Frontdoor, Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, welcome to Frontdoor's Third Quarter 2020 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 will begin today's call. Please go ahead, Mr. Davis.

Thank you, operator. Good afternoon, everyone, and thank you for joining Frontdoor's Third Quarter 2020 Earnings Conference Call. Joining me today are Frontdoor's Chief Executive Officer, Rex Tibbens, and Frontdoor's Chief Financial Officer, Brian Turcotte. 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. 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, November 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 their most comparable GAAP financial measures in our press release and the appendix to the presentation to better assist you in understanding our financial performance. I'll now turn the call over to Rex for opening comments. Rex?

Thanks, Matt, and good afternoon, everyone. We recently celebrated our second year as a standalone public company. Since that time, we have made significant strides in reshaping Frontdoor. Our transformation is far from over, but I am extremely pleased with our progress to date. Despite the pandemic and an extremely challenging external environment, the team has continued to deliver by accelerating our revenue growth, expanding dynamic pricing, and growing our on-demand business by launching our new ProConnect service offering. Let's now turn to Slide 4 and review our current business progress. Last quarter, we talked about leaning into marketing investments for digital and broadcast media. I am happy to report that this strategy to accelerate revenue growth is working. We increased our direct-to-consumer unit growth by over 20% in the third quarter. Additionally, our direct-to-consumer revenue growth was firmly in the double digits in the third quarter, and we expect that to continue into 2021. This is a result of the halo effect from our efforts to date, even though we are reducing our fourth-quarter marketing investments due to higher media costs from the election. Our real estate channel performed better than we originally expected this quarter, much stronger real estate fundamentals. We are seeing the same drivers as you: families leaving urban centers to move to the suburbs, low mortgage rates, and strong demand for second homes. The National Association of Realtors, or NAR, reported existing home sales increased 13% in the third quarter because of these trends. These factors are driving up prices and resulting in the lowest home inventory on record according to NAR. As a result, the strong sellers market has the potential to negatively impact the industry's capture rate for home service plan sales compared to existing home sales. This is because sellers are less inclined to provide a home service plan as part of the transaction. Despite the potential impact on capture rates, we still benefit from a much stronger real estate market. This means that we now have a strong macro tailwind for our real estate channel going into 2021. Given the drivers I just mentioned, we now expect the top of our sales funnel, or the combined growth of our first-year direct-to-consumer or real estate home service plans, to be about 1% higher than 2019. This is a tremendous accomplishment given the significant COVID-19 headwinds. I am also pleased to report that our efforts to increase customer retention are working despite the challenging external circumstances. Customer retention is now at 76% and our home service plan growth was up 4% in the third quarter. We will continue to monitor how the challenging near-term environment could impact our customer retention, but we believe we are taking the right steps on our journey to move the retention rates into the 80% range. Now turning to dynamic pricing, we just launched our next phase of the product in our direct-to-consumer channel last month. We believe this effort will expand our potential customer base to those previously priced out of the market due to the industry's historical practice of state-level pricing. Additionally, we expanded our dynamic pricing models in the renewal channel, where we will start to adjust additional customer information, such as service request history and planned tender into our dynamic pricing algorithms. We can now use dynamic pricing to update prices for over 80% of our customers. This will help better balance our dual goals of growing our customer base and protecting gross margins across geographies. From an efficiency standpoint, it allows for real-time price adjustments to offset increased costs and inflation. Our dynamic pricing capability is a critical product, allowing us to be more nimble than ever as we manage through the current external environment. As a reminder, approximately 70% of our customers are on auto-renew and auto-pay plans. This recurring revenue subscription-based model is a huge advantage that dynamic pricing has helped to optimize. In fact, by the end of 2021, we expect to cover most of our increased service request costs related to COVID-19 with additional price increases. We will deliver this increase through dynamic pricing in a way that minimizes the impact on overall retention. As I mentioned earlier, COVID-19 has resulted in an increase in service requests, primarily in the appliance trade, as our customers spend more time at home. On one hand, we view the elevated service request levels as long-term tailwinds since customers utilizing their plan tend to renew at a meaningfully higher rate. We also expect higher direct-to-consumer demand, as the pressures causing elevated levels of service requests also drove a 20% increase in web searches for the term 'home warranty' in the third quarter. On the other hand, higher service requests are impacting our near-term results, which Brian will speak to shortly. At this point, we expect an elevated level of appliance service requests to continue at least through the end of the year. Additionally, we expect industry-wide availability challenges for appliances and parts to continue through early next year based on what we're hearing from our suppliers. Keep in mind, these issues are not unique to Frontdoor. We are navigating through the industry-wide issue of low appliance availability. Demand has been significantly higher, and appliance production has not been able to catch up from earlier supply disruptions. I'd point out that over the last two years, our team has developed the operational muscle to mitigate these types of swings in our business. For example, we are addressing the higher service request in the appliance trade by taking the following actions. First, we are targeting a mid-single digit overall price increase in 2021. We're starting with price increases in our renewal channel now, our direct consumer