Ladies and gentlemen, welcome to Frontdoor's Third Quarter 2023 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'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 2023 earnings conference call. Joining me today are Frontdoor's Chairman and Chief Executive Officer, Bill Cobb; and Frontdoor's Chief Financial Officer, Jessica Ross. 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. There is also additional information about our Frontdoor brands at frontdoor.com and our new mobile app that you can download in the App Store and at Google Play. 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 1, 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 what a quarter. We crushed it. It was just over a year-ago when Frontdoor was experiencing some of the lowest margins ever as a result of an extremely challenging macroeconomic environment. Our team responded to these challenges and took decisive action to improve the business. Fast forward a year and we have had an exceptional turnaround in our financial performance. Third quarter revenue increased 8% to $524 million, and our gross margin has rebounded 760 basis points to 51%. This drove a $48 million increase in adjusted EBITDA to a record high for a quarter of $128 million. Given these results, we are raising our full-year outlook for revenue, adjusted – and adjusted EBITDA and share repurchases for the second time this year. While things continue to fall our way, we have also done a lot of smart things to drive process improvements, which are contributing to better margins. Jessica will describe these in more detail shortly. The key message is we expect the benefit of these process improvement initiatives and cost trends to largely continue into next year. Now, I want to highlight an important point. At our Investor Day in March, we laid out a target of $2 billion in revenue and at least $300 million in adjusted EBITDA for 2025. We have already surpassed our adjusted EBITDA target, and we are working extremely hard to close the gap on our revenue objectives between now and then. I believe Frontdoor is an extremely compelling investment. And while I don't normally comment on our share price, I want to call out our current valuation, which is at one of the lowest points in the last five years. This is truly an inflection point for Frontdoor. And while some of this is market-driven, we are taking advantage…

Thanks, Bill, and good morning, everyone. As Bill just mentioned, we are extremely pleased with our strong third quarter financial performance. Our prior pricing actions continue to flow through, inflation is moderating, and we are seeing a greater financial benefit from our comprehensive cost management efforts. Now turning to Slide 10, where third quarter revenue increased 8% versus the prior year period to $524 million. This was driven by a 10% increase in price, which more than offset at 2% decline in volumes. Looking at revenue in more detail on Slide 11. Third quarter revenue from our renewal channel increased 14% as a result of our prior pricing actions flowing through. Real estate revenue decreased 23% and direct-to-consumer revenue decreased 16% as a result of lower volume. Other revenue increased $11 million driven by our growing on-demand home services business, primarily our HVAC upgrade program. Now let's turn to Slide 12. Gross profit for the quarter increased $57 million to $268 million, and our gross margin increased 760 basis points to 51%. This improvement was driven by higher realized price, continued process improvement initiatives, favorable cost development, a transition to higher service fees, and a lower number of service requests per customer, that was partly offset by inflationary cost pressure. On Slide 13, you'll see that our higher gross margin largely flowed through the net income, which increased to $43 million to $71 million and adjusted EBITDA improved $48 million to an all-time high of $128 million. Let's now move to the table on Slide 14 and I'll provide more context for the year-over-year improvement in third quarter adjusted EBITDA. Starting at the top, we have $37 million of favorable revenue conversion, primarily driven by our pricing initiative, partly offset by the decline from lower volume. Contract claims cost decreased…

Thanks, Jessica. I would just like to point out that we are experiencing a bit of a delay on our phone call, so please bear with us during the Q&A process as there might be a bit of delay between questions and answers. Operator, let's now open up the line for questions.

Thank you. [Operator Instructions] Our first question today comes from the line of Mark Hughes from Truist. Please go ahead, Mark. Your line is now open.

Yes. Good morning. Thank you.

Hi, Mark.

Hi, Mark.

I think last quarter you talked about shifting a little bit of marketing spend, I think it was $20 million that was going to the direct-to-consumer channel. Did that flow through in the quarter? Or is there a lag perhaps on the likely impact on new business?

Yes. Mark, thanks for the question. There is a lag by the time we got that into market, and we've also upped our spend to Q4. So overall, our spend on American Home Shield, which – as we earlier in the year, we thought would be down versus last year, is actually going to be up. So we're trying to fuel some growth as we head into the relaunch early next year. But as I said in the script, we're going to be very tactical right now. We're still going to continue to use discounting. We are trying to put some more marketing spend behind what we call the good/bad campaign. But all roads are going to lead to the relaunch next year with a new marketing campaign and new look. And really, we've got to get back to selling the virtues, if you will of a home warranty, and that's what we plan to do.

Our next question today comes from the line of Sergio Segura from KeyBanc. Please go ahead. Your line is now open.

