Frontdoor, Inc. (FTDR) Earnings Call Transcript

All right. Good afternoon, everyone. Cory Carpenter, Internet Analyst at J.P Morgan. We have Frontdoor with us today. Bill and Jessica. Thank you for joining us.

Cory. How are you doing?

All right. So Frontdoor, been around for over 50 years, but for those newer to the story, could you start with a high-level overview of the business and also the industry?

Yes. I mean it's a company that was started really based on the real estate industry, where the initiative was that beyond home insurance, there was a need for a product or service that could help with the normal wear and tear of appliances and systems in the home. It generally has been through the real estate industry that people have access to American Home Shield about 25 years ago. The company moved to a direct-to-consumer initiative. So those are the two pathways in, is either through the real estate transaction or you can go on the website or an 800 number and call and get access to joining up with us. The business, the way it works is a member of American Home Shield has an issue, a repair or something is broken in the home. They call us. We -- they will pay a service fee to have a contractor come out, they will come out, repair it. And in the large majority of cases, occasionally, we will replace the item. And that's kind of the virtuous cycle, the way it works is that we have a contractor network of about 16,000 contractors around the country, about 2,500 or so or what we call our preferred or our better contractors but for consumers, it does a couple of things. Budget protection against unwanted repairs, which are always going to happen in a home, and it gives you a peace of mind that you have somebody who can come in, who's curated, who is vetted and that you can depend on us to deliver a service.

So Bill, you're coming up on about, I think, your 2-year anniversary as CEO, what have been your initial priorities? And how has Frontdoor changed during this time?

Yes. I came in at a time of high inflation. And we were sort of all over the place. We were not well organized internally. We're still hiring a lot of -- had a lot of head count requests out there and -- so I came in and just wanted to do some simple things. Let's slow down to put an end to the hiring, let's get a control of our expenses and we did a whole SG&A analysis. Let's face right into the inflation situation. So we made the decision to price to cover our costs, which led to some rapid price increases. And frankly, have been -- we thought inflation would sustain at a high level for longer. It has not, which has been a benefit for us from a margin perspective. Also changed over the leadership team. I just did some things to just operate the company in a better way with a focus on trying to grow both revenue and EBITDA at the same time. And it's been pretty successful. We've been able to grow our EBITDA from about $214 million we finished '22 because we did finish pretty strong and then we finished last year at $346 million, I think it was Jessica? $346 million. And then after Q1, we just gave a guide where we raise the target for '24. So we've been operating well, and I think the company is in good shape. We've got a great leadership team, and I'm really pleased with the point we're at.

So I want to talk about the industry bit. For an industry that's been around for decades, it feels like I'm always surprised by how little is known. How do you frame the addressable market opportunity for home service plans? And what do you think needs to happen to increase penetration from the current 5 million homes that have plans?

Yes, it is curious that for an industry that provides such a terrific service, for relatively affordable levels, $50, $60, $70 a month, most of our people are on auto pay. That the service that it provides has been curious for us. It's about 5 million homes that have a home warranty. We've estimated based on the demographics of those who have a home warranty today that we can about triple -- that the addressable market for home warranties is about 15 million households. So we do think that there's a lot of room out there. Obviously, with what's going on with the real estate business that has dampened our first year units. We can -- I'm sure we're going to talk about that in a minute. But I do think that we have an ability to expand the market because the value proposition still is strong. All our research shows when you put -- sit down with consumers and put the proposition in front of them, for this amount of money, you have service of your 23 systems and appliances in the home. It really resonates with consumers. We just have to do a better job of marketing and pricing it in a way that is going to attract more and more people.

And we'll definitely talk more about marketing. One more on industry. So 5 million plans. Could you talk about the competitive landscape, what that looks like? And then also what you think of as your competitive moats?

Yes. We have a pretty large share relative to everybody else. So we pretty much -- while we pay attention to what others are doing, we believe we provide the best coverages to our members. We believe we have the best service. We have the best contractor base. So we spend -- we eyeball competitors, but we are pretty much focused on our own area and executing and driving that. In terms of where that goes, I think that there are -- there are definitely start-ups and people who are poking at this area. But for our company, we have almost 2 million members. We have relatively low CapEx, only about 2% of revenue. We're going to throw off -- over 50% of our EBITDA is free cash flow. We've got a lot of cash right now. We'll -- I'm sure we'll talk about the balance sheet in a bit. But it's a really great model, I think, in the whole home services area. It's hard to be a 2 million member, $1.8 billion in revenue, $360 million thereabouts in EBITDA, low capital and the way we turn up cash.

So focusing on Frontdoor now. Hoping you could talk about the key trends impacting your two primary customer acquisition channels, real estate and then also direct to consumer?

