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

Hi. Good afternoon, everyone. Cory Carpenter, Internet analyst at JPMorgan. Happy to have Frontdoor Chairman and CEO, Bill Cobb; and CFO, Jessica Ross, with me today. Bill has been CEO since 2022, Chairman since before the ServiceMaster spin, and Jessica joined in 2022 from Salesforce. So thank you both for joining.

Hi, Cory.

I got plenty of questions to go through. We'll open it up if there's time, though, at the end for Q&A. I think everybody knows by now, you can submit a question electronically. I have the iPad or we can do a microphone around the room. So starting off higher level, I think for you, Bill, just for those newer to the story, to kick off, I thought it would be helpful to give a brief overview of the Frontdoor business model and also the industry you operate in.

Okay. Good afternoon, everybody. We are the only publicly traded home warranty company. It's a subscription-based model that protects homeowners from what inevitably is going to happen. Things are going to break down in the home. It's different from home insurance, which is if something might happen with us, something will happen. And we cover 29 systems and appliances in the home, everything from washers and dryers, appliances, HVAC equipment, et cetera. We have 3 different types of services you can sign up for good, better, best, if you will, and depending upon the coverages that you get. But we're really there to get service calls, answer the call to repair or replace whatever system is brought up. We average about 2 calls a year per member. We actually like it when our members call because that leads to a higher renewal rate. Ultimately, we have a terrific core business, the home warranty business, but we have a bigger vision, which is to utilize our 2.1 million member base to look at what we call non-warranty initiatives, either partnerships that we do with other suppliers such as our partnership with Moen or what we call our HVAC, our new HVAC program, which is we've built to a $100 million business, which replaces existing HVACs with new equipment, and we can get into why we think that's such a good deal. Finally, we just expanded our business a few months ago. We purchased a 210 homebuyers warranty, which brought a home warranty business, a scale play for us that we could fit right into our infrastructure and a new business called New Home Structural Warranties that brings us into the housing starts business with builders. And we now have about a [ 20% ] share in that, and that's the largest provider of home structural warranty. So that's a pretty good overview. Jessica, I don't know if you guys have anything to add.

No, I think just in addition, as Bill referenced, we continue to expand into non-warranty and on-demand services. The new HVAC program that you referenced was kind of our first play to that point. We've got the Moen partnership, which is kind of our real first partnership where we're leveraging our plumbers, and we'll get some more into that as well. But yes, really excited about those opportunities.

So you just finished a record year of profitability last year. You were guided to another one in 2025. But the company was struggling 3 years ago when you guys joined. So what's changed? And how have you evolved the company in recent years?

Yes. I think when I came in, and I was the chair before, but the previous CEO, decided to leave. And when I came in, I thought we've got to really zero in on our core business. I think a lot of good companies get away from that. We needed to get back to our core home warranty business and really operate that well. And what that has done it's enabled us to really get on solid footing. Let's build up our member count. Let's take care of our current customers, our renewal book. Let's operate the company better. Let's get back together with our contractors and get in a better place with them because that was a conflict a friction point for us during COVID. So we just decided to operate the company better, and let's really run a good home warranty business. As we got that stabilized is when we started to look at other opportunities with that member base, which is similar to what I talked to you about earlier with the non-warranty options that we have. So we now have a more diversified revenue base than we did 3 years ago. We are now back on our front foot in terms of growing customers again. We continue to retain customers at record levels. And so the mix is coming together really nicely. And in the end, this is a cash machine. We have low CapEx. We turn up a lot of cash. We had $117 million of free cash in Q1 on a company that's guiding right now to a little over $2 billion in revenue.

Well, and I would think that Bill often undersells his leadership. When Bill came in and he really lit the fire under the company, the business. I think prior to, it was more of a view of a kind of reactive versus proactive in terms of the mindset of how we manage costs, et cetera, et cetera. We've really embodied an operational excellence culture across the business that has just continued to treat this flywheel of optimization under Bill's leadership.

So 2 questions on the industry. You did mention you're the only publicly traded company, so I feel like there's not a ton of -- always a ton of understanding. Bill, you've spoken to a TAM of 15 million home service plans in the U.S. before. Industry has been around 5 million for a number of years. So I think kind of 2 questions here. What's kept this number from moving higher would be one. And then two, what do you think needs to happen to increase penetration?

