Frontdoor, Inc. Q3 FY2025 Earnings Call

Good day, ladies and gentlemen, and welcome to Frontdoor's Third Quarter 2025 Earnings Conference 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 morning, everyone, and thank you for joining Frontdoor's Third Quarter 2025 Earnings Conference Call. Bill Cobb, Chairman and CEO; Jessica Ross, CFO; and Jason Bailey, VP of Finance, will be joining me on 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 www.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 5, 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 will now turn the call over to Bill Cobb for opening comments. Bill?

Thanks, Matt Davis, and good morning, everyone. What a year Frontdoor is having. Our results reflect the continuation of superior financial and operational performance and we are on track for record financial results in 2025. Let's get into the third quarter highlights on Page 4. Starting with revenue, which increased 14% period-over-period to $618 million. Gross profit margin increased 60 basis points to 57%. Net income grew 5% to $106 million and adjusted EBITDA grew 18% to $195 million. Additionally, first year organic DTC ending member count grew 8%. Real estate member count grew sequentially in Q3, a milestone that we have not seen for the past 5 years. New HVAC revenue continues to crush it. Synergies from the 2-10 acquisition remain ahead of schedule, and we have used our strong cash flows to repurchase shares, totaling $215 million through October 31. Our results speak for themselves, and they show the power of our strategy and the momentum we've built. Now flip to Slide 5. We are firing on all cylinders, and that strong momentum has positioned us to deliver across our business. First, operational excellence is at our core. Three years of disciplined execution have built a strong foundation to accelerate growth. Second, DTC continues to perform, with 5 straight quarters of organic member growth. Third, we see the real estate channel turning the corner, supported by the return of a buyer's market. Fourth, retention rates are strong and remain near all-time highs. We're committed to delivering an outstanding experience for our 2 million-plus members through continuous innovation and technology. And finally, our non-warranty growth continues to be a game changer. Leveraging the success of the new HVAC program, we are well-positioned to replicate that model by expanding into other replacement categories. Let's double-click on each point, beginning on Slide 6. We've talked a lot over the past few quarters about building a foundation of operational excellence and for good reason. These efforts have translated directly into stronger financial results. Over the past 3 years, we have focused our margin improvement efforts in 2 key areas: one, pricing actions; and two, operational efficiencies. Let me start with pricing. In 2022, we faced the highest inflation in a generation, and we responded decisively with double-digit price increases, not only to catch up to those inflationary pressures, but also to address where inflation was heading. We did this using our dynamic pricing capabilities, which deliver smart and strategic price adjustments, particularly for higher usage members. We also raised our trade service fee, which is actually an offset to claims costs, providing us another lever to respond to inflation. Now turning to operations. We've made meaningful strides in improving execution and cost discipline. We have enhanced and accelerated our contractor management process. This has driven better alignment, better execution, better member experiences, and better costs. One key proof point is that our preferred contractor utilization has improved 200 basis points on average over the last 3 years. Our supply chain team has done an excellent job of leveraging our purchasing volume and extensive supplier network to negotiate better terms and allocate purchases to maximize cost savings. When you combine these pricing actions and operational efficiencies, we have improved our gross profit margin over 1,000 basis points since I started in the middle of 2022. In fact, we have had so much success improving our margins that we are reevaluating the long-term margin targets we provided at Investor Day earlier this year, and we will provide more information about that on our next earnings call. Moving to the direct-to-consumer channel on Slide 7. The DTC channel is performing very well, and our efforts to drive member count growth are paying off. In the third quarter, we grew organic DTC member count by 8% versus the prior year period. This is now 5 consecutive quarters of organic growth. Our success in DTC is due to several factors. First, the Warrantina campaign is working. I'll show you supporting data on the next slide, but we developed this campaign with younger audiences in mind, specifically millennials, since the average first-time homebuyer is now 38 years old. From a targeting perspective, we have sharpened our media strategy to focus on the middle of the media funnel, where consumers go from being aware of us to considering us. This strategy has improved our marketing effectiveness and media efficiency. Next, simply speaking, our promotional pricing strategy is bringing in more members. This strategy works because we can quickly return these cohorts to traditional pricing within the first 2 years without compromising renewal rates. Further, we are directly targeting new homebuyers who did not purchase a warranty with their new home transaction. Our multichannel approach includes paid search, social media, commercial partnerships, and word-of-mouth campaigns, and we are getting more sophisticated in our digital marketing approach. AI is coming into play and enhancing our search strategy by moving