Ladies and gentlemen, welcome to Frontdoor’s First Quarter 2022 Earnings 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 will begin today’s call. Please go ahead, Mr. Davis.

Thank you, operator. Good afternoon, everyone and thank you for joining Frontdoor’s first quarter 2022 earnings conference call. Joining me today are Frontdoor’s Chief Executive Officer, Rex Tibbens; 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 and 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, May 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 Rex for opening comments. Rex?

Thanks, Matt and good afternoon everyone. Frontdoor delivered another strong quarter of revenue growth despite continuing macroeconomic headwinds. Today, we plan to focus our discussion on two near-term external challenges, cost inflation in the real estate market and our long-term opportunity. Beyond these challenges, the rest of our business is generally on target with what we laid out last quarter. Turning to Slide 4, where we will provide an overall business update and how we are addressing the challenging macroeconomic environment. First, we are moving with urgency to address accelerating inflation. Brian will address this topic in more detail, but in short, U.S. inflation rates are rising at the highest level since 1981. Inflation in the home services space is rising faster than the overall economy. As a result, we are seeing service costs accelerate faster than we anticipated and higher than we priced for. In response, we are redoubling our efforts to address rising inflation and support our customers and contractors during this extraordinary time. Contractors across the country are experiencing record cost as they help us resolve the hassle of owning a home. We are intentionally working with our contractor network to find innovative ways to reduce cost and improve customer service in these unprecedented times, but this comes with a near-term cost. Separately, our real estate channel continues to be impacted by historically strong sellers market as a result of extremely low home inventory levels. This is driving a decline in our first year real estate sales and I will address this topic shortly. Much of the near-term pressure from inflation in real estate is macro in nature and is not intrinsic to our normal business operations. We remain focused on improving the key drivers of our business and focusing on controlling the controllable. While we continue…

Thanks, Rex and good afternoon everyone. Please turn to Slide 7 and I will review our first quarter 2022 financial results. First quarter 2022 revenue increased 7% versus the prior year period to $351 million as a result of higher pricing and a mix shift to higher priced products in our home service plan business. Looking at our home service plan channels, First quarter revenue derived from customer renewals was up 10% versus the prior year due to improved price realization and growth in a number of renewed home service plans. First year real estate revenue was down 20% versus the prior year, reflecting the 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 higher than we had projected due to the continuation of the challenging sellers market driven in part by extremely low home inventory levels across the U.S. First year direct-to-consumer or D2C channel revenue was up 14% versus the prior year due to improved price realization and a mix shift to higher-priced products. First quarter revenue reported in our other channel increased $5 million over the prior year, primarily due to continued solid growth at ProConnect and Streem. First quarter revenue for ProConnect and Streem was $7 million and $2 million respectively and should continue to ramp up over the balance of the year. Gross profit declined 3% in the first quarter versus the prior year period to $144 million, and our gross profit margin was 41%. Net income declined $3 million in the first quarter of 2022 as lower gross profit and increased investments in sales, marketing and technology, as well as higher personnel costs more than offset lower interest expense. Adjusted net…

Thanks, Brian. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have so please note that our guidance is limited to the outlook we provided. Operator, let’s open the line for questions.

Thank you, Matt. [Operator Instructions] Our first question is from the line of Jeff Schmitt from William Blair. Jeff, your line will be open now, if you would like to proceed with your question.

Hi, good afternoon, everyone. Did you say that claims cost inflation was sort of in the lower mid-teens but then you’re targeting kind of high single-digit price increases? And I’m curious just because, I guess, why not just push for 10% to 15% price increases to combat this? Or is the market environment too competitive? I would think your competitors are going through the same type of pain. So I guess, why not get more aggressive on the pricing front?

Yes, this is Rex. A couple of things. One, in our last call, we talked about kind of a mid-single-digit price increase because we thought that’s kind of where inflation was going to be. And so as Brian mentioned, now we’re targeting kind of another round of price increases. So I think between those two things, as Brian mentioned, over time, I do believe that, that begins to mitigate the impact of inflation. Brian, I think you’d add to that?

Yes. And just to be clear, the inflation rate will be mid-teens through the first half of the year. And then end the year on a full year basis in low teens. So it trails off a bit in the second half as we lap some of the pressure from last year.

Okay. And a question on the new Platinum plans. The – which I think you said included some kind of maintenance options. What’s the progress of that? What type of growth are you seeing there? And is there any cannibalization of, I guess, the ProConnect maintenance business at all?

No. So for Platinum, we’re actually seeing something that customers like the blend of both home service plan coverage as well as maintenance services. And so we’re actually seeing a higher mix of Platinum than we originally had forecasted for, which is always a great sign. We don’t think it cannibalizes ProConnect at all. And we actually think that maintenance services, is a great retention tool for our customers longer-term.

Okay, thank you for the answers.

