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

Welcome, everybody. I am Aaron Kessler, Senior Internet Analyst at Raymond James. Pleased to have with us for our next presentation, frontdoor. Joining us from frontdoor today will be Rex Tibbens, CEO; and Brian Turcotte, CFO; as well as from Investor Relations, we have Matt Davis and Matt Harrell as well. So start off, maybe just for those who are not familiar with the frontdoor, if you can provide a brief overview of frontdoor. What are some of your key brands? And how has the business evolved over the last few years? And then which inning are we in with some of the changes that -- maybe it will be a second question, kind of some of the changes that you've looked to implement since you've joined the company. And then we can -- we'll jump into Q&A from there. [Operator Instructions] With that, welcome, and I'll hand it over to Rex and Brian.

Well, thanks, Aaron. Thanks for having us. It was, I think, just a year ago, when we did this live and the way how the world has definitely changed, but I think, certainly, frontdoor is well positioned for that change. And I apologize, the tree pollen is very high, and so I'll be crackly through this entire presentation. But in terms of our history, frontdoor is really a 50-year-old company. You might know one of our larger brands and that is American Home Shield. So I joined in 2018 kind of midway through. We spun the company out of ServiceMaster and really rebranding them in the frontdoor. We have a couple of different brands, first and foremost, around our home services plan business; American Home Shield, which is our largest one guard, landmark in HSA. And then we've been on a very rapid transformation of the company, and certainly, I come from the tech world. So I have a lot of ideas around how to really transform this business. And frankly, it's one of the things that drew me here was that this is, I think, one of the the last large industry is ripe for disruption. So if you think about the $400-billion space that's home services, home service plans only account for a small portion of that. But yet, we have the skilled trades that we work with that can certainly attack half of that $400-billion TAM. That's why we moved into other services in our brief 2.5-year history since going public. And we have on-demand service called American Home Shield ProConnect, which allow you, if you don't want a home service plan, to really consume home services today via the web, but tomorrow, it'll be an app. And then we purchased a company called Streem, which really, I think, is at the forefront of augmented reality or the partner haggling with both Apple and Google. To really start to -- start our vision, that's to take the pass lot of owning a home. And so if you think about how well does Streem do that. Well, 50 years ago, we rolled a truck to see what was wrong. And today, we still roll a truck to see what's wrong when we can have a 2-way conversation on your smart device and really start to understand and capture a lot of data in terms of what's wrong with your refrigerator or so or what have you. And so that's really the transformation we started 2.5 years ago. And in terms of innings, I think it depends on what part of the business we're talking about because we have emerging businesses around Streem and ProConnect. We're very much in early innings, but we're 4x larger than our closest competitor when it comes to home service plans. So I think we're a leader in innings there for sure.

Maybe just start on the core business, even though you're the leader, they're still, I believe, only about a $5 million-plus or minus of home warranty plans. There's $150 million plus or so U.S. households. So the question we often get is kind of why are penetration rates so low? How much can you further penetrate that? And maybe what can frontdoor do from a customer education standpoint on driving home the value of these -- the home warranty plans?

Well, maybe there's a couple of things. One is, your stats are correct. We're about 4% penetrated in the U.S. I think it really goes down to brand and recognition -- our awareness, sorry, education. When you think about a home service plan, the 2 real value propositions are budget protection and convenience for peace of mind. And really, that convenience factor, I think, is growing rapidly. And that's why we're so bullish on ProConnect. And so we think that -- we don't think -- I think, we're proving that we can really go beyond just home service plans and that's why we're bullish about our growth, and we've said publicly in our last earnings call, we're planning on growing double digits and sustained double digits in the coming years. And I think how we do that is through better marketing and education for customers.

Got it. And how does your -- maybe the good, better, best strategy fit into maybe expanding that TAM of the core business as well?

