Ladies and gentlemen, welcome to Frontdoor's Fourth Quarter and Full-Year 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 fourth quarter and full-year 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. 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, February 28, 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, everybody. Let's start with 2023 where we smashed expectations and delivered record financial performance. As you can see from slide 4, we drove revenues 7% higher to a record $1.78 billion despite a decline in overall [Technical Difficulty] demand. Gross margins rebounded 700 basis points to 50%, a nine-year high. Adjusted EBITDA increased 62% to an all-time high of $346 million. We generated $170 million of free cash flow, and we returned $120 million to investors through share repurchases. In short, the turnaround in our financial performance has been remarkable. So how do we complete such a successful turnaround? When I stepped into the CEO role 21 months ago, the company was struggling to respond to inflationary cost pressures. Since that time, I brought in new leadership, we accelerated our pricing actions, we took decisive steps to improve execution, and we increased our retention rates. I am extremely proud of how everyone responded to these challenges. And to be perfectly transparent, the plan came together faster and better than we had hoped, notwithstanding that we had a lot of things fall our way in 2023. One of the main themes you will hear today is when we experience a challenge in any part of our business, we do the research and we establish a strategy, and then we execute against that strategy. This is what we did with our margins over the last two years and this is now what we're focused on doing for our top line sales, which is a great transition to slide 5. So let me be clear. Our top priority for 2024 is to focus on driving customer growth. We will do this by relaunching the American Home Shield brand, increasing direct to consumer sales, driving renewal rates higher and…

Thanks, Bill. And good morning, everyone. It is amazing to see the progress Frontdoor has made since I first spoke at our Investor Day just 12 months ago. We took decisive actions to improve execution and combat a challenging environment, which contributed to gross margins rebounding to the highest levels in nearly 10 years, along with record adjusted EBITDA. I could not be more proud of our teams and what we have accomplished together since I started 14 months ago. Please turn to slide 12 and our fourth quarter financial summary. Fourth quarter revenue increased 8% versus the prior-year period to $366 million. Net income increased 4% to $9 million and adjusted EBITDA increased 35% to $45 million. Next, we will move to slide 13 where gross profit for the quarter increased 22% versus the prior year period to $177 million and our gross margin increased 570 basis points to 48%. Let's now move to the adjusted EBITDA bridge on slide 14. Starting at the top, we had $29 million of favorable revenue conversion, driven by a 15% increase in price over the prior year period, partly offset by a 7% decline in volume. Contract claims costs decreased $4 million, which was better than expected. This includes $10 million of favorable weather, a transition to higher service fees and continued process improvement initiatives, which was partially offset by ongoing inflationary pressure as well as a $19 million change in favorable claims cost development. Sales and marketing costs increased $17 million over the prior year period, primarily due to investments to drive growth in our direct to consumer channel and our Frontdoor brand. And finally, general and administrative costs increased $6 million, primarily due to increased personnel costs. Please turn to slide 15 where I'll review highlights from our 2023 financial…

Thanks, Jessica. In closing, I want to leave you with the top reasons to invest in Frontdoor, Inc., as shown on slide 23. First, we are the leader in home warranties and have a massive growth opportunity. Second, we have a great core business that is supported by a recurring revenue model. And I believe our American Home Shield brand is at an inflection point for future growth. Third, our margins have rebounded and we are looking to deliver a consistent margin profile in 2024. Fourth, we generate a significant amount of cash, and we use that to aggressively repurchase shares. And finally, it is clear to me that Frontdoor share price is significantly undervalued. When you look at slide 24, you can see that our adjusted EBITDA multiple is at an all-time low. We're currently trading at an approximately 9 times multiple, well below our peak multiple of approximately 18 times and also below our average of 13 times. Logic would say that our valuation has to improve as we continue to deliver strong financial performance, our growth initiatives take root and as market conditions normalize. So, operator, let's now open the line for questions.

