Frontdoor, Inc. (NASDAQ:FTDR) Q1 2024 Earnings Call Transcript May 4, 2024
Frontdoor, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen. Welcome to Frontdoor’s First Quarter 2024 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 of the call. At this time, we’ll begin today’s call. Please go ahead, Mr. Davis.
Matt Davis: Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor’s First Quarter 2024 Earnings Conference Call. Joining me today are Frontdoor’s Chairman and Chief Executive Officer, Bill Tom and Frontdoor’s Chief Financial Officer, Jessica Ross, 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 May 2nd, 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?
William Cobb: Thank you very much, Matt Davis and hello again, everybody, Frontdoor Inc. continues to operate extremely well, and we are off to a great start in 2024 as we delivered another quarter of record results. As you can see on slide 4, revenue grew 3% to $378 million. Gross margin increased 510 basis points to 51%. Adjusted EBITDA rose 33% to an all-time first quarter high of $71 million. And as a result of our strong first quarter financial performance, we are increasing our full year 2024 adjusted EBITDA outlook. So while we continue to exceed expectations on the margin side, our top priority remains growing our customer base. Let’s be clear, right upfront. Demand for home warranties has been down due to some challenging market conditions, but we view this as a temporary cyclical issue.
The main cause of lower demand has been real estate. As I’ve said before, we sell our products as part of the real estate process and as the number of existing homes has declined from 6 million in 2022 to just over 4 million homes today, we have had significantly fewer opportunities to sell our products. This was due in part to rising mortgage rates, which recently reached a one year high. At the same time, existing home inventory has been extremely tight. This is not only limited existing home sales, but it has also resisted in a significant power shift to the seller over the last several years. As a result, our real estate channel sales are less than half of what they were five years ago. And this continues to impact our customer count, revenue growth, profitability and cash flows.
And from everything that we see. This is true for the rest of the home warranty category. So while we are still optimistic that the real estate channel will eventually come back, we are waiting to see more tangible proof of the turnaround. Now turning to the direct-to-consumer channel, where we have also seen lower demand. For those of you new to our story, home warranties have historically been sold primarily through the real estate channel. It was only about 25 years ago when we started marketing and selling directly to homeowners. This was a powerful growth engine for us as we saw a strong correlation between marketing spend and our sales. However, about a year after COVID, and we began seeing a decline in consumer demand as the recent indicator of this Google searches for the short term, Home Warranty were down 7% this past March.
We have known that something needed to change and here’s some of the things we learned from really digging into consumer research. First, consumers have a hard time understanding home warranties, they easily confuse it with homeowners insurance or other products. Second, consumers want to feel like they’ve got someone in their corner. What really resonated with our focus groups is when we grounded them in the higher level benefits of a home warranty like peace of mind, freedom and happiness. Third, we have not done enough to stand out from our competition. The category has been defined by what we call a sea of sameness among providers, and we realize we needed to take action to break out from the competition. Additionally, consumer behavior has been impacted by the larger macroenvironment as a result of rising inflation and higher costs.
This has been echoed by several of the other companies as recently as this morning was mentioned, consumers are pulling back on spending. We view this as a temporary reset of consumer spending. As consumers have not been prioritizing the budget protection and convenience of home warranties. I will go into how we are addressing this shortly. Now turning to renewals, which continues to be a bright spot for us. For the first quarter 2024, our retention rate grew to 76.3%. While this includes a lower mix of real estate customers. Retention continues to perform very well. Our team has done a great job of implementing a wide range of initiatives to improve retention, such as better engaging our consumers, specifically during the onboarding process, expanding dynamic pricing to minimize churn, continuing to improve the customer experience with a large part of that effort coming from increasing utilization of our preferred contractors.
