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" as well as those factors discussed in "Risk Factors" included in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 .
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 endedJune 30, 2020 and 2019, we generated revenue, net income and Adjusted EBITDA of$417 million ,$49 million and$100 million , respectively, and$388 million ,$60 million and$105 million , respectively. For the six months endedJune 30, 2020 and 2019, we generated revenue, net income and Adjusted EBITDA of$711 million ,$62 million and$147 million , respectively, and$658 million ,$73 million and$149 million , respectively. For the six months endedJune 30, 2020 , our total operating revenue included 69 percent of revenue derived from existing customer renewals, while 18 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 six months endedJune 30, 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 have taken a number of 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. 19 --------------------------------------------------------------------------------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. 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. Financial Impact to our Business. While we did not experience a material impact on our financial condition and results of operations during the first quarter, during the second quarter of 2020, our financial condition and results of operations were adversely impacted by COVID-19 as follows: ?We experienced a decline in first-year real estate sales attributable, in part, to the adverse impact COVID-19 had onU.S. existing home sales. Due to the annual nature of our service plan agreements, the impact of this decline will carry forward into future periods. ?We experienced an increase in appliance and plumbing claims primarily due to the increased usage of home systems and appliances driven by state and local shelter at home orders and recommendations.
?We increased our marketing spend in the first-year direct-to-consumer channel to help mitigate the decline in first-year real estate sales.
?We incurred incremental wages at our contact centers due to increased demand driven by temporary closures at our offshore business process outsourcers.
?We incurred incremental direct costs in response to COVID-19, which were temporary in nature and primarily related to incremental health and childcare benefits for our employees and hoteling costs related to our offshore business process outsourcers. The COVID-19 situation remains very fluid, and we continue to adjust our response in real time. It remains difficult to predict the overall impact COVID-19 will have on our business through the remainder of the year. We anticipate thatU.S. existing home sales and our first-year real estate sales will continue to be adversely impacted by COVID-19. In addition, we anticipate a continued increase in claims and incremental investments in marketing due to the factors noted above. Macroeconomic Conditions Macroeconomic conditions that may affect customer spending patterns, and thereby our results of operations, include home sales, consumer confidence and employment rates. During the second quarter of 2020, the COVID-19 pandemic increased economic uncertainty in these areas and adversely impactedU.S. existing home sales. We believe our ability to acquire customers through the direct-to-consumer channel helps to mitigate the effects of downturns in the real estate market, while our nationwide presence limits the risk of poor economic conditions in any particular geography. 20
--------------------------------------------------------------------------------
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.
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 six months endedJune 30, 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 ofJune 30, 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. 21
--------------------------------------------------------------------------------
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
?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. 22
--------------------------------------------------------------------------------
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. ? 23
--------------------------------------------------------------------------------
Results of Operations
Three Months EndedJune 30, 2020 Compared to the Three Months EndedJune 30, 2019 Three Months Ended Increase June 30, (Decrease) % of Revenue (In millions) 2020 2019 2020 vs. 2019 2020 2019 Revenue$ 417 $ 388 8 % 100 % 100 % Cost of services rendered 200 183 9 48 47 Gross Profit 218 205 6 52 53 Selling and administrative expenses 125 104 20 30 27 Depreciation and amortization expense 10 6 61 2 2 Restructuring charges 1 - * - - Interest expense 14 16 (10) 3 4 Interest and net investment loss (income) 3 (2) * 1 - Income before Income Taxes 65 81 (19) 16 21 Provision for income taxes 17 20 (17) 4 5 Net Income$ 49 $ 60 (19) % 12 % 16 %
________________________________
* not meaningful
Six Months EndedJune 30, 2020 Compared to the Six Months EndedJune 30, 2019 Six Months Ended Increase June 30, (Decrease) % of Revenue (In millions) 2020 2019 2020 vs. 2019 2020 2019 Revenue$ 711 $ 658 8 % 100 % 100 % Cost of services rendered 347 326 7 49 49 Gross Profit 364 333 9 51 51 Selling and administrative expenses 229 193 19 32 29 Depreciation and amortization expense 18 12 47 2 2 Restructuring charges 4 - * 1 - Spin-off charges - 1 * - - Interest expense 29 31 (7) 4 5 Interest and net investment loss (income) 1 (3) * - - Income before Income Taxes 83 98 (16) 12 15 Provision for income taxes 21 25 (16) 3 4 Net Income$ 62 $ 73 (16) % 9 % 11 %
________________________________
* not meaningful
24
--------------------------------------------------------------------------------
Revenue
We reported revenue of$417 million and$388 million for the three months endedJune 30, 2020 and 2019, respectively, and$711 million and$658 million for the six months endedJune 30, 2020 and 2019, respectively. Revenue by major customer acquisition channel is as follows: Three Months EndedJune 30, 2020 Compared to the Three Months EndedJune 30, 2019 Three Months Ended June 30, (In millions) 2020 2019 Increase (Decrease) Renewals$ 289 $ 263 $ 26 10 % Real estate(1) 74 75 (1) (1) Direct-to-consumer(1) 51 48 4 7 Other 3 2 1 * Total revenue$ 417 $ 388 $ 30 8 %
________________________________
* not meaningful
(1)First-year revenue only.
