Frontdoor, Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, welcome to Frontdoor's First Quarter 2021 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. Please go ahead Mr. Davis.

Thank you, operator. Good afternoon, everyone and thank you for joining Frontdoor's First Quarter 2021 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 2 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 6, 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 in order 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 are off to a fast start in 2021, as we continue executing on our strategic plan for the year. In the first quarter, we achieved our highest quarterly revenue growth since the spin-off, with year-over-year revenue growing from 8% in Q4 to 12% in Q1, a 50% increase in the revenue growth rate quarter-to-quarter. We expect to achieve sustained overall annual double-digit revenue growth going forward. Now turning to slide 4, where I'll provide a quick update on our 2021 objectives. Let me start with the drivers of our double-digit revenue growth. I am very pleased with our first year direct-to-consumer or DTC channel growth of 16%, which validates the marketing investments and conversion funnel improvements we made over the last several quarters. We also successfully completed the nationwide rollout of our new B2C product redesign in April and have seen a strong response to our new premium product, Shield Platinum. This new product line, coupled with our ability to dynamically price, should continue to provide revenue tailwinds for us in 2021 and beyond. As it relates to our first year real estate channel, the macroeconomic backdrop remains mixed. On one hand, the National Association of Realtors reported existing home sales increased 15% in the first quarter, with median price increasing a record 17% in March. On the other hand, home inventory remains extremely tight. While we generally benefit from the higher number of real estate transactions, the lower inventory creates a seller's market where the seller is less inclined to include a home service plan as part of the transaction. As discussed on our last call, our team has been refocusing our real estate broker partners' efforts to market more to buyers in the sales transaction, and we've been seeing some real progress as a result of this initiative. Additionally, we experienced some temporary slowness from the February winter storms in certain key markets such as Texas, but we still expect those homes to close and to capture those customers. Home service plan growth is expected to accelerate over the year. While we are monitoring what might happen to consumer behavior as the economy starts to open up more, we believe we are well-positioned for the future. Our second objective for 2021 is to advance our automation initiatives. Our North Star remains focused on proactively innovating our processes through automation that will drive improvements in the customer and contractor experience. These efforts are targeted at reducing cycle time, improving customer retention, reducing costs, and giving us more line of sight in potential service issues and the opportunity to intervene before they become a customer problem. In the first quarter, we completed the appliance purchasing portal, launched a new contractor portal, and further enhanced the use of stream video calls in our core home service plan operations. While there's much more I want to accomplish on this front, I am pleased with the effort our team has made on advancing multiple projects at the same time. We generally remain on track or ahead of schedule. In fact, we are already receiving positive feedback from our customers and contractors on how we interact with them. This is a multi-year journey as we are truly redefining our business and the industry. Our third objective is to expand our customer retention initiatives. In the first quarter, we saw some near-term pressure on renewals as a result of COVID-19, which was twofold. First, the industry-wide appliance equipment and parts availability issues resulted in longer cycle times. Second, we have sub-optimal customer service levels in our customer care centers during the peak of the pandemic in 2020 that may impact our renewal rates this year. We've made great strides in customer retention in 2020 and I expect customer retention to improve over the remainder of 2021 as we continue to focus in this area. As I've said in the past, we can achieve much greater retention rates through our ongoing digital transformation and our teams won't stop until we reach our goals. Our fourth objective is to execute our growth strategies for both ProConnect and Streem. ProConnect is off to a good start this year, with a larger component of their growth still coming in the back half of the year. The team has been deepening our contractor capacity, introducing core trade into new markets, and improving our marketing efforts. We've also begun to cross-market ProConnect services to our existing home service plan customers and we will ramp those efforts over the next several months. Our current home service plan customers have enjoyed the convenience of signing up for additional maintenance services, such as preseason HVAC maintenance checks. These types of services are a good tool for reminding customers of the value proposition we bring outside of their traditional home service contract. We are still on target for updating the American Home Shield website to be able to cross-market ProConnect to our 30 million annual visitors to that site. The internal rollout of Streem's augmented reality service is going very well. We are now focused on accelerating contractor and customer adoption rates through strong support from marketing and product management to drive awareness. Our goal is to continue to ramp the number of service requests that utilize Streem to not only enhance the customer experience by reducing the cycle time but also to improve our contractor interactions and reduce costs. We also remain excited about the environmental benefits of using Streem to reduce the number of contractor truck rolls needed to complete a service request. In summary, we are off to a great start for the year and our business continues to perform extremely well. I'm excited by our revenue growth and plans for the remainder of the year. We remain extremely positive on the long-term fundamentals for all of our businesses as a result of strong execution. However, we are still early in 2021 and there's a lot more work to do as we continue to execute against an aggressive set of goals. I will now turn the call over to Brian. Brian?