[Operator Instructions]. First question today comes from Jeff Schmitt with William Blair.

In the DTC channel, it looks like you're expecting revenues to decline 20% in Q1, I think, and then 10% for 2024. What do you think it will take to turn growth positive there? Is it a pricing issue they need to come down? Is it more advertising, you think? Or is it just a broader industry issue where you need consumer demand to be stronger?

You've captured it pretty well. I think the industry is the biggest issue. Since the real estate market which really has an overlay to the entire industry, since that has moved to such a strong seller's market, it has really dampened real estate sales, which has had some impact on DTC. We haven't done a good job, as I said, of talking about the value of the home warranty. I think the brand is a little tired. I think that's why we're doing this relaunch. I think that freshening the brand, and I referenced some other brands that have done this that are category leaders, I think our pricing efforts – by stabilizing – we had to get our margins right, as you know. So we're not looking for the significant price increases that we've taken in the past. So I think this combination of factors will begin to turn things. We're excited about our relaunch beginning in about a month. And I honestly believe this is going to turn, but we tried to give you a guide that we felt was appropriate at this point, and we've got to prove it as the year goes on.

On the on-demand business, what type of profitability do you expect from that kind of over time? I'm sure you build that out and spend more – maybe you won't see it in 2024, but over time, help us maybe think about that. I would think the upgrade program would be pretty profitable. But then you have to repair the maintenance pieces. So how should we think about that profitability?

At this point, because a lot of the upgrades have been with a repair credit, which has dampened our margins – I think, over time, we think it's going to be a healthy business, most likely lower than home warranties. But the dollar volume, we like the dollar volume. And I think what we're starting to build a culture of, is by being very methodical and continuous improvement is part of our daily efforts, we're going to help to build that margin profile over time. So, we feel good about it in the long term. But for now, it's clearly nowhere close to the home warranty margin. I don't know, Jessica, if there's anything else.

I think you've covered it, Bill.

We now turn to Brian Fitzgerald with Wells Fargo.

Excellent color on the marketing outlook around the DTC business. I want to ask, are you seeing anything – ex what you're doing kind of indigenously, are you seeing any changes to note in promotional environment in the quarter in terms of your activity or your competitors activity? And then, comparing your 2024 plan to 2023 and the relaunch, could you talk a bit about your approach both to marketing and promotion around DTC channel? Is the phasing there, is it going to be centered or right around April, maybe very similar to what we saw with the Frontdoor rebrand? Are you going to pursue that same kind of playbook in phasing around the relaunch this year?

On the first one, on the promotional levels, we've been aggressive on our discounting. I think that's been common throughout the industry. Nothing out of the ordinary in Q4, but I think it's been pretty consistent. We've had to be more aggressive on discounting because of all the pricing action we took, and we've talked about that. With regard to AHS, obviously, we're pointing a lot of things to April. And this is different than Frontdoor, we're trying to establish a new brand. We're trying to build awareness, et cetera. We have high awareness of American Home Shield. This is going to be the start of a continuous effort to improve the value proposition for American Home Shield. So it kicks off with all the things I talked about, a new logo and a refreshed website, new advertising, celebrity, all that stuff. But that is only part of the equation as we go forward. We've got to improve the value proposition and that's what the plans are. Not ready to talk specifically about what those are, but you'll hear more about that in the coming months.

One thing that I would just add, I think last year we were – because we were really focused on the Frontdoor brand, we had kind of lower marketing upfront, so that we could spend it towards the middle and back half of the year. This year, you're going to see better pacing in our spend throughout the year

Because in Q1 of last year, we had really lowered the American Home Shield spending. We're spending at a better level this year to lead into the relaunch.

One more for me, if I could. Last quarter, you had talked about potential improvements from an improved customer experience. Did that continue to play out through the quarter? And where do you think we are getting wise in terms of addressing the consumer experience improvement opportunities?

