Ladies and gentlemen, welcome to Frontdoor's First Quarter 2024 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 First Quarter 2024 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 on the 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, May 2, 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?

Thank you very much, Matt Davis, and hello again, everybody. Frontdoor, Inc. continues to operate extremely well, and we are off to a great start in 2024 as we delivered another quarter of record results. As you can see on Slide 4, revenue grew 3% to $378 million. Gross margin increased 510 basis points to 51%. Adjusted EBITDA rose 33% to an all-time first quarter high of $71 million. And as a result of our strong first quarter financial performance, we are increasing our full year 2024 adjusted EBITDA outlook. So, while we continue to exceed expectations on the margin side, our top priority remains growing our customer base. Let's be clear right up front. Demand for Home Warranties has been down due to some challenging market conditions, but we view this as a temporary cyclical issue. The main cause of lower demand has been real estate. As I've said before, we sell our products as part of the real estate process and as the number of existing homes has declined from $6 million in 2022 to just over 4 million homes today, we have had significantly fewer opportunities to sell our products. This was due in part to rising mortgage rates, which recently reached a 1-year high. At the same time, existing home inventory has been extremely tight. This is not only limited to existing home sales, but it has also resisted in a significant power shift to the seller over the last several years. As a result, our real estate channel sales are less than half of what they were 5 years ago, and this continues to impact our customer count, revenue growth, profitability and cash flows. And, from everything that we see, this is true for the rest of the home warranty category. So, while we are…

Thanks, Bill, and good morning, everyone. Before I get into the details, I wanted to first build on Bill's remarks with a few high-level thoughts about our quarter and outlook. First, we want to celebrate that we had another record quarter, which was primarily driven by better-than-expected margins as the team continues to drive operational excellence across the business through our margin expansion initiatives. Second, in response to our strong first quarter performance, I'm pleased to share that we are raising our full year outlook for gross margin and adjusted EBITDA. Now, let's turn to Slide 9, where I'll review our first quarter 2024 financial summary. First quarter revenue increased 3% versus the prior year period to $378 million. Net income increased 56% to $34 million, and adjusted EBITDA increased 33% to $71 million, which both represent records for first quarter performance. Now, moving to Slide 10, where gross profit for the quarter increased 14% versus the prior year period to $195 million and gross margin improved 510 basis points to 51%. The gross profit improvement was primarily driven by higher realized price, a transition to higher service fees and continued process improvement initiatives and was partially offset by inflationary cost pressures. Let's now move to the adjusted EBITDA bridge on Slide 11, where I'll provide more context for the year-over-year improvement in first quarter adjusted EBITDA. Starting at the top, we had $14 million of favorable revenue conversion, driven by an 11% increase in price over the prior year period. This was partially offset by an 8% decline in volume, primarily driven by lower sales in our first year channels. This also includes a $6 million increase in other revenue due to higher on-demand home services, primarily from the new HVAC program. Contract claims costs decreased $10 million, which…

Thanks, Jessica. One final note before we go to your questions. You heard me on the last call talk about how I think our stock is undervalued. I still firmly believe that. Our first quarter performance demonstrates the exceptionally strong earnings power of our platform. We generate a lot of cash that we will use to grow or to buy back stock. And finally, I am confident that we are on the right path to increasing the growth trajectory of our customer base. There are so many upsides to this category in our company that we have decided to hold another Investor Day to share our vision and strategy with investors and analysts. The day we have chosen is November 7 in New York City. I think it will be well worth your time to attend, and we will share more information as we get closer to November. Operator, let's now please open up the line for questions.

[Operator instructions] Our first question go to Jeff Schmitt of William Blair.

Unit volume continues to decline in the mid-single digits. Do you think it's going to take a better, just kind of a real estate environment, lower inflation, kind of better macro for that to improve? Or could you potentially cut prices, just given how strong gross margins are now? I mean it seems maybe shot overshot a little bit on pricing.