Thanks, Jeff. Our next question is from Ian Zaffino of Oppenheimer. Ian, your line is now open. Please proceed.

Hi. Great. Thank you very much. On the pricing side, is there anything you can do to get pricing more immediately – have you thought about surcharges or some other form of price increases that you could take to maybe offset some of the inflation better than you’re able to do right now? Thanks.

Hi, it’s Rex. Certainly, it’s something we’ve explored. I think since we sell an annual contract, there is not an opportunity to have an immediate surcharge, if you will. But A lot of the things that we’ve worked through with our pricing increases is we’ve taken kind of a data science approach to our models for dynamic pricing, just to remind the group I think pricing, we look at both usage as well as kind of cost within the zip code. So between those things and the risk deciles we looked at, we’ve been pretty, I think, surgical in terms of how we’re raising prices. Keep in mind that our service contracts are annual, therefore, we recognize the revenue twelfth at a time. So that’s why we think that this plays out over time, but it’s not going to be the immediate improvement.

Okay. And then just a follow-up, on the ProConnect side, are you in taking similar price increases to cover inflation there? Is there an opportunity to take more? And I’m just trying to think of how that kind of fits with your $40 million of guidance. If that’s the case, it might be higher than that. Maybe help us understand that? Thanks.

Sure. So certainly, I think the – for some areas, there is a potential opportunity, but it’s also the areas that we’re currently building within ProConnect. So just as a reminder, we started with appliances and maintenance services. Certainly, I think there is maybe a small opportunity in appliances. But as we roll into both plumbing and electrical there is an opportunity to take more price, but it’s also somewhat nascent, that’s the part that you’re building up. So I think it will help. I’m not sure it’s going to take us beyond our revenue target of $40 million.

Okay, thanks very much.

Our next question is from the line of Youssef Squali of Truist Securities. Youssef, your lien is now open. Please proceed.

Great. Thank you. So two quick questions for me. One, still on pricing. So versus inflation assumption hitting you in the call it, low to mid-teens for the year versus the price increase in the high single digits. Arguably, as you institute the price increase, it’s going to take time for a tool over – how much are you assuming that you’re going to be able to recapture from that, call it, low teens price inflation? And second, can you maybe talk about the marketing efficiency you’re seeing in your DTC channel some time back, I think you pulled back a little bit on marketing because marketing efficiency through that channel was not as good as you have hoped maybe your assumption about sustained double-digit growth in DTC. Does that come at the expense of maybe ROAs or is that still within your acceptable ROAs? Thank you.

Yes, sure. I’ll take the direct-to-consumer question, Brian, I’d ask you to comment on how our pricing will kind of lap into this year and next. So for direct consumer, you’re right, late last year, the team faced a couple of the challenges but as we’ve reported last quarter, that’s behind us. We’re still seeing a great – certainly, things are more expensive. I think the team has worked on both conversion and efficiency. We optimized our e-commerce platform and our digital marketing. We’ve spread over other areas. And so those things continue to perform well, and that’s why we’re still bullish on direct-to-consumer and still think that we will have double-digit growth for the remainder of the year. But we’re seeing it somewhat in price and mix first, but we expect units towards the back of the year. But these actions we’ve taken last year are definitely providing some green shoots as we look forward to the second half of this year.

And Youssef, to your question about the pricing and reclaiming some gross profit or gross margin, as Rex said, it just takes time, right? It takes a few months to roll these price increases out. And then you recognize revenue monthly and so you’ve got the cost upfront and then you get the margin recovery over time. So it’s not going to happen this year, as you saw from our forecast of 44% to 45% gross margin. But as we get into next year, we were able to get more of that pricing benefit. And as we think about long-term, dynamic pricing will certainly be a great lever for us to get back to 50% gross margins for the home service plan business, but it will be dependent on how quickly future real estate rebound, etcetera. So anyway, it’s going to take some time to long story short to get back to the gross margins we need to get to.

Okay. Thanks for your clarification.

Thank you. And our next question is from Aaron Kessler of Raymond James. Aaron, your line is now open. Please proceed.

Great. Thank you. Just a couple of questions. Maybe first, if you can talk about kind of customer acquisition costs you’re seeing and maybe specific to the D2C channel. And then I think you just – maybe just to clarify, I think you talked about inflation kind of in the mid-teens. What’s kind of the rough mix between – in your estimates between kind of labor costs as well as parts as well? Thank you.

Sure. So I’ll take direct-to-consumer and ask Brian to comment on inflationary costs. So for direct-to-consumer certainly, we’re seeing slightly higher CACs, but also keep in mind that with prices increases and mix changes to more of our product, that actually helps give us more headroom if you will from an LTV perspective. So, we are certainly seeing some inflationary pressures there, but nothing out of ordinary. Since we have transitioned to our e-commerce platform and changed our mix profile, I think that the team is executing very well. We – last year brought in some programs in-house that continues to provide green shoots for us. So, as we spread our marketing across digital, direct mail and broadcast, we are still pretty confident in our plan.

