Frontdoor Q1 2024 Earnings Call Transcript

There are 9 speakers on the call.

Operator

Ladies and gentlemen, welcome to Frontdoor's First Quarter 20 24 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.

Operator

Please go ahead, Mr. Davis.

Speaker 1

Thank you, operator. Good morning, everyone, and thank you for joining Frontera's Q1 2024 earnings conference call. Joining me today are Frontera's Chairman and Chief Executive Officer, Bill Tomm 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, 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.

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

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 $378,000,000 Gross margin increased 510 basis points to 51%. Adjusted EBITDA rose 33% to an all time first quarter high of $71,000,000 And as a result of our strong Q1 financial performance, we are increasing our full year 2024 adjusted EBITDA outlook.

Speaker 2

So while we continue to exceed expectations on the margin side, our top priority remains growing our customer base. Let's be clear right upfront, 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 6,000,000 in 2022 to just over 4,000,000 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.

Speaker 2

At the same time, existing home inventory has been extremely tight. This is not only limited 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 still optimistic that the real estate channel will eventually come back, we are waiting to see more tangible proof of the turnarounds.

Speaker 2

Now turning to the direct to consumer channel where we have also seen lower demand. For those of you new to our story, home warranties have historically been sold primarily through the real estate channel. It was only about 25 years ago when we started marketing and selling directly to homeowners. This was a powerful growth engine for us as we saw a strong correlation between marketing spend and our sales. However, about a year after COVID, we began seeing a decline in consumer demand.

Speaker 2

As a recent indicator of this, Google searches for the term home warranty were down 7% this past March. We have known that something needed to change and here are some of the things we learned from really digging into consumer research. 1st, consumers have a hard time understanding home mortgage. They easily confuse it with homeowners insurance or other products. 2nd, consumers want to feel like they've got someone in their corner.

Speaker 2

What really resonated with our focus groups is when we grounded them in the higher level benefits of a home warranty like peace of mind, freedom and happiness. 3rd, we have not done enough to stand out from our competition. The category has been defined by what we call a sea of sameness among providers and we realized we needed to take action to break out from the competition. Additionally, consumer behavior has been impacted by the larger macro environment as a result of rising inflation and higher costs. This has been echoed by several other companies as recently as this morning who have mentioned consumers are pulling back on spending.

Speaker 2

We view this as a temporary reset of consumer spending as consumers have not been prioritizing the budget protection and convenience of home warranties. I will go into how we are addressing this shortly. Now turning to renewals, which continues to be a bright spot for us. For the Q1 of 2024, our retention rate grew to 70 6.3%. While this includes a lower mix of real estate customers, retention continues to perform very well.

Speaker 2

Our team has done a great job of implementing a wide range of initiatives to improve retention such as better engaging our consumers 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 is a dual benefit of lowering costs while delivering a better experience. And finally, we have increased the number of customers on autopay, which remains at a record 86% in the Q1, which makes them much more likely to renew their home warranty. We know there is 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 As you would imagine, most of this came in the 2nd Q3 and we are expecting a similar pattern this year as we head into our peak summer season. In fact, we recently enhanced the Frontdoor app so that all users can now buy a new HVAC system.

Speaker 2

We are also continuing to grow into alternative revenue streams by building out our technology capabilities for additional on demand services. Our vision is to provide a consolidated ecosystem where customers have access to video chats with an expert, which might then turn into purchasing a la carte repair and maintenance services or even new systems and appliances, all through our app. More to come here, but we know that the market opportunity is significant and we will continue to work to find ways to monetize that demand. Let's now turn to Slide 6 and our opportunity. As I said in our last call, there are about 5,000,000 homes in the U.

Speaker 2

S. That have a warranty. We believe that figure could be approximately 3 times higher if consumers better understood the value of a home warranty, which brings us to the American Home Shield brand relaunch, which is a primary component of our strategy to increase demand. And I'm very excited that we successfully kicked off the relaunch in early April. We took a holistic approach to the relaunch which has the following components.

Speaker 2

At the highest level, we wanted to break out from that sea of sameness in the home warranty category and that starts with a new strategy that truly brings a refreshed and high energy look to our brand. We also wanted to connect to new and larger audiences, so we came up with an innovative ad campaign with a new voice and a new brand visual identity. We wanted to have a catchy recognizable tagline and that's why we came up with don't worry, be warranty. This tagline captures that feeling we want homeowners to take away, peace of mind, freedom and happiness. It's proactive and goes right at the main word that defines our services.