This is a dual benefit of lowering costs while delivering a better experience. And finally, we have increased the number of customers on AutoPay, which remained at a record 86% in the first quarter, which makes them much more likely to renew their home warranty. We know there is more we can do to improve our customer service and we are diligently working on those initiatives, but I am super proud of our team’s accomplishments in this area. We’ve also been very proud of our new HVAC sales program, which delivered over $50 million of revenue in 2023. As you would imagine, much of this came in the second and third quarter, and we are expecting a similar pattern this year as we head into our peak summer season. In fact, we recently enhanced the Frontdoor app so that all users can now buy a new HVAC system.
We are also continuing to grow into alternative revenue streams by building out our technology capabilities for additional on-demand services. Our vision is to provide a consolidated ecosystem where customers have access to video chats with an expert which might then turn into purchasing a-la-carte repair and maintenance services or even new systems and appliances all through our app, more to come here, but we know that the market opportunity is significant, and we will continue to work to find ways to monetize that demand. Let’s now turn to slide 6 and our opportunity. As I said on our last call, there are about 5 million homes in the US that have a warranty. We believe that figure could be approximately three times higher if consumers better understood the value of a home warranty, which brings us to the American Home Shield brand relaunch, which is a primary component of our strategy to increase demand.
And I’m very excited that we successfully kicked off the relaunch in early April, we took a holistic approach to the relaunch, which has the following components. At the highest level we wanted to break out from that sea of sameness in the home warranty category. And that starts with a new strategy that truly brings a refreshed and high energy look to our brand. We also wanted to connect to new and larger audiences. So we came up with an innovative ad campaign with a new voice and a new brand visual identity. We wanted to have a catchy recognizable tag line. And that’s why we came up with Don’t Worry. Be Warranty. This tag line captures that feeling. We want homeowners to take away peace of mind, freedom and happiness. It’s proactive and goes right at the main word that defines our services.
We also needed a new logo so that consumers can better distinguish us from our competition. So we refreshed with brighter, bolder colors and a more modern look, we wanted to use comedy and a strong well-known personality to do something different to break through to consumers. That’s why we are extremely excited about our new celebrity spokesperson for ‘Warrantina, starring Rachel dredge, which we believe will drive greater interest in our products. And finally, we wanted a comprehensive media campaign with new marketing partners, as shown on Slide 8. This is now a true omnichannel campaign that is highly visible. We are we develop great new partnerships that are better reflected our customer base for example, we launched a campaign on WrestleMania.
We were also on CNN’s coverage of the solar eclipse in a big way with our website traffic hitting new highs that day. Speaking of the website, I encourage all of you to visit ahs.com and hope you notice it not only has an updated look, but it also has a more intuitive interface and navigation tools that will improve conversion. In summary, we are truly bringing a refreshed and high energy look to our brand. However, we know we have relaunched our brand in the face of a challenging macroenvironment for home warranties. But that is the point as the leader in our category is our job to turn demand around and we are optimistic this relaunch will improve the growth trajectory for home warranties for years to come. With this much change, it would be premature to talk results thus far.
However, we are excited about what we are seeing in web traffic and in other areas and look forward to providing you more details on our next call. Before I turn the call over to Jessica, I want to reiterate that we are off to a great start in 2024. And our first quarter performance continues to show that Frontdoor Inc. is operating extremely well. Jessica?
Jessica Ross: Thanks Bill, and good morning, everyone. Before I get into the details, I wanted to first build on Bill’s remarks with a few high-level thoughts about a quarter and outlook. First, we want to celebrate that we had another record quarter, which was primarily driven by better than expected margins as the team continues to drive operational excellence across the business through our margin expansion initiatives. Second, in response to our strong first quarter performance, I’m pleased to share that we are raising our full year outlook for gross margin and adjusted EBITDA. Now let’s turn to Slide 9, where I’ll review our first quarter 2024 financial summary. First quarter revenue increased 3% versus the prior year period to $378 million.
