to thank all of the Compass employees and all of the Compass agents for their hard work and commitment to make Encompass the number one real estate brokerage by sales volume in the United States for the 2nd year in a row. In a difficult market, Our agents continue to outperform and I just want to say thank you. We continue to successfully manage our expenses down and are prepared for the uncertainty of 2024. Eventually, the real estate market will come back and when it does, I am incredibly confident that Compass is well positioned for incredible success.

Speaker 2

Thank you, everyone. Hi.

Operator

I'd like to thank our speakers for today's presentation and thank you all for joining us. This now concludes today's call and you may now disconnect.

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