Frontdoor, Inc. (NASDAQ:FTDR) Q1 2023 Earnings Call Transcript

Frontdoor, Inc. (NASDAQ:FTDR) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Ladies and gentlemen, welcome to Frontdoor’s First Quarter 2023 Earnings Call. Today’s call is being recorded and broadcast on the Internet. Beginning today’s call is Matt Davis, Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call. At this time, we’ll begin today’s call. Go ahead, Mr. Davis.

Matt Davis: Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor’s First Quarter 2023 Earnings Conference Call. Joining me today are Frontdoor’s Chairman and Chief Executive Officer, Bill Cobb; and Frontdoor’s Chief Financial Officer, Jessica Ross. Let me start by reminding you that we are coming off our Investor Day in early March, and there is a lot more detail about our company and our strategy in the Investor Day presentation, which we will be referring back to during today’s call. The press release and slide presentation that will be used during today’s call can be found on the Investor Relations section of Frontdoor’s website, which is located at investors.frontdoorhome.com. There’s also additional detail about our new Frontdoor brand at frontdoor.com, and in our new mobile app that you can download in the App Store and on Google Play.

As stated on Slide 3 of the presentation, I’d like to remind you that this call and webcast may contain forward-looking statements. These statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company’s filings with the SEC. Please refer to the Risk Factors section in our filings for a more detailed discussion of our forward-looking statements and the risks and uncertainties related to such statements. All forward-looking statements are made as of today, May 4, and except as required by law, the company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

We will also reference certain non-GAAP financial measures throughout today’s call. We have included definitions of these terms and reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and the appendix to the presentation in order to better assist you in understanding our financial performance. I will now turn the call over to Bill Cobb for opening comments. Bill?

Bill Cobb: Thanks, Matt, and good morning, everyone. Before we get into the details of our first quarter earnings call, I wanted to address our full year 2023 outlook. Let me be clear, while we had a tremendous first quarter, we will not be raising our full year 2023 outlook at this time. It is not our practice to raise our outlook after just one quarter. It’s too early to do that. We are heading into our peak summer season, which typically has much higher claims. Additionally, our first quarter financial results benefited from favorable timing around SG&A spend and weather. On the revenue side, our go-to-market channels remain challenged, and it is still too early to assess the revenue profile of our new Frontdoor brand. So with that, let’s jump into Slide 4 of the web deck.

I am pleased to report that we are making good progress on advancing our strategic initiatives that we laid out at our Investor Day in March. As I just mentioned, our first quarter financial results were significantly better than expected. We saw gross margins expand as our prior pricing actions are flowing through. Cost pressures continue to moderate, and our process improvement initiatives are beginning to take hold. For example, we drove a significant increase in preferred contractor utilization, which rose 270 basis points to a 10-year high of 84% in the first quarter. Additionally, we continue to make progress in sourcing more parts and replacement equipment for our contractors, where our larger size enables us to purchase at a substantial discount.

We also increased our direct-to-consumer or DTC demand, which I will cover in more detail shortly. And in April, we launched Frontdoor, our one-stop app for all things home maintenance and repair. While it remains early in the year, we are delivering on what we said we would do, and we look forward to continuing our progress throughout the rest of 2023. Now let’s turn to Slide 5, where I will cover the new Frontdoor app that was launched in April. We reviewed the new offering in detail at our Investor Day. In short, we believe that we have really differentiated our offering through the video chat with an expert feature, which will revolutionize how homeowners maintain and repair their homes. Our team has supported this launch with an innovative and talked about marketing campaign.

Some of you have probably already seen our fun and compelling TV and digital spots. Our robust marketing effort also leverages several strategic partnerships, such as Major League Baseball’s opening week, Home & Garden TV and NFL Draft week. We also have a program with Amazon, which will land the Frontdoor brand on millions of doorsteps across the country through our customized box design. That will happen mid-summer. All of these efforts are working. Since our launch three weeks ago, the app has now been downloaded over 165,000 times. We look forward to sharing more details next quarter. But for now, we are very pleased with the pace of downloads. Now let’s turn to Slide 6, which serves as a quick reminder of our Frontdoor product lineup. Frontdoor Basic is a free offering, where consumers can download the app at no cost and get one free video chat with an expert.