Speaker 2

We also needed a new logo so that consumers can better distinguish us from our competition. So we refreshed it with brighter bolder colors and a more modern look. We wanted to use comedy and a strong well known personality to do something different to breakthrough to consumers. That's why we're extremely excited about our new celebrity spokesperson, Warren Tina, starring Rachel Dratch, which we believe will drive greater interest in our products. And finally, we wanted a comprehensive media campaign with new marketing partners as shown on Slide 8.

Speaker 2

This is now a true omni channel campaign that is highly visible. We developed great new partnerships that better reflected our customer base. For example, we launched the campaign on WrestleMania. We were also on CNN's coverage of the solar eclipse in a big way with our website traffic hitting new highs that day. Speaking of the website, I encourage all of you to visit ahs dotcom and hope you notice it not only has an updated look, but it also has a more intuitive interface and navigation tools that will improve conversion.

Speaker 2

In summary, we are truly bringing a refreshed and high energy look to our brand. However, we know we have relaunched our brand in the face of a challenging macro environment for home warranties, but that is the point. As the leader in our category, it is our job to turn demand around and we are optimistic this relaunch will improve the growth trajectory for home warranties for years to come. With this much change, it would be premature to talk results thus far. However, we are excited about what we're seeing in web traffic and in other areas and look forward to providing you more details on our next call.

Speaker 2

Before I turn the call over to Jessica, I want to reiterate that we are off to a great start in 2024 and our Q1 performance continues to show that Frontdoor Inc. Is operating extremely well. Jessica?

Speaker 3

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. 2nd, in response to our strong Q1 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 Q1 2024 financial summary.

Speaker 3

1st quarter revenue increased 3% versus the prior year period to $378,000,000 Net income increased 56% to $34,000,000 and adjusted EBITDA increased 33 percent to $71,000,000 which both represent records for 1st quarter performance. Now moving to Slide 10, where gross profit for the quarter increased 14% versus the prior year period to $195,000,000 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 Q1 adjusted EBITDA. Starting at the top, we had $14,000,000 of favorable revenue conversion driven by an 11% increase in price over the prior year period.

Speaker 3

This was partially offset by an 8% decline in volume, primarily driven by lower sales in our 1st year channels. This also includes a $6,000,000 increase in other revenue due to higher on demand home services, primarily from the new HVAC program. Contract claims costs decreased $10,000,000 which was better than expected. This includes a transition to higher service fees that had 2 impacts. 1st, higher service fees resulted in a lower number of service requests per customer as we typically see a temporary change in customer behavior until they become accustomed to the new fee amounts.

Speaker 3

2nd, higher service fees also resulted in a lower net cost per service request as these fees are a contra cost to claims expense on our income statement. Additionally, our contract claims costs improved over the prior year period in part due to our ongoing process improvement initiatives. This includes improving our planning processes, moving more of our service requests to our preferred contractors, our new high cost claims review program and leveraging our bulk purchasing power. These improvements were partially offset by ongoing inflation as well as a $5,000,000 unfavorable change in claims cost development year over year. Now moving to sales and marketing costs, which increased $7,000,000 over the prior year period, primarily due to better pacing of our marketing investments to drive growth in our direct to consumer channel.

Speaker 3

And finally, general and administrative costs increased $3,000,000 primarily due to increased personnel costs. To sum up our bridge, all of this resulted in adjusted EBITDA increasing $18,000,000 to $71,000,000 With these results, we exceeded the midpoint of our outlook by approximately $25,000,000 and I want to take a moment to provide some context here. First, remember when we provided our outlook. We were working with late February data and assumed normal weather for March. But then March came in much more favorable than anticipated, which was the primary driver of lower incidents or about a $10,000,000 favorable impact compared to our guide.

Speaker 3

As a result, our net cost per service request came in much lower than anticipated in the Q1. With a better than expected incidence rate, we were able to allocate more jobs to our preferred contractor network, which handled 84% of our service requests in the Q1. Additionally, we continue to benefit from our process improvements and rigorous cost management by our Contractor Relations team. We also benefited from some favorable timing around our marketing investment. Let's now turn to Slide 12 for a review of our statement of cash flows.