Revenue increased eight percent for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 , driven by higher renewal revenue due to growth in the number of renewed home service plans, partly as a result of customer retention improvement initiatives, and improved price realization. The decrease in real estate revenue reflects a decline in the number of first-year real estate home service plans, due, in part, to the adverse impact COVID-19 had onU.S. existing home sales, offset, in part, by improved price realization. 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. Six Months EndedJune 30, 2020 Compared to the Six Months EndedJune 30, 2019 Six Months Ended June 30, (In millions) 2020 2019 Increase (Decrease) Renewals$ 489 $ 444 $ 45 10 % Real estate(1) 130 129 - - Direct-to-consumer(1) 87 81 6 7 Other 6 4 2 * Total revenue$ 711 $ 658 $ 53 8 %
________________________________
* not meaningful
(1)First-year revenue only.
Revenue increased eight percent for the six months endedJune 30, 2020 compared to the six months endedJune 30, 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. Real estate revenue was relatively flat, as improved price realization was offset by a decline in the number of first-year real estate home service plans, due, in part, to the adverse impact COVID-19 had onU.S. existing home sales. 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 June 30, 2020 2019 Growth in number of home service plans 3 % 4 % Customer retention rate 75 % 75 % 25
--------------------------------------------------------------------------------
Cost of Services Rendered
We reported cost of services rendered of$200 million and$183 million for the three months endedJune 30, 2020 and 2019, respectively, and$347 million and$326 million for the six months endedJune 30, 2020 and 2019, respectively. The following tables provide a summary of changes in cost of services rendered:
Three Months Ended
(In millions) Three Months EndedJune 30, 2019 $ 183 Impact of change in revenue 5 Contract claims costs 13
Three Months Ended
The increase in contract claims costs reflects higher incidence in the appliance and plumbing trades, which is primarily a result of customers sheltering at home in response to COVID-19, and normal inflation. Contract claims costs also reflects a favorable weather impact of approximately$1 million and process improvement benefits.
Six Months Ended
(In millions) Six Months EndedJune 30, 2019 $ 326 Impact of change in revenue 9 Contract claims 13
Six Months Ended
The increase in contract claims costs reflects higher incidence in the second quarter of 2020 in the appliance and plumbing trades, which is primarily a result of customers sheltering at home in response to COVID-19, and normal inflation. Contract claims costs also reflects a favorable weather impact of approximately$5 million , process improvement benefits and lower incidence in the heating trade in the first quarter of 2020.
Selling and Administrative Expenses
We reported selling and administrative expenses of$125 million and$104 million for the three months endedJune 30, 2020 and 2019, respectively, and$229 million and$193 million for the six months endedJune 30, 2020 and 2019, respectively. For the three months endedJune 30, 2020 and 2019, selling and administrative expenses comprised sales, marketing and customer service costs of$90 million and$74 million , respectively, and general and administrative expenses of$35 million and$30 million , respectively. For the six months endedJune 30, 2020 and 2019, selling and administrative expenses comprised sales, marketing and customer service costs of$164 million and$138 million , respectively, and general and administrative expenses of$65 million and$55 million , respectively. The following tables provide a summary of changes in selling and administrative expenses:
Three Months Ended
(In millions) Three Months EndedJune 30, 2019 $ 104 Sales and marketing costs 14 Customer service costs 2 Stock-based compensation expense 2 General and administrative costs 3 Three Months EndedJune 30, 2020 $ 125
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 investments in technology and
incremental direct costs related to COVID-19 of
26
--------------------------------------------------------------------------------
Six Months Ended
(In millions) Six Months EndedJune 30, 2019 $ 193 Sales and marketing costs 20 Customer service costs 6 Stock-based compensation 4 Secondary offering costs (2) General and administrative costs 8 Six Months EndedJune 30, 2020 $ 229
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,
investments in technology and incremental direct costs related to COVID-19 of
Depreciation Expense Depreciation expense was$5 million and$4 million for the three months endedJune 30, 2020 and 2019, respectively, and$10 million and$9 million for the six months endedJune 30, 2020 and 2019, respectively.