The free product also includes rich content, including maintenance tips and repair videos. It’s a great way to introduce the product and encourage upgrading to our more robust offering, Frontdoor Prime. At $99 per year, Prime includes everything in the basic plan, but members get 3 video chats per year. They also get access to steeply discounted HVAC systems with available financing and special member pricing on home products and services. If you haven’t already done so, I encourage you to download the app and try it out for yourself. You can also go to frontdoor.com for more details. Now moving to Frontdoor Pro, on-demand home services with a la carte pricing. This is our service delivery channel rather than a consumer-facing offering. Its services are available through both, the Frontdoor and AHS brands.

We are very excited about the potential growth in Frontdoor Pro, which could be one of the largest revenue streams for the new brand. Specifically, we are extremely optimistic about our HVAC upgrade offering that is exceeding our revenue expectations so far this year. Turning to Slide 7, and our upcoming Frontdoor Premium product that will be coming out in June. Premium is our reinvention of the home service plan. It is our goal to make this an easy, convenient one-stop shop for everything the homeowners need to repair and maintain their homes. It’s an annual membership plan that starts at $35 per month. Premium includes all the benefits of Frontdoor Pro — Frontdoor Basic and Prime, and it will cover the same systems and appliances that we do today under American Home Shield, with an additional option for HVAC coverage.

For premium members, it is easy to make service requests through the app. For a flat service fee of $100, we will fix the covered item, or the member will be provided with a payout of $500. In the case of those who elect HVAC coverage, the payout will be $1,000. This process allows for a more digitally enhanced and transparent experience, while enabling us to better predict costs. Additionally, for premium members receiving a payout, we will work with them to replace their system or appliance. This includes all of the prime discounts previously mentioned. Now turning to Slide 8, where I will provide a business update on American Home Shield, starting with the DTC channel. First, I want to be clear that we have two growth engines, and we are as equally focused on growing American Home Shield as we are on launching the new Frontdoor brand.

DTC has been a tremendous growth platform for us. And while it has been challenged recently, we are redoubling our efforts to get this channel back to positive customer growth. In fact, our team has really been digging into the main drivers of the recent decline. While it is an ongoing body of work, the team has identified three main issues impacting near-term demand. The first main issue is price. Over the past year, we significantly raised price for our home service plans in response to inflation. This was done with the goal of getting our gross margins back to historical levels. As part of our deep dive, the analysis showed that price had a bigger impact on our go-to-market channels and that the category for new consumers might not be as inelastic in this market environment.

On the other hand, we have been pleasantly surprised by the stronger-than-expected elasticity in our renewal channel as our renewal rates have improved. Inflation is the second main issue impacting near-term demand. We have seen that higher inflation has impacted consumer sentiment and behavior. Further, with inflation comes rising media costs, creating additional pressure on our go-to-market strategies. In response to these recent findings, we have pivoted our discounting strategy. Since we last spoke to you at our Investor Day, we have explored new discounting strategies and continue to test and learn how to better attract new DTC members. While we are pleased with these learnings and some of these early sales trends, we want to see more results before we adjust our full year DTC expectations.

Additionally, we have also taken steps to improve conversion. We are becoming more efficient at converting the demand we do generate. This is through efforts such as upgrading our call center leadership and training. DTC marketing spend is the third main issue impacting near-term demand. We had reduced DTC marketing spend in our original 2023 operating plan for AHS. This was done to improve overall marketing efficiency. Now that we are seeing better marketing effectiveness, we have decided to increase our spend compared to our initial plan in 2023. We will also work to continue to optimize marketing throughout the remainder of the year. Those are the near-term actions we are taking to address the decline in DTC sales. Longer term, we will continue to enhance branding and marketing as well as the value of American Home Shield.