Yes. Let's start with real estate. So it's pretty well known that the real estate business has been going through some interesting times. 2 years ago, 6 million homes were sold which you would say was a very vibrant market for us. The issue with the high amount of homes sold was that it was a seller dominated market. There was not a lot of inventory on the days on market. And for us to be an attractive proposition, we need sellers in their listings to include a home warranty plan. When they're getting multiple offers and they're getting offers within days as opposed to months, that attraction lessens. So that has hurt us. And now the industry with the interest rates growing, people are sitting in their homes at 2% and 3% mortgages. People are not as adept or attracted to buying and selling homes. So we're down to 4 million homes being sold, this is the estimate for this year. I still -- I think we're just going through a tougher time. I think it's cyclical. Talk to a lot of people in the real estate industry, they've seen this before. We will come through this. But right now, it's a little tough. When interest rates start to fall, I think the flywheel is going to start. And I do think it has an overhang leading into DTC that it has impacted DTC. It's hard to show a direct co-relation but it is something that we believe does have an impact with all this swirl around real estate. Now DTC has generally fallen for most of the competitors, including ourselves. It has become, I think, inflation with the price increases that we were able to take to cover our costs. It did have a rapid rise against consumer spend, and this is a discretionary purchase. And there is also high inflation. So that will work itself out we're confident of. We think we're hitting some of the low points as we go forward. And we think once we get -- and we believe we will, get first year units humming again, we've got a terrific model in terms of what we've done on controlling our costs, working with our contractors, controlling our claims costs and the cash generation that we were able to effect.

So on the real estate side, a challenging market, like you said, but what are you doing or what are you able to do to position yourself for when you do see a rebound?

Yes. We're working very closely with our brokerage partners is one element. So we've got a number of marketing services agreements with those brokerage houses. Our sales teams are working up various ways of intersecting with getting deeper with the top agents in the country. We're very attuned to the types of things that we can do to try to get right now a greater share of real estate. We are beholden to the market to some extent. But we haven't sat down and just said, well, let's see what happens. We are being very aggressive with our sales team in terms of going out there. Now in addition to that, in the real estate piece, we are also -- and we'll probably talk about this, we are also very focused on delivering other areas of revenue growth, and that's what -- and I'm sure we'll talk about it, Cory, the new HVAC program has been a big benefit to us as we're going through these tough times. That has been a revenue upside almost from a standing start that we're really happy about and continues to accelerate for us.

So one more real estate then we'll go direct to consumer, Could you talk about attach rates? What are they normally? Has that changed? And then a lot of change going with realtor commissions right now or proposed changes? Do you see that impacting Frontdoor at all?

Yes, the attach rate has been a killer for us for everybody in the industry. It used to be around 30% of all real estate transactions, had a home warranty attached. That's fallen to about half of that, about 15%, 16%. That is something that we believe will accelerate. I don't know if -- I don't think we'll get back to 30% attached but that should accelerate as the market starts to stabilize. So that has been a dampening of the volume piece just through attach rates. Now as far as the commission rate, there's been a lot of swirl on that. I think that I don't -- I think it could be a net benefit to us because I think that speaking to some folks in the real estate business, the better agents have been negotiating rates anyway. I think it's more of a -- of immediate convention. I don't think it's going to impact us. If anything, we think on balance, it's going to help us because the better agents are going to take their listings and try to differentiate them and home warranty is one of the ways that they can differentiate them.

Okay. Moving to direct to consumer. I think perhaps your biggest initiative this year is relaunching the American Home Shield brand. Where are you in this process? And what can you tell us about the early results?

Yes. We relaunched American Home Shield. It's a 50-year-old brand, and we've talked about how in many situations and you look at a Domino's, you look at an Arby's, you look at an Old Spice, brands need to be -- brands are resilient and -- but they do need to be refreshed. And that's what we're trying to do with American Home Shield. We have a new website. We have a new logo. We have sharper colors. We've got a new tagline called "Don't worry. Be warranty." We've got a new spokesperson, the former Debbie Downer -- Rachel Dratch, who is what we're calling Warrantina. It's new creative. So we've got a package of initiatives, and we're really pleased with the website, that to show a new face to the industry. The industry is marked by what we call a sea of sameness. The names are similar. All the colors are red, white and blue. There's not a real ability to differentiate, and that's what we're trying to do with Warrantina. This is going to be a long run. This is going to -- relaunches take a while to effect. I'm not going to give any updates on results. We'll do that at Q2. But I'm really pleased with the package of initiatives and how they've come together.

Okay. How do -- could you talk about how the retention and margin profiles differ for real estate and direct-to-consumer? And once you do get a customer to renew after the first year, what is their retention like?

Yes. So this is one that has puzzled me frankly, since I started here, which is the real estate renewal rate is about 30%. And actually, we've moved it up to 30%. And it's been traditionally in the mid-20s or so. Why we -- yes, we renewed DTC one in the low to mid- 70s in terms of renewal rate. And then as we go from 2-plus years, we're approaching 80%. So we get to a point where we have such a disproportionate change between DTC and real estate. We are spending a lot of time on the real estate side, trying to get that renewal rate up because that's kind of found money. They are our customers. Sometimes they don't know they're our customers, which is one of the things that we have to do. But that's a big effort for us. But we're really pleased with our renewal book of business. It's the backbone of the company. It's 3/4 of our members. And we've put a lot of time and attention across the company, whether that's working with our contractors, our marketing teams on what we call the member journey so that we're staying in touch with members along the 12-month contract. So we've improved our preferred contractor rate. We've done a lot of things to really improve that renewal book, and we think we can continue to do that as we go forward.

