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Registrant's
telephone number, including area code
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name
of each exchange on which registered
iCommon Stock, $0.001 par value per share
iRDFN
iThe
Nasdaq Global Select Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
☒
iYes
☐
No
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
☒
iYes
☐
No
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
iLarge accelerated
filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As
used in this Quarterly Report on Form 10-Q (this "Quarterly Report"), the terms "Redfin,""the Company,""we,""us," and "our" refer to Redfin Corporation and its subsidiaries taken as a whole, unless otherwise noted or unless the context indicates otherwise.
Note Regarding Forward-Looking Statements
This Quarterly Report contains forward-looking statements. All statements contained in this report other than statements of historical fact, including statements regarding our future operating results and financial position, our business strategy and plans, our market
growth and trends, and our objectives for future operations, are forward-looking statements. The words “believe,”“may,”“will,”“estimate,”“continue,”“anticipate,”“intend,”“expect,”“could,”“would,”“project,”“plan,”“potentially,”“preliminary,”“likely,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described under Item 1A of our Annual Report for the year ended December
31, 2018, as supplemented by Part II, Item 1A of this Quarterly Report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the effect of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Accordingly, you should not rely on forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, performance,
or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update any of these forward-looking statements for any reason after the date of this report or to conform these statements to actual results or revised expectations.
Note Regarding Industry and Market Data
This Quarterly Report contains information using industry publications that generally state that the information contained therein has been obtained from sources believed to be reliable, but such information may not be accurate or complete. While we are not aware of any misstatements regarding the information from these industry publications, we have not independently verified any of the data from third-party sources nor have we ascertained the underlying
economic assumptions relied on therein.
Notes to Condensed Consolidated Financial
Statements
(in thousands, except for shares and per share amounts, unaudited)
Note 1: iSummary of Significant Accounting Policies
i
Basis
of Presentation—The consolidated financial statements and accompanying notes have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). All amounts are presented in thousands, except share and per share amounts.
The financial information as of December 31, 2018 that is included in this Quarterly Report is derived from the audited consolidated financial statements and notes for the year ended December 31, 2018 included in Item 8 in the Annual Report on Form 10-K (the “2018 Annual Report”) of Redfin Corporation (the "Company" or "Redfin"). Such financial information should be read in conjunction with the notes and management’s discussion and analysis of the consolidated
financial statements included in the 2018 Annual Report.
The unaudited condensed consolidated financial statements, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company's financial position as of September 30, 2019, the statements of comprehensive income (loss) and stockholders' equity for the three and nine months ended September 30, 2019 and 2018, and the statement
of cash flows for the nine months endedSeptember 30, 2019 and 2018. The results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019 or for any interim period or for any other future year.
i
Principles
of Consolidation—The unaudited condensed consolidated interim financial statements include the accounts of Redfin and its wholly owned subsidiaries. Intercompany transactions and balances have been eliminated.
i
Use of Estimates—The preparation of consolidated financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and results of operations during the respective
periods. The Company evaluates its estimates on an ongoing basis. During the nine months endedSeptember 30, 2019, the estimated useful life of capitalized software for internal use was updated from one to itwo years. This change
in estimate was not material. In addition, with the adoption of Accounting Standards Codification Topic 842, Leases, the Company estimated its incremental borrowing rate for the determination of the present value of lease payments. Further description of the impact of this pronouncement is included in Note 6. The amounts ultimately realized from the affected assets or liabilities will depend on, among other factors, general business conditions and could differ materially in the near term from the carrying amounts reflected in the consolidated financial statements.
/i
Cash
and Cash Equivalents—Cash equivalents consist primarily of money market instruments and U.S. treasury securities. The Company considers all highly liquid investments originally purchased by the Company with original maturities of three months or less at the date of purchase to be cash equivalents and classified as available-for-sale.
i
Investments—The
Company has itwo types of investments: (i) available-for-sale investments that are available to support operational needs of the Company, which are reported on the balance sheet as short-term and long-term investments, and (ii) long-term equity investments accounted for under the cost method, which are reported in other non-current assets.
Available-for-sale
The
Company's short-term and long-term investments consist primarily of U.S. treasury securities, all of which are classified as available-for-sale. Available-for-sale debt securities are recorded at fair value, and unrealized holding gains and losses are recorded as a component of accumulated other comprehensive income. Available-for-sale securities with maturities of one year or less and those identified
/
7
by management at the time of purchase to be used to fund operations within one year are classified as short-term. All other available-for-sale securities are classified as long-term. The Company
evaluates its available-for-sale securities, both ones classified as cash equivalents and as investments, for other-than-temporary impairment on a quarterly basis. Unrealized losses are charged against net earnings when a decline in fair value is determined to be other than temporary. The Company reviews factors to determine whether a loss is other than temporary, such as the length and extent of the fair value decline, the financial condition and near-term prospects of the issuer, and whether the Company has the intent to sell or will more likely than not be required to sell before the securities' anticipated recovery, which may be at maturity. Realized gains and losses are accounted for using the specific identification method. Purchases and sales are recorded on a trade date basis. There were
ino other than temporary impairments during the periods presented.
Cost Method Investments
In December 2018, the Company purchased an equity interest in a privately held company for approximately
$i2,000, which is classified as long-term. The investment is an equity security without a readily determinable fair value that is accounted for at cost minus any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. The Company performs a qualitative assessment considering impairment indicators to evaluate whether the investment is impaired
as of the end of each reporting period.
i
Advertising and Advertising Production Costs—The Company expenses advertising costs as they are incurred and production costs as of the first date the advertisement takes place. Advertising costs totaled $i5,279
and $i5,936 for the three months ended September 30, 2019 and 2018, respectively, and $i59,357
and $i29,167 for the nine months endedSeptember 30, 2019 and 2018, respectively, and are included in marketing expenses. Advertising production costs totaled $i17
and $i7 for the three months ended September 30, 2019 and 2018, respectively, and $i166
and $i20 for the nine months endedSeptember 30, 2019 and 2018, respectively, and are included in marketing expenses.
/
i
Recently
Adopted Accounting Pronouncements—In January 2019, the Company adopted ASU 2016-02, Leases (Topic 842), using the optional alternative transition method under ASU 2018-11, Leases (Topic 842) Targeted Improvements. The optional alternative transition method applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company evaluated its portfolio of leases and determined a cumulative-effect adjustment to the opening balance of retained earnings was not needed, as the portfolio of leases contains only operating leases.
The
Company elected the package of practical expedients permitted under the transition guidance within the standard, allowing the Company to carry forward the historical lease classification, carry forward the conclusions on whether current or expired contracts contain leases, and carry forward the accounting for initial direct costs for existing leases. Additionally, the Company elected the practical expedient for use of hindsight to determine the lease term for existing leases whereby it evaluated the performance of existing leases in relation to our leasing strategy and determined that most renewal options would not be reasonably certain to be exercised. This resulted in the shortening of lease terms for
the existing leases.
Adoption of the standard resulted in the recording of right of use assets and corresponding lease liabilities of $i33,953 and $i49,395,
respectively, as of January 1, 2019, the difference of which is due to lease incentives. Further description of the impact of this pronouncement is included in Note 6.
In January 2019, the Company adopted the guidance in the U.S. Securities and Exchange Commission (the "SEC") final rule under SEC Release No. 33-10532, Disclosure Update and Simplification. In August 2018, the SEC issued the final rule amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated, or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments,
an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the
/
8
beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed.
In August 2018, the Financial Accounting Standards Board ("FASB") issued authoritative guidance under ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software: Customer’s Accounting for Implementation Costs
Incurred in a Cloud Computing Arrangement that is a Service Contract. The ASU requires implementation costs incurred by customers in cloud computing arrangements (i.e., hosting arrangements) to be capitalized under the same premises of authoritative guidance for internal-use software, and deferred over the noncancelable term of the cloud computing arrangements plus any option renewal periods that are reasonably certain to be exercised by the customer or for which the exercise is controlled by the service provider. The ASU is effective for public entities for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company elected to early adopt this standard in the third quarter of 2019 on a prospective
basis, which did not result in a material effect on the Company's consolidated financial statements.
