FTDR - NASDAQ

Good day, ladies and gentlemen, and welcome to Frontdoor's Third Quarter 2025 Earnings Conference Call. Today's call is being recorded and broadcast on the Internet. 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.

Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor's Third Quarter 2025 Earnings Conference Call. Bill Cobb, Chairman and CEO; Jessica Ross, CFO; and Jason Bailey, VP of Finance, will be joining me on today's call. 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 www.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, November 5, 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. I will now turn the call over to Bill Cobb for opening comments. Bill?

Thanks, Matt Davis, and good morning, everyone. What a year Frontdoor is having. Our results reflect the continuation of superior financial and operational performance and we are on track for record financial results in 2025. Let's get into the third quarter highlights on Page 4. Starting with revenue, which increased 14% period-over-period to $618 million. Gross profit margin increased 60 basis points to 57%. Net income grew 5% to $106 million and adjusted EBITDA grew 18% to $195 million. Additionally, first year organic DTC ending member count grew 8%. Real estate member count grew sequentially in Q3, a milestone that we have not seen for the past 5 years. New HVAC revenue continues to crush it. Synergies from the 2-10 acquisition remain ahead of schedule, and we have used our strong cash flows to repurchase shares, totaling $215 million through October 31. Our results speak for themselves, and they show the power of our strategy and the momentum we've built. Now flip to Slide 5. We are firing on all cylinders, and that strong momentum has positioned us to deliver across our business. First, operational excellence is at our core. Three years of disciplined execution have built a strong foundation to accelerate growth. Second, DTC continues to perform, 5 straight quarters of organic member growth. Third, we see the real estate channel turning the corner, supported by the return of a buyer's market. Fourth, retention rates are strong and remain near all-time highs. We're committed to delivering an outstanding experience for our 2 million-plus members through continuous innovation and technology. And finally, our nonwarranty growth continues to be a game changer. Leveraging the success of the new HVAC program, we are well positioned to replicate that model by expanding into other replacement categories. Let's double-click on each point, beginning on Slide 6. We've talked a lot over the past few quarters about building a foundation of operational excellence and for good reason. These efforts have translated directly into stronger financial results. Over the past 3 years, we have focused our margin improvement efforts in 2 key areas: one, pricing actions; and two, operational efficiencies. Let me start with pricing. In 2022, we faced the highest inflation in the generation, and we responded decisively with double-digit price increases, not only to catch up to those inflationary pressures, but also to address where inflation was heading. We did this using our dynamic pricing capabilities, which deliver smart and strategic price adjustments, particularly for higher usage members. We also raised our trade service fee, which is actually an offset to claims costs, providing us another lever to respond to inflation. Now turning to operations. We've made meaningful strides in improving execution and cost discipline. We have enhanced and accelerated our contractor management process. This has driven better alignment, better execution, better member experiences and better costs. One key proof point is that our preferred contractor utilization has improved 200 basis points on average over the last 3 years. Our supply chain team has done an excellent job of leveraging our purchasing volume and extensive supplier network to negotiate better terms and allocate purchases to maximize cost savings. When you combine these pricing actions and operational efficiencies, we have improved our gross profit margin over 1,000 basis points since I started in the middle of 2022. In fact, we have had so much success improving our margins that we are reevaluating the long-term margin targets we provided at Investor Day earlier this year, and we will provide more information about that on our next earnings call. Moving to the direct-to-consumer channel on Slide 7. The DTC channel is performing very well, and our efforts to drive member count growth are paying off. In the third quarter, we grew organic DTC member count by 8% versus the prior year period. This is now 5 consecutive quarters of organic growth. Our success in DTC is due to several factors. First, the Warrantina campaign is working. I'll show you supporting data on the next slide, but we developed this campaign with younger audiences in mind, specifically millennials, since the average first-time homebuyer is now 38 years old. From a targeting perspective, we have sharpened our media strategy to focus on the middle of the media funnel, where consumers go from being aware of us to considering us. This strategy has improved our marketing effectiveness and media efficiency. Next, simply speaking, our promotional pricing strategy is bringing in more members. This strategy works because we can quickly return these cohorts to traditional pricing within the first 2 years without compromising renewal rates. Further, we are directly targeting new homebuyers who did not purchase a warranty with their new home transaction. Our multichannel approach includes paid search, social media, commercial partnerships and word-of-mouth campaigns and we are getting more sophisticated in our digital marketing approach. AI is coming