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spk05: Ladies and gentlemen, welcome to Front Door's third quarter 2021 earnings call. Today's call is being recorded and being broadcasted 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'll begin today's call. Please go ahead, Mr. Davis.
spk12: Thank you, Operator. Good afternoon, everyone, and thank you for joining Front Door's third quarter 2021 earnings conference call. Joining me today are Front Door's Chief Executive Officer, Rex Tibbins, and Front Door'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 Front Door's website, which is located at investors.frontdoorhome.com. As stated on slide two 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 materially differ from those discussed here today. These risk factors are explained in detail in the company's filings with the FDC. Please refer to the risk factor 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, October 28th, 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 the 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.
spk09: Rex? Thanks, Matt, and good afternoon, everyone. In the third quarter, Front Door delivered strong financial results. Other speaks to the progress our organization has made. There's still much more we are doing to build a strong foundation for the future. Starting on slide four, since the onset as a public company, Front Door's vision is to redefine the home services space and become a top provider of residential repair and maintenance solutions, and this vision remains as strong as ever. We believe the total addressable market for U.S. home services is approximately $400 billion, and no one company has yet to provide an ideal homeowner experience. We believe that Front Door is well-positioned to become the industry leader over time. Home repair represents about 25% of the addressable home services market, and it's the most challenging segment to operate in as the customer already has something broken, and that's where we have mainly operated over our 50-year history. Looking ahead, the long-term roadmap includes expansion into home maintenance services and eventually home improvement as a way to appeal to a broader customer base. We are doing this by transforming the way we evolve the customer experience from a difficult manual process to a seamless and digital best-in-class experience that homeowners will love. Our long-term vision remains the same, to provide excellent service and take the hassle out of homeownership. While the pandemic has presented a number of challenges to us, our contractors, our vendors, and our customers, we still have made significant progress over the last few years. However, we're not satisfied at the pace of change and need to accelerate the advancement of our technology initiatives as fast as possible. I'll speak more about that in a moment. our first priority is to pivot and narrow our near-term focus on improving the customer experience for core home service plan customers we'll do this by providing digital self-service options and prioritizing a mobile first strategy this includes developing an application or app to better interact with our customers which we are targeting to launch next year we already offer a self-service option through our mobile web customer portal but we'll further enhance this functionality for our app additionally We will also further leverage the synergies and functionality of Stream, our proprietary remote video communications platform, and ProConnect, our on-demand service, across our core business to improve the overall experience. We see a future of a digital-first approach to customer problem-solving through Stream, as well as providing more maintenance services through ProConnect for a more holistic approach to solving everyday hassles of homeownership. Providing home service plans represents the vast majority of our business today, and our success is due to offering a dual-value proposition of providing critical budget protection from unplanned out-of-pocket expenses and the convenience of using our qualified network of providers to complete the appliance or system repair. That's why it's critical we improve the customer experience to achieve our long-term objectives in the larger home services space. By making it easier and seamless for customers and contractors to do business with us, We will improve the customer and contractor retention, drive revenue growth, improve service efficiency, and move further toward a best-in-class offering. We're also expanding into the larger home services market through our on-demand offering, ProConnect, and believe we are well-positioned to emerge as a leader in home services space over time. One of the main reasons I joined Front Door was the appealing proposition of transitioning an established nationwide network of contractors focused on home service plans to support an on-demand offering And that is still the case today. We remain on track to deliver over $20 million of on-demand revenue in 2021 as we have expanded the depth of our services in the market. Looking forward, we expect Proconnex growth to continue to be strong. However, it may be somewhat slower than the outlook I shared with you late last year. A lot has changed over the last year and a half or so. Building a new business takes time and investment, and we are now moving forward with an intentional balance between cost and growth, especially during this period of continued uncertainty. We've had several learnings during the first year of operating ProConnect, and I firmly believe in the symbiotic relationship between our home service plan and on-demand businesses. While we have been driving higher demand through ProConnect's standalone digital marketing efforts, there's still more we need to do to enhance our overall standalone digital sales process. We also would like to create more job leads through our existing and prospective home service plan customer base. We're seeing mid-single-digit repeat business within the ProConnect customer base that is primarily driven by our appliance trades. Our plumbing electric trade expansions took longer to ramp, but we are now beginning to perform. We are continuing to apply these and other learnings, and we'll adjust our go-to-market strategy to obtain optimized results. As a result, we are now targeting ProConnex revenue to be more than double in 2022 from the $20 million target in 2021, and we will provide further updates on our outlook in February. That's turning to slide five in a discussion of the historically challenging market dynamics impacting our real estate channel. Similar to past quarters, the National Association of Realtors, or NAR, reported a tight existing home sales market with homes remaining on the market for only 17 days and overall inventory levels at a near record low of 2.4 months. Additionally, you can see that NAR reported a significant rebound in existing home sales late last year that contributed to the tight market conditions. In this seller's market, we expect it will continue to be difficult to sell a home service plan as part of a real estate transaction for the next several quarters as this tight market does not show signs of loosening anytime soon. Data from the home service plan industry is limited, but we are confident that most of the decline in