Recently Issued Accounting Pronouncements—In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), which modifies the disclosures on fair value measurements by removing the requirement to disclose the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and the policy for timing of such transfers. The ASU expands the disclosure requirements for Level 3 fair value measurements, primarily focused on changes in unrealized gains and losses included in other comprehensive income. The ASU is effective for public entities for fiscal years
beginning after December 15, 2019, with early adoption permitted. The Company has not yet completed its assessment of the impact of the new standard on the Company’s consolidated financial statements.
In June 2016, the FASB issued authoritative guidance under ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), which modifies the measurement of credit losses on financial instruments. This guidance requires the use of an expected loss impairment model for instruments measured at amortized cost based on relevant information about past events, including historical experience, current conditions, and reasonable
and supportable forecasts that affect the collectibility of the reported amount. For available-for-sale debt securities, an entity is required to recognize credit losses through an allowance for credit losses rather than as an impairment. The ASU is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted. The adoption of this guidance requires a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company completed its assessment of the impact of the new standard on the Company’s consolidated financial statements and does not expect a material impact.
Note
2: iSegment Reporting and Revenue
In its operation of the business, the Company's management, including its chief operating decision maker, who is also the Chief Executive Officer, evaluates the performance of the Company’s operating segments based on revenue and gross profit. The
Company does not analyze discrete segment balance sheet information related to long-term assets, all of which are located in the United States. All other financial information is presented on a consolidated basis. The Company has ifive operating segments and itwo
reportable segments, real estate services and properties.
Revenue is primarily generated from commissions and fees charged on each real estate services transaction completed by the Company or its partner agents, and proceeds from the sales of homes. The Company’s key revenue components are brokerage revenue, partner revenue, properties revenue, and other revenue. Revenue earned but not received is recorded as accrued revenue on the Company's consolidated balance sheets, net of an allowance for doubtful accounts. Accrued revenue, consisting of commission revenue, is known and is clearing escrow, and therefore it is not
estimated.
i
Information on each of the reportable and other segments and reconciliation to consolidated net income (loss) is as follows:
A
summary of assets and liabilities as of September 30, 2019 and December 31, 2018, related to the Company's financial instruments measured at fair value on a recurring basis, is set forth below, along with the balance sheet accounts they are classified within:
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant
Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Assets
Cash
equivalents
Money market funds
$
i425,776
$
i425,776
$
i—
$
i—
Loans
held for sale
i4,913
i—
i4,913
i—
Prepaid
expenses and other current assets
Interest rate lock commitments
i254
i—
i—
i254
Total
prepaid expenses and other current assets
i254
i—
i—
i254
Total
assets
$
i430,943
$
i425,776
$
i4,913
$
i254
Liabilities
Accrued
liabilities
Forward sales commitments
$
i141
$
i—
$
i141
$
i—
Total
liabilities
$
i141
$
i—
$
i141
$
i—
There
were no material transfers between levels, and there was no significant activity within Level 3 financial instruments during the periods presented.
See Note 14 for the carrying amount and estimated fair value of the Company's i1.75% Convertible Senior Notes
due 2023 (the "Notes").
Assets and liabilities recognized or disclosed at fair value on a nonrecurring basis include items such as property, plant and equipment, goodwill and other intangible assets, cost method investments, and other assets. These assets are measured at fair value if determined to be impaired. The Company did not record any significant nonrecurring fair value measurements after initial recognition for the period ended September 30, 2019.
11
Gross unrealized holding
gains and losses on available-for-sale debt securities were not material as of September 30, 2019.
Inventory
costs include direct property acquisition costs and any capitalized improvements, net of applicable lower of cost or net realizable value write-downs. As of September 30, 2019 and December 31, 2018, lower of cost or net realizable value write-downs were $i272 and $i190,
respectively.
Properties not available for sale represent purchased properties that have been temporarily rented back to the previous homeowner, typically for less than 30 days. Both properties not available for sale and properties under improvement are expected to be sold in less than twelve months.
The following is the inventory activity for the nine months ended September 30, 2019:
Depreciation
and amortization expense for property and equipment amounted to $i2,453 and $i2,099 for the three months ended September
30, 2019 and 2018, respectively, and $i6,018 and $i5,757
for the nine months endedSeptember 30, 2019 and 2018, respectively.
Note 6: iLeases
The
extent of the Company’s lease commitments consists of operating leases for physical office locations with terms ranging from one to i11 years. The Company has accounted for the portfolio of
12
operating
leases by disaggregation based on the nature and term of the lease. Generally, the leases require a fixed minimum rent with contractual minimum rent increases over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet, but rather lease expense from these leases is recognized on a straight-line basis over the lease term.
When available, the rate implicit in the lease to discount lease payments to present value would be used; however, none of the Company's significant leases as of September 30, 2019 provide a readily determinable implicit rate. Therefore, the Company must estimate its incremental borrowing rate
for each portfolio of leases to discount the lease payments based on information available at lease commencement.
The Company has evaluated the performance of existing leases in relation to its leasing strategy and determined that most renewal options would not be reasonably certain to be exercised.
The right of use asset and related lease liability are determined based on the lease component of the consideration in each lease contract. The Company has evaluated its lease portfolio for appropriate allocation of the
consideration in the lease contracts between lease and nonlease components based on standalone prices and determined the allocation per the contracts to be appropriate.
(a) Includes
lease expense with initial terms of 12 months or less of $i399 and $i1,889 for the three months ended and nine months ended September
30, 2019, respectively.
(a) Interest and other consists of interest expense related to capitalized right of use lease liabilities of $i9,050,
commitments related to leases that have not yet commenced and leases with initial terms of 12 months or less.
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
$
i7,040
Right
of use assets obtained in exchange for lease liabilities
Operating leases
$
i50,263
Note
7: iCommitments and Contingencies
Legal Proceedings—On August 28, 2019, one of the Company's former third-party licensed sales associates, which are referred to as associate agents, filed a complaint against the Company
in the
13
Superior Court of California, County of San Francisco. The complaint is pled as a class action and alleges that the Company misclassified the plaintiff as an independent contractor instead of an employee. The case includes representative claims under California’s Private Attorney General Act. The plaintiff is seeking unspecified amounts of unpaid overtime wages, straight time wages, meal and rest period compensation, penalties, injunctive, and other equitable relief, and reasonable attorneys' fees and costs. Given the preliminary stage of this case, the claims and issues presented, and the great uncertainties regarding which associate agents, if any, may be part of a class if one is certified, the
Company cannot estimate a range of reasonably possible losses.
In addition to the matter discussed above, from time to time, the Company is involved in litigation, claims, and other proceedings arising in the ordinary course of its business. Such litigation and other proceedings may include, but are not limited to, actions or claims relating to employment law (including misclassification), intellectual property, privacy and consumer protection, the Real Estate Settlement Procedures Act of 1974, the Fair Housing Act of 1968 or other fair housing statutes, cybersecurity incidents, data breaches or misappropriation, and commercial or contractual disputes. They may also relate to ordinary-course brokerage disputes, including, but not limited to, failure to disclose property defects, failure
to meet client legal obligations, commission disputes, personal injury or property damage claims, and vicarious liability based upon conduct of individuals or entities outside of the Company's control, including partner agents and third-party contractor agents.
Facility Leases and Other Commitments—The Company leases its office space under noncancelable operating leases with terms ranging from one to i11
years. Generally, the leases require a fixed minimum rent with contractual minimum rent increases over the lease term, and certain leases include escalation provisions. Other commitments primarily relate to homes that the Company is under contract to purchase through its properties segment but that have not closed, and network infrastructure for the Company’s data operations. iFuture
minimum payments due under these agreements as of September 30, 2019 are as follows:
(a) The
future minimum lease payments are presented on the same basis as the financial information presented in audited consolidated financial statements and notes for the year ended December 31, 2018 included in the 2018 Annual Report.
Note 8: iAcquired Intangible Assets
i
The
following table presents details of the Company's intangible assets subject to amortization as of the dates presented:
Acquired
intangible assets are amortized using the straight-line method over their estimated useful life, which approximates the expected use of these assets. Amortization expense amounted to $i122 and $i366
for each of the three and nine months ended September 30, 2019 and 2018. Amortization expense of $i2,440 will be recognized over the next five years, or $488 per year.
