All right. Good afternoon, everyone. Cory Carpenter, internet analyst at J.P. Morgan. We have Frontdoor with us today. Bill and Jessica, thank you for joining us.
Hey, Cory. How you doing?
All right, so, Frontdoor, been around for over 50 years. But for those newer to the story, could you start with a high-level overview of the business and also the industry?
Yeah, I mean, it's a company that was started really based on the real estate industry, where the initiative was that beyond home insurance, there was a need for a product or service that could help with normal wear and tear of, you know, appliances and systems in the home. It generally has been through the real estate industry that people have accessed American Home Shield. About 25 years ago, the company moved to a direct-to-consumer initiative. So those are the two pathways in, is either through the real estate transaction, or you can go on the website or an 800 number and call and get access to, you know, joining up with us.
The business, the way it works is, a member of American Home Shield has an issue, a repair, or something's broken in the home. They call us. They will pay a service fee to have a contractor come out. They will come out, repair it, and in the large majority of cases, occasionally, we will replace the item. And, that's kind of the virtuous cycle, the way it works, is that we have a contractor network of about 16,000 contractors around the country. About 2,500 or so are what we call our preferred or our better contractors.
But for consumers, it does a couple of things: budget protection against unwanted repairs, which are always gonna happen in a home, and it gives you peace of mind that you have somebody who can come in, who's curated, who's vetted, and that you can depend on us to deliver a service.
Bill, you're coming up on about, I think, your two-year anniversary as CEO. What have been your initial priorities, and how has Frontdoor changed during this time?
Yeah, I came in at a time of high inflation, and you know, we were sort of all over the place. We were not well organized internally. We were still hiring a lot of, you know, had a lot of headcount requests out there. So I came in and just wanted to do some simple things. Let's slow down, let's put an end to the hiring, let's get control of our expenses, and we did a whole SG&A analysis. Let's face right into the inflation situation. So we made the decision to price to cover our costs, which led to some rapid price increases, and frankly, have been... We thought inflation would sustain at a high level for longer. It has not, which has been a benefit to us from a margin perspective.
Also changed over the leadership team, and just did some things to just operate the company in a better way, with a focus on trying to grow both revenue and EBITDA at the same time. And, it's been pretty successful. We've been able to grow our EBITDA from, you know, about $214 million. We finished 2022, 'cause we did finish pretty strong, and then we finished last year at $346 million, I think it was, Jessica. And then after Q1, we just gave a guide where we raised the target for 2024. So we've been operating well, and I think the company is in good shape. We've got a great leadership team, and I'm really pleased with the point we're at.
So I wanna talk about the industry a bit. For an industry that's been around for decades, it feels like I'm always surprised by how little is known. How do you frame the addressable market opportunity for home service plans, and what do you think needs to happen to increase penetration from the current, you know, 5 million homes that have plans?
Yeah, it is. It is curious that, for, for an industry that provides such a terrific service, for relatively affordable levels, you know, $50-$70 a month, most of our people are on auto pay, that the service that it provides has been curious for us. It's about five million homes that have a home warranty. We've estimated, based on the demographics of those who have a home warranty today, that we can about triple that the addressable market for home warranties is about 15 million households. So we do think that there's a lot of room out there. Obviously, with what's gone on with the real estate business, that has dampened our first-year units. I'm sure we're gonna talk about that in a minute.
But I do think that we have an ability to expand the market because the value proposition still is strong. All our research shows when you sit down with consumers and put the proposition in front of them, that for this amount of money, you have service of your 23 systems and appliances in the home, it really resonates with consumers. We just have to do a better job of marketing and pricing it in a way that is gonna attract more and more people.
We'll definitely talk more about marketing. One more on industry. So five million plans, could you talk about the competitive landscape, what that looks like, and then also what you think of as your competitive moats?