our unit sales is due to the unprecedented market dynamics and that similar challenges are being faced by many of our competitors. We also believe that this decline is transitory and that we will see improvements after the housing market reverts to more of a normal supply-demand balance. Now turning to the business update on slide six. Let me start by saying that we continue to look for opportunities to mitigate the impact of the seller's market and reinvigorate our revenue growth within our real estate channel. As I mentioned on our last call, we are responding in three ways. First, our DTC channel launched a marketing campaign that is specifically crafted for targeting recent homebuyers. While we are seeing early success from this program, it is very new and will take time to grow. We have a new real estate channel campaign that is aimed at reinforcing the value proposition of home service plans with both real estate agents and home buyers. We're also continuing to focus on top brokers and agents to drive growth across our top national accounts. And third, we are focused on expanding our strategic partnership opportunities beyond our current real estate brokerage agreements. Further diversifying our partnership and distribution channels will open new channels for growth, as well as help mitigate swings in the real estate market. we remain focused on doing just that by expanding and growing into new segments over the next several years. While we expected first-year real estate channel to decline in the third quarter, we also faced some headwinds in the direct consumer or B2C channel and in renewals. Let me provide details in each of these areas. After a very strong performance in 2020, we've had some challenges in our B2C channel this year as a result of a number of changing dynamics. The good news is that we believe most of these challenges are largely behind us, that we will regain our momentum over the next few quarters. Let me provide some additional context on the challenges we faced. The primary drivers were lower than expected customer demand and higher than expected advertising costs driven by competition for advertising inventory. For example, we saw a nearly 20% decline in internet search demand for the home service plan category in the third quarter of 2021 compared to the prior year period as customers emerged from lockdown and drove lower TV viewership and less digital search. You'll recall that we saw strong marketing efficiency last year as our value proposition resonated extremely well with customers sheltering at home and advertising rates were very favorable. The transition to the current environment has been more challenging than expected with our B2C broadcast rate increasing more than 50% during the second and third quarters of 2021 compared with prior year period on a like-for-like basis. This was much more than we anticipated as demand rebounded back from the pandemic-driven lows we saw late last year. In response, we have diversified our demand mix, pivoted to find new sources of demand, and re-evaluated our conversion funnel to improve the sales process. This includes moving to new digital sources and implementing an expanded broadcast strategy. We believe these changes will return customer demand for our products to levels we originally projected. Second, we launched our good, better, best product lineup. However, our sales teams took longer than expected to ramp and become proficient at selling our higher-priced but higher-value new products to customers. We quickly responded and improved how our sales team positioned our new products through better training and technology. We've already seen improvements to expected performance levels from earlier in the year. And third, the transition of technology from our legacy e-commerce platform to a more modern architecture took longer than expected. While we intended to drive better lead conversion, the initial transition did not optimize our search traffic as well as we would have expected. In response, we've improved our e-commerce platform through additional A-B testing and optimization to help drive the higher conversion for customers navigating our website. Finally, the team understands DGC is our biggest lever for new unit growth, and we simply must execute our plan more quickly and flawlessly going forward. This is a channel that can return to double-digit revenue growth next year, but again, it'll take a few quarters for our volume improvements to show up in reported revenue. The good news is that we will see more price and mix driving strong revenue growth as unit volume recovers to more normalized levels. We remain laser-focused on improving our customer retention rate. However, our customer retention rate rounded down to 74% in the third quarter. While the decline is mostly due to a drop in new customers, specifically in our real estate channel, it is also being impacted by our dynamic pricing model, continued challenges across the global supply chain, and the overall customer experience.
spk06: As I mentioned before, we are constantly adjusting our dynamic pricing model to to ingest new information and adjust customer pricing.
spk09: One of these changes was to intentionally increase prices for our highest usage customers. While our prices continue to be inelastic, we saw more cancels than expected from those higher usage customers that received the highest price increases. This has impacted our revenue, retention rate, and customer growth. However, the intentional pruning of our lowest gross margin customers was a contributor to our strong financial performance this quarter, which Brian will review in a moment. While this action may have increased growth profit in the short term, we have since taken a long options as a result of a challenging global supply chain, which continues to add friction to the overall customer experience. We are seeing the greatest impact on our appliance trade and with certain HVAC parts. While we are seeing some improvement in parts equipment availability over the last month, we are still not back to pre-pandemic levels. Global supply chains continue to be very fragile, with great uncertainty around transportation, labor, and ship availability for at least the next 6 to 12 months. Our team continues to do a great job of mitigating the impact as much as they can, but we expect cost inflation and parts and equipment availability challenges to impact our cost and customer experience heading into next year. While I'm disappointed we couldn't continue the momentum we generated in increasing the customer retention rate that we began last year, I remain positive that we are doing the right things to improve it going forward. As I mentioned earlier, our number one near-term objective is to improve the customer experience. Our new chief digital officer, Tony Bacos, and his team are extremely focused on improving the customer experience and have developed a set of digital-first tenets to help guide our near-term technology efforts. Customer expectations and comfort using digital tools are increasing. In short, anything our customers can do over the phone, they should be able to do using a mobile app, mobile web, or desktop experience.
spk06: We are committed to providing customers with digital self- service options, with mobile being a priority.