beyond traditional keyword targeting. We are using more intelligent, context-driven approaches, which have improved discoverability and relevance with large language models or LLMs, such as ChatGPT. Let's turn to Slide 8 to talk about the effectiveness of the Warrantina campaign. The campaign is resonating, and we are leaning into education to balance the entertainment factor. Our research shows that key metrics such as likability, relevance, and purchase interest are up significantly in just 6 months' time. And as you can see in red, our value proposition of budget protection and convenience is landing even more with those under the age of 45. The team's work over the past 5 quarters has been excellent. But we are not stopping here. We are allocating more marketing spend in the fourth quarter to position us for another strong year in 2026. Now turning to Slide 9 and the real estate channel. The story here is finally one of optimism. Despite ongoing macro challenges, our ending member count in the real estate channel has increased sequentially in the third quarter, the first improvement since 2020. While the macro environment in the real estate sector is showing some signs of improvement, challenges still remain. According to the National Association of Realtors, September existing home sales increased 4.1% to a seasonally adjusted annual rate of $4.06 million. However, this is still among the lowest levels of home sales in 30 years. Moreover, affordability remains a concern with home prices climbing another 2% on average in September to $415,000. The bright spot Total housing inventory increased 14% year-over-year, and we are now at 4.6 months of supply. While inventory remains below pre-COVID levels, it is now at a 5-year high. This shift signals that a transition to a buyer's market is underway, where homes stay on the market longer and sellers are more likely to add a home warranty to help close the deal. Here are some of our aggressive actions to improve sales. Increasing engagement with real estate agents, we are delivering a differentiated product and agent interest has picked up significantly around our video chat with an expert feature. We are also continuing to provide education on the benefits of a home warranty and have a compelling value proposition that keeps our brands top of mind. Additionally, we have implemented targeted promotions to drive renewed interest and excitement with both agents and new homebuyers. Our actions, combined with these market dynamics are resulting in us outpacing the market. Moving on to retention rates on Slide 10. In the third quarter, our customer retention rate was at 79.4%. Retention remains strong because we are delivering a better member experience through technology and process improvements. On the technology side, we have had 2 big wins. First, AHS App adoption is growing. Launched only a year ago, almost 20% of our members have already downloaded our app, an outstanding result. This enables easier service request submission and real-time contractor updates. In the past 12 months, members have submitted 200,000 service requests through the app and usage continues to ramp. Second, and to quote one of our members, 'Video chat with an expert is exceptional.' Since the launch in February, our visual experts have completed about 35,000 video chats and members love it, giving us nearly perfect thumbs-up ratings. It is a true differentiator in the home services industry, and it is free for our members. Behind the scenes, we're also driving continuous improvements to deepen member loyalty and strengthen retention, such as early engagement with new members through onboarding and tailored offers, improving the number of members on AutoPay, usage of preferred contractors, which was 84% in the third quarter. And we are also leveraging technology to improve the member experience, including system improvements to support smarter job routing to our contractors and using AI to accelerate authorizations and assist in coverage decisions, enabling a 10x increase in the speed of coverage reviews. The impact is clear. Stronger relationships, higher satisfaction, and a service experience that sets us apart. Retention isn't just a metric. It's proof that our strategy is working. On Slide 11, let's talk about another bright spot of Frontdoor, non-warranty revenue. This is a major success story and an even bigger opportunity. As a reminder, non-warranty is comprised of a number of programs but is currently fueled by our new HVAC sales. The program is scaling fast, and we are raising our full-year outlook for new HVAC revenue again. Now to $125 million, a 44% increase over 2024. The opportunity ahead is enormous. In 3 years' time, we have sold around 50,000 HVAC units to our base of more than 2 million members. The runway for expansion is clear. We are now applying these learnings to other trades. We recently expanded our appliance replacement pilot, offering great deals on a full range of new appliances, and we are looking to launch this great offer nationwide next year. We are also exploring opportunities in roof and water heater replacement. Again, together, these categories represent an opportunity of $2 billion with our members, opening the front door to significant long-term growth. We especially love this program because every sale is a relatively customer acquisition cost-free opportunity across our member base. And looking into the future, we see additional potential through our 210 acquisition, which provides us access to 19,000 builder partners. This positions us to expand beyond HVAC and create new revenue streams across multiple trades and in new customer channels. We will share more about this on our next earnings call. On that high note, I'll now turn the call over to Jessica.

