Frontdoor, Inc. (FTDR)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. The cautionary statements discussed in “Cautionary Statement Concerning Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K should be read as applying to all forward-looking statements wherever they appear in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K, particularly in “Cautionary Statement Concerning Forward-Looking Statements” and “Risk Factors” included in Item 1A of this Annual Report on Form 10-K.

For a discussion of our results of operations for the year ended December 31, 2023 compared to the year ended December 31, 2022, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our 2023 Annual Report on Form 10-K filed with the SEC on February 28, 2024, which specific discussion is incorporated herein by reference.

Overview

Frontdoor is the leading provider of home warranties and new home structural warranties in the United States, as measured by revenue, and operates primarily under the American Home Shield and 2-10 HBW brands. Our customizable home warranties help customers protect and maintain their homes, typically their most valuable asset, from costly and unplanned breakdowns of essential home systems and appliances. Our home warranty customers usually subscribe to an annual service plan agreement that covers the repair or replacement of major components of up to 29 home systems and appliances, including electrical, plumbing, HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops, as well as optional coverages for electronics, pools, spas and pumps. Our new home structural warranty business provides value to home builders and owners of new homes by providing coverage, including insurance-backed coverage for workmanship, systems and/or structural failures, as well as other post-construction services. We also offer non-warranty home services via our website and app to our home warranty customers directly and others through partnerships and our subscription-based Frontdoor app. As of December 31, 2024, we had approximately 2.1 million active home warranties across all brands in the United States.

For the year ended December 31, 2024, we generated revenue, net income and Adjusted EBITDA of $1,843 million, $235 million and $443 million, respectively. For the year ended December 31, 2023, we generated revenue, net income and Adjusted EBITDA of $1,780 million, $171 million and $346 million, respectively. For a reconciliation of net income to Adjusted EBITDA, see “—Results of Operations—Adjusted EBITDA.”

For the year ended December 31, 2024, our total operating revenue included 78 percent of revenue derived from existing customer renewals, while seven percent and nine percent were derived from new home warranty sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and six percent was derived from other revenue channels. For the year ended December 31, 2023, our total operating revenue included 77 percent of revenue derived from existing customer renewals, while eight percent and 11 percent were derived from new home warranty sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and four percent was derived from other revenue channels.

2-10 HBW Acquisition

On December 19, 2024, we completed the acquisition of all of the issued and outstanding common stock of 2-10 HBW pursuant to a purchase agreement dated June 3, 2024 for aggregate cash consideration of $585 million, subject to certain customary adjustments based on, among other things, the amount of cash, debt, transaction expenses, working capital and regulatory capital in the business of 2-10 HBW as of the closing of the transaction. 2-10 HBW is a leading provider of new home structural warranties that provide home builders insurance-backed coverage and/or administrative services for workmanship, systems and/or structural failures. 2-10 HBW is also a provider of home warranties. See Note 7 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on this acquisition.

2024 Debt Refinancing

We entered into an amendment to our Credit Agreement, which became effective on December 19, 2024, in part, to fund the 2-10 HBW Acquisition. See "—Liquidity and Capital Resources—2024 Debt Refinancing” and Note 12 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on our liquidity and the debt refinancing transactions.

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Key Factors and Trends Affecting Our Results of Operations

Macroeconomic Conditions

Current macroeconomic conditions, including inflation, high interest rates, the challenging real estate market, and ongoing global geopolitical issues, may affect existing home sales, consumer sentiment or labor availability. These conditions may reduce demand for our services, increase our costs or otherwise adversely impact our business. While these macroeconomic conditions generally impact the United States as a whole, we believe our nationwide presence limits the impact on us of unfavorable economic conditions in any particular region of the United States.

During 2024, as compared to 2023, our financial condition and results of operations continued to be adversely impacted by the following:

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Challenging real estate market conditions, driven by a decline in the number of home resale transactions, primarily resulting from high interest rates combined with low home inventory levels, continue to constrain demand for home warranties.

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Consumer sentiment remains mixed as a result of a broad range of current macroeconomic conditions, including pressure on consumer prices and high interest rates. We believe this environment continues to impact demand for home warranties.

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Our labor, parts and equipment costs continue to be impacted by inflation.

The ultimate implications of the current macroeconomic conditions on our results of operations and overall financial performance remain uncertain. It remains difficult to predict the overall continuing impact these conditions will have on our business as they may reduce demand for our services, increase our costs or otherwise adversely impact our business.