into play and enhancing our search strategy by moving beyond traditional keyword targeting. We are using more intelligent, context-driven approaches, which have improved discoverability and relevance with large language models or LLMs, such as ChatGPT. Let's turn to Slide 8 to talk about the effectiveness of the Warrantina campaign. The campaign is resonating, and we are leaning into education to balance the entertainment factor. Our research shows that key metrics such as likability, relevance and purchase interest are up significantly in just 6 months' time. And as you can see in red, our value proposition of budget protection and convenience is landing even more with those under the age of 45. The team's work over the past 5 quarters has been excellent. But we are not stopping here. We are allocating more marketing spend in the fourth quarter to position us for another strong year in 2026. Now turning to Slide 9 and the real estate channel. The story here is finally one of optimism. Despite ongoing macro challenges, our ending member count in the real estate channel has increased sequentially in the third quarter, the first improvement since 2020. While the macro environment in the real estate sector is showing some signs of improvement, challenges still remain. According to the National Association of Realtors, September existing home sales increased 4.1% to a seasonally adjusted annual rate of $4.06 million. However, this is still among the lowest level of home sales in 30 years. Moreover, affordability remains a concern with home prices climbing another 2% on average in September to $415,000. The bright spot Total housing inventory increased 14% year-over-year, and we are now at 4.6 months of supply. While inventory remains below pre-COVID levels, it is now at a 5-year high. This shift signals that a transition to a buyer's market is underway, where homes stay on the market longer and sellers are more likely to add a home warranty to help close the deal. Here are some of our aggressive actions to improve sales. Increasing engagement with real estate agents, we are delivering a differentiated product and agent interest has picked up significantly around our video chat with an expert feature. We are also continuing to provide education on the benefits of a home warranty and have a compelling value proposition that keeps our brands top of mind. Additionally, we have implemented targeted promotions to drive renewed interest and excitement with both agents and new homebuyers. Our actions, combined with these market dynamics are resulting in us outpacing the market. Moving on to retention rates on Slide 10. In the third quarter, our customer retention rate was at 79.4%. Retention remains strong because we are delivering a better member experience through technology and process improvements. On the technology side, we have had 2 big wins. First, AHS App adoption is growing. Launched only a year ago, almost 20% of our members have already downloaded our app, an outstanding result. This enables easier service request submission and real-time contractor updates. In the past 12 months, members have submitted 200,000 service requests through the app and usage continues to ramp. Second, and to quote one of our members, "Video chat with an expert is dope." Since the launch in February, our visual experts have completed about 35,000 video chats and members love it, giving us nearly perfect thumbs-up ratings. It is a true differentiator in the home services industry and it is free for our members. Behind the scenes, we're also driving continuous improvements to deepen member loyalty and strengthen retention such as early engagement with new members through onboarding and tailored offers, improving the number of members on AutoPay, usage of preferred contractors, which was 84% in the third quarter. And we are also leveraging technology to improve the member experience, including system improvements to support smarter job routing to our contractors, and using AI to accelerate authorizations and assist in coverage decisions, enabling a 10x increase in the speed of coverage reviews. The impact is clear. Stronger relationships, higher satisfaction and a service experience that sets us apart. Retention isn't just a metric. It's proof that our strategy is working. On Slide 11, let's talk about another bright spot of Frontdoor, nonwarranty revenue. This is a major success story and an even bigger opportunity. As a reminder, nonwarranty is comprised of a number of programs but is currently fueled by our new HVAC sales. The program is scaling fast, and we are raising our full year outlook for new HVAC revenue again. Now to $125 million, a 44% increase over 2024. The opportunity ahead is enormous. In 3 years' time, we have sold around 50,000 HVAC units to our base of more than 2 million members. The runway for expansion is clear. We are now applying these learnings to other trades. We recently expanded our appliance replacement pilot, offering great deals on a full range of new appliances, and we are looking to launch this great offer nationwide next year. We are also exploring opportunities in roof and water heater replacement. Again, together, these categories represent an opportunity of $2 billion with our members, opening the front door to significant long-term growth. We especially love this program because every sale is a relatively CAC-free opportunity across our member base. And looking into the future, we see additional potential through our 210 acquisition, which provides us access to 19,000 builder partners. This positions us to expand beyond HVAC and create new revenue streams across multiple trades and in new customer channels. We will share more about this on our next earnings call. On that high note, I'll now turn the call over to Jessica.

