FRONTDOOR, INC. The following information should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q, the audited consolidated and combined financial statements and related notes thereto included in our 2019 Form 10-K and with the information under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2019 Form 10-K. The cautionary statements discussed in "Cautionary Statement Concerning Forward-Looking Statements" and elsewhere in this report should be read as applying to all forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this report, particularly in "Cautionary Statement Concerning Forward-Looking Statements" and "Risk Factors" included in Part II, Item 1A of this report.
Overview
Frontdoor is the largest provider of home service plans in theU.S. , as measured by revenue, and operates under theAmerican Home Shield , HSA,OneGuard and Landmark brands. Our home service plans help our customers maintain their homes and protect against costly and unexpected breakdowns of essential home systems and appliances. Our home service plan customers subscribe to an annual service plan agreement that covers the repair or replacement of major components of up to 21 home systems and appliances, including electrical, plumbing, central HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops. In 2019, we launched Candu, our on-demand home services brand, and acquired Streem, a technology startup that uses augmented reality, computer vision and machine learning to help home service professionals more quickly and accurately diagnose breakdowns and complete repairs and to help real estate professionals consult with and provide virtual tours to potential buyers and agents. We serve over two million customers annually across all 50 states and theDistrict of Columbia .
For the three months ended
For the three months endedMarch 31, 2020 , our total operating revenue included 68 percent of revenue derived from existing customer renewals, while 19 percent and 12 percent were derived from new unit sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and one percent was derived from other revenue streams. For the three months endedMarch 31, 2019 , our total operating revenue included 67 percent of revenue derived from existing customer renewals, while 20 percent and 12 percent were derived from new unit sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and one percent was derived from other revenue streams.
Key Factors and Trends Affecting Our Results of Operations
Impact of COVID-19
OnMarch 11, 2020 , the WHO characterized COVID-19 as a pandemic, and onMarch 13, 2020 , theU.S. declared a national emergency concerning the outbreak. The broader implications of COVID-19 on our results of operations and overall financial performance remain uncertain. In response to the pandemic, we took several steps to protect the well-being of our employees, customers and contractors, and we continue to respond to the real-time needs of our business. Specifically, we have: Established a Cross-Functional Business Continuity Team. This core team actively monitors national and local developments and emerging issues, deploys coordinated and strategic real-time responses to address the needs of employees, customers and contractors, and ensures ongoing operational efficiency during this time. Changed How Employees Work. We have fully transitioned all of our contact center agents to work remotely from their homes, ensuring uninterrupted customer service. All other employees, including those at ourMemphis corporate headquarters,Denver technology center,India technology center and the Streem office inPortland , are also working remotely.Increased Customer Communications . Our contractor network has been designated by theU.S. Department of Homeland Security as "Essential Critical Infrastructure Workers " during the COVID-19 response and has consistently been deemed "essential" by state and local governments. As of today, we do not foresee significant disruption to our ability to provide services to our customers. Nevertheless, we are managing customer responses on a case-by-case basis, and actions may vary by location. To address virus-related concerns and ensure that we are handling the most critical service requests first, we have established a special COVID-19 response team, increased customer communication and implemented safety screening protocols during the service initiation and delivery process. 18 -------------------------------------------------------------------------------- Accelerated the Deployment of Streem's Augmented Reality Technology. In order to protect the health and safety of the public, including our customers, contractors and real estate partners, we have accelerated the deployment of Streem's augmented reality remote video technology. Using this innovative solution, we are enabling contractors to engage remotely with customers to reduce the number of required in-person visits and speed the repair process. For real estate professionals, an agent can connect remotely with a home seller, lead a virtual tour and guide the owner to areas that need closer inspection, all while allowing the creation of high definition digital assets that future buyers can view remotely without ever entering the home. Increased Contractor Education and Communication. Because the contractor network provides essential services, it is generally operating normally despite varying state and local conditions. We are leveraging theCenters for Disease Control and Prevention ("CDC") recommendations to increase customer and technician screening for COVID-19 and remain in ongoing communication with contractors to enable them to operate withinCDC guidelines and help ensure the health and safety of their technicians, as well as our customers. To further these efforts, we introduced our Streem technology platform to our contractors at no cost during this time, enabling social distancing for customers and contractors through remote diagnostics and reduced in-person interactions to resolve customers' issues. While our supply chain has not experienced significant disruptions to date, we are closely monitoring the transportation and distribution of parts and replacement units. The COVID-19 situation remains very fluid, and we continue to adjust our response in real time. While we did not experience a material impact on our financial condition and results of operations during the first quarter, it remains difficult to predict how COVID-19 will impact our business through the remainder of the year. We anticipate that theU.S. real estate market and our first-year real estate sales channel will be adversely impacted by the virus.