Yeah. We have a pretty large share relative to everybody else, so we've pretty much. You know, while we pay attention to what others are doing, we believe we provide the best coverages to our members. We believe we have the best service, we have the best contractor base. So we spend, we eyeball competitors, but we're pretty much focused on our own area and executing and driving that. In terms of where that goes, I think that there are, there are, you know, definitely startups and people who are poking at this area. But for our company, we have almost two million members. We have relatively low CapEx, only about 2% of revenue. We're gonna throw off, you know, over 50% of our EBITDA as free cash flow. We've got a lot of cash right now.
We'll talk. I'm sure we'll talk about the balance sheet in a bit. But it's a really great model, I think, in the whole home services area. It's hard to beat a 2 million member, $1.8 billion in revenue, $360 million, thereabouts, in EBITDA, low capital, et cetera, and the way we turn up cash.
Focusing on Frontdoor now, hoping you could talk about the key trends impacting your two primary customer acquisition channels: real estate and then also direct-to-consumer.
Yeah, let's start with real estate. So, it's pretty well known that the real estate business has been going through some interesting times. Two years ago, six million homes were sold, which you would say was a very vibrant market. For us, the issue with the high amount of homes sold was that it was a seller-dominated market. There was not a lot of inventory on the days on market. And, for us to be an attractive proposition, we need sellers in their listings to include a home warranty plan. When they're getting multiple offers, and they're getting offers within days as opposed to months, that attraction lessens. So that has hurt us, and now the industry, with the interest rates growing, people are sitting in their homes with 2% and 3% mortgages.
People are not as adept or attracted to buying and selling homes. So we're down to four million homes being sold is the estimate for this year. I still think we're just going through a tougher time. I think it's cyclical. Talked to a lot of people in the real estate industry. They've seen this before. We will come through this, but right now, it's a little tough. When interest rates start to fall, I think the flywheel is gonna start. And I do think it has an overhang leading into DTC, that it has impacted DTC. It's hard to show a direct correlation, but it is something that we believe does have an impact with all this swirl around real estate.
Now, DTC has generally fallen for most of the competitors, including ourselves. It has become I think inflation, with the price increases that we were able to take to cover our costs, it did have a rapid rise against consumer spend, and this is a discretionary purchase, and there is also high inflation. So that will work itself out, we're confident of. We think we're hitting some of the low points as we go forward, and we think once we get, and we believe we will, get first-year units, you know, humming again, we've got a terrific model in terms of what we've done on controlling our costs, working with our contractors, controlling our claims costs, and the cash generation that we are able to, to affect.
On the real estate side, challenging market, like you said, but what are you doing, or what are you able to do to position yourself for when you do see a rebound?
Yeah, we're working very closely with our brokerage partners as one element. So we've got a number of marketing services agreements with those brokerage houses. Our sales teams are working up various ways of intersecting with getting deeper with the top agents in the country. We're very, very attuned to the types of things that we can do to try to get, right now, a greater share of real estate. We are beholden to the market to some extent, but we haven't sat down and just, you know, said, "Well, let's see what happens." We're being very aggressive with our sales team in terms of going out, going out there. Now, in addition to that, in the real estate piece, we are also
and we'll probably talk about this, we are also very focused on delivering other areas of revenue growth, and that's what, and I'm sure we'll talk about it, Cory, the new HVAC program has been a big benefit to us. As we're going through this tough times, that has been a revenue upside, almost from a standing start, that we're really happy about and continues to accelerate for us.
So one more on real estate, then we'll go direct to consumer. Could you talk about attach rates? What are they normally? Has that changed? And then, a lot of change going with realtor commissions right now or proposed changes, do you see that impacting Frontdoor at all?
Yeah, the attach rate has been a killer for us, for everybody in the industry. It used to be around 30% of all real estate transactions had a home warranty attached. That's fallen to about half of that, about 15%-16%. That is something that we believe will accelerate. I don't think we'll get back to 30% attached, but that should accelerate as the market starts to stabilize. So that has been a dampening of the volume piece, just through attach rates. Now, as far as the commission rate, there's been a lot of swirl on that.
