Frontdoor, Inc. (NASDAQ:FTDR) Q4 2023 Earnings Call Transcript
Frontdoor, Inc. (NASDAQ:FTDR) Q4 2023 Earnings Call Transcript February 28, 2024
Frontdoor, Inc. beats earnings expectations. Reported EPS is $0.2, expectations were $0.03. 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 Fourth Quarter and Full-Year 2023 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.
Matt Davis: Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor's fourth quarter and full-year 2023 earnings conference call. Joining me today are Frontdoor's Chairman and Chief Executive Officer, Bill Cobb, 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, February 28, 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?
Bill Cobb: Thanks, Matt. And good morning, everybody. Let's start with 2023 where we smashed expectations and delivered record financial performance. As you can see from slide 4, we drove revenues 7% higher to a record $1.78 billion despite a decline in overall [Technical Difficulty] demand. Gross margins rebounded 700 basis points to 50%, a nine-year high. Adjusted EBITDA increased 62% to an all-time high of $346 million. We generated $170 million of free cash flow, and we returned $120 million to investors through share repurchases. In short, the turnaround in our financial performance has been remarkable. So how do we complete such a successful turnaround? When I stepped into the CEO role 21 months ago, the company was struggling to respond to inflationary cost pressures.
Since that time, I brought in new leadership, we accelerated our pricing actions, we took decisive steps to improve execution, and we increased our retention rates. I am extremely proud of how everyone responded to these challenges. And to be perfectly transparent, the plan came together faster and better than we had hoped, notwithstanding that we had a lot of things fall our way in 2023. One of the main themes you will hear today is when we experience a challenge in any part of our business, we do the research and we establish a strategy, and then we execute against that strategy. This is what we did with our margins over the last two years and this is now what we're focused on doing for our top line sales, which is a great transition to slide 5.
So let me be clear. Our top priority for 2024 is to focus on driving customer growth. We will do this by relaunching the American Home Shield brand, increasing direct to consumer sales, driving renewal rates higher and expanding our on-demand revenue, while positioning the company for an eventual turnaround in the real estate market. On the margin front, we feel very good about delivering a consistent margin profile in 2024, with the volatility of the past two years behind us. As a reminder, we had to take a significant price increases to combat inflation and right-size our margins, which frankly impacted customer growth. Now that inflation has come down and margins have stabilized, we do not need to continue to take double-digit price increases and can focus on growing our customer count over the long term.
In addition to the objectives shown on this page, we have a host of initiatives designed to continue to build a strong foundation across our contractor relations, procurement and technology groups. Many of these efforts are aimed at our longer term goals, to enhance the customer experience, expand on-demand offerings and improve operational efficiency, all with the ultimate objective of accelerating customer growth. Now turning to slide 6 and the significant long term growth opportunity for home warranties. In the US, there are about 5 million homes that have a warranty. We believe that figure could be approximately 3 times higher if consumers could better understand the value of a home warranty. As a category leader, it is our job to solve that problem and drive demand for our products.
Let me quickly walk you through some of the main reasons consumers should buy a home warranty for American Home Shield. First, we offer homeowners financial protection from expensive repairs or replacements that will inevitably happen. The median savings account balance for American households is only $5,300, according to the last Federal Reserve survey. So, this aspect of our value proposition specifically appeals to those homeowners. Second, we offer customer convenience. You don't have to deal with climbing into your hot attic to see why your air conditioner is not working. Nor do you have to deal with finding a reliable and insured contractor. We have built a curated nationwide contractor network to support you. And unlike an insurance company, we typically don't just write you a check, we take care of covered repairs for you and get you back up and running.
And finally, our value proposition offers peace of mind, that the work will be done right and guaranteed, so that you can feel in control of your home. Owning a home can be challenging and the value proposition that we offer is still very relevant to consumers. Homeowners just want their systems and appliances to work, and that is exactly the service we provide. On slide 7, you will see that American Home Shield is the largest home warranty company with 2 million customers and 16,000 contractors and that we completed approximately 4 million service requests last year. We have built a virtuous flywheel where our size gives us leverage with our contractors and suppliers. This provides us with a superior margin profile, which we can then invest in the business.
As the leader in the category, we have the opportunity to reset the industry by changing our approach to what a home warranty is and how we should go to market. We will do that by relaunching the American Home Shield brand to reignite unit growth, as shown on slide 8. Let me start by answering the question, why a relaunch and what exactly does that mean? To stay relevant, smart brands must evolve. This is especially true with category leaders who have been around for a while. American Home Shield is over 50 years old, and we have built tremendous equity with millions of homeowners. But there is a time when even the best consumer brands must bring a fresh approach to the marketplace. Think Duncan or Domino's, Arby's or Old Spice. It is now our time.