channel in January, and we'll finish with real estate in February of 2021. Second, we are reevaluating all of our supply and service processes, primarily relating to those impacting the appliance industry. This includes deepening and expanding our supplier relationships, improving access to the fastest-moving appliances, increasing speed of parts acquisition, and expanding our service provider network. Our preferred contractor deployment is at nearly 82% in 2020 despite higher demand. Also, our multi-vendor strategy helps mitigate the macro impact on our business as we are still able to source parts in these challenging times. These are two examples that validate our process improvements are working. For those of you trying to model 2021, we have not yet seen the impact from our actions to mitigate higher appliance service requests. We will see the full impact of these actions next year. Higher service request demand and COVID-19-related staffing challenges at our third-party call centers have also driven a decline in our customer service levels. Simply put, we struggle to keep up with the call demand. This is more than a little frustrating for me as we have previously made really good progress in improving our overall customer service levels since our spinoff. This issue has been particularly acute in the appliance trade. Normally in the fourth quarter, we would scale down our call center operations to match the lower level of demand. However, this year, we are investing an incremental $5 million in service expense during the fourth quarter to handle the higher number of service requests and improve the customer experience. Over the last several months, our team has been working on several initiatives to get us back to our targeted service levels by the end of the year. We have already begun to see improvements in late September and October as we continue to add and optimize staff around the globe. Finally, we are still committed to continuing our self-service journey and adding more service options for customers over time. I would now like to give you an update on our emerging businesses, beginning with Streem on Slide 5. 2020 has been a building year for Streem, which was a small start-up team when we acquired them in late 2019. Streem's augmented reality was recently featured by both Apple and Google as a great product to help businesses operate better. Streem's platform is being leveraged by innovative brands, including Lowe's, Best Buy, Traeger, British Gas, and CLEAResult. Additionally, we recently announced the release of software development kits, commonly referred to as SDKs, to show how powerful and easily customizable the Streem platform and technology can be for their business. In our business, we believe that Streem can provide environmental health and cost benefits. We plan to do this by improving upfront diagnostics, which will drive an increase in the number of jobs completed on the first visit. The use of Streem will reduce the number of truck rolls and related carbon emissions, limit face-to-face interaction in the COVID-19 environment, and improve cycle time. Looking ahead to next year, 2021 will be focused on leveraging the SDKs to grow Streem's business and their partnerships, as well as utilizing Streem to offer a richer service experience to our home service plan and on-demand customers. Now turning to our on-demand offering on Slide 6. Just a few days ago, we rebranded and enhanced our on-demand service offering, now called ProConnect under the American Home Shield brand. ProConnect will leverage the strength, trust, and brand awareness of American Home Shield to dramatically scale our on-demand offering. We also expanded our on-demand offering from five to 35 cities, which extends our coverage to most major metro areas across the U.S. ProConnect will leverage the synergies of being part of the American Home Shield by effectively drafting under the overall brand marketing umbrella. This will allow us to maximize existing traffic and improve search ratings for ProConnect. For example, we have over 2 million home service plan customers and over 30 million annual visitors to our AHS website that can generate low acquisition cost jobs for on-demand service. Many of the unique visitors to ahs.com do not purchase a home service plan, and we believe we can capture some of those prospective customers who might still need home maintenance and repair. It will also let us potentially upsell ProConnect customers into a home service plan if it better suits their needs. We will market ProConnect three ways. First, we will continue to market on-demand separately by investing in search and other digital marketing through ahs.com/proconnect. This will start with appliance and other services for most of our 35 markets. We'll expand services to our moat of licensed contractors over 2021 and look to add new markets in 2022. Second, we will market to existing AHS home service plan customers by focusing on cross-selling and maintenance services such as HPSE upgrades. Main services are a unique way to engage our customers for services they may need while also driving higher retention. Third, starting early next year, we plan to market to prospective new customers on the AHS Website. We will also provide an expanded offering of repair, preventative maintenance, and move-in services in 2021. Our north star for on-demand remains the same. We will offer convenience scheduling for same-day or next day service, transparency with upfront pricing on select services, savings from affordable pricing, and peace of mind with a guarantee that the job will be done right. At this point, we anticipate ProConnect will complete approximately 80,000 service requests in 2021, 200,000 in service requests in 2022, and 400,000 service requests in 2023. While we expect our average revenue per job to vary as we add additional services, this translates into an estimated annual earning revenue of $20 million, $60 million, and $120 million, respectively, over the next three years. In conclusion, we have a powerful and resilient business model. We have a strong financial position, and we are making investments today that will accelerate our revenue trajectory over the next several years. Our investments to drive growth are working, and we are building a business focused on sustainable double-digit revenue growth and unlocking the full potential of our emerging businesses. Despite the pandemic, we intend to grow faster in 2021 and expect to deliver double-digit revenue growth. Finally, we are navigating the challenging external environment extremely well, and I am confident that we are becoming a stronger organization from our learnings this year. I'll now turn the call over to Brian, who will cover our financial results in more detail.