spk09: We've made significant progress on certain aspects of the experience, such as our appliance and contractor portals, but we intend to do more to transform the entire experience into a digital one. We want this to evolve quickly, and the team is focused on reducing friction points across our system and increasing digital and mobile interactions with our customers over the course of the next 12 to 18 months. While we have faced some near-term challenges, our long-term vision remains as strong as ever. We are still delivering strong profitability and growth despite unprecedented real estate market conditions, a difficult supply chain, and ongoing challenges from the pandemic that will last to 2022. We'll continue to look for opportunities to grow faster while transforming our service experience into a digital one. We are playing the long game and we are focused on strengthening our foundation to deliver strong and consistent growth in the future. I'll now turn the call over to Brian. Brian?
spk13: Thanks, Rex, and good afternoon. Let's now turn to slide seven. and I'll review our third quarter 2021 financial results. Revenue increased 7% versus the prior year period at $471 million, primarily driven by higher pricing in our home service plans and strong year-over-year growth from both ProConnect and Stream. Higher price accounted for 5% of our revenue growth, while volume accounted for 2% of our growth, primarily from ProConnect and Stream, as the number of home service plan customers remained relatively flat versus the prior year period, as volume gains and renewals were offset by challenges in the first-year real estate channel. Looking at our home service plan channels, revenue derived from customer renewals is in growth in the number of renewed home service plans. First-year real estate revenue was down 5% versus the prior year period, primarily due to a decline in the number of home service plans in this channel as a result of the tight existing home sales market partly offset by improved price realization. Direct-to-consumer or D2C channel revenue is up 7%, which is the prior year period, primarily due to improved price realization, driven by both our new product mix and normal rate increases. As a reminder, our new good, better, best product mix in the D2C channel was launched earlier this year and consists of the silver, gold, and platinum offerings. These are higher priced, but more inclusive coverage products compared to our previous offerings, we believe that will drive greater customer satisfaction and higher retention. Revenue reported in our other channel increased $6 million over the prior year period, primarily due to continued growth at ProConnect and Stream. ProConnect revenue was $4 million and Stream's revenue was $3 million in the third quarter. September year date, ProConnect revenue was $14 million, and streams revenue to generate more than $20 million in 2021, and plans to more than double that amount of revenue in 2022.
spk06: In the third quarter versus the prior year period, to $254 million.
spk13: Approximately 500 basis points higher than the prior year period, and our highest gross profit margin over 15 years. One of the primary drivers of this improvement is the favorability of contract claims costs over the prior year period, primarily due to a lower number of service requests across all trades and the continued flow-through of process improvement benefits. Some of these benefits include dynamic pricing, improved contractor deployment, technology enhancements in our service software, and cross-functional
spk06: the third quarter. Adjusted net income increased 55% from the prior year period to $78 million.
spk13: Adjusted EBITDA was $122 million in the third quarter, or 34% higher than the prior year period. This exceeded our guidance range by more than $20 million as a result of improved gross profit margin, as well as better than expected results from our cost management initiatives. Let's move to the table on slide eight, and I'll walk through the adjusted EBITDA bridge from third quarter 2020 to third quarter 2021. Starting at the top, we had $24 million in favorable revenue conversion in the third quarter versus the prior year period. As a reminder, revenue conversion includes the impact of the change in the number of home service plans, as well as the impact of year-over-year price changes. The impact of the change in the number of home service plans considers the associated revenue on those plans less an estimate of contract claims cost based on margin experience in the prior year period. Contract claims costs flipped in the third quarter to a favorable variance of $16 million versus the prior year period that excluded the impact of the change from higher revenue. As a reminder,
spk06: Contract claims costs include the impact of changes in the number of service requests and cost inflation.
spk13: As I mentioned, the favorability of contract claims costs over the prior year period was primarily due to a lower number of service requests across all trades and process improvement benefits. We're lapping the higher-than-normal COVID-19-related contract claims in the third quarter of 2020 and also have lower HVAC service requests due to milder temperatures across Texas and the Southeast. These benefits were partly offset by higher cost inflation, including unfavorable cost trends due to industry-wide parts and equipment availability challenges. In regard to weather, during the third quarter, we noted the U.S. was approximately 3% cooler than the prior year period, and we benefited in key HVAC markets, as I just mentioned. We estimated sales and marketing costs of $370 million in the third quarter versus the prior year period, and primarily included investments in the DTC channels. On our previous earnings call, we told you we anticipated spending $13 million more this quarter versus the prior year period. But due to the transition in our marketing tactics, we pulled back on our spending and shifted more in the fourth quarter to ensure a more efficient deployment of our resources. Customer service costs decreased $1 million in the third quarter versus the prior year period due to a lower number of service requests and challenges in hiring and retaining customer service staff. And finally, General and administrative costs increased $3 million in the third quarter versus the prior year period due to higher personnel costs and investments in technology. Please now turn to slide nine for a view of our cash flow and cash position for third quarter 2021 compared to the prior year period. Net cash provided from operating activities was $142 million. The nine months ended September 30, 2021. It was comprised of $207 million in earnings adjusted for non-cash charges offset in part by $65 million in cash use for working capital. Cash use for working capital was driven by normal seasonality and the impacts on deferred revenue related to a decline in the number of first-year real estate home service plans and a higher proportion of monthly paid customers. As a reminder, in the real estate channel, we typically collect the annual value of the home service plan up front through the closing process when the home is sold, and these funds are reported as deferred revenue on the balance sheet until recognized. The decline in first-year real estate plans is the primary driver for a lower deferred revenue balance. Net cash used for investing activities was $23 million and was primarily comprised of technology-related capital expenditures, $3 million, reflecting debt reduction and refinancing in the first half of the year and share of purchases in the third quarter. As we announced in September, our Board of Directors approved a three-year, $400 million share of purchase program
spk06: and we would purchase $25 million worth of stock during the third quarter.