Thanks, Bill, and good morning, everyone. I will now cover the financial results for the third quarter, beginning with revenue on Slide 13. We delivered strong top line growth of 14% in the third quarter with revenues reaching $618 million. This performance was driven by 12% from higher volume and 3% from higher price. From a channel perspective, renewal revenue was up 9%, benefiting from 2-10 volumes and higher price realization from leveraging our dynamic pricing capabilities. Real estate revenue grew 21%, driven primarily by contributions from 2-10. Direct-to-consumer revenue increased 11%, supported by volume gains from our promotional pricing strategy and targeted marketing efforts as well as contributions from 2-10. This was partially offset by lower pricing. And finally, our nonwarranty business continues to be a key growth engine with other revenues up 73% year-over-year. This growth was propelled by our new HVAC and loan programs along with contributions from 2-10 new home structural offering. Now moving down the P&L to gross profit on Slide 14. Gross profit grew 16% to $353 million in the third quarter, with gross profit margin expanding by 60 basis points versus the prior year period. During the quarter, inflation was in the low to mid-single digits across contractors, parts and equipment. Favorable weather trends reduced the number of service requests in the HVAC trade, providing a $6 million benefit and claims cost development was a $5 million benefit compared to a $3 million benefit in the prior year period. Turning to Slide 15, where we will review net income and adjusted EBITDA. For the third quarter, net income grew 5% to $106 million and adjusted EBITDA grew 18% to $195 million. Adjusted EBITDA margin improved to 32% in the third quarter, up about 100 basis points from the prior year period. Let me quickly walk you through the drivers. We had $47 million of favorable revenue conversion, primarily from the 2-10 acquisition and higher price. Contract claims costs were flat versus the prior year period, which includes the already discussed inflation impacts and favorable incidents and claims development. We also had $20 million of higher SG&A due to the addition of 2-10 and personnel costs. Now moving to earnings per share on Slide 16. On a fully diluted basis, earnings per share grew 9% to $1.42 per share, and adjusted earnings per share grew 15% to $1.58 per share. Now turning to Slide 17 and our free cash flow and financial position. Our year-to-date free cash flow increased 64% to $296 million, and our total cash position increased to $563 million. Through October, we purchased $215 million worth of shares. Now let me take a step back and really highlight our cash flow conversion. Our year-to-date cash conversion was 60% compared to 46% in the prior year period. This sustained cash generation and conversion is a defining feature of our business model and a cornerstone of our financial strength. With that, I will now turn it over to Jason to walk through the outlook.

Thanks, Jessica. Now turning to Slide 18 and our fourth quarter outlook. For the fourth quarter, we expect revenue to be in the range of $415 million to $425 million. We expect fourth quarter adjusted EBITDA to be in the range of $50 million to $55 million. This range anticipates higher SG&A spend as we are reinvesting some of our gross profit favorability in the marketing to drive growth. Now turning to Slide 19 and how this translates into our full year outlook for 2025. For the full year, we are increasing our revenue outlook to be in the range of $2.075 billion to $2.085 billion, driven by better-than-expected performance in the new HVAC program, the renewals channel and the real estate channel. This is approximately a $15 million increase from our prior outlook at the midpoint. Based on this, total revenue is expected to be up 13% in 2025, driven by about 10% from the 2-10 acquisition and 3% from organic growth. Our underlying revenue assumptions include a 10% increase in renewal channel revenue, a 12% increase in real estate channel revenue, a 3% increase in D2C channel revenue and a $75 million increase in other revenue. Turning to operating performance. We are narrowing our gross profit margin expectation to be approximately 55.5%. As previously mentioned, we are increasing our sales and marketing spend during the fourth quarter which translates to full year SG&A in the range of $670 million to $675 million. Taking this combined with the strong third quarter performance, we are raising our full year adjusted EBITDA to be in the range of $545 million to $550 million. As a reminder, our full year adjusted EBITDA outlook also includes interest income and excludes $8 million of 2-10 integration costs and stock-based compensation of approximately $33 million. We are lowering our capital expenditure expectations to approximately $30 million. And lastly, our annual effective tax rate is expected to be approximately 25%. And while we're not providing 2026 guidance today, we look forward to sharing more details on our expectations and priorities during our next earnings call. I will now turn the call back over to Bill for a few closing remarks.

