Frontdoor, Inc. (FTDR) Earnings Call Transcript & Summary

Okay. Great. So let's go ahead and get started. I'm Cory Carpenter, Internet Analyst at JPMorgan. And joining me this afternoon is Rex Tibbens, CEO of frontdoor; and Chief Financial Officer, Brian Turcotte. Thanks for joining us. So for those newer to the story, frontdoor is the largest provider of home service plans in the United States with over 2 million customers across multiple brands, including American Home Shield. I'll kick off with questions, but if anyone in the audience would like to ask a question, you can click on the Q&A button, and we'll get to as many of you as we can. So Rex and Brian, thanks for joining us.

Thank you.

Thanks for having us.

Okay. So certainly, a lot to discuss, given the current environment. But before we dig into that, maybe Rex for you, I thought it would be helpful to kick off with a quick recap of the front door business today, transformations that have taken place at the company over the past few years?

Yes. We've certainly been very busy since we spun the company in October of 2018. The first order of business was really to put us on a very different operational footing. So the company has kind of been run on a series of averages, if you will, so really getting the company down to the inputs. So if you're building a financial model, obviously, that all your inputs are averages, then that's a pretty terrible model. So really getting down to deep from a data and metrics perspective. We now have dashboards and metrics on everything that we can think to run the company. Secondly, we wanted to really augment already a great team with some additional leaders. So we've hired a great team to augment an already great team and really set us on a different footing. From a technology perspective, we're way behind from a technology perspective. So really, the first year was about moving us to the cloud. So we can be far more nimble and be able to build microservices around some of our key components of the business. And then it's important that from a cost-containment perspective, we created tiger teams and really got deep on some of the cost problems of the company. And then we developed dynamic pricing, which allows us to really, I think, an industry first, to move from a situation where we're pricing contracts on a statewide basis to now get it down really to a neighborhood basis. So ZIP+4 or ZIP+9 in some cases. So by doing that, now we have the ability to really pivot around gross margin, making sure that we're pricing contracts the right way. And then that was kind of year 1. Year 2, we moved to more -- or in year 2, but really focused more moving from cost to growth and retention. We've hired a new CMO to really focus on our broadcast and digital efforts. And then the teams are doing a lot of work around retention, which even in the face of COVID, where we've still been able to maintain 75%. So a lot of things in that 18, 20 months that's been underway here at frontdoor.

Okay. So maybe fast forwarding to today, certainly, extraordinary times the past couple of months. What have you learned about the business? And could you talk some about the changes you've made to adapt to the current environment?

Well, we knew from the great financial crisis in '08, '09 or '07 to '09, that it's a very -- we have a very resilient business. And I think that continues to be tested even today. We -- our first and foremost, our most important thing was to move our employees to work from home situation. We -- majority of our headcount is call centers. And so within 8 days, we're able to essentially virtualize the company move to a cloud-based contact center management system that has really allowed us to not even miss a beat. So from an efficiency perspective, we're kind of -- as if we're at the same day, we turned out the light. So everyone's at home. We're working productively. And then we focused on our customers who may have concerns around contractors coming in their homes. We have hotline set up for folks to walk them through that process. And for our contractors, they were having -- they were struggling finding the proper PPEs. We've purchased over 200,000 or at 200,000 PPE masks for them to use. For our partners, both contractors and for realty partners, we've really accelerated the use of Streem. So we provided Streem free of charge for our top brokerage firms so they can do virtual walk-throughs with their clients, create virtual -- not walk-throughs, but virtual open houses, if you will, with potential clients. And then for contractors, they're finally believing what we've always believed about Streem and Streem really gives you the ability to help begin to solve customers' problems without having to ever go into their home. So things like hot water heaters were able to quickly assess that it needs to be replaced, well, there is no need in sending someone inside. We can begin to Streem automatically, we will measure the opening to ensure that new tank will fit. We can see if there's any plumbing changes that need to take place and if we should need to pull a permit. So those are all things that we capture make model serial number and provide all that information to a contractor, well today, contractors are doing that for themselves. So we've really rallied behind this pandemic and trying to keep things -- business is normal because we do provide an essential service.

That's helpful from an operational perspective. I think in terms of business impact from COVID-19. You surprised some investors with your resilience. Earnings last week. Revenue accelerated in the first quarter, profit came in above your guide as well. So what if any impact have you seen today on the business? And you kind of touched on some of this, but why have you been so successful and resilient in the current environment?

