Frontdoor Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 28, 2024

There are 9 speakers on the call.

Operator

Ladies and gentlemen, welcome to Frontdoor's 4th 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.

Operator

At this time, we'll begin today's call. Please go ahead, Mr. Davis.

Speaker 1

Thank you, operator. Good morning, everyone, and thank you for joining Frontera's 4th 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.

Speaker 1

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.

Speaker 1

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?

Speaker 2

Thanks, Matt, and good morning, everyone. 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 $1,780,000,000 despite a decline in overall demand. Gross margins rebounded 700 basis points to 50%, a 9 year high. Adjusted EBITDA increased 62% to an all time high of $346,000,000 We generated $170,000,000 of free cash flow and we returned $120,000,000 to investors through share repurchases.

Speaker 2

In short, the turnaround in our financial performance has been remarkable. So how did we complete such a successful turnaround? When I stepped into the CEO role 21 months ago, the company was struggling to respond to inflationary 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.

Speaker 2

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, we establish a strategy and then we execute against that strategy. This is what we did with our margins over the last 2 years and this is now what we are 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 expanding our on demand revenue while positioning the company for an eventual turnaround in the real estate market.

Speaker 2

On the margin front, we feel very good about delivering a consistent margin profile in 2024 with the volatility of the past 2 years behind us. As a reminder, we had to take significant price increases to combat inflation and right size our margins, which frankly impacted customer growth. Now that inflation has come down and margins have stabilized, we do not need to continue to take double digit price increases and can focus on growing our customer count over the long term. In addition to the objectives shown on this page, we have a host of initiatives designed to continue to build a strong foundation across our contractor relations, procurement and technology groups. Many of these efforts are aimed at our longer term goals to enhance the customer experience, expand on demand offerings and improve operational efficiency, all with the ultimate objective of accelerating customer growth.

Speaker 2

Now turning to Slide 6 and the significant long term growth opportunity for home warranties. In the U. S, there are about 5,000,000 homes that have a warranty. We believe that figure could be approximately 3 times higher if consumers could better understand the value of a home warranty. As a category leader, it is our job to solve that problem and drive demand for our products.

Speaker 2

Let me quickly walk you through some of the main reasons consumers should buy a home warranty for American Home Shield. First, we offer homeowners financial protection from expensive repairs or replacements that will inevitably happen. The median savings account balance for American households is only $5,300 according to the last Federal Reserve survey. So this aspect of our value proposition specifically appeals to those homeowners. 2nd, we offer customer convenience.

Speaker 2

You don't have to deal with climbing into your hot attic to see why your air conditioner is not working, nor do you have to deal with finding a reliable and insured contractor. We have built a curated nationwide contractor network to support you. And unlike an insurance company, we typically don't just write you a check. We take care of covered repairs for you and get you back up and running. And finally, our value proposition offers peace of mind that the work will be done right and guaranteed so that you can feel in control of your home.

Speaker 2

Owning a home can be challenging and the value proposition that we offer is still very relevant to consumers. Homeowners just want their systems and appliances to work and that is exactly the service we provide. On Slide 7, you will see that American Home Shield is the largest home warranty company with 2,000,000 customers and 16,000 contractors and that we completed approximately 4,000,000 service requests last year. We have built a virtuous flywheel where our size gives us leverage with our contractors and suppliers. This provides us with a superior margin profile, which we can then invest in the business.

Speaker 2

As the leader in the category, we have the opportunity to reset the industry by changing our approach to what a home warranty is and how we should go to market. We will do that by relaunching the American Home Shield brand to reignite unit growth as shown on Slide 8. Let me start by answering the question, why a relaunch and what exactly does that mean? To stay relevant, smart brands must evolve. This is especially true with category leaders who have been around for a while.

Speaker 2

American Home Shield is over 50 years old and we have built tremendous equity with millions of homeowners. But there is a time when even the best consumer brands must bring a fresh approach to the marketplace. Think Dunkin' or Domino's, Arby's or Old Spice. It is now our time. So let's get specific about what we mean by a brand relaunch.

Speaker 2

First, we are improving our brand positioning strategy. Our consumer research tells us that consumers are failing to understand the value of home warranty bring. As the category leader, we must do a better job of educating homeowners and that is exactly what this brand we launch will accomplish. We will explain what it means to warranty your home in a creative memorable way. 2nd, we are improving how we execute that strategy with an innovative ad campaign, a new tagline, a new logo, as well as a new brand voice and visual identity that will launch in early April.