spk13: The cash flow, calculated as net cash provided from operating activities minus property additions, was $119 million for the nine months ended September 30, 2021, compared to $127 million for the prior year period. We ended the third quarter of 2021 with $309 million in total cash. which included restricted net assets of $178 million and unrestricted cash of $131 million. Our unrestricted cash, combined with $248 million of available capacity under our revolving credit facility, provides us with a solid available liquidity position of $379 million. As we continue to generate robust free cash flow, we're targeting a full-year 2021 adjusted EBITDA conversion to free cash flow of approximately 55%, or a range of $170 million to $175 million. Going forward, our capital allocation strategy remains the same. First, we'll invest for growth, which includes organic investments and acquisitions. We're focused on finding the right balance of organic investment to drive both higher revenue growth and consistently strong margins. In terms of acquisitions, we continue to evaluate opportunities in the larger home services space, as well as in technology to either drive the demand side or the supply side of our business. Our second objective is to provide a prudent debt structure for the long term, and we achieved our objective with the debt repayment and refinancing completed in June. The benefits of this refinancing show up on our balance sheet and on the interest expense line, which is half of the prior year level. Our third capital allocation objective is to return cash to you, our valued shareholders. With the refinancing completed, our capital allocation strategy progressed to the point where we instituted the aforementioned share of purchase program in September. It's our intention to return the majority of our excess cash to shareholders in the near term, but we would pause that program for an acquisition or other considerations detailed in our public finals. And I'll conclude my prepared remarks with our fourth quarter and full year 2021 financial outlook on slide 10 and our current single-digit growth in our D2C and remittal channels, along with an approximate 20% decrease in our real estate channels. I'll also mention that the fourth quarter is typically the lightest quarter of the year in terms of revenue as a result of the seasonal adjustments to revenue related to claims cost pacing. Fourth quarter adjusted EBITDA is expected to range between $40 million and $45 million. During the full year of 2021, Revenue is projected to be within a range of $1.59 billion to $1.6 billion and implies a yearly revenue growth rate of approximately 8% in line with our historical growth rates as a standalone company. Our full year 2021 gross profit margin is expected to increase to approximately 50%.
spk06: Expect the favorable trends I previously discussed to continue
spk13: of the year we're targeting full year 2021 sgma to be approximately 520 million dollars 5 million to 15 million dollars lower than the outlook range we provided last quarter due in part to better cost management i'll also note for those of you who've had a bridge from 2021 sgma to our adjusted ebitda outlook that we expect non-cash stock-based compensation to increase approximately $8 million in 2021 versus the prior year. Additionally, our SG&A projection includes approximately $30 million of combined operating expense for ProConnect and Stream as we invest to ramp their size and scale heading into 2022. We've increased our full-year 2021 adjusted EBITDA outlook to be between $310 million $315 million, a $20 million to $25 million increase from the midpoint of our previous annual guidance range due to continued gross profit margin favorability in our cost management activities. The updated range also implies an impressive increase of 15% to 17% compared to our full year 2020 adjusted EBITDA total of $270 million. Based on our current view of the four-year 2022 revenue outlook, we believe a high single-digit revenue growth rate is achievable. This is a similar growth rate to both 2020 and 2021.
spk06: It considers the continued unprecedented market challenges in the real estate channel
spk13: and lower than expected unit growth throughout 2021 and the corresponding recognition of revenue over a 12-month period. In terms of our full-year 2022 gross profit margin outlook, while we believe we'll continue to see the benefits from dynamic pricing, the process improvements continuing into next year, we're trying to balance inflationary cost pressures that appear to be increasing as we exit 2021, particularly around raw materials, transportation, and labor. In addition, we'll need to estimate the number of service requests for 2022 based on history and recent trends. An example of inflationary cost pressures include water heater OEMs announcing six separate price increases over the course of 2021 due to rising steel prices. As I've mentioned on previous calls, Our strategic sourcing team has done a tremendous job mitigating inflationary pressures for parts and equipment throughout the pandemic and look forward to providing our detailed outlook on our fourth quarter and full year 2021 earnings call in February.
spk06: In conclusion, we're tackling the challenges that will make us a better company in the long run and are delivering strong cash flows that we're now returning to shareholders.
spk13: We have a lot of opportunities ahead of us, and I remain optimistic that we will achieve great things in the years to come. With that, I'll turn the call back over to Matt to open the question and answer session. Matt?
spk12: Thanks, Brian. As a reminder, during the question and answer session, we encourage you to ask any questions that you may have, but please note that guidance is limited to the outlook we've provided. Operator, let's open the line for questions.