Seasonality

Our business is subject to seasonal fluctuations, which drive variations in our revenue, net income and Adjusted EBITDA for interim periods. Seasonal fluctuations are primarily driven by a higher number of HVAC work orders with respect to our home warranty business in the summer months. In 2024, approximately 21 percent, 29 percent, 29 percent and 21 percent of our revenue, approximately 14 percent, 39 percent, 43 percent and four percent of our net income, and approximately 16 percent, 36 percent, 37 percent and 11 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, particularly our home warranty business, and our results of operations, are affected by weather conditions. Extreme temperatures, typically in the winter and summer months, can lead to an increase in home warranty service requests related to home systems, particularly HVAC systems, resulting in higher costs and lower profitability, while mild temperatures in the winter or summer months can lead to lower home systems claim frequency, resulting in lower costs and higher profitability. For example, favorable weather trends in 2024 as compared to 2023 resulted in a lower number of home warranty service requests per customer in the HVAC trade, which favorably impacted contract claims costs.

While weather variations as described above may affect our business, major weather events and other similar Acts of God, or natural disasters such as hurricanes, tornadoes, typhoons, wildfires or earthquakes, typically do not increase our obligations to provide service. Generally, repairs associated with such isolated events are addressed by homeowners’ and other forms of insurance, as opposed to the home warranties that we offer.

Tariff and Import/Export Regulations

Changes in U.S. tariff and import/export regulations may impact the costs of parts, appliances and home systems. 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, or blanket tariffs on goods from countries that are key suppliers of replacement parts for appliances and home systems, could increase the costs of our parts, appliances and home systems.

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Competition

We compete in the U.S. home warranty category and the broader U.S. home services industry. The home warranty category is highly competitive. While we have a broad range of competitors in each locality and region, we are one of the few companies that provide home warranties nationwide. The broader U.S. home services industry is also highly competitive. We compete against businesses providing non-warranty home services directly and those offering leads to contractors seeking to provide non-warranty home services. The principal methods of competition, and by 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. We believe our nationwide network of qualified professional contractor firms, in combination with our large base of contracted customers, differentiate us from other platforms in the home services industry.

Our new home structural warranty business faces competition from other providers of new home structural warranties and builders that self-insure.

Acquisition Activity

We anticipate that the highly fragmented nature of the home services industry will continue to create strategic opportunities for acquisitions. Historically, we have used acquisitions to grow our customer base in high-growth geographies, and we intend to continue to do so. Most recently, we acquired 2-10 HBW, which provides us more home warranty customers and increased revenue, in addition to opportunities for a new sales channel and a more diversified business portfolio. We have also used acquisitions to enhance our technological capabilities and geographic presence. We may also explore opportunities to make strategic acquisitions that will expand our service offering in the broader home services industry, such as new home structural warranties acquired as part of 2-10 HBW. See “— 2-10 HBW Acquisition” for additional information related to the acquisition.

Non-GAAP Financial Measures

To supplement our results presented in accordance with U.S. GAAP, we have disclosed non-GAAP financial measures 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 measures of Adjusted EBITDA and Free Cash Flow. See “—Results of Operations—Adjusted EBITDA” for a reconciliation of net income to Adjusted EBITDA and “—Liquidity and Capital Resources—Free Cash Flow” for a reconciliation of net cash provided from operating activities to Free Cash Flow, as well as “Key Business Metrics” for further discussion of Adjusted EBITDA and Free Cash Flow. Management uses Adjusted EBITDA and Adjusted EBITDA margin to facilitate operating performance comparisons from period to period, and Adjusted EBITDA is also a component of our incentive compensation program. We believe these non-GAAP financial measures provide investors, analysts and other interested parties useful information to evaluate our business performance as they facilitate company-to-company operating performance comparisons. Management believes Free Cash Flow is useful as a supplemental measure of our liquidity. Management uses Free Cash Flow to facilitate company-to-company cash flow comparisons, which may vary from company to company for reasons unrelated to operating performance. While we believe these non-GAAP financial measures are useful in evaluating our business, they should be considered as supplemental in nature and are not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies, limiting their usefulness as comparative measures.

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:

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revenue,

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operating expenses,

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gross profit,

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gross profit margin,

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net income,

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earnings per share,

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Adjusted EBITDA,

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Adjusted EBITDA margin,

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net cash provided from operating activities,

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Free Cash Flow,

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•
number of home warranties, and

•
customer retention rate.

Revenue. The majority of our revenue is generated from home warranty contracts entered into with our customers. Home warranty 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 home warranty sales, customer retention and acquisitions. We derive substantially all of our revenue from customers in the United States.

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 healthcare; contractor costs; parts, appliances and home systems costs; tariffs; insurance premiums; and various regulatory compliance costs.

Gross Profit and Gross Profit Margin. The presentation of gross profit and gross profit margin provides measures of performance which are primarily a function of the revenue drivers discussed above and contract claims costs drivers, primarily contractor costs and parts, appliances and home systems costs. Gross profit is computed by deducting cost of services rendered from revenue. Gross profit margin is computed as gross profit as a percentage of revenue.

