Ladies and gentlemen, welcome to Frontdoor's Third 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 that are 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 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, 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 3, 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, and good morning, everyone. Since taking over the CEO role in June, my leadership team and I have taken quick and decisive action to tackle 1 of the most challenging macroeconomic environments in the company's history, and we are delivering on the initiatives outlined on our last earnings call. We are laser-focused on rebuilding the core Home Service Plan business. We are improving execution. We are taking aggressive action to fight inflation and we are reducing our SG&A expense footprint. While we are seeing signs of better days ahead, there is more work to be done as we continue to transform Frontdoor. Let's begin on Slide 4 and the actions we have taken over the last several months. First, we completed a comprehensive review of our SG&A expense footprint that resulted in a 7% workforce reduction, primarily outside of the revenue generating and service-related areas. These actions are working as we have reduced our 2020 SG&A by $45 million from our original outlook. Second, consistent with our second quarter comments, our own pricing strategy continues to target a 12% to 13% price increase in 2022 compared to year-end 2021, one of the largest in the company's history. Third, we are improving execution within our core Home Service Plan business. Under new leadership, we are changing Frontdoor's culture to further optimize how we operate. And lastly, we are working to advance our business transformation initiatives. I have challenged our team to reimagine how Home Service Plans can work better for our customers and our contractors. For example, we recently completed an extensive consumer segmentation study. We have been analyzing the data and expect it will allow us to better meet the needs of different audiences. Let's now turn to Slide 5 and the direct-to-consumer or DTC channel, where we…

Thanks, Bill, and good morning, everyone. Please turn to Slide 8, and I'll review our third quarter 2022 financial results. Third quarter revenue increased 3% versus the prior year period to $484 million as a result of a 5% increase from price and changes in customer product mix, which more than offset a 3% decline in customer volume. Looking at our Home Service Plan channels, third quarter revenue derived from customer renewals increased 8% versus the prior year period due to improved price realization and growth in the number of renewed Home Service Plans. First year real estate revenue decreased 30% versus the prior year period, reflecting a continued decline in the number of Home Service Plans in this channel 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 DTC revenue increased 8% versus the prior year period with 11% growth driven by improved price realization and a mix shift to higher-priced products, partly offset by 3% lower volume. Third quarter revenue reported in our other channel increased $2 million over the prior year period driven primarily by growth in our ProConnect on-demand home services business. Gross profit declined 17% in the third quarter versus the prior year period to $210 million, and our gross profit margin was 43%. The gross profit decline was driven by a $58 million increase in contract claims costs, primarily reflecting inflationary cost pressures, which I'll speak to more in a moment. Net income decreased $48 million in the third quarter to $28 million, primarily driven by the gross profit decrease, a $14 million goodwill and intangibles impairment charge and $5 million for restructuring. The $14 million goodwill and intangible assets impairment was driven by a shift in focus to…

Thanks, Brian. I truly believe that this is an industry that is ripe for innovation. In addition to the work we are doing with the core business, the team has been doing some really innovative work that I'm excited to share with you at our Investor Day on 3/2/23 in Midtown Manhattan. We are currently in the testing phase and some of our plans will evolve over the next several months. So we aren't going to get into specifics today. But as you can see from Slide 12, we have a great venue lined up and I encourage all of you to try to attend in person. With that, I will now hand it over to Matt to open the Q&A session.

Thanks, Bill. [Operator Instructions]. Operator, let's open the line for questions.

[Operator Instructions]. And our first question today comes from the line of Ian Zaffino of Oppenheimer.

This is Isaac Sellhausen on for Ian. I guess starting just on the pricing side, you guys called out the higher pricing in the quarter and the full year guidance assumes, so I guess, higher price and product mix. I guess you had talked about targeting a 12% to 13% price increase this year. I guess how much do we sort of expect that to benefit this year and then into next year?

Yes. Isaac, I had mentioned, and I know it gets a little confusing because of the way we have to recognize revenue. For 2022, the realized price increase will be 8%.

Okay. Great. And then just on the contract claims costs, I guess, could you give us a little bit of color on sort of the cost and the inflation side between just contractor expenses and types of parts and equipments? I guess is there anything decelerating? Or what have you seen accelerate from the last quarter?