Hi Aaron, it’s Brian. What was your inflation question again, I am sorry?

Yes. Thank you. You kind of mentioned mid-teens overall inflation. Just curious, I think you may have mentioned labor cost is about 10%, is having kind of parts were up, kind of the remainder, or how should we think about the mix between labor costs and parts, if you have a good sense?

Yes. The data that we have seen shows that it looks like labor costs that are probably hitting our contractors are the mid to high-single digits that they are facing with their technicians. And when they look at their – what they are paying for parts and equipment, the inflation is probably at a rate of 15% to 25% inflation, which is very high. We are facing more like 10% with what we buy due to our purchasing leverage. So, that’s pretty high. And think about fuel, they are paying 50% more today than a year ago for fuel for their trucks. So, there is a lot of inflation that’s facing our contractors today. But from what we purchase, it’s more like 10%. Is that helpful?

Got it. Okay. Thank you.

Thank you. Our next question is from the line of Justin Patterson with KeyBanc. Justin, your line is now open. Please proceed.

Great. Thank you and good afternoon. I wanted to go back to some of the comments you let off, that Rex, about just investing more around improving customer service, improving the self-service capabilities. Can you talk about the timeline for that to phase into the business? And then as these investments start to bear fruit and macro conditions normalize, how should we think about the potential benefit that could have to both retention rates, margins and pricing power over time? Thank you.

Hi Justin, I think that this has kind of been an ongoing work. I don’t think I know this has been ongoing work since we started. And we are really starting to see traction from a self-service perspective, get a team a lot of kudos in terms of our – My Account feature has definitely improved. Our automated phone systems have improved. So, I think I said early on, the last time I wanted to talk to someone was never, and we still believe that and that you should be able to resolve any issue you have through digital means. And so we think that as we roll out our app later in the year, that continues to strengthen what customers can do from a self-service perspective. We think that starting with a digital-first approach for resolving problems through Streem, simply now starting to click to call a feature where you can bring the agent online, that is kind of walk in your shoes and understand your issue digitally. Those are all things that make the customer experience better. And the byproduct of that is, is they are also lower cost. And so – the combination of those things should help us over time bring down our service costs. And then from a retention perspective, we think that a lot of these things are a more delightful experience and should drive retention because it could be a very different approach to solving the problem than we have seen in the industry. And so we think those combination of factors will help not only, improve our support costs going forward, but also provide a more delightful customer experience, which should then dovetail into better retention.

Thank you.

You bet.

And our next question is coming from the line of Brian Fitzgerald from Wells Fargo. Brian, your line is now open.

Thanks guys. A couple of questions. You had nice performance in D2C in the quarter. Wondering if you could tease out volume versus pricing trends there, many of the drivers and the strength that you saw in the channel in the quarter? And then Rex, you talked about upgrading customers to premium includes coverage and maintenance. Can you give us the kind of any trajectory there? What does the tangent like, what are – what’s the conversion rates there, what’s the penetration rates there? I’m trying to assess what kind of the opportunity and the momentum is there.

Sure. So, from a direct-to-consumer perspective, you should expect at least in the first half of the year, you have driven primarily by price and mix and then you will see units come on towards the latter part of the year. As it relates to our Platinum products, we kind of test our way into Platinum and realize that customers kind of enjoy having not just a break fix kind of moment with us, but also rely on us for maintenance services as well. And the primary maintenance service for Platinum is an HVAC tune up, but we will be rolling out additional things in the coming months as well. So, in terms of penetration, I don’t think we have outlined our mix. But certainly, Platinum is performing better than we thought. But Brian, I don’t know if you could comment on what we said publicly from a mix perspective, but at least in my knowledge, I don’t think we have given mixed numbers.

Not at this time, Rex.

Okay. Thank you, guys. I appreciate it.

Thank you. And our next question is from the line of Cory Carpenter from JPMorgan. Cory, your line is now open. Please go ahead.

Hi. Thank you. It sounds like the change in the revenue guide is completely due to the real estate channel. But Rex and Brian, I just wanted to confirm that with you. And then, Rex, hoping you could talk more broadly just around what you are seeing in the competitive environment for a bit. Do you think you are gaining or losing any share in the real estate or direct-to-consumer market more broadly? Thank you.