Speaker 2

3rd, we will drive greater interest through the use of a celebrity spokesperson across our marketing channels. 4th, the relaunch will be supported by a refreshed or user friendly website, which will launch in late March to support the early April media campaign. I am extremely excited about what the relaunch of American Home Shield can do for us. Now turning to Slide 9 and an update on our real estate channel. The National Association of Realtors or NAR reported that existing home sales declined 20% in 2023 to 4,100,000 homes, the lowest level since 1995.

Speaker 2

Mortgage rates increased to an average of 6.8% in 2023, a 22 year high, which impacted consumer affordability. At the same time, inventory still remains tight. NAR reported properties remained on the market for just 36 days in January, which is a slight increase from the 33 days a year ago, but well below normal levels. We sell our products through real estate brokers. And last year, we had significantly fewer opportunities to place our home warranty as part of a home sale because of the challenging housing market.

Speaker 2

In fact, our real estate channel sales in 2023 were less than half of what they were 5 years ago, as the macro factors continue to be a drag on our revenue, profitability and cash flows. As a result of these trends persisting over the last several years, we have taken steps to optimize our real estate channel spend. We have reduced the size of our sales team, worked to optimize agreements with our real estate partners and continue to look at new and creative ways to market our products to drive sales. In short, it's a tough market, but we will be well positioned for when the market improves for our home warranty sales. Looking forward to 2024, there are signs the market will improve.

Speaker 2

NAR is projecting sales to increase to 4,700,000 homes and inventory levels could improve as more sellers enter the market. However, we have not seen any material improvements in our real estate business so far this year and until we see more tangible proof, it will continue to be a drag on our overall sales. Now turning to Slide 10, where we've continued to see impressive improvements in our retention rates over the last few years. By the end of 2023, our retention rate increased to 76.2%. While this includes a lower mix of real estate customers, retention rates definitely exceeded our expectations last year.

Speaker 2

And how we've done this? We've taken the steps to fully understand the customer lifecycle journey and have implemented a wide range of initiatives to improve retention, including better engaging our customers, specifically during the onboarding process, expanding dynamic pricing to minimize churn, continuing to improve the customer experience with a large part of that effort coming from increasing utilization of our preferred contractors. This has the dual benefit of lowering costs while delivering a better experience. In fact, our customer 5 star ratings increased to an all time high in 2023, while our 1 star rating decreased to an all time low. And finally, we have increased the number of customers on autopay to a record 86% in 2023, which makes them much more likely to renew their home warranty.

Speaker 2

We know there's more we can do to improve our customer service and we are diligently working on those initiatives, but I am super proud of our team's accomplishments in this area. Now turning to Slide 11 and our on demand services. We have been making a lot of changes to this part of our business, which is approaching $100,000,000 of revenue. And I want to take a moment to clarify how we think about on demand. We've launched the new Frontdoor brand last year to provide a digital solution to expand our customer base.

Speaker 2

We built an app. We are providing access to video chats with an expert and we have other services such as partner discounts available to our customers through the app. At this point, there are 3 parts to our on demand business upgrades, maintenance services and appliance repair services. Upgrades are currently the largest part of our on demand business. We expanded our HVAC upgrade program last year, which grew to $50,000,000 This year, we are targeting it to grow even more.

Speaker 2

Over time, we intend to further expand upgrades to include hot water heaters and appliances. 2nd is maintenance services. This includes things like HVAC tune ups, dryer vent cleaning and carpet cleaning. Over time, we are looking to expand into additional preventive maintenance offerings. 3rd, appliance repair service that we are offering in a limited number of markets today.

Speaker 2

The plan is to expand into additional geographies, while also looking to broaden our offering into our traditional trades. What I like about the approach we're taking is that we're doing it methodically and with a heavy focus on execution and delivering on near term revenue. Additionally, we are investing in the tech resources and capabilities required to enhance access to these services through the app. In closing, 2023 was a terrific year for us. We took decisive action to improve execution that resulted in record financial performance.

Speaker 2

I will now turn the call over to Jessica to cover our financial results in more detail.

Speaker 3

Thanks, Phil, 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 team and what we have accomplished together since I started 14 months ago. Please turn to Slide 12 and our 4th quarter financial summary.