Amortization Expense
Amortization expense was$4 million and$1 million for the three months endedJune 30, 2020 and 2019, respectively, and$7 million and$3 million for the six months endedJune 30, 2020 and 2019, respectively. For the three and six months endedJune 30, 2020 , the increase was primarily due to amortization of intangible assets recognized from our acquisition of Streem.
Restructuring Charges
Restructuring charges were$1 million and less than$1 million for the three months endedJune 30, 2020 and 2019, respectively, and$4 million and less than$1 million for the six months endedJune 30, 2020 and 2019, respectively.
For the three months ended
For the six months endedJune 30, 2020 , restructuring charges comprised$2 million of lease termination costs and$1 million of severance and other costs related to the decision to consolidate the operations of Landmark with those ofOneGuard , which was completed during the first quarter of 2020, as well as$1 million of accelerated depreciation of certain technology systems. For the six months endedJune 30, 2019 , restructuring charges comprised severance costs.
Interest Expense
Interest expense was$14 million and$16 million for the three months endedJune 30, 2020 and 2019, respectively, and$29 million and$31 million for the six months endedJune 30, 2020 and 2019, respectively.
Interest and Net Investment Loss (Income)
Interest and net investment loss (income) reflects a loss of$3 million for the three months endedJune 30, 2020 and income of$2 million for the three months endedJune 30, 2019 and a loss of$1 million for the six months endedJune 30, 2020 and income of$3 million for the six months endedJune 30, 2019 . For the three and six months endedJune 30, 2020 , amounts primarily comprised a$3 million loss on investment, offset, in part, by interest on our investment portfolio. For the three and six months endedJune 30, 2019 , amounts primarily comprised interest on our investment portfolio.
Provision for Income Taxes
The effective tax rate on income was 25.5 percent and 25.1 percent for the three months endedJune 30, 2020 and 2019, respectively, and 25.4 percent for each of the six months endedJune 30, 2020 and 2019. 27
--------------------------------------------------------------------------------
Net Income
Net income was$49 million and$60 million for the three months endedJune 30, 2020 and 2019, respectively, and$62 million and$73 million for the six months endedJune 30, 2020 and 2019, respectively. For the three and six months endedJune 30, 2020 compared to 2019, the decrease was driven by the aforementioned operating results, offset, in part, by a decrease in the provision for income taxes as a result of lower income before income taxes.
Adjusted EBITDA
Adjusted EBITDA was$100 million and$105 million for the three months endedJune 30, 2020 and 2019, respectively, and$147 million and$149 million for the six months endedJune 30, 2020 and 2019, respectively. The following tables provide a summary of changes in our Adjusted EBITDA:
Three Months Ended
(In millions) Three Months EndedJune 30, 2019 $ 105 Impact of change in revenue 25 Contract claims costs (13) Sales and marketing costs (14) Customer service costs (2) General and administrative costs (1) Other (1)
Three Months Ended
The increase in contract claims costs reflects higher incidence in the appliance and plumbing trades, which is primarily a result of customers sheltering at home in response to COVID-19, and normal inflation. Contract claims costs also reflects a favorable weather impact of approximately$1 million and process improvement benefits.
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 investments in technology. Other primarily consists of interest and net investment income.
Six Months Ended
(In millions) Six Months EndedJune 30, 2019 $ 149 Impact of change in revenue 44 Contract claims (13) Sales and marketing costs (20) Customer service costs (6) General and administrative costs (6) Six Months EndedJune 30, 2020 $ 147 The increase in contract claims costs reflects higher incidence in the second quarter of 2020 in the appliance and plumbing trades, which is primarily a result of customers sheltering at home in response to COVID-19, and normal inflation. Contract claims costs also reflects a favorable weather impact of approximately$5 million , process improvement benefits and lower incidence in the heating trade in the first quarter of 2020.