Thank you, Rex, and good afternoon, everyone. Let's now turn to Slide 7, and I'll review our third quarter financial results. Revenue increased 8% versus the prior year period to $440 million, driven by approximately 4 points of both higher price and increased volume. If we look at our home service plan channels, revenue derived from customer renewals was up 9% versus the prior year period due to growth in the number of renewed home service plans, driven in part by customer retention improvement initiatives and improved price realization. First-year direct-to-consumer revenue was up 13% versus the prior year period, reflecting growth in the number of first-year direct-to-consumer home service plans, mostly driven by the increased investments in marketing Rex mentioned as well as improved price realization. First-year real estate revenue was down 2% versus the prior year period, reflecting a decline in the number of first-year real estate home service plans. This decline was due in part to the adverse impact COVID-19 had on U.S. existing home sales in the second quarter, partially offset by improved price realization. As Rex mentioned, our real estate channel performed better than we originally expected this quarter on much stronger real estate fundamentals, including a strong rebound in existing home sales compared with a significant decline in the second quarter. As I mentioned last quarter, macroeconomic factors take about 12 months to cycle through our reported results, and this blunts either the positive or negative impact of our first-year real estate sales in any quarter. As a result, our reported revenue will somewhat lag any macroeconomic trends. Gross profit increased $9 million, or 4%, in the third quarter versus the prior year period to $215 million, and our gross profit margin was 49%. Net income was $49 million, a 20% decline versus the prior year period, while adjusted net income was $50 million, a 19% decline versus the prior year. Adjusted EBITDA was $91 million in the third quarter and at the lower end of our guidance range. We estimate that COVID-19 negatively impacted results by approximately $23 million during the quarter, including $12 million to $14 million of higher claims costs and $9 million of incremental marketing investments, which I'll now cover on Slide 8. Starting at the top, we had $28 million of favorable revenue conversion in the third quarter versus the prior year period. The increase was driven by approximately equal contributions from higher price and increased volume. Excluding the impact of the change from higher revenue, contract claims costs increased $19 million in the third quarter versus the prior year period. This increase was primarily driven by both a higher number of service requests and increased costs in the appliance and plumbing trades as well as normal inflation. The higher costs in the appliance trade were driven in part by industry-wide appliance availability challenges. As I mentioned, we estimate that $12 million to $14 million of the higher claims costs are related to increased appliance and plumbing usage and customers sheltering at home during the pandemic. On our second quarter earnings call, I projected that we'd see $8 million to $10 million of higher claims costs in the third quarter related to COVID-19, but the number of service requests increased more than we expected. The higher contract claims costs were partially offset by a favorable weather impact of approximately $1 million in process improvement benefits. Sales and marketing costs increased $16 million in the third quarter versus the prior year period. This increase was primarily due to an investment of approximately $12 million in our direct-to-consumer or D2C channel. Consistent with what we projected on our previous earnings call, about $9 million of the increase was directed toward opportunistic marketing investments to increase our D2C customer count growth at attractive acquisition costs in response to the adverse impact COVID-19 had on our real estate channel in the second quarter. As a reminder, first year real estate units lost in the second quarter when existing home sales dropped significantly will have an unfavorable impact on our revenue each quarter until we replace those units. The $6 million increase in service costs was primarily related to managing a higher number of service requests and investments in customer retention initiatives. As Rex mentioned, we believe our increased investment in service in 2020 has helped increase our customer retention rate to 76% on a trailing 12-month basis through the third quarter. For the full year 2020, we expect investments in our home service plan business as well as an additional $15 million to $20 million investment in our emerging businesses of on-demand and Streem to increase our full year SG&A expense as a percent of revenue by 325 basis points versus the prior year. However, as a result of our actions to continue to invest in the