Frontdoor, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
Frontdoor is the largest U.S. provider of home service plans by revenue, operating under the American Home Shield, HSA, OneGuard and Landmark brands. It serves more than two million customers across all 50 states and the District of Columbia. The filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.
The October 2018 spin-off from ServiceMaster affects comparability: pre-spin-off periods are combined financial statements with allocations of certain ServiceMaster costs, while post-spin-off periods reflect Frontdoor as an independent company. ServiceMaster fully transferred its remaining Frontdoor shares on March 27, 2019.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $271 million | $247 million | 10% |
| Gross profit | $128 million | $113 million | 13% |
| Gross margin | 47% | 46% | Up approximately 150 bps |
| Net income | $13 million | $13 million | Flat |
| Net margin | 5% | 5% | Lower on a calculated basis |
| Diluted EPS | $0.15 | $0.16 | Down $0.01 |
| Adjusted EBITDA | $43 million | $32 million | Up $11 million |
| Operating cash flow | $52 million | $49 million | Up $3 million |
| Free cash flow | Approximately $48 million | Approximately $44 million | Improved |
Revenue growth was led by renewals, which increased 13% to $182 million. Real estate revenue increased 1% to $54 million, direct-to-consumer revenue increased 8% to $33 million, and other revenue was $1 million. Home service plan growth was 5% versus 6% in the prior-year period, while customer retention remained 75%.
Cost of services rendered increased 7% to $143 million, below the rate of revenue growth. Lower contract claims costs, favorable weather and operational efficiencies more than offset higher underlying repair costs. Selling and administrative expenses increased 9% to $89 million, reflecting targeted sales and marketing spending, professional fees, technology costs, incentive compensation and $2 million of spin-off-related dis-synergies.
Adjusted EBITDA increased to $43 million, or approximately 16% of revenue, from $32 million, or approximately 13% of revenue. Reported operating results included $16 million of interest expense in 2019 versus less than $1 million in 2018, primarily due to approximately $1 billion of financing completed in connection with the spin-off.
Cash and cash equivalents were $341 million at March 31, 2019, and marketable securities were $7 million, for total cash and short-term securities of $348 million. The company had $250 million of available capacity under its revolving credit facility and no outstanding letters of credit.
Total debt was approximately $983 million, including a $650 million term loan facility and $350 million of 6.750% senior notes due 2026, net of issuance costs and discounts. Long-term debt reported on the balance sheet was $976 million. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Revenue increased 10%, primarily from renewal growth, improved price realization and higher direct-to-consumer sales.
- Gross margin improved as claims costs declined, partly due to milder winter weather and operating efficiencies.
- Net income was unchanged because higher gross profit and Adjusted EBITDA were substantially offset by increased interest expense, higher depreciation and amortization, and higher standalone operating costs.
- Spin-off charges declined to $1 million from $7 million; management does not expect additional spin-off charges during the remainder of 2019.
- Restructuring charges were less than $1 million in 2019 versus $2 million in 2018.
- Operating lease right-of-use assets and lease liabilities were recognized under ASC 842, increasing the balance sheet by approximately $24 million at adoption without affecting earnings or cash flow.
- Accumulated other comprehensive loss increased by $5 million due to an unrealized after-tax loss on an interest-rate swap.
- Operating cash flow increased, while financing cash outflows declined substantially because the prior-year period included $37 million of net transfers to ServiceMaster.
Guidance, outlook, risks and unusual items
Management expects approximately $7 million of annualized operating costs associated with spin-off dis-synergies, including an approximately $3 million increase versus 2018. Capital expenditures for full-year 2019 are expected to be approximately $30 million to $40 million, including recurring needs and investments in information systems and productivity-enhancing technology.
Management believes operating cash flow, revolving-credit availability and access to capital markets will provide adequate liquidity. However, substantial indebtedness creates significant debt-service requirements, and debt agreements restrict additional borrowing, asset sales, dividends and certain other transactions. Regulatory requirements restrict distributions from certain subsidiaries; approximately $197 million of net assets were subject to such restrictions at March 31, 2019.
Key risks include competition, economic conditions affecting home sales and consumer spending, weather-driven claims volatility, contractor and labor availability, repair and parts inflation, tariffs, interest rates, cybersecurity, regulatory compliance, litigation, customer retention, marketing effectiveness, dependence on real estate relationships, impairment risk, tax obligations related to the spin-off and the company’s limited history as an independent public company.
Claims liabilities are based on actuarial estimates and are generally settled within six months. Management does not expect currently pending legal matters to have a material adverse effect, although unfavorable outcomes could materially affect a future period. The company reported no significant off-balance-sheet arrangements, and disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether renewal growth and 75% customer retention support sustained 5% or higher plan growth.
- Whether favorable weather-related claims trends persist and how repair-cost inflation affects margins.
- The effect of approximately $1 billion of debt and variable-rate exposure on future interest expense and cash flow.
- Progress toward the expected $7 million annualized spin-off dis-synergy cost base and the absence of further spin-off charges.
- Whether full-year capital expenditures remain within the $30 million to $40 million expectation.
- Availability of cash held by regulated subsidiaries and the practical ability to upstream funds.
- The impact of ServiceMaster-related accounting allocations on comparisons with 2018 and on the company’s normalized standalone cost structure.