We landed the year with a really strong retention rate, and so those process improvements continue to play through. We are really better engaging our customers through the onboarding process end to end, as Bill talked about, the work that we did to really understand the full customer service lifecycle. We continue to use our expanding utilization of our dynamic pricing tool, which we really think is a competitive advantage for us. So we are seeing the results, but it's something that we're not letting up on.

We now turn to Ian Zaffino with Oppenheimer.

On the SG&A, I was wondering if you could just maybe unpack that a little bit as far as the guidance into 2024. What does it puts and takes here? I know you're doing a bunch of relaunches which will cost money. What are you doing, I guess, to offset that and maybe walk us through that bridge?

I think big picture, Ian, remember, we are essentially holding SG&A flat. There's some increases that are really just due to inflation and G&A. So, really think about it, last year was the year of Frontdoor. This year, we're very focused on AHS. It's really a shift between the two. I think the other thing, just getting back to Bill's comment on a culture of process improvements, I think knowing that we need to invest in growth, we've also been very intentional about managing costs across the business, so that we can shift spend into investments for growth, such as marketing. So, I think really feeling good about the guide into the year.

If I can squeeze in one more on the retention side. Good job, I guess 50 basis points improvement this year. What are we kind of expecting over the next several years? Where do we think we can get it? How do we get there? Is it a matter of bringing auto pay up to the 90% level? Basically, help us understand. Like, where to go and how do you get there?

I don't think we're ready for a number. But I think we're tasking ourselves that this has to be a continuous improvement approach to retention. And I think you pointed out, we've made great strides in auto pay, we're not done with that. We've made great strides in understanding the consumer journey. We've improved the percentage of preferred contractors, which is – you heard about five stars are at the highest and one stars at the lowest. These are all part of an effort within the company, a relentless effort to improve that retention rate, because we know that's really the lifeblood of the company. And so, we got a lot of people committed to doing that.

And I would just add, again, we've got a very strong pricing team. It's really been leveraging dynamic pricing, and I think that's the muscle we continue to build and will get stronger, and plays a big role in our retention rate.

We now turn to Mark Hughes with Truist.

In the real estate channel, seems like the declines have been shallowing, down 15% this quarter, but your guide, I think, for Q1 is down 20% to 25%. I hear what you're saying that you haven't seen turn yet. But it seems like the industry data would look a little more upbeat than that. I'm just curious to get your thoughts.

Let me address that. I think that's a really good call out, Mark. What I was saying in the script was the NAR data would indicate 13% improvement in real estate sales for the year, continuing improvements in inventory levels and the like, and we're rooting that on. We want that to happen. What the point was, at this point, two months in, we have not seen a merchant material change. And obviously, you saw the industry declined 20%. Last year, we were right in line with those numbers. And the macro on this particular channel is such that it almost drives what our home warranty sales will be. I think we're encouraged by the NAR data. I think we're encouraged by my conversations with a number of top leaders in real estate. But we're just trying to point out that, at this point, we haven't seen the turn.

Jessica, you talked about the claims inflation, I think 5% for the full year. Looks like the fourth quarter underlying claims are pretty good when you back out the change in the claims development. Even when you adjust for the weather, seems like it was pretty good. Do you have the fourth quarter specific claims inflation number?

Yeah, it's 5%.

It was 5%? And 5% for the full year as well?

We're really lucky, especially as we're heading into the year feeling that we're moving into normalized inflation there and holding at that mid-single-digit.

If I can just squeeze in one more, your price increases 15% this quarter. That was faster than the full year, I think faster than last quarter. You've talked about maybe doing some pricing promotion. But, in fact, the pricing accelerated. What drove that?

Again, we took very aggressive pricing actions in 2022. And you're really seeing the peak of those actions hitting in Q4 of this year. You'll see that in Q1 of next year as well. And that's incorporated into our guide. And then you'll expect for those to taper off, but that's still those 2022 actions flowing through just based on the way that those hit earned revenue.