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, if any, of non-qualified stock options, performance options (which are stock options that become exercisable upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement), restricted stock units ("RSUs"), performance shares (which are contractual rights to receive a share of our common stock (or the cash equivalent thereof) upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement) and restricted stock awards ("RSAs") are reflected in diluted earnings per share by applying the treasury stock method.

Adjusted EBITDA and Adjusted EBITDA Margin. We evaluate our operating and financial performance primarily based on Adjusted EBITDA, which is a financial measure not calculated in accordance with U.S. GAAP. We define Adjusted EBITDA as net income before: depreciation and amortization expense; goodwill and intangibles impairment; restructuring charges; acquisition-related costs; provision for income taxes; non-cash stock-based compensation expense; interest expense; loss on extinguishment of debt; 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 and acquisition initiatives and equity-based, long-term incentive plans.

Net Cash Provided from Operating Activities and Free Cash Flow. We focus on measures designed to monitor cash flow, including net cash provided from operating activities and Free Cash Flow. Free Cash Flow is a financial measure that is not calculated in accordance with U.S. GAAP and represents net cash provided from operating activities less property additions.

Number of Home Warranties and Customer Retention Rate. We report on our number of home warranties and customer retention rate as measurements of our operating performance. These measurements are presented on a rolling 12-month basis in order to avoid seasonal anomalies. The number of home warranties is representative of our recurring home warranty customer base and is measured as the number of customers with active contracts as of the respective period-end date. Our customer retention rate is calculated as the ratio of the number of end-of-period home warranty contracts to the sum of the number of beginning-of-period home warranty contracts and the number of new home warranty sales and acquired accounts during the respective period.

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Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to: revenue recognition; business combinations; home warranty claims accruals; the valuation of property and equipment, goodwill and intangible assets; useful lives for recognizing depreciation and amortization expense; accruals for current and deferred tax accounts; stock-based compensation expense; and litigation matters. We base our estimates on historical experience and on various other factors and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our most significant estimates and judgments.

Business Combinations

We account for business combinations using the acquisition method of accounting. Under the acquisition method, the purchase price of the acquisition is allocated to the acquired tangible and identifiable intangible assets and assumed liabilities based on their estimated fair values at the time of the acquisition. This allocation involves a number of assumptions, estimates and judgments that could materially affect the timing or amounts recognized in the consolidated financial statements. In developing estimates of fair values for long-lived assets, including identifiable intangible assets, we utilize a variety of inputs including forecasted cash flows, anticipated growth rates, discount rates, customer attrition, royalty rates, estimated replacement costs and depreciation and obsolescence factors. Determining the fair value for tangible assets such as real and personal property and specifically identified intangible assets such as customer lists and developed technology involves judgment. We may refine our estimates and make adjustments to the assets acquired and liabilities assumed over a measurement period, not to exceed one year. Upon the conclusion of the measurement period or the final determination of the values of assets acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recognized to the consolidated statements of operations.

See Note 7 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the preliminary allocation of the purchase price to the fair value of the assets acquired and liabilities assumed.

Home Warranty Claims Accruals

Home warranty claims costs are expensed as incurred. Accruals for home warranty claims are made using internal actuarial projections, which are based on current claims and historical claims experience. Accruals are established based on estimates of the ultimate cost to settle claims. Home warranty claims take approximately three months to settle, on average, and substantially all claims are settled within six months of incurrence. The amount of time required to settle a claim can vary based on a number of factors, including whether a replacement is ultimately required. In addition to our estimates, we engage a third-party actuary to perform an accrual analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and information provided by us. We regularly review our estimates of claims costs along with the third-party analysis and adjust our estimates when appropriate. We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved. For example, industry-wide parts and equipment availability challenges and inflation can impact our ability to estimate the cost to settle claims. We believe our recorded obligations for these expenses are consistently measured. Nevertheless, changes in claims costs can materially affect the estimates for these liabilities.

Goodwill and Intangible Assets

Goodwill and indefinite-lived intangible assets are not amortized and are subject to assessment for impairment on an annual basis, or more frequently if circumstances indicate a potential impairment. We perform our annual assessment for impairment on October 1 of every year. Goodwill and indefinite-lived intangible assets are tested for impairment at the reporting unit level. The Company can elect to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the reporting unit does not pass the qualitative assessment, or if the Company does not elect to perform the initial qualitative assessment, then the reporting unit’s carrying amount is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. Failure to achieve these expected results or market multiples may cause a future impairment of goodwill at the reporting unit. Goodwill and indefinite-lived intangible assets are considered impaired if the carrying amount of the reporting unit exceeds its fair value.