spk05: Thank you. If you would like to ask a question, please press star followed by one on your telephone keypads now. We have the first question on the phone lines today from Jeff Schmidt of William Blair. So, Jeff, please go ahead. I've opened your line.
spk11: Hi. Good afternoon. Question on ProConnect. It sounds like it's on track to hit the $20 million of revenue this year. I think you previously said that would be, you know, kind of 80,000 service requests at a cost of 250 per request. I was curious if it's tracking to that, and then, you know, you assume you think revenue will double next year. Like, how does that unit cost? Does the cost per request go up in your assumptions, I guess, as you kind of roll out higher costs?
spk09: Yeah, thanks for your question, Jeff. I don't believe we ever said $250 per request, maybe backed into that number, but certainly 80,000 service requests for this year. In terms of next year, we're certainly targeting doubling revenue. It really comes down to the mix. So that's why I'm a little hesitant to back into the $250 number because We plan on expanding our trades with appliance and electric plumbing, HVAC, and so that number will be, I think, somewhat fluid based on the type of work we do. We also plan on expanding our maintenance services of HVAC tune-ups, upgrades, that type of thing. So it's going to really be dependent on the mix. I think it would be hard to give a concrete dollar amount for each service request.
spk11: Okay. And then the investments in ProConnect and Stream, just to scale them, I think you mentioned it would be around $30 million of SG&A. Is that all going to hit this year, or I guess how much are you expecting? Is that going to be the majority of the cost, or should we expect more next year to scale those?
spk09: Well, the numbers that Brian indicated earlier are for this year. Certainly, as we move into next year, I think... you know, the majority of the costs will be around marketing. So, you know, I think that we need to look at a couple different things. One is, you know, certainly we'll continue to, you know, use search and digital for ProConnect. I think there's also a great opportunity to cross-sell to our visiting AHS customers, which is, you know, certainly a great way to lower our, you know, our acquisition costs. And then, you know, I'd also look at, you know, we're really trying to drive more major services as well, which will also lower our CAC. And then the last thing I would point out is, which I made my prepared remarks, is that, you know, at least in the appliance trade, we're seeing mid-single-digit repeat business. And that's one of the key indicators, I think, one, for success in the program, but two, uh to also lower our overall marking cost and so that will help us uh scale going uh going into 2022. okay um great thank you for the color thank you thank you we now have a question on the line from corey carpenter of jp morgan so corey your line is open
spk04: Great. Thanks for the questions. I had two, just one on claims. Clearly, I know they came in lower than you were expecting, but just curious, are those basically back to pre-pandemic levels today or maybe even below pre-pandemic levels? And what expectations are you assuming for that next year? And then on ProConnect, Rex, maybe could you just provide a little more detail around kind of why you made the decision here to balance more profit in growth next year? Any more color you could provide there would be helpful. Thanks.
spk09: Sure, Corey. I'll start with ProConnect, and then I'll hand over to Brian to talk about kind of overall gross margin or cost. As I said in my prepared remarks, I think we're growing well. As you recall, we're in 35 cities. Our plumbing and electric trade expansions took a little longer to ramp than we anticipated, but we're continuing to apply these and our other learnings to our go-to-market strategy. And so what we don't want to do is kind of overheat the market from a marketing perspective if we're not ready from an expansion perspective. So that's what we mean by kind of balancing the market, if you will. And then as we consider expanding into our current base, you know, kind of the cross-sell initiatives, we want to make sure we have enough offerings in terms of, you know, maintenance services for our customers as well. So I think everything is kind of, you know, is growing well. We just want to make sure that we have enough selection for customers to drive that repeat business that I talked about earlier. Brian, do you want to take the COBS question?
spk13: Sure, Rex. Thanks. And Corey, thanks for the question. Yes, service requests trended pretty close to pre-pandemic levels in Q3, which is a great trend for us. And we really saw no impact from the Delta surge that we anticipated. So that was good news as well. And looking forward, I think we're cautiously optimistic about Q4 and then going into 2022. But we're going to watch the trends really closely. But at this At this point in time, the trends look pretty good as far as service requests across trades, especially the pandemic trades of plumbing and appliance. Great. Thank you all.
spk04: Thank you. Thank you.
spk05: Thank you. We have another question on the line from Ian DeFano from OPMR. So, Ian, please go ahead.
spk03: Hi. Thank you. You know, you guys believe you mentioned labor shortages. Can you talk a little bit more about that? How are you going about getting around that? You know, where is that actually hurting your business? And, you know, what type of inflation should we expect from that? Thanks.
spk09: Sure. Sure. You know, I'll take that. This is Rex. So, you know, certainly one of the things we're of continuing to strengthen the community we have with our contractors. Our percent of preferred this year is, you know, one of the highest levels it's, I think, been as, you know, since our – certainly as a standalone company. From our contractors is – our network contractors, so those who, you know, we kind of use sparingly and try to, you know, kind of grow them and becoming more of our, you know, our – our direct dispatch or our preferred contractors. And so, you know, certainly those contractors are beginning to feel the squeeze from a labor perspective. They tend to be, you know, smaller players for us, I think, in the industry overall. And so continuing to be able to recruit skilled tradespeople, I think, is beginning to create an issue for them. I think the great thing for us is that because we have this relationship with our preferred providers, we seem to be weathering that storm pretty well. I think the only thing from a preferred perspective that may be causing some issues are things like office staff, but I think the team's done an incredible job of really kind of working our way through what's certainly a very tight labor market.
