Frontdoor, Inc.
Q2 2022 Earnings Call Transcript

Published: 7 Aug 2022

[Operator:]

Ladies and gentlemen, welcome to Frontdoor's Second Quarter 2022 Earnings Call. [Operator Instructions] Beginning today's call is Matt Davis, Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call. At this time, we'll begin today's call. Please go ahead, Mr. Davis.

[Matt Davis:]

Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor's Second Quarter 2022 Earnings Conference Call. Joining me today are Frontdoor's Chairman and Chief Executive Officer, Bill Cobb, and Frontdoor's Chief Financial Officer, Brian Turcotte. The press release and slide presentation that will be used during today's call can be found on the Investor Relations section of Frontdoor's website, which is located at investors.frontdoorhome.com. As stated on Slide 3 of the presentation, I'd like to remind you that this call and webcast may contain forward-looking statements. These statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company's filings with the SEC. Please refer to the Risk Factors section in our filings for a more detailed discussion of our forward-looking statements and the risks and uncertainties related to such statements. All forward-looking statements are made as of today, August 4. And except as required by law, the company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. We will also reference certain non-GAAP financial measures throughout today's call. We have included definitions of these terms and reconciliations of these non-GAAP financial measures to their most comparable GAAP financial measures in our press release and the appendix to the presentation in order to better assist you in understanding our financial performance. Before I turn the call over to Bill for opening comments, let me start with a brief introduction. As many of you know, Bill has been Chairman since the spin-off of Frontdoor, and he assumed the CEO role at the beginning of June. Bill is a tenured executive, with over 35 years of business experience at world-class market-leading companies. He has served on several boards and was the President and Chief Executive Officer of H&R Block from 2011 to 2017. Prior to that, he had extensive corporate and marketing experience through various leadership roles at eBay, Pepsi and Pizza Hut from 1987 to 2008. You can find more on Bill's background on Frontdoor's website. I am very pleased to now turn the call over to Frontdoor's new CEO, Bill Cobb, for opening comments. Bill?

[Bill Cobb:]

Thanks, Matt, and hi, everyone. It is great to be here to speak with all of you. I look forward to getting out and meeting our investors over the next several months, and I'm extremely excited about the opportunity to lead the next phase of Frontdoor's journey. Let me start on Slide 4 by saying that over the last few months, I have been able to meet with a broader group of Frontdoor's associates, and I continue to be impressed with the level of talent across the organization. I am also very bullish on the company's future, as we know, there is substantial demand for home repair and maintenance services across the United States. I am confident that we have a great business with a bright long-term future ahead of us. However, we are facing some significant near-term issues that are worse than I expected coming into this position. We are looking at a macroeconomic environment that continues to deteriorate, rapid cost inflation, declining consumer sentiment and a dynamic global backdrop marked by war, rising geopolitical tensions and global supply chain disruptions. So let me state it right up front. We are lowering our full year 2022 adjusted EBITDA to be in a range of $170 million to $190 million as a result of these factors. These are difficult times, and I have been struck by the magnitude of the impact on our financial outlook. But let me be clear, we will work our way through it and emerge stronger for it. I still completely believe in the future of this company, and the last two months in the job has only increased by conviction despite the tough outlook for 2022. Frontdoor competes in the growing home services space, has a great recurring revenue business model, a strong management team and a solid foundation as the leader in the home service plan category. Let's turn to Slide 5, and review some of the changes that are currently underway at Frontdoor as we are moving quickly to improve execution and better balance revenue growth and earnings. Specifically, our teams are working on the following areas

[Brian Turcotte:]