business during the pandemic, we estimate that we will deliver double-digit revenue growth in 2021. Please now turn to Slide 9 for a review of our cash and cash flow position. Net cash provided from operating activities for the nine months ended September 30, 2020, was $154 million, the same as the prior year period. Net cash used for investing activities was $25 million, an increase of $6 million versus the prior year period. This was primarily due to an increase in capital expenditures, mostly to support investments in technology. Net cash used for financing activities was $6 million, the same as the prior year period and is primarily comprised of required debt payments. Free cash flow, which we calculate as net cash provided from operating activities minus property additions, was $127 million for the nine months ended September 30, 2020, compared to $138 million for the prior year period. This decrease in free cash flow was primarily due to higher capital expenditures in 2020. Our adjusted EBITDA conversion and free cash flow rate for the nine months ended September 30, 2020, was 53%. As I mentioned on our previous earnings call, our adjusted EBITDA conversion to free cash flow rate is typically higher in the first half of the year because of the timing related to cash payments, specifically, cash paid for service requests and cash taxes. We still anticipate our full year 2020 adjusted EBITDA to free cash flow conversion rate to be around 50%. Cash and marketable securities totaled $551 million at the end of the third quarter, a $3 million increase compared to June 30, 2020. Of that total, restricted net assets required to meet state regulatory reserve requirements totaled $176 million, while the remaining $374 million are considered to be unrestricted. Our available liquidity at the end of the third quarter was $624 million, which includes the aforementioned $374 million of unrestricted cash plus an available undrawn revolving credit facility of $250 million. On our first-quarter earnings call in early May, I mentioned that we viewed our available liquidity and ability to generate cash to be a significant advantage as we navigated through the uncertain COVID-19 economic environment. That statement has proven to be accurate. As we continue to invest in the business during the pandemic, both organically and through the on-demand business acquisition, while adding to our cash balance. As we look forward, our priorities for cash allocation remain the same in terms of investing in organic growth, pursuing strategic acquisitions, repaying debt, and returning cash to shareholders. However, we plan to be opportunistic in considering all of these cash uses and the priority ranking could certainly change as we continue to strive to increase shareholder value. I'll now conclude my prepared remarks with some comments regarding our fourth-quarter financial outlook. Based on our preliminary October results and current forecast for November and December, we expect our fourth-quarter 2020 revenue to range between $315 million and $325 million or an increase of 5% to 8% versus the prior year period. We also expect adjusted EBITDA to range between $28 million and $32 million compared to $48 million in the prior year period. The fourth-quarter outlook includes three key assumptions: first, continued direct-to-consumer and renewal channel revenue growth and first-year real estate revenue to be relatively flat versus the prior year period; second, an estimated unfavorable claims cost impact of $12 million to $14 million from higher appliance and plumbing service requests as a result of our customers continuing to shelter at home; and third, an additional $9 million investment in service expense in the fourth quarter versus the prior year period to handle the higher number of service requests and improve the customer experience. Of that total increase in service investment, approximately $5 million is attributed to the impact of COVID-19. In closing, while we remain as optimistic as ever about the long-term prospects of the business, our near-term results continue to be impacted by COVID-19. In the third quarter, we estimate that COVID-19 negatively impacted our adjusted EBITDA by approximately $23 million, mostly related to the additional service requests and incremental marketing investments I previously mentioned. For the fourth quarter, we estimate the negative impact on adjusted EBITDA from COVID-19 to be approximately $17 million to $19 million due primarily to the increased appliance and plumbing service requests and the incremental investment in service I mentioned. Despite these challenges, we continue to generate meaningful revenue growth, attractive margins, and strong cash flows. We are making productive and efficient investments for the long-term health of the business. Our customer retention is increasing, and we have a substantial and growing liquidity position that allows us to take advantage of market opportunities.