Well, the -- one of the major value propositions of the home service plan is budget protection. We think there's a lot of people out there who are very focused on budget protection during these times. The second one being convenience. So I think certainly when you look at our 3 or actually 4 sources of revenue. One, our first year real estate sales, certainly, it's going to be impacted, and that's why we pulled guidance, we just don't know yet. But we were able to provide guidance for Q2. As we begin to understand how quickly existing home sales can come back, then we can start to really understand the true impact for the year. For the second revenue stream, direct-to-consumer, first year direct-to-consumer sales, during this pandemic, serendipitously, we -- in April, had launched a new TV commercial, which folks haven't seen it, I would encourage to look at it. And that's performed very well for us. During all that, the 2 largest providers -- or sorry, consumers of broadcast ad sales are travel and automakers, and they've essentially pulled out of the market for now. So it's really allowed us to buy -- normally, we buy remnant TV. We could buy Prime Time at very attractive rates. And so we've really leaned into broadcast, and we've seen that new TV spot convert at double-digit from our old TV spot. So that's certainly been helpful for us. For digital spend in direct-to-consumer, we've seen a lot of people pull back in the market. So we -- which, obviously, lowers the rates. We've taken advantage of that as well and continue to spend on digital. Both those things really allow us to create better marketing efficiency, which should equate to better sales. Now obviously, real estate is larger from a first year perspective than direct-to-consumer. So if nothing else, it sets us up for a great '21 because our direct-to-consumer customers renew at a rate that's a little over 2.5x that of our first year real estate. The third revenue channel is -- which is our largest revenue channel, that's renewals. It's 2/3 of our revenue. We've been working a lot on retention since the back half of last year that continues to pay dividends for us. And we've seen our retention rate steady through April, too early to call May, but I wouldn't be surprised if it's the same. So we've seen better-than-expected growth from a direct-to-consumer perspective. We're staying in direct to consume -- our renewals, and we're kind of a -- we're in a wait and see mode on where real estate goes. The great thing about the model from a resiliency perspective, it really allows us to move our marketing dollars from real estate into direct consumer. So essentially, for us, it's a mix shift. And so that's exactly what we've been doing. The last, yet very small piece of the revenue pie is, Candu and some of our other initiatives. Candu and Streem will be the 2 larger ones in that kind of other revenue bucket. And those have been performing very well. We've talked about Streem, Candu has seen week-over-week growth as well. And still, we're only in 5 cities, so still very nascent revenue. But gives us a lot of encouragement when during the pandemic, we continue to see growth.

So maybe looking forward, as you mentioned in your guidance, first year real estate channel that is impacted and to a certain extent out of your control. And it's also just under 20% of your revenue. So one question we get a lot from investors is just how to think about the magnitude of impact you could see. So I guess my question is if in terms of precedence, is there anything you can look at for maybe '08, '09 crisis, or a macro proxy that could kind of help in terms of magnitude of impact we could see in the real estate channel?

When you look at -- when we look at the GFC, we grew revenue both in -- and Brian, keep you honest, always screwed up, '08 and '09 or is it '07 and '08. But -- I think it's '08 and '09. We grew 2% and 4% -- or is it 4% and 2%? I always get that backwards.

That's correct.

Yes. So we actually think there is a good possibility that we will outperform that, and this is certainly a much larger impact to our economy, 33 million people out of work. And that just speaks to the resiliency of the model. It's -- it kind of goes back to the value proposition of budget protection. When times are tight, people want to make sure that we're there for them to help take care of any unforeseen repairs. So we think that the changes we've made over the last 1.5 years, almost 2 years, really speaks to the resiliency of our business model.

Okay. I'll take one from the audience, and actually a good segue, I wanted to spend some time on Candu. So one question we just got is at a high level, could you lay out your vision for Candu?

Well, the home service plan business, we're 40-plus percent of that market, but that market is small of the total $400 billion home services marketplace. So as we move into more on-demand type services, now we can instead of reaching 5 million homes, we can reach 180 million homes if you factor in property management as well. So the total addressable market is much, much larger. And we think that as we continue to focus solely on skilled trades of heating and air conditioning, plumbing, electric, appliance, pool, spa, et cetera, that really -- we have the ability to leverage 17,000 contracting firms, over 60,000 technicians to now provide on-demand type services through us as well. We're sitting on about 50 years of repair data. So I think we are very adept at understanding how much things should cost. And our vision is that when you have a problem, you can go to our website or hopefully, eventually, an application. And we can tell you how much something should cost. We can tell you when someone can be there, and we can guarantee that it gets fixed. So when you think about that broader $400 billion space is half of that is repair and maintenance and the other half is home improvement. And we think that the Candu really gives us a shot at, at least the first $200 billion of that opportunity.