Thanks, Bill, and good morning, everyone. Please turn to Slide 8, and I'll review our second quarter 2022 financial results. Second quarter 2022 revenue increased 5% versus the prior year period to $487 million as a result of higher pricing and a mix shift to higher-priced products in our home service plan business, which more than offset a slight decline in customer volume. Looking at our home service plan channels, second quarter revenue derived from customer renewals increased 10% versus the prior year period due to growth in the number of renewed home service plans and improved price realization. First year real estate revenue decreased 26% versus the prior year period, reflecting a continued decline in the number of home service plans in this channel, offset in part by improved price realization. The decline in the number of home service plans in this channel was due to the ongoing challenges presented by the seller's market, driven in part by extremely low home inventory levels across the U.S. First year direct-to-consumer, or D2C, revenue increased 15% versus the prior year period due to improved price realization and a mix shift to higher-priced products as the volume was relatively flat. Second quarter revenue reported in our other channel increased $5 million over the prior year period, primarily driven by ProConnect growth. Gross profit declined 13% in the second quarter versus the prior year period to $211 million, and our gross profit margin was 43%. I'll speak to the inflationary cost pressures that unfavorably impacted gross profit in a moment. Moving down to income statement. I would point out that as part of our efforts to better match our office space footprint to our current needs and also to reduce operating expense, we are entering into a sublease for our downtown Memphis headquarters. Our plans are to do a smaller and less expensive space, which is more centrally located for our Memphis-based employee population. While this action resulted in a noncash impairment charge of $11 million in the second quarter related to our headquarters facility operating lease right-of-use assets and leasehold improvements, the cash flow and adjusted EBITDA impacts over the remainder of our lease term are expected to be positive. Net income decreased $7 million in the second quarter of 2022 to $33 million. Adjusted net income decreased $22 million over the prior year period to $44 million. Adjusted EBITDA was $77 million in the second quarter or $37 million lower than the prior year period. Let's move to the table on Slide 9, and I'll provide context for the year-over-year decline in second quarter adjusted EBITDA. Starting at the top, we had $23 million of favorable revenue conversion in the second quarter of 2022 versus the prior year period. Contract claims costs increased $53 million in the second quarter versus the prior year period, primarily driven by an acceleration of inflationary cost pressures, including rising contract-related expenses and higher parts and equipment costs. Second quarter claims costs were also unfavorably impacted by approximately $4 million from the extremely hot weather across the country, primarily in May. Additionally, contract claims cost for the second quarter of 2022 include a $7 million unfavorable adjustment related to the adverse cost development of prior period claims. Sales and marketing costs increased $6 million in the second quarter versus the prior year period, primarily related to increased investments in the DTC channel and ProConnect. And finally, general and administrative costs increased one million dollar in the second quarter, primarily due to increased professional fees. I'll now go into more detail on the significant claims cost inflation we're experiencing as a result of the challenging macroeconomic environment, the effects on the business and our ongoing cost mitigation strategies. Over the 12 months ended June 2022, the consumer price index increased 9.1%, not only the largest 12-month increase in over 40 years, but also included an acceleration over the last two months of the second quarter. Furthermore, we are seeing cost inflation in home services rising even faster. For example, in June, our contractors were faced with fuel costs that were up over 60% versus one year ago. We also saw the producing price index for heating and air conditioning equipment and appliances up over 20% and 15%, respectively. It is one of the most challenging environments we've ever faced, and it continues to evolve as issues such as the war in Ukraine and its impact on fuel prices and rolling COVID lockdowns in China impacting the global supply chain. However, we are seeing some green shoots as certain commodity prices are now declining. For example, cold-rolled steel, a critical component in the manufacture of water heaters and HVAC equipment, declined 20% in June versus the prior year period. Additionally, as I mentioned last quarter, while we have great pricing visibility and an ability to influence our own direct purchases of parts and equipment, we don't have that same level of real-time visibility into our contractor costs. Our contractors, for the most part, who are small business owners, generally pass along their higher cost to us. And as they can take months to complete their billing process, our ability to identify and manage accelerating contractor costs in the near term is limited. I believe it would be helpful to provide more context as to how the current environment impacts Frontdoor's operations. The challenging macroeconomic environment, including higher parts and equipment costs and contractor-related inflation, resulted in our second quarter year-over-year cost per service request increasing about 23%, which was much higher than the mid- to high-teens increase we experienced in the first quarter. We believe the main drivers of this inflation are

[Bill Cobb:]

Thanks, Brian. A couple of final thoughts. This management team is not pleased with where we are with this outlook. Our Board has directed me to make the changes necessary as quickly as possible. As a result, we are working with a high level of intensity to do everything we can to improve our results for the rest of 2022 and put ourselves in the right footing heading into next year. With that, I'll now turn the call back over to Matt to open the question-and-answer session. Matt?

[A - Matt Davis:]

Thanks Bill. [Operator Instructions] Please note that our guidance is limited to the outlook we've provided. Operator, let's open the line for questions.

[Operator:]

[Operator Instructions] Our first questions comes from Ian Zaffino from Oppenheimer. Your line is now open. Please go ahead.