Thank you, Brian. Operator, let's open the line for questions.

The first question comes from Aaron Kessler from Raymond James.

I have a couple of questions. First, could you provide insights on the potential revenues from current AHS subscribers compared to new business for ProConnect? I'm also interested in understanding the main changes and potential cost savings as we attract more organic traffic. Lastly, what investments in ProConnect should we consider for 2020 and 2021?

So for ProConnect, I think one of the major drivers for us for the name change was really to continue to be able to go behind our AHS website and be able to leverage our marketing spend. So we think that we have the ability to really drive a lot of organic traffic, such as the ability to cross-sell to 2.2 million customers today and then 30 million visitors. So that's a lot of eyeballs, so to speak, that we've already paid for. So that's really why we want to change the name. In terms of how much is organic, how much is through search? But we're going to that detail just yet. But as we laid out in our comments, we do see significant growth for the next three years, which we have laid out.

And just maybe quickly on the service costs. I think last quarter, you talked about pulling forward some of the service costs. Is that still the case potentially or should we think about continued headwinds from higher service costs really until consumer shelter-at-home lasts and kind of post-COVID here?

In terms of service costs, certainly, as people continue to shelter at home, if that begins to lift and obviously, that will provide us tremendous tailwind. But as we talked about earlier, we haven't seen the impact to our dynamic pricing changes. We just recently made the net pricing change for renewals, just two-thirds of our business. So we hope that the impact for appliances and plumbing start to wane in early '21, but we're preparing for the impacts through our process changes that we laid out earlier in the comments, pricing, and then continuing to work with our contractors.

Next question comes from Ralph Schackart from William Blair.

Just wanted to get a sense of sort of linearity or sort of the order of magnitude of service request that you saw during the quarter. Just a sense, are they starting to slow, do they continue to be steady, or are they increasing? Just curious on the sort of the pace of that in Q3 and kind of what you've seen so far in Q4.

Certainly, if you think about our business, it's really in a bell curve. Obviously, we're busier in Q2 and Q3. For Q4, the increased service costs are simply because we have a higher volume for appliances. But when you look at kind of the overall service request for the business, it starts to tail off in Q4, but it is higher for appliances. So we're not seeing really a change to other parts of the business. It's just strictly appliances.

And I don't know if you caught the end of my prepared remarks, but I did lay out another $12 million to $14 million of claims cost from appliances and plumbing in Q4, which is the same number from Q3. So you can see it is being fairly linear from the impact from COVID-19 on our claims costs in Q3 and Q4.

One more, if I could. Just switching gears to the customer service side, assuming you're just adding incremental call center agents, but perhaps give us some perspective on other initiatives you're taking on here during COVID. Any thoughts on how this could strengthen the overall customer service experience going forward in that post-COVID environment?

Certainly, the silver lining in a very challenging situation is that COVID-19 has long-term benefits for us by enhancing our value proposition and increasing demand for our services. We have reorganized our teams to improve response times and overcome the challenges we face with the OEMs we depend on. Our main difficulty is connecting with their call centers to check on the status of appliance replacements. As we collaborate with these OEMs to reduce their call times, we expect to benefit as well. The team has done an outstanding job of realigning staff and processes to make things smoother for our customers. We are optimistic heading into next year, and even this quarter, we anticipate significantly better service times and hopefully improved cycle times.

Next question comes from Cory Carpenter from JPMorgan.

Maybe just starting, Rex, with on-demand. I definitely appreciate the commentary around revenue targets for the next few years. Just kind of hoping you could help frame how you're thinking about the level and the types of investments that maybe needed to be made behind that, especially relative to kind of the $15 million to $20 million level this year.

So we're not prepared to give complete guidance for next year in terms of that, but I think you'll find it will be roughly in the same range as this year. I don't see a big incremental increase from a spend perspective. Years two and three, I think we still need to look at, but I think next year should be roughly in line with where we are today.