Speaker 3

Net cash provided from operating activities was $84,000,000 for the 3 months ended March 31 as a result of our exceptionally strong earnings and was comprised of $51,000,000 in earnings adjusted for non cash charges and $34,000,000 in cash provided from working capital that was primarily driven by seasonality. Net cash used for investing activities was $10,000,000 and was primarily comprised of capital expenditures related to investments in technology. Net cash used for financing activities was $21,000,000 and was comprised of $13,000,000 of share repurchases as well as $4,000,000 of scheduled debt payments. We ended the quarter with $378,000,000 in cash. This was comprised of $165,000,000 of restricted cash and $213,000,000 of unrestricted cash.

Speaker 3

We were also extremely pleased with our free cash flow conversion of $73,000,000 for the 3 months ended March 31. The majority of the increase over the prior year period was driven by higher earnings, and I believe this number speaks to the cash generating power of our business. Now turning to Slide 13, where I'll provide an update on our current capital structure. We continue to have an extremely strong financial position and a consistent capital allocation framework. Our number one priority remains to focus on growth, and we continue to prioritize investments that expand units as well as grow revenue and adjusted EBITDA, both organically and through opportunistic M and A.

Speaker 3

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 very modest level of debt and we have a low net leverage ratio of 1.1 times. And finally, our 3rd objective is to return cash to shareholders. Through the end of April, we repurchased $33,000,000 worth of shares, which brings our total to $314,000,000 since we initiated our share repurchase program in 2021. Let me conclude this section by saying that I recognize that our unrestricted cash of over $200,000,000 is above our targeted range of between 100 to $150,000,000 required to run the business.

Speaker 3

This higher cash balance was driven by our better results, coupled with timing and seasonality. This in turn drove our net leverage ratio down to 1.1 times, which is below our targeted net leverage ratio of around 2 to 2.5 times. We are coming off of some very volatile earnings and it was not that long ago that our net leverage ratio was closer to 3 times. I want to ensure that our investors know we do not plan on keeping our unrestricted cash or leverage ratio at the current level. We have a significant amount of financial flexibility and we will continue to follow the capital allocation strategy I just walked through when making decisions about utilizing our cash, which is focused on growth and share repurchases.

Speaker 3

Now turning to Slide 14, where I will walk through our Q2 and full year 2024 outlook. We expect our 2nd quarter revenue to be between $530,000,000 $540,000,000 which reflects a mid single digit increase in our renewals channel, a decline in our real estate channel of approximately 15% to 20%, a roughly 15% decline in our B2C channel, which reflects an expected improvement from our Q1 results and a $10,000,000 increase in other revenue to $34,000,000 2nd quarter adjusted EBITDA is expected to range between $130,000,000 $140,000,000 a 12% increase over the prior year period. Now turning to our full year 2024 outlook, starting with revenue, where we are maintaining a range of $1,810,000,000 to 1.84 $1,000,000,000 This assumes a mid single digit increase in the renewals channel, a 10% decline in the D2C channel and a 15% to 20% decline in the real estate channel. As a reminder, there is a timing difference between the time a sale occurs and reported revenue, which we recognize over 12 months. It also assumes other revenue will increase approximately 30% to $100,000,000 primarily driven by higher on demand revenue, mainly sales from our new HVAC program.

Speaker 3

We continue to expect a mid single digit increase in realized price, which will be offset by a mid single digit decline in realized volume from lower member count. As a reminder, our 2023 home warranty count was down 6%, and we expect this to decline 1% to 3% in 2024 to approximately $1,950,000 We are raising our full year gross profit margin outlook to be approximately 50% as we continue to stabilize margins in our core business. This outlook assumes normal weather as we enter into our peak season when our system is typically more stressed. We are also assuming that inflation will be in the low to mid single digits on a net cost per service request basis and the number of service requests will decline 5% to approximately $3,700,000 We are maintaining our full year SG and A range to be between 580 $1,000,000 $595,000,000 as our 2024 plan includes a previously announced transition of marketing investments from the Frontdoor brand to the American Home Shield brand to support the relaunch. As Bill mentioned earlier, we are very excited about the brand relaunch as we anticipate it will play a critical role in increasing demand and growing revenue for the long term.