I think it could be a net benefit to us because I think that, you know, speaking to some folks in the real estate business, the better agents have been negotiating rates anyway. I think it's more of a, you know, a media convention. I don't think it's gonna impact us. If anything, we think, on balance, it's gonna help us because the better agents are gonna take their listings and try to differentiate them, and home warranty is one of the ways that they can differentiate them.
Okay. Moving to direct consumer, I think perhaps your biggest initiative this year is relaunching the American Home Shield brand. Where are you in this process, and what can you tell us about the early results?
Yeah. W e relaunched American Home Shield. You know, it's a 50-year-old brand, and we've talked about how in many situations, and you look at a Domino's, you look at an Arby's, you look at an Old Spice, brands need to be-- brands are resilient, and, but they do need to be refreshed, and that's what we're trying to do with American Home Shield. We, we have a new website, we have a new logo, we have sharper colors, we've got a new tagline called "Don't worry, be warranty." We've got a new spokesperson, the former Debbie Downer, Rachel Dratch, who is, or what we're calling Warrantina. It's new creative. So we've got a package of initiatives, and we're really pleased with the website, that to get-- show a new face to the industry.
The industry is marked by what we call a sea of sameness. The names are similar, all the colors are red, white, and blue. There's not a real ability to differentiate, and that's what we're trying to do with Warrantina. This is gonna be a long run. This is gonna, y ou know, relaunches take a while to effect. I'm not gonna give any updates on results. We'll do that at Q2. But what I'm really pleased with the package of initiatives and how they've come together.
Okay. Could you talk about how the retention and margin profiles differ for real estate and direct consumer? And then once you do get, you know, like, customers to renew after their first year, what is the retention like?
Yeah, so this is one that has puzzled me, frankly, since I started here, which is the real estate renewal rate is about 30%, and actually, we've moved it up to 30%. It's been traditionally in the mid-20s% or so.
Mm-hmm.
And yet we renew DTC one at in the low to mid 70s% in terms of renewal rate, and then as we go from two plus years, we're approaching 80%. So we get to a point where we have such a disproportionate change between DTC and real estate. We are spending a lot of time on the real estate side, trying to get that renewal rate up, 'cause that, that's kind of found money. They are our customers. Sometimes they don't know they're our customers, which is one of the things that we have to do. But that's a big effort for us, but we're really pleased with our renewal book of business. It's the backbone of the company.
It's three-quarters of our members, and that we've put a lot of time and attention across the company, whether that's working with our contractors, our marketing teams, on what we call the member journey, so that we're staying in touch with members along the 12-month contract. So there, you know, we've improved our preferred contractor rate. We've done a lot of things to really improve that renewal book, and we think we can continue to do that as we go forward.
So you mentioned price increases earlier, to offset inflation. Question there is, what have you learned about price elasticity, and how should we think about pricing as a driver of growth going forward?
Yeah, I mean, when I first used to hear when I was just chairman, not CEO, you know, we're generally inelastic. Well, we've tested that one with the price increases we've had, so we are more elastic than we have been. I think generally, when people, when we talk to consumers, et cetera, and I think it's proven out in renewal rates, as long as we perform the service and the core value proposition, we should be fine with our pricing. I think it will settle out. It has been a little bit of a shock to the system in terms of the amount of increase, which I think did test the inelasticity aspect. But I do think, as a value proposition, we want to earn our way through there.
I think that people will come back to realizing what a great value this is, and so I'm not particularly worried in the long term. In the short term, I think it has dampened some of our volume.
Okay. So, one topic I wanted to talk about was customer service. The industry as a whole has been plagued by customer service historically. You're trying to change that. Could you talk about the progress you've made and what you're doing to address it?
Yeah, I mean, this is an industry, and I'll talk industry, and then I'll get specifically to us, that is based on a, you know, a contract with each member, and there's coverages, amounts, and of course, there are things that are not covered. That's the friction point in terms of what's hampered the industry from time to time, is people's lack of understanding of what is covered through a home warranty and what is not. I think we have taken the approach of simplifying our contract. It's still kind of complicated, but it's much simpler than it was, doing a better job of training our authorization agents and the people who interact to go through the coverages with our members, and I think it's borne out.