Macroeconomic Conditions
Macroeconomic conditions that may affect customer spending patterns, and thereby our results of operations, include home sales, consumer confidence and employment rates. We believe our ability to acquire customers through the direct-to-consumer channel helps to mitigate the effect of a downturn in the real estate market, while our nationwide presence limits the risk of poor economic conditions in any particular geography.
Seasonality
Our business is subject to seasonal fluctuations, which drives variations in our revenue, net income and Adjusted EBITDA for interim periods. Seasonal fluctuations are primarily driven by a higher number of central HVAC work orders in the summer months. In 2019, approximately 20 percent, 28 percent, 30 percent and 22 percent of our revenue, approximately 9 percent, 39 percent, 40 percent and 12 percent of our net income, and approximately 14 percent, 35 percent, 35 percent and 16 percent of our Adjusted EBITDA was recognized in the first, second, third and fourth quarters, respectively.
Effect of Weather Conditions
The demand for our services, and our results of operations, are affected by weather conditions. Extreme temperatures can lead to an increase in service requests related to home systems, particularly central HVAC systems, resulting in higher claim frequency and costs and lower profitability. Weather conditions that have a potentially favorable impact to our business include mild winters or summers, which can lead to lower home systems claim frequency. For example, seasonally mild temperatures were a factor throughout 2019, leading to a decrease in contract claims costs. While weather variations as described above may affect our business, major weather events and other Acts of God, such as hurricanes, flooding and tornadoes, typically do not increase our obligations to provide service. As a rule, repairs associated with such isolated events are addressed by homeowners' and other forms of insurance as opposed to home service plans that we offer, and such insurance coverage in fact reduces our obligations to provide service to systems and appliances damaged by insured, catastrophic events.
Tariff and Import/Export Regulations
Changes inU.S. tariff and import/export regulations may impact the costs of home systems, appliances and repair parts. Import duties or restrictions on components and raw materials that are imposed, or the perception that they could occur, may materially and adversely affect our business by increasing our costs. For example, rising costs due to blanket tariffs on imported steel and aluminum could increase the costs of our home systems, appliances and repair parts. 19
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Competition
We compete in the home service plan industry and the broaderU.S. home services market. The home service plan industry is a highly competitive industry. The principal methods of competition, and the areas in which we differentiate ourselves from our competitors, are quality and speed of service, contract offerings, brand awareness and reputation, customer satisfaction, pricing and promotions, contractor network and referrals.
Acquisition Activity
We have a track record of acquiring other businesses and successfully integrating them into our operations, including the acquisition of Streem in 2019. We anticipate that the highly fragmented nature of the home service plan industry will continue to create strategic opportunities for further consolidation, and, with our scale, we believe we will be the acquirer of choice in the industry. In particular, we intend to focus strategically on underserved regions where we can enhance and expand service capabilities. Historically, we have used acquisitions to cost-effectively grow our customer base in high-growth geographies, as well as enhance our technology capabilities, and we intend to continue to do so. We may also explore opportunities to make strategic acquisitions that will expand our service offering in the broader home services segment.