14
Note
9: iAccrued Liabilities
i
The following table presents the detail of accrued liabilities
as of the dates presented:
Other payables consists primarily of customer deposits for cash held in escrow on behalf of real
estate buyers using Title Forward, the Company's wholly owned title and settlement services subsidiary. Since the Company does
not have rights to the cash, the customer deposits are recorded as a liability with a corresponding asset in the same amount recorded within restricted cash. iThe following table presents the detail of other payables as of the dates presented:
Preferred
Stock—As of September 30, 2019 and December 31, 2018, the Company was authorized to issue i10,000,000 shares of preferred stock with a par value of $i0.001,
of which ino shares were issued or outstanding.
2017 Equity Incentive Plan—The Company's 2017 Equity Incentive Plan ("2017 EIP") became effective on July 26, 2017, and provides for the issuance of incentive and nonqualified common stock options and restricted
stock units to employees, directors, officers, and consultants of the Company. The number of shares of common stock initially reserved for issuance under the 2017 EIP was i7,898,159. The number of shares reserved for issuance under the 2017 EIP will increase automatically on January 1 of each calendar year beginning on January
1, 2018, and continuing through January 1, 2028, by the number of shares equal to the lesser of i5% of the total outstanding shares of the Company's common stock as of the immediately preceding
December 31 or an amount determined by the board of directors.
Amended and Restated2004 Equity Incentive Plan—The Company granted options under its 2004 Equity Incentive Plan, as amended ("2004 Plan"), until July 26, 2017, when the plan was terminated in connection with the Company’s initial public offering. Accordingly, ino
shares are available for future issuance under the 2004 Plan. The 2004 Plan continues to govern outstanding equity awards granted thereunder.
2017 Employee Stock Purchase Plan—The Company initially reserved i1,600,000 shares
of common stock for issuance under the 2017 Employee Stock Purchase Plan (the "2017 ESPP"). The number of shares reserved for issuance under the 2017 ESPP will increase automatically on January 1 of each calendar year beginning after the first offering date and continuing through January 1, 2028, by the number of shares equal to the lesser of i1%
of the total outstanding shares of the Company’s common stock as of the immediately preceding December 31 or an amount determined by the board of directors. During the three and nine months ended September 30, 2019, zero and i262,110
shares of common stock, respectively, were issued under the 2017 ESPP.
i
The Company has reserved shares of common stock, on an as-converted basis, for future issuance as follows:
The
grant date fair value of options to purchase common stock is recorded as stock-based compensation over the vesting period. As of September 30, 2019, there was $i4,092 of total unrecognized compensation cost related to options to purchase common stock, which is expected to be recognized
over a weighted-average period of i1.25 years.
On June 1, 2019, the Company granted stock options subject to performance conditions, with
a target of i150,000 shares and a maximum i300,000
shares, to the Company's Chief Executive Officer. The options have an exercise price of $i27.50 per share and have the same performance and vesting conditions
as the restricted stock units subject to performance conditions that the Company granted in 2019 (the "2019 PSUs").
Restricted Stock Units—iThe following table summarizes activity for restricted stock units for the nine months ended September 30, 2019:
The
grant date fair value of restricted stock units is recorded as stock-based compensation over the vesting period. As of September 30, 2019, there was $i76,009 of total unrecognized
compensation cost related to restricted stock units, which is expected to be recognized over a weighted-average period of i3.08 years.
As of September 30, 2019, there were outstanding
i279,826 restricted stock units subject to performance conditions (the "PSUs") at i100%
of the target level. During the nine months ended September 30, 2019, a net ($i126) for share-based compensation expense was recognized for the PSUs, which includes (i) an adjustment of ($i610)
related to the PSUs granted in 2018 as the probability of achieving the performance conditions was determined to be not probable and (ii) a charge of $i484 related to the 2019 PSUs.
16
Compensation
Cost—iThe following table details, for each period indicated, (i) the Company's stock-based compensation net of forfeitures, and the amount capitalized in internally developed software and (ii) includes changes to the probability of achieving outstanding performance-based equity awards, each as included in the
Company’s condensed consolidated statements of operations:
Net income (loss) per share is computed by dividing the net income (loss) by the weighted-average number of shares of common stock outstanding. The Company has outstanding stock options, restricted stock units, options to purchase shares under its employee stock purchase plan, and convertible senior notes, which are considered in the calculation of diluted net income (loss) per share whenever doing so
would be dilutive.
i
The following table sets forth the calculation of basic and diluted net income (loss) per share during the periods presented:
The
following outstanding shares of common stock equivalents as of September 30, 2019 and 2018 were excluded from the computation of the diluted net income (loss) per share for the periods presented because their effect would have been anti-dilutive:
There
is ino impact from the Notes on the Company's diluted net loss per share for the three and nine months ended September 30,
2019 because the Notes are accounted for based on the treasury stock method as the Company has the ability, and intent, to settle any conversions of the Notes solely in cash.
Note 13: iIncome Taxes
17
The
Company’s effective tax rate for the nine months ended September 30, 2019 and 2018 was i0% as a result of the Company recording a full valuation allowance against the deferred tax assets.
In
determining the realizability of the net U.S. federal and state deferred tax assets, the Company considers numerous factors including historical profitability, estimated future taxable income, prudent and feasible tax planning strategies and the industry in which it operates. Management reassesses the realization of the deferred tax assets each reporting period, which resulted in a valuation allowance against the full amount of the Company’s U.S. deferred tax assets for the nine months ended September 30, 2019 and 2018. To the extent that the financial results of the U.S. operations improve in the future and
the deferred tax assets become realizable, the Company will reduce the valuation allowance through earnings.
Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in the Company's ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset taxable income. Any such annual limitation may significantly reduce the utilization of the net operating losses before they expire. A Section 382 limitation study performed as of March 31, 2017 determined there was an ownership change in 2006 and $i1,538
of the 2006 net operating loss is unavailable.
As of December 31, 2018, the Company had accumulated approximately $i125,850 of federal tax losses, approximately $i6,180
(tax effected) of state tax losses. Federal net operating losses are available to offset federal taxable income and begin to expire in 2025. Federal net operating loss carryforwards of $i39,365 generated during 2018 are available to offset future U.S. federal taxable income over an indefinite period.
The
Company’s material income tax jurisdiction is the United States (federal). As a result of net operating loss carryforwards, the Company is subject to audit for tax years 2005 and forward for federal purposes. There are tax years which remain subject to examination in various other jurisdictions that are not material to the Company’s financial statements.
Note 14: iDebt
Warehouse
Credit Facilities—To provide capital for the mortgage loans that it originates, Redfin Mortgage, the Company's wholly owned mortgage origination subsidiary, utilizes warehouse credit facilities that are classified as current liabilities in the Company's condensed consolidated balance sheets. The following table summarizes borrowings under these facilities as of the periods presented:
Borrowings
under the facility with Western Alliance Bank ("Western Alliance") mature on June 15, 2020 and generally bear interest at a rate equal to the greater of (i) one-month LIBOR plus i2.00% or (ii) i3.50%.
The agreement governing the facility requires Redfin Mortgage to maintain certain financial covenants. Redfin Mortgage is in default of this facility because it failed to satisfy a financial covenant as of September 30, 2019, but Western Alliance has not enforced its remedy under the agreement of requiring Redfin Mortgage to repurchase all outstanding loans held by the lender.
Borrowings under the facility with Texas Capital Bank, N.A. ("Texas Capital") mature on May 6, 2020 and generally bear interest at a rate equal to the greater of (i) the rate of interest accruing on the outstanding principal balance of the loan minus i0.5%
or (ii) i3.5%. Due to Redfin Mortgage's failure to satisfy a financial covenant under the Western Alliance facility, it is in default of the Texas Capital facility. However, Texas Capital has not enforced its remedies under the agreement, which principally include the rights to (i) cease purchasing participation interests in loans from Redfin Mortgage and (ii)
sell all interests of Texas
18
Capital or Redfin Mortgage in any loan subject to the agreement. Redfin Corporation has guaranteed Redfin Mortgage’s obligations under the agreement.
Secured Revolving Credit Facility—To provide capital for the properties that it purchases, RedfinNow, the Company's subsidiary that buys homes directly from homeowners and resell them to homebuyers, has, through a special purpose entity ("SPE"), entered into a secured revolving credit facility with Goldman Sachs Bank USA. iThe
following table summarizes borrowings under this facility as of the period presented:
The
facility matures on January 26, 2021, but the Company may extend the maturity date for an additional six months to repay outstanding borrowings. Borrowings under the facility generally bear interest at a rate of one-month LIBOR (subject to a floor of i0.50%)
plus i2.65%. In instances involving "bad acts," Redfin Corporation has guaranteed repayment of amounts owed under the facility, in some situations, and indemnification of certain expenses incurred, in other situations. For the three months ended September 30, 2019, the
Company amortized $i102 of the debt issuance costs.