Thanks, Jason and Jessica. I wanted to close with a few thoughts. Once again, the Frontdoor has delivered. Our execution has been outstanding, and we have fundamentally changed how we think and how we operate. This has helped to drive record financial performance and cash flows. We are raising our revenue and adjusted EBITDA outlook again. And with that, we expect to finish 2025 on a high note. And at the same time, we have made measurable progress on our strategic initiatives, and we remain hyper-focused on driving member growth. Now one final item. Earlier this morning, we announced that Jessica has resigned as CFO and will be succeeded by Jason Bailey effective November 10. We regularly challenge ourselves to make sure we are organized to best leverage and deploy our deep bench of talent. As Jessica feels, she has accomplished what she set out to do when she first joined us that led to her decision to resign from the company. To her credit, Jessica has agreed to stay on as an adviser to me through December to ensure a smooth transition. Jessica has made many contributions to our company over the past 3 years. During her tenure, our revenue and profits have grown to new heights, and we have delivered on our financial commitments to our shareholders. I would like to thank Jessica Ross for her dedicated service as CFO. At the same time, the Board and I are very excited to name Jason Bailey as our next CFO. Jason brings over 25 years of progressive leadership experience in finance and public accounting, including over 15 years of service with Frontdoor and its predecessor. He also has 11 years of public accounting experience at Deloitte and Arthur Andersen. I've had the privilege of working closely with Jason for the past 7 years. He knows the home services industry deeply. He is truly an expert in all aspects of our business, and I'm very confident in his ability to lead our finance organization. This will be a seamless transition. With that, operator, please open the line for Q&A.

[Operator Instructions]. Thank you. Our first question is coming from Jeff Schmitt with William Blair.

On the cost inflation, it sounds like it increased to maybe 4% or even 5% in the quarter. It had been trending in the low single digits. Could you talk about what drove that, whether it -- was it mainly tariff impacts just on parts and equipment and it could be temporary?

So Jeff, it was not 5%. It was closer to 4%, just about ticking toward 4%, which means we have to call it low to mid. Obviously, for the year, we're still projecting low single-digit inflation. But essentially, you nailed it. It's -- it was a tick up in appliance cost. Most of our another component parts, but our equipment is domestically produced. So we have not been hit anywhere near as much by tariffs as some other areas, but appliance has ticked up. But like we said with our dynamic pricing model and with our trade service fee approaches, with the operational execution we have, we feel we're strongly that we're able to manage through that. But it's something we watch.

Okay. And then could you talk about the promotional strategy that you implemented in the real estate channel what all is going on there? And did that drive an increase in attachment rates in the quarter?

Yes. I think good news for us is -- as I talked about, the macro environment is improving for us, which enables our -- the initiatives we've undertaken to gain more fuel. Now specific to promotions, we ran a -- generally, we've never run price off promotions. We did do $100 off for the months of July and August. And we also did a partner -- a couple of partner specific promotions that we ran that helped us from our analysis to outpace the real estate market overall. So we're very pleased with certainly the direction and the trajectory of where real estate is going. And as I've said in the call finally.

Our next question is coming from Maxwell Fritscher with Truist.

I'm calling in for Mark Hughes. In the nonwarranty section or segment the pilot program, what are your early observations there? What sort of timing and pace are you anticipating for that expansion?

Yes. We're shooting -- we're not giving a specific -- we'll talk more about this in February, but we're shooting for it to expand nationwide in 2026. It's a little more complicated than HVAC in the sense of the number of appliances. We have to work through that in our platform and the like. But that's also part of the excitement of it is that we have many opportunities to interact with our members across a variety of appliances. So the plan is to go nationwide at some point in 2026. We're still working through that and we're still working through the specifics of appliance ordering and the like. But we think it's a real opportunity and our initial impression is this is being well received by our members.