Yes. I think we've been a stagnant industry, and I include us in that. There was our Chief Revenue Officer, calls it a sea of sameness that was made to the industry. Everybody have a similar name and similar look and feel. And so we started to break out from that in the last couple of years. We have -- we've redone the brand in terms of its look and feel. We have a new advertising campaign. We have brought out an app. We now have -- use that app to bring out a video chat with an expert where our members can call up before they need a service request to see if they can fix it themselves or get advice on what the service request should do, get them -- have them be smarter when the contractor comes by. We actually disclosed last week that on those video chats with an expert call is about 17%. The homeowner is being able to fix it themselves, which they love because they don't have to sit around and wait for a contractor or pay a trade service fee. So I think the industry has lacked innovation, and we're trying to take the lead in that. I think we haven't been as an industry aggressive in marketing. We certainly are doing that across the marketing mix today. And so I think that it really comes down to -- We haven't sold the value proposition. The value proposition for home warranty is great. Here you have those 29 systems and appliances I talked about earlier and for $60, $70 a month, plus or minus, we're going to cover those for a year. And in the end, repairs can -- between the contractor trip fee and the actual repair can really run you a lot more than that. And we take care of that once you pay your trade service fee. So the just the basic value proposition has got to be sold better, and that's what we intend to do.

So you touched on this earlier with HVAC in non-warranty services, but maybe if we can go a little deeper there. If you could just talk about your different and various initiatives within non-warranty services? And then also why you're making -- why now in terms of making a push there? .

Yes, I think what we did was we sat back a couple of years ago and said, we have this -- at the time, a little under 2 million, now it's over 2 million member base. Let's take advantage of the opportunities that, that would present itself with. And so we know that from our business, we have to go and repair and replace. And sometimes people have aging equipment, but it's not quite ready to be replaced or they want to get more efficiency from, let's say, their HVAC. So we now have a program we started with HVAC. We're looking to expand it to water heaters and appliances and there's another 1 with roof repair that I can talk about. But that we are able to go to our homeowners before it's ready to be replaced and say, would you like to upgrade your equipment now, get the efficiency of energy savings, we have constructed this in a way that we have a deal with our contractors on what the margin they'll accept. We buy very well from our OEMs. So we are able to offer our members a 20% to 40% discount, depending upon the location over what a new system would be if they just called somebody up. And it's proven to be very successful. It's a great program for our contractors, our members win downstream for us, we have less truck rolls because it's new equipment, so you don't have to repair it as much. In addition, for the member, their efficiency, their heating electric bills get better in heating and electric. So there's a lot of win-win-win to this, and it's proven to be very successful. We now are guiding to over a $100 million business in 2025, and we're really pleased with the impact that that's had.

Okay. So before we get kind of more into the kind of the core business, I want to get -- maybe get tariffs and macro out of the way on everyone's mind. So first on macro...

It's requirement for JPMorgan and to ask about tariffs.

I think it's a requirement. .

Requirement.

Part of the registration process for the conference. So Bill, what are you seeing in the current macro environment? And how do you think about just the broader resilience of Frontdoor should we enter a recession, which I know is a moving target? And then maybe, Jessica, for you, could you just talk about how macro impacted your approach to the outlook you gave a few weeks?

So for us, Q1 and Jessica can talk about this in a little more detail, we saw 0 inflation. It was -- we had no inflation. So we had no impact from tariffs. We have guided our Q2 to anticipate because we can look out enough in a few months. We don't see any impact from tariffs there. I think it will come. Where tariffs hit us is through primarily parts and equipment about for our costs, about half of our contractor costs, labor and all the things associated with the contractor, and the other is equipment, parts and equipment. For us, the equipment for HVAC, water heaters, appliances, a lot of that is domestically produced. So we're insulated from the tariffs. Parts come primarily from China, and there are things like circuit boards that go into smart appliances, which are increasingly a part of our mix. So right now, and I'll let Jessica talk about the guide what we've built in. Right now, we haven't seen an impact from tariffs. We anticipate it. We have seen some of our OEMs are starting to raise prices. So we do anticipate that coming. But right now, we're bought in a way where we can cover out the next couple of months. And then we've built into the guide, I think, some protections around what we anticipate will be some impact.