Critical Accounting Policies and Estimates
Our critical accounting policies and estimates are described under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2019 Form 10-K. There have been no material changes to our critical accounting policies for the three months endedMarch 31, 2020 , certain of which are described below.
In accordance with applicable accounting standards, goodwill and indefinite-lived intangible assets are not amortized and are subject to assessment for impairment by applying a fair-value-based test on an annual basis, or more frequently, if circumstances indicate a potential impairment. As ofMarch 31, 2020 , we do not believe there are any circumstances, including those related to COVID-19, that would indicate a potential impairment of our goodwill or indefinite-lived intangible assets. We will continue to monitor the macroeconomic impacts on our business in our ongoing evaluation of potential impairments. Non-GAAP Financial Measures To supplement our results presented in accordance withU.S. GAAP, we have disclosed non-GAAP financial measures of operating results that exclude or adjust certain items. We present within this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section the non-GAAP financial measure of Adjusted EBITDA. See "Results of Operations - Adjusted EBITDA" for a reconciliation of net income to Adjusted EBITDA, as well as "Key Business Metrics - Adjusted EBITDA" for further discussion of Adjusted EBITDA. Management uses Adjusted EBITDA to facilitate operating performance comparisons from period to period. We believe this non-GAAP financial measure provides investors, analysts and other interested parties useful information to evaluate our business performance as it facilitates company-to-company operating performance comparisons. While we believe this non-GAAP financial measure is useful in evaluating our business, it should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance withU.S. GAAP. In addition, this non-GAAP financial measure may not be the same as similarly entitled measures reported by other companies, limiting its usefulness as a comparative measure.
Key Business Metrics
We focus on a variety of indicators and key operating and financial metrics to monitor the financial condition and performance of the continuing operations of our business. These metrics include: ?revenue, ?operating expenses, ?net income, ?earnings per share, ?Adjusted EBITDA, ?Adjusted EBITDA margin,
?net cash provided from operating activities,
?Free Cash Flow,
?growth in number of home service plans, and
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--------------------------------------------------------------------------------?customer retention rate.
Revenue. Home service plan contracts are typically one year in duration. We recognize revenue at the agreed upon contractual amount over time using the input method in proportion to the costs expected to be incurred in performing services under the contracts. Our revenue is primarily a function of the volume and pricing of the services provided to our customers, as well as the mix of services provided. Our revenue volume is impacted by new unit sales, customer retention and acquisitions. We derive substantially all of our revenue from customers in theU.S. Operating Expenses. In addition to changes in our revenue, our operating results are affected by, among other things, the level of our operating expenses. Our operating expenses primarily include contract claims costs and expenses associated with sales and marketing, customer service and general corporate overhead. A number of our operating expenses are subject to inflationary pressures, such as salaries and wages, employee benefits and health care; contractor costs; home systems, appliances and repair costs; tariffs; insurance premiums; and various regulatory compliance costs. Net Income and Earnings Per Share. The presentation of net income and basic and diluted earnings per share provides measures of performance which are useful for investors, analysts and other interested parties in company-to-company operating performance comparisons. Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potentially dilutive shares of common stock been issued. The dilutive effect of stock options, RSUs, performance shares and restricted stock awards are reflected in diluted net income per share by applying the treasury stock method. Adjusted EBITDA and Adjusted EBITDA margin. We evaluate performance and allocate resources based primarily on Adjusted EBITDA, which is a financial measure not calculated in accordance withU.S. GAAP. We define Adjusted EBITDA as net income before: provision for income taxes; interest expense; depreciation and amortization expense; non-cash stock-based compensation expense; restructuring charges; Spin-off charges; secondary offering costs; and other non-operating expenses. We define "Adjusted EBITDA margin" as Adjusted EBITDA divided by revenue. We believe Adjusted EBITDA and Adjusted EBITDA margin are useful for investors, analysts and other interested parties as they facilitate company-to-company operating performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives, Spin-off charges and equity-based, long-term incentive plans.