Yes. Thanks for the question. Great question. Yes, we saw really -- we think our inflation from our contractors is stabilizing. As I mentioned in my prepared remarks, the inflation rate on a service request basis was about the same from second quarter year-over-year. So that tells me it's stabilizing. I can't quite say moderation yet, but that could be coming. The benefits in the quarter really from lower service requests, which was good news. And also, if you look at our overall EBITDA beat, we had favorable SG&A as well. So overall, it was a good quarter in that respect. Is that helpful? .

Isaac, the other thing I would add, our contractor relations team has really redoubled efforts to work through this sort of unprecedented increase in inflation and at least in the last 20 years or so. So we are still cautious. We're working closely with them. We -- things happen in the economy and saw the change in interest rates again yesterday. So we're being cautious. But I think we feel like we have our arms wrapped around this and that while I think Brian said it well, we're not exactly saying things have moderated or stabilized. I think we have a better understanding of it and I think we're even closer to it. And as you know, I think Brian has said this repeatedly, the majority of that costs are in the labor side. The labor rates, labor -- even labor shortages, fuel, et cetera, and the other side is the parts and equipment piece, which has increased. But I think, Brian, it's fair to say that is probably we're able to point to even more a stabilized, wouldn't you say?

Yes, I agree.

Okay. Great. That's helpful. And then just last one, if I could squeeze it in. I know you guys provided the Home Service Plans account by channel, which is helpful to break it out. I know, obviously, you gave the guidance for the full year on the customer growth. Maybe if you could just provide some details on how you're thinking about 2023 in terms of renewals and the DTC channel obviously, you gave some color on the real estate side, but that would be helpful just to parse through the 3 different channels.

Yes. We're not ready yet to talk about 2023, but we obviously have a lot to share with you when we get together in March.

Our next question is from the line of Aaron Kessler of Raymond James.

Maybe can you just talk about, Bill, your thoughts on the on-demand offering going forward? How are you thinking about that? Maybe 2, on the SG&A kind of reductions, kind of what areas specifically? And third, just on the ad environment. I think you said it still remains tough, although some of that data sounds like it's getting a little bit easier as well as, so any commentary there would be helpful.

Yes. Let me try to take them in order. Aaron, on demand, we do more than doubled ProConnect revenue this year versus last year. And as I said in the second quarter, there's something here, and we are a believer in the on-demand business. We are figuring out exactly how to go to market. We want it to be a bigger business. But Raj Midha and his team have done a really nice job of developing that area in terms of the service offering. And so we're pretty bullish on that. We'll have a lot more to say about it as we said in March, but just within 2022, we're pretty pleased with the efforts we're making, the connection with the contractors, et cetera. So that is going to be -- that is clearly in our future plans. When it comes to SG&A, I talked about the workforce reduction, which you never want to do those kind of things, but we felt that we had to take some steps to optimize our workforce. Other areas, we did reduced some marketing spend. We did reduced some other areas of SG&A. I try to lead the service operations alone so that we can continue to service our customers, especially through the high season in Q3. But it was a broad-based effort, and I was really proud of the executive team, we came together. We spent a lot of time on this. We obviously looked hard at the head count and we were very judicious in our decisions there. But we looked at all aspects of the cost structure and that's why I think you can see the -- some evidence of that, that we have -- from what we originally told you in 2022, we're down $45 million. And as far as ad spending goes, yes, very good point. It does look like, and you've seen the results from some of the major platforms that they're struggling a little bit, which I think is going to help us. We were -- the looking back is that I think it has been a difficult environment. It's still a pretty competitive environment. So I wouldn't say we've got a moderation in marketing cost, but I think it is trending in the right direction to your point. And hopefully, that's going to help us generate more leads. I don't know, Brian, if there's anything you want to add.

No. That's spot on.

Our next question is from the line of Jeff Schmitt of William Blair.

I believe you said the cost per claims were up around 22% unless I misheard that. Can we get a sense on how much labor was up versus parts and equipment? I mean it sounds like labor is up more, but what's sort of the breakout there?

Yes. It was similar to Q2. And if we look at our overall claims cost, it's about half contract related, which would be labor, fuel, their overhead and the other half that parts and equipment, and that was pretty consistent this quarter versus last quarter.

I think the specific number was 23%, right?

Yes, 23%.