So let's get specific about what we mean by a brand relaunch. First, we are improving our brand positioning strategy. Our consumer research tells us that consumers are failing to understand the value a home warranty brings. As the category leader, we must do a better job of educating homeowners, and that is exactly what this brand relaunch will accomplish. We will explain what it means to "warranty your home" in a creative, memorable way. Second, we're improving how we execute that strategy with an innovative ad campaign. A new tagline, a new logo, as well as a new brand voice and visual identity that will launch in early April. Third, we will drive greater interest through the use of a celebrity spokesperson across our marketing channels. Fourth, the relaunch will be supported by a refreshed or user friendly website, which will launch in late March to support the early April media campaign.
I am extremely excited about what the relaunch of American Home Shield can do for us. Now turning to slide 9 and an update on our real estate channel. The National Association of Realtors, or NAR, reported that existing home sales declined 20% in 2023 to 4.1 million homes, the lowest level since 1995. Mortgage rates increased to an average of 6.8% in 2023, a 22-year high, which impacted consumer affordability. At the same time, inventory still remains tight. NAR reported properties remained on the market for just 36 days in January, which is a slight increase from the 33 days a year ago, but well below normal levels. We sell our products through real estate brokers. And last year, we had significantly fewer opportunities to place a home warranty as part of a home sale because of the challenging housing market.
In fact, our real estate channel sales in 2023 were less than half of what they were five years ago, as the macro factors continue to be a drag on our revenue, profitability and cash flows. As a result of these trends persisting over the last several years, we have taken steps to optimize our real estate channel spend. We have reduced the size of our sales team, worked to optimize agreements with our real estate partners, and continue to look at new and creative ways to market our products to drive sales. In short, it's a tough market, but we will be well positioned for when the market improves for home warranty sales. Looking forward to 2024, there are signs the market will improve. NAR is projecting sales to increase to 4.7 million homes and inventory levels could improve as more sellers enter the market.
However, we have not seen any material improvements in our real estate business so far this year. And until we see more tangible proof, it will continue to be a drag on our overall sales. Now turning to slide 10 where we've continued to see impressive improvements in our retention rates over the last few years. By the end of 2023, our retention rate increased to 76.2%. While this includes a lower mix of real estate customers, retention rates definitely exceeded our expectations last year. And now we've done this, we've taken the steps to fully understand the customer lifecycle journey and have implemented a wide range of initiatives to improve retention, including better engaging our customers, 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 has the dual benefit of lowering costs, while delivering a better experience. In fact, our customer five-star ratings increase to an all-time high in 2023, while our one star rating decrease to an all-time low. And finally, we have increased the number of customers on auto pay to a record 86% in 2023, which makes them much more likely to renew their home warranty. We know there's 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. Now turning to slide 11 and our on-demand services. We have been making a lot of changes to this part of our business, which is approaching $100 million of revenue. And I want to take a moment to clarify how we think about on-demand.
We've launched the new Frontdoor brand last year to provide a digital solution to expand our customer base. We built an app, we are providing access to video chats with an expert, and we have other services such as partner discounts available to our customers through the app. At this point, there are three parts to our on-demand business – upgrades, maintenance services, and appliance repair services. Upgrades are currently the largest part of our on-demand business. We expanded our HVAC upgrade program last year, which grew to $50 million. This year, we're targeting it to grow even more. Over time, we intend to further expand upgrades to include hot water heaters and appliances. Second is maintenance services. This includes things like HVAC tune-ups, dryer vent cleaning, and carpet cleaning.
Over time, we are looking to expand into additional preventive maintenance offerings. Third, appliance repair service that we're offering in a limited number of markets today. The plan is to expand into additional geographies, while also looking to broaden our offering into our traditional traits. What I like about the approach we're taking is that we're doing it methodically and with a heavy focus on execution and delivering on near term revenue. Additionally, we are investing in the tech resources and capabilities required to enhance access to these services through the app. In closing, 2023 was a terrific year for us. We took decisive action to improve execution that resulted in record financial performance. I will now turn the call over to Jessica to cover our financial results in more detail.
