Frontdoor, Inc. annual report, FY2021

Business Context and Reporting Period

Frontdoor, Inc. filed its Form 10-K for the fiscal year ended December 31, 2021. The company provides home service plans under the American Home Shield, HSA, OneGuard and Landmark brands, and also operates ProConnect and Streem technology businesses. It had approximately 2.2 million active plans, 17,000 contractor firms and more than four million annual service requests across all 50 states and the District of Columbia.

Revenue was primarily recurring: 69% came from customer renewals, 16% from first-year real estate-channel sales, 13% from direct-to-consumer sales and 3% from other activities.

Financial Performance and Key Metrics

Metric	2021	2020	Change
Revenue	$1.602 billion	$1.474 billion	9%
Gross profit	$784 million	$716 million	10%
Net income	$128 million	$112 million	14%
Diluted EPS	$1.50	$1.31	15%
Adjusted EBITDA	$300 million	$270 million	11%
Adjusted EBITDA margin	18.7%	18.3%	Improved
Net cash from operating activities	$185 million	$207 million	Down $22 million
Free cash flow	$154 million	$175 million	Down $21 million

Gross margin was approximately 49% in both years. The effective tax rate declined to 23.4% from 24.5%. Interest expense declined to $39 million from $57 million, but the company recorded a $31 million loss on extinguishment of debt related primarily to the June 2021 refinancing and redemption of the 2026 Notes.

Revenue by channel included $1.103 billion of renewals, up 9%; $252 million of real estate revenue, down 4%; $201 million of direct-to-consumer revenue, up 10%; and $46 million of other revenue, compared with $16 million in 2020. The customer retention rate declined to 74% from 76%, and active plans declined 2% to 2.21 million from 2.25 million.

Liquidity, Debt and Capital Allocation

Cash and cash equivalents were $262 million at December 31, 2021, compared with $597 million at year-end 2020.
Available liquidity was $336 million, consisting of $88 million of unrestricted cash and $248 million of available revolving-credit capacity. Letters of credit outstanding totaled $2 million.
Total consolidated debt was approximately $625 million carrying value, including $17 million classified as current; estimated fair value was $630 million.
The June 2021 refinancing replaced prior debt with a $260 million Term Loan A, a $380 million Term Loan B and a $250 million revolving facility. Term Loan A and the revolver mature in 2026; Term Loan B matures in 2028.
The company was in compliance with its debt covenants at year-end. Approximately $175 million of subsidiary net assets were subject to regulatory restrictions on distributions.
Frontdoor repurchased 2.6 million shares for $103 million under a three-year, $400 million authorization. It paid no dividends and does not expect to pay dividends in the foreseeable future.
Capital expenditures were $31 million in 2021. Management expected 2022 capital expenditures of approximately $40 million to $50 million, with no other material capital commitments reported.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven by higher renewal revenue, improved price realization and increased direct-to-consumer sales. Real estate revenue declined because tight housing inventory and lower existing-home transactions reduced first-year plan sales.
Cost of services rendered increased 8% to $818 million. Parts and equipment shortages, elevated appliance replacement rates, inflation and higher contractor labor and contractor-supplied equipment costs increased claims pressure.
Selling and administrative expenses increased 9% to $511 million, reflecting higher direct-to-consumer, ProConnect and Streem marketing investment, personnel costs and technology spending.
Operating cash flow and free cash flow declined primarily because deferred revenue fell as real estate-plan volume decreased and customers shifted from annual-pay to monthly-pay arrangements.
Debt was substantially refinanced and reduced, but the transaction generated a $31 million loss on extinguishment, including a $21 million make-whole premium on the 2026 Notes.
Shareholders’ equity improved from a $61 million deficit to a $2 million surplus, primarily due to 2021 net income, partially offset by share repurchases.

Outlook, Management Commentary, Risks and Unusual Items

Management expects continued investment in customer and contractor technology, digital innovation, ProConnect, Streem, dynamic pricing, contractor-network expansion and data capabilities. The filing does not provide a formal revenue or earnings forecast. It does provide expected 2022 capital expenditures of approximately $40 million to $50 million.

COVID-19 continued to affect results through weaker real estate-channel demand, elevated appliance usage and claims, supply-chain disruptions, labor shortages, higher contractor costs and customer-experience pressures. Management expected supply-chain and labor challenges, inflation and elevated service costs to continue affecting retention and profitability, although the overall future pandemic impact remained uncertain.

Weather and seasonality can materially affect claims frequency and margins, particularly through summer HVAC demand. Quarterly results are not necessarily indicative of full-year performance.
The company relies on independent contractors, preferred contractors, business-process outsourcers and a limited number of national suppliers. Service quality, labor availability, parts availability and supplier pricing are key execution risks.
Competition, marketing effectiveness, real estate-market conditions, consumer confidence, inflation, interest rates and tariffs may affect demand and profitability.
Cybersecurity, privacy, technology-system failures and evolving data-protection requirements could cause operational disruption, liability and reputational damage.
Debt remains significant and includes variable-rate exposure. A one-percentage-point interest-rate change was estimated to affect annual interest expense by approximately $3 million on the Term Loan Facility after the swap and by approximately $3 million on the revolver if fully drawn.
The company faces regulatory and legal risks relating to consumer protection, home service plans, telemarketing, privacy, licensing and insurance-related requirements. Management did not expect existing legal proceedings to have a material adverse effect, but noted that outcomes cannot be predicted with certainty.
The home service plan claims accrual was identified as the critical audit matter because it depends on subjective loss-development assumptions, historical claims experience and market conditions.
No goodwill or trade-name impairment charges were recorded in 2021 or 2020. The company reported effective disclosure controls and effective internal control over financial reporting, with an unqualified auditor opinion.

Important Facts for Investors to Verify

Reconcile Adjusted EBITDA of $300 million and free cash flow of $154 million to the applicable GAAP measures and assess the effect of excluded items.
Review the sustainability of the 74% customer-retention rate and the decline in active plans from 2.25 million to 2.21 million.
Evaluate whether claims inflation, appliance replacement rates, contractor costs and parts availability improve or continue to pressure margins.
Assess debt maturities, variable-rate exposure, refinancing terms, covenant headroom and the effect of the LIBOR-to-successor-rate transition.
Consider liquidity available to the parent company versus cash held by regulated subsidiaries subject to distribution restrictions.
Monitor the $400 million share-repurchase authorization against free cash flow, leverage and operating-investment requirements.
Verify execution of the stated 2022 capital-investment plan and whether ProConnect and Streem generate material incremental revenue.
Review regulatory, cybersecurity, privacy, contractor, supplier and tax-indemnification exposures, including potentially uncapped obligations related to the Terminix spin-off.