Yes, absolutely. For real estate, I think your summation is correct. Certainly, it’s been challenging as we think about both inventory continues to go down. And then the more troubling thing for us was the higher percentage of investor buyers, which takes away even more inventory from traditional home buyer who we would be marketing to. So, as it relates to direct-to-consumer, I think that we are focused on controlling the controllables and both direct-to-consumer and renewables are two areas where I think we can really make headway. And so certainly, direct-to-consumer, we have diversified our spend conversions looking pretty well. And then from a renewal perspective, we have optimized dynamic pricing. We continue to change our products from our Good, Better, Best strategy. And that’s actually one of the – we are hopeful from a real estate perspective as we have launched that will help us. But in terms of share, I can’t comment on kind of what other folks are doing. But historically, we look at share, we are not losing share, so to speak, in real estate for sure. But certainly, with a much lower inventory the pie has gotten a lot smaller, but our portion of that pie, at least in our analysis suggest that we are not losing share there. And then overall, I think we continue to perform, and we don’t see any signs of weakness from a competitive perspective, certainly just weakness from a macroeconomic and inflationary perspective. So, we are still focusing on the things we can control. And I think we will continue to deliver profitable growth on those areas.

Your assumption was correct. Our outlook for B2C and renewals is really the same from the February call. We only changed was the real estate going from decline of just over 10% to mid-20% rev decline. So, you were correct.

Okay. Thanks Brian.

Sure.

And our final question today comes from Eric Sheridan of Goldman Sachs. Eric, your line is now open. Please proceed.

Thanks for squeezing me in. I want to come back to Slide 9 and maybe just ask a few follow-ups to things that were talked about already. In framing aggressively mitigating the headwinds you are seeing, can you talk first about your confidence interval and the ability to raise price without causing any impact from a churn standpoint and how you sort of ensure that you get balance right, looking out over the next couple of quarters. On the second point of improving contractor processes, can you give us a little bit more color on what goes into that and the duration by which we could see that improvement as we go over the next couple of quarters. And then on expanding the supply chain, can you give us again a little bit more detail on how the duration of that plays out and how we can monitor that from the outside in as your results progress in the quarters ahead? Thanks so much.

Sure. So, from a dynamic pricing perspective, this is something that we watch very closely. Again, we have on a [indiscernible] basis, we look at our customers and we segment them by deciles. And so whether it’s by usage or by risk, we have a pretty, I think, pretty robust models around each one of those deciles. And as we raise prices, what is the level of elasticity for each one of those deciles. And we haven’t seen any changes in that even with the level of pricing increases that we have given. We do think there is an opportunity in our higher deciles where our customers are using us more than the norm to charge them an even higher premium and we have seen that those customers are willing to pay because they like that coverage. So, we haven’t seen any changes to our models. We haven’t seen any backlash, if you will, from what we expect from a retention perspective for each one of those deciles. So, it seems to continue to be working very well for us. And then I am sorry, on the other questions, Brian, if you want to take the inflation one, and I will –actually both of them, I think you can handle.

Yes. I think the second one was about the improving process improvements and cost improves with contractors. Is that right, Eric?

Yes. Just on improving contractor processes and expanding supply chain, how should we be thinking about the duration of the impacts playing out in the quarters ahead, so we start to see benefits from that – whatever you are putting in place from a mitigation standpoint, just so we can understand that? Thanks.

Right. Yes, and Rex, please jump in. Regarding the process improvements of contractors, improving the percent of preferred mix from the historic, I guess low-80% is pretty sudden. I mean that’s a quick impact, the more we can push our service request to our percent referred, the lower our costs are going to be. So, that’s pretty quick. It’s just – it’s the amount of time that they take to raise that level. And I think the control team is doing a great job of that today. So, we should be able to see more of that as we go forward. And regarding supply chain, as I mentioned, we are paying 8% to 12% more today for parts and equipment than we did a year ago. But our contractors are paying 15% to 25%, round numbers. So, anything we can shift to our sourcing from theirs is going to save us money and help gross profit and gross margin. So, again, that could be fairly quick as well. We just have to get them to allow us to purchase for them. Rex, anything else you would like to add?

I will add two things. One is on our preferred contractors. They seem to have a much better handle on being able to help us manage cost, because the volume they handle. And so that’s why it’s so important that we increase the percent of preferred, because the kind of network contract, if you will, are certainly a lot more expensive than our preferred. And then the second is, I think there has been some work or will continue to do some work on optimizing our selection algorithms for contractors so that we can help increase that percent of preferred. So, this is definitely a big unlock or a cost mitigator for us as well as what Brian spoke about in terms of where we source parts versus our contractors.

Great. And that is it for all our questions today. So, I would like to hand back to Rex Tibbens for any closing remarks.

Thank you. In closing, while Frontdoor is facing some near-term external challenges around accelerating inflation rates in the macro real estate environment that are beyond our control, we absolutely remain focused on improving the key drivers of our business and really focusing on controlling the controllable. So, thank you again for your time this afternoon, and we look forward to talking to you in our next earnings call.

Ladies and gentlemen thank you again for joining Frontdoor’s first quarter 2022 earnings call. Today’s call is now concluded.