Well, I think what allows us to do, one is to simplify the offers. Today, I think we have a lot of different offers, and they can be confusing. So the best way to educate someone is to simplify something, so it's just easy to understand. And so the kind of good, better, best strategy, your best being our new shield platinum, includes a lot of ancillary services as well, like an HVAC tune-up. And why that's important is that kind of goes back to the convenience of -- someone is kind of taking a possible way for you and that they show up, make sure that before cooling season or heating season that you're kind of ready for that. And we see that as really opportunities as we move forward to provide more of these maintenance-like services, just as a convenience feature for our home service plan customers as well as a possible entrée into on-demand as well.

Got it. And in terms of the demographics to your customers, how might that be changing? And kind of who is your target customer today?

Well, I think there's a misconception that it skews to lower home prices or maybe lower income, but actually, if you look at the demographics, it's dead on as it relates to home value, average income and age, where it skews actually a little higher in our first-tier direct consumer area is people who make over $100,000 a year. And so about 36% of those chose a home or 36% of the mix is for those folks. So it actually skews a little higher in direct-to-consumer, which again, I think, points us towards -- there's a real growth opportunity for on-demand services.

Got it. And maybe just thinking about some of the growth drivers for the core business as well. Kind of we've obviously seen a comp mix of unit growth and price increases. How should we think about the mix over the near-to-intermediate term of kind of unit growth versus price growth and then what do you think start longer-term opportunity from a unit growth perspective?

Yes. Well, certainly, last year, it was more price than volume. I think that the scales tipped this year. And Brian, feel free to chime in, but I believe it's 50-50 or even a little more weighted towards the volume than price. The value of dynamic pricing is that it allows us to kind of throttle forward and throttle back, if you will, around gross margins. So that if we do see something in the market that is a little more expensive than planned, we can begin to cover that or we can begin to throttle back and increase growth that way as well through pricing. And so I think you'll see part of our double-digit growth plan is more units, not just pricing. And so I think this is the first year in a while where we're taking the scales being more volume than price, and we kind of see that going forward.

Yes. And maybe just on that point, where are you at this point of rolling out dynamic pricing across kind of your real estate channel, D2C channel as well as right with your key renewal channels as well?

Sure. So it's been the market for a while. But we made our pricing increases in November from new customers and then direct-to-consumer was, I believe, in January, and Brian, keep me honest. Real estate, we're using our models from direct from dynamic pricing. But a lot of our realty firm still are, unfortunately, a little bit of paper and pencil and so they still utilize pamphlets, I'm kind of wondering if there's a set of stick not to go with that. But so as they migrate more to think that's really happening in that industry to an API-based platform like a dot loop or something like that, that gives us the opportunity to really integrate deeply with those systems and have true dynamic prices. But we're leveraging the models for real estate, that's going to be, I think, a little longer to be truly dynamic in that space.

Got it. And then on the conference call, you talked a little bit about some of the maybe headwinds in 2021 for the real estate channel, although at the same time, we're seeing obviously, very strong growth of residential homes, but it's a sellers' market, which maybe they don't need to offer as many warranty plans. How are you thinking about the real estate channel, potential growth accelerating in 2021?

Yes. I think you hit the nail on the head. Certainly, once it's the sellers' market, then we have to really focus on buyers, not sellers, right? And the advantage to that is now that they could or should perform much like direct-to-consumer customer and that they're a lot more educated and informed on kind of what they're getting. And so we think this could have potential tailwinds for retention -- first year retention as well, but we're solely focused on working with our realtors from a buyer perspective, just because it's such a hot market. Typically, we do see that you have the potential to get written out of the deal, so to speak. And so that's why we really leaned into our buyers' market versus the sellers' market.

Got it. Great. And maybe just on that point, obviously, you've focused much more on the D2C channel over the last couple of years. Within that kind of maybe how has your marketing advertising strategy evolved? And any updates on kind of LTV to CAC, especially as you go more D2C?