Jessica Ross: Thanks, Bill. And good morning, everyone. It is amazing to see the progress Frontdoor has made since I first spoke at our Investor Day just 12 months ago. We took decisive actions to improve execution and combat a challenging environment, which contributed to gross margins rebounding to the highest levels in nearly 10 years, along with record adjusted EBITDA. I could not be more proud of our teams and what we have accomplished together since I started 14 months ago. Please turn to slide 12 and our fourth quarter financial summary. Fourth quarter revenue increased 8% versus the prior-year period to $366 million. Net income increased 4% to $9 million and adjusted EBITDA increased 35% to $45 million. Next, we will move to slide 13 where gross profit for the quarter increased 22% versus the prior year period to $177 million and our gross margin increased 570 basis points to 48%.
Let's now move to the adjusted EBITDA bridge on slide 14. Starting at the top, we had $29 million of favorable revenue conversion, driven by a 15% increase in price over the prior year period, partly offset by a 7% decline in volume. Contract claims costs decreased $4 million, which was better than expected. This includes $10 million of favorable weather, a transition to higher service fees and continued process improvement initiatives, which was partially offset by ongoing inflationary pressure as well as a $19 million change in favorable claims cost development. Sales and marketing costs increased $17 million over the prior year period, primarily due to investments to drive growth in our direct to consumer channel and our Frontdoor brand.
And finally, general and administrative costs increased $6 million, primarily due to increased personnel costs. Please turn to slide 15 where I'll review highlights from our 2023 financial results. Revenue increased 7% versus the prior year to $1.78 billion. Net income more than doubled to $171 million and adjusted EBITDA increased 62% to a record $346 million. Now turning to slide 16 where gross profit for the year increased 25% to $885 million, and our gross margin increased 700 basis points versus 2022 to 50%, which is also a nine-year high. Now moving to slide 17 where we will walk through the decisive actions we took to improve our margins in response to the challenging macroeconomic environment. First, we were aggressive about price in response to rising inflation, which resulted in an 11% increase in realized price in 2023.
As a reminder, we typically sell 12-month contracts. So pricing actions take 24 months to fully show up in our financials. It is about 12 months to impact all relevant contracts and then another 12 months for those contracts to fully translate into earned revenue. Second, we improved cost control and planning processes. Third, we leveraged our purchasing power with suppliers and contractors. And finally, we implemented a new review process for our highest cost jobs. Let's now move to the adjusted EBITDA bridge on slide 18. Starting at the top, we had $126 million of favorable revenue conversion, driven by an 11% increase in price, partly offset by a 4% decline in volume. Contract claims cost decreased $52 million compared to the full year 2022.
This improvement was driven by a lower number of service requests per customer, which includes a $30 million impact from favorable weather; a $23 million change in claims cost development as we had favorable claims cost development of $11 million in 2023 compared to a $12 million unfavorable claims cost development in 2022; a transition to higher service fees; and continued process improvement initiatives. All of that was partially offset by higher costs, driven by inflation of 5%. Sales and marketing costs increased $46 million versus full year 2022, primarily related to the Frontdoor brand, as well as investments in the direct to consumer channel to drive sales. Customer service costs decreased $6 million, primarily due to a lower number of service requests.
General and administrative expense increased $15 million, primarily due to increased personnel costs. And interest and net investment income increased $13 million as a result of rising interest rates on cash deposit. All of this culminated into a 62% increase in adjusted EBITDA in 2023. Let's now turn to slide 19 for a review of our statement of cash flows. Net cash provided by operating activities was $202 million for the 12 months ended December 31. Net cash used for investing activities was $32 million and was primarily comprised of capital expenditures related to investments in technology. Net cash used for financing activities was $137 million and was mainly comprised of share repurchases. We returned $120 million to our valued investors by repurchasing 3.6 million shares in 2023 or approximately 4% of our outstanding shares.
You will also see that our free cash flow was $170 million for the 12 months ended December 31. We ended the year with $325 million in cash. This was comprised of $157 million of restricted net assets and unrestricted cash of $168 million. Now, before I get to our outlook, I'd like to review our current capital structure in more detail. We have an extremely strong financial position and a consistent capital allocation framework. Our number one priority is to focus on growth, and we will continue to prioritize investments that expand revenue, both organic 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 modest level of debt and we have an extremely strong net leverage ratio of 1.2 times. And finally, our third objective is to return cash to shareholders. As a reminder, we have returned a total of $280 million through share repurchases since we initiated the program in 2021. This amounts to 8.1 million shares or approximately 10% of our outstanding share count. Looking ahead, we are targeting $100 million every purchases in 2024. Now turning to slide 21 where I will walk through our first quarter and full-year 2024 outlook. We expect our first quarter revenue to be between $370 million and $380 million, which reflects an upper single digit increase in our renewal revenue, a decline in real estate revenue of approximately 20% to 25%, a roughly 20% decline in our DTC revenue, and a $5 million increase in other revenue to $17 million.