Speaker 3

4th quarter revenue increased 8% versus the prior year period to $366,000,000 Net income increased 4% to $9,000,000 and adjusted EBITDA increased 35% to $45,000,000 Next, we will move to Slide 13, where gross profit for the quarter increased 22% versus the prior year period to $177,000,000 and our gross margin increased 5 70 basis points to 48%. Let's now move to the adjusted EBITDA bridge on Slide 14. Starting at the top, we had $29,000,000 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 cost decreased $4,000,000 which was better than expected. This includes $10,000,000 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 $19,000,000 change in favorable claims cost development.

Speaker 3

Sales and marketing costs increased $17,000,000 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 $6,000,000 primarily due to increased personnel costs. Please turn to Slide 15, where I'll review highlights from our 2023 financial results. Revenue increased 7% versus the prior year to $1,780,000,000 net income more than doubled to $171,000,000 and adjusted EBITDA increased 62% to a record $346,000,000 Now turning to Slide 16, where gross profit for the year increased 25 percent to $885,000,000 and our gross margin increased 700 basis points versus 2022 to 50%, which is also a 9 year high. Now moving to Slide 17, where we will walk through the decisive actions we took to improve our margins in response to the challenging macroeconomic environment.

Speaker 3

1st, we were aggressive about price in response to rising inflation, which resulted in an 11% increase in realized price in 2023. As a reminder, we typically sell 12 month contracts. So pricing actions take 24 months to fully show up in our financials. It is about 12 months to impact all relevant contracts and then another 12 months for those contracts to fully translate into earned revenue. 2nd, we improved cost control and planning processes.

Speaker 3

3rd, we leveraged our purchasing power with suppliers and contractors. And finally, we implemented a new review process for our highest cost jobs. Let's now move to the adjusted EBITDA bridge on Slide 18. Starting at the top, we had $126,000,000 favorable revenue conversion, driven by an 11% increase in price, partly offset by a 4% decline in volume. Contract claims cost decreased $52,000,000 compared to the full year 2022.

Speaker 3

This improvement was driven by a lower number of service requests per customer, which includes a $30,000,000 impact from favorable weather a $23,000,000 change in claims cost development as we had favorable claims cost development of $11,000,000 in 2023 compared to a $12,000,000 unfavorable claims cost development in 2022, a transition to higher service fees and continued process improvement initiatives. All of that was partially offset by higher costs driven by inflation of 5%. Sales and marketing costs increased $46,000,000 versus full year 2022, primarily related to the Frontdoor brand, as well as investments in the direct to consumer channel to drive sales. Customer service costs decreased $6,000,000 primarily due to a lower number of service requests. General and administrative expense increased $15,000,000 primarily due to increased personnel costs.

Speaker 3

And interest and net investment income increased $13,000,000 as a result of rising interest rates on cash deposits. All of this culminated into a 62% increase in adjusted EBITDA in 2023. Let's now turn to Slide 19 for a review of our statement of cash flows. Net cash provided from operating activities was $202,000,000 for the 12 months ended December 31. Net cash used for investing activities was $32,000,000 and was primarily comprised of capital expenditures related to investments in technology.

Speaker 3

We returned $120,000,000 to our valued investors by repurchasing 3,600,000 shares in 2023 or approximately 4% of our outstanding shares. You will also see that our free cash flow was 1 $170,000,000 for the 12 months ended December 31. We ended the year with $325,000,000 in cash. This was comprised of $157,000,000 of restricted net assets and unrestricted cash of $168,000,000 Now before I get to our outlook, I'd like to review our current capital structure in more detail. We have an extremely strong financial position and a consistent capital allocation framework.

Speaker 3

Our number one priority is to focus on growth and we will continue to prioritize investments that expand revenue, both organic and through opportunistic M and A. Our second objective is to ensure we have a solid financial profile, which includes maintaining appropriate levels of liquidity to run the business and a prudent long term debt structure. We currently have a modest level of debt and we have an extremely strong net leverage ratio of 1.2 times. And finally, our third objective is to return cash to shareholders. As a reminder, we have returned a total of $280,000,000 through share repurchases since we initiated the program in 2021.