spk12: Okay, great. Thank you very much. Thank you. Thank you.
spk05: Thank you. We now have a question from Mike from Goldman Sachs. So, Mike, please go ahead when you're ready.
spk10: Hey, good afternoon. Thank you very much for the question. I was just wondering if you could promise when you talk about 2022, should we assume that real estate in 2022 realizes a similar decline as you're looking for in the fourth quarter? All information there would be great. And then also on 2022, I'm sorry if I missed it, but is the 50% gross margin outlook for 2021 a good way to think about next year? You know, I certainly appreciate that there's cost inflation that you'll have to manage through. Thank you.
spk13: I'm happy to please jump in, Rex. The first question about the 2022 revenue guide, Mike, I think that's what I wrote down here. Yeah, we're guiding towards something similar to the past this year and last, which is sort of in the 8% range. And I think based on the trends in real estate, first-year real estate, we'll have another revenue growth that will be negative next year as well in the real estate channel. just because of the way the business builds over time. We've got to rebuild our volume. We'll get price and mix, but we're going to have volume challenges next year until the back half of the year, and then it'll begin to grow. hopefully towards historic rates. It'll be a good year for DTC. We think that's going to rebound nicely. And also renewals will have, you know, maybe comparable to this year, maybe a little less. But that will all build towards that 8% revenue growth year over year. Is that helpful?
spk10: That is. Thank you.
spk13: And then your other question was, I'm sorry, I forgot it already.
spk10: Is 50% gross margins?
spk13: yeah um the challenge is going to be i think as i mentioned my prepared remarks that i think dynamic pricing will continue to be working very well for us and all the process improvements we're making will flow through but i'm concerned about inflation like every other cfo that you probably have heard the past few weeks um we just don't know what's going to happen uh you know we've We see parts and equipment availabilities improving each month and not to pre-pandemic levels, but the inflation on labor, raw materials, transportation, I think are going to drive prices higher for parts and equipment heading into next year. So that's a concern. And I really don't have a good feel for global commodities, Mike, whether it's steel or copper, resins. what have you and that um you know that's what we're factoring to our gross margin calculus for next year the benefits of dynamic pricing and process improvements offset by potentially higher inflation great thank you brian i appreciate all the incremental color sure thank you
spk05: We now have Yusuf Tawali from Tourist Security. So, Yusuf, please go ahead when you're ready.
spk07: Yeah, hi. This is Nick Cronin. Just wanted to know what role has dynamic pricing played in normalizing gross margins in the current environment? It looks really good this quarter. So, Nick, Mark, I'll be helpful. Thanks.
spk09: Yeah, it's Rex. You know, certainly it played a part, but it wasn't, I think, the overarching part. You know, as Brian mentioned before, we've had a lot of, you know, process improvements as well as, you know, I think we also had, you know, lower service requests as well. You know, the issue, I think it's a good issue with that, as we continue to To optimize our models, this quarter, for our highest usage, highest cost customers, we had higher price increases. While it's still inelastic, we did see higher than expected cancellations for those customers, which does flow to higher profitability. But I wouldn't say it was the key driver of cancellation. of the profitability this quarter, but certainly helped. And so in terms of dynamic pricing, you know, we've since adjusted those models so that we continue to retain those customers and ramp up, you know, the pricing over time so that we're able to keep the customer and, you know, continue to keep the revenue as well. But I think the real drivers, as Brian pointed out in his prepared remarks, you know, outside dynamic pricing process improvements, which include higher percent of preferred similar technology improvements.
spk06: You know, certainly as we continue to tweak, you know, our algorithms around dispatching and some of our customer service software, that's definitely helped us as well.
spk09: But really just all the cross-functional effort of the team, you know, coupled with, you know, good weather and lower service requests, especially for HVAC, were the main drivers this quarter. Brian, feel free to chime in there.
spk13: No, I think you nailed it.
spk07: Got it. Thank you. Thank you.
spk05: And win of Credit Suisse. So, Brian, your line is open.
spk08: Hey, guys. It's Brian after Kevin. Appreciate you taking our questions.
spk06: Hey, Brian. Our first one here is, hey, guys.
spk08: Yeah, our first one here is just on, you know, as it relates to the macro environment, you sort of touched on how, obviously, you know, it's impacting your competitors as well. You know, so we're just curious. you know, have you seen the macro environment, you know, cause these step changes in, you know, the competitive environment overall? And, you know, given you guys are, you know, I think four times the size of your next largest peer, do you think maybe these cross currents could be, you know, serve as an opportunity for some share gains? You know, recognizing obviously that the TAM overall is, you know, pretty underpenetrated, but just any thoughts there?