Thanks, Bill, and good morning, everyone. I will now cover the financial results for the third quarter, beginning with revenue on Slide 13. We delivered strong top line growth of 14% in the third quarter with revenues reaching $618 million. This performance was driven by 12% from higher volume and 3% from higher price. From a channel perspective, renewal revenue was up 9%, benefiting from 2-10 volumes and higher price realization from leveraging our dynamic pricing capabilities. Real estate revenue grew 21%, driven primarily by contributions from 2-10. Direct-to-consumer revenue increased 11%, supported by volume gains from our promotional pricing strategy and targeted marketing efforts as well as contributions from 2-10. This was partially offset by lower pricing. And finally, our non-warranty business continues to be a key growth engine with other revenues up 73% year-over-year. This growth was propelled by our new HVAC and loan programs along with contributions from 2-10 new home structural offering. Now moving down the P&L to gross profit on Slide 14. Gross profit grew 16% to $353 million in the third quarter, with gross profit margin expanding by 60 basis points versus the prior year period. During the quarter, inflation was in the low to mid-single digits across contractors, parts and equipment. Favorable weather trends reduced the number of service requests in the HVAC trade, providing a $6 million benefit, and claims cost development was a $5 million benefit compared to a $3 million benefit in the prior year period. Turning to Slide 15, where we will review net income and adjusted EBITDA. For the third quarter, net income grew 5% to $106 million and adjusted EBITDA grew 18% to $195 million. Adjusted EBITDA margin improved to 32% in the third quarter, up about 100 basis points from the prior year period. Let me quickly walk you through the drivers. We had $47 million of favorable revenue conversion, primarily from the 2-10 acquisition and higher price. Contract claims costs were flat versus the prior year period, which includes the already discussed inflation impacts and favorable incidents and claims development. We also had $20 million of higher SG&A due to the addition of 2-10 and personnel costs. Now moving to earnings per share on Slide 16. On a fully diluted basis, earnings per share grew 9% to $1.42 per share, and adjusted earnings per share grew 15% to $1.58 per share. Now turning to Slide 17 and our free cash flow and financial position. Our year-to-date free cash flow increased 64% to $296 million, and our total cash position increased to $563 million. Through October, we purchased $215 million worth of shares. Now let me take a step back and really highlight our cash flow conversion. Our year-to-date cash conversion was 60% compared to 46% in the prior year period. This sustained cash generation and conversion is a defining feature of our business model and a cornerstone of our financial strength. With that, I will now turn it over to Jason to walk through the outlook.