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As of December 31, 2024, we do not believe there are any circumstances that would indicate any other 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.

Newly Issued Accounting Standards

New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. See Note 2 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on newly issued accounting standards.

Results of Operations

* not meaningful

Revenue

We reported revenue of $1,843 million and $1,780 million for the years ended December 31, 2024 and 2023, respectively. The following table provides a summary of our revenue by major customer acquisition channel for our home warranties and other revenue:

(1)
First-year revenue only.

(2)
For the year ended December 31, 2024, includes approximately $6 million as a result of the 2-10 HBW Acquisition on December 19, 2024.

Revenue increased four percent for the year ended December 31, 2024 compared to the year ended December 31, 2023. The increase in renewal revenue reflects improved price realization resulting from our prior pricing actions, offset, in part, by a decline in the number of renewed home warranties. The decrease in real estate revenue reflects a decline in the number of first-year real estate home warranties driven by the challenging real estate market, offset, in part, by higher price realization. The decrease in direct-to-consumer revenue reflects lower price realization resulting from our efforts to drive incremental sales. The increase in other revenue was driven by growth in non-warranty home services, primarily new HVAC sales.

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The following table provides a summary of the number of home warranties, reduction in number of home warranties and customer retention rate:

(1)
As of December 31, 2024, excluding the 2-10 HBW home warranties acquired on December 19, 2024, the number of home warranties was 1.94 million, the reduction in home warranties was three percent and the customer retention rate was 78.5 percent.

The growth in the number of home warranties as of December 31, 2024 was primarily driven by the 2-10 HBW acquisition, offset, in part, by the challenging real estate market.

Cost of Services Rendered

We reported cost of services rendered of $852 million and $895 million for the years ended December 31, 2024 and 2023, respectively. The following table provides a summary of the changes in cost of services rendered:

The impact of change in revenue is driven by growth in non-warranty home services, offset, in part, by the reduction in number of home warranties, other than the 2-10 HBW home warranties acquired on December 19, 2024.

The decrease in contract claims costs primarily reflects the impact of higher trade service fees, which drove a lower number of home warranty service requests per customer and a lower net cost per service request, a favorable weather impact of $8 million, as milder weather drove a lower number of home warranty service requests in the HVAC trade, and continued process improvement initiatives, specifically relating to better cost management across our contractor network. The decrease was offset, in part, by ongoing inflationary cost pressures. Additionally, contract claims costs reflects a $5 million favorable adjustment in 2024 related to the development of prior period claims, compared to a $11 million favorable adjustment in 2023.

Selling and Administrative Expenses

We reported selling and administrative expenses of $612 million and $581 million for the years ended December 31, 2024 and 2023, respectively. The following table provides a summary of the components of selling and administrative expenses:

The following table provides a summary of the changes in selling and administrative expenses:

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Sales and marketing costs increased primarily due to our investment in marketing associated with our direct-to-consumer channel, offset, in part by, a reduction in costs driven by sales optimization efforts. Acquisition-related costs are driven by the 2-10 HBW Acquisition and represent direct third-party costs, including legal, accounting and financial advisory fees. Other general and administrative costs increased primarily due to increased personnel costs.

Depreciation and Amortization Expense

Depreciation expense was $35 million and $32 million for the years ended December 31, 2024 and 2023, respectively, with the increase primarily driven by incremental capital expenditures in the period. Amortization expense was $4 million for each of the years ended December 31, 2024 and 2023.

Restructuring Charges

Restructuring charges were $8 million and $16 million for the years ended December 31, 2024 and 2023, respectively.

In 2024, restructuring charges included $7 million of severance costs and $1 million of expenses related to the exit of certain operating leases.

In 2023, restructuring charges included $10 million in non-cash impairment charges related to the operating lease right-of-use assets and related property and equipment of certain of our leased and company-owned facilities as discussed further in Note 6 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, $2 million of professional fees and $3 million of severance costs. The impairment charges were the result of our decision to exit the leased and company-owned properties. The severance costs related to our continued review and optimization of selling, general and administrative expenses.

Interest Expense

Interest expense was $40 million for each of the years ended December 31, 2024 and 2023.

Interest and Net Investment Income

Interest and net investment income was $20 million and $16 million for the years ended December 31, 2024 and 2023, respectively. The increase was primarily driven by higher cash and cash equivalents balances.

Loss on Extinguishment of Debt

During the year ended December 31, 2024, we recorded a loss on extinguishment of debt of $3 million, which included the write-off of unamortized debt issuance costs and original issue discount. See "—Liquidity and Capital Resources—2024 Debt Refinancing” and Note 12 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on the debt refinancing transactions. There was no loss on extinguishment of debt recorded in the year ended December 31, 2023.

Provision for Income Taxes

The effective tax rate on income was 24.1 percent and 25.0 percent for the years ended December 31, 2024 and 2023, respectively. The decrease in the effective tax rate was primarily due to stock-based compensation, offset, in part, by non-deductible acquisition-related transaction costs.

Net Income

Net income was $235 million and $171 million for the years ended December 31, 2024 and 2023, respectively, with the increase primarily driven by the operating results discussed throughout “—Results of Operations” above.

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Adjusted EBITDA

Adjusted EBITDA was $443 million and $346 million for the years ended December 31, 2024 and 2023, respectively. The following table provides a summary of the changes in our Adjusted EBITDA:

The impact of change in revenue is driven by improved price realization, offset, in part, by the reduction in number of home warranties, other than the 2-10 HBW home warranties acquired on December 19, 2024.

The decrease in contract claims costs primarily reflects the impact of higher trade service fees, which drove a lower number of home warranty service requests per customer and a lower net cost per service request, a favorable weather impact of $8 million, as milder weather drove a lower number of home warranty service requests in the HVAC trade, and continued process improvement initiatives, specifically relating to better cost management across our contractor network. The decrease was offset, in part, by ongoing inflationary cost pressures. Additionally, contract claims costs reflects a $5 million favorable adjustment in 2024 related to the development of prior period claims, compared to a $11 million favorable adjustment in 2023.

Sales and marketing costs increased primarily due to our investment in marketing associated with our direct-to-consumer channel, offset, in part by, a reduction in costs driven by sales optimization efforts. Other general and administrative costs increased primarily due to increased personnel costs.

A reconciliation of net income to Adjusted EBITDA is as follows:

(1)
We exclude restructuring charges, acquisition-related costs and loss on extinguishment of debt from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability.

(2)
We exclude non-cash stock-based compensation expense from Adjusted EBITDA because it is a non-cash expense and because it is not used by management to assess ongoing operational performance. We believe excluding this expense from Adjusted EBITDA is useful to investors in aiding period-to-period comparability.

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Liquidity and Capital Resources

Liquidity

A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement contains 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 of December 31, 2024, we were in compliance with the covenants under the Credit Agreement. We do not believe current macroeconomic conditions will affect our ongoing ability to meet our debt covenants.

Cash and cash equivalents and short- and long-term marketable securities totaled $474 million and $325 million as of December 31, 2024 and 2023, respectively. Our cash and cash equivalents and short- and long-term marketable securities include balances associated with regulatory requirements in our business. See “—Limitations on Distributions and Dividends by Subsidiaries.” As of December 31, 2024 and 2023, the total net assets subject to these third-party restrictions were $184 million and $157 million, respectively. As of December 31, 2024, there was $2 million of letters of credit outstanding under our $250 million Revolving Credit Facility, and the available borrowing capacity under the Revolving Credit Facility was $248 million. The letters of credit are posted in lieu of cash to satisfy regulatory requirements in certain states in which we operate. We currently believe that cash generated from operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility as of December 31, 2024 will provide us with sufficient liquidity to meet our obligations in the short- and long-term.

We closely monitor the performance of our investment portfolio, primarily cash deposits and short- and long-term marketable securities. We regularly 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 have a diversified investment strategy for our cash investments and give priority to the major financial institutions that serve as lenders under the Credit Agreement. Generally, our cash deposits may be redeemed on demand and are maintained with major financial institutions with solid credit ratings, although our holdings exceed insured limits in substantially all of our accounts.

We may, from time to time, issue new debt, repurchase or otherwise retire or extend our debt and/or take other steps to reduce our debt or otherwise improve our financial position, gross and net leverage, results of operations or cash flows. These actions may include new debt issuance, open market debt repurchases, negotiated repurchases, other retirements of outstanding debt and/or opportunistic refinancing of debt. The amount of debt that may be issued, repurchased or otherwise retired or refinanced, if any, and the price of such issuances, repurchases, retirements or refinancings will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations.

2024 Debt Refinancing

On December 19, 2024, we entered into the second amendment to the Credit Agreement, which provides for a $418 million Term Loan A maturing December 19, 2029, an $800 million Term Loan B maturing December 19, 2031 and a $250 million Revolving Credit Facility terminating December 19, 2029. The net proceeds from the transaction were used to repay the Prior Term Loan Facilities, including accrued and unpaid interest, to fund the 2-10 HBW Acquisition, which also closed on December 19, 2024, and to pay related fees and expenses of all these transactions with the remainder designated to fund share repurchases or for other general corporate purposes.

In connection with the second amendment to the Credit Agreement, we repaid all of the then current outstanding principal amounts of the Prior Term Loan Facilities, consisting of $218 million related to the Prior Term Loan A and $368 million related to the Prior Term Loan B, and recorded a loss on extinguishment of debt of $3 million, which included the write-off of unamortized debt issuance costs and original issue discount. Additionally, on December 19, 2024, we amended and restated the Revolving Credit Facility, which carried, and continues to carry, a $2 million balance.

See Note 12 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for additional information related to our indebtedness.

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2-10 HBW Acquisition

On December 19, 2024, we completed the acquisition of all of the issued and outstanding common stock of 2-10 HBW pursuant to a purchase agreement dated June 3, 2024 for aggregate cash consideration of $585 million, subject to certain customary adjustments based on, among other things, the amount of cash, debt, transaction expenses, working capital and regulatory capital in the business of 2-10 HBW as of the closing of the transaction. 2-10 HBW is a leading provider of new home structural warranties that provide home builders insurance-backed coverage and/or administrative services for workmanship, systems and/or structural failures. 2-10 HBW is also a provider of home warranties. See Note 7 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on this acquisition.

Share Repurchase Program

On July 26, 2024, our Board of Directors approved a new share repurchase authorization of up to $650 million of our common stock over the three-year period from September 4, 2024 through September 4, 2027. Purchases under this new $650 million repurchase program may be made from time to time by the company in the open market at prevailing market prices (including through a Rule 10b5-1 Plan), in privately negotiated transactions, or through any combination of these methods, through September 4, 2027. The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of the company’s stock, general market and economic conditions, the company’s liquidity requirements, applicable legal requirements and other business considerations. The repurchase program does not obligate us to acquire any number of shares in any specific period or at all and may be suspended or discontinued at any time at our discretion. As of December 31, 2024, we repurchased a total of 709,077 outstanding shares at an aggregate cost of $41 million under this program, which is included in treasury stock on the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K. We expect to fund future share repurchases from net cash provided from operating activities.

On September 3, 2024, our previous repurchase authorization of up to $400 million expired. We repurchased a total of 11,319,091 shares at an aggregate cost of $400 million under this previous program, which is included in treasury stock on the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.

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 regulatory restrictions on the ability of certain of our subsidiaries to transfer funds to us. 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. None of our subsidiaries is 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 audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K, are summarized in the following table:

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Operating Activities

Net cash provided from operating activities was $270 million for the year ended December 31, 2024, compared to $202 million for the year ended December 31, 2023.

Net cash provided from operating activities in 2024 comprised $312 million in earnings adjusted for non-cash charges, offset, in part, by $36 million in cash used for working capital and $6 million in payments for restructuring charges. Cash used for working capital was primarily driven by seasonality, payments of accrued bonuses and a decline in the number of first-year real estate home warranties, which are typically paid for upfront at the time of closing on the home sale.

Net cash provided from operating activities in 2023 comprised $242 million in earnings adjusted for non-cash charges, offset, in part, by $7 million in payments for restructuring charges and $33 million in cash used for working capital. Cash used for working capital was primarily driven by a decline in the number of first-year real estate home warranties, which are typically paid for upfront at the time of closing on the home sale, and favorable development of prior period claims.

Investing Activities

Net cash used for investing activities was $622 million and $32 million for the years ended December 31, 2024 and 2023, respectively.

Capital expenditures were $39 million and $32 million in 2024 and 2023, respectively, and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2025 relating to committed, recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately $35 million to $45 million. We have no additional material capital commitments at this time.

We paid $583 million, net of cash acquired, for the 2-10 HBW Acquisition in 2024. See Note 7 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on this acquisition.

Financing Activities

Net cash used for financing activities was $447 million and $137 million for the years ended December 31, 2024 and 2023, respectively.

During the year ended December 31, 2024, we refinanced our Term Loan Facilities. We borrowed $1,216 million and used a portion of the proceeds to repay $585 million of principal on the Prior Term Loan Facilities. In addition, we made other scheduled principal payments of debt of $13 million and purchased outstanding shares of our common stock at an aggregate cost of $161 million. Repurchases of common stock included associated commissions and taxes of $2 million.

During the year ended December 31, 2023, we made scheduled principal payments of debt of $17 million and purchased outstanding shares of our common stock at an aggregate cost of $121 million. Repurchases of common stock included associated commissions and taxes of $1 million.

Free Cash Flow

The following table reconciles net cash provided from operating activities, which we consider to be the most directly comparable U.S. GAAP measure, to Free Cash Flow using data derived from the audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K.

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Contractual Obligations

The following table presents our contractual obligations and commitments as of year ended December 31, 2024:

(1)
These items are included in the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.

(2)
These amounts represent future interest payments related to existing debt obligations based on interest rates and principal maturities specified in the Credit Agreement. Payments related to the Term Loan Facilities are based on applicable variable and fixed interest rates as of December 31, 2024 plus the specified margin in the Credit Agreement for each period presented. As of December 31, 2024, the estimated debt balance as of each year ending from 2025 through 2029 is $1,172 million, $1,120 million, $1,068 million, $1,016 million and $650 million, respectively, and the weighted-average interest rate on the estimated debt balances is 6.3 percent as of each year ending from 2025 through 2028 and 6.6 percent for the year ending 2029. See Note 12 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the terms and maturities of existing debt obligations.

(3)
These amounts represent future payments relating to real estate operating leases.

Financial Position

The 2-10 HBW Acquisition on December 19, 2024 significantly changed certain accounts on our statement of financial position. For a summary of the amounts of identified assets acquired and liabilities assumed at the acquisition date, as determined based on management's preliminary assessment of the acquisition date fair value, see Note 7 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

A summary of the other significant changes in our financial position from December 31, 2023 to December 31, 2024 is as follows:

•
Cash and cash equivalents increased during 2024, primarily reflecting cash provided from operating activities and the 2024 debt refinancing activities, offset, in part, by capital expenditures and purchases of outstanding shares.

•
Long-term debt, including the current portion, increased during 2024, reflecting the 2024 debt refinancing activities, offset, in part, by scheduled debt payments.

•
Total shareholders’ equity was $239 million as of December 31, 2024 compared to $136 million as of December 31, 2023. The increase was primarily driven by net income, offset, in part, by repurchases of our common stock. See the audited consolidated statements of changes in equity (deficit) included in Item 8 of this Annual Report on Form 10-K for further information.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. The cautionary statements discussed in “Cautionary Statement Concerning Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K should be read as applying to all forward-looking statements wherever they appear in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K, particularly in “Cautionary Statement Concerning Forward-Looking Statements” and “Risk Factors” included in Item 1A of this Annual Report on Form 10-K.

For a discussion of our results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our 2022 Annual Report on Form 10-K filed with the SEC on March 1, 2023, which specific discussion is incorporated herein by reference.

Overview

Frontdoor is the leading provider of home warranties in the United States, as measured by revenue, and operates primarily under the American Home Shield brand. Our customizable home warranties help customers protect and maintain their homes, typically their most valuable asset, from costly and unplanned breakdowns of essential home systems and appliances. Our home warranty customers usually subscribe to an annual service plan agreement that covers the repair or replacement of major components of more than 20 home systems and appliances, including electrical, plumbing, HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops, as well as optional coverages for electronics, pools, spas and pumps. Frontdoor also provides on-demand home services and a one-stop app experience for home repair and maintenance. Enabled by our Streem technology, the app empowers homeowners by connecting them in real time through video chat with qualified experts to diagnose and solve their problems. As of December 31, 2023, we had 2.0 million active home warranties across all brands in the United States.

For the year ended December 31, 2023, we generated revenue, net income and Adjusted EBITDA of $1,780 million, $171 million and $346 million, respectively. For the year ended December 31, 2022, we generated revenue, net income and Adjusted EBITDA of $1,662 million, $71 million and $214 million, respectively. For a reconciliation of Adjusted EBITDA to net income, see “—Results of Operations—Adjusted EBITDA.”

For the year ended December 31, 2023, our total operating revenue included 77 percent of revenue derived from existing customer renewals, while eight percent and 11 percent were derived from new home warranty sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and four percent was derived from other revenue channels. For the year ended December 31, 2022, our total operating revenue included 72 percent of revenue derived from existing customer renewals, while 11 percent and 13 percent were derived from new home warranty sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and three percent was derived from other revenue channels.

Key Factors and Trends Affecting Our Results of Operations

Macroeconomic Conditions

Current macroeconomic conditions, including inflation, higher interest rates, the challenging real estate market and rising global geopolitical issues, may affect existing home sales, consumer sentiment or labor availability. These conditions may reduce demand for our services, increase our costs or otherwise adversely impact our business. While these macroeconomic conditions generally impact the United States as a whole, we believe our nationwide presence limits the impact on us of unfavorable economic conditions in any particular region of the United States.

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During 2023, our financial condition and results of operations continued to be adversely impacted by the following:

Challenging real estate market conditions, driven by a decline in the number of home resale transactions, primarily resulting from higher interest rates, combined with low home inventory levels, continue to constrain demand for home warranties in the first-year real estate channel.

Consumer sentiment remains mixed as a result of a broad range of current macroeconomic conditions, including pressure on consumer prices and rising interest rates. We believe this environment impacted demand for home warranties in the first-year direct-to-consumer and renewal channels.

Our contractor network continues to be impacted by inflation, including higher labor, parts and equipment costs and labor availability challenges. We continue to take actions to mitigate these impacts, including increasing the percent of service requests completed by lower-cost preferred contractors, increasing the share of parts and equipment our contractors source through us at lower costs and other process improvement efforts.

The ultimate implications of the current macroeconomic conditions on our results of operations and overall financial performance remain uncertain. It remains difficult to predict the overall continuing impact these conditions will have on our business as they may reduce demand for our services, increase our costs or otherwise adversely impact our business.

Seasonality

Our business is subject to seasonal fluctuations, which drive variations in our revenue, net income and Adjusted EBITDA for interim periods. Seasonal fluctuations are primarily driven by a higher number of HVAC work orders in the summer months. In 2023, approximately 21 percent, 29 percent, 29 percent and 21 percent of our revenue, approximately 13 percent, 41 percent, 42 percent and five percent of our net income, and approximately 15 percent, 35 percent, 37 percent and 13 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, typically in the winter and summer months, can lead to an increase in service requests related to home systems, particularly HVAC systems, resulting in higher costs and lower profitability, while mild temperatures in the winter or summer months can lead to lower home systems claim frequency, resulting in lower costs and higher profitability. For example, favorable weather trends in 2023 as compared to 2022 resulted in a lower number of service requests per customer, which favorably impacted contract claims costs.

While weather variations as described above may affect our business, major weather events and other similar Acts of God, or natural disasters such as typhoons, hurricanes, tornadoes, wildfires or earthquakes, typically do not increase our obligations to provide service. Generally, repairs associated with such isolated events are addressed by homeowners’ and other forms of insurance as opposed to the home warranties that we offer.

Tariff and Import/Export Regulations

Changes in U.S. tariff and import/export regulations may impact the costs of parts, appliances and home systems. 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 parts, appliances and home systems.

Competition

We compete in the U.S. home warranty category and the broader U.S. home services industry. The home warranty category is highly competitive. While we have a broad range of competitors in each locality and region, we are one of the few companies that provide home warranties nationwide. The broader U.S. home services industry is also highly competitive. We compete against businesses providing on-demand home services directly and those offering leads to contractors seeking to provide on-demand home services. The principal methods of competition, and by 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. We believe our nationwide network of qualified professional contractor firms, in combination with our large base of contracted customers, differentiate us from other platforms in the home services industry.

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Acquisition Activity

We anticipate that the highly fragmented nature of the home warranty category will continue to create strategic opportunities for acquisitions. Historically, we have used acquisitions to cost-effectively grow our customer base in high-growth geographies, 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 industry. We have also used acquisitions to enhance our technological capabilities and geographic presence.

Non-GAAP Financial Measures

To supplement our results presented in accordance with U.S. GAAP, we have disclosed non-GAAP financial measures 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 measures of Adjusted EBITDA and Free Cash Flow. See “—Results of Operations—Adjusted EBITDA” for a reconciliation of net income to Adjusted EBITDA and “—Liquidity and Capital Resources—Free Cash Flow” for a reconciliation of net cash provided from operating activities to Free Cash Flow, as well as “Key Business Metrics” for further discussion of Adjusted EBITDA and Free Cash Flow. Management uses Adjusted EBITDA and Adjusted EBITDA margin to facilitate operating performance comparisons from period to period, and Adjusted EBITDA is also a component of our incentive compensation program. We believe these non-GAAP financial measures provide investors, analysts and other interested parties useful information to evaluate our business performance as they facilitate company-to-company operating performance comparisons. Management believes Free Cash Flow is useful as a supplemental measure of our liquidity. Management uses Free Cash Flow to facilitate company-to-company cash flow comparisons, which may vary from company to company for reasons unrelated to operating performance. While we believe these non-GAAP financial measures are useful in evaluating our business, they should be considered as supplemental in nature and are not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies, limiting their usefulness as comparative measures.

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,

number of home warranties, and

customer retention rate.

Revenue. The majority of our revenue is generated from annual home warranty contracts entered into with our customers. Home warranty 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 home warranty sales, customer retention and acquisitions. We derive substantially all of our revenue from customers in the United States.

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 healthcare; contractor costs; parts, appliances and home systems costs; tariffs; insurance premiums; and various regulatory compliance costs.

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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, if any, of stock options, performance options (which are stock options that become exercisable upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement), restricted stock units (“RSUs”), performance shares (which are contractual rights to receive a share of our common stock (or the cash equivalent thereof) upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement) and restricted stock awards (“RSAs”) are reflected in diluted earnings per share by applying the treasury stock method.

Adjusted EBITDA and Adjusted EBITDA margin. We evaluate our operating and financial