So you mentioned price increases earlier to offset inflation. Question there is, what have you learned about price elasticity? And how should we think about pricing as a driver of growth going forward?

Yes. I mean, when I -- I used to hear when I was just Chairman, not CEO, we're generally inelastic. Well, we've tested that one with the with the price increases we've had. So we are more elastic than we have been. I think generally, when people -- when we talk to consumers, et cetera, and I think it's proven out in renewal rates, as long as we perform the service and the core value proposition, we should be fine with our pricing. I think it will settle out. It has been a little bit of a shock to the system in terms of the amount of increase, which I think did test the inelasticity aspect. But I do think as a value proposition, we want to earn our way through there. I think that people will come back to realizing what a great value this is. And so I'm not particularly worried in the long term. In the short term, I think it has dampened some of our volume.

Okay. So one topic I wanted to talk about is customer service. The industry as a whole is kind of -- has been plagued by customer service historically. You're trying to change that. Could you talk about the progress you've made and what you're doing to address it?

Yes. I mean this is an industry and I'll talk industry, and I'll get specifically to us, that is based on a contract with each member. And there's coverages amounts, and of course, there are things that are not covered. That's the friction point in terms of what's hampered the industry from time to time is people's lack of understanding of what is covered through a home warranty and what is not. I think we have taken the approach of simplifying our contract. It's still kind of complicated, but it's much simpler than it was, doing a better job of training our authorization agents and the people who interact to go through the coverages with our members. And I think it's borne out our service times have improved greatly over the last couple of years. Our 5 stars ratings are at the highest level we've ever had. Our 1 star are at the lowest level that they ever have been. Our executive escalations, nastygrams that were sent to me are at all-time lows. We still get some. We're not perfect, but the improvement has been significant. And I'm really pleased with the effort across the organization by our service ops team and our other operators that we're serving our members really well, and we'll continue to do so.

Okay. So so far, we've talked on the home service side, which is the vast majority of your revenue. But you did mention the HVAC program. You launched the Frontdoor brand last year. You recently announced you surpassed 2 million downloads. Could you just update us on what the offering looks like today and the role you see it playing in the broader portfolio? .

Yes. So we've had great attraction to the Frontdoor concept of being able to video chat with an expert. We went out and hired a number of expert -- people who are in the -- plumbers, electricians, handymen, HVAC specialists and appliance specialists. We have them on staff. They are our employees. And so the core concept is a -- is what we call the Frontdoor Unlimited and you have access to unlimited video chats for 1 year. What we've done, we had launched Frontdoor originally as a home service plan. That was my fault. It was the disaster, we pulled it out. We did not need a second home warranty business. What we need is an on-demand in-person business, and that's what we're driving toward. What we really think about, think of this as an ecosystem where we're trying to get more and more users through the interest in the video chat, and then look at the various services we can do on an on-demand in person, think of it as without a -- no need for a contract. Now the lawyers will tell me, of course, they have to sign something and all that stuff. But primarily, it's not a 12-month contract. And so we're able to do appliance repair on demand. We're able to put a new HVAC system in your home on demand. We're able to do maintenance issues, carpet cleaning, gutter cleaning, reeking et cetera, on demand. So that's what we're trying to build, and that's a business we listed under an other category on our statements. Of about -- we think it's going to be about $100 million this year. Now the vast majority of that is this new HVAC Upgrade Program, which has been a real winner for us, and it's a great value proposition for our contractors and our members but we're trying to build out a companion business to home warranty. And the way I talk to investors about it is, look, we got a very strong core business in Home Warranty. It's got very good margins. We free up -- we turn up a lot of cash. And then we have this option value as we try to build out over the coming years, this on-demand business. So that's your option value on the stock. But the core business, I think we're managing extremely well.

So what's been -- why has the HVAC program been so successful? What are consumers -- what's resonating? And then could you talk about some of the other monetization strategies you're testing?

Yes. I think what we've done is we've partnered with our contractors and our OEM suppliers and so our supply chain team is buying equipment extremely well and making it available. We've got to deal with our contractors to what their margin profile will be. And what that amounts to is then about a 30% to 40% discount generally for individuals to put in a new HVAC system. That's a low-margin product for us, but it has a downstream effect of the more new equipment out there, the less truck rolls, the less repairs we have to do. So that's not seen in the margin, but that is seen in our dispatches and the like. So we think it has a terrific benefit of -- and the attraction for people to upgrade their systems because these are more efficient systems, the electric bill is lower. So there's a lot of benefits to the member and not only they're saving of money on what it would generally cost to put in a new HVAC system.