Business Context and Reporting Period
Frontdoor, Inc. filed its Form 10-K for the fiscal year ended December 31, 2019, with quarterly data including the fourth quarter. The company provides home service plans under the American Home Shield, HSA, OneGuard and Landmark brands across all 50 states and the District of Columbia. It serves more than two million customers annually through approximately 17,000 contractor firms.
2019 was the company’s first full fiscal year following the October 1, 2018 spin-off from ServiceMaster. Frontdoor launched its Candu on-demand home services business and acquired Streem, a technology company focused on augmented reality, computer vision and machine learning for home-service diagnostics.
Financial Performance and Liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $1,365 million | $1,258 million | 8% |
| Gross profit | $678 million | $572 million | 18% |
| Net income | $153 million | $125 million | 23% |
| Net income margin | 11.2% | 9.9% | 130 bps |
| Adjusted EBITDA | $303 million | $238 million | 27% |
| Adjusted EBITDA margin | 22.2% | 18.9% | 330 bps |
| Net cash from operating activities | $200 million | $189 million | 6% |
| Free cash flow | $178 million | $163 million | 9% |
| Diluted EPS | $1.80 | $1.47 | 22% |
Fourth-quarter 2019 revenue was $300 million, gross profit was $139 million and net income was $19 million. Results are seasonal, with the second and third quarters producing the largest portions of annual revenue and profit.
- Renewal revenue increased to $926 million from $835 million and represented 68% of total revenue, compared with 66% in 2018.
- Real-estate channel revenue was $263 million, essentially flat year over year; direct-to-consumer revenue increased 7% to $167 million.
- Cost of services rendered was $687 million, broadly flat despite revenue growth. Savings from process improvements and cost reductions, seasonally mild weather and favorable claims development offset inflation and tariff-related repair-cost increases.
- Selling and administrative expenses increased 16% to $392 million, primarily due to higher direct-to-consumer marketing, spin-off-related operating costs, personnel, insurance and incentive compensation expenses.
- Interest expense increased to $62 million from $23 million because of the debt incurred in connection with the spin-off. The effective tax rate was 24.9%, compared with 25.1% in 2018.
- Cash and short-term marketable securities totaled $434 million at year-end, including $428 million of cash and cash equivalents. The company had $250 million of available revolver capacity and no outstanding letters of credit.
- Total debt was approximately $980 million carrying value, consisting principally of a $634 million term loan and $345 million of 6.750% senior notes due 2026. Shareholders’ equity remained negative at $179 million, improving from negative $344 million in 2018.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated through higher renewal revenue, improved price realization and increased direct-to-consumer marketing investment.
- Customer retention remained 75%, while growth in the number of home service plans slowed to 3% from 6%.
- Adjusted EBITDA margin improved materially as claims-cost initiatives and weather benefits more than offset higher marketing and corporate costs.
- Spin-off charges declined to $1 million from $24 million; management does not expect further spin-off charges in 2020. Ongoing spin-off dis-synergies were approximately $4 million in 2019, with normal annualized costs expected to be approximately $8 million.
- Frontdoor acquired Streem on December 4, 2019 for $55 million, consisting of $36 million in cash and $19 million in restricted stock awards. The purchase-price allocation remained subject to finalization at year-end.
- Investing cash outflows increased to $61 million from $10 million, primarily due to $38 million of net cash used for acquisitions. Capital expenditures declined to $22 million from $27 million.
- The company adopted lease accounting under ASC 842 on January 1, 2019, recognizing approximately $24 million of operating lease right-of-use assets and liabilities without a material income-statement or cash-flow impact.
Guidance, Outlook, Commentary, Risks and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management expects 2020 capital expenditures of approximately $30 million to $40 million for recurring needs, information systems and productivity-enhancing technology. The company also stated that it intends to consider debt repurchases, refinancing or other actions to reduce debt or improve leverage and cash flow.
- Management plans to expand Candu beyond select Atlanta-area neighborhoods and into additional skilled trades during 2020, while using Streem technology in both the core and on-demand businesses.
- Landmark and OneGuard operations are expected to be consolidated in the first quarter of 2020; approximately $3 million of additional restructuring charges, primarily lease termination costs, were expected.
- Key operating risks include competition and pricing pressure, dependence on third-party contractors and suppliers, weather-driven claims volatility, inflation and tariffs affecting parts and appliances, labor availability, regulatory compliance, litigation, cybersecurity and technology failures.
- Debt-related risks are significant. Variable-rate borrowings expose the company to higher interest expense, although a $350 million interest-rate swap fixes the applicable base rate at 3.0865% through August 2025. A one-percentage-point rate change would affect annual interest expense by approximately $3 million on the term loan after the swap and approximately $3 million on a fully drawn revolver.
- Regulated subsidiaries had $168 million of net assets subject to restrictions on distributions to the parent. The company depends on subsidiary distributions to fund corporate expenses and debt service.
- Home service plan claims accruals involve substantial actuarial judgment and were identified as a critical audit matter. Legal and regulatory proceedings arise in the ordinary course; management did not expect currently disclosed matters to have a material adverse effect, but outcomes cannot be predicted with certainty.
- The company reported no goodwill or trade-name impairment charges in 2019 and no significant off-balance-sheet arrangements.
- Deloitte & Touche LLP issued unqualified opinions on the financial statements and internal control over financial reporting.
Important Facts for Investors to Verify
- Whether renewal growth and the 75% customer-retention rate remain durable as plan growth slows.
- Whether claims-cost savings persist after the favorable 2019 weather and claims-development effects, particularly if HVAC demand or repair inflation increases.
- Whether Candu and Streem generate material revenue, customer retention or cost benefits relative to their investment and integration costs.
- Progress on reducing approximately $980 million of debt, compliance with leverage covenants and sensitivity to variable interest rates.
- The final purchase-price allocation and any subsequent accounting adjustments for the Streem acquisition.
- Whether the planned Landmark-OneGuard consolidation is completed on schedule and within the expected restructuring-cost range.
- The impact of restricted subsidiary assets, tax matters associated with the spin-off and potential indemnification obligations to ServiceMaster.
- Future effects of contractor availability, supplier concentration, tariffs, cybersecurity events, regulation and extreme weather on margins and cash flow.