Net income increased 56% to $34 million and adjusted EBITDA increased 33% to $71 million, which both represent records for first quarter performance. Now moving to Slide 10, where gross profit for the quarter increased 14% versus the prior year period to $195 million and gross margin improved 510 basis points to 51%. The gross profit improvement was primarily driven by higher realized price, a transition to higher service fees and continued process improvement initiatives and was partially offset by inflationary cost pressures. Let’s now move to the adjusted EBITDA bridge on Slide 11, where I’ll provide more context for the year-over-year improvement in first quarter adjusted EBITDA, starting at the top, we had $14 million of favorable revenue conversion, driven by an 11% increase in price over the prior year period.
This was partially offset by an 8% decline in volume primarily driven by lower sales in our first year channels. This also includes a $6 million increase in other revenue due to higher on-demand home services, primarily from the new HVAC program. Contract claims costs decreased $10 million, which was better than expected. This includes a transition to higher service fees that had two impacts. Third, higher service fees resulted in a lower number of service requests per customer as we typically see a temporary change in customer behavior until they become accustomed to the new fee amounts. Second, higher service fees also resulted in a lower net cost per service request, and these fees are a contra cost to claims expense on our income statement.
Additionally, our contract claims costs improved over the prior year period in part due to our ongoing process improvement initiative. This includes improving our planning processes, moving more of our service requests to our preferred contractors. Our new high cost claims review program and leveraging our bulk purchasing power. These improvements were partially offset by ongoing inflation as well as a $5 million unfavorable change in claims cost development year over year. Now moving to sales and marketing costs, which increased $7 million over the prior year period, primarily due to better pacing of our marketing investments to drive growth in our direct to consumer channel. And finally, general and administrative costs increased $3 million, primarily due to increased personnel costs.
To some of our bridge, all of this resulted in adjusted EBITDA increasing $18 million to $71 million. With these results, we exceeded the midpoint of our outlook by approximately $25 million. And I want to take a moment to provide some context here. First, remember, when we provided our outlook, we were working with the late February data and assumed normal weather from March, but then March came in much more favorable than anticipated which was the primary driver of lower incidence or about a $10 million favorable impact compared to our guide. As a result, our net cost per service request came in much lower than anticipated in the first quarter. With a better than expected incidence rate, we were able to allocate more jobs to our preferred contractor network which handled 84% of our service requests in the first quarter.
Additionally, we continue to benefit from our process improvements and rigorous cost management by our contractor relations team. We also benefited from some favorable timing around our marketing. Let’s now turn to slide 12 for a review of our statement of cash flow. Net cash provided from operating activities was $84 million for the three months ended March 31st as a result of our exceptionally strong earnings and was comprised of $51 million in earnings adjusted for noncash charges and $34 million in cash provided from working capital that was primarily driven by seasonality. Net cash used for investing activities was $10 million and was primarily comprised of capital expenditures related to investments in technology. Net cash used for financing activities was $21 million and was comprised of $13 million of share repurchases as well as $4 million of scheduled debt payments.
We ended the quarter with $378 million. This was comprised of $165 million of restricted cash and $213 million of unrestricted cash. We were also extremely pleased with our free cash flow conversion of $73 million for the three months ended March 31st. The majority of the increase over the prior year period was driven by higher earnings, and I believe this number speaks to the cash generating power of our business. Now turning to Slide 13, where I’ll provide an update on our current capital structure. We continue to have an extremely strong financial position and a consistent capital allocation framework. Our number one priority remains to focus on growth, and we continue to prioritize investments that expand units as well as grow revenue and adjusted EBITDA, both organically and through opportunistic M&A.
Our second objective is to ensure we have a solid financial profile, which includes maintaining appropriate levels of liquidity to run the business and a prudent long-term debt structure. We currently have a very modest level of debt, and we have a low net leverage ratio of 1.1x. And finally, our third objective is to return cash to shareholders. Through the end of April, we repurchased $33 million worth of shares, which brings our total to $314 million since we initiated our share repurchase program in 2021. Let me conclude this section by saying that I recognize that our unrestricted cash of over $200 million is above our targeted range of between $100 million to $150 million required to run the business. This higher cash balance was driven by our better results, coupled with timing and seasonality.