spk09: Yeah, I can't, you know, certainly I think the biggest thing we have going for us is our scale. You know, when you think about our buying ability, think about, you know, our supply chain team of how we're expanding our parts and replacements availability, I think that Certainly, we have, you know, greater buying power over our competition, but we don't have any definitive data that would, you know, prove that, obviously. Well, I do think we have data, if you look at our gross margin compared to the category, and that's through, you know, a lot of work that we've done over, you know, the last two and a half, three years as it relates to, you know, inserting technology where, you know, we can further our scale, and that's, you know, around, dynamic pricing that's around improving our supply chain. We now have an appliance portal. We have the ability to pre-position some of our fast-moving inventory. And really increasing our efforts around customer experience, not only is it better for the customer, but some of the things we're doing is actually better for gross margin as well. So we think that the real share gains will come as as we continue to focus on making the customer or service experience more of a digital one, you know, we're committed to really providing more self-service options, which will, you know, hopefully lower cycle time and increase, you know, more, you know, a more digital experience, so it should lower cost as well. So it's all about removing friction from our processes and and make it better for the customer. We think that's how we, you know, we win overall, you know, these to be our customers.
spk08: Makes sense. And then our follow-up here was just, you know, obviously a lot of capacity on the balance sheet and, you know, appreciate the commentary on kind of how you guys are thinking about M&A. But, you know, if you could just remind us, what sort of framework do you employ specifically you know, be it return hurdle or whatever the case may be when, you know, evaluating potential deals. And if you could just comment on, you know, in each of the verticals what, you know, valuations are looking like from your standpoint. Thanks so much.
spk09: Brian, feel free to chip in here. But certainly, you know, as it relates just to M&A, I mean, if you want to, Brian, certainly talk about overall, you know, capital allocation strategy. But as it relates to M&A, you know, we're still in the same, you know, we still have the same viewpoint as it relates to looking for, you know, technology that helps further that, you know, that digital experience, you know, I just talked about. We think, you know, our acquisition of Stream is really starting to pay dividends as it relates to especially our appliance customers being able to you know, kind of see what they see virtually and really provide a very different experience. So we'll continue to look for technology, you know, either tuck-ins or, you know, adjacencies to help us with that. And then as it relates to, you know, kind of a roll-up strategy, if we will, for other, you know, home service plan companies, we're certainly not against that. We still think that Valuations in services overall seems to be still very, very high. And so one of the things that, you know, I think that, you know, we continue to deploy is a very disciplined strategy as it relates to, you know, making sure we're not giving away our synergy values. And so, you know, we look at a lot of things, but I think we have a very high bar in terms of if we acquire something, we want to ensure that it's truly, you know, accretive for our investors. Brian, anything you'd add to that?
spk13: I guess I'd only add that, you know, you mentioned in your question about capital allocation, overall, you know, Rex, Matt, and I, you know, have really been laser focused on capital allocation, you know, pre-spin and over the past three years. And, you know, we've been investing in the business. We've made a few small acquisitions, one modest, another modest one in stream. And we knew at some point, you know, we were going to repay debt. We finance our debt, we pay our debt, which we did earlier this year. And while we're looking for acquisitions, there's nothing on the horizon, as Rex mentioned, that we think is the right value for us. So that sort of leads into why we announced the share repurchase plan was, you know, we've got our refinancing debt repayment behind us. We've been investing strongly in the business. We had a lot of cash on the balance sheet. We generated a lot of cash. I think we mentioned we're going to generate 170 to 175 million this year, free cash flow. So we thought it was a great time to announce the share repurchase plan that our board approved and return value to shareholders that way. So hopefully that's helpful.
spk05: We now have Brian Fitzgerald of Wells Fargo. So Brian, I've opened your line.
spk01: Thanks. Got a lot of questions answered. Maybe one on what you just touched on, the benefits from process improvement. I'm wondering how much runway you see there for additional benefits. And then you just touched on Steam a couple times. How does that fit into the process improvements? How's it rolling out post you're purchasing it? And is it deploying to your playbook? Is it deploying faster? Are you seeing better synergies and more impacts than before? than you originally thought with the stream?
spk09: I'll start with stream, then we can talk about the cost side after that. Certainly, this year has been, I think, a good year as it relates to stream and our ability to integrate within our business. We've been rolling it out over kind of our core home service business This year, you know, customers and contractors, you know, when they use it seem to really enjoy, you know, the ability to really look at, you know, or have someone look at kind of what they're seeing. And we think that is. You know, that is the future of the company as it relates to, you know, we founded the business 50 years ago. And, you know, what hasn't changed is you kind of roll a truck to kind of see what's wrong. And it seems like a really antiquated way when now we can have, you know, almost a Zoom-like call with the customer. We can see what they see in terms of problems. But in the future, we'll be able to predict what's going on. We'll be able to understand or predict what we're looking at. We should be able to understand what our supply position is in terms of the replacement parts or replacement overall. So Once we build all the kind of backing capability of doing that, it becomes a very differentiated tool for front door, but also for our contractor base in general. So it helps us continue to even build the base within our existing contractor base. But the other thing I'm really excited about for Stream is I think it's an incredible ESG benefit in that, When you're not rolling trucks to kind of understand the issue, that is far better for our environment and far better for our future world as well. And so we're still very bullish on Stream. The other thing I would say is we purchased Stream primarily for our internal capability. But we continue to focus and add enterprise accounts as well. And, you know, anytime you have, you know, software, it's a great business. So very small base, and we have a long way to go. But considering, you know, how early we are into the cycle as well, I think Stream is kind of off and running. Your second question was kind of around, and keep me honest here, but I think, you know, will these gross margin improvements happen? continue into next year. I believe Brian addressed that earlier in terms of I think we're seeing a lot of improvements this year from dynamic pricing and from our technology and process improvements. The real wild card for us going into next year is going to be the supply chain. It's still very fragile, and we've got to really understand what does inflation look like for next year? It's still too early to call the ball, but certainly we're not taking our foot off the gas as it relates to continuing to find ways to pull costs out from a technology or a process improvement perspective.