Convertible Senior Notes—On July 23, 2018, the Company issued $i143,750
aggregate principal amount of Notes. The Notes are senior, unsecured obligations of Redfin, and bear interest at a fixed rate of i1.75% per year, payable semi-annually in arrears on January 15 and July 15. The effective interest rate of the liability portion of the debt is i7.25%.
The Notes mature on July 15, 2023, unless earlier repurchased, redeemed or converted. As of September 30, 2019, no conversion events have occurred. The Company will settle conversions of the Notes by paying or delivering, as the case may be, cash, shares of its common stock, or a combination of cash and shares of its common stock, at its election. The Company has the ability, and intends, to settle any conversions solely in cash.
The
total estimated fair value of the Notes as of September 30, 2019 and December 31, 2018 was approximately $i131,028 and $i117,875,
respectively, based on the closing trading price of the Notes on last day of trading for the period. The fair value has been classified as Level 2 within the fair value hierarchy given the limited trading activity of the Notes.
i
The following table sets forth total interest expense recognized related to the Notes for the periods presented:
Total
amortization of debt issuance costs and accretion of equity portion
i1,541
i1,128
i4,572
i1,128
Contractual
interest expense
i629
i482
i1,887
i482
Total
interest expense related to the Notes
$
i2,170
$
i1,610
$
i6,459
$
i1,610
/
19
Note
15: iSubsequent Events
Flagstar Warehouse Credit Facility—In October 2019, Redfin Mortgage entered into a Mortgage Warehousing Loan and Security Agreement with Flagstar Bank, FSB ("Flagstar"). Under this warehouse credit facility, Redfin Mortgage may receive funds from Flagstar to finance eligible mortgage loans that it has originated. The facility has a maximum borrowing capacity of $i15,000,
and borrowings under the facility generally bear interest at a rate equal to the greater of (i) one-month LIBOR plus i2.00% or (ii) i3.00%.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements, the accompanying notes, and other information included in this Quarterly Report and our Annual Report for the year ended December 31, 2018.
In particular, the disclosure contained in Item 1A in our Annual Report, as updated by Part II, Item 1A in this Quarterly Report, may reflect trends, demands, commitments, events, or uncertainties that could materially impact our results of operations and liquidity and capital resources.
The following discussion contains forward-looking statements, such as statements regarding our future operating results and financial position, our business strategy and plans, our market growth and trends, and our objectives for future operations. Please see "Note Regarding Forward-Looking Statements" for more information about relying on these forward-looking statements. The following discussion also contains information using industry publications. Please see "Note Regarding Industry and Market Data" for more information about relying on these industry publications.
When
we use the term "basis points" in the following discussion, we refer to units of one‑hundredth of one percent.
Overview
We help people buy and sell homes. Our primary business is a residential real estate brokerage, representing customers in over 90 markets throughout the United States and Canada. We pair our own agents with our own technology to create a service that is faster, better, and costs less. We meet customers through our listings-search website and mobile application.
We use the same combination of technology and local service to originate mortgage
loans and offer title and settlement services; we also buy homes directly from homeowners who want an immediate sale, taking responsibility for selling the home while the original owner moves on.
Our mission is to redefine real estate in the consumer’s favor.
Key Business Metrics
In addition to the measures presented in our consolidated financial statements, we use the following key metrics to evaluate our business, develop financial forecasts, and make strategic decisions.
The number of, and growth in, visitors to our website and mobile application are important leading indicators of our business activity because these channels are the primary ways we meet customers. For a particular period, monthly average visitors refers to the average of the number of unique visitors to our website and mobile application for each of the months in that period. Monthly average visitors are influenced by, among other things, market conditions that affect interest in buying or selling homes, the level and success of our marketing programs, seasonality, and how our website
appears in search results. We believe we can continue to increase monthly visitors, which helps our growth.
Given the lengthy process to buy or sell a home, a visitor during one month may not convert to a revenue-generating customer until many months later, if at all.
When we refer to "monthly average visitors" for a particular period, we are referring to the average number of unique visitors to our website and our mobile application for each of the months in that period, as measured by Google Analytics, a product that provides digital marketing intelligence. Visitors are tracked by Google Analytics using cookies, with a unique cookie being assigned to each browser or mobile application on a device. For any given month, Google Analytics counts all of the unique
cookies that visited our website or either our iOS or Android mobile application during that month; each such unique cookie is a unique visitor. If a person accesses our mobile application using different devices within a given month, each such mobile device is counted as a separate visitor for that month. If the same person accesses our website using an anonymous browser, or clears or resets cookies on his or her device, each access with a new cookie is counted as a new unique visitor for that month. Additionally, in some instances, third-party technological limitations or user software settings may cause Google Analytics to count a person as a unique visitor when he or she is not.
Real
Estate Services Transactions
We record a brokerage real estate services transaction when one of our lead agents represented the homebuyer or home seller in the purchase or sale, respectively, of a home. We record a partner real estate services transaction when (i) one of our partner agents represented the homebuyer or home seller in the purchase or sale, respectively, of a home or (ii) a Redfin customer sold his or her home to a third-party institutional buyer following our introduction of that customer to the buyer. We include a single transaction twice when our lead agents or our partner agents serve both the homebuyer and the home seller of the transaction.
Increasing the number of real estate services transactions is critical to increasing our revenue and, in turn, to achieving profitability. Real estate services transaction volume
is influenced by, among other things, the pricing and quality of our services as well as market conditions that affect home sales, such as local inventory levels and mortgage interest rates. Real estate services transaction volume is also affected by seasonality and macroeconomic factors.
Real Estate Services Revenue per Transaction
Real estate services revenue per transaction, together with the number of real estate services transactions, is a factor in evaluating business growth and determining pricing. Changes in real estate services revenue per transaction can be affected by, among other things, our pricing, the mix of transactions from homebuyers and home sellers, changes in the value of homes in the markets we serve, the geographic mix of our transactions, and the transactions we refer to partner agents and third-party institutional
buyer.
We generally generate more real estate services revenue per transaction from representing homebuyers than home sellers. However, we believe that representing home sellers has unique strategic value, including the marketing power of yard signs and digital marketing campaigns, and the market effect of controlling listing inventory. To keep revenue per brokerage transaction about the same from year to year, we expect to reduce our commission refund to homebuyers if more of our brokerage transactions come from home sellers.
We calculate real estate services revenue per transaction by dividing brokerage,
partner, or aggregate revenue, as applicable, by the corresponding number of real estate services transactions in any period.
Aggregate Home Value of Real Estate Services Transactions
The aggregate home value of brokerage and partner real estate services transactions is an important indicator of the health of our business, because our revenue is largely based on a percentage of each home’s sale price. This metric is affected chiefly by the number of customers we serve, but also by changes in home values in the markets we serve. We include the value of a single transaction twice when our lead agents or our partner agents serve both the homebuyer and home seller of the transaction.
U.S. Market Share by Value
Increasing
our U.S. market share by value is critical to our ability to grow our business and achieve profitability over the long term. We believe there is a significant opportunity to increase our share in the markets we currently serve.
We calculate the aggregate value of U.S. home sales by multiplying the total number of U.S. home sales by the mean sale price of these sales, each as reported by the National Association of Realtors. We calculate our market share by aggregating the home value of brokerage and partner real estate services transactions. Then, in order to account for both the sell- and buy-side components of each transaction, we divide that value by two-times the estimated aggregate value of U.S. home sales.
Revenue from Top-10 Markets as a Percentage of Real Estate Services Revenue
Our
top-10 markets by real estate services revenue are the metropolitan areas of Boston, Chicago, Denver (including Boulder and Colorado Springs), Los Angeles (including Santa Barbara), Maryland, Northern Virginia, Portland (including Bend), San Diego, San Francisco, and Seattle. We expect our revenue from top-10 markets to decline as a percentage of our total real estate services revenue over time.
Average Number of Lead Agents
The average number of lead agents, in combination with our other key metrics such as the number of brokerage transactions, is a basis for calculating agent productivity and is one indicator of the potential future growth of our business. We systematically evaluate traffic to our website
and mobile application and customer activity to anticipate changes in customer demand, helping determine when and where to hire lead agents.
