Ladies and gentlemen, welcome to Frontdoor's Third Quarter 2020 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Matt Davis, Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call. At this time, we will begin today's call. Please go ahead, Mr. Davis.

Thank you, operator. Good afternoon, everyone, and thank you for joining Frontdoor's Third Quarter 2020 Earnings Conference Call. Joining me today are Frontdoor's Chief Executive Officer, Rex Tibbens and Frontdoor's Chief Financial Officer, Brian Turcotte. The press release and slide presentation that will be used during today's call can be found on the Investor Relations section of Frontdoor's Web site, which is located@investors.frontdoorhome.com. As stated on Slide 3 of the presentation, I'd like to remind you that this call and webcast may contain forward-looking statements. These statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company's filings with the SEC. Please refer to the Risk Factors section in our filings for a more detailed discussion of our forward-looking statements and the risks and uncertainties related to such statements. All forward-looking statements are made as of today, November 4, and except as required by law, the company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. We will also reference certain non-GAAP financial measures throughout today's call. We have included definitions of these terms and reconciliations of these non-GAAP financial measures to their most comparable GAAP financial measures in our press release and the appendix to the presentation in order to better assist you in understanding our financial performance. I'll now turn the call over to Rex for opening comments. Rex?

Thanks, Matt, and good afternoon, everyone. We recently celebrated our second year as a standalone public company. Since that time, we have made significant strides in reshaping front door. Our transformation is far from over, but I'm extremely pleased with our progress to date. Despite the pandemic, an extremely challenging external environment, the team has continued to deliver by accelerating our revenue growth, expanding dynamic pricing and growing our on-demand business by launching our new Proconnect service offering. Let's now turn to Slide 4 and review our current business progress. Last quarter, we talked about leaning into marketing investments for digital and broadcast media. I'm happy to report that this strategy to accelerate revenue growth is working. We increased our direct-to-consumer unit growth by over 20% in the third quarter. Additionally, our direct-to-consumer revenue growth was firmly in the double digits in the third quarter, and we expect that to continue into 2021. This is a result of the halo effect from our efforts to date, even though we are reducing our fourth quarter marketing investments due to higher media cost from the election. Our real estate channel performed better than we originally expected this quarter, much stronger real estate fundamentals. We are seeing the same drivers as you. Families leaving urban centers to move to the suburbs, low mortgage rates and strong demand for second homes. The National Association of Realtors, or NAR, reported existing home sales increased 13% in the third quarter because of these trends. These factors are driving up prices and resulted in the lowest home inventory on record according to NAR. As a result in the strong sellers market, which has the potential to negatively impact the industry's capture rate for home service plan sales compared to existing home sales. This is because sellers are…

Thank you, Rex, and good afternoon, everyone. Let's now turn to Slide 7, and I'll review our third quarter financial results. Revenue increased 8% versus the prior year period to $440 million, driven by approximately 4 points of both higher price and increased volume. If we look at our home service plan channels, revenue derived from customer renewals was up 9% versus the prior year period due to growth in number of renewed home service plans, driven in part by customer retention improvement initiatives and improved price realization. First year direct-to-consumer revenue was up 13% versus the prior year period, reflecting growth in the number of first year direct-to-consumer home service plan, mostly driven by the increased investments in marketing Rex mentioned as well as improved price realization. And first year real estate revenue was down 2% versus the prior year period, reflecting a decline in the number of first year real estate home service plan. This decline was due in part to the adverse impact COVID-19 had on US existing home sales in the second quarter, partially offset by improved price realization. As Rex mentioned, our real estate channel performed better than we originally expected this quarter on much stronger real estate fundamentals, including a strong rebound in existing home sales compared with a significant decline in the second quarter. As I mentioned last quarter, macroeconomic factors take about 12 months to cycle through our reported results, and this blunts either the positive or negative impact of our first year real estate sales in any quarter. As a result, our reported revenue will somewhat lag any macroeconomic trends. Gross profit increased $9 million or 4% in the third quarter versus the prior year period to $215 million, and our gross profit margin was 49%. Net income was $49 million,…

Thanks, Brian. Operator, let's open the line for questions.

[Operator Instructions] The first question comes from Aaron Kessler from Raymond James.