Yes. And just again, back to also the broader macro, we continue to see consumer sentiment that's remaining challenged. Real estate continues to be something that we're evaluating. I think for this year, we've been pretty much waiting and seeing and really baking anything on a return into the outlook that we've provided. So I think in terms of setting the stage for our overall outlook for 2025, we were considering all of those things. That being said, I think we were very fortunate that for Q1, we had exceptionally strong results. As Bill said, from an inflation perspective. And we report inflation on a net cost per service request basis, and it was essentially flat for us. And that's just really a result of the process improvements and things that we talked about from a cost structure perspective and how we've been managing that as well. I think we had positive momentum on the top line. We have some benefits on renewals coming in better than we expected, as well as our non-warranty program continued to deliver more revenue, especially on the new HVAC side. So all that being said, as Bill said, we -- Q1, we took that favorability we were able to -- we've got a good line of sight into Q2. And so essentially, in terms of 2025, it really was this balance of, let's take the Q1 favorability and balance that with some uncertainty on the tariff side. For us, we've been able to really kind of measure the impacts of inflation about for every 1% change. It's about $10 million into our business. So for the back half, we said, okay, we've got mid-single-digit inflation and then add on some additional uncertainty for tariffs. So we baked in about $30 million. The additional for us, uncertainty we can't control the weather. And so we also baked in some conservativeness on some -- on the weather side as well, about $15 million, which is, again, essentially just assumes some hedges in the back half. But also taking into account the good favorability we saw in the front half -- that we're seeing in the front half of the year.

Yes, Cory, I think we're talking about this before the meeting, before the session here. We've been able to beat our guidance. One of the reasons is because every year we build in what we think is "normalized" weather." Weather has a big impact on our business, especially in the HVAC area. When it's super hot in the - especially in the southern states, it has a big impact. We've had relatively good weather from a Frontdoor perspective. But every year, we have to build that into our guidance, assuming that the weather is normalized. So that's what Jessica is speaking to.

All right. I think you addressed both tariffs and macro and 1 question. So I'll allow us to move on. So kind of zooming in on the core home service business, which I know you really started to refocus on when you joined, a you have 2 primary customer acquisition channels, you have real estate, you have direct-to-consumer. How would you characterize the health and the trends impacting each of those channels?

Yes. So let's start with real estate, which, many of you know, has really had a tough few years. The latest information is -- National Association of Realtors is saying, in 2025, we'll see about 4 million homes sold. The high point, I think, in '21 or '22 was 6 million. So it's been a big hit to the real estate industry. Prices continue to rise. It's like 21 straight months of price increases for the average home. So real estate continues to be struggling, pretty stagnant. A couple of blips showing up our inventory has improved. There's about 4 months of inventory out there now, which is starting to get to how a real estate market that's in balance between buyers and sellers is generally 4 to 6 months. What that means for us is that's usually a good thing because sellers are now incented to offer a home warranty as part of their offering to attract buyers. So that's a good thing because during the seller-dominated time, attach rates for real estate for the industry have gone down, they've gone down for us as well. So that's a good thing if we can get attach rates up. But overall, until interest rates show some sign of ameliorating, we are going to be, I think, stuck in terms of -- we had 6% decline in real estate in Q1. It's about what we're forecasting now, maybe a little worse, for the balance of the year. But it's just a tough market right now. Conversely, DTC1, we've now had 3 straight quarters of customer -- of organic customer growth. We feel very good about that. We feel very good about our marketing messaging, not only from the awareness side, but in terms of what we call the middle of the marketing funnel, which is where you really drive your leads and converting those leads. And that's really what our business comes down to, where we can drive leads. And we've done a nice job with that. We had 4% organic growth in Q1. Overall, in DTC1, we had 15% growth with the addition of 2-10. But what we're really focused on is that organic number. And so I think the DTC1 area is very healthy. We can talk about renewals later, but that continues to be a strong point for the company. But we feel really good about our renewal book that we have a lot of control over in terms of how we treat our members. And then we really think DTC1 is looking very favorable, very healthy, and we're going to continue to drive against that.

Again, I'm just reiterating, in real estate, there's an element of it is what it is, and we've been very focused on what we can control and with DTC1, I think, really continuing to drive that. We've had 3 sequential quarters of unit growth on the DTC side, which is really just a sign that the work we're doing is working.