We calculate the average number of lead agents by taking the average of the number of lead agents at the end of each month included in the period.
Components of Our Results of Operations
Revenue
We generate revenue primarily from commissions and fees charged on real estate services transactions closed by our lead agents or partner agents.
Real Estate Services Revenue
Brokerage Revenue—Brokerage revenue consists of commissions
earned on real estate services transactions closed by our lead agents. We recognize commission-based revenue on the closing of a transaction, less the amount of any commission refund or any closing-cost reduction, commission discount, or transaction-fee adjustment. Brokerage revenue is affected by the number of real estate services transactions we close, the mix of brokerage transactions, home-sale prices, commission rates, and the amount we refund to customers.
Partner Revenue—Partner revenue consists of fees paid to us from partner agents or under other referral agreements when the referred transactions
close, less the amount of any payments we make to customers. We recognize these fees as revenue on the closing of a transaction. Partner revenue is affected by the number of partner transactions closed, home-sale prices, commission rates, and the amount we refund to customers. If the portion of customers we introduce to our own lead agents increases, we expect the portion of revenue closed by partner agents to decrease.
Properties Revenue
Properties revenue is earned when we sell homes that we previously bought directly from homeowners. Properties revenue is recorded at closing on a gross basis, representing the sales price of the home. RedfinNow is our primary properties offering.
Other Revenue
Other services revenue includes fees earned from mortgage banking services, title settlement services,
Walk Score data services, and advertising.
Intercompany Eliminations
Intercompany eliminations represents revenue earned from transactions between operating segments which we eliminate in consolidating our financial statements. This primarily consists of services performed from our real estate services segment for our properties segment.
Cost of Revenue and Gross Margin
Cost of revenue consists primarily of personnel costs (including base pay, benefits, and stock-based compensation), transaction bonuses, home-touring and field expenses, listing expenses, property costs related to our properties segment, office and occupancy expenses, and depreciation
and amortization related to fixed assets and acquired intangible assets. Property costs related to our properties segment include the property purchase price, capitalized improvements, selling expenses directly attributable to the transaction, and property maintenance expenses.
Gross profit is revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin has and will continue to be affected by a number of factors, but the most important are the mix of revenue from our relatively higher-gross-margin real estate services segment and our relatively lower-gross-margin properties segment, real estate services revenue per transaction, agent and support-staff productivity, personnel costs and transaction bonuses, and, for properties, the cost of homes.
Operating Expenses
Technology
and Development
Our primary technology and development expenses are building software for our customers, lead agents, and support staff to work together on a transaction, and building a website and mobile application to meet customers looking to move. These expenses consist primarily of personnel costs including stock-based compensation, data-license expenses, software costs, and equipment and infrastructure costs, such as for data centers and hosted services. Technology and development expenses also include amortization of capitalized internal-use software and website and mobile application development costs.
Marketing
Marketing
expenses consist primarily of media costs for online and offline advertising, as well as personnel costs including stock-based compensation.
In the nine months ended September 30, 2019, we incurred approximately $36 million on offline advertising media costs, compared to around $12 million for all of 2018.
General and Administrative
General and administrative expenses consist primarily of personnel costs including stock-based compensation, facilities costs and related expenses for our executive, finance,
human resources, and legal organizations, depreciation related to our fixed assets, and fees for outside services. Outside services are principally comprised of external legal, audit, and tax services.
Interest Income
Interest income consists primarily of interest earned on our cash and cash equivalents and short-term and long-term investments.
Interest Expense
Interest expense consists of interest payable on our convertible senior notes. Interest is payable on the notes at the rate of 1.75% semiannually in arrears on January 15 and July 15, commencing on January 15, 2019. Interest expense also includes the amortization of debt discount and issuance costs related to the notes and secured revolving credit facility.
Results
of Operations
The following tables set forth our results of operations for the periods presented and as a percentage of our revenue for those periods.
In the three months ended September 30, 2019, revenue increased by $98.4 million, or 70%, as compared with the same period in 2018. Brokerage revenue represented $27.3 million, or 28%, of the increase. Brokerage revenue grew 23% as compared with 2018, driven by a 25% increase in brokerage transactions and a 2% decrease in real estate services revenue per transaction. We believe this increase in brokerage transactions was attributable to higher levels of customer awareness of Redfin and increasing customer demand. Properties
revenue represented $68.8 million, or 70%, of the increase. Properties revenue grew 606% as compared with 2018, driven by a greater market presence and consumer awareness of RedfinNow, which resulted in a 600% increase in the number of properties sold.
Cost of Revenue and Gross Margin
Three
Months Ended September 30,
Change
2019
2018
Dollars
Percentage
(in thousands, except percentages)
Cost
of revenue
Real estate services
$
100,048
$
83,274
$
16,774
20
%
Properties
80,909
11,656
69,253
594
Other
5,117
3,071
2,046
67
Intercompany
elimination
(768
)
(51
)
(717
)
1,406
Total cost of revenue
$
185,306
$
97,950
$
87,356
89
Gross
profit (loss)
Real estate services
$
54,078
$
42,991
$
11,087
26
%
Properties
(745
)
(306
)
(439
)
143
Other
44
(380
)
424
(112
)
Total
gross profit
$
53,377
$
42,305
$
11,072
26
Gross
margin (percentage of revenue)
Real estate services
35.1
%
34.0
%
Properties
(0.9
)
(2.7
)
Other
0.9
(14.1
)
Total
gross margin
22.4
30.2
In the three months ended September 30, 2019, total cost of revenue increased by $87.4 million,
or 89%, as compared with the same period in 2018. This increase in cost of revenue was primarily attributable to a $63.9 million increase in cost of properties due to selling more homes by our properties business, a $14.1 million increase in personnel costs including stock-based compensation and transaction bonuses due to increased headcount and increased brokerage transactions, respectively, and a $3.6 million increase in home-touring and field costs from serving more brokerage customers.
Total gross margin decreased 780 basis points for the three months ended September 30, 2019, as compared with the same period in 2018, driven primarily by the relative
growth of our properties business compared to our real estate services and other businesses, partially offset by improvements in real estate services, properties and other gross margin.
Real estate services gross margin increased 110 basis points for the three months ended September 30, 2019, as compared with the same period in 2018. This was primarily attributable to a 120 basis-point decrease in personnel costs including stock-based compensation and transaction bonuses as a percentage of revenue.
Properties gross margin increased 180 basis points for the three months ended September 30,
2019, as compared with the same period in 2018. This was primarily attributable to a 140 basis-point decrease in personnel costs including stock-based compensation and a 40 basis-point decrease in listing expenses, partially offset by a 50 basis-point increase in the cost of properties, each as a percentage of revenue.
Other gross margin increased 1,500 basis points for the three months ended September 30, 2019, as compared with the
same period in 2018. This was primarily attributable to a 450 basis-point decrease in personnel costs including stock-based compensation, a 420 basis-point decrease in office and occupancy expenses, and a 410 basis-point decrease in operating expenses, each as a percentage of revenue.
Operating Expenses
Three Months Ended September 30,
Change
2019
2018
Dollars
Percentage
(in
thousands, except percentages)
Technology and development
$
18,801
$
14,310
$
4,491
31
%
Marketing
8,361
8,236
125
2
General
and administrative
18,779
16,470
2,309
14
Total operating expenses
$
45,941
$
39,016
$
6,925
18
Percentage
of revenue
Technology and development
7.9
%
10.2
%
Marketing
3.5
5.9
General
and administrative
7.9
11.7
Total operating expenses
19.3
%
27.8
%
In
the three months ended September 30, 2019, technology and development expenses increased by $4.5 million, or 31%, as compared with the same period in 2018. The increase was primarily attributable to a $3.7 million increase in personnel costs including stock-based compensation and a $0.5 million increase in occupancy and office expenses, each due to increased headcount.
In the three months ended September 30, 2019, marketing expenses increased by $0.1 million, or 2%, as compared with the same period in 2018.
The increase was attributable to a $0.7 million increase in personnel costs including stock-based compensation, partially offset by a $0.7 million decrease in marketing media.
In the three months ended September 30, 2019, general and administrative expenses increased by $2.3 million, or 14%, as compared with the same period in 2018. The increase was primarily attributable to a $2.2 million increase in personnel costs including stock-based compensation, largely the result of increases in headcount to support continued growth.