Yes. I think, Jeff, let me answer your question because I think you've hit on the right point here. Real estate has hurt us. There's no doubt about it. We have been increasing our level of discounting for DTC 1. So, that is something that is underway. And hopefully, we're going to realize the benefits of that. With the guide that we put together, obviously, we think things are going to improve. We have not seen real estate improve to date. But everyone I talk to in the real estate industry says it's going to turn, it's going to turn, it's going to turn. So, I think based on the guide we put together for the rest of the year, we do have confidence that real estate will start to lessen the decline and that the turnaround in DTC as we relaunch the brand will start to be felt over the coming quarters.

And then, yes, I guess, on your '24 guide, so you have revenue growth of 2% to 3% you have DTC revenues declining 10% unit growth down 1% to 3%. So, obviously, they both had kind of a tougher first quarter. So, do you have either of those kind of turning growth turning positive by year-end or maybe not quite that far? What's the kind of trend there?

I think trended wise, it continues to get better. I'm not ready to commit to when we turn positive. But, clearly, the math would indicate that we're going to start to improve quarter-by-quarter. And certainly, as we head into '25, I think we feel pretty good about where we're going to be.

The next question is to Cory Carpenter of JPMorgan.

You announced the Frontdoor outreach the $2 million download mark a few days ago. Could you just address what's driving the engagement given you did ship some marketing dollars away from that towards American Home Shield? So, is that mostly organic demand? And then, where are you with some of your conversion optimization efforts there?

Yes. So, we've been pleased that I think the Frontdoor proposition has taken hold. So, I think despite the shift of money, the download piece has continued to grow as have people signing up. The goal here has always been to get more customers, and we now view Frontdoor is a holistic business. We run everything through the front door model for both our in-person services, our HVAC upgrades. We have the unlimited product out there now. We just, in the last week, enabled any basic user in the app to be able to get an HVAC upgrade. So, it's kind of the way we've evolved to the Frontdoor model is to really make this the centerpiece of our on-demand services. So, it's really not about conversion per se from the app. It's more about how do we continue to grow users and how do we grow engagement with them for the variety of services that we offer.

And just a quick follow-up maybe for Jessica. The 11% price increase in 1Q. I know you expected it to be higher relative to the midportion guide for the full year. But did you take another round of pricing? Was that above expectations? Or could you just talk about how you expect pricing kind of increase the growth through the year?

Yes. No. If you remember, Cory, this is still coming off of those pricing actions that we took in 2022, which, again, those take 12 to 18 months to flow through the peak of that was Q4 and Q1. So, this was really the hit of the peak, and you're going to see that decline over the years. Again, those 2022 pricing actions are just tapering off throughout the year.

The next question goes to Ian Zaffino of Oppenheimer.

I guess 2 questions. I mean first one would be just the DTC business. When you think about maybe adjusting prices here, what type of magnitude do you think you need to adjust prices on to kind of restore growth in that business? And I know you have like a lot of branding going on too, so that probably mitigates the need to maybe adjust prices. But as analysts, when we look at this, what should we kind of expect? And how do we think about that? And then, Jessica, just on inflation. Can you maybe give us a breakdown between maybe labor parts, by trade or something along those lines?

Yes, I'll take the first one and then, Jessica, you take the second one. As far as DTC and pricing, we are doing a blend of discounting as well as all the elements of the brand relaunch that we've talked about. We think we're starting to connect on some of the discounting work that we've done based on the guide we do feel good about where DTC is headed. It's come through a tough trough here. The whole industry is down and overall home warranties. We've talked about real estate before. But I think the array of options, I think we needed to break out from what we keep calling the sea of saying this. I think we're doing that with the relaunch elements. And so, I feel good about where we're headed not only on those elements, but also the pricing actions we've decided to take. So, I'll turn it over to Jessica for the inflation piece.