Yes. We hired a new CMO in, I believe it was March of last year, he came in at a great time. But certainly, we saw last year incredible broadcast media rates. We were buying prime time for what remnant used to cost. And clearly, that's a longer the case. But since he joined, we've done a lot of -- yes, as a technology background, we've done a lot of engineering work around our MarTech, if you will. And we're projecting that we'll have double digits in all of our channels. But certainly, in direct-to-consumer, we're doing that at a flat CAC. So we're really focused on conversion. And so while our marketing budget certainly is up, we plan to do that on a flat kind of customer acquisition cost. And so I think there's still -- we don't publish our LTV-to-CAC ratios, but they're still very attractive, and that's why we're lean in even more in marketing. I think it's going to be a continued opportunity for us. We did say, I think, in our Q4 call, during the -- when real estate kind of plummeted in Q2, we pivoted to being in -- more in the direct consumer, and we got a 2:1 ratio from that. Now clearly, that's not 2:1 any more in these rates, but you can just see how attractive it still can be for us.

Got it. Great. And then I know, Rex, you've talked a little bit about some of the automation initiatives that you've been working on, including kind of the web-based, the plants purchasing portal, mobile-first, contractor portal, integrating systems with top vendors as well as expand the use of Streem. Kind of which inning are you in with some of these? And how should we think about the impact on the margins and productivity for the business as well?

Well, I'm going to show age. So half the people won't get this joke. But until folks, really, I'm trying to go from the Mad Man to the Jetsons, right? So we're trying to kind of get out of the old and really leverage technology for the new. And I think you saw a lot of that change over 2020. I think there's still a lot more that we can do. Again, I want this to be as much of a virtual process as possible because that's how we get true leverage for the company. And that's how we get a much differentiated and, frankly, better customer experience. And so I think what you'll see is that we're still focused on a lot of the back end things that make it easier for customers, how we authorize things, how we get parts to people, those are all things that aren't terribly s***, but do cost a lot of money. So the other thing is that I think we're just -- we're scratching the surface with Streem. And so I don't know why in the future, we can't just have a quick video call, understand what's wrong and then resolve it in the first time, right, and so really create a delightful experience for customers. And this is not just home service plans, but our ProConnect offerings as well.

Got it. Great. And then just maybe from a contractor perspective, I think, maybe you invest probably under-appreciate the value of having kind of your strong connections they do have with contractors, with 15,000 contractors, I think, 50,000 or 60,000 technicians at this point. Can you just talk about kind of how much of an advantage is it your contractor network? And also, your focus on your preferred network, why that's so important for the business as well?

Sure. So we've had a strong contractor community for decades, and we really focus on that community, certainly, during the pandemic, I think, we only -- we might be the only one or really a handful of companies that really focused on getting -- helping source personal protective equipment for our contractors. And that community remembers things like that, and we focus a lot on our preferred contractors. And the reason why we're focused on preferred contractors is that they make up over 80% of our volume, but only 40% of our total contractor base. And why does that matter? Well, we guarantee them volume and then we get about half the retail rate from a labor perspective. So imagine a world where you can continue to inject technology and reduce truck rolls and not only an incredible ESP benefit, but it's also a great way to help them expand their business because they can use Streem not just for what we're doing, but for the retail business as well. And so trying to buy the ways, to build that community and widen the mode is definitely front of mind for us, but it's really about taking care of our contractors, which in turn take care of us. And so we're not selling them leads. We're not kind of creating a different marketplace model. We're trying to truly put revenue in their pocket.

Got it. Great. And then maybe a couple of questions on ProConnect as well. Maybe first, just kind of how big is the opportunity for ProConnect versus the core business. And then second, from a competitive perspective, obviously, there's a lot more competitors, investors would think about in -- for ProConnect, whether it's Yelp or ANGI's HomeServices, a lot will make even a task for -- at it. So a lot more competition within the ProConnect market. How are you looking to differentiate that business?