And then just a follow-up, if I can. On customer retention, I think certainly the highest it's been in a really long time. I'm just curious. Are you seeing that coming more from real estate, direct-to-consumer, or maybe both? And then could you just expand a bit more on some of the initiatives that have been successful with retention?

I think the biggest help for us has been our retention team. So a dedicated retention team has been a huge cross-functional effort for many quarters now. And I guess a ton of kudos to that team who wakes up every morning kind of thinking about retention, and it's certainly beginning to pay off. So I wouldn't say it's specifically real estate or direct-to-consumer. Keep in mind that the customers after year two renew at the same rate, so they're very focused on having the retention teams very focused on cancellations, and making sure that there's no issues so we can retain that customer for the following year. Those process improvements have really been the catalyst for the change in retention.

Next question comes from Ian Zaffino from Oppenheimer.

Can you guys just talk a little bit more about the dynamic pricing, maybe how should it have gotten through? How long will it take to get it all through? And on the back side of this, as people shelter less in place, how do you think about dynamic pricing in that environment and maybe your ability to hold on to some pricing? Thanks.

I'll take that one. For renewals, we've already made the change. The great thing about dynamic pricing is it's just that. It's dynamic. So we were able to make those changes in a matter of days versus months that used to take us. So for two-thirds of our revenue, as it begins, as folks begin to renew, they'll see a different price. Keep in mind that it's based on each customer, so some will see less, some will see more. And in terms of the rollout, direct-to-consumer will be next, followed by real estate. The direct-to-consumer will be in January, and hopefully by February, real estate should follow. You should see all the price increases starting no later than Q1. But keep in mind, at least for renewals, it's when the customer renews. So it's going to take the full year to kind of get through that. To your second question in terms of what happens in a post-COVID world, I for one am looking forward to that day. But the great thing about dynamic pricing allows you to flex up or flex down. It certainly has the ability to change pricing for all channels again, but I think as we've proven, this is a fairly inelastic market. So I think there'll be some opportunity to still capture price, but we'll have to kind of see once we get to that time.

The next question comes from Michael Ng from Goldman Sachs.

I was wondering if you could expand a little bit more on your outlook for double-digit revenue growth in 2021. What's that really driven by? Is it the mid-single digit pricing you spoke about? Is it better retention? Is it the benefit from ProConnect? Just would love to hear about some of the drivers and your confidence level in that acceleration in revenue growth.

We’re confident about the double-digit revenue growth from a couple of aspects. One, we think that even though with tight inventory, we’ll see at least a modest improvement in real estate next year. We're really bullish on our direct-to-consumer opportunities. We'll continue our work as it relates to retention. The teams aren't finished. As we said before, we're not going to stop until we get to the 80s, and then we're going to figure out the next plan after that. So from a core home service plan business perspective, I think we really have the opportunity to fire on all cylinders. You add that to emerging businesses of both ProConnect and Streem, and that's what really allows us to deliver that double-digit growth.

And I can appreciate you probably aren't giving detailed guidance for 2021 yet, but should we expect gross margins to normalize next year? Obviously, gross margins this year are a little bit weaker than expected. But as pricing catches up to make up the higher claims costs, should 2021 be more of a normal gross margin year?

Yes, our forecast for this year for the full year is between 48% and 49%, as you know, which is not that much lower than our typical 50% target that we've given to the Street for the past two years. So we're not really in a position yet to give you gross margin for 2021, but 48% to 49% to 50% in that range would be probably a realistic estimate for next year.

Next question comes from Matt Gaudioso from Compass Point.

Just a question on marketing spend. Obviously, it's nice to see the revenue growth acceleration in the channel there. I was wondering if you could touch on. Did this come in line with your expected increase as it related to the higher spend in the channel? Just wondering if it came in line with your targets there. And then how that strategy evolves into 2021 with the real estate strength we're seeing now? I know you mentioned that I think I heard that the SG&A expenses were 325 basis points higher in 2021. Thanks.

For direct-to-consumer, it actually exceeded our expectations. We saw over a 20% increase in units and double-digit revenue growth. Overall, we believe it performed exceptionally well. The team has additional plans and strategies for 2021, and we will continue to invest in that channel as appropriate. Regarding SG&A, I will now hand it over to Brian.