Thanks, Jessica. Now turning to Slide 18 and our fourth quarter outlook. For the fourth quarter, we expect revenue to be in the range of $415 million to $425 million. We expect fourth quarter adjusted EBITDA to be in the range of $50 million to $55 million. This range anticipates higher SG&A spend as we are reinvesting some of our gross profit favorability in the marketing to drive growth. Now turning to Slide 19 and how this translates into our full year outlook for 2025. For the full year, we are increasing our revenue outlook to be in the range of $2.075 billion to $2.085 billion, driven by better-than-expected performance in the new HVAC program, the renewals channel, and the real estate channel. This is approximately a $15 million increase from our prior outlook at the midpoint. Based on this, total revenue is expected to be up 13% in 2025, driven by about 10% from the 2-10 acquisition and 3% from organic growth. Our underlying revenue assumptions include a 10% increase in renewal channel revenue, a 12% increase in real estate channel revenue, a 3% increase in D2C channel revenue, and a $75 million increase in other revenue. Turning to operating performance. We are narrowing our gross profit margin expectation to be approximately 55.5%. As previously mentioned, we are increasing our sales and marketing spend during the fourth quarter which translates to full year SG&A in the range of $670 million to $675 million. Taking this combined with the strong third quarter performance, we are raising our full year adjusted EBITDA to be in the range of $545 million to $550 million. As a reminder, our full year adjusted EBITDA outlook also includes interest income and excludes $8 million of 2-10 integration costs and stock-based compensation of approximately $33 million. We are lowering our capital expenditure expectations to approximately $30 million. And lastly, our annual effective tax rate is expected to be approximately 25%. And while we're not providing 2026 guidance today, we look forward to sharing more details on our expectations and priorities during our next earnings call. I will now turn the call back over to Bill for a few closing remarks.

Thanks, Jason and Jessica. I wanted to close with a few thoughts. Once again, Frontdoor has delivered. Our execution has been outstanding, and we have fundamentally changed how we think and how we operate. This has helped to drive record financial performance and cash flows. We are raising our revenue and adjusted EBITDA outlook again. And with that, we expect to finish 2025 on a high note. And at the same time, we have made measurable progress on our strategic initiatives, and we remain hyper-focused on driving member growth. Now one final item. Earlier this morning, we announced that Jessica has resigned as CFO and will be succeeded by Jason Bailey effective November 10. We regularly challenge ourselves to make sure we are organized to best leverage and deploy our deep bench of talent. As Jessica feels, she has accomplished what she set out to do when she first joined us that led to her decision to resign from the company. To her credit, Jessica has agreed to stay on as an adviser to me through December to ensure a smooth transition. Jessica has made many contributions to our company over the past 3 years. During her tenure, our revenue and profits have grown to new heights, and we have delivered on our financial commitments to our shareholders. I would like to thank Jessica Ross for her dedicated service as CFO. At the same time, the Board and I are very excited to name Jason Bailey as our next CFO. Jason brings over 25 years of progressive leadership experience in finance and public accounting, including over 15 years of service with Frontdoor and its predecessor. He also has 11 years of public accounting experience at Deloitte and Arthur Andersen. I've had the privilege of working closely with Jason for the past 7 years. He knows the home services industry deeply. He is truly an expert in all aspects of our business, and I'm very confident in his ability to lead our finance organization. This will be a seamless transition. With that, operator, please open the line for Q&A.

Thank you. Our first question is coming from Jeff Schmitt with William Blair.

On cost inflation, it appears to have risen to about 4% or even 5% this quarter, having previously been in the low single digits. Can you explain what caused this increase, specifically if it was mainly due to tariff impacts on parts and equipment and if it might be temporary?

So Jeff, it was not 5%. It was closer to 4%, just about reaching 4%, which means we have to refer to it as low to mid. For the year, we are still expecting low single-digit inflation. You’re right that there was a slight increase in appliance costs. Most of our other components are domestically produced, so we haven't been impacted as much by tariffs as other areas, but appliance costs have increased. However, with our dynamic pricing model and our trade service fee strategies, along with our operational execution, we are confident that we can manage these changes. It's something we keep an eye on.

Okay. And then could you talk about the promotional strategy that you implemented in the real estate channel? What all is going on there? And did that drive an increase in attachment rates in the quarter?

Yes. The good news for us is that the macro environment is improving, which allows us to further our initiatives. Regarding promotions, we traditionally haven't run price-off promotions, but we offered $100 off during July and August. We also executed a couple of partner-specific promotions that helped us surpass the overall real estate market. We're very pleased with the direction and trajectory of the real estate sector as I've mentioned during the call.

Our next question is coming from Maxwell Fritscher with Truist.

I'm calling in for Mark Hughes. In the non-warranty section or segment the pilot program, what are your early observations there? What sort of timing and pace are you anticipating for that expansion?