Specifically, we need to further differentiate and promote our products over the competition. We are also continuing our work to optimize pricing and discounting as we refresh our value proposition with key consumer segments. Now turning to Slide 9 and our real estate channel. The National Association of Realtors updated the adjusted annual rate of existing home sales for March to 4.4 million homes or a 22% decline over the prior year period. Inventory levels remain low and only 2.6 months of supply, which is one of the main drivers delaying the transition to a more balanced buyer and seller market. Regardless of market conditions, our sales team is focused on improving sales accountability through data usage and market-level dashboards. But at this point, it remains a challenging market to sell home service plans.

Now turning to Slide 10, and our renewal channel. As I mentioned earlier, customer retention rates are coming in better than expected despite a targeted realized price increase of 11% in 2023. Retention rates actually increased 180 basis points to 75.9% in the first quarter. While channel mix shift is clearly a driver, our dynamic pricing strategies are delivering a price increase that our existing customers still find tremendous value in. We also continue to work on process improvements to drive members to renew. Now in closing, we are off to a great start in 2023. We continue to expect our financial results to improve over 2022 as our prior pricing actions take hold, inflation headwinds continue to moderate and as we expand our process improvement efforts.

As I told you at our Investor Day, we now have 2 growth engines that are focused on different consumer segments that will drive the business for years to come. I will now turn the call over to Jessica to review our financial results. Jessica?

Jessica Ross: Thanks, Bill, and good morning, everyone. Please turn to Slide 11, and I’ll take you through our first quarter 2023 financial results. Starting at the top of our income statement, where first quarter revenue increased 4% versus the prior year period to $367 million, driven by a 10% increase from price, which more than offset a 5% decline in volume. Now let’s move to Slide 12, where I’ll review our revenue by channel. First quarter revenue derived from customer renewals increased 13% versus the prior year period due to realization of pricing actions taken last year. First year real estate revenue decreased 28% versus the prior year period, reflecting a continued decline in the number of home service plans sold due to the strong sellers market.

First year DTC revenue decreased 5% versus the prior year period due to the items Bill covered earlier. Now let’s turn to Slide 13. Gross profit for the quarter increased $26 million to $170 million. This resulted in a 540-basis point increase in our gross profit margin to 46%. The gross profit improvement was primarily driven by higher realized price, a lower number of service requests driven by favorable weather as well as the moderation of inflationary cost pressures, as our cost per service request came in slightly better than expected at 7%. Our first quarter gross profit also reflects operational improvements we have made to the business such as increasing the percentage of jobs we assigned to our preferred contractors by 270 basis points to a 10-year high of 84%, as Bill mentioned earlier.

Our management team continues to be focused on initiatives such as this to drive operational excellence and sustainable margin improvement for our shareholders. On Slide 14, you’ll see that net income increased $20 million in the first quarter of 2023 to $22 million as a result of higher gross margins and favorable timing of SG&A expenses. Adjusted net income increased $20 million over the prior year period to $23 million. Adjusted EBITDA improved $29 million to $54 million. Let’s move to the [Indiscernible] table on Slide 15, and I’ll provide more context for the year-over-year improvement in first quarter adjusted EBITDA. Starting at the top, we had $22 million of favorable revenue conversion. Contract claims costs decreased $4 million in the first quarter, primarily driven by a lower number of service requests per member and $6 million of favorable development, slightly offset by inflationary cost pressures.

Sales and marketing costs increased $3 million in the first quarter, primarily driven by efforts to grow the direct-to-consumer channel. Customer service costs decreased $2 million in the first quarter, driven by a lower number of service requests. And finally, interest and net investment income increased $3 million as a result of rising interest rates on cash deposits. In summary, our first quarter adjusted EBITDA [Indiscernible] was a record split between favorable gross margin and SG&A costs as well as continued execution of process improvement. Please now turn to Slide 16 for a review of our first quarter cash flow. Net cash provided from operating activities was $60 million for the 3 months ended March 31, 2023, which is comprised of $34 million in earnings adjusted for noncash charges and $26 million in cash provided from working capital.