Our service times have improved greatly over the last couple of years. Our five-stars ratings are at the highest level we've ever had. Our one-star are at the lowest level that they ever have been. Our executive escalations, you know, nastygrams that are sent to me, are at all-time lows. We still get some, we're not perfect, but the improvement has been significant, and I'm really pleased with the effort across the organization by our service ops team and our other operators, that we're serving our members really well and will continue to do so.
Okay, so so far, we've talked on the, on the home service side, which is the vast majority of your revenue, but you did mention the HVAC program. You launched the Frontdoor brand last year. You recently announced you surpassed 2 million downloads. Could you just update us on what the offering looks like today and the role you see it playing in the broader portfolio?
... Yeah, so we have, we've had great attraction to the Frontdoor concept of being able to video chat with an expert. We went out and hired a number of expert people who were in the plumbers, electricians, handymen, HVAC specialists, and appliance specialists. We have them on staff. They are our employees. And so the core concept is what we call the Frontdoor Unlimited, and you have access to unlimited video chats for one year. What we've done, we had launched Frontdoor originally as a home service plan. That was my fault. It was a disaster. We pulled it out. We did not need a second home warranty business. What we need is an on-demand, in-person business, and that's what we're driving toward.
Think of this as an ecosystem, where we're trying to get more and more users through the interest in the video chat, and then look at the various services we can do on an on-demand, in-person. Think of it as no need for a contract. Now, the lawyers will tell me, of course, they have to sign something and all that stuff, but primarily, it's not a 12-month contract. And so we're able to do appliance repair on demand. We're able to put a new HVAC system in your home on demand. We're able to do maintenance issues, carpet cleaning, gutter cleaning, rekeying, etc., on demand. So that's what we're trying to build, and that's a business we listed under another category on our statements.
We think it's gonna be about $100 million this year. Now, the vast majority of that is this new HVAC upgrade program, which has been a real winner for us, and it's a great value proposition for our contractors and our members. But we're trying to build out a companion business to home warranty, and the way I talk to investors about it is: Look, we've got a very strong core business in home warranty. It's got very good margins. We free up, we turn up a lot of cash, and then we have this option value as we try to build out over the coming years, this on-demand business. So that, that's your option value on the stock. But the core business, you know, I think we're managing extremely well.
Why has the HVAC program been so successful? What are consumers, y ou know, what's resonating? And then could you talk about some of the other monetization strategies you're testing?
Yeah. I think what we've done is we've partnered with our contractors and our OEM suppliers, and so our supply chain team is buying equipment extremely well and making it available. We've cut a deal with our contractors to what their margin profile will be. And what that amounts to is then about a 30%-40% discount generally for individuals to put in a new HVAC system. That's a low-margin product for us, but it has a downstream effect of the more new equipment out there, the less truck rolls, the less repairs we have to do. So that's not seen in the margin, but that is seen in our dispatches and the like. So we think it has a terrific benefit of...
The attraction for people to upgrade their systems because these are more efficient systems, they, the electric bill is lower, so there's a lot of benefits to the member, and not only the saving of money on what it would generally cost to put in a new HVAC system.
So one more on on-demand, then we'll go to financials and capital allocation. Excuse me. How do you think about the revenue contribution, the margin profile of the Frontdoor brand in, you know, kind of the near term and the long term?
Yeah, I think that, we're still working through. I mean, right now, we have the new HVAC program. We think there are other applications to appliance replacement and potentially even water heaters. I think the big play for us is going to be with the video chat right now, about 25% of the time, we can fix the problem over the video chat. Another 25% of the time, the expert will tell people how to fix it, what part they need to go to a hardware store or whatever, to buy. And then about half the time, you're gonna need a repair, you're gonna need a repair person, and we send them the information for one of our contractors, so they can be in touch with them. We want to eventually complete the sale.