Okay. And then just thinking about pricing increases 12% to 13% sort of on, but I understand that takes time to earn through, but it seems like that could come up light. So I guess, where do you feel your pricing is in the industry kind of relative to competitors? Is there anything that may be holding you back from going higher there? Will you need to go higher there do you think to really repair margins?

Yes, that -- we're looking at that is what I would say is. And I don't mean dodge the question, I'm not at all. We are not going to do any price increases for this year. We're still formulating our pricing for next year. I'm not ready to chat about that yet. We may be able to, but at this point, we're still modeling that out. And we have done some things in our marketing efforts because of the price increases to try to guide people more to the gold product than the platinum product, which is a little bit lower priced, and the coverages are a little different. But -- so we are trying to do some things within the marketing mix to try to drive positive units, but more to come on that, but it's certainly a lot of question within the company.

Our next question is from the line of Cory Carpenter from JPMorgan.

Just wanted to see if you had any sense on what's driving the lower service request volume in the quarter. I think you said that came in below your expectations? And then just how you're thinking about that going forward? And then maybe for Bill, could you just talk more about your discounting strategy in the direct-to-consumer channel? I think you said you started that in September and you claim on doing some more in 4Q and how that fits in with the broader price increases you're making?

Sure. Thanks, Cory. Yes, I think Q3, there was a lot of benefit from HVAC. I think the weather cooperated for us. So that was a lot of the benefit in the quarter. But also, what we're seeing since the start of this pandemic, and the pandemic trades have been plumbing and appliances, those have begun to trend down continually since the peak. So those are getting more favorable, too. So the trends are going in the right direction. I would say appliance trends are still higher than they were pre-pandemic, but those should come down over time. So again, the Q3 was basically mostly HVAC favorability.

Yes. When it comes to pricing, Cory, the discounting. I think what we've looked at is as competitors have gotten more aggressive, and they're doing things like comparing our platinum highest-priced product to their middle-priced product and we find some gains like that, and that's fair -- that is what it is. We're trying to pulse in some promotions as part of an overall pricing strategy to drive units. Part of this is consumer-driven with all the talk of inflation in recession. We're still a discretionary purchase as a home warranty business. So it's -- we're just trying to fit that into as another lever in our marketing arsenal. It's -- we don't disclose when we're going to do it. We run it tight wide generally and with all of our marketing materials. So I think it's just part of the overall pricing strategy. And it's designed to have a pulse, drive some units. Most of that revenue benefit will come in next year, but we have to manage this thing as a multiyear, 12-month business. So it's just part of the overall marketing mix and ways for us to try to drive units.

Our next question is from the line of Brian Fitzgerald from Wells Fargo.

Thanks for the incremental detail on the renewal rates by channel. Real estate seems stable and what you pointed out to versus what you pointed out historically, wondering if you could give us some context for how direct-to-consumer and renewal channels, how the renewal rates there are coming in and also anything on seasonality? That 72% blended rate is that normal given seasonality? And how should we view that in context of 75% you reported on a trailing 12 months, should we expect that TTM figure to round down?

So the renewal -- are you talking retention or renewal? You're talking renewal here? Let me do renewal. I still can't figure out the difference, but I talk to these guys about it every time. But when it comes to renewal rate, which is how many customers we have today versus what we had a year ago. Actually, overall, it's been trending slightly positive, which is -- these are numbers that are pretty stable. So when you can get a blip going in the right direction, it's a good thing. So in terms of where it's at right now, I think we feel like we're in a good place. And as I think we said in the script, the renewal rate has even ticked up a little bit. So I think we're generally pleased with the stability we have there, especially during these strange times. But as far as retention goes, Brian, do you want to comment on that?

Yes. I know we probably confused you a little bit giving you both metrics, but they're different. And the renewal rate is really a ratio of customers you began a period with and end the period with. Retention is a little more complicated because it includes additional customers added during the period. So that's really the difference between the 2. And actually, our retention rate is running fairly well at 75% this year.

It incorporates cancels, too, right? Yes, I'm learning along the way, Brian.

Yes, absolutely. And to Bill's point, our cancels are trending favorably. So that explains some of our benefit for retention rate at this point.

Got it. And our second question was on the preferred contractor network. Is it fair to assume that some of your contractors are seeing a slowdown in some of their other demand channels? And how is that playing out in terms of the rates you're able to pay and your ability to recruit into the preferred network?