Yes. I think in my comments, I mentioned it was up 325 basis points this year to drive all the initiatives. And that's why you see the double-digit revenue growth that we're forecasting for next year, Matt. So it's a good story, and it's a big part of our growth profile going forward. What was your precise question regarding SG&A?

Next question comes from Youssef Squali from Truist Securities.

And, Rex, it's nice to hear you talk about double-digit growth for next year. Quick question on just dynamic pricing. You guys obviously have been talking about enrolled dynamic pricing even before COVID. As you think through kind of how to tweak prices, just based on the inefficiency of the old pricing model versus maybe greater usage and higher-risk customers. Are both now part of the algorithm for dynamic pricing, or is it still based on the way you guys were thinking about it pre-COVID? And then, secondarily, I was wondering if you can maybe just speak to the availability of service providers, maybe the percentage of service requests that get filled by preferred service providers.

Sure, Youssef. We're excited about that double-digit growth as well. I'll take your last question first. We're actually doing very well from a percent-to-preferred perspective. As I mentioned in the prepared comments, we were over 80%, I believe 82% as it comes to appliance. Percent to preferred, I think we're roughly in the same range as it relates to all of our preferred contractors or preferred providers. So I think that's an incredible testimony to the team that even with a higher service request, we're still able to get our most experienced and thankfully, lowest-cost contractors out to service those units. As it relates to dynamic pricing, a couple of things to think about. The first journey for dynamic pricing was really just to be able to price on a non-level, almost a subdivision level. We're continuing to move forward those models into being able to look at things like service history and other factors that will allow us to make the models even better, and that's coming in 2021. So our strategy for dynamic pricing hasn't really changed, and we're still marching to be able to continue to refine the models and be able to adjust different types of data that really allows us to provide a differentiated price for each customer rather than kind of blanket pricing, if you will. So those things will come over the course of next year, but I think that dynamic pricing really allows us to continue to build this very resilient model for us.

I have one last question. Regarding Streem, I believe you mentioned it as a factor contributing to your confidence in achieving that double-digit growth rate. You provided details about ProConnect, so I was hoping you could give us a general idea of the potential revenue Streem could generate next year. I understand it's still early, but since you brought it up, I would appreciate your insight.

Yes, I believe the majority of the revenue is generated from ProConnect. When we acquired the company late last year, it consisted of just a small team, and we have since expanded the team and secured some impressive accounts. However, we are still in the early stages of growth. Therefore, I anticipate that we could see growth double or even triple as we progress, although it's from a very small starting point. Expect to see more significant contributions from Streem revenue as we move into the coming years.

Next question comes from Kevin McVeigh from Credit Suisse.

I wonder, I guess, what drove the decision, particularly given the elevated costs, I don't know, warranty side to step up the sales and marketing, I guess, just within the context of the business overall. I guess just any thoughts on that would be helpful.

I think the decision was simple. COVID is not going to last forever. And so we want to make sure that we'll continue to invest in the long game and really invest in the business overall. Last quarter, we saw tremendous opportunity in broadcast and digital as rates were at historic lows. So why not take advantage of those? We think we can use dynamic pricing to begin to offset some of the cost pressures that we're seeing from COVID-19. We don't expect COVID-19 to last forever, but say it did, dynamic pricing will allow us to get through that as well. So rather than focus solely on cost and kind of back off, if you will, we saw a great opportunity to lean forward and accelerate our revenue growth and take advantage of some pretty attractive rates from a marketing perspective. So that's really the catalyst for our decision-making, and I think that it's paid off. If we hadn't done that, we wouldn't see double-digit revenue growth for next year because, again, two-thirds of our revenue is renewals. The faster we can fill the funnel, the faster you can grow.

And then, I guess, any sense of the cadence on the retention? So the 76 to 80 over time, do we expect that? And then is there any sensitivity to one kind of 100 basis points of retention is to the revenue?

I'm just going to say, theoretically, a point of retention would add $15 million to $20 million of revenue. But on an annualized basis, it's probably going to be less than that, probably something more in the range of $10 million to $14 million realistically on a point of retention. And Rex, I'll let you take the first part of that question.