We wanna, we wanna be the ones who send the contractor, complete the sale, recognize the revenue. There's some tech that needs to be built with that, in terms of collecting, collecting money and, you know. Right now, we're based on a service contract, and there's a whole lot of complications, not unsolvable, but that's on the roadmap so that we can drive that. So that'll be a big revenue driver for us, in addition to the repair and maintenance stuff that I talked about earlier. I think as from a margin profile, Cory, I think generally it will be lower, which is why Jessica, right now, we're at about 50% margins on the core home warranty business.
We could probably be a little bit higher on that, but we'll probably be lower on the on-demand, which is why we're saying that we generally would be, corporately, a margin, gross margin in the high 40s.
Jessica, thanks for your patience. So a few questions on financials. You became CFO not too long ago. Gross margins were at an all-time low when you joined. You also had the benefit of dealing with significant inflation out of the pandemic. Could you talk about the progress you've made, the past few years, and just the financial profile of the company today?
Well, overall, I will say, we as an executive leadership team are very proud of the work that we've done over the past couple of years, and feel very good about the overall financial profile, but also where our margins stand today, which, as you know, Cory, my first Investor Day last March was a very different situation coming out of 2022. So when I think about where we are today, I'd point to a couple of key actions that we took as a leadership team. First, Bill alluded to, we increased prices in a very highly inflationary environment, which, you know, at the time, I think end of 2022, we were at about 15% inflation, and we needed to address that.
Second, we really focused on improving our overall cost control and our planning processes across the board, by really leveraging our scale and our purchasing power with suppliers, and also really, and contractors, as well as implementing a really robust review of our highest cost jobs, which we really started to see the benefit of that in our peak season last summer, and that continues to be something that rolls through. But when I step back holistically, and I think about where we were, where we are today, I think, at the end of the day, what's really changed under Bill's leadership and with this new executive leadership team, is that we are just, much more aligned as an executive leadership team, which has driven a different tone from the top, better execution across the business.
When I think about my observations, you know, stepping in in 2023, and Bill a little bit, you know, earlier to that, we really have shifted the business from one that was more reactionary to a much more proactive operating model, which has just put us in a position to manage whatever comes our way in a much better way.
So, Bill may have kind of given us a preview.
He gave us a preview.
But with gross margins back near all-time highs, just how do you think about margins from here? Are they structurally higher? Or do you see opportunities for leverage in the model if it's not in the gross margin line?
Yeah, no, and as Bill shared, I think we're really guided to upper 40% range, which really accounts for both the core business, which we do see some upside there, but also, as we're building out our on-demand product portfolio, which Bill alluded to, has a lower margin range. So, you know, I think with all of the work that we've done, and I'd say it spans beyond, you know, we talked about control, supply chain, we've really implemented a culture of process improvements, and we're really being very prudent about our margins across the board.
I'd say we're more in margin management mode than margin expansion mode, and really using that flexibility that we've built to focus on our number one priority, which is absolutely growing the business, growing units, and leveraging things like our dynamic pricing muscle, which is something we've been developing over the past four years, and discounting strategy, et cetera, to really invest in growing the top line.
I have two on capital allocation. We might have time to open it up for Q&A at the end, so if you would like to ask a question, raise your hand, and they'll send a mic. So on capital allocation, last earnings call, Jessica, you mentioned your cash balance is higher than your target level, and your leverage is below your target level. So I'll put that in the good, good problem to have bucket, but just given that dynamic, you know, how are you thinking about deploying capital?
Well, I wanna make sure that our investors know that we are not planning on staying parked at a 1.1x leverage ratio, and our cash balance is where they are sitting today. I think there's some timing and seasonality coming into Q1. For those that listened to our call, March came in a lot stronger than planned, so we generated some more cash than anticipated. But recognizing that, I just want to reiterate, our capital allocation strategy has remained unchanged. So our number one priority is growth, and that's either organically or inorganically through M&A. And when we talk about opportunistic M&A, what does that look like? It's real businesses that are gonna be accretive to revenue, units, and Adjusted EBITDA.