Thanks Rex and good afternoon everyone. Let's now turn to slide five and I'll review our first quarter 2021 financial results. Revenue increased 12% versus the prior year period to $329 million driven by approximately seven percentage points of volume growth and five points of higher pricing. I would also point out the volume component includes strong year-over-year growth off of a small base from both ProConnect and Streem. If we look at our home service plan channels, revenue derived from customer renewals was up 12% versus the prior year period due to improved price realization and growth in the number of renewed home service plans. First year real estate revenue was up 2% versus the prior year period primarily from improved price realization. Due to the annual nature of our home service plan agreements, first year real estate revenue continues to be impacted by the steep decline in existing US home sales that occurred in the second quarter of 2020 as well as the strong seller's market Rex mentioned earlier. As background, our first year real estate units increased over 4% in the first quarter of 2020 versus the same period in 2019 and had strong momentum until COVID-19 impacted existing home sales in the second quarter. As we lap that second quarter, our volume is expected to show a strong rebound when compared with the prior year period. First year direct-to-consumer revenue was up 16% versus the prior year period. This was primarily due to incremental marketing investments in the second and third quarters of 2020 and increased year-over-year investment in the first quarter of 2021, resulting in a higher number of home service plans. Other revenue increased $5 million over the prior year period, primarily due to an increase in the growth trajectories for both ProConnect and Streem. Also, we remain confident that ProConnect will achieve the annual revenue target we previously provided, approximately $20 million in 2021 as a result of completing 80,000 jobs across the 35 cities we currently serve. Gross profit increased 1% in the first quarter versus the prior year period to $148 million and our gross profit margin was 45%, which I'll review in a moment. Net income was $5 million, while adjusted net income was $9 million. Net income and adjusted net income declined $8 million and $9 million respectively from the prior year period due to lower operating results offset in part by a decrease in provision for income taxes. Adjusted EBITDA was $36 million in the first quarter 2021 versus $47 million in the prior year period. This was just above the top end of our guidance range as appliance service requests were somewhat lower than projected in January and February. We also benefited from realigning the timing of our SG&A spend to better match demand. Let's move to the table on slide six and I'll walk through the adjusted EBITDA bridge from first quarter 2020 to first quarter 2021. Starting at the top we had $28 million of favorable revenue conversion in the first quarter versus the prior year period. Excluding the impact of the change from higher revenue contract claims costs increased $26 million in the first quarter versus the prior year period. This was primarily driven by a higher number of service requests in the appliance, plumbing, and HVAC trades, increased cost pressure in the appliance trade, and inflation, all offset in part by process improvement benefits. We estimate that COVID-19-related appliance and plumbing service requests negatively impacted first quarter claims cost by approximately $11 million. The higher cost in the appliance trade were mostly a result of industry-wide parts availability issues that drove additional appliance replacements. The increased number of service requests in our HVAC trade versus the prior year period was driven by a higher number of heating degree days and the extremely cold temperatures that accompanied large winter storms, resulting in an unfavorable impact to claims cost in the quarter of approximately $5 million. Sales and marketing costs increased $5 million in the first quarter versus the prior year and were primarily investments to drive growth in the direct-to-consumer channel, ProConnect and Streem. Our store service costs increased $2 million in the first quarter versus the prior year due to a higher number of service requests and related call volume. We believe about half of the service cost increase was COVID-19-related and the balance for investments in customer retention initiatives. And finally, general and administrative costs increased $4 million in the first quarter versus the prior year due to increased personnel expense and investments in technology. Please now turn to slide seven for a review of our cash flow and cash position for first quarter 2021 compared to the prior year period. Net cash provided from operating activities was $52 million, a $7 million decrease versus the prior year period primarily due to lower earnings. Net cash used for investing activities was $7 million and included recurring capital needs and technology projects. Net cash used for financing activities was $105 million compared to $3 million in the prior year period and was primarily due to a discretionary term loan debt repayment of $100 million in February. Free cash flow, calculated as