And thanks, Ian. Remember, as we communicate front door inflation, it is on a net cost per service request basis, and so we don't communicate that individually, but rather that includes everything from contractor-related costs, parts and equipment, the impact of regulatory changes, process improvement initiatives and the impact of our trade service fees. So, what I will say is that for Q1, inflation really came in relatively flat, which was a bit lower. I think it's continuing to moderate, which is why we adjusted our guide for the full year to be from, I think previously we communicated mid to low, and now we're at more of a low to mid. About mid, sorry, let me just clarify, to mid. So, we've continued to see some improvements there. And hopefully, that's helpful.

The next question goes to Sergio Segura of KeyBanc.

First, Bill, hoping you could just talk about the American Shield brand we want so far, just what you're seeing. I know it's early, but just what you're seeing in your expectations for how this will increase demand for the service over the course of the year. And if you think, ultimately, just kind of the macroeconomic environment that you guys have been speaking to is going to impact the trajectory of the customer growth for this year.

Okay. Obviously, it's too early to tell to give specific results. We'll talk about that in the Q2 call. I do think what's happened that's very encouraging is that all the elements of the relaunch have come together and fit together really well. I think all the things I went through in the call, I think the new logo looks great. I think our media plan has been terrific. I think the advertising has been great. The website, we're really pleased with what's been going on there. So, the elements are in place for us to really start to kick start out of the CF sameness that we've talked about. I think the other piece is that we believe real estate is going to get better. But there's not much we can do about the macro on that. But we're not sitting back and just waiting for hope real estate gets better. We are working very hard, as you've seen with all the work we've done on our renewals business. As I said in the call, I'm super proud of the effort the team has done there from our marketing efforts, our pricing team, our contractor relations team, our service ops team, everybody has really pulled together to really drive. These are our customers, and we want to continue to keep them as part of our company. And then supplemented by the initiative really from a standing start where our new HVAC program has really taken off as another vector in our overall revenue stream. So, while we are going through this trough of new user counts being tough, we are not sitting idly by and hoping for the best. We are working across all elements trying to come up with new initiatives and new ways of thinking. And as you can see by our overall '24 guide, we know we're coming through a tough piece in Q1. Q2 is going to get a little better, but I think it's going to be continuing that phase. But in the second half, I think we're going to have improved numbers and leading into 2025.

And then maybe a follow-up for Jessica. You guys had very strong performance on the margin side and raised our outlook for the year. I guess, how should we think about that upside flowing down the profitability and increasing the pace of buybacks versus opportunities to invest even more behind growth initiatives to accelerate revenue growth?

Now, thanks, Sergio. I think it's a great question. I think as I said in my remarks, we recognize that we are sitting at a very low leverage ratio and a pretty strong unrestricted cash balance, and it's not our intention to sit here for the long term. I think where we really want to be is at a longer-term target of about 2 to 2.5 tons on our leverage ratio and really focused on the $100 million to $150 million that we need to run the business. So, we are very focused on sticking to our capital allocation strategy, which is really focused on growth and whether that be organically through or through opportunistic M&A. And absent that, excess cash is to buy back shares. So, we've consistently been doing that since we launched the program, and there was a little bit of timing and seasonality here for Q1, but it is our neo intention to continue to do that.

[Operator instructions] And our next question goes to Mark Hughes of Truist.

In thinking about the opportunistic M&A, would that typically be bringing new capabilities perhaps? Or are those deals normally to get that policyholder base, and so it's more of a, call it, financial transaction? How do you look at that?

Yes. Mark, I think we try to look at it in a holistic manner. So, we have a BD group that takes a look at a variety of opportunities that can run the gamut of what you're exactly talking about. We don't have a stated policy of what we are specifically looking for because as an industry leader, I think we have the opportunity to look broadly at opportunities that may enhance the value of our company. So, that's really the approach we're taking right now.

Then, you've touched on the other revenue, the HVAC opportunity. Could you maybe flesh that out, what gives you confidence or visibility that you continue to expand? I think you perhaps in the past you pointed out that there is some penetration of that program with some of your contractors, but there's more to do. Do I have that right? How do you think about that growth?