[Ian Zaffino:]

Great. Thanks For taking my question. Bill, I wanted to ask a few things now that you're in the CEO seat. You mentioned ProConnect really not performing the way it should be. What exactly is going wrong there? Why does it continue to lose money? Is it basically a scaling thing? Is there something else wrong with the product? Maybe help us understand what you identify as the issues there? And maybe what you can do to sort of get it back on the right track? And then I have a follow-up. Thanks.

[Bill Cobb:]

Yes. I think we have -- starting at the beginning, I think we have a branding issue. The term ProConnect may not have been the best term; and two, it has a ProConnect -- it's a pretty generic item. And we haven't really spent beyond building that brand and explaining really what it is about. Second, I think we expanded too quickly. We expanded to too many cities and too many trades as opposed to building up our process and the way it happens. So we kind of spread out to, I think, 35 cities or so. We had all of our major trades. And we, in hindsight, probably should have been focused on maybe find us trade in limited number of markets. Third, I think the way we engage with contractors and their value proposition was not enticing to contractors. So I think we had some trouble getting contractors, and I think they're a little confused by the proposition. So that's why, as I said in the script, there's a whole overhaul that we're looking at in terms of how we go to market. But let me try to step back then, and I can follow up if I didn't fully answer your question. We have the home service plan, which is primarily a repair and replace model. What we want to do with our on-demand offering is have a repair and maintenance offering so that we are focused on areas that you don't have to access our business, our brand because you don't have a year-long subscription. We think that in tandem, a subscription model, the year -- annual contracts plus an ability to engage with us on a one-off a la carte, whatever you want to call it, basis around repair and maintenance is really an ideal blending of our overall business model. So I think, like I said earlier, this is important to keep our focus on, on-demand. We've got to restage the ProConnect business. And in the interim, we're continuing to support it, albeit at lower levels. So we'll continue to see revenue coming out of this year. And there's been some good work done by the current team on funnel improvements and interaction with our customers and our contractors. So it's going to be important as we go forward, but it just hasn't been executed the way we probably should have.

[Ian Zaffino:]

Okay. Thank you. That's helpful. And then on the real estate side, I know you laid out a bunch of the headwinds you're seeing at the sort of macro. But are you also seeing maybe a share shift inside that market, maybe you're not holding the share like you intended to, you're not growing the share like you want to? And if that's the case, what do you plan to do about it? How do you plan to address that? And then if I just sneak in one other question, maybe for Brian, is third quarter has been very hot so far. What are you assuming as far as headwinds from the weather and increased service calls? Thanks.

[Bill Cobb:]

Yes. So Ian, let me address the real estate piece because while I won't comment specifically on whether we've lost share or not, let's put it this way, we have to gain share. Our performance in real estate is not to the level notwithstanding a challenging market. And Jes Fields, our new Chief Sales Officer, is all over this. She has brought in a new sales culture, she's brought in accountability, and she's doing things that are blocking and tackling. She's got now -- everybody has a weekly field sales plan, there's a weekly training module every week that the field agents have to go into. She is completely focused on real estate and not trying to chase a bunch of other opportunities, which maybe we should get to later on. Right now, we need to fix real estate, and Jes is all over that. She's so much energy and she's really brought a dynamism, if you will, I think that's a word, to our sales process. So I couldn't be more thrilled with her hiring. And I believe she is sort of a no-excuses person, and she believes there are going to be five million to six millions of homes sold this year, and we need to get our fair share of that. Brian, I'll turn it over to you for the other question.

[Brian Turcotte:]

Thanks, Bill, and good morning, Ian. Regarding the third quarter and HVAC claims, we've had the benefit of seeing July, and it was a hot July, but we've built that into our forecast and also maybe a little more hot weather in August. And we start to trail off towards the end of the third quarter, obviously, with HVAC claims. So I think we've built that into our guidance, but we're not sitting pat watching the weather. As I mentioned in my prepared remarks, we're improving our processes to lower our cost. We're trying to move to the mid-range, mid-80s for our preferred contractors. We're expanding our recruiting for contractors. We're improving the end-to-end processes, as I mentioned in the call. And also on the sourcing side, trying to lower our costs through maximizing our sourcing efforts and purchasing lower cost materials that our contractors could purchase. So we're watching the weather, we're trying to reduce our costs and things we can control. Is that helpful?

[Operator:]

Thank you. Our next question comes from Youssef Squali from Truist Securities. Please go ahead. Your line is now open.