We now turn to Sergio Segura with KeyBanc.

Congratulations on another strong quarter of gross margin expansion. We noticed that the guy does call for the – 2024 guide does call for gross margins to come down a bit. So just wondering if there's any underlying conservatism with that outlook and any opportunities that you see in the business to expand gross margins from the 49% level they currently are at?

I think the big thing there is, remember, we are lapping $30 million as favorable weather, which accounts for about 200 bps of margin. And we are really looking at that upper 40s as being normalized for the business, especially as we think about on-demand and the mix going forward. But we continue to be aggressive on process improvements. And so, that guide really takes into account the $30 million, plus the continued benefits that we are seeing from process improvements across the business.

Sergio, I think you make a good point. I thought Jessica answered it completely. It's one of those things, I said in my script, notwithstanding the fact that we did get a few things break our way last year, including weather was one of them. So as we put together the plan for this year, as we put together the guidance for all of you, we have to take into effect that we might have gotten a few breaks, like on weather. Look at what happened in January. As Jessica said, it looks like February has offset that. But that's the kind of thing, as you're forecasting these things together, you've got to be mindful that anomalies need to be factored out.

And I just think about our Investor Day last year, I feel like one of the biggest questions, when are we going to get back to 50/20? Or when are we going to get back to those upper 40s? And again, just really proud of the team and the work that's been done to get us where we are today?

And if I could ask a second one, just wondering what gives you the confidence to reaccelerate customer growth in 2024 without a real significant increase in marketing spend? Why not spend more aggressively with customer growth being the one of your top priorities this year?

I think as Jessica said, if you look at the investment behind American Home Shield, it is up because we invested more in Frontdoor last year and took away from AHS. Our AHS investment will be stronger in 2024. The other thing that gives me confidence is the whole of the program, not just the marketing efforts in April, but the things we're looking at to enhance the value proposition later in the year and into 2025. And that's why I think we're – in my words that I used, we're kind of on a relentless march now. The category has been stagnant or down. I think the brand's gotten a little tired, we need to freshen it up. We need to come out with more things that are going to turn consumers heads and that's why I think we'll start to head north with our customer growth.

Our final question comes from Cory Carpenter with J.P. Morgan.

I was hoping you could talk about the level of consumer engagement you're seeing with on-demand services. And then, as you shift your marketing spend to the AHS relaunch, what are your expectations in 2024 for on-demand? I know you were planning to build out in that booking capability some other stuff. Maybe you should update on where you are with some of those initiatives.

From an engagement perspective, the interesting thing about this part of our business is, it's a real partnership with our contractors. In the traditional home warranty business, our contractors execute the concept as we get service calls, and we're dealing a lot direct to the consumer with real estate. And this one is really getting contractors to go do upgrades, and it's really a partnership with them. So from a consumer point of view, we're still building that out in terms of how we engage with them. But I think the great thing about this particular part of the business is we can do things that don't cost a lot of money by just engaging with our contractors in the right way. And that's one of the core strengths of our company, is that contractor network that we have, the 2,500 or so preferred contractors and another 12,000, 13,000, 14,000 other contractors. And we're getting better at this. We had a nice pick up in HVAC last year, and we've got other things to come, as I mentioned. So I think this is one that is both going to be a combination of consumer engagement and contractor engagement.

Just from what we're expecting for 2024, other revenue is going to be up approximately 30% to $100 million. And the majority of that is really HVAC upgrades. But I thought Bill did a really nice job laying out the full portfolio of our on-demand services in his shared remarks. So, also in there are things from the other on-demand services, such as the HVAC tune-ups, rekey as well. So, again, this is a great opportunity to also test into it. We're learning a lot, but we're also seeing a lot of strength from the upgrade component of that business.

Ladies and gentlemen, this concludes our Q&A and today's Frontdoor fourth quarter and full-year 2023 earnings call. We'd like to thank you for your participation. You may now disconnect your lines.