Yes. We're not providing specific details at this time, but we're aiming for a nationwide expansion in 2026. It's a bit more complex than HVAC due to the number of appliances involved. We need to navigate that within our platform. However, this complexity also presents exciting opportunities for engagement with our members across various appliances. Our plan is to launch nationwide during 2026, and we're actively working on the specifics regarding appliance ordering and other logistics. We believe this initiative presents a significant opportunity, and early feedback from our members has been very positive.

Got it. And then a small piece of the overall revenue number here, but the DTC guide of up 3% for the full year, if my math is correct, it implies around a mid-single-digit decline there. So what's driving your thoughts around that segment in 4Q?

Pricing is aligned with our unit strength, which we believe is our top priority, as it will ultimately impact our renewal book, the backbone of our company. The price reductions and promotional pricing strategy have decreased revenue, but we are able to offset this and sustain healthy margins and pricing due to strong retention rates. While we do forgo some revenue upfront with our first-year customers, we have strategically decided that this approach is worthwhile to build our renewal book over time.

So I'd probably also add that Q4 is impacted by our seasonal adjustment. It's our lowest quarter as we know our guidance.

Our next question is coming from Sergio Segura with KeyBanc Capital Markets.

Bill, Jessica. It was a pleasure working with you, and I wish you all the best for the future. I have two questions. First, regarding member growth in the real estate channel, how much of that success do you attribute to the market shifting to a buyer's market compared to your strategic initiatives, promotional strategy, and increased agent engagement mentioned in the presentation? For the second question, can you provide more details on the increase in SG&A outlook for the year and where you are investing those additional funds?

On the first question regarding real estate, the improvement in the macro environment is beneficial for our actions. It's not that we've suddenly discovered new strategies, but we have introduced a promotional program that we've discussed earlier. This macro improvement has helped us enhance our initiatives in real estate. It's difficult to pinpoint exactly how much can be attributed to the macro conditions versus our promotional pricing, but they are all working cohesively to help us make progress in this area. Regarding SG&A, we are pleased with the Warrantina campaign, particularly its success among potential homebuyers under 45, which is our marketing team's target demographic. We're focusing our additional investments not only on the Warrantina campaign but also on the middle of the funnel, where we can boost consideration. This approach moves beyond just raising awareness at the top of the funnel and emphasizes building consideration. We are also excited about our advancements in digital marketing, where we're enhancing traditional search engine marketing through the integration of large language models like ChatGPT. We believe these efforts will lead to increased demand and, ultimately, improved conversion rates.

And thank you, Sergio. It's been great working with you as well. Yes.

You will not hear that this will be the last of Jessica Ross.

Our next question is coming from Cory Carpenter with JPMorgan.

Bill, thought it was notable that you mentioned in your prepared remarks the potential reevaluation of your long-term margin target, that's certainly been a big topic of the date given you're punching above what you said earlier this year. Maybe could you just help us with what's changed since the Investor Day that's giving you the confidence to potentially do this when you're doing the exercise this year. And Jason, just a very quick question for you. Thinking you told us organic revenue, I think you expect to be 3% for the full year. Are you able to comment on what organic revenue growth was in the quarter?

I'll address the first part. Cory, what gives us confidence is the strength of our margins and our execution, along with our strategies regarding pricing and trade service fees to tackle inflation. These factors have led us to believe that we have reached a new level. While we are still determining what that level entails, we feel confident in the targets we set during a period filled with uncertainty. Although uncertainty will always exist as we move forward into the year, we are reassured by our model. We are in the process of finalizing our plans for approval by the Board and will provide more information in February. Jason, regarding the question about organic revenue?

Yes, Cory, for Q3, we'd say it was mid-single digits, probably 3 key drivers there. One, to think about our non-warranty pricing and then there's still some seasonal adjustment. So when you're comparing that, that's why I'd probably pull you back to the full year at 3%.

Thank you, ladies and gentlemen. As we have no further questions in the queue, this will conclude today's conference. You may disconnect your lines at this time, and we thank you for your participation.