Speaker 3

This amounts to 8,100,000 shares or approximately 10% of our outstanding share count. Looking ahead, we are targeting $100,000,000 of repurchases in 2024. Now turning to Slide 21, where I will walk through our Q1 and full year 2024 outlook. We expect our Q1 revenue to be between $370,000,000 $380,000,000 which reflects an upper single digit increase in our renewal revenue, a decline in real estate revenue of approximately 20% to 25%, a roughly 20% decline in our D2C revenue and a $5,000,000 increase in other revenue to $17,000,000 1st quarter adjusted EBITDA is expected to range between $40,000,000 $50,000,000 The decline from the prior year period is driven by an increase in marketing investments to drive DTC sales, which also reflects better pacing of marketing spend throughout the year and will set us up for our brand relaunch in the Q2. I would also like to mention that this outlook does not include a significant impact from weather.

Speaker 3

While we experienced an increase in service requests from the cold weather in January, this was largely offset by favorable weather in February. Before I turn to our full year outlook, I want to take a moment to address the 2025 outlook we provided at our Investor Day last year. At the time, we targeted $300,000,000 of adjusted EBITDA by the end of 2025. We have absolutely exceeded that objective and 2 years earlier than we expected. We also shared a $2,000,000,000 revenue target.

Speaker 3

A lot has changed since then. We provided that outlook at a time when we thought that the real estate channel was going to significantly improve, which has not happened. At this point, we are solely focused on delivering on our 2024 objectives. Once we assess how the AHS brand relaunch goes, as well as how market conditions evolve throughout this year, we will come back to you with an update on our 2025 goals. Now for our 2024 outlook.

Speaker 3

Starting with revenue, where we expect it to range between $1,810,000,000 and $1,840,000,000 This assumes a mid single digit increase in the renewals channel, a 10% decline in the B2C channel and a 15% to 20% decline in the real estate channel. It also assumes other revenue will increase approximately 30% to $100,000,000 primarily driven by sales from our HVAC program. Our revenue guide also assumes a mid single digit increase in realized price, which will be delivered through our dynamic pricing model to minimize churn. Due to the timing of our price increases, we would expect slightly more price at the beginning of the year, which will then taper as the year progresses. To be clear, we priced for a much higher rate of inflation than what we experienced in 2023.

Speaker 3

As a result, our gross margins rebounded back to normalized levels in the upper 40% range. Now that inflation expectations have moderated, we can turn our focus to growing our customer base. This will be offset by a mid single digit decline in realized volume from lower customer counts. As a reminder, our 2023 customer count was down 6%, and we expect this to decline 1% to 3% in 2024 to approximately $1,950,000 As we look at this by channel, we would expect the largest decline to come from Real Estate. Additionally, our renewal channel is expected to slightly fall in 2024 as a result of a decline in our go to market channels flowing through.

Speaker 3

We expect our full year gross profit margin outlook to be between 48.5% 49.5%. It is important to note that we are lapping $30,000,000 of favorable weather in 2023, which amounts to about 200 basis points of margin. It also reflects a slightly higher mix of on demand services. So we are very much viewing this as delivering stable margins in our core business this year. Our guide also assumes that inflation will be in the mid single digits on a net cost per service request basis.

Speaker 3

Additionally, the number of service requests is expected to decline 5% to approximately $3,700,000 which assumes a slightly higher incidence rate across a lower total number of customers. Our full year SG and A target is between $580,000,000 $595,000,000 and includes a shift of marketing investments from the Frontdoor brand to the American Home Shield brand to support the relaunch. In total, we are essentially holding SG and A spend flat as we grow revenue. Based on these inputs, we expect our full year adjusted EBITDA range to be between $350,000,000 $360,000,000 Our full year outlook also includes $11,000,000 of interest income and reflects stock compensation expense of approximately $35,000,000 And finally, we expect our full year capital expenditures to range between $35,000,000 $45,000,000 and the annual effective tax rate to be approximately 25%. Turning to Slide 22.

Speaker 3

Before I close, I want to make a very important point. 2023 was a truly exceptional year, one of outsized financial performance. Adjusted EBITDA was up 62%. And as much as I would love to continue that performance, I don't think that is realistic. Instead, I look to our 2 year adjusted EBITDA CAGR from 2022 through 2024, which is expected to be up nearly 30%.

Speaker 3

That's an impressive return. I will now turn it back over to Bill for closing statements. Bill?

Speaker 2

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. 2nd, we have a great core business that is supported by our recurring revenue model.