I think the biggest differentiator is that I don't think the other companies are solving the customer's problem and the customer being mature in, in-customer as well as a contractor. These marketplace businesses are just selling needs. And so if you're a customer, you have to do the legworks of the trade and pick for you or how many men you get. And if you're the contractor, you have to do leadworks or late work rather to turn that lead that you pay for into revenue. What we're trying to do is leverage this kind of 50 years of data to provide pricing transparency and scheduling transparency. And the most important part, guaranteeing the works that you've done because that's the other part, although you may have reached out in the marketplace, they're not guaranteeing that the person like fixes it, right, like we are doing. And so what we're doing is we're offering a unit of revenue to the contractors and you get an instant market signal of like do they want that or not. And so I think it's a very differentiated way of approaching the market. And clearly, we're -- we have a lot of room to go in terms of getting the brands and the traffic that others haven't, but I think we're focusing solely on solving the customer problem. Now you also asked about TAM. The TAM is all 130 million, 140 million single-family homes and certainly, it can go beyond that, if we want to get into property management or other things, but the TAM is much larger for ProConnect and as a current home service plan business.

And then based on that front, what are the key investments that we should thinking about for ProConnect for 2021? I think you talked about marketing and traditional marketing. Maybe talk about how you're evolving the marketing strategy and then also deepening trade offerings and then geo expansion as well.

Yes. So we're in 35 cities now primarily in appliances. You should expect to see plenty of electric to follow suit to that. And then probably the last would be HVAC. And then from a marketing perspective, certainly, we're using digital marketing like most folks are, but the reason why we rebranded under AHS ProConnect because we have 30 million visitors that come to our website, love that we had 30 million home service planning customers, that's just not the case, right? So why not really leverage that traffic, leverage all the links and so forth from the SEO, SEM perspective to really lower the CAC for ProConnect that allow us to get a bigger bang for our marketing dollar. So that's certainly where we're heading with that. And then we do that 2.2 million customers that, I think, would love some of our maintenance services and so we'll be advertising to them as well. And I did get a question, very -- on the last earnings call, that how come it's -- why is it taking you kind of 6 months to just reach your customers? Well, we're only in 35 cities, right? So we have to build the geo location in order to do that. Otherwise, it's just simply plug and switch but -- so a little bit of tech to be built, but I'm pretty bullish on our abilities for ProConnect.

Got it. And then you've talked about the -- on the core business, your -- relative to size to your competitors. I think you mentioned roughly 4x the size of your next competitor. How are you thinking about opportunities to further gain market share or consolidate market share? And is there any regions where frontdoor maybe is weaker that you could look to expand into as well?

Well, we're in all 50 states today. Certainly, we're -- we'll talk about capital allocation later, but we're certainly acquisitive along a number of fronts. We, I think, don't have as deeper of penetration in the Northeast, but we do have quite a decent book there as well. So I think we're solely focused on growing what we have. If there's opportunities to consolidate, we'd certainly look at that, but I don't want to -- I just don't want to buy a book of business, as certainly on to come with something that adds value for shareholders. And certainly, today's multiples, it'd be tough to make a go of it.

Got it. And then just for those investors, maybe I haven't listened to the earnings calls, maybe if you can just review the COVID impact that we saw in 2020, and how are you thinking about potential COVID impacts for 2021? Has COVID impacted kind of just the way you're thinking about the business generally, also?

Yes. Brian, you want to talk about the impact? And I can talk a little bit about the forward look.

Give Rex a little bit rest there.

Yes. Thanks, Rex. Thanks, Aaron. Yes, for 2020, we had an EBITDA impact of about $54 million from COVID-19. The claims activity really ramped up the first week in May in appliance and plumbing as people were sheltering at home. So in total, we had about $36 million from higher service requests for appliance and plumbing. Due to the way real estate slowed down in the second quarter, we decided to make an incremental $13 million investment in D2C marketing to drive more units to make up for that. And then we had $5 million of additional service investment due to all the call volume coming in because of the service request. So that's $54 million in 2020. What we're going to see, we believe, is the trend for the service request for appliance and plumbing continuing into the first and second quarters of 2021 and then slowing in the back half of the year to a rate somewhat above historical average for our service request, but lower than we had in the second half of 2020. So what we said in Q1, I believe, $12 million to $14 million of additional service request cost and about $2 million to $3 million of service request and $2 million to $3 million of investment in our service operations to handle the calls.