Speaker 3

Based on these updated inputs, we are increasing our full year adjusted EBITDA range to be between $360,000,000 $370,000,000 Our full year outlook also includes $13,000,000 of interest income and reflects stock compensation expense of approximately $30,000,000 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%. In conclusion, we are very pleased with our Q1 financial results. We continue to deliver better than expected adjusted EBITDA as a result of the rigorous work the team has done to execute on our margin expansion initiatives, and we remain committed to finding new and innovative ways to continuously improve our business. I will now turn the call back over to Bill for a few closing remarks before we open up the line for questions. Bill?

Speaker 2

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 Q1 performance demonstrates the exceptionally strong earnings power of our platform.

Speaker 2

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 date 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.

Speaker 2

Operator, let's now please open up to the line for questions.

Operator

Our first question go to Geoff Schmidt of William Blair. Jeff, please go ahead. Your line is open.

Speaker 4

Hi, good morning. 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 pricings.

Speaker 2

Yes. I think, Jeff, let me answer your question because I think you've hit on the right points here. Real estate has hurt us, there's no doubt about it. We have been increasing our level of discounting for DTC1. So that is something that is underway and hopefully we're going to realize the benefits of that.

Speaker 2

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 everything 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.

Speaker 4

Okay. And then, yes, I guess on your 20 4 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 a kind of a tougher Q1. So do you have either of those kind of turning growth, turning positive by year end or maybe not quite that far?

Speaker 4

What's the kind of trend there?

Speaker 2

I think trended wise, it continues to get better. I'm not ready to commit to when we turn positive, but that clearly the math would indicate that we're going to start to improve quarter by quarter. And certainly as we head into 2025, I think we feel pretty good about where we're going to be.

Speaker 4

Right. Okay, great. Thank you.

Speaker 2

Thanks, Jeff.

Operator

Thank you. The next question goes to Cory Carpenter of JPMorgan. Cory, please go ahead. Your line is open.

Speaker 5

Thanks. You announced the Frontdoor outreach to $2,000,000 down loan mark a few days ago. Could you just address what's driving the engagement given you did shift 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?

Speaker 5

Thank you.

Speaker 2

Yes. So we've been pleased that I think the front door 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 as a holistic business. We run everything through the Frontdoor model for both our in person services, our new our HVAC upgrades.

Speaker 2

We have the any basic user in the app to be able to get there, get an HVAC upgrade. So it's kind of the way we've evolved the front door model is to really make this the centerpiece of our on demand services. So that's 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.

Speaker 5

Thank you. 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 mid single digit percent cash for the full year. But did you take another round of pricing? Was that above expectations?

Speaker 5

Or could you just talk about how you expect pricing kind of increasing to grow through the year? Thank you.

Speaker 3

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 months to 18 months to flow through. The peak of that was Q4 and Q1. So this is 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.

Speaker 5

Okay. Thank you.

Speaker 3

Thanks, Cory. Great. Thanks, Cory.

Operator

Thank you. The next question goes to Ian Zaffino of Oppenheimer. Ian, please go ahead. Your line is open.

Speaker 6

Hi, great. Thank you very much. I guess two questions. I mean, first one would be on 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?

Speaker 6

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 and 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? Thank you.

Speaker 2

Yes, I'll take the first one and then Jessica you take the first 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.

Speaker 2

The whole industry is down in 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 sameness. 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.

Speaker 2

So I'll turn it over to Jessica for the inflation piece.

Speaker 3

Okay. And thanks, Ann. Remember, as we communicate front door inflation, it is on a net comp for 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.

Speaker 3

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.

Speaker 5

Okay. Thank you very much.

Speaker 3

It's about mid, sorry. Let me just clarify to mid. So we continue to see some improvements there, Ian. Hopefully, that's helpful.

Speaker 5

Yes. Thank you very much.

Speaker 2

Thanks, Liam.

Operator

Thank you. The next question goes to Sergio Segura of KeyBanc. Sergio, please go ahead. Your line is open.

Speaker 5

Thank you. Good morning. Thanks for taking the questions. First, Bill, I was hoping you could just talk about the American Shield brand that 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?

Speaker 2

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 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.