Net Cash Provided from Operating Activities and Free Cash Flow. We focus on
measures designed to monitor cash flow, including net cash provided from
operating activities and Free Cash Flow, which is a financial measure not
calculated in accordance with
Growth in Number of Home Service Plans and Customer Retention Rate. We report
our growth in number of home service plans and customer retention rate in order
to track the performance of our business. Home service plans represent our
recurring customer base, which includes customers with active contracts for
recurring services. Our customer retention rate is calculated as the ratio of
ending home service plans to the sum of beginning home service plans, new unit
sales and acquired accounts for the applicable period. These measures are
presented on a rolling, 12-month basis in order to avoid seasonal anomalies.
?
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Results of Operations
Three Months Ended Increase
March 31, (Decrease) % of Revenue
(In millions) 2020 2019 2020 vs. 2019 2020 2019
Revenue $ 294 $ 271 8 % 100 % 100 %
Cost of services rendered 147 143 3 50 53
Gross Profit 147 128 15 50 47
Selling and administrative expenses 105 89 18 36 33
Depreciation and amortization expense 8 6 33 3 2
Restructuring charges 3 - * 1 -
Spin-off charges - 1 * - -
Interest expense 15 16 (3) 5 6
Interest and net investment income (2) (1) 27 (1) -
Income before Income Taxes 17 18 (2) 6 7
Provision for income taxes 4 5 (8) 1 2
Net Income $ 13 $ 13 1 % 4 % 5 %
________________________________
* not meaningful
Revenue
We reported revenue of$294 million and$271 million for the three months endedMarch 31, 2020 and 2019, respectively. Revenue by major customer acquisition channel is as follows: Three Months Ended March 31, (In millions) 2020 2019 Increase (Decrease) Renewals$ 200 $ 182 $ 18 10 % Real estate(1) 56 54 1 2 Direct-to-consumer(1) 35 33 2 7 Other 3 1 1 * Total revenue$ 294 $ 271 $ 23 8 %
________________________________
* not meaningful
(1)First-year revenue only.
Revenue increased eight percent for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 2019 , driven by higher renewal revenue due to improved price realization and growth in the number of renewed home service plans, partly as a result of customer retention improvement initiatives. The increase in real estate revenue reflects improved price realization, offset, in part, by a decline in the number of first-year real estate home service plans. The increase in direct-to-consumer revenue reflects growth in the number of first-year direct-to-consumer home service plans, mostly driven by increased investments in marketing, and improved price realization. Growth in number of home service plans and customer retention rate are presented below. As of March 31, 2020 2019 Growth in number of home service plans 3 % 5 % Customer retention rate 75 % 75 % 22
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Cost of Services Rendered
We reported cost of services rendered of$147 million and$143 million for the three months endedMarch 31, 2020 and 2019, respectively. The following table provides a summary of changes in cost of services rendered: (In millions) Three Months EndedMarch 31, 2019 $ 143 Impact of change in revenue 5 Contract claims costs -
Three Months Ended
Excluding the impact of the change in revenue, contract claims costs were relatively flat, primarily due to lower incidence, which was partly driven by a favorable weather impact of approximately$4 million , offset by an increase in the underlying cost of repairs, which was due to normal inflation, offset, in part, by process improvements and cost reduction initiatives.
Selling and Administrative Expenses
We reported selling and administrative expenses of
(In millions) Three Months EndedMarch 31, 2019 $ 89 Sales and marketing costs 7 Customer service costs 4 Stock-based compensation expense 2 Secondary offering costs (1) General and administrative costs 5 Three Months EndedMarch 31, 2020 $ 105
The increase in sales and marketing costs was primarily driven by higher targeted marketing spend to drive sales growth in the direct-to-consumer channel. The increase in customer service costs was primarily driven by investments to enhance customer service. General and administrative costs increased compared to prior year primarily due to higher personnel costs.