And then still early, you launched Candu in December of 2019, could you just update us on where you are today? And I think you mentioned earlier, you're still seeing demand increase week-by-week. So just touch on the customer response you've seen early on?

Sure. So the next big phase for us is really trade expansion. Today, we're in appliance only, and we're only in 5 cities. So step 2 is to expand into other trades. But the things I need to see in order to be comfortable with expanding to additional cities really come down to our customers using the product multiple times. Well, for rolling appliances, we have had customers use it multiple times, but I'd be great if you had all trades or most of our trades as a part of the Candu platform so that now we can see that repeat usage. Secondly, we want to make sure our customer acquisition costs are in a good place that makes sense to scale to other cities. So those are 2 things we're very focused on. From a demand perspective, we -- again, we're seeing week-over-week growth in those 5 cities, especially encouraging to us given we're in a pandemic. And then secondly, it's -- we're receiving great customer service scores. So between those things, we're still very bullish on the product. As we said before, '19 was a build year, '20, we begin to scale it and really scale and optimize in '21. I think we're still on plan to do that.

And I know you said last week, still on track for the $15 million to $20 million, no change there. Some resources in the near term, maybe shifting to some more COVID-19 type projects. Could you just walk us through how big of changes that if any? Or things just getting pushed back a month? Or how should we think about that?

Yes. Still on track to spend $15 million to $20 million this year -- $15 million, $20 million this year. Primarily, that will be a little bit of technology and majority of this is marketing spend. The -- for trade expansion, I said a quarter or 2, my team loves a good challenge. And like, no, no, I think we can do it in a month or 2. So you can imagine trying to virtualize the company in a little over a week, how we had -- it was all hands on deck to achieve that. So we got a little behind from a technology perspective. But the team is pretty confident they'll catch up. So I think we're looking at a couple of months delay. And then our overall plans for the year, I don't think we'll be severely impacted.

And then in terms of financial impact, again, understanding it's still early on the revenue side, certainly. How do you think about the margin profile of on-demand versus home service plans maybe today and then also the opportunity longer term?

Well, certainly when you build in the business, you look at the core unit economics, which I think are fitted in line with what we had projected. I think there will be from an EBITDA perspective, it'll be in line with kind of our current business. As you're building that business, obviously, we're investing. So in gross, we're not making money, we're investing money. So but I think the investment thesis for us still holds up. We're still on plan from a number of jobs we want to complete this year. And I think we're learning the things we want to learn, and we're progressing nicely.

And maybe last one on Candu. But -- 3 to 5 years from now, looking back, what does success look like for you? How big of a business does Candu have the potential to be in your eyes?

Well, certainly, our home service plan business. Depending on what happens this year. Last year, we were a little under $1.4 billion that's a pretty big business to overcome, right? But if you look at the total addressable market, we think in 3 to 5 years, Candu is still a very material part of our overall business. That is contributing margins that makes sense for us as a company. I don't think in 5 years, it overtakes home service plans, but I think it's a significant amount of revenue and a significant contributor to the business.

So maybe shifting gears away -- gears a bit away from Candu. Last week, you mentioned April claims incidents were below the prior year. We've gotten a few questions over the past few days. So I think what would be helpful is, could you give us a sense of how big of a pullback you saw just the magnitude of it? And then how much of a factor you think COVID-19 may have played versus normal fluctuations, such as weather?

Yes. We're still looking at it. But I think where we've kind of landed now is that April is always is kind of a shoulder season for us. It can get warmer in April or it can get cooler in April. What we saw is a single-digit decline in incidents in the first part of April. As we got towards the last few days of April, we saw a significant heat -- unprecedented heat in places like Arizona and California, which certainly than our accuracy claims kicked in. So we were down. I wouldn't view it as it's totally COVID-related. We have been getting this question a lot. Certainly, I think for life-sustaining things like air conditioning, heat, hot water, your refrigerator, certainly, I think we're not seeing any real change to volume in those areas. Maybe from a plumbing perspective, you've got a leak, you possibly, you're going to wait on those type of things, that's not the majority of our volume. So we probably have a very small amount of volume that maybe people are holding back on, but I don't view that as material at this point. I think that we'll have kind of normal forecasted claims kind of beyond the April time frame. So I wouldn't read too much into -- people are not using us because of COVID.

It sounds like -- you kind of have just answered the question, but my follow-up to that was how valid of a concern it is to think about this post-COVID-19 claims build up. The other thing that has been pointed out sometimes is just people in their homes are more and more stressed on AC systems. But it sounds like, in general, that's not a big concern for you.

