Frontdoor, Inc. — Form 10-Q Summary
Business context and reporting period
Frontdoor provides annual home service plans covering repair or replacement of major home systems and appliances 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.
This report covers the three and six months ended June 30, 2019, compared primarily with the corresponding 2018 periods. The 2018 comparative financial statements are combined historical results of the separated business formerly owned by ServiceMaster, while 2019 reflects Frontdoor as an independent public company. ServiceMaster completed the spin-off on October 1, 2018 and disposed of its remaining Frontdoor interest on March 27, 2019.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $388 million | $355 million | $658 million | $602 million |
| Gross profit | $205 million | $159 million | $333 million | $272 million |
| Gross margin | 52.8% | 44.8% | 50.6% | 45.2% |
| Net income | $60 million | $45 million | $73 million | $58 million |
| Net margin | 15.5% | 12.7% | 11.1% | 9.6% |
| Adjusted EBITDA | $105 million | $73 million | $149 million | $105 million |
| Adjusted EBITDA margin | 27.1% | 20.6% | 22.6% | 17.4% |
| Operating cash flow | Not separately provided | Not separately provided | $140 million | $122 million |
| Basic and diluted EPS | $0.71 | $0.53 | $0.87 | $0.69 |
At June 30, 2019, cash and cash equivalents were $420 million and short-term marketable securities were $5 million. The company had $250 million of available capacity under its revolving credit facility and no outstanding letters of credit.
Total debt was $982 million on a carrying-value basis, including a $637 million term loan and $345 million of 6.750% senior notes due 2026. Estimated fair value of total debt was $1.019 billion. Current and long-term debt totaled $982 million, compared with $984 million at December 31, 2018.
Total assets were $1.179 billion and total shareholders’ deficit was $278 million at June 30, 2019. Operating lease right-of-use assets and lease liabilities of approximately $24 million were recognized upon adoption of ASC 842.
Material changes versus the prior comparable period
- Revenue increased 9% in both the quarter and six-month period. Renewal revenue increased 12%, supported by growth in the home service plan base and improved price realization. Direct-to-consumer revenue increased 8%, primarily from higher sales following increased marketing investment. Real estate revenue increased approximately 1%.
- Home service plan growth was 4% at June 30, 2019 versus 6% a year earlier, while customer retention remained 75%.
- Cost of services rendered declined 7% in the quarter and 1% year to date despite revenue growth. Contract claims costs benefited from process improvements, cost-reduction initiatives, seasonally mild weather and favorable claims development.
- Underlying repair costs increased by $11 million in the quarter and $15 million year to date, driven by inflation and tariffs, partly offsetting claims-cost improvements.
- Selling and administrative expenses increased 19% in the quarter and 14% year to date, reflecting higher sales and marketing spending, insurance costs, incentive compensation, professional fees, stock-based compensation and post-spin-off operating costs.
- Interest expense increased to $16 million in the quarter and $31 million year to date because of approximately $1 billion of financing completed in connection with the spin-off. Prior-year interest expense was less than $1 million in each comparable period.
- Spin-off charges fell to less than $1 million in the quarter and $1 million year to date, compared with $8 million and $15 million, respectively, in 2018. The company stated that it does not expect additional spin-off charges during the remainder of 2019.
- Operating cash flow increased to $140 million from $122 million year to date. Investing cash use declined to $12 million from $16 million, and financing cash use declined to $4 million from $74 million, principally because 2018 included $67 million of transfers to ServiceMaster.
Guidance, outlook, commentary and risks
Management expects 2019 capital expenditures for recurring needs, information systems and productivity-enhancing technology to be approximately $30 million to $40 million. The filing does not provide revenue or earnings guidance.
Management projects an approximately $3 million increase in spin-off-related dis-synergies in 2019 versus 2018, resulting in annualized incremental operating costs of approximately $7 million that are expected to represent the normal independent-company cost structure.
Management attributed favorable second-quarter claims costs to process improvements, cost reductions and mild weather, but noted continuing pressure from repair-cost inflation and tariffs. The business is seasonal, with higher HVAC-related service activity generally occurring during the summer months.
Key risks include substantial indebtedness and debt-service requirements, variable interest rates, restrictions under credit agreements, regulatory limits on subsidiary distributions, weather and claims volatility, inflation and tariffs, competition, labor and contractor availability, customer retention and acquisition costs, cybersecurity and information-technology disruptions, legal and regulatory actions, adverse economic conditions affecting home sales and consumer spending, and the company’s limited history as an independent entity.
Accruals for home service plan claims rely on actuarial projections and claims experience. Management does not expect pending legal and regulatory matters to have a material adverse effect, but acknowledges that unfavorable outcomes could materially affect a particular reporting period.
Important facts for investors to verify
- Whether claims-cost savings from process improvements and mild weather are sustainable as weather and repair inflation change.
- The effect of approximately $1 billion of debt on future interest expense, free cash flow and covenant compliance.
- Actual 2019 capital expenditures relative to the $30 million to $40 million expectation and the company’s ability to maintain strong operating cash flow.
- Whether home service plan growth, renewal revenue and the 75% customer retention rate support continued revenue growth.
- The impact of increased direct-to-consumer marketing spending on customer acquisition costs and profitability.
- Regulatory restrictions on approximately $203 million of subsidiary net assets and the ability to upstream cash to the parent.
- Potential changes in tariffs, contractor and labor costs, appliance and parts prices, interest rates, and consumer demand.
- The comparability of 2018 results, which include ServiceMaster allocations and do not include Frontdoor’s post-spin-off financing and independent-company cost structure.