Frontdoor, Inc. 2019 Q3 Form 10-Q Summary
Business context and reporting period
Frontdoor is a U.S. provider of home service plans operating under the American Home Shield, HSA, OneGuard and Landmark brands. Its plans cover repair or replacement of major household systems and appliances. The filing covers the three and nine months ended September 30, 2019, with comparisons to the corresponding 2018 periods.
Frontdoor completed its spin-off from ServiceMaster on October 1, 2018 and became fully separated from ServiceMaster in March 2019. Accordingly, 2018 results are combined historical results and may not be directly comparable to the company’s post-spin-off operating structure.
Key financial metrics
| Metric | Three months ended Sept. 30, 2019 | Three months ended Sept. 30, 2018 | Nine months ended Sept. 30, 2019 | Nine months ended Sept. 30, 2018 |
|---|---|---|---|---|
| Revenue | $407 million | $377 million | $1,065 million | $979 million |
| Gross profit | $206 million | $176 million | $539 million | $448 million |
| Gross margin | 51% | 47% | 51% | 46% |
| Net income | $61 million | $49 million | $134 million | $108 million |
| Net margin | 15% | 13% | 13% | 11% |
| Adjusted EBITDA | $106 million | $86 million | $255 million | $191 million |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $154 million | $126 million |
| Capital expenditures | Not provided for the quarter | Not provided for the quarter | $15 million | $21 million |
Basic earnings per share was $0.72 for the quarter and $1.59 for the nine-month period, compared with $0.58 and $1.28, respectively, in the prior-year periods. Free cash flow, defined by management as operating cash flow less property additions, was approximately $139 million for the first nine months of 2019 versus $105 million in the prior-year period.
At September 30, 2019, cash and cash equivalents were $425 million, marketable securities were $7 million, and total liquidity including short-term investments was $432 million. The company reported $250 million of available borrowing capacity under its revolving credit facility and no outstanding letters of credit.
Total debt was approximately $981 million at carrying value, consisting primarily of a $650 million term loan facility and $350 million of senior notes, net of issuance costs and discounts. Long-term debt on the balance sheet was $974 million. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Third-quarter revenue increased 8%, while nine-month revenue increased 9%, primarily due to higher renewal revenue, growth in the home service plan base and improved price realization.
- Renewal revenue increased 11% in the quarter and 12% year to date. Direct-to-consumer revenue increased 6% in the quarter and 7% year to date. Real estate revenue declined 2% in the quarter and was flat year to date.
- Gross margin improved by approximately 4 percentage points in the quarter and 5 percentage points year to date. Lower contract claims costs reflected process improvements, cost-reduction initiatives, seasonally mild weather and favorable claims development.
- Claims-cost benefits were partly offset by higher underlying repair costs associated with inflation and tariffs.
- Selling and administrative expenses increased 16% in the quarter and 15% year to date, driven by targeted marketing, higher personnel and incentive compensation costs, insurance costs and post-spin-off expenses.
- Interest expense increased to $16 million in the quarter and $47 million year to date, compared with $7 million in each prior-year comparable period, primarily due to financing transactions completed in connection with the spin-off.
- Spin-off charges declined to less than $1 million in the quarter and $1 million year to date, compared with $8 million and $23 million, respectively, in 2018. No additional spin-off charges were expected for the remainder of 2019.
- Home service plan growth slowed to 3% at September 30, 2019 from 7% a year earlier, and customer retention declined to 74% from 76%.
Guidance, outlook, commentary, risks and unusual items
- Management projected approximately $25 million to $30 million of full-year 2019 capital expenditures for recurring needs, information systems and productivity-enhancing technology.
- Management expected full-year 2019 spin-off-related dis-synergies to increase by approximately $4 million versus 2018, resulting in annualized incremental operating costs of approximately $7 million.
- Management stated that operating cash flow, revolving-credit availability and access to capital markets were expected to provide adequate resources for operating and financing needs, although future access could be affected by credit ratings, capital-market liquidity and economic conditions.
- Seasonality and weather materially affect claims frequency and profitability, particularly through central HVAC service requests. Mild weather benefited 2019 results.
- Key risks include substantial indebtedness and interest-rate exposure, competition, economic conditions affecting home sales and consumer spending, contractor and labor availability, inflation and tariffs affecting repair costs, regulatory and consumer-protection requirements, cybersecurity, litigation, customer retention, marketing effectiveness and the company’s limited history as an independent entity.
- The company uses an interest-rate swap to hedge a portion of variable-rate debt. Approximately $4 million of net-of-tax unrealized hedging losses in accumulated other comprehensive income were expected to be reclassified into earnings over the following 12 months, subject to changes in interest rates.
- Legal and regulatory matters arise in the ordinary course. Management did not expect them to have a material adverse effect, but adverse outcomes could materially affect a particular period.
- Frontdoor adopted the new lease standard on January 1, 2019, recognizing approximately $24 million of operating lease right-of-use assets and liabilities without a cumulative-effect adjustment.
Important facts for investors to verify
- Whether renewal growth and customer retention stabilize after the decline in retention and slower plan growth.
- How much of the improved claims-cost performance reflects sustainable process improvements versus favorable weather and claims development.
- The effect of inflation, tariffs and repair-part costs on future gross margins.
- Debt-service requirements, variable-rate exposure, covenant compliance and available revolver capacity.
- Progress toward the company’s projected 2019 capital expenditures and normalized post-spin-off operating-cost structure.
- The comparability of 2018 results, given ServiceMaster cost allocations and the October 2018 spin-off.
- Whether marketing investments in the direct-to-consumer channel generate sufficient incremental sales and customer retention.