Got it. And then a small piece of the overall revenue number here, but the DTC guide of up 3% for the full year, if my math is correct, it implies around a mid-single-digit decline there. So what's driving your thoughts around that segment in 4Q?

So pricing is with our unit strength, which is what we feel is the #1 priority because, obviously, that feeds over time into our renewal book, which is the backbone of the company. So the price reductions that we've done, the promotional pricing strategy has taken that revenue down but we're able to offset it and maintain healthy margins and healthy pricing because of the strength of our retention rates. So we do give up some revenue upfront with our first year customers, but we made the strategic decision that that's worth it in order to get our renewal -- get that into the renewal book over time.

So I'd probably also add that Q4 is impacted by our seasonal adjustment. It's our lowest quarter as we know our guidance.

Our next question is coming from Sergio Segura with KeyBanc Capital Markets.

Bill, Jessica. I just want to say it was a pleasure working with you and best of luck with what the future holds for you. I had 2 questions. Maybe first on the member growth in the real estate channel. How much of that success there would you attribute to the market shifting to a buyer's market versus some of your strategic initiatives and the promotional strategy and increased agent engagement that you called out in the presentation? And then on the second question, just for the SG&A for the year, the increase in the outlook. Just provide any more color on where those -- where you're investing those incremental dollars?

Okay. So on the first one on real estate. I think what -- to your question, which is an insightful one. I think the macro environment improving helps our actions. So it's not that we've suddenly discovered some of these actions of meeting with agents. But the new thing is a promotional program that we talked about earlier. So I think that this has enabled us to -- the macro environment has enabled us to fuel some of these actions. So I'm not sure I can differentiate exactly what's macro and what's our promotional pricing. But it is all working together to help us start to turn the corner in real estate. Now as far as SG&A, where are we spending money, we're -- as we said in the call, we're pretty pleased with the Warrantina campaign, especially how it's doing relative to home -- potential homebuyers under the age of 45, which is where our marketing team is targeting their efforts. So where we're looking to deploy the extra money is around not only the Warrantina campaign, but what we call the middle of the funnel, which is where consideration is higher. So you go from the top of the funnel, which is trying to build awareness and the like, to the middle of the funnel where you're building consideration. And then we're pretty excited about some of the things we're doing in digital marketing, as I talked about, where we're enhancing our traditional search engine marketing with the work we're doing with large language models, the ChatGPTs of the world. And then we think we're getting more sophisticated in that and getting higher demand and eventually higher conversion.

And thank you, Sergio. It's been great working with you as well. Yes.

You'll not hear -- this will not be the last of Jessica Ross.

[Operator Instructions] Our next question is coming from Cory Carpenter with JPMorgan.

Bill, thought it was notable that you mentioned on -- in your prepared remarks, the potential reevaluation of your long-term margin target, that's certainly been a big topic of the date given you're punching above what you said earlier this year. Maybe could you just help us with what's changed since the Investor Day that's giving you the confidence to potentially do this when you're doing the exercise this year. And Jason, just a very quick question for you. Thinking you told us organic revenue, I think you expect to be 3% for the full year. Are you able to comment on what organic revenue growth was in the quarter?

So I'll take the first one. So Cory, I think what's giving us conviction and as I said, we'll -- we'll talk about this more in February. But with our -- with the strength of our margins, the execution we've done, all of the things I talked about in the call, our ability to price and use trade service fees to potentially combat inflation. All of those things together have given us pause to say, look, I think that we have moved to a new level. We're going to work through what that level is. But I think that the targets we gave you, which were during a time frame when there was a lot of uncertainty, not that -- well, as we go into the year, there's always uncertainty, but we feel pretty confident in our model, and so we'll be looking to come forward with a reassessment of what we said at Investor Day. So I won't comment specifically on what that will be, but that's what we're working through. We're working through getting our final plans approved by the Board, et cetera. But we'll have lots to tell you in February. Jason, as far as the organic revenue question?

Yes, Cory, for Q3, we'd say it was mid-single digits, probably 3 key drivers there. One, to think about our nonwarranty pricing and then there's still some seasonal adjustment. So when you're comparing that, that's why I'd probably pull you back to the full year at 3%.