net cash provided from operating activities minus property additions, was $45 million in the first quarter of 2021, compared to $52 million for the prior year period. The decline was due to lower cash from operating activities. Cash totaled $538 million, which included restricted net assets of $175 million and unrestricted cash of $363 million. Our available liquidity at the end of first quarter 2021 totaled $611 million and included $248 million of available capacity under our revolving credit facility. I should note that we are continuing our efforts to free up restricted cash. For example, during the first quarter, we issued $2 million in letters of credit to release the same amount of restricted cash. Although small in scope, it's indicative of our focus on freeing this cash for more productive uses. As I mentioned last quarter, when discussing our capital allocation strategy, we will continue to responsibly invest in both the core home service plan business as well as ProConnect and Streem. However, even with these investments, we would expect our business to generate a sizable amount of excess cash this year. Beyond organic growth, we remain acquisitive and continue to evaluate potential opportunities within the home services industry and in the technology space. I'll now conclude my prepared remarks by providing our full year and second quarter 2021 financial outlook. As you can see on slide 8, our full year 2021 outlook remains the same as previously provided despite the better than expected first quarter adjusted EBITDA results. This is due to the factors previously mentioned, including the lower-than-projected appliance service requests early in the first quarter and SG&A expense timing. Before I leave the full year outlook, I would like to provide more color on our projected gross margin of 48% based on the questions we received from analysts and investors following our fourth quarter earnings call. First, global supply chain issues have been in the headlines since the pandemic began and more recently as a result of the severe winter storms, and we continue to see inflationary pressure on our business as a result. Appliances, water heaters, and replacement parts remain in short supply and cost more to acquire and transport than one year ago. While inventory levels have improved since late 2020, availability is still not at pre-COVID levels. Production at most of our key suppliers is at or near capacity, but demand remains higher than normal, and the global supply chain issues are impacting delivery speeds. Pricing and availability for items such as plastic resin, insulation metals, processor chips, as well as logistics are not expected to improve until later this year. While the environment is challenging, we have an experienced and innovative supply chain team that is working closely with our suppliers to source equipment and parts, and I suspect our position is relatively better than most companies providing home services. Second, we're projecting roughly the same elevated level of appliance service request incident rates we experienced in the second half of 2020 through mid-second quarter 2021 and then dropping to a rate roughly halfway between that elevated rate and historical service request rates for the balance of the year. Third, we have benefited from lower than normal summer temperatures during the past two years and the favorable impact on our HVAC service requests. For 2021, we are planning on a higher service request rate. But if we have another mild summer, that could provide upside to gross margin. And fourth, we're projecting a higher mix of first-tier direct-to-consumer and ProConnect revenue in 2021, which is margin dilutive. The larger benefits from dynamic pricing will not be realized until later in the year. I would like to make one final comment about our full year 2021 outlook. We had an unusually low effective tax rate of 9.8% in the first quarter, primarily due to excess tax benefits from share-based awards. However, we continue to expect our full year 2021 effective tax rate to be approximately 25%. Moving to the second quarter outlook. We expect our revenue to range between $460 million and $470 million, and adjusted EBITDA to range between $90 million and $105 million. We're providing a slightly wider range for adjusted EBITDA this quarter, given the timing uncertainty around both COVID-19-related service requests and the summer weather impact on HVAC clients. The second-quarter outlook includes the following assumptions: continued direct-to-consumer and renewal channel revenue growth, along with a significant increase in first-year real estate revenue as we lap the COVID-19 impact on existing home sales one year ago; continued cost inflation pressure as a result of the drivers I previously mentioned, as well as the ongoing impact of COVID-19 on the number of appliance service requests; a $9 million increase in sales and marketing investments to support our growth objectives; a $6 million increase in service investments, primarily driven by customer growth, improved service levels, and customer retention initiatives; and additional general and administrative investments to support our growth. With that, I'll now turn the call back over to Matt to open the question-and-answer session. Matt?