Yes. No, fair point. We have a couple of tailwinds here. First of all, there's the environmental change or the regulatory change around refrigerant, which is going to render some of the refrigeration for older equipment obsolete. So, people are going to have to upgrade their equipment. So, that's a macro that's going to help us. Second is our relations with our contractor team in the sense of, there is great enthusiasm with our HVAC contractors to engage in this program, and it's really simple economics for them. They'd much rather do a $5,000 install and then roll a truck for a couple of hundred dollar repair. So, we have great enthusiasm from contractors. And then finally, the consumer receptivity to this and the value proposition with our ability to interact with our contractors to buy well with the OEMs and then obviously, our marketing abilities really adds up to a terrific business proposition for us. So, that's why we're pretty pumped up about this area.

And I think the one thing that I would add to, I think the contractor relations team has really been out there doing a road show, also expanding the adoption with the contractors, and I continue to be really excited about that. So, I think it's both the consumer. What we're anticipating from a consumer perspective, but we are doing everything we can here on the ground to make sure that the program is scaling.

And then Jessica, the claims development or reserve development. I think it was a $1 million tailwind this quarter. Are there things structurally that you can talk about there? I think the maybe in the past when inflation improved, you ended up kind of coming in better than expected in your earlier accruals ended up being too high. Frankly speaking, where do we stand on that?

Yes. No, I think it's a great point. It's actually something that I've been reflecting on. I think when that first quarter that I came in, so Q4 2022 and delivered results, we had an adjusted EBITDA beat of about $24 million. And I think we had about $25 million of claims cost development in that quarter. And coming down to that one, I think as we've gotten off the volatility of that inflation, it's really stabilized and narrowed. So, that same quarter, we had about 15% of that year of Frontdoor inflation, tailing down to flat. I think that really aligns with why you're seeing the tightening up of that claims cost development. Yes, I was just going to say, I think there's inflationary pressure. So, I just want to reiterate the work that the team is doing in terms of driving process improvements across the board that are also tightening up our costs. So, I think there's getting to everything firing on all cylinders. It's just a holistic process working together.

The next question to Brian Fitzgerald of Wells Fargo.

A couple of follow-ups. When you guys think of the strengths and weaknesses of the brand historically, talking about the marketing campaign and across regions and demographics, how are you thinking about the opportunities to maybe address regional or demographic opportunities that may have been underserved in the past? And then I got one follow-up.

Yes. I think the core of this is with any 50-year-old brand, you've got to revitalize it. But I think brands are extremely resilient. So, I think that we've had a really good look at trying to revitalize a brand. I didn't set it off, Brian. I really will answer your questions. Anyway, I'll keep going. We'll go find out what's going on here, but it's perfect timing. Anyway, to your point about targeting, I think that there is and Kathy Collins and the marketing group have done a lot of work around new demographics. The Latino market is one that we're particularly interested in as they become a larger part of home ownership overall. We have a Spanish language website now. And that's just some of the elements. This is just one example of ways we are trying to get more specific on our targeting efforts. But it's the right point to bring up. I think from a regional perspective, we still think there is a lot of opportunity beyond the Sunbelt, kind of the smile states, where we have traditionally been very strong. So that is something that we're also trying to drive is greater penetration into some more northern markets. But that is part of the opportunity set that we think we're going to help to grow into.

And then the other question we had was around the gross margin benefits from the service fee change. Could you give us some color on your expectations for how long that tailwind potential persists?

One thing I would say, and I'll let Jessica answer this specific is the trade service fee increase was really an outcome of -- as contractor costs increased with labor costs and fuel and insurance and all those elements. We raised the trade service fee really in response to staying current with where a contractor costs were. Now, as far as how it flows through the P&L, I'll let Jessica --

Yes. No, I mean, again, these are behavior shifts and so they can take time. So, we've anticipated this in our plan throughout 2024.

We have no further questions. Ladies and gentlemen, thank you again for joining Frontdoor's First Quarter 2024 Earnings Call. Today's call is now concluded.