Speaker 2

And I believe our American Home Shield brand is at an inflection point for future growth. 3rd, our margins have rebounded and we are looking to deliver a consistent margin profile in 2024. 4th, we generate a significant amount of cash and we use that to aggressively repurchase Pieris. 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.

Speaker 2

We are currently trading at approximately 9 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

Thank First question today comes from Jeff Schmitt with William Blair. Your line is open. Please go ahead.

Speaker 4

Hi, good morning everyone. In the DTC channel, it looks like you're expecting revenues to decline 20% in Q1, I think, and then 10% for 4%. What do you think it will take to turn growth positive there? Is it a pricing issue? Do they need to come down?

Speaker 4

Is it more advertising you think? Or is it just a broader industry issue where you need consumer demand to be stronger?

Speaker 2

Keep going, Jeff. No. You've captured it pretty well. I think the industry is the biggest issue we have had 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 and has had some impact on DTC.

Speaker 2

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. So 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.

Speaker 2

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 it's going to 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 got to prove it as the year goes on.

Speaker 4

Okay, great. And then on the on demand business, what type of profitability do you expect from that kind of over time? I'm sure as 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?

Speaker 2

Yes, I'll take it first and then Jessica, if you want to jump in. 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 revenue 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.

Speaker 2

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 the home warranty margins. I don't know, Jessica, if there's anything else you want to add?

Speaker 3

No, I think you covered it, Bill. It's going to be a mix.

Operator

We now turn to Brian Fitzgerald with Wells Fargo. Your line is open. Please go ahead.

Speaker 5

Thanks, JJ. You talked and thanks for color on the marketing outlook around the DBC business. I wanted to ask, are you seeing anything ex what you're doing kind of indigenously? Are you seeing anything, any changes to note in promotional environment in the quarter in terms of your activity or your competitors' activity? And then comparing your 'twenty four plan to 'twenty three and the relaunch, could you talk a bit about your approach both to marketing and promotion around DTC channel?

Speaker 5

Is the phasing there? Is it going to be centered right around April, maybe very similar to what we saw with the Frontdoor rebrand? Should we see it are you going to pursue that same kind of playbook and phasing around the re launch this year?

Speaker 2

Yes. Okay. So 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.

Speaker 2

And with the we've had to be more aggressive on discounting because of all the pricing actions we took and we've talked about that. With regard to AHS, I think obviously we're pointing out a lot of things to April. But this is and this is different than front door, we're trying to establish a new brand. We're trying to introduce build awareness, etcetera. We have high awareness of American Home Shield.

Speaker 2

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, new logo and refresh 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.

Speaker 3

Yes. And the 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 fund it in the towards the middle and back half of the year. This year you're going to see better pacing in our spend throughout the year.

Speaker 2

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.

Speaker 5

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

Speaker 3

Yes. No, I mean, we landed the year with a really strong retention range, so that we those process improvements continue to play through. We are really better engaging our customers through the onboarding process end to end, as Phil talked about, the work that we did to really understand the full customer service life cycle. 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.

Speaker 5

Okay. Thank you. Appreciate it.

Speaker 2

Thanks, Brian.

Speaker 3

Thanks, Brian.

Operator

We now turn to Ian Zaffino with Oppenheimer. Your line is open. Please go ahead.

Speaker 6

Hi, great. On the SG and A, I was wondering if you could just maybe unpack that a little bit as far as the guidance into 2024. What are the puts and takes here? Because 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?

Speaker 6

Thanks.

Speaker 3

So I think big picture, Ian, remember, we are This year, we are very focused on AHS. That's really a shift between the 2. This year we are very focused on AHS. That's really a shift between the 2. I think the other thing just getting back to Bill's comment on a culture of process improvements.

Speaker 3

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 we're really feeling good about the guide into the year.

Speaker 6

Okay. And then if I could 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 could get it?

Speaker 6

How do we get there? Is it a matter of bringing autopay up to the 90% level? Basically help us understand like where to go and how you get there? Thanks.

Speaker 3

Yes, I

Speaker 2

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 5 stars at the highest, low stars at wind stars at the lowest.

Speaker 2

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 have a lot of people committed to doing that.

Speaker 3

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

Speaker 6

All right, great. Thank you very much.

Speaker 2

Thanks, Ian.

Speaker 3

Thanks, Ian.