[Youssef Squali:]

Hi. Good morning guys. This is Nick Cronin, on for Youssef. Can you just talk a little bit about the pace of price increases? I think you said you've gone through two already this year with another to go. And any impact you're seeing on customer churn? And then secondly, just for Streem, is that still on track to do $10 million to $15 million this year? I know you called out ProConnect going down. Thanks.

[Bill Cobb:]

So let me take the price increase piece, and Brian, please augment whatever comments I make. As Brian said, we have taken two price increases, we're planning on a third. We are targeting it, well -- by the time the year ends, we will have taken approximately a 12% to 13% increase in price. Any churn or declines have been as expected, as we've said all along. We are generally inelastic. We don't take that for granted. So we're doing everything to market and provide value to our customers. But given this incredible inflation and contractor costs, we're somewhat forced into taking pricing beyond what we might normally have expected. So as you noted, we will have a decline in customers this year, but that is primarily due to the real estate channel. So I feel pretty good about how we're controlling and managing and staging the pricing actions that we're taking. But I'll turn the rest over to you, Brian.

[Brian Turcotte:]

No, I think you covered it well, Bill. I would -- the only thing I'd say, Nick, is that 12% to 13% price increase, if you look at it on an annualized basis, on our revenue base, that increase more than covers the COGS increase we're going to have this year. And although we're not going to see it all this year, as I described in my comments, we'll see the benefits next year. But that just shows the power of pricing with our model.

[Youssef Squali:]

Got it. And then Streem, is that on pace to do $10 million to $15 million still?

[Brian Turcotte:]

Yes, Streem is not going to track that way again. As Bill described, we're going to view that as a technology play for us. We love the business, but it's more of a technology play supporting our core home service plan business. So we're investing less money into that business to find customers and enterprise customers. So that volume, we -- that revenue will be much lower this year than that.

[Bill Cobb:]

And you've built that in the guidance -- the revenue guide we gave you, that's included.

[Brian Turcotte:]

That's included in the guidance, yes.

[Youssef Squali:]

Great. Thanks guys.

[Brian Turcotte:]

It will be less than $10 million.

[Operator:]

Our next question comes from Justin Patterson from KeyBanc. Your line is now open. Please go ahead.

[Justin Patterson:]

Great. Thank you very much. Perhaps just a big picture one around the home service plan opportunity. This is a product that's been in market for quite some time now. How do you think about just the attractiveness of that opportunity? Where you are in market share penetration? And what the incremental investments are to really grow home service plan adoption more meaningfully? Thank you.

[Bill Cobb:]

Yes. Justin, it's one I ponder every day, if you will. Part of the reason we're doing the customer segmentation study, which we haven't done for a few years, is to state the obvious. The world has changed and certainly the home being so much more a centerpiece of your complete life. We've got to understand those dynamics. The research -- the tracking work we do, there is still a need for repair, home maintenance, replacement of major systems. So I think the core market, the addressable market -- and we talk a lot about $500 billion total addressable market. I'm trying to get to a real total addressable market for us. We're not going to get into the renovation business. But I do think that between the on-demand area and home service plans, we're going to have a sufficiently large business to try to attack. So I think the opportunity is still there. I do believe we have to modernize our approach. I think there are some steps we have to take on the product and the offering. We took some steps this year with our Platinum product, which expanded services. We're able to get an additional pricing opportunities there, but we also ran into more service costs, and we launched that in the year where we had all the issues that Brian talked about with contractor costs. So I think there's some rebalancing we need to do. But I think, overall, the market is still there. As for investment, diving through all of that right now, I think we can still have a very healthy financial model as we go forward. I think we just have to figure out what's the best way to go to market with that in terms of our marketing, our sales effort, and that's really what we're grinding on right now. Operator. Is there another call?

[Operator:]

Our next question comes from Eric Sheridan from Goldman Sachs. Please go ahead. Your line is now open.

[Eric Sheridan:]

Thanks for taking the question. Maybe taking a step back, I know we've talked a lot about the short term on the call. But Bill, you're new to the role you have now in the organization. It's been a couple of months since you took on that role. Can you give us a little bit of your perspective of what you've seen from inside the company? And how you think about your agenda versus maybe what in prior periods the company was focused on? And how you think about affecting change inside the organization? Maybe that's question one. And then two, just coming back to the real estate. Again, zooming out, understood blocking and tackling renewed focus around gaining share. Can you give us a little bit sense of like how the market share dynamic changes? Like what should we be thinking of in terms of the ramp of putting investments behind wanting to change the dynamic in real estate and actually seeing it come through in the results? And how much of that is in your control as a result of investments versus out of your control just because of the broader real estate environment. Thanks for the back..