This in turn drove our net leverage ratio down to 1.1x, which is below our targeted net leverage ratio of around 2x to 2.5x. We are coming off of some very volatile earnings, and it was not that long ago that our net leverage ratio was closer to 3x, I want to ensure that investors know, we do not plan on keeping our unrestricted cash or leverage ratio at the current level. We have a significant amount of financial flexibility and we will continue to follow the capital allocation strategy I just walk through when making decisions about utilizing our cash which is focused on growth and share repurchase. And now turning to slide 14, where I will walk through our second quarter and full year 2024 outlook. We expect our second quarter revenue to be between $530 million and $540 million, which reflects a mid-single digit increase in our renewal channel, a decline in our real estate channel of approximately 15% to 20% and roughly 16% decline in our DTC channel, which reflects an expected improvement from our first quarter results and a $10 million increase in other revenue to $34 million.
Second quarter adjusted EBITDA is expected to range between $130 million and $140 million, a 12% increase over the prior year period. Now turning to our full year 2024 outlook, starting with revenue, where we are maintaining our range of $1.81 billion to $1.84 billion. This assumes a mid-single digit increase in the renewals channel, a 10% decline in the DTC channel and a 15% to 20% decline in the real estate channel. As a reminder, there is a timing difference between the time of sale occurs and reported revenue, which we recognize over 12 months. It also assumes other revenue will increase approximately 30% to a $100 million, primarily driven by higher on-demand revenue mainly sales from our new HVAC program. We continue to expect a mid-single digit increase in realized price, which will be offset by a mid-single digit decline in realized volume from lower member count.
As a reminder, our 2023 home warranty count was down 6%, and we expect this to decline 1% to 3% in 2024 to approximately $1.95 million. We are raising our full year gross profit margin outlook to be approximately 50% as we continue to stabilize margins in our core business. This outlook assumes normal weather as we enter into our peak season. When our system is typically more strict. We are also saying that inflation will be in the low to mid-single digits on a net cost per service request basis and the number of service requests will decline 5% to approximately $3.7 million. We are maintaining our full year SG&A range to be between $580 million and $595 million as our 2024 plan includes a previously announced transition of marketing investments from the Frontdoor brand to the American Home Shield brand to support the relaunch.
As Bill mentioned earlier, we are very excited about the brand relaunch as we anticipate it will play a critical role in increasing demand and growing revenue for the long term. Based on these updated inputs, we are increasing our full year adjusted EBITDA range to be between $360 million and $370 million. Our full year outlook also includes $13 million of interest income and this led to stock compensation expense of approximately $30 million. And finally, we expect our full year capital expenditures to range between $35 million and $45 million and the annual effective tax rate to be approximately 25%. In conclusion, we are very pleased with our first quarter financial results. We continue to deliver better than expected adjusted EBITDA as a result of the rigorous work the team has done to execute on our margin expansion initiatives, and we remain committed to finding new and innovative ways to continuously improve our business.
I will now turn the call back over to Bill for a few closing remarks before we open up the line for questions. Bill?
William Cobb: Thanks Jessica. One final note before we go to your questions, you’ve heard me on the last call, talk about how we think our stock is undervalued. I still firmly believe that. Our first quarter performance demonstrates the exceptionally strong earnings power of our platform. We generate a lot of cash that we will use to grow or to buy back stock. And finally, I am confident that we are on the right path to increasing the growth trajectory of our customer base. There are so many upsides to this category in our company that we have decided to hold another Investor Day to share our vision and strategy with investors and analysts. The date we have chosen is November 7th in New York City. I think it will be well worth your time to attend and we will share more information as we get closer to November. Operator, let’s now please open up for those who are on the line for questions.
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