Second, our number two priority is a strong balance sheet, which you've already pointed out, you know, it's a good problem to have, and we're really there, and which really provides us the flexibility to really pull all levers across our capital allocation strategy. And then finally, our number three priority is returning all excess cash to shareholders. So beyond the $100 million-$150 million that it takes to run our business, and absent M&A, we are gonna continue to repurchase shares and return that to shareholders.
So on the M&A topic, we were surprised there was not much consolidation in the industry during the downturn. I mean, really, given, you know, you are the only pure play company.
Do you think consolidation would be beneficial? If so, what's your appetite for acquisitions?
Well, I think I'm not gonna speak for the industry overall, but what I will say is that we continue to be opportunistic on M&A. And again, it's for that, we've done some technology plays in the past. We acquired Streem. I think for us, we're really, again, talking about real businesses that are gonna be accretive to revenue, units, and Adjusted EBITDA. Our number one priority continues to be growth, but absent that, we will continue to return all excess cash to shareholders.
I have one more question, but before I ask it, does anyone in the audience have a question? All right.
Thank you. For new home sales, existing versus builders, are the attach rates different? Are the margin profiles different? Is there anything else you can elaborate there on?
So we don't deal with new home sales. We're existing homes. We deal with the wear and tear of existing homes, so we don't have a relationship in the new home area. We primarily focus on existing homes and those types of situations.
And then, thank you. And then one more on that. The attach rate used to be 30%, I think you said, and it got down to 15%. But you said you didn't think it would get back to 30%.
Yeah, I think-
What changed?
I think it's I think dynamics like this are difficult. You know, the slide down to 15%, I think to start to build our way back, I think people have gotten more accustomed to, you know, there's dynamics that are different now. Cash sales are, what, 28% of all real estate transactions. People are moving toward no home inspection. So the dynamics of the industry have changed such that I don't think we can get back to that. Now, can we get back into the 20s, can we get back into the teens, et cetera? Yeah, I think we, I think we can. But I think it is something that we can move in the right, move in the right direction, and then we'll go from there as an industry.
Okay. And then are there certain regions of the country that are more important for you in those existing home sales rekindling than others?
Yeah, I mean, our business is primarily our three biggest markets are California, Florida, and Texas. We're primarily a business from Washington down through the, you know, kind of the Smile area, up through Virginia. We do not have strong businesses in the Northeast or the Midwest. I still don't completely get that, 'cause there are HVAC systems everywhere, and there's plumbing everywhere. But, that's been the history of the company. Not that we can't do better in those other areas, but that's primarily the strongholds. And fortunately for us, in Arizona, those are the growth markets also.
Any other questions?
Is there a lot of overlap between your on-demand service providers and service providers on other on-demand platforms, Yelp or Angi? Or do you have a distinct set of SPs?
Yeah. Our contractors can work other home warranty or home service areas. So they are not exclusive to us, and we don't want them to be exclusive to us because we believe we get better pricing on our warranty customers in dealing with that when they can have what we call a retail business or the like. So we prefer that our contractors, especially our preferred contractors, have a full book of business beyond just warranty.
Awesome. Well, I think we have time. We're going orange, so we'll do our closing question. Maybe, Bill, for you, just bigger picture, what are the 1-2 things you're most excited about in the years ahead? And you can't say it's the real estate market. Or think could be transformative to the business.
Yeah, I think there's a couple of things. One, I really like the way the company's situated. I like the way we're set up. I do think I'm looking forward to... I do believe fundamentally that both real estate and DTC are gonna turn, and that that's when, if you will, this model really sings. I think we'll continue to be really good at renewals. I think we'll be really good at managing contractors, claims costs, and the like, and we'll manage our spending.
I think the other thing is, on the on-demand side, I think there's a world of opportunity for us out there. I think we can do a lot more in the maintenance area. I think that is something that, as we become a full provider of services, that we can do a lot more in that area. I think there's more room to grow in terms of new equipment replacements, whether they be appliances, HVACs, or water heaters. So I think this on-demand companion to our home warranty business is the other part that I'm most excited about.
Great. Well, thanks for joining. We'll end there.
Thanks, Corey.
Thanks.