So maybe sticking with direct-to-consumer. You've placed a big emphasis on driving new member growth, as you just mentioned. Could you talk about the strategies you're implementing there? And just maybe elaborate a bit more on the early results you're seeing?

Yes. So what we've done is we're trying to surround the consumer with a series of messages. One, like I said, was to reestablish the brand. We've got this new character Warrantina, who is our spokesperson. So we're really trying to drive that top-of-the-funnel awareness piece. And then those numbers are up, likability is up, in all of those consumer measures. Translating that now into leads, our demand number or leads are up, our conversion is up. So we're starting to see that come into play also. We've also taken on some deep discounting. So we are now pulsing our discounting. We're not doing month-long discounts. And the idea behind this is to get people in the door. So we're accepting a lower revenue on our first-year clients in DTC. Real estate pricing has remained pretty constant, and that's really not a factor because that's within the -- it comes to us from the title company through the closing process. So DTC1, pricing, we've decided to get much more aggressive with discounting, try to get people in the door because we've found, we've been in this a little over 2 years, we're able to renew people and get them back to the level of margin that we had hoped for within 18 to 24 months. And that's been really successful. And again, it goes to what Jessica said where we have those service calls. People like the service. And so we're kind of giving up some revenue on DTC1, we're making it up on renewals, and the whole thing comes together pretty nicely. So that's kind of our pricing strategy on DTC1, plus the innovation I talked about. People want to have an app, they use their app. The video chat with an expert where you can call up, and these are our associates now, these are plumbers, electricians, HVAC folks who have come off the road, they were tired of climbing on their houses, so now they're sitting at their desk helping people. And they're all service-oriented. And it's been a wildly successful user experience for us. So it's all of those elements that really lend us to a really healthy, what we believe DTC1 business is.

And I think to the product differentiation, we've often talked about home warranty as -- see as famous. And so that was really the impetus for the marketing strategy and how do we top out introducing the app last year for this virtual expert. I think we are really the only person -- the only company that's doing that. As we shared on our call, 17% of the virtual expert calls have resulted in a resolution for the member, which just means we don't have to give them -- to have a truck roll. They don't have to have someone pumping through their house. They're feeling empowered that they've done it on their own, and it's been a really nice, to Bill's point, user experience.

Okay. So I want to talk a bit more on the 2-10 acquisition. Maybe, Bill, to start, just if you could discuss the strategic rationale, where you're at on the integration process. And Jessica, for you, just the expectation on the impact it could have on financials this year.

Yes. So for 2-10, we knew them from the industry. They were a good competitor. They ran a good business. They dealt with their members well. And so we realized that from a scale perspective, if we could procure this asset, we could load -- which about 3/4 of their business is home warranty, we could bring that right into our infrastructure and get a lot of efficiencies in people, redoing contracts, just fold them in like any -- we do have a couple of brands in home warranty, and this fits in beautifully. We also were able to acquire their new home structural business, which is where the name 2-10 comes from, which essentially gives you, in simple terms, home warranty coverage for the first 2 years and structural coverage for 10 years against things like soil erosion and termites -- not termites, right, not termites -- but any structural impediment that we have to go -- it's a high severity business but low incidence business. A really good business, which gets us into the housing starts business, gives us access to about 19,000 homebuilders. And there's a total of 1 million members who are now in their system who have taken a home structural warrant -- a new home structural warranty over the last 10 years. So for us, a lot of access to a new market, a lot more members, a lot more clients. And as to the synergies, we felt were very strong. So even in the first year, we've guided to $10 million in synergies. We're well on our way on there. We think in the next few years, it will enable us to get about $30 million as we bring the back end together so that we have one platform, have one contractor relations team, one service ops team. So there's a lot of efficiencies there. So we really like this asset. It fit with us. We're able to keep our leverage ratio in the range that we like, which is 2 to 2.5. We're now at 1.9. So we've absorbed it well, and we're really pleased with how the integration is going.

So let's -- final channel, but your biggest channel, renewals. The retention rate within renewal is at an all-time high. What's been driving the better retention in this channel? And where do you still see runway for improvement?