[Bill Cobb:]

Okay. And if I didn't get all that, come back at it. But in terms of my perspective relative to where we were. At the highest level, the strategy has not changed. We still believe that there's a lot of vitality in home service plans. And we still believe that there is an opportunity for us, notwithstanding we may not have executed it particularly well to date in the on-demand piece. So that is the highest level, is unchanged. What has changed is the increased emphasis I put on home service plans. I think, previously, we're really trying to build Streem off the platform as a separate business, if you will, in ProConnect. And I think I've come to believe that we need to be more centered almost call it one business and use the assets that we have with Streem, use the learning that we have with ProConnect, use the ability for us to evolve the home service plan piece to really build a better offering as we go forward. That is what a couple of minutes ago is what we're grinding on. So I think the company, generally, the broad population is really excited about the direction we're going in. There's a lot of people who -- I've used the term around the company, let's reinvent the category we invented, and that's a little bit of the mantra that we're using internally as we really are questioning all elements of that. And I think we can have a very exciting modern offering. We continue to make steps on our digital transformation. It reminds me a little bit of when I walked in to H&R Block, and Block made their major strategic error 15 years before I got there in 2011 when they didn't engage within the digital area. They said it's going to cannibalize their business, they listened to the franchisees. And we didn't really have a very good digital offering. By the time I left there, we had a product that in some reviews was superior to TurboTax. Same situation here. We've been talking about a digital transformation. I'm really, really impressed with Tony Bacos, the people he's brought in with him in terms of the way he is relentlessly focusing on that. So I think we've got a lot of things lined up here. I've got some new members of the management team that I'm fired up about in terms of marketing and sales. And then Raj, who's working on product and pricing is just -- his experience is just invaluable. So we're pretty jazzed about our opportunity as we go forward, notwithstanding the no one's happy with where we are in 2022. As far as real estate goes, I think what Jes and I have talked about is we've got to stop worrying about where the market is going. As Jes pointed out, when she presented to our Board last week, we're still going to have five million or six million homes sold next year. That's what our focus needs to be. We need to be in the game with regard to all those sales. We have just re-upped our partnership with Anywhere, former Realogy. We've got a partnership with HSOA. I was with Jes last week on a sales call with another partner that we're trying to build a trusted partner relationship with. So we are trying to go at a high level with major real estate houses, and yet -- and also do it, grind it out real estate agent by real estate agent. So as I said a little bit earlier, it's a lot of blocking and tackling. We got to make sure that we have coverage. We got to make sure we have plans. We got to make sure we have targets, and that's really the spirit that Jes has brought forward.

[Operator:]

[Operator Instructions] Our next question comes from Brian Fitzgerald from Wells Fargo. Please go ahead Brian.

[Brian Fitzgerald:]

Thank you. We wanted to ask about the dynamics you're seeing, maybe more in general, in repair, in extensions, in the maintenance, maybe into home improvement over time. With the macro headwinds rising, are you seeing any shifts in consumer behavior resonating through dynamics, getting more frugal, maybe more tolerance for fixing versus replacing, anything you can tell there?

[Bill Cobb:]

It's a great question, Brian. I think I would describe it right now as swirling winds. I think a lot of people have -- with the downturn in the stock market, with really some uncertainty generally, with the way inflation has impacted people at the grocery store, in restaurant and all the other areas, I don't think we have a full picture of this right now because it has been -- the pace has been brisk. I think, generally, these things normalize. My experience is we're going through the shock, we're going to get through it. People are going to still want to buy a new home, people still want to their home, people are still going to need to maintain their home, repair systems, et cetera. Let's try and keep talking about the broad perspective for this company is actually quite strong. We have to execute better. There's no doubt about that. But I think that we still see things -- while there's some shocks to the system, we still see things that point to a positive future. And we'll get through this stage both as a company, and, I think in general, as an economy, and then we'll go from there.

[Operator:]

That concludes our Q&A session for today. I will now hand back to the management team for closing remarks.

[Matt Davis:]

Thank you for participating this morning in our Q2 earnings call. We look forward to speaking with you going forward. Thank you.

[Operator:]

Ladies and gentlemen, thank you again for joining Frontdoor's second quarter 2022 earnings call. Today's call is now concluded.