A couple of questions. Maybe first, just on the ProConnect. It'd be good to get a sense for maybe revenues that you think are -- could be driven from current AHS subscribers versus kind of new business. Also be interested with the kind of main change, maybe potential cost savings as you get more organic traffic, and then just the investments in ProConnect that we should think about for 2020 and 2021 as well.

So for ProConnect, I think one of the major drivers for us for the name change was really to continue to be able to go behind our AHS Web site and be able to leverage our marketing spend. So we think that we have the ability to really drive a lot of organic traffic, such if you consider that the ability to cross sell to 2.2 million customers today and then 30 million visitors. So that's a lot of eyeball, so to speak, that we've already paid for. So that's -- which really why we want to change the name. In terms of how much is organic, how much is through search? But we're going to that detail just yet. But as we laid out in our comments, we do see significant growth for the next three years, which we have laid out.

And just maybe quickly on the service costs. I think last quarter, you talked about pulling forward some of the service costs. Is that still the case potentially or should we think about continued headwinds from higher service costs really until consumer shelter-at-home lasts and kind of post COVID here?

In terms of service costs, certainly, as people continue to shelter at home, if that begins to lift and obviously, that will us tremendous tailwind. But as we talked about earlier, we haven't seen the impact to our dynamic pricing changes. We just recently made the net pricing change for renewals, just two thirds of our business. So we hope that the impact for appliances and plumbing start to wane in early '21, but we're preparing for the impact through our process changes that we laid out earlier in the comments, pricing and then continuing to work with our contractors.

Next question comes from Ralph Schackart from William Blair.

Just wanted to get a sense of sort of linearity or sort of the order of magnitude of service request that you saw during the quarter. Just a sense, are they starting to slow, do they continue to be steady, or are they increasing? Just curious on sort of the pace of that in Q3 and kind of what you've seen so far in Q4.

Certainly, if you think about our business, it's really in a bell curve. Obviously, we're busier in Q2 and Q3. For Q4, the increased service costs are simply because we have higher amount of volume for appliances. But when you look at kind of the overall service request for the business starts to tail off in Q4 but it is higher for appliances. So we're not seeing really a change to other parts of the business. It's just strictly appliances.

And I don't know if you caught the end of my prepared remarks, but I did lay out another $12 million to $14 million of claims cost from appliances and plumbing in Q4, which is the same number from Q3. So you can see it is being fairly linear from the impact from COVID-19 on our claims costs in Q3 and Q4.

One more, if I could. Just switching gears to customer service side, assuming you're just adding incremental call center agents, but perhaps give us some perspective, other initiatives you're taking on here doing COVID. Any thoughts on how this could strengthen the overall customer service experience going forward in that post-COVID environment?

Well, certainly, I guess, the silver lining in a very dark cloud is that COVID-19 actually benefits us, I think, from a long-term perspective that certainly has increased our value proposition and demand for our services, specifically to the services. We've really moved teams around in order to be able to not only answer our phones more quickly, but also -- the big struggle we have is for the OEMs we rely on. It's getting through to their call centers to check the status of appliance replacements. And so I think as we work with those OEMs to lower their call times, we should see the tailwind of that on our side as well. But the team's done a phenomenal job of kind of reshifting a lot of headcount and processes to streamline it for customers. And we're pretty bullish to going into next year, even this quarter, we'll see much better service times and, hopefully, much improved cycle time.

Next question comes from Cory Carpenter from JPMorgan.

Maybe just starting, Rex, with on-demand. I definitely appreciate the commentary around revenue targets for the next few years. Just kind of hoping you could help frame how you're thinking about the level and the types of investments that maybe needed to be made behind that, especially relative to kind of the $15 million to $20 million level this year.

So we're not prepared to give complete guidance for next year in terms of that, but I think you'll find it will be roughly in the same range as this year. I don't see a big incremental increase from a spend perspective. Years two and three, I think we still need to look at but I think next year should be roughly in line with where we are today.

And then just a follow-up, if I can. On customer retention, I think certainly the highest it's been in a really long time. I'm just curious. Are you seeing that coming more from real estate, direct-to-consumer or maybe both? And then could you just expand a bit more on some of the initiatives that have been successful with retention?