Right. Got it. Great. And maybe just a follow-up on that, Brian, maybe just like how -- got a question as well on the cost of services, how should investors be thinking about cost of services as a percentage of revenues longer term, obviously, near term inflated by COVID costs. And then what impact does ProConnect have on cost of services longer term? Is that a lower gross margin business, et cetera?

Sure. I don't know if you want Rex to answer the other half of the first question or I can jump on the cost now, whatever you like.

Whatever works for you, You can...

Okay, let me just -- yes, we still think that we're -- we can get back to a 50% gross margin for the HSP, home service plan business. We projected 48% this year to all of these exogenous factors. But we certainly can get back to 50% for the core home service plan business, if that helps to answer that question.

Yes. That's great. And then any insights into how investors should think about the margins on the ProConnect business longer term, obviously, still early today?

I can take that one. I think that I'll give you the -- the consultant answer is, it depends. I think overall, we should expect roughly the same gross margins. But certainly, there are categories that HVAC tune-ups, for example, aren't going to be as high gross margin. It's a very competitive space, but it drives customer adoption, right? So we look at all the different trade-offs, not just the gross margin, but how is it impacting the overall business, but we're pretty confident that longer term, it's kind of roughly in line or maybe slightly lower, but not much from a gross margin perspective.

Got it. And maybe just a follow-up on also maybe from a cost and operational efficiencies perspective. I know you spent a lot of time over the last couple of years working on various initiatives, including supply chain, customer service, obviously, the Streem acquisition. How are you thinking about some of these initiatives should improve the cost structure over the next few years?

Well, we still need to get leverage from customer service. And so that's been the journey I've been on since walking in the door. And I think we're still very much in early innings there. It's a very complex thing and that you don't want to do anything that's going to harm retention and/or customer service, but that's why we think really doubling down on Streem this year, really beginning to grow that within our customer service organization, certainly will help. We're focused on cycle times, which help as well, which reduces your overall call volume. And then we have to make -- we have to make a kind of stupid sample, if you will, that you'll never want to call, you just want to kind of go online and understand. And so we've done a lot of work around statuses and that type of thing. And now we're working with our partners to make sure that we have the correct statuses as well and that it makes sense for customers. But certainly, the faster we can speed up the cycle time then you can properly set expectations, which should lower your overall service cost as well.

And maybe a follow-up to that. I know, Rex, you've talked about investing in kind of the data platform since you joined and probably transforming what it was, I guess, a non -- very much a non-data business, but how are some of the investments that you've made there since you've been -- since you joined in 2018?

Yes. I think they're going well. I think this is another more longer-term thing in that. We're leveraging our underlying data for ProConnect. So in the appliance space, we offer a flat-fee opportunity for customers that certainly leverages our underlying data. From a dynamic pricing perspective, we're leveraging our underlying data. And so we've been using a lot for internal purposes, but I still think we're probably a couple of years away from being able to monetize it for other things. But we're trying to architect it in a way that if we see that opportunity sooner, then certainly, we would take advantage of that.

Got it. Maybe for Brian, just the [indiscernible] discussed, we got a question on long-term EBITDA margin, should we still think about roughly 20% plus there? And then kind of provide us an update on kind of your capital allocation strategy going forward, given the, obviously, very profitable core business and how you're looking to allocate that?

Yes, great question. Absolutely. We think we're a low-20s EBITDA margin business going forward. We get beyond COVID-19 and some of the pressures. So certainly, that's how we view the company on an ongoing basis. And regarding capital allocation, as I said on our earnings call, first and foremost, we're a growth company. So we're going to keep investing in the core home service plan business, invest in our emerging businesses. And then after that, in the right priority, we were 4x levered at spin in 2018. We're now 2.1x and generate a lot of cash. So we want to pay down some debt. We paid down $100 million of our term loan B just before the earnings call. We'll revisit that later in the year, but we're going to keep looking for, as Rex mentioned, opportunities to invest in the business inorganically as well whether it's in the home services plan space or technology space. We're going to keep looking for opportunities to invest in the business to grow it both organically and inorganically.