First quarter adjusted EBITDA is expected to range between $40 million and $50 million. The declines in the prior year period is driven by an increase in marketing investments to drive DTC sales, which also reflects better pacing of marketing spend throughout the year and will set us up for our brand relaunch in the second quarter. I would also like to mention that this outlook does not include a significant impact from weather. While we experienced an increase in service requests from the cold weather in January, this was largely offset by favorable weather in February. Before I turn to our full year outlook, I want to take a moment to address the 2025 outlook we provided at our Investor Day last year. At the time, we targeted $300 million of adjusted EBITDA by the end of 2025.
We have absolutely exceeded that objective, and two years earlier than we expected. We also shared a $2 billion revenue target. A lot has changed since then. We provided that outlook at a time when we thought that the real estate channel was going to significantly improve, which has not happened. At this point, we are solely focused on delivering on our 2024 objectives. Once we assess how the AHS brand relaunch goes, as well as how market conditions evolve throughout this year, we will come back to you with an update on our 2025 goals. Now for our 2024 outlook, starting with revenue where we expected to range between $1.81 billion and $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.
It also assumes other revenue will increase approximately 30% to $100 million, primarily driven by sales from our HVAC program. Our revenue guide also assumes a mid-single-digit increase in realized price, which will be delivered through our dynamic pricing model to minimize churn. Due to the timing of our price increases, we would expect slightly more price at the beginning of the year, which will then taper as the year progresses. To be clear, we price for a much higher rate of inflation than what we experienced in 2023. As a result, our gross margins rebounded back to normalized levels in the upper 40% range. Now that inflation expectations have moderated, we can turn our focus to growing our customer base. This will be offset by a mid-single-digit decline in realized volume from lower customer counts.
As a reminder, our 2023 customer count was down 6%, and we expect this to decline 1% to 3% in 2024 to approximately 1.95 million. As we look at this by channel, we would expect the largest decline to come from real estate. Additionally, our renewal channel is expected to slightly fall in 2024 as a result of a decline in our go-to-market channels flowing through. We expect our full year gross profit margin outlook to be between 48.5% and 49.5%. It is important to note that we are lapping $30 million of favorable weather in 2023, which amounts to about 200 basis points of margin. It also reflects a slightly higher mix of on-demand services. So we are very much viewing this as delivering stable margins in our core business this year. Our guide also assumes that inflation will be in the mid-single-digits on a net cost per service request basis.
Additionally, the number of service requests is expected to decline 5% to approximately 3.7 million, which assumes a slightly higher incidence rate across a lower total number of customers. Our full year SG&A target is between $580 million and $595 million, and includes a shift of marketing investments from the Frontdoor brand to the American Home Shield brand to support the relaunch. In total, we are essentially holding SG&A spend flat as we grow revenue. Based on these inputs, we expect our full-year adjusted EBITDA range to be between $350 million and $360 million. Our full year outlook also includes $11 million of interest income and reflects stock compensation expense of approximately $35 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%.
Turning to slide 22. Before I close, I want to make a very important point. 2023 was a truly exceptional year, one of outsized financial performance. Adjusted EBITDA was up 62%. And as much as I would love to continue that performance, I don't think that is realistic. Instead, I look to our two year adjusted EBITDA CAGR from 2022 through 2024, which is expected to be at nearly 30%. That's an impressive return. I will now turn it back over to Bill for closing statements. Bill?
Bill Cobb: Thanks, Jessica. In closing, I want to leave you with the top reasons to invest in Frontdoor, Inc., as shown on slide 23. First, we are the leader in home warranties and have a massive growth opportunity. Second, we have a great core business that is supported by a recurring revenue model. And I believe our American Home Shield brand is at an inflection point for future growth. Third, our margins have rebounded and we are looking to deliver a consistent margin profile in 2024. Fourth, we generate a significant amount of cash, and we use that to aggressively repurchase shares. And finally, it is clear to me that Frontdoor share price is significantly undervalued. When you look at slide 24, you can see that our adjusted EBITDA multiple is at an all-time low.
We're currently trading at an approximately 9 times multiple, well below our peak multiple of approximately 18 times and also below our average of 13 times. Logic would say that our valuation has to improve as we continue to deliver strong financial performance, our growth initiatives take root and as market conditions normalize. So, operator, let's now open the line for questions.
Operator: [Operator Instructions]. First question today comes from Jeff Schmitt with William Blair.
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