Cash provided from working capital was primarily driven by seasonality as our first quarter can be an exceptionally strong cash generation period. Net cash used for investing activities was $8 million for the three months ended March 31, 2023 and was primarily comprised of capital expenditures related to investments in technology. Net cash used for financing activities was $7 million for the three months ended March 31, 2023 and was primarily comprised of debt payments. On Page 17, you will see that our free cash flow, calculated as net cash provided from operating activities, less property additions, was $52 million for the 3 months ended March 31, 2023. We are projecting approximately $100 million of free cash flow for the full year. We ended the first quarter with $337 million in cash.

This was comprised of $150 million of restricted net assets and unrestricted cash of $187 million. I covered our capital allocation strategy in detail at our Investor Day in March. The main message I want to deliver on this call is that we have a solid financial position, our unrestricted cash is growing along with our confidence in the business, and it remains our intention to return approximately $80 million of cash to shareholders through our existing share repurchase program in 2023. Now turning to Slide 18. I’ll conclude my prepared remarks with our current thoughts regarding the financial outlook for the second quarter and full year 2023. We expect our second quarter revenue to be within a range of $505 million to $520 million. This reflects a nearly 15% increase in the renewal channel, partially offset by a roughly 25% decline in the real estate channel and a low double-digit revenue decline in the DTC channel.

Second quarter adjusted EBITDA is expected to range between $80 million and $90 million, an increase of $10 million from the prior year period as a result of higher gross margin. This outlook ultimately includes a meaningful increase in SG&A as we invest in the new Frontdoor brand that Bill spoke about earlier. Turning to our full year outlook. We are maintaining our revenue range of $1.7 billion to $1.74 billion. The full year assumptions include approximately 10% revenue growth in the renewal channel, a low double-digit revenue decline in the DTC channel and a nearly 20% decrease in the real estate channel. We continue to expect approximately 11% growth from higher price, which will more than offset a 6% decline from lower volume. Note that we priced for higher inflation than what we are currently seeing in 2023.

We also expect our home service plan member count to decline in the mid- to upper single digits in 2022. We slightly raised our full year gross profit margin outlook to be between 43.5% and 46%. This reflects the benefit of prior pricing actions flowing through and a moderation of inflation. This also assumes that inflation will average approximately 9% on a cost per service request basis. And the number of members service requests will be down in the mid-single-digit range to approximately 4.2 million. Additionally, we increased our full year SG&A target by $10 million from last quarter to now range between $570 million and $595 million. This increase is related to investments in marketing spend for American Home sales. However, we are working to improve our marketing efficiency, and our current outlook continues to reflect lower AHS marketing spend compared to prior year.

Our outlook assumes approximately $60 million of marketing spend associated with the launch of the new Frontdoor brand. Based on these updated inputs, we maintained our full year adjusted EBITDA range to be between $220 million and $240 million. This includes stock compensation expense of approximately $30 million and $12 million of interest income. We are carefully monitoring inflation, SG&A investments, weather and other variables as we evaluate the back half of the year. And finally, we’re projecting our full year capital expenditures to range between $35 million and $45 million and the annual effective tax rate to be approximately 26%. In conclusion, we delivered strong first quarter results as our pricing actions continue to flow through, cost pressures moderated and as we benefited from several favorable items related to [timing].

We remain confident in our long-term business outlook as we continue to invest in building a strong foundation towards the future. With that, I’ll now turn the call back over to Matt for questions.

Matt Davis: Thanks, Jessica. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have, but please note that guidance is limited to the outlook we’ve provided. Operator, let’s open the line for questions.

Q&A Session

Operator: [Operator Instructions] Our first question for today comes from Cory Carpenter of JPMorgan.

Operator: Our next question comes from Maxwell [Fresher] from Truist.

Operator: Our next question comes from Ian Zaffino from Oppenheimer.

Operator: Our next question comes from Justin Patterson of KeyBanc.

Operator: Our next question comes from Brian Fitzgerald of Wells Fargo.

Operator: Our next question comes from Eric Sheridan of Goldman Sachs.

Operator: Our next question comes from Jeff Schmitt of William Blair.

Operator: Thank you. At this time, we have no further questions. Ladies and gentlemen, thank you again for joining Frontdoor’s First Quarter 2023 Earnings Call. Today’s call is now concluded.