Business Context and Reporting Period
Frontdoor, Inc. filed its unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The company is a U.S. provider of home service plans operating under the American Home Shield, HSA, OneGuard and Landmark brands, with additional on-demand services through ProConnect and Streem. It serves more than two million customers annually across all 50 states and the District of Columbia.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $440 million | $407 million | $1,151 million | $1,065 million |
| Gross profit | $215 million | $206 million | $579 million | $539 million |
| Gross margin | 49% | 51% | 50% | 51% |
| Net income | $49 million | $61 million | $111 million | $134 million |
| Net margin | 11% | 15% | 10% | 13% |
| Diluted EPS | $0.57 | $0.72 | $1.29 | $1.58 |
| Adjusted EBITDA | $91 million | $106 million | $238 million | $255 million |
| Adjusted EBITDA margin | 21% | 26% | 21% | 24% |
| Operating cash flow | Not separately provided | Not separately provided | $154 million | $154 million |
- Revenue increased 8% in both the quarter and year-to-date period. Renewal revenue grew 9% in the quarter and 10% year to date, while direct-to-consumer revenue grew 13% and 9%, respectively. Real estate revenue declined 2% in the quarter and was flat year to date.
- Cost of services rendered increased 12% in the quarter and 9% year to date, causing gross-margin compression. Contract claims costs rose primarily because of higher appliance and plumbing claims, increased home-system usage during shelter-at-home conditions, appliance availability constraints and inflation.
- Selling and administrative expenses increased 24% in the quarter and 21% year to date, driven principally by targeted direct-to-consumer marketing, customer-service costs, technology investment and higher stock-based compensation.
- Interest expense declined to $14 million in the quarter and $43 million year to date, compared with $16 million and $47 million, respectively, due primarily to lower rates on unhedged variable-rate debt.
- Cash and cash equivalents were $551 million at September 30, 2020, compared with $428 million at December 31, 2019. Marketable securities were less than $1 million at September 30, 2020.
- Total debt was approximately $976 million at September 30, 2020, including a $630 million term loan and $346 million of 2026 senior notes. The company had no revolving-facility borrowings and $250 million of available capacity.
- Available liquidity was $624 million, consisting of $374 million of unrestricted cash and $250 million of revolving borrowing capacity. Approximately $176 million of net assets remained subject to third-party regulatory restrictions.
- Capital expenditures were $26 million year to date versus $15 million in the prior-year period. Management expected full-year 2020 capital expenditures of approximately $35 million to $40 million.
Material Changes Versus the Prior Comparable Period
- Renewal growth and improved pricing drove revenue growth, while COVID-19-related pressure on existing-home sales reduced first-year real estate sales.
- Customer retention improved to 76% from 74%, and growth in home service plans improved to 4% from 3%.
- Profitability declined despite higher revenue: Q3 net income decreased 20%, year-to-date net income decreased 18%, and Adjusted EBITDA decreased 14% and 7%, respectively.
- Gross margin decreased by approximately two percentage points in both comparison periods, and Adjusted EBITDA margin decreased by approximately five and three percentage points, respectively.
- Year-to-date restructuring charges increased to $4 million from less than $1 million, reflecting Landmark-OneGuard consolidation costs and accelerated depreciation of technology systems.
- The company completed a $5 million acquisition in the second quarter to expand its on-demand offering and finalized the purchase-price allocation for the 2019 Streem acquisition. Goodwill increased to $512 million from $501 million.
- Shareholders’ deficit improved to $71 million from $179 million at year-end, principally because of $111 million of year-to-date net income, partly offset by accumulated other comprehensive losses.
Guidance, Outlook, Commentary and Risks
- Management stated that COVID-19 adversely affected second- and third-quarter results and expects continued increases in claims and contact-center wages. The company noted that the effects remain difficult to predict and may carry forward because service plans are annual.
- Management accelerated deployment of Streem’s augmented-reality technology to support remote diagnostics, virtual tours and fewer in-person visits.
- The company reported that its contractor network generally continued operating as an essential service, but appliance and replacement-part availability remained a supply-chain concern.
- Management believed operating cash flow, cash on hand and available revolver capacity would be sufficient to meet obligations for the foreseeable future. The company was in compliance with its debt covenants as of September 30, 2020.
- Key risks include the continuing COVID-19 pandemic, weaker existing-home sales, consumer and employment conditions, contractor and labor availability, appliance and parts costs, competition, regulatory and legal matters, cybersecurity, technology execution, acquisitions, substantial indebtedness, interest rates and restrictions on subsidiary distributions.
- Legal and regulatory matters arise in the ordinary course. Management did not expect them to have a material adverse effect, but acknowledged that unfavorable outcomes could materially affect a particular period.
- The interest-rate swap liability increased to $47 million from $27 million at year-end. Approximately $8 million, net of tax, of unrealized hedging losses in accumulated other comprehensive income was expected to be reclassified into earnings over the following 12 months, although the final amount may differ.
Important Facts for Investors to Verify
- Assess whether renewal growth and the 76% retention rate can offset ongoing weakness in first-year real estate sales.
- Monitor appliance and plumbing claim frequency, contractor costs, supply availability and the resulting effect on gross and Adjusted EBITDA margins.
- Reconcile Adjusted EBITDA to GAAP net income and evaluate the company’s exclusion of restructuring, COVID-19, acquisition and investment-related items.
- Review debt maturities, variable-rate exposure, swap effectiveness, covenant compliance and the availability of unrestricted liquidity.
- Evaluate whether the projected $35 million to $40 million of 2020 capital expenditures and continued technology investments generate expected operating benefits.
- Consider regulatory restrictions that limit distributions from subsidiaries, including approximately $176 million of restricted net assets.
- Track COVID-19 effects on claims, labor costs, marketing efficiency, customer acquisition and future-period revenue from lower real estate sales.