In
the nine months endedSeptember 30, 2019, revenue increased by $183.8 million, or 51%, as compared with the same period in 2018. Brokerage revenue represented $60.5 million, or 33%, of the increase. Brokerage revenue grew 19% during the period, driven by a 21% increase in brokerage transactions and a 1% decrease in real estate services revenue per transaction. We believe this increase in brokerage transactions was attributable to higher levels of customer awareness of Redfin and increasing customer demand. Properties revenue represented $118.1
million, or 64%, of the increase. Properties revenue grew 505% during the period, driven by a greater market presence and consumer awareness of RedfinNow, which resulted in a 460% increase in the number of properties sold.
In the nine months endedSeptember 30, 2019, total cost of revenue increased by $172.6
million, or 64%, as compared with the same period in 2018. This increase in cost of revenue was primarily attributable to a $109.5 million increase in cost of properties due to selling more homes by our properties business, a $36.0 million increase in personnel costs including stock-based compensation and transaction bonuses due to increased headcount and increased brokerage transactions, respectively, and a $10.5 million increase in home-touring and field costs from serving more brokerage customers.
Total gross margin decreased 660 basis points for the nine months endedSeptember 30, 2019, as compared with the same period in
2018, driven primarily by the relative growth of our properties business compared to our real estate services business and a decrease in real estate services gross margin, partially offset by improvements in properties and other gross margin.
Real estate services gross margin decreased 110 basis points for the nine months endedSeptember 30, 2019, as compared with the same period in 2018. This was primarily attributable to a 60 basis-point increase in home-touring and field costs, a 40 basis-point increase in occupancy and office expense, and a 30 basis-point increase in listing expenses, partially offset by a 40 basis-point decrease in personnel costs
including stock-based compensation and transaction bonuses, each as a percentage of revenue.
Properties gross margin increased 60 basis points for the nine months endedSeptember 30, 2019, as compared with the same period in 2018. This was primarily attributable to a 50 basis-point decrease in personnel costs including stock-based compensation, as a percentage of revenue.
Other gross margin increased 1,400 basis points for the nine months endedSeptember 30, 2019, as
compared with the same period in 2018. This was primarily attributable to a 620 basis-point decrease in personnel costs including stock-based compensation, a 290 basis-point decrease in office and occupancy expenses, and a 260 basis-point decrease in operating expenses, each as a percentage of revenue.
In
the nine months endedSeptember 30, 2019, technology and development expenses increased by $10.3 million, or 26%, as compared with the same period in 2018. The increase was primarily attributable to a $8.7 million increase in personnel costs including stock-based compensation due to increased headcount.
In the nine months endedSeptember 30, 2019, marketing expenses increased by $32.6 million, or 91%, as compared with the
same period in 2018. The increase was attributable to a $30.3 million increase in marketing media costs as we expanded advertising.
In the nine months endedSeptember 30, 2019, general and administrative expenses increased by $9.3 million, or 19%, as compared with the same period in 2018. The increase was primarily attributable to a $5.7 million increase in personnel costs including stock-based compensation, largely the result of increases in headcount to support continued growth, a $1.4 million increase in outside services, primarily Internet-based software services, and a $1.3 million increase in corporate
events costs.
Liquidity and Capital Resources
As of September 30, 2019, we had cash and cash equivalents of $209.2 million and investments of $100.5 million, which consist primarily of operating cash on deposit with financial institutions, money market instruments, and U.S. treasury securities.
Also as of September 30, 2019, we had $143,750,000 aggregate principal amount of convertible senior notes outstanding. The notes mature on July 15, 2023, unless
earlier repurchased, redeemed or converted, and interest is payable in arrears on January 15 and July 15 of each year, commenced on January 15, 2019.
As we continue to expand our RedfinNow business, we expect to incur significant additional cash outlay compared to historical periods due to costs related to the business, such as the property purchase price, capitalized improvement costs, and property maintenance expenses. For the nine months ended September 30, 2019, we relied on our cash on hand to fund these costs. See Note 4 to our condensed consolidated financial statements for more information on our cash outlay for our properties business. For future periods, we expect to also rely on borrowings from our secured revolving credit
facility to fund the property purchase price. See Note 14 to our condensed consolidated financial statements for more information regarding this facility.
Our mortgage business has significant cash requirements due to its origination of mortgage loans. Historically, it has relied on warehouse credit facilities with different lenders to fund substantially the entire portion of the mortgage loans that it originates. Once our mortgage business sells a loan that it originates in the secondary mortgage market, it uses the proceeds to reduce the outstanding balance under the related facility. See Notes 14 and 15 to our condensed consolidated financial statements for more information regarding these warehouse credit facilities. To the extent our mortgage business expands its operations, it will
require additional capacity under its existing warehouse credit facilities or the availability of new facilities, if cash on hand is unavailable.
We believe that our existing cash and cash equivalents and investments, together with cash we expect to generate from future operations, borrowings from our secured revolving credit facility, and proceeds from our mortgage business's warehouse credit facilities, will provide sufficient liquidity to meet our operational needs and fulfill our debt obligations. However, our liquidity assumptions may change or prove to be incorrect, and we could exhaust our available financial resources sooner than we currently expect. As a result, we may seek new sources of credit financing or elect to raise additional funds through equity, equity-linked, or debt financing
arrangements. We cannot assure you that any additional financing will be available to us on acceptable terms or at all.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Our operating cash flows result primarily from cash received from our real estate services and sales of homes from our properties business. Our primary uses of cash from operating activities include payments for personnel-related costs, including employee benefits and bonus programs, marketing and advertising activities, purchases of homes for our properties business,
and outside services costs. Additionally, our mortgage business generates a significant amount of operating cash flow activity from the origination and sale of loans held for sale.
Net cash used in operating activities was $132.6 million for the nine months ended September 30, 2019, primarily attributable to a net loss of $73.0 million, offset by $35.2 million of non-cash items related to stock based compensation, depreciation and amortization, amortization of debt discounts and issuance costs, and lease expense related to right-of-use assets. Changes in assets and liabilities increased cash used in operating activities by $94.8 million driven primarily by a $82.8 million increase in inventory related to our properties business, a $17.3 million increase in net loans held for sale related
to our mortgage business, and a $9.1 million increase in accrued revenue as a result of higher revenue and timing of real estate services transactions at the end of the period. This was partially offset by an increase of $19.0 million in accrued liabilities and other payables primarily related to timing of payments.
Net cash used in operating activities was $20.8 million for the nine months ended September 30, 2018, primarily attributable to a net loss of $29.8 million, offset by $21.7 million of non-cash items related to stock based compensation, depreciation and amortization, and amortization of debt discounts and issuance costs. Changes in assets and liabilities increased cash used in operating activities by $12.8 million driven primarily by an increase of $21.8 million in inventory
related to our properties business. This was partially offset by a $10.9 million increase in accrued expenses due primarily to $8.7 million of payroll liabilities, and a $2.0 million increase in our employee stock purchase plan liability.
Net Cash Used In Investing Activities
Our primary investing activities include the purchase of investments and property and equipment, primarily related to capitalized software development expenses and leasehold improvements.
Net cash used in investing activities was $113.0
million for the nine months ended September 30, 2019, primarily attributable to $106.0 million in purchases of investments, $7.4 million related to equipment, furnishings, and leasehold improvements for new or expansion of existing office spaces, and $5.4 million of capitalized software development expenses.
Net cash used in investing activities was $5.5 million for the nine months ended September 30, 2018, primarily attributable to $3.6 million of capitalized software development expenses.
Net Cash Provided By Financing Activities
Our primary financing activities have come from our initial public offering in August 2017, our
follow-on offerings of common stock and convertible senior notes in July 2018, stock option exercises, and the sale of shares under our employee stock purchase plan. Additionally, our mortgage business generates a significant amount of financing cash flow activity due to borrowings from and repayments to our warehouse credit facilities.
Net cash provided by financing activities was $25.8 million for the nine months ended September 30, 2019, primarily attributable to a $17.3 million increase in our net borrowings under our warehouse credit facilities, and $10.9 million in proceeds from the issuance of shares resulting from employee equity plans.
Net cash provided by financing activities was $274.6 million for the nine months
ended September 30, 2018, primarily attributable to net proceeds from our follow-on offerings of common stock and convertible senior notes. The net proceeds consisted of $107.6 million from the issuance of common stock and $139.0 million from the issuance of notes.