I think the biggest help, for us, has been our retention team. So a dedicated retention teams since it’s been a huge cross-functional effort for many quarters now. And I guess a ton of kudos to that team who wakes up every morning kind of thinking about retention and certainly beginning to pay off. So I wouldn't say it's specifically real estate or direct-to-consumer. Keep in mind that the customers after year two renew at the same rate, so they're very focused on having the retention teams very focused on cancellations, and making sure that there's no issues so that we can retain that customer for the following year. And so those process improvements have really been the catalyst for the change in retention.

Next question comes from Ian Zaffino from Oppenheimer.

Can you guys just talk a little bit more about the dynamic pricing, maybe how should it have gotten through? How long will it take to get it all through? And on the back side of this, as people shelter less in place. How do you think about dynamic pricing in that environment and maybe your ability to hold on to some pricing? Thanks.

I'll take that one. For renewals, we've already made the change. The great thing about dynamic pricing is it's just that. It's dynamic. So we were able to make those changes in a matter of days versus months that used to take us. So for two thirds of our revenue, as it begins, as folks begin to renew, they'll see a different price. And keep in mind that it's based on each customer. So some will see less, see more. And in terms of the rollout, direct-to-consumer will be next followed by real estate. The direct to consumer will be in January and hopefully, by February, real estate should follow. So you should see all the price increases starting no later than Q1. But keep in mind, at least for renewals, it's when the customer renews. So it's going to take the full year to kind of get through that. To your second question in terms of what happens in a post-COVID world, I for one, am looking forward to that day. But the great thing about dynamic pricing allows you to flex up or flex down. And so it certainly has the ability to change pricing for all channels again but I think as we've proven, this is a fairly inelastic market. So I think there'll be some opportunity to still capture price but we'll have to kind of see once we get to that time.

The next question comes from Michael Ng from Goldman Sachs.

I was wondering if you could expand a little bit more on your outlook for double digit revenue growth in 2021. What's that really driven by? Is it the mid single digit pricing you spoke about? Is it better retention? Is it the benefit from ProConnect? Just would love to hear about some of the drivers and your confidence level in that acceleration in revenue growth.

We’re confident about the double digit revenue growth from a couple of aspects. One, we think that even though with tight inventory we’ll see at least a modest improvement in real estate next year. We're really bullish on our direct-to-consumer opportunities. We'll continue our work as it relates to retention. The teams aren't finished. As we said before, we're not going to stop until we get to the 80s and then we're going to figure out the next plan after that. So from a core home service plan business perspective, I think we really had the opportunity to fire on all cylinders. You add that to emerging businesses of both ProConnect and Streem and that's what really allows us to deliver that double-digit growth.

And I can appreciate you probably aren't giving detailed guidance for 2021 yet, but should we expect gross margins to normalize next year? Obviously, gross margins this year are a little bit weaker than expected. But as pricing catches up to make up the higher claims costs, should 2021 be more of a normal gross margin year?

Yes, our forecast for this year for full year is between 48% and 49%, as you know, which is not that much lower than our typical 50% target that we've given to the Street for the past two years. So we're not really in a position yet to give you gross margin for 2021 but 48 to 49% to 50% in that range would be probably a realistic estimate for next year.

Next question comes from Matt Gaudioso from Compass Point.

Just a question on marketing spend. Obviously, nice to see the revenue growth acceleration in the channel there. I was wondering if you could touch on. Did this come in line with your expected increase as it related to the higher spend in the channel. Just wondering if it came in line with your targets there. And then how that strategy evolves into 2021 with the real estate strength we're seeing now? I know you mentioned that I think I heard that the SG&A expenses were 325 basis points higher in 2021. Thanks.

For direct-to-consumer actually outperformed our expectations. So we saw 20% plus increase from a units perspective and double digit revenue growth. So we thought it performed very well. I think the team is -- and some other checks and up their sleeve for 2021 but definitely, we'll continue to invest in that channel as it makes sense. In terms of SG&A, I'll turn that over to Brian.

Yes. I think in my comments, I mentioned it was up 325 basis points this year to drive all the initiatives. And that's why you see the double digit revenue growth that we're forecasting for next year, Matt. So it's a good story, and it's a big part of our growth profile going forward. What was your precise question regarding SG&A

The question around SG&A was I thought I heard that it was up 325 basis points for 2021. So got it, that was for 2020.