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

Thank you. We will now start the question-and-answer session. Today's first question comes from Youssef Squali with Truist Securities. Please go ahead.

Great, thank you very much. I have two questions please. First, Rex, I want to go back to the DTC segment, which is really impressive, up 16%. I want to talk a little bit, maybe the market inefficiency that you're seeing there, the sustainability of that. How do you see that trending throughout the rest of the year? And then, on the retention, I think you guys talked about renewals seeing some pressure. Can you just unpack that a little bit for us? How do you see that also reversing throughout the rest of the year? Thank you.

Sure, Youssef. In terms of direct-to-consumer, the investments we made last year and this year are really starting to show results. I anticipate sustained double-digit growth for the rest of the year. We're still focused on improving conversion and making technological enhancements to the sales funnel. I'm proud of our team for achieving 16% growth, even before the pandemic, which is quite encouraging. Regarding retention, we mentioned it might be affected by rounding down. As Brian noted earlier, industry-wide appliance issues during the pandemic led to longer hold times, but we've addressed the staffing and training challenges in our call center. We've been actively working on the delivery of appliances and parts, and Brian's earlier comments highlight the team's success in expanding our parts suppliers and managing real-time inventory with the manufacturers. Additionally, we've launched the appliance portal to simplify the process for customers needing replacements, aiming to enhance their experience. I believe these efforts will lead to improved retention as we move through the year. We're also beginning to integrate Streem into our business operations, and I think these cross-functional initiatives will provide a significant boost to retention.

Thanks, Rex.

And our next question today comes from Ralph Schackart with William Blair. Please go ahead.

Good afternoon. Thanks for taking the question. First question just on pricing increases as consumers come up for renewal, and I'm assuming the new renewals are at a higher price. Just curious about the receptiveness of the consumers to take the higher pricing? And then I think in the prepared remarks you talked about Streem perhaps also playing into that. And just a reminder, if you're charging for Streem now and how those commercialization efforts are going? Thank you.

In terms of pricing, we are focusing on our customers using a ZIPCO plus nine approach, which means we are analyzing at the subdivision level and evaluating the risk deciles within those subdivisions. We are not observing any changes in elasticity. We can measure it clearly and continue to make adjustments as needed. With the new pricing, I believe the pandemic has introduced a wider value proposition. We haven't noticed any shifts in elasticity. Regarding Streem, we do not charge customers for utilizing it to address their issues. However, the Streem team is expanding in terms of its SaaS business, having established partnerships with companies like Lowe's and CLEAResult. We anticipate growth in revenue from Streem externally, as well as integrating Streem more thoroughly into our operations to offer a comprehensive digital diagnosis for our customers.

That’s helpful. Thanks, Rex.

And our next question today comes from Mike Ng with Goldman Sachs. Please go ahead.

Thank you for the question. I have two points to discuss. First, it looks like ProConnect is on track, and you may reach your annual target of around $20 million. Can you provide an update on your ProConnect expansion plans for the remainder of the year and whether you believe there is potential to surpass your target? Second, I would like to know more about your insights into the parts supply constraints. You mentioned that conditions might improve later this year. Is that due to a decrease in demand or is it because your manufacturers are increasing supply, which you expect will alleviate some of the pressure? Thank you.

I'll discuss the ProConnect aspect first and then invite Brian to address the supply chain. Regarding ProConnect, I believe we have made a strong start. We are focused on execution and currently operating in 35 markets, on track to expand into other trades and meet our job volume targets. While I can't confirm that we will exceed our plan, I am confident about our current progress in relation to it. We began with appliances and will soon be rolling out plumbing and electrical services. We are present in some cities but haven't reached all 35 yet. Everything is functioning well, and like the company as a whole, our emphasis is on execution. Brian, would you like to talk about the supply chain?

Sure. Thanks, Rex, and hi, Mike. How are you doing? Yeah, we're seeing some light at the end of the tunnel on parts. And I think it's two-fold. One, as Rex said, our supply chain team is doing a great job leveraging our national supplier relationships. We're expanding our supplier base. We're doing all sorts of things, and we're integrating with our suppliers to order parts. So I think we're doing a good job from that perspective. But as well, the OEMs and parts suppliers, I think, they're doing a better job catching up. It's just that demand continues to outstrip supply. But I think towards the end of the year, we'll be doing a much better job getting that into balance.

Yes. That’s really helpful. Thanks, Rex. Thanks, Brian.

And our next question today comes from Robert Coolbrith with Wells Fargo Securities. Please go ahead.

Thanks for taking my questions. On retention, I think you've noted in the past the opportunity to maybe utilize dynamic pricing to help with retention in cases where you may have had an adverse customer support demand or even cases where there may have been a lot of utilizations. So just wondering if you might be able to comment on the opportunity to address the retention issues with maybe some support from dynamic pricing? And then on the supply side, I know you noted some of the issues around the supply chain. I was just wondering if you still have plenty of runway with your preferred provider networks? Any issues around hourly inflation or just availability in those networks as demand continues to be pretty robust? Thanks.