Critical Accounting Policies and Estimates
Discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue, and expenses at the date of the financial statements. Generally, we base our
estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates are described in Note 1 of our Annual Report for the year ended December 31, 2018. There has been two material changes to the critical accounting policies and estimates in Note 1 of our Annual Report, which are related to the adoption of Accounting Standards
Codification Topic 842, Leases, as described in Notes 1 and 6 to our condensed consolidated financial statements, and to the accounting and classification of investments, as described in Notes 1 and 3 to our condensed consolidated financial statements.
Recent Accounting Standards
See Note 1 to our condensed consolidated financial statements for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted.
Item 3. Qualitative and Quantitative Disclosures About Market Risk.
Our primary operations
are within the United States and in the first quarter of 2019 we launched limited operations in Canada. We are exposed to market risks in the ordinary course of our business. These risks primarily consist of fluctuations in interest rates that would impact our cash, cash equivalent, and investments. The goals of our investment policy are liquidity and capital preservation. We do not enter into investments for trading or speculative purposes. Our investment policy allows us to maintain a portfolio of
cash equivalents and investments in a variety of securities, including U.S. treasury and agency issues, bank certificates of deposit that are 100%
insured by the Federal Deposit Insurance Corporation, and SEC-registered money market funds that consist of a minimum of $1 billion in assets and meet the above requirements.
Interest Rate Risk
The principal market risk we face is interest rate risk. We had cash and cash equivalents of $209.2 million and $432.6 million at September 30, 2019 and December 31, 2018, respectively. In addition, we had investments of $100.5 million and $0 at September 30, 2019 and December 31, 2018, respectively. Our investments
are comprised of available-for-sale securities that consist primarily of U.S. treasury securities with maturities of 2 years or less. Available-for-sale securities are recorded on our consolidated balance sheets at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income.
We believe that we do not have any material exposure to changes in the fair value of these assets as a result of changes in interest rates due to the short-term nature of our cash and cash equivalents. Declines in interest rates, however, would reduce future investment income. A 100 basis-point decline in interest rates, occurring during and sustained throughout any of the periods presented, would not have been material.
Foreign Currency Exchange Risk
As our operations
in Canada have been limited, and we do not maintain a significant balance of foreign currency, we do not currently face significant risk with respect to foreign currency exchange rates.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive and principal financial officers, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934), as of the end of the period covered by this Quarterly Report. Based
on such evaluation, our principal executive and principal financial officers have concluded that as of such date, our disclosure controls and procedures were effective at the reasonable assurance level described below.
Changes in Internal Control
In connection with the evaluation required by Rule 13a-15(d) under the Securities Exchange Act of 1934, there were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our
management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance
with the policies or procedures
may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
On August 28, 2019, one of our former third-party licensed sales associates, which we call associate agents, filed a complaint against us in the Superior Court of California, County of San Francisco. See Note 7 to our condensed consolidated financial statements for more information regarding this complaint.
Item 1A. Risk Factors.
Except
as discussed below, there have not been any material changes from the risk factors included in Item 1A of our Annual Report for the year ended December 31, 2018. You should carefully consider the risks described below, together with all other information in this Quarterly Report, before investing in any of our securities. The occurrence of any single risk or any combination of risks could materially and adversely affect our business, operating results, financial condition, liquidity, or competitive position, and consequently, the value of our securities. The material adverse effects include, but are not limited to, not growing our revenue or market share at the pace that they have grown historically or at all, our revenue and market share fluctuating on a quarterly and annual basis, an extension of our history of losses and a failure to become profitable, not achieving the revenue and net income (loss) guidance that we
provide, and harm to our reputation and brand.
Referring customers to our partner agents and our third-party partnerships may harm our business.
We refer customers to third-party partner agents when we do not have a lead agent available due to high demand or geographic limitations. Our dependence on partner agents can be particularly heavy in certain new markets as we build our operations to scale in those markets. Our partner agents are independent licensed agents affiliated with other brokerages, and we do not have any control over their actions. If our partner agents were to provide poor customer service, engage in malfeasance, or otherwise violate the laws and rules to which we are subject, we may be subject to legal claims and our reputation and business may be harmed.
In
July 2019, we commenced a partnership with Opendoor in certain markets where RedfinNow, our direct home purchase and resale business, does not currently operate. In those markets, home sellers can request, through Redfin's website and mobile applications, an instant offer from Opendoor to purchase their home. Home sellers will have this ability to request an Opendoor offer in addition, and as an alternative, to retaining a Redfin agent to represent them during the home selling process.
From time to time, we may enter into additional arrangements to refer consumers to, or partner with, third parties when we are unable or unwilling to serve those consumers directly.
Our
arrangements with third parties may limit our market share, revenue, growth, and brand awareness. For example, referring customers to third parties potentially redirects repeat and referral opportunities to those third parties. Furthermore, to the extent we enter into a new, or seek to expand operations in an existing, market where we have an arrangement with a third party, consumers may choose to continue to work with those third parties, which limits our growth. Additionally, any third-party arrangements may also dilute the effectiveness of our marketing efforts and may lead to consumer confusion or dissatisfaction when they are offered the opportunity to work with the third party rather than us.
We may be unable to secure intellectual property protection for all of our technology and methodologies, enforce our intellectual property rights, or protect our other proprietary
business information.
Our success and ability to compete depends in part on our intellectual property and our other proprietary business information. To protect our proprietary rights, we rely on trademark, copyright, and patent law, trade-secret protection, and contractual provisions and restrictions. However, we may be unable to secure intellectual property protection for all of our technology and methodologies or the steps we take to
enforce our intellectual property rights may be inadequate. Furthermore, we may also be unable to protect our proprietary
business information from misappropriation.
If we are unable to secure intellectual property rights, our competitors could use our intellectual property to market offerings similar to ours and we would have no recourse to enjoin or stop their actions. Additionally, any of our intellectual property rights may be challenged by others and invalidated through administrative processes or litigation. Moreover, even if we secured our intellectual property rights, others may infringe on our intellectual property and we may be unable to successfully enforce our rights against the infringers because we may be unaware of the infringement or our legal actions may not be successful. Finally, others may misappropriate our proprietary business information, and we may be unaware of the misappropriation or unable to enforce our legal rights in a cost-effective manner. If any of these events
were to occur, our ability to compete effectively would be impaired.
We process, transmit, and store personal information, and unauthorized access to, or the unintended release of, this information could result in a claim for damages, regulatory action, loss of business, or unfavorable publicity.
We process, transmit, and store personal information to provide services to our customers and as an employer. As a result, we are subject to certain contractual terms, as well as federal, state, and foreign laws and regulations designed to protect personal information. While we take measures to protect the security and privacy of this information, it is possible that our security controls over personal data and other practices we follow may not prevent the unauthorized access to, or the unintended release of, personal information. If such unauthorized access or unintended release occurred,
we could suffer significant damage to our brand and reputation, customers could lose confidence in the security and reliability of our services, and we could incur significant costs to address and fix these security incidents. These incidents could also lead to lawsuits and regulatory investigations and enforcement actions.
We are subject to costs associated with defending and resolving proceedings brought by government entities and claims brought by private parties.
We are from time to time involved in, and may in the future be subject to, government investigations or enforcement actions and private third-party claims arising from the laws to which we are subject or the contracts to which we are a party. Item 3 of our Annual Report for the year ended December
31, 2018 describes some of these types of investigations, actions, and claims. Any such investigations, actions, or claims can be costly to defend or resolve, require significant time from management, or result in negative publicity. Furthermore, to the extent we are unsuccessful in defending an action or claim, we may be subject to civil or criminal penalties, including significant fines or damages, the loss of ability to operate in a jurisdiction, or the need to change certain business practices (including redesigning, or obtaining a license for, our technology or modifying or ceasing to offer certain services).
As described in Part II, Item 1 of this Quarterly Report, we are currently the subject of a claim alleging that we had misclassified third-party licensed sales associates as independent contractors instead of employees. While we have previously settled similar complaints, there is no assurance that we will be
able to settle this claim on similar terms or at all. Accordingly, this complaint may be costly to resolve, require significant time from management, result in negative publicity, or require us to change certain business practices related to our third-party licensed sales associates. Furthermore, we may be subject to additional lawsuits or administrative proceedings for similar claims, which may have similar negative effects on us.