spk06: It's really going to come down to what does inflation look like for next year and how much of that can we
spk05: uh mitigate to dynamic pricing uh brian anything else you would add to that no that was spot on rex awesome appreciate it guys yeah absolutely thank you thank you brian we now have a question from aaron kesler of raymond james so aaron please go ahead
spk08: Great. Thanks. A couple of questions. One is on the fall to the DTC rebound. So you kind of said you have good confidence. And for 22, just a couple of factors that give you that strong confidence in the DTC rebounds, easier comps, pricing, et cetera. And then maybe something you call up on the inflation costs. Assume you can kind of adjust that in the pricing. How quickly can you adjust that if we do see greater than expected inflation costs as well? Thank you.
spk09: Sure, I'll take the last one first. As it relates to dying pricing, with the exception of real estate, we can make pricing changes fairly quickly. As it relates to renewals, which is two-thirds of our revenue, we can make it in less than a week. So it's pretty quick. In terms of your question around B2C, what gives us confidence is A lot of the things that we talked about for this quarter are truly behind us. I think we have an opportunity to continue to diversify our demand mix. We pivoted to new sources of demand, and I think the team is – I think we're seeing the level of execution that we saw previously. We evaluated our conversion funnel to improve our sales process. Sales teams now – uh understand our new a new product lineup as it relates to the good better best uh and you know we we've uh made a lot of improvements to our e-commerce site uh through a b testing and optimization so those are the things that gives us confidence that uh you know direct consumer should should rebound uh next year uh keep in mind that from a unit perspective it'll take a while for it to uh to show the numbers since we recognize revenue at 12 in time but we will we'll see the added benefit of both better mix and price going into next year as well. So that's what gives us confidence for direct consumer going into 2022. Got it. Thank you.
spk05: We now have the final question on the line from Justin Anderson of KeyBank. So, Justin, please go ahead when you're ready.
spk02: Thanks. I haven't heard that variation in my last name before. You changed your name? Yeah. Well, hopefully you're all doing well. Rex, I appreciate that you're rationalizing spend in ProConnect given market conditions. Should we be doing this as a temporary pause or add more expansion there again? So that's question one on ProConnect and the investment dynamics. And then just digging into the labor dynamics, more, what do you think is the biggest driving factor toward really broadening out the selection that customers see? Is it really just labor at the existing contractors, or do you actually need to broaden out the types of contractors you're working with as you go market by market? Thank you.
spk09: Yeah, good to hear from you, Justin. I think taking the last question first, You know, I think, I think we need to continue to expand our, uh, you know, maintenance services for our existing customers as well as, uh, you know, expand our core, uh, our core trades, uh, in, in our existing, uh, pro connect markets. Um, so just a quick history lesson, you know, we started with, uh, primarily appliance and then we moved to plumbing electric and we're in HVAC in a couple of cities. We need to further expand those. I really want to see the, you know, in terms of your question of, you know, what makes you go faster. I want to see greater repeat business. I want to see, you know, our ability to cross-sell to our existing NHS customers. All things we have seen, you know, our plumbing electric trade expansion, like I said, took a little longer to ramp, but are beginning to perform. Because it all really comes down to once we get, you know, see a lowering of our well as a good customer experience, that's what gives me optimism to pour more money into the market knowing we'll get more stickier demand, if you will. So those are the things that we look at and continue to drive with. But keep in mind it's You know, we're two years into the journey. We went from, you know, basically zero to 20 million the first year. I'm confident we can double it next year. If we see a greater opportunity, you know, we'll definitely invest more to grow ProConnect. From a labor perspective, certainly, you know, one thing that we are watching carefully is, you know, making sure that there is labor there for these jobs. So far it hasn't been but, again, it's a small base, right? So just like we're watching labor very closely in our broader contractor market as it relates to home service plans, we're doing the same thing as it relates to ProConnect. And so far, you know, it's not a mountain we can't climb.
spk10: Got it. Thank you. Thank you.
spk05: Thank you, Justin. As we have no further questions on the line, I would like to hand back to Rex for some closing remarks.
spk09: Thank you, Operator. While we are facing some near-term headwinds, our long-term vision remains as strong as ever. We are still delivering strong profitability and growth, despite unprecedented real estate market conditions, a difficult global supply chain, and ongoing challenges from the pandemic that will last into 2022. We will continue to look for opportunities to grow faster while transforming our service experience into a digital one. We are playing the long game, and we are focused on strengthening our foundation to deliver strong and consistent growth in the future. I look forward to talking to you at our next earnings call.
spk05: Ladies and gentlemen, thank you again for joining Front Door's third quarter 2021 earnings call. Today's call is now concluded.
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