Depreciation Expense
Depreciation expense was
Amortization Expense
Amortization expense was
Restructuring Charges
Restructuring charges were
For the three months endedMarch 31, 2020 , restructuring charges comprised$2 million of lease termination costs and$1 million of severance and other non-personnel costs related to the decision to consolidate the operations of Landmark with those ofOneGuard , which was completed during the first quarter of 2020. For the three months endedMarch 31, 2019 , restructuring charges comprised severance costs. Interest Expense
Interest expense was
Interest and Net Investment Income
Interest and net investment income was
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Provision for Income Taxes
The effective tax rate on income was 25.0 percent and 26.9 percent for the three
months ended
Net Income
Net income was
Adjusted EBITDA
Adjusted EBITDA was
(In millions) Three Months EndedMarch 31, 2019 $ 43 Impact of change in revenue 18 Contract claims costs - Sales and marketing costs (7) Customer service costs (4) General and administrative costs (5) Three Months EndedMarch 31, 2020 $ 47 Excluding the impact of the change in revenue, contract claims costs were relatively flat, primarily due to lower incidence, which was partly driven by a favorable weather impact of approximately$4 million , offset by an increase in the underlying cost of repairs, which was due to normal inflation, offset, in part, by process improvements and cost reduction initiatives.
The increase in sales and marketing costs was primarily driven by higher targeted marketing spend to drive sales growth in the direct-to-consumer channel. The increase in customer service costs was primarily driven by investments to enhance customer service. General and administrative costs increased compared to prior year primarily due to higher personnel costs.
A reconciliation of Net Income to Adjusted EBITDA is presented below.
Three Months Ended
March 31,
(In millions) 2020 2019
Net Income $ 13 $ 13
Depreciation and amortization expense 8 6
Restructuring charges 3 -
Spin-off charges - 1
Provision for income taxes 4 5
Non-cash stock-based compensation expense 3 2
Interest expense 15 16
Secondary offering costs - 1
Adjusted EBITDA $ 47 $ 43 Liquidity and Capital Resources
Liquidity
A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement, as well as the Indenture, contain covenants that limit or restrict our ability, including the ability of certain of our subsidiaries, to incur additional indebtedness, repurchase debt, incur liens, sell assets, make certain payments (including dividends) and enter into transactions with affiliates. As ofMarch 31, 2020 , we were in compliance with the covenants under the agreements that were in effect on such date. 24
-------------------------------------------------------------------------------- Cash and short-term marketable securities totaled$484 million and$434 million as ofMarch 31, 2020 andDecember 31, 2019 , respectively. Cash and short-term marketable securities include balances associated with regulatory requirements in our business. See "-Limitations on Distributions and Dividends by Subsidiaries." As ofMarch 31, 2020 andDecember 31, 2019 , the total net assets subject to these third-party restrictions was$169 million and$168 million , respectively. As ofMarch 31, 2020 , there were no letters of credit outstanding and there was$250 million of available borrowing capacity under the Revolving Credit Facility. Available liquidity was$565 million atMarch 31, 2020 , consisting of$315 million of cash not subject to third-party restrictions and$250 million of available borrowing capacity under the Revolving Credit Facility. Our investment portfolio has been invested in high-quality debt securities. We closely monitor the performance of these investments. From time to time, we review the statutory reserve requirements to which our regulated entities are subject and any changes to such requirements. These reviews may result in identifying current reserve levels above or below minimum statutory reserve requirements, in which case we may adjust our reserves. The reviews may also identify opportunities to satisfy certain regulatory reserve requirements through alternate financial vehicles. We may, from time to time, repurchase or otherwise retire or extend our debt and/or take other steps to reduce our debt or otherwise improve our financial position, gross leverage, results of operations or cash flows. These actions may include open market debt repurchases, negotiated repurchases, other retirements of outstanding debt and/or opportunistic refinancing of debt. The amount of debt that may be repurchased or otherwise retired or refinanced, if any, and the price of such repurchases, retirements or refinancings will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations.