Thank you. Good morning, Bill and Jessica. Congratulations on the very strong quarter. Two questions. So 2023 was largely driven by price, wondering how we should think about the mix of plan growth versus pricing growth going forward. Sounds like it should be more balanced into the future. And then on gross margins, congratulations on the [beat] despite a historically hot summer, can you talk about work you've guys done to mitigate the impact of weather and I guess should we expect less volatility tied to weather on gross margins going forward? Thank you.

So wait there's a delay, right, Matt.

Yes.

Sorry, Sergio. First of all, congratulations to you on your promotion. So great to hear from you. I'll take the first question and then we'll give the second one to Jessica. I'll take the pricing question. The answer is yes. You are correct. It'll be more balanced. When we look back at our pricing strategy, in 2022, we were probably a little late and with the $100 million in cost increases we had last year, we had to price aggressively. Inflation has moderated, as you saw. So that is coming down, it's flowing through. So we will have a more balanced approach. We have not nailed down, as Jessica said, our exact pricing strategy for 2024, as of yet. We're still working on that, but it will not be – clearly at the levels that we have this year. So we'll have more to say on that in the Q4 earnings. So gross margin, I'll turn it over to Jessica.

Yes. Hi, Sergio. Thanks for the question. Yes. Just in terms of margins, we talked a lot last quarter about things falling our way and margin really being driven by a lot of that weather favorability that we saw. I think as we're thinking about this quarter, we're really just super excited that this is the business just performing to get better. Bill came in a year-ago and really focused the team on execution. Our teams across the Board have been focused on process improvements, and it's not just been one silver bullet. I mean, it's been every team, every function, and what we really saw this quarter is the manifestation of those in our results. And we talked about various things like the high cost claims review that was implemented last year, but it was really during this peak season that we really saw that come to life, and we saw the benefits of that. And so as we think about going forward, we're seeing these external factors normalize, but we're also seeing kind of the results of the hard work as our business has been doing, really manifesting and coming to life, and we expect that to continue in our margins as we look to Q4 and beyond.

Thank you. The next question today comes from the line of Brian Fitzgerald from Wells Fargo. Please go ahead. Your line is now open.

Thanks, guys. A couple of quick questions. A follow-up on the price increases. Can you talk about the phasing? Is that a steady tailwind as we meet or through 2024, or does it crescendo at some point? And then the second question was just on the debt ratio. I think Jessica, you mentioned 1.3x. Do you have a bogey or a target you'd like to keep that at? Thank you.

Which one you want?

I can take both. Just on pricing. As you know, it takes about 12 to 18 months for our pricing actions to flow through, and we took some really aggressive pricing actions in 2022. Even with those, we're expecting about mid to single – mid single-digit price increase flowing into 2024 from those actions. So if we're thinking about next year, it is really us being focused on unit growth versus leveraging any additional significant pricing increases. But again, we are finalizing our strategic plan and we'll come back to you with more on that on 2024. From a leverage ratio perspective, we really try to keep that between 1x and 2x. So we're feeling really good about where we're sitting right now, but it's something to continue to keep our eyes on.

Thank you. Appreciate it.

Thanks, Brian.

The next question today comes from the line of Ian Zaffino from Oppenheimer. Please go ahead. Your line is now open.

Hi. Great. I'd love to hear a little bit more about AHS and kind of the marketing or the relaunch you plan to do. I know there was – basically, I'm seeing a lot more ads on AHS in particular. So what's going to change as you get into next year and “relaunch the brand?” And then just if I could squeeze in one more on the Frontdoor side, how are you thinking about either breakeven points or losses or profitability of that? And what I mean by that is, is you're adjusting prices, you kind of drop the premium model. You’re now working on that roughly $2 a month plan. What do you actually need there as far as profitability or breakeven, et cetera? Thanks.

Thanks, Ian. Let me take both of those and then Jessica may add something on the Frontdoor piece. Let's start with AHS. I think that we've talked about the category softness, and I think that some of the sticker shock from the price increases that all of us had to take around this area have hurt the overall demand plus real estate is just as we said in this, severe decline. And real estate will work itself out. So that will be part of the comeback whenever that occurs. We keep thinking the bottom is here, but it keeps dipping. The other piece is a new message and I said in the script, we want to, if you will, celebrate home warranty. So I don't think we as a brand have done a good job of really getting back to the essence of why a home warranty, the financial protection, the peace of mind that it brings. I don't think we've done a good enough job there. And so our marketing team is working on re-messaging. At the same time, as I said, we're running, we like the good/bad approach. We think it's a fresh new approach. So I think it's going to be a better focus on marketing, a more impactful marketing approach coupled with people rediscovering the category and pricing slowing down, if you will. On the Frontdoor piece. I think what I've been happy about, we talked about the consumer response, et cetera. I'm disappointed. And that's on the premium piece that we tried to come in with a second home service plan. We've got a good home service plan on American Home Shield. We really want to zero in on this larger segment, the 42 million people that we talked about in Investor Day, 42 million households rather. The whole on-demand piece, you heard us reference pay-as-you-go, or a-la-carte. We think that there's really a market for people who don't want to get locked into a contract and want to pay for a repair or upgrade their system on a one-time basis. And that's really what we're going to zero in on. So for now, we're really trying to engage, we're not making money at $25 with unlimited chats, but we think it's a good lead into the brand. It's certainly the unique user experience with our experts. We are really proud of, and we think it's going to enhance the brand long-term. So still working on the specifics of that – as we bring the booking engine into the app and the like. So we've got – we're very, very excited about the strategy, but you know, as Jessica said, we've got to bring the execution level to the same level that we've had across the company. Is there anything you want to add on that?