Yes. There's not one thing that we've done well, except that it is -- a large part of the company spends their time in this area. What I mean by that is we have driven up our preferred contractor percentage, which we have a series of -- we have about 16,000 contractors overall, about 4,000 are preferred. We've driven that rate of their service, which they are our best contractors, best service contractors, they get the highest 5-star ratings, the lowest 1-star ratings, to about 85%. In addition to that, our marketing team does a very good job managing, if you will, the member through their contract term, which is 1 year. So there, we're very knowledgeable now about what each member is looking for. We have taken this dynamic pricing approach, which we can speak to, and we really are able to price almost to the person and their situation. We also have built a really vital team that "saves" customers. If they're looking to cancel or they don't want to renew, we're very aggressive on trying to get them to stay with us, offering incentives to keep us because this is really where we -- I call it the backbone of the company, the renewals book. So overall, it's been a series of things. We have a high amount of folks, 84%, on monthly auto-pay, which we find is conducive to renewals. So there's just a variety of efforts that we take to really take this important metric and continue to grow it. I don't know, Jess, anything else you want to add?

No, I would just say I think the theme that we've seen over the past couple of years is it's not just any one like shiny object, silver bullet, right? The key to this business, whether it's managing costs or really driving a better member experience, is a lot of -- a series of a lot of things, and we've really been pushing the business to do that well over the past couple of years.

So moving to some financial questions before we close. The average price of a Frontdoor home service plan has gone from just over $700 to nearly $900 over the past 3 years. You talked about a 4% price increase this year. So could you just talk about your pricing power and how you think about pricing as a growth lever over time?

Yes. No, absolutely. We've talked many times about the #1 strategic priority, it's all about driving new home warranty membership growth. And I think we've demonstrated that this is a very inelastic category. Once the member uses our product, our renewal rates have been exceptionally strong and consistent over the past several years. And so I think the price element is just such an important piece. As I think about our overall strategy, I think Bill talked about it, we've got this nice flywheel now. We can discount to bring new members in. And then because of our retention rates, we can really leverage our price, our scale and our pricing capabilities across dynamic pricing, to retain -- to drive prices up from a retention perspective. So we've got a best-in-class dynamic pricing tool. This is something we are very, very proud of. We've built it over the past 4 to 5 years, and it's something that we really view as a true competitive advantage for us. And so we talked about the pulse discounting, and then dynamic pricing really works at the renewal on a very individual customer level. And so we are looking at each individual customer. We're able to look at their geography, the availability of contractors, their usage of the product and basically assess their inelasticity or elasticity and set pricing at that level. And so I think that there was some confusion at Investor Day that we have this one price lever and we pull it and that we don't pull it anymore. We are actively taking price at every single renewal point with this tool, which has allowed us to position -- I think we're at about 4% average with the current member base and a 2% to 4% realized price on this lever we're guiding to for the year.

Yes. I would just add, just so you understand. So when Jessica was talking about inelastic, we break it down by our 3 channels. Real estate, pricing really comes to the -- it has been pretty similar over the years because the agent and the seller are providing that for the buyer. So there's -- they're really doing that as an incentive to get you to buy "multiple hundreds of thousands of dollar" home. We're inelastic on the renewal book, which we think we've proven out as a retention. What we've changed is we've always said we're inelastic, but we see the elasticity on our DTC1 business, which is why we've become so aggressive on the pricing there because that is how we beat competition and make sure that we are the best value at that level, so that we have this nice blend of inelastic channels. And then the one that has more elasticity is the one that we really focus a lot of our time and attention on.

So shifting to the volume part of the equation. I think if there's one takeaway is that you've been clear that your top priority is to return to organic unit growth. What needs to happen to get you there? How are you thinking about the potential time line?

Yes. I mean I think real estate, I don't know what the time line is. We're very active. We've got a great real estate sales force that's working every day. It's calling on agents and the like and trying to drive that effort. In terms of DTC1, we're right in the middle of it. We feel that all the things I talked about earlier, the innovation piece, what we're doing with discounting, what we're doing with our mid-funnel marketing, we're targeting Hispanic millennials as a special group that we're going after because they have a high propensity to look at buying a new home. I think -- but our efforts in paid social, in direct marketing, in online marketing has really been paying -- is paying dividends with our demand up and our conversion up. So we feel really good about how this is going right now. And I think we're in a prime position. And like I said, we've had 3 consecutive quarters where we have grown that organic growth.