Limitations on Distributions and Dividends by Subsidiaries
We depend on our subsidiaries to distribute funds to us so that we may pay obligations and expenses, including satisfying obligations with respect to indebtedness. The ability of our subsidiaries to make distributions and dividends to us depends on their operating results, cash requirements, financial condition and general business conditions, as well as restrictions under the laws of our subsidiaries' jurisdictions. Our subsidiaries are permitted under the terms of the Credit Agreement and other indebtedness to incur additional indebtedness that may restrict or prohibit the making of distributions, the payment of dividends or the making of loans by such subsidiaries to us. Furthermore, there are third-party restrictions on the ability of certain of our subsidiaries to transfer funds to us. These restrictions are related to regulatory requirements. The payments of ordinary and extraordinary dividends by certain of our subsidiaries (through which we conduct our business) are subject to significant regulatory restrictions under the laws and regulations of the states in which they operate. Among other things, such laws and regulations require certain subsidiaries to maintain minimum capital and net worth requirements and may limit the amount of ordinary and extraordinary dividends and other payments that these subsidiaries can pay to us. We expect that such limitations will be in effect for the foreseeable future. InTexas , we are relieved of the obligation to post 75 percent of our otherwise required reserves because we operate a captive insurer approved byTexas regulators in order to satisfy such obligations. None of our subsidiaries are obligated to make funds available to us through the payment of dividends.
Cash Flows
Cash flows from operating, investing and financing activities, as reflected in
the condensed consolidated statements of cash flows included in Part I, Item 1
of this report, are summarized in the following table.
Three Months Ended
March 31,
(In millions) 2020 2019
Net cash provided from (used for):
Operating activities $ 60 $ 52
Investing activities (3) (5)
Financing activities (3) (2)
Cash increase during the period $ 54 $ 45 Operating Activities
Net cash provided from operating activities was$60 million for the three months endedMarch 31, 2020 , compared to$52 million for the three months endedMarch 31, 2019 . 25
-------------------------------------------------------------------------------- Net cash provided from operating activities in 2020 comprised$25 million in earnings adjusted for non-cash charges and a$35 million decrease in cash required for working capital. The decrease in cash required for working capital was driven by growth in our underlying business. Net cash provided from operating activities in 2019 comprised$22 million in earnings adjusted for non-cash charges and a$29 million decrease in cash required for working capital. The decrease in cash required for working capital was driven by growth in our underlying business.
Investing Activities
Net cash used for investing activities was
Capital expenditures increased to$8 million for the three months endedMarch 31, 2020 , compared to$4 million for the three months endedMarch 31, 2019 , and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2020 relating to recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately$30 million to$40 million . We have no additional material capital commitments at this time. Cash flows provided from purchases, sales and maturities of securities, net, for the three months endedMarch 31, 2020 and 2019 were$5 million and$3 million , respectively, and were driven by the maturities of marketable securities. There were no sales of marketable securities in the three months endedMarch 31, 2020 and 2019.
Cash flows used for other investing activities for the three months ended
Financing Activities
Net cash used for financing activities was
Contractual Obligations
Our 2019 Form 10-K includes disclosures of our contractual obligations and
commitments as of
Financial Position
The following discussion describes changes in our financial position from
Cash and cash equivalents increased from prior year levels, primarily due to cash provided from operating activities.
Deferred revenue increased from prior year levels, primarily due to the recognition of a contract liability of$44 million related to the recognition of monthly-pay customer revenue on an other-than-straight-line basis to match the timing of cost recognition. Other long-term liabilities increased from prior year levels, primarily due to the change in the valuation of our interest rate swap. See Note 16 to the condensed consolidated financial statements included in Part I, Item 1 of this report for more information.
Off-Balance Sheet Arrangements
As of
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
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