Got it. Great. Let me get a couple of questions from investors. One, I guess one of the questions, I guess, what's preventing players like ANGI's from entering your core business? I guess the opposite of what you're doing is just looking to enter a third business more and more as well.

Well, I think it's the business model I described. Certainly, I think ANGI bought a very small home service planning company. I don't know the status of that, but we have the scale, and you have to be really -- to really understanding the business in order to scale it. And so it's not just something -- this is a very, I think, different business from ANGI's in that, this isn't a marketplace business. You truly have to understand, you're taking on the risk, right? So you have to understand the pricing and the underlying claims and how it all kind of comes together, and that's not something that would be easy to, I think, learn and scale. I think time will tell on their acquisitions, but it's a completely different space than driving eyeballs to your website and selling leads to contractors.

Right. Got it. Okay. And then another question from an investor. For the ProConnect business, what is the incentive for contractors, not to try to, I guess, form just direct relationship with customers and not have to pay a take rate to ProConnect? I assume it's obviously, they're going to have to spend money on marketing if they're not using a service that ProConnect, but would like to get your perspective.

Yes. Well, I mean, you make the same argument, why, why, why use ANGI, right? It's because it's a competitive area and then they're trying to get customers, and they're not generally savvy when it comes to marketing, they're great at repairing and maintaining things. So we're leveraging our relationships with them. This is about driving more volume and growing their business at an attractive margins for them. Because again, they're not having to invest in business development and kind of the front of the house, if you will. We're just serving enough jobs and then if it fits within their schedule, then I would -- I'd argue these are more profitable for them.

Yes. And generally, when you talk to contractors, I assume, they're least favorite part of their business just getting new customers, having to market and figure out from every month, what's the best channel to market to what has been your experience -- what's your experience talking with contractors?

Yes. They -- I think, they're very excited about, but that vary fast. They've kind of built their business on repairing and maintaining things. That's what they're good at and so they enjoy and that's what their technicians enjoy. It's all the kind of digital marketing and kind of how all that's changed. I think they have less interest in that. They're just -- they want to do the work.

Got it. Great. And maybe one final question here. And for a follow-up on the M&A side, how high would you go on the leverage side for a deal? And what are the priorities for M&A? Anything different than this maybe the smaller tech tuck-ins you have done over the last couple of years?

Well, what I'd say is M&A is hard no matter if it's a $10-million deal or $10-billion deal, I'm not saying to do a $10-billion deal. It's the same amount of work for the team and the same distractions. And so we certainly would look for any opportunity, but it really has to pass our threshold, if you will, for not only return, but the 2 things, I think, the kill deals and our culture and not being able to get your synergy cost and certainly, things we've looked at in the past. I think the multiples are so high that we're essentially giving up all our synergy costs, which makes no sense for investors. And so I think I'm very focused from a technology and distribution perspective and then next would be other differentiated home service plan companies, but in terms of how high will we go, I think, you've -- or we've proven that we can delever very quickly. And so I think the answer would be, as high as we need to go for the right deal, but certainly, the right deal would be the right deal for investors as well. We're not just -- have money and we're out chasing deals. I think we're being very methodical about kind of what we would take on or what we wouldn't take on because once all the fanfare is over, you still have to deliver every 13 weeks.

Got it. Great. I don't see any more questions, and I think we're coming up on about 40 minutes here. So unless there's anything we missed, I think, we can wrap up. And I think any final things we'd like to point out, Rex or Brian?

Well, I'd just like to say, one, thanks again for having us. We're truly excited here at frontdoor. I mean even in the middle of the pandemic, we're pretty bullish on sustainable double-digit growth and excited about what's to come for ProConnect and Streem. So thanks again for having us.

Yes. Thank you for presenting today, and we'll talk to you soon. Thanks, everybody.

Thank you. Take care.