Yes. Certainly, if you left for work, you turn up your air a couple of degrees to save some money. But doesn't really have a big impact on us from a claims perspective. You're using your refrigerator, whether you're there or not, maybe you open it and close it more and over a lifetime, maybe. But we haven't seen any real material changes in the types of incidences or types of claims. So I don't think people being at home more causes more claims for us at all.

So a couple of questions we got now in -- on Streem, getting a lot of attention in the current environment. So maybe to just start, you mentioned last week, you're accelerating your investments there, temporarily offering it for free to service providers and real estate agents. Could you talk about how you're utilizing Streem today and the response you've seen early on from the offering?

Sure. So for our realty community, we're giving Streem to them for free so that they can carry on their business, right? So it's not just about a virtual tour that you post to Zillow. This is more about how our realtors are interacting with potential new clients. So being able to do a video walk-through to suggest changes to the home before it's listed, you can make initiations. You can send that video back to the customer so that they have a record of things that they may want to mutually agree to change. And then while they're selling the home, you can do personalized walk-throughs with potential buyers. We do all of this as a way to show continued deep partnership with these brokerage firms. So when they do come out of this crisis, we're well positioned from a relationship perspective and we're top of mind. For our contractor community, as I said before, I think they're beginning to see what we've always believed about Streem. And that's -- you can provide a great customer experience, without having to first be in the home. If you think about this industry started almost 50 years ago. And it's always been a role of truck to see what's going on. Well, now, that's a very antiquated view of how to help customers. Now you can open up a Streem with the customer. You can see the issue firsthand. You can capture, make model and serial number, you can take measurements. You can, again, and take those things so that -- starting my career, to tell you that it was right place -- or sorry, right part, right place, right time, that's really the same thing for us, and that Streem allows us to make sure that we have the right parts, the right fix, right tech at the right time for the customer. So we think that for contractors, this really gives them a whole new set of tools to make them more efficient, which should make us more efficient. And so that's why we're so bullish on this, just if nothing from an efficiency perspective. And then beyond contractors and realtors, there's really a great third-party opportunity with Streem in that we've been inundated with inbound interest in Streem from cable companies, utilities, OEMs, big-box retailers, you name it, there's a lot of folks out there trying to solve the same problem that Streem solves. So again, a very small team, and we'll be very selective about who we partner with and we'll prioritize those opportunities. But we do think there's a great opportunity here to sell it as a service and have third-party relationships with other companies. So we couldn't be more proud of the Streem team and its abilities.

Okay. So another comment you made last week, just wanted to touch on, I thought it was interesting, was that some smaller home service plan businesses are exiting the market or maybe experiencing service issues. Could you expand a bit on what you're seeing in the competitive environment? And I mean, could this be an opportunity for you to step on the gas a bit and take more share?

Yes, certainly, we won't name names. But we've seen a couple of more medium-sized companies basically to shut their doors and going to leave their customers hanging because they didn't have the ability to create a remote workforce or maybe didn't want to create a remote workforce. Over the last couple of years, and especially in some parts of the country, we see a lot of kind of mom-and-pop home service plan companies spring up generally, they're tied to realty firms or someone who frankly, wants to make an easy buck and certainly, it's a cash churn business until about the third year when you start to see the claims come in. And that's what we're starting to see now is a lot of smaller ones have kind of folded up shop because, one, getting contractors to come out is difficult; but two, I think they're just frankly kind of going bust if you will. In terms of what opportunities that for us? Well, there's not a lot of regional players left out there. But certainly, we'll continue to be inquisitive for those regional players who -- that might make sense. Certainly, if their -- the private equity owner, we would probably pass just given the multiples. But we expect multiples to come down, and we will always be inquisitive in that area from a tuck-in perspective. Where we see actually more opportunity from an M&A perspective is around technology that would help propel us faster from a Candu or even a Streem perspective. So obviously, from a venture capital, people aren't writing as larger checks. And I think there's companies out there who may be struggling and might welcome the opportunity to be part of the frontdoor family.

So maybe sticking with M&A. And Brian, maybe one for you here. Over $550 million of available liquidity. Your leverage is down from 4x separation to just over 2 today. Could you talk about how you think about target leverage levels and potential size of transactions?