Operator

We now turn to Mark Hughes with Truist. Your line is open. Please go ahead.

Speaker 7

Yes, thanks. Good morning. In the real estate channel, it seems like you've been the declines have been shallowing, they're 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 a turn yet, but it seems like the industry data would look a little more upbeat than that.

Speaker 7

So I'm just curious to get your thoughts.

Speaker 2

Yes, let me address that. I think that's a really good call out, Mark. What I was saying in the script was the NOR 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.

Speaker 2

What the point was at this point, 2 months in, we have not seen a material change. And obviously, you saw the industry decline 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. So I think we're encouraged by the NAR data.

Speaker 2

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.

Speaker 7

And then Jessica, you talked about inflation, claims inflation, I think 5% for the full year. It looks like the Q4 underlying claims are pretty good when you back out the change in the claims development. It seems like you even when you adjust for the weather, it seems like it's pretty good. Do you have the 4th quarter specific claims inflation number?

Speaker 3

Yes, it's a 5%.

Speaker 7

It was 5% for the full year? 5%.

Speaker 3

Yes. And we're really looking at it as especially as we're heading into the year feeling that we're moving into normalized inflation there and holding at that mid single digit.

Speaker 7

Yes. If I could just squeeze in one more, your price increase is 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 you have in fact the pricing accelerated. What drove that?

Speaker 3

Yes. 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 to though for those to taper off. But that's still those 2022 actions flowing through just based on the way that those hit earned revenue.

Speaker 7

Yes. Okay. Thank you.

Speaker 6

Thank you, Mark. Thanks, Mark.

Operator

We'll now turn to Sergio Segura with KeyBanc. Your line is open. Please go ahead.

Speaker 8

Great. Thank you and good morning. Congratulations on another strong quarter of gross margin expansion. I did notice that the guide does call for the 2024 guide, it does call for margins 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

Speaker 6

are at?

Speaker 3

Yes. No, I think the big thing there is remember we are lapping $30,000,000 of 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 30,000,000 dollars plus the continued benefits that we are seeing from process improvements across the business.

Speaker 2

Yes. I think, Sergio, I think you make a good point. I thought Jessica answered it completely. It's one of those things where we got a lot I said in my script, notwithstanding the fact that we did 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.

Speaker 2

Look at what happened in January. And as Jessica said, it looks like February has offset that. But that's the kind of thing that as you're forecasting these things, you got to be mindful that anomalies need to be factored out.

Speaker 3

Well, and I just think about our Investor Day last year, I feel like one of the biggest questions are when are we going to get back to fifty-twenty 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.

Speaker 8

Got it. And if I could ask a second one, just wondering what gives you the confidence to reaccelerate customer growth in 'twenty four 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?

Speaker 2

Yes. I mean, I think as Jessica said, if you look at the investment behind American Home Shield, it is up because we invested more in front door last year and took away from AHS. So 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 use, it's we're kind of on a relentless march now.

Speaker 2

The category has been stagnant or down. I think the brand has 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.

Speaker 8

That's helpful. Thank you both Bill and Jessica.

Speaker 3

Thanks. Thanks Sergio.

Operator

Our final question comes from Cory Carpenter with JPMorgan. Your line is open. Please go ahead.

Speaker 6

Good morning.

Speaker 1

I'm hoping you could talk about the

Speaker 6

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 app booking capability and some other stuff, but maybe you should update on where you are with some of those initiatives. Thank you.

Speaker 2

Okay. So from an engagement perspective, the interesting thing about this part of our business is it's a real partnership with our contractors. This is 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 and with real estate. 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.

Speaker 2

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. So that's where we and we're getting better at this. We had a nice kick up in HVAC last year and we've got other things in the to come as I mentioned.

Speaker 2

So I think this is one that is both going to be a combination of consumer engagement and contractor engagement.

Speaker 3

Yes. And then just from what we're expecting for 2024, other revenue is going to be approximately 30% to $100,000,000 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.

Speaker 3

We're learning a lot, but we're also seeing a lot of strength, from the upgrade component of that business.

Speaker 8

Thank you, both.

Speaker 5

Thanks,

Operator

Rory. Ladies and gentlemen, this concludes our Q and A and today's Frontdoor 4th quarter and full year 2023 earnings call. We'd like to thank you for your participation. You may now disconnect your lines.

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Earnings Conference Call
Frontdoor Q4 2023
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