Next question comes from Youssef Squali from Truist Securities.

And, Rex, it's nice to hear you talk about double digits growth for next year. Quick question on just dynamic pricing. You guys obviously have been talking about enrolled dynamic pricing even before COVID. As you think through kind of how to tweak prices, just based on the inefficiency of the old pricing model versus maybe greater usage and higher risk customers. Are both now part of the algo for dynamic pricing or is it still based on the way you guys were thinking about it pre COVID? And then secondarily, I was wondering if you can maybe just speak to the availability of service providers, maybe percentage of SRs that get service requests that get filled by preferred SPs.

Sure, Youssef. We're excited about that double digit growth as well. I'll take your last question first. We're actually doing very well from a percent-to-preferred perspective. As I mentioned in the prepared comments, we were over 80%, I believe 82% as it comes to appliance. Percent to preferred, I think we're roughly in the same range as it relates to all of our preferred contractors or preferred providers. So I think that's an incredible testimony to the team that even with a higher service request, we're still able to get our most experienced and thankfully, lowest cost contractors out to service those units. As it relates to dynamic pricing, a couple of things to think about. The first journey for dynamic pricing was really just to be able to price on a non-level, almost a subdivision level. We're continuing to -- more for those models into being able to look at things like service history and other factors that will allow us to make the models even better and that's coming in 2021. So our strategy for dynamic pricing hasn't really changed, and that we're still marching to being able to continue to refine the models and be able to adjust different types of data that really allows us to provide a differentiated price for each customer rather than kind of blanket pricing, if you will. So those things will come over the course of next year, but I think that dynamic pricing really allows us to continue to build this very resilient model for us.

And one last question, if I may. On Streem, I think you mentioned Streem as part of what gives you confidence in that double digit growth rate. So you did break out the ProConnect. So I was wondering if you can maybe help us just get a general sense of how -- what kind of revenue could Streem contribute next year. I know it's really early, but since you mentioned it.

Yes. I think majority of the revenue comes from ProConnect. One thing to keep in mind when we bought the company late last year, it was just a hand -- a team of a handful of people and we've since grown the team and have some great marquee accounts, but still early innings in terms of growth. So certainly, I expect to double, if not triple growth, as we move forward but it's on a very small pace. So I think you'll see more of the power of Streem revenue as we get further out in the out-years.

Next question comes from Kevin McVeigh from Credit Suisse.

I wonder, I guess, what drove the decision, particularly given the elevated costs, I don't know, warranty side to step up the sales and marketing, I guess, just within the context of the business overall, I guess. Just any thoughts on that would be helpful.

I think the decision was simple. COVID is not going to last forever. And so we want to make sure that we'll continue to invest in the long game and really invest in the business overall. Last quarter, we saw tremendous opportunity in and broadcast and digital as rates were at historic lows. So why not take advantage of those? We think we can use dynamic pricing to begin to offset some of the cost pressures that we're seeing from COVID-19. And we don't expect COVID-19 to last forever, but say it did, dynamic pricing will allow us to get through that as well. So rather than focus solely on cost and kind of back off, if you will, we saw a great opportunity to lean forward and accelerate our revenue growth and take advantage of some pretty attractive rates from a marketing perspective. So that's really the catalyst for our decision making and I think that it's paid off. And if we hadn't done that, we wouldn't see double digit revenue growth for next year because, again, two thirds of our revenue is renewals. And so the faster we can fill the funnel, the faster you can grow.

And then, I guess, any sense of the cadence on the retention? So the 76 to 80 over time, do we expect that? And then is there any sensitivity to one kind of 100 basis points of retention is to the revenue?

Do you want to take that, Brian?

I'm just going to say, theoretically, a point of retention would add $15 million to $20 million of revenue. But on an annualized basis, it's probably going to be less than that, probably something more in the range of, I don't know, $10 million to $14 million realistically on a point of retention. And Rex, I'll let you take the first part of that question.

So Kevin, as you've seen, we've kind of been on a very early to increase retention requires a lot of process work and, frankly, a lot of data analysis. We're not prepared to give a time line of how we get from 76 to 80 by quarter. But the team continues to wake for every day thinking about how do we change the game here. And we do think the differentiated service offerings that, for example, better utilization of Streem that helps us fix problems faster for customers will always lead to better retention. And so we have other things that we need to work on as a company and those are the things that are going to really allow us to get into the 80s.