Sure. Thanks, Cory. Good question. We've proven that we can delever the business, as you said, going from 3.9x that spend to 2.2x net leverage in the first quarter of this year. Rex and I talk about this a lot philosophically. And we question if setting a leverage ceiling is really the right thing to do because that could possibly limit our opportunities within that constraint, right? So we think it's better to really value the long-term strategic and financial impact of any potential investment that we would make for this business. And then once you do that, then you can look at what kind of borrowings would you need to make your debt service, what would that be within our capital structure. So that's probably a better way for frontdoor to approach this M&A opportunities as, again, what can we fit within our structure and make strategic and financial sense longer term.

Good timing. We just got an M&A question from the audience. So the question is, you have 6 brands today, what type of brands or core competencies would you expect to add or look to add to the portfolio?

Well, I think if we answer that question, then those things will get a lot more expensive, right? But in general terms, we're excited about different technologies much like Streem kind of changes how people think about the problem in terms of taking the hassle out of the home. And there's a kind of different categories that we're very interested in. But unfortunately, we can't go into those categories right now because certainly, that makes them more expensive.

So moving on to the most exciting topic, which is cost and operational efficiencies. This is an area you've had a lot of success in over the past year. So I think 2 questions for you. First, where the biggest opportunities still remain on the cost side? And then I think second, you are pretty close to your longer-term margin targets. So how much more room do you think you have to drive efficiencies?

Yes. So the -- in terms of kind of what are the next big buckets. Brian recently hired a VP of Supply Chain, who is already, I think, turning over a lot of rocks, so to speak. We think that as a leader in the industry, we're still not getting though the level of procurement leverage that we think we can. It's not bad, but it could be much better. So that's something that he's hyper-focused on. And we think that's a good opportunity for us. The second, we've talked a lot about, and that's around moving us more towards a self-service perspective when it comes to customer service. I always use the joke. Last time I don't want to pick up the phone and call anyone was never, but still 60% of the time, you have to pick up the phone to call us. Now we have an online presence, but for whatever reason, customers would rather come through the phone. Well, that probably means that we don't have great self-service options for them. We're not updating them in real time. So those are all things that as we move it's 7% to 8% of our revenue is spent on answering the phone and customer service. So it's very important to us that we really create a phenomenal self-service platform so that, one, it's less expensive for us, but it's just a much better customer experience. And that's why you think about how integrate things like Streem and other artificial intelligence capabilities, we think we have a plan to do it. It's going to be a multiyear plan to get there. But that's -- we're talking about close to $100 million we spend on customer service. Your second question was around -- oh, margins. So from a margin perspective, we're still very excited about dynamic pricing. So dynamic pricing really gives you the opportunity to kind of toggle back and forth from the level of gross margin that you're looking for. So for folks on the Zoom here, dynamic pricing really moves you from a statewide level pricing down to a neighborhood-wide pricing. We can build cost curves by neighborhood. We can be begin to infer, as I say, sub-zero neighborhood or is this a whirlpool neighborhood and price accordingly. We're just scratching the service here. I want to ingest more things like average income, average home price, just to make the models better and better. But that really gives you an opportunity is that in the past, I think you use my California example because San Francisco labor prices were so high, we probably outpriced ourselves and stocked in places like that where labor rates were less expensive. So that's what dynamic pricing will help us do. But I don't see a world where we want to have 55%, 60% gross margins because I think that really means that we're probably giving up units that we could change our pricing in order to drive more customer growth. So I think that's kind of where we want to maintain is in kind of that around 50% from a gross margin perspective.

So we can't end on a cost efficiency question. So maybe one more. And I think this is a question we get a lot, especially to those newer to the industry, less familiar. But I think it's a very interesting one, which is you guys specifically have been around for 50 years nearly, but when we look at industry penetration, only 4% of 125 million homes in the U.S. have home service plans. So I think the question we get a lot is, why is penetration so low? And then as we think about frontdoor 3, 4, 5 years from now, what is the opportunity? How big do you think it can get?

Sure so I think it's -- we've -- as frontdoor has grown or has American Home Shield has grown, so has the marketplace. So I think that it's really a function of how much money we want to put behind marketing to drive brand awareness to then grow to market. I don't think there's a -- I don't think we're even near the ceiling of where we could grow from a home service plan perspective. As we talked about, the overall market is 5 million homes, that's why we're very enamored by Candu. We're now -- we're looking at a total addressable market that's multiples of the home service plan marketplace. So those 2 things combined, Candu is an incredible call option for the -- for frontdoor, that's who we are, frontdoor. And when we think about -- we're growing our home service plan business pre-COVID, high single digits, those 2 things combined to us mean a very compelling value proposition for investors.

Great. Well, I think we went 1 minute over. So thank you both for joining us. And thanks, everyone, on the Zoom.

Thanks for having us, Cory. Take care.

Thanks, Cory.

Bye.