So Kevin, as you've seen, we've kind of been on a very early to increase retention requires a lot of process work and, frankly, a lot of data analysis. We're not prepared to give a timeline of how we get from 76 to 80 by quarter. But the team continues to wake up every day thinking about how do we change the game here. We do think the differentiated service offerings that, for example, better utilization of Streem that helps us fix problems faster for customers will always lead to better retention. Those are the things that are going to really allow us to get into the 80s.

Next question comes from Robert Coolbrith from Wells Fargo Securities.

Going back to your comments on the seller's market dynamic that you're seeing in the real estate channel, a few questions there. Could you give us a sort of snapshot on your mix of business going into COVID versus now between seller pays, buyer pays, agent pays? Then secondly, anything incremental you think you can do on agent or by outreach or education that drives category adoption and preference for AHS? And then finally, as you maybe do see more of the business tilt toward buyer pays over time, any thoughts on how that could impact retention in the real estate channel?

We have been focusing more on the buyer side rather than the seller side for clear reasons that I've mentioned. While we haven't detailed those specifics and channels, it's safe to say that our attention will continue to be on buyers as inventory remains limited. To address this, our real estate team has been actively engaging with all our partners. As I mentioned in the previous call, we are experiencing a positive impact from the ability to provide additional services to agents since the pandemic began, which keeps us at the forefront of their minds. We are also collaborating closely across all of the top ten realty firms, which should be beneficial for us. In California, we have started offering natural hazard disclosures to assist our agents. Overall, this joint effort with our agent partners gives us hope for success in 2021.

Next question comes from Justin Patterson from Keybank.

I'll start with ProConnect. Can you talk about the initial learnings from the first five markets and how you thought about refining the products for these 30 new ones? For example, I do know there were some changes in both the flat fee pricing and the 6-month guarantee.

Justin, great to hear your voice again. Welcome back. Certainly, as you launch new markets, there's always going to be learnings. I think some of the biggest learnings for us have been tweaking their algorithms around the flat fee pricing. We'll do that until the dot of time, so to speak. The biggest thing for us was really making sure we could get to a marketing customer acquisition cost that made sense. This is why we are really leaning into drafting under the AHS umbrella. It's really about distribution. To be able to cross-sell to our 2.2 billion existing customers, we had that opportunity. But now the 30 million people who come to our site that will really give us a lot of opportunity to potentially lower those acquisition costs. By focusing on those things, we think that it's why we're confident we can roll this out to 35 cities and begin to really scale. In terms of your guaranteed question, I think we're always going to be tweaking kind of that peace of mind element of convenience, technology savings. Peace of mind, I think, is a small tweak, but we'll continue to look at those types of things every month as we scale.

And then my next question, kind of uplevel some of that. As we think about on-demand scaling, the great progress you've shown with the renewal rates and then just the refinements of dynamic pricing. How might you invest differently in customer acquisition than you did in the past? Since it seems like a lot of these trends are positive LTV and that, theoretically, you get more aggressive on that customer acquisition side.

As we look at things in terms of cohorts, we're looking at what channels folks are coming on, and so it does give us an opportunity to market at different rates, so to speak, as it relates to this customer's lifetime value. Those are all things we have really hooked out over the last couple of years, and we'll continue to refine. You're right, this gives us an opportunity then to make a very pinpoint decision on how much we're willing to spend to acquire a customer and what markets may be more advantageous than others. The power of bringing these three things together and not just having a single-focused business, we think that on-demand really gives us an opportunity to market customers differently, as home service plans allow us to market to on-demand customers as well. It's a very symbiotic relationship, but it will definitely change how we think about long-term value per customer.

There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to Rex Tibbens for any closing remarks.

Thank you, operator, and thank you to all of our investors and analysts who participated on today's call. As I mentioned on our first call, Frontdoor is playing the long game in terms of increasing shareholder value. Our investments to accelerate both near-term and long-term revenue growth are working. We also outlined a solid growth plan for our emerging businesses that will become a much more significant revenue driver for us over the next few years. Finally, I could not be more proud of how the Frontdoor team has continued to navigate the ever-changing environment while embracing new challenges. We have a resilient business model, and we are becoming a stronger, more nimble organization as a result of the pandemic. Thank you again for your continued interest in Frontdoor, and I look forward to speaking to you all again soon.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.