Speaker 2

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 this sea of 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.

Speaker 2

But we're not sitting back and just waiting for, gee, I 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. I'm really 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 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 of new user accounts being tough, we are not sitting idly by and hoping for the best.

Speaker 2

We are working across all elements trying to come up with new initiatives and new way of thinking. And as you can see by our overall 2024 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 at the second half, I think we're going to be have improved numbers and leading into 2025.

Speaker 5

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

Speaker 5

Thanks.

Speaker 3

No. 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.

Speaker 3

I think where we really want to be is at a longer term target of about 2 to 2.5 times on our leverage ratio and really focused on the $100,000,000 to $150,000,000 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 and 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 consent our intention to continue to do that.

Speaker 7

Great. Thank you both.

Operator

Thank you. And our next question goes to Mark Hughes of Truist. Mark, please go ahead. Your line is open.

Speaker 7

Yes. Thank you. Good morning. Hey, Mark. In thinking about the opportunistic morning, the opportunistic M and A, would that typically be bringing new capabilities perhaps or is that are those deals normally to get that policyholder base and so it's more of a call it financial transaction.

Speaker 7

How do you look at that?

Speaker 2

Yes, I think Mark, I think we try to look at it in a holistic manner. So we have a BB 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.

Speaker 7

And 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 pointed out that there's some penetration of that program with some of your contractors, but there's more to do. Do I have that right?

Speaker 7

How do you

Speaker 2

think about that growth? Yes, 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 refrigerant for older equipment obsolete. So people are going to have to upgrade their equipment.

Speaker 2

So that's a macro that's going to help us. 2nd 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 than come then go roll a truck for a couple of $100 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.

Speaker 2

So that's why we're pretty pumped up about this area.

Speaker 3

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 they continue to be really excited about that. So I think it's both the consumer what we're And then

Speaker 7

And then Jessica, the claims development or reserve development, I think it was $1,000,000 tailwind this quarter. Is there anything structurally that you can talk about there? I think that 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. Structurally speaking, is there where do we stand on that?

Speaker 3

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 $24,000,000 and I think we had about 25,000,000 dollars of claim cost development that quarter. And coming down to that one, I think we've gotten off the volatility of that inflation.

Speaker 3

It's really stabilized and narrowed. So that same quarter, we had about 15% or that year of front door inflation, tailing down to flat, I think that really aligns with why you're seeing the tightening up of that claims cost development. And again, remember, our Thank you. Oh, no. There.

Speaker 3

Thank you.

Speaker 7

Okay. Yes. What was the point you were going

Speaker 3

to make there, Jessica? Yes. I was just going to say, I think there's an inflationary 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 again getting to everything firing on all cylinders. It's just a holistic process working together.

Speaker 7

Great. Appreciate that detail. Thank you.

Operator

Thank you. The next question goes to Brian Fitzgerald of Wells Fargo. Brian, please go ahead. Your line is open.

Speaker 8

Thanks. 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

Speaker 2

are you thinking about

Speaker 8

the opportunities to maybe address regional or demographic opportunities that may have been underserved in the past? And then I got one follow-up.

Speaker 2

Yes. I think the core of this is with any 50 year old brand, you've got to revitalize it. And if you but I think brands are extremely resilient. So I think that we've had a really good look at trying to revitalize a brand, have a fire alarm in our building.

Speaker 3

Can I have your attention, please? Can I have your attention, please?

Speaker 2

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 of course, 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.

Speaker 2

The Latino market is one that we're particularly interested in as they become a larger part of homeownership overall. We have a Spanish language website now and that's just some of the elements. That's 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.

Speaker 2

So that is something that we're also trying to drive is a 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.

Speaker 8

Thanks, Bill. 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?

Speaker 2

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 of those elements, We raised the trade service fee really in response to staying current with where contractor costs were. Now as far as how it flows through the P and L, all of that Yes.

Speaker 3

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

Speaker 8

Great. Thanks, Bill. Thanks, Jessica.

Speaker 3

Yes, Bill. Thanks.

Operator

Thank you. We have no further questions. Ladies and gentlemen, thank you again for joining Frontdoor's Q1 2024 Earnings Call. Today's call is now concluded.

Earnings Conference Call
Frontdoor Q1 2024
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