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 and investments in technology.
28
--------------------------------------------------------------------------------
A reconciliation of Net Income to Adjusted EBITDA is presented below.
Three Months Ended Six Months Ended June 30, June 30, (In millions) 2020 2019 2020 2019 Net Income $ 49$ 60 $ 62 $ 73 Depreciation and amortization expense 10 6 18 12 Restructuring charges 1 - 4 - Spin-off charges - - - 1 Provision for income taxes 17 20 21 25 Non-cash stock-based compensation expense 5 3 8 4 Interest expense 14 16 29 31 Secondary offering costs - - - 2 Other non-operating expenses(1) 5 - 5 - Adjusted EBITDA$ 100 $ 105 $ 147 $ 149
________________________________
(1)Other non-operating expenses for the three and six months endedJune 30, 2020 includes (a) a loss on investment of$3 million , (b) incremental direct costs related to COVID-19 of$1 million , which were temporary in nature and primarily related to incremental health and childcare benefits for our employees and hoteling costs related to our offshore business process outsourcers and (c) acquisition-related transaction costs of less than$1 million .
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 ofJune 30, 2020 , we were in compliance with the covenants under the agreements that were in effect on such date. We do not believe that COVID-19 will affect our ongoing ability to meet the covenants in our debt instruments, including our Credit Agreement and Indenture. Cash and short-term marketable securities totaled$548 million and$434 million as ofJune 30, 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 ofJune 30, 2020 andDecember 31, 2019 , the total net assets subject to these third-party restrictions was$176 million and$168 million , respectively. As ofJune 30, 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$622 million atJune 30, 2020 , consisting of$372 million of cash not subject to third-party restrictions and$250 million of available borrowing capacity under the Revolving Credit Facility. We currently believe that cash generated by operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility atJune 30, 2020 will provide us with sufficient liquidity to meet our obligations for the foreseeable future. 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. 29
--------------------------------------------------------------------------------
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. Six Months Ended June 30, (In millions) 2020 2019 Net cash provided from (used for): Operating activities$ 140 $ 140 Investing activities (19) (12) Financing activities (4) (4)
Cash increase during the period
Operating Activities
Net cash provided from operating activities was
Net cash provided from operating activities in 2020 comprised$94 million in earnings adjusted for non-cash charges and a$46 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$93 million in earnings adjusted for non-cash charges and a$47 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$18 million for the six months endedJune 30, 2020 , compared to$10 million for the six months endedJune 30, 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 six months endedJune 30, 2020 and 2019 were$5 million and$4 million , respectively, and were driven by the maturities of marketable securities. There were no sales of marketable securities in the six months endedJune 30, 2020 and 2019. 30
-------------------------------------------------------------------------------- Cash payments for business acquisitions, net of cash acquired, were$5 million for the six months endedJune 30, 2020 , compared to$3 million for the six months endedJune 30, 2019 , and represent ongoing strategic investments in our business. The business acquisition in the six months endedJune 30, 2020 was made to expand the Candu on-demand offering.
Cash flows used for other investing activities for the six months ended
Financing Activities
Net cash used for financing activities was$4 million for each of the six months endedJune 30, 2020 and 2019 and primarily consisted of payments on debt and finance lease obligations. Contractual Obligations
Our 2019 Form 10-K includes disclosures of our contractual obligations and
commitments as of
As ofJune 30, 2020 , we have entered into additional leases as a lessee for real estate that have not yet commenced. Rent payments are expected to commence during the second half of 2020 and first half of 2021, with lease terms between three and seven years. These leases will result in future non-cancelable operating lease payments of$2 million in 2021 and$9 million in the years thereafter (2022-2028).
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.
Accounts payable increased from prior year levels, reflecting the timing of payments due to the seasonality of our business.
Home service plan claims increased from prior year levels, primarily due to the seasonality of contract claims, which increased amounts due to contractors and suppliers. Other accrued liabilities and other long-term liabilities each 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.
31
--------------------------------------------------------------------------------
© Edgar Online, source