I don't think we're seeing -- we're not hear -- I'm not hearing that, Brian. I don't know if you -- that their demand is slowing. I think people are still looking for contractors overall. So we're not -- we're not seeing -- and I hear where you're going in terms of is there a benefit that would accrue to us if their demand is slowing. So I have not heard that. So I don't think that's a consideration right now.

And the next question is from the line of Justin Patterson of KeyBanc.

Two, if I can. I'll look positive comments on renewal rate. Could you talk about how measures of customer satisfaction are trending? I know there were some frustrations with contractor availability earlier in the year, trying to get request resolved. So I'm curious if the combination of lower reflect this quarter, plus some operational improvements are driving faster turnaround times and better customer satisfaction? And I'll stop there and then follow up after that response.

I think we're -- right now, things are similar to where the rates are is they are stable at this point. I think we've had a good year for the service operations team. I think that we've come through the high season. There's always one-off situations that we haven't gotten to particularly some of the acute situations wherein HVAC goes out in very hot climates. But generally, I think our customer satisfaction is held, it's stable. I think we got better this year with a lot of our internal metrics on customer service. So right now, I think we're in a good zone always looking to improve, but right now, it's stable along with the other measures.

Got it. And then for the follow-up, I was interested in your comments about sellers having to use Home Service Plans more to move inventory in this type of environment. You're starting to see higher attach rates of Home Service Plans. Any quantification of just what that delta looks like, the incremental uptick? When you step back and you look at the decades of data that Frontdoor has, how should we think about the potential uplift from both the shift to more of a buyer's market in play and then also just the extra partnership that you have with real estate channel to augment that?

Yes. Thanks, Justin. I don't think we're in a position yet to quantify. And frankly, I think, Jes Fields, our Chief of Sales is very close, very well known in the industry, and is very close to some of our major partners. I think they're trying to figure it out, too, because the shift has been so quick, so severe in terms of some of the numbers we saw from the NAR and then what we anticipate seeing in October. So I don't think we're to a point where we can look at. I'd love to be talking about uplift in real estate. That's for sure. And Jes is working hard and her team on that. But I think that this is almost in real time that a lot of the brokers and agents are realizing they're going to have to improve their listings, they improve the appeal of the listings for 1.5 years or so they could roll them all in the court and just say go play. Now it's back to a competitive market, it's where buyers have more choice. So we're still working through that because it has been so abrupt even in the time since I took over here, the real estate shift has been pretty abrupt. So it's in motion right now, and I think it's a fair question to ask, but I don't think we're in a position to have any quantification.

And our next question is from the line of Eric Sheridan from Goldman Sachs.

Maybe just one. If we could go back to sort of the revamped marketing strategy. Can you give us a little bit more color on what that might mean in terms of channels where you're getting optimistic in terms of engaging in with marketing dollars to possibly drive better outcomes as we move out of '22 into '23? Will that have an impact in terms of the type of channel mix or distribution you get for the product over the long term? And how should we be thinking about marketing ROI in general based on what you've learned ahead of revamping the marketing strategy?

Yes. I'm going to give you hopefully a comprehensive answer here because we're trying to operate on a few different levels. One of the things we're trying to do is there's a temptation to spend all your marketing efforts on new clients and new customers associated in the DTC area. Our marketing team spending a lot of time on renewals and conversion. There -- I may have spoken about this in the last call. But we're in the midst of trying to intercept if you will, or identify potential nonrenewals earlier. Surprisingly and almost counterintuitively, people who don't have a claim are at risk of nonrenewal because there's a little bit of why do I need this service. So in a peculiar way, we actually want you to call us because it does drive a longer-term relationship. But there are other things that we can -- that are indicators to us that enable us to get more specific and more targeted by -- if there's a high degree of complaints, if there are long service times. And we're trying to get smarter about that as they're in the middle of their contract to try to drive conversion. The other piece is we have a big effort in real estate. You can see the difference in renewal rates by channel. And we have made strides in real estate over the last year or so. That 29% number is actually up a few points. I know we haven't talked about this before, but this is really an important area for us because we have captive clients, people who are in our business. So the marketing team is working a lot on conversion and renewals. Now when it comes to DTC, we are testing some new creative and promotions. And we're looking at…

And we have no further questions. So this concludes the Q&A session. Ladies and gentlemen, thank you again for joining Frontdoor's Third Quarter 2022 Earnings Call. Today's call has now concluded.