Yes, absolutely. In terms of dynamic pricing as it relates to retention, the great thing about dynamic pricing is just that: dynamic. So we can focus on unit growth or we can focus on gross margin expansion. I think the team has done a nice job of kind of balancing those two things. In terms of pure retention, we do have retention teams in place. So if someone has an issue with price or has had a service experience that may lead to them wanting to exit, our team has playbooks in terms of how to address that. I think both those things are going well, and that's why I'm kind of bullish on my comments around the strong tailwind as it relates to retention in the back half of the year. As it relates to labor for our contractors, we continue to push our algorithms so that we're getting the most from our preferred contractors. Happy to say, we continue to be in the low to mid-80s across the country. That’s no small feat with certainly some of the appliance issues. But the team has done an incredible job managing this on both a macro level and a retail level. As it relates to ensuring we have enough contractors, we haven't seen any issues. Again, our preferred contractors represent about 40% of their business. So it's a very symbiotic relationship between the companies. I think they are having some troubles with staffing issues like dispatchers. It's a very high labor market right now. But at least in terms of the skilled core trades, we're not seeing any indications yet of trouble ahead.

Great. Thank you.

You bet.

And our next question today comes from Kevin McVeigh of Crédit Suisse. Please go ahead.

Hey, Rex or Brian, I wonder if you could compare and contrast some of the equipment shortages you're seeing in this cycle versus the last one. It's probably about 24 months ago, because it seems like you're managing through it a lot more effectively this time as opposed to the last one and probably what's an even more challenging environment. So maybe just some puts and takes, if you like operationally you're a lot further along. Is that the right way to think about it? But just if you could maybe compare and contrast both experiences a little bit?

Yes. I can talk about some of the technology, and then I would ask Brian. He's far closer to it. I think Brian would probably tell you, because Brian owns that team and they're doing so well. But I'll take some of the...

Yes. I figure that, Rex. That's why I asked the question.

Yes. Certainly, from a technology perspective, I give the team a lot of props in terms of we're looking for the right APIs to connect into. So we have a lot more inventory visibility. The team has gotten, I think, a lot more educated over the last couple of years in terms of our ability to dynamically do authorizations. So I think it's a whole confluence of what I'd say good technical hygiene in terms of digitally connecting with our key suppliers, as well as expanding our key suppliers. And then as it relates to some of the more strategic sourcing and things that have been going on in the last 24 hours, I'll turn that over to Brian.

Yes, Rex, you hit a lot of them. We had a very strong supply chain team that I inherited, and we brought in a great leader about a year ago that just raised the level of the team. We've built really close relationships with our partners, our OEMs, and parts suppliers. I think that's paying off when times are tough, and I think we can go to them. We have leverage with them to get parts maybe a little quicker than we could have previously. And again, expanding the supplier base is key. And then just as Rex said, using technology to integrate with our suppliers to order parts and be able to track them more quickly in the system and getting them delivered to the contractors. It all comes together. I think we're doing a much better job today than we did two years ago.

That's helpful. And then any thoughts as to pricing? I mean it seems like just given some of the shortages and some of the labor pressure things like that you're probably able to have more fulsome conversations, as it relates to pricing. But just any thoughts on that within the context of the dynamic lens if you could?

Sorry, pricing in terms of how we price our home service plan contracts or pricing in terms of the supply chain issues?

No. More on the home service plan contracts, I apologize.

Yes. So this is where dynamic pricing just keeps paying dividends for us. Certainly being able to quickly pivot as it relates to price has been key for us. As renewals continue to lap our last pricing increase, we expect that to help us moving forward throughout the course of this year. So we made some pricing adjustments late last year and early this year, and I expect those to help offset some of the gross margin pressure that Brian talked about. Obviously, as the country opens up more, this will give us an opportunity depending on how quickly we move away from home, so to speak or not at their home every day. This may give us some opportunity to focus more on unit growth rather than gross margin. So that's the great thing about dynamic pricing is it's just that: dynamic.

That’s helpful. Thank you so much.

Thank you. Hey, Kevin, one thing I'm remiss not saying is that the supply chain team works very well with both our service organizations and our operations teams to make it really work. So I apologize for leaving them out at all. We all work together as a team to deliver the experience.

Thank you, sir. Ladies and gentlemen, thank you all again for joining Frontdoor's First Quarter 2021 Earnings Call. Today's call is now concluded. You may disconnect your lines and have a wonderful day.