One more on capital allocation, and we'll end on a bigger picture question. We might have time for one question if anybody wants to submit one online or raise your hand in the room. But on capital allocation, you just closed the fairly sizable acquisition. You're actively buying back your stock. Your leverage is still below your long-term target. So kind of given those dynamics, Jessica, how are you thinking about your capital allocation priorities this year?

Well, just for those -- I mean, our capital allocation strategy has been very consistent: first, focus on growth; second, really maintaining a strong financial profile; and then returning capital shareholders. And I think you hit on a couple of things. From a growth perspective, we've talked about the 2-10 acquisition. We're very focused on our organic growth strategy. We just increased our SG&A spend in our guide because, as Bill said, the mid-funnel strategy is working, and we're putting some more dollars there. You already hit it. I think we're in probably the strongest financial position that we've been in, which is -- especially in uncertain times like this. We've got a leverage ratio of 1.9x, which, as Cory said, is in line with our target of 2 to 2.5x. We've got a lot of liquidity on the balance sheet. And with that, we were also able to raise our share repurchase guide for the year from $180 million to over $200 million. And we've already purchased $100 million year-to-date. So I think we're going to continue to be consistent with the way that we've been deploying capital. Again, we've got a lot of flexibility, which, again, in these uncertain times, gives us -- puts us in a really strong position.

Yes. I mean we're a cash machine. We ended Q1 with over $500 million in total cash. Majority of that is unrestricted, which is why we've been able to be so aggressive on our share repurchases. But we feel really good, like Jessica said, about our liquidity, about our return on invested capital. We have low CapEx, relatively about 2% of revenue. We are able to really look at our -- this as a real gold mine for us that we can figure out how to deploy. But right now, we're being aggressive on share repurchase because we think, frankly, we're undervalued in terms of any kind of measure that you would look at. So that's what we will continue to be doing.

Any questions in the audience? I think your microphone is coming.

If you're confident on the inelasticity of DTC pricing, it seems like to get the other $10 million possible TAM, it would just be a matter of LTV and CAC. What's the formula there? Why can't you just take some of the -- take some money, spend it on marketing and get a bunch of those? I imagine that's not easy.

Yes. Nothing is ever that easy, no. But our LTV, even with our discounting approach is still over $1,200, which we're happy with. Our CAC is around $500, so it's a great equation for us. Real estate LTV is about $700, but that's a pretty efficient channel for us because that's really -- it comes on the heels of trying to go after DTC1. So I think in terms of additional marketing, I think we feel that we continue to spend at healthy enough levels. I think we've been aggressive on discounting. We continue to ratchet it up. So I think we're going to continue along the lines of what you're saying. So we're in agreement on that.

Yes. I mean there's a lot -- again, there's a lot of intention with the -- start with the top of funnel, the investment in the marketing campaign that we launched last year, and we're in the heart of like really working that mid-funnel because I think that's really where the conversion happens. And again, we've seen results, which is why we're going to continue to invest there.

All right. Last question and we'll close. Bigger picture question, what are you guys most excited about over the next couple of years? What do you think is the most underappreciated part of the story?

I think the -- I don't know. Underappreciated, I'd say, is the resilience of our model and how well we operate the business. I mean we really have to -- it's a large system. We manage 16,000 contractors. We have 2,500-or-so service ops personnel who support our customers. We have a large technology organization. It's a big operation. And I think we've managed it extremely well. We watch our -- we manage our costs well. We are active on trying to drive the top line. And I think that whole way we operate the business, I think that that's the underappreciated part. In terms of what am I most excited about, I'm most excited about the way we can continue to drive our core business and this non-warranty, going to our members, more partnerships that we can build like the Moen partnership and others to leverage our contractor base, to go to this $2.1 million member base, how that whole thing comes together, I think we'll have a more diversified revenue stream and yet continue to operate the company really well.

No, I would just -- I mean, that is the thing that people miss. The core business, like that is a cash cow. We're in a financial -- a very strong financial position, and that's what allows us to invest in this option value of non-warranty. And I think there's a lot of opportunity there that we are very excited about, which is going to not only create better experiences for our members, but also tap into home services more broadly.

Great. I think we'll end it there. Thank you.

Thanks, Cory. Thanks, everyone.

Thank you, Cory. Thanks, everyone.