We have also, in the past, been the subject of complaints alleging that we had improperly classified certain of our employees as exempt from minimum wage and overtime laws. The legal tests for determining overtime exemptions consider many factors that vary from state to state and have evolved based on case law, regulations, and legislative changes, as well as complicated factual analysis. We may be subject to additional complaints or administrative proceedings regarding our employee classification.
If
Redfin Mortgage is unable to obtain sufficient financing through warehouse credit facilities to fund its origination of mortgage loans, then we may be unable to grow our mortgage origination business.
Redfin Mortgage relies on borrowings from its warehouse credit facilities to fund substantially all of the mortgage loans that it originates. To grow its business, Redfin Mortgage depends, in part, on having sufficient borrowing capacity under its current facilities or obtaining additional borrowing capacity under new facilities. If it were unable to receive the necessary capacity, or receive such
capacity on acceptable terms, and did not have cash on hand available, then Redfin Mortgage may be unable to maintain or increase the amount of mortgage loans that it originates, which will adversely affect its growth.
Redfin Mortgage has historically been unable to meet certain financial covenants contained in its warehouse credit facilities. While each lender has historically waived these breaches of the financial covenants, there is no assurance that every lender will continue to do so in the event of future covenant breaches. If a lender were to enforce its remedies for a future breach, which may include the right to seize pledged mortgage loans, then Redfin Mortgage may lose a portion of its assets and will be unable to rely on the facility to fund its mortgage originations, which may adversely affect Redfin Mortgage's business.
The
borrower under our secured revolving credit facility intends to rely on proceeds from the sale of financed homes to repay amounts owed under such facility, but in certain instances, such proceeds may be insufficient or unavailable to repay the amounts owed.
Pursuant to a secured revolving credit facility with Goldman Sachs Bank USA, or Goldman Sachs, as the administrative agent and sole initial lender, a special purposes entity, or SPE, that is an indirect wholly owned subsidiary of Redfin Corporation, may borrow money to partially fund purchases of homes for our properties business. The SPE has the option of repaying amounts owed with respect to a particular financed home upon the sale of such home and using the proceeds from such sale. However, there is no assurance the sale proceeds will equal or exceed the amounts owed.
Additionally,
in certain instances, the SPE may be required to repay amounts owed with respect to a financed home prior to the sale of that home. For example, the amount that the SPE is eligible to borrow for a home, which we refer to as the advance rate, depends, in part, on how long it has owned that home. As the SPE owns a home past certain time periods, the advance rate decreases and it becomes obligated to repay all or a portion of the borrowed funds. Additionally, a home must satisfy certain criteria to be eligible for financing under the facility. If a financed home ceases to satisfy the criteria, then the SPE must immediately repay all amounts owed with respect to the home. If either of these scenarios occur, then the SPE will be unable to rely on the proceeds from the sale of the home for repayment.
In the situations described above, the SPE must use its cash on hand to repay the
amounts owed. To the extent it does not have sufficient cash and is unable to make the required repayments, then the SPE may default under the facility.
Our inability to comply with the terms of our secured revolving credit facility may adversely affect our properties business and, in some instances, give the lenders recourse to Redfin Corporation when the value of the assets securing the facility are insufficient to cover the amounts owed to the lenders.
Borrowings under our secured revolving credit facility are secured by the SPE's assets, including the financed homes, as well as the equity interests in the SPE. To the extent the SPE is unable to make payments when due under the facility, or it or certain other Redfin entities are unable to comply with the facility's ongoing representations
and warranties or covenants (including financial covenants of Redfin Corporation), then an event of default may occur. An event of default would require the SPE to immediately repay all amounts owned under the facility and cause the SPE to be unable to borrow from the facility. Accordingly, our properties business will need to rely solely on its cash to fund home purchases, and to the extent such cash is unavailable, our properties business would be unable to purchase the homes required for its growth. Furthermore, an event of default may result in Goldman Sachs owning the SPE's equity interests or its assets, including any financed homes and cash held by the SPE, and result in our properties business losing a portion of its assets.
While the lenders' recourse in most situations following an event of default is only to the SPE or its assets, Redfin Corporation has guaranteed
amounts owed under the facility and certain expenses in
situations involving "bad acts" by a Redfin entity. To the extent a Redfin entity commits a "bad act," then Redfin Corporation may become obligated to pay such amounts owed or certain expenses.
The cross-acceleration and cross-default provisions in the agreements governing our indebtedness may result in an immediate obligation to repay all of our outstanding indebtedness.
The indenture
governing our convertible senior notes and one of our warehouse credit facilities contain cross-acceleration provisions while our secured revolving credit facility and two of our warehouse credit facilities contain cross-default provisions. These provisions could have the effect of creating an event of default under an agreement for our indebtedness, despite our compliance with that agreement, due solely to an event of default or failure to pay amounts owed under another agreement for our indebtedness. Accordingly, all or a significant portion of our outstanding indebtedness could become immediately payable due solely to our failure to comply with the terms of a single agreement governing our indebtedness.
As of a result of Redfin Mortgage's failure to comply with a financial covenant in its warehouse credit facility with Western Alliance Bank (and the default resulting from
such non-compliance), it also defaulted on its warehouse credit facility with Texas Capital Bank, N.A. pursuant to that facility's cross-default provision. See Note 14 to our condensed consolidated financial statements for more information regarding these defaults.
Certain provisions in the agreements governing our indebtedness may delay or prevent an otherwise beneficial takeover attempt of us.
Certain provisions in the agreements governing our indebtedness may make it more difficult or expensive for a third party to acquire us. These provisions may have the effect of delaying or preventing a takeover that would otherwise be beneficial to our stockholders.
For example, the indenture
for our convertible senior notes will require us to repurchase our convertible senior notes for cash upon the occurrence of a fundamental change (as defined in the indenture) of us and, in certain circumstances, to increase the conversion rate for a holder that converts its notes in connection with a make-whole fundamental change. A takeover of us may trigger the requirement that we repurchase our convertible senior notes and/or increase the conversion rate, which could make it more costly for a potential acquirer to engage in such takeover.
Furthermore, under the loan agreement for our secured revolving credit facility, an event of default occurs upon a change in control (as defined in the loan agreement), unless Goldman Sachs, as the administrative agent, consents to the change in control.
Accordingly, a takeover may require us and the third-party acquiror to obtain Goldman Sachs's consent.
If the London Inter-Bank Offered Rate, or LIBOR, is discontinued, interest payments under our secured revolving credit facility and certain warehouse credit facilities may be calculated using another reference rate.
In July 2017, the United Kingdom Financial Conduct Authority, or FCA, which regulates LIBOR, announced that the FCA intends to phase out the use of LIBOR by the end of 2021. In response, the U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, has proposed replacing U.S. dollar LIBOR with the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements, backed by U.S. Treasury securities. The market
transition away from LIBOR towards SOFR is expected to be complicated, and there is no guarantee that SOFR will become a widely accepted benchmark in place of LIBOR. LIBOR is used as a benchmark rate throughout our secured revolving credit facility and certain of our warehouse credit facilities and some of these agreements do not provide fallback language for circumstances in which LIBOR ceases to be published. The transition process may involve, among other things, increased volatility and illiquidity in markets for instruments that currently rely on LIBOR and may result in increased borrowing costs, the effectiveness of related transactions such as hedges, uncertainty under our secured revolving credit facility and certain of our warehouse credit facilities, or difficult and costly processes to amend such documentation. There remains uncertainty
regarding the future utilization of LIBOR and the nature of any replacement rate, and we are uncertain what impact a transition away from LIBOR may have on our business, financial results, and operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On July 27, 2017, the U.S. Securities and Exchange Commission declared effective the Registration Statement on Form S-1 (file number 333-219093) for our initial public offering.
There has been no change to the information provided under "Use of Proceeds" in Part II, Item 2 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2017.
Item 6. Exhibits.
The exhibits required to be filed or furnished as part of this Quarterly Report are listed below. Notwithstanding any language to the contrary, exhibits 32.1, 32.2, 101, and 104 shall not be deemed to be filed as part of this Quarterly Report for purposes of Section 18 of the Securities Exchange Act of 1934.
Cover
page interactive data file, submitted using inline XBRL (contained in Exhibit 101)
X
† Portions of this exhibit have been omitted because the information is both not material and would likely cause
competitive harm to us if publicly disclosed.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.