Next question comes from Robert Coolbrith from Wells Fargo Securities.

Going back to your comments on the seller's market dynamic that you're seeing in the real estate channel, a few questions there. Could you give us a sort of snapshot on your mix of business going into COVID versus now between seller pays, buyer pays, agent pays? Then secondly, anything incremental you think you can do on agent or by outreach or education that drives category adoption and preference for AHS? And then finally, as you maybe do see more of the business tilt toward buyer pays over time, any thoughts on how that could impact retention in the real estate channel?

So certainly, we've been leaning in more on the buyer side than the seller side for obvious reasons that I talked about. We haven't really broken it out in terms of those specifics and channels. But safe to say that our focus will remain in buyer as inventory remains tight. And in terms of kind of how are we working through that, we've done a lot of work as a real estate team to really lean into all of our providers, as I talked about -- or all of our partners, rather. As I talked about on the last call, I think we are seeing the halo effect of being able to offer extreme, we offer other things to agents when the pandemic began. So we'll be top of mind. We continue to drive kind of joint efforts together across all the top 10 realty firms. So I think that will definitely help us. In California, we've -- beginning to offer natural hazard disclosures, things like that, to help our agents. So a very joint effort with our agent partners but we're hopeful for '21.

Next question comes from Justin Patterson from Keybank.

I'll start with ProConnect. Can you talk about the initial learnings from the first five markets and how you thought about refining the products for these 30 new ones? For example, I do know there were some changes in both the flat fee pricing and the 6-month guarantee.

Justin, great to hear your voice again. Welcome back. Certainly, as you launch new markets, there's always going to be learnings. I think some of the biggest learnings for us we are always tweaking their algorithms around the flat fee pricing. And we'll do that until the dot of time, so to speak. The biggest thing, for us, was really making sure we could get to a marketing CAC that made sense. And this is why we really are leaning into drafting under the AHS umbrella and it's really about distribution. So be able to cross-sell to our 2.2 billion existing customers we had that opportunity. But now the 30 million people who come to our site, that will really give us a lot of opportunity to potentially lower those acquisition costs. So by focusing on those things, we think that -- it's why we're confident we can roll this out to 35 cities and begin to really scale. In terms of your guaranteed question, I think we're always going to be tweaking kind of that piece-of-mind element of convenience, technology savings. And peace of mind, I think is a small tweak but we'll continue to look at those type of things every month as we scale.

And then my next question, kind of uplevel some of that. As we think about on-demand scaling, the great progress you've shown with the renewal rates and then just the refinements of dynamic pricing. How might you invest differently in customer acquisition than you did in the past? Since it seems like a lot of these trends are positive LTV and that, theoretically, you get more aggressive on that customer acquisition side.

So as we look at things in terms of cohorts, we're looking at what channels folks are coming on, and so it does give us an opportunity to market at different rates, so to speak, as it relates to this customer's LTV. So those are all things that we've really hooked out over the last couple of years and we'll continue to refine. But you're right, this gives us an opportunity then to make a very pinpoint decision on how much we're willing to spend to acquire a customer and what markets that may be more advantageous than others. So that's the power of kind of bringing these three things together and not just having a single-focused business. We think that on-demand really gives us an opportunity to market to customer differently as HSP or home service plans allow us to market to on-demand customers as well. So it's a very symbiotic relationship but will definitely change how we think about long-term value per customer.

There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to Rex Tibbens for any closing remarks.

Thank you, operator, and thank you to all of our investors and analysts, who participate on today's call. As I mentioned on our first call, Frontdoor is playing the long game in terms of increasing shareholder value. Our investments to accelerate both near-term and long-term revenue growth are working. We also outlined a solid growth plan for our emerging businesses that will become a much more significant revenue driver for us over the next few years. Finally, I could not be more proud of how the Frontdoor team has continued to navigate the ever changing environment while embracing new challenges. We have a resilient business model and we are becoming a stronger, more nimble organization as a result of the pandemic. Thank you again for your continued interest in Frontdoor, and I look forward to speaking to you all again soon.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.