No, I would just add in, I'm glad you asked both questions AHS and Frontdoor. Because as we think about growing this business and long-term profitability, it really is about both brands. We are very pleased and thrilled with how our margins have rebounded so quickly. And we're really excited about, especially like a lot of that has been our core, but as we're thinking about the future and really growing this business, it's going to be about being innovative. It's going to be launching new products and offerings and going after more customers, which is really about Frontdoor. I think the margin profile of that product is going to be very different, I think, from a home on an on-demand services perspective. And so if we're thinking about that longer term profitability mix, it's really, again, like I said earlier, going to depend on what of that is coming from Frontdoor. But we are excited about both. We're excited about where our margins are right now and what that's going to look like going forward.

Okay. Thank you very much.

Thank you very much.

Okay. Thank you, Ian.

The next question today comes from the line of [indiscernible] from JPMorgan. Please go ahead. Your line is now open.

Hey. This is Danny Pfeiffer on for Cory Carpenter. I just have two quick ones. On the claims cost inflation, can you maybe unpack that 4% in 3Q and talk about what components are being the stickiest there? And then on the second one, on the success in on-demand services outside of HVAC, are there any other categories or services to call out you're seeing success in or most excited for from a revenue opportunity perspective? Thanks.

Why don’t you pick the first, I'll pick the second.

Thanks, Bill. So just from a claims cost perspective, yes, we have been forecasting, right, 9% compared to the 4% that we're seeing this quarter. I think a couple of things I just want to – concepts that I just want to put out there is, one, there's a lot of concepts in this business that operate on a delayed views, right? We talk about our pricing actions, claims cost development, and some of that is what you've seen this year just in terms of how we've seen inflation or deflation manifest into our results. We've talked also about in terms of, as you think about Frontdoor cost inflation, really it being comprised of three buckets, the contractor-related costs, parts and equipment and additionally, some of the impact that we're seeing on regulatory changes. I think right now what we're seeing from inflation is it's really comprised or heavily driven by two buckets, the contractor-related costs and the parts and equipment. And that's probably equally balanced between the two of those, which are really trending closer to CPI right now at this 4%.

Now, with regard to other services, to your question, Danny. So let me unpack this. So the engine for us right now is upgrades, specifically HVAC upgrades. We have a long way to go on that. That is just touching the service. We are thrilled with our contractor relations team, our contractors have done, the marketing team in terms of reaching out to our customers in terms of getting an HVAC upgrade. And I won't go into right now, we'll talk about this more in Q4. The changes that the EPA is bringing in that it's going to basically force a bunch of consumers to have to upgrade their system, but I won't get into that now. We will talk about that in Q4. But upgrades are the engine. We do think that there is opportunity, real opportunity in appliance and water heater. We're getting the model down on HVAC and then moving to probably those two areas, whether we could get into pool, spa and other things. But the two to think about behind HVAC are appliances and water heaters. Then the repair piece. We've been doing appliance repairs in about 15 markets, and we're working through the model and how that whole piece works. That is showing good traction. We will expand the number of markets we're still working through what that is, but repair will be not only in the shorter term an expansion of markets, but as we get a booking engine into the app where people can call for a repair as they put it an a-la-carte basis, that we think will be an additional good driver. I think there'll be a, let me call it a nice little business on maintenance. We actually have a good business right now doing tune-ups around HVAC. I think we're still working through. We have other maintenance services. I think we've got to sort through how we position those to customers and make those available. But I think that is a part of it, that's a natural part. So I'm excited from an on-demand basis that we can look at these three areas and have real opportunity and all, it's pretty much a greenfield for us.

Thanks.

The next question today comes from the line of Eric Sheridan from Goldman Sachs. Please go ahead. Your line is now open.

Thanks so much for taking the questions. Maybe two, if I could. First on marketing longer-term, you obviously leaned into marketing intensity in the last 12-plus months and seeing good returns on that. How should we thinking about marketing levels and marketing ROI that you want to sort of think about for the medium to long-term as sort of a cost input to drive the types of growth you want to establish as a baseline for the business? That'd be number one. And then number two, I'm curious just to go a little bit deeper in the idea that you could be in the more individual service request business over the long-term, and how you think about the market opportunity there and what investments would be key to capitalize on that potential shift? Thank you.

Okay. Let me take those, and Jessica, if you want to add anything to that. In terms of the marketing investment, we have – as Jessica pointed out earlier, we have two growth engines here. Next year, we will be spending the vast majority of our marketing money on American Home Shield. We're still working through the exact mix. We'll spend less on Frontdoor. But it is important to keep the vitality of the Frontdoor brand. Because to answer your second question in terms of on-demand, the catalyst for that is going to be customers, all non-AHS customers, thinking that Frontdoor is the place to go for repairs, maintenance, and upgrades. So the key is to continue to build the brand and make it synonymous with this a-la-carte offering. That's going to take us a while, but we have to maintain a level of pressure for next year. So that in terms of a return will probably be a negative return next year. But it'll be part of our overall fit within our overall equation in terms of our SG&A expense, et cetera. So that's Frontdoor and that's how we think we can get to the on-demand piece. The other thing is the TAM on that market is much bigger than just the home warranty market, and that's what makes us excited. We have seen with this real estate situation that people are staying in their homes longer. Well, systems are going to continue to break and so we do think that there's a big opportunity for people who don't want to get locked into a contract to use the on-demand piece. Now, as far as AHS investment, that'll be a – in a more traditional sense of the spending we have for the returns we want to generate. So that will be – I won't get into specifics of what we're looking for in terms of CAC or anything else. But that'll be – that's an existing business, that's a business we want to invest in. We did not spend at the levels we probably should have this year, but we're going to correct that next year. And I think with a fresh new message and really driving home the benefits of the home warranty, I'm excited that our DTC one business will start to turn around, we'll see on real estate, and I'm really pleased with how renewals continue to be so resilient.

Thank you.

[Operator Instructions] The next question is a follow-up question from Mark Hughes from Truist. Please go ahead, Mark. Your line is now open. Please do ensure that you are unmuted locally.

Okay. Yes. Here I am. Thank you. Good morning. Is there a particular seasonality to be on-demand? Is that a kind of Q2, Q3 along with the HVAC? Or should we think about that being more steady through the year?

I think that's an intriguing question. I don't think we know it. We don't have a great answer for you now. Other than I think generally home services follow a seasonal pattern, which is spring cleaning, spring, I got to get our house in order over the summer stuff breaks, especially in the HVAC area. So I do think the seasonality would be consistent, but I can tell you that we've got a great empirical study on this. But I think my sense is, this maybe a little better as a year-round business, but if it just follows the pattern of our service requests, the seasonality would be the same.

And then on the real estate channel, I hear what you're saying about higher interest rates impacting activity there, some indication perhaps at least year-over-year, some of the purchase activity could be steady or even moving up possibly. How much do you need kind of more days on market to put pressure on the sellers? Or if you could just theoretically if the existing home sales flattened out or turned positive, how much of a help would that be?

Yes. As the days on market is a big deal. I know only 21 days on market because with that level of inventory that drive demand is high against a limited number of homes. So the seller doesn't feel. It doesn't feel it's necessary to attach a home warranty. I think what – if ideally it's more like four to six months worth of inventory, that probably is more ideal for us. But we're not sitting still, just fields and the real estate team are really starting to turn their attention, trying to engage buyer agents more, not just the seller agents to get that direct-to-consumer piece. We also have a big team lined up against trying to drive increased real estate RE 1 renewals. So there are various ways we can go at this. The overall real estate business while we're working through this macroeconomic effect of the industry continuing to have this severe decline. And again, the real estate business is resilient. It's going to come back. We continue to hold our share within the amount of home warranties that are done through the real estate channel. But having said that, we're working across a lot of different dimensions to try to drive units.

Understood. And then Jessica, did you give specific numbers for sizing the weather impact on EBITDA or the preferred contractor utilization?

Over to you, Jessica.

No.

You're the weather person.

Yes. No, well, we definitely had less flavor on Q3 compared to prior quarters this year. We talked about last quarter there being about – sorry, last quarter we talked about the decline in the cooling degree days and that being significantly lower, this year was about 3% up compared to last year. So last quarter Q3. So that should give you some flavor into where that's placed. Definitely less of an impact in Q3 than what we saw in the first half of the year.

And then the preferred contractor utilization?

And that's about 83% this year. And again, 1% change in percent to preferred drives about $5 million in gross profit.

Excellent. Thank you.

Awesome. Thank you.

Ladies and gentlemen, thank you again for joining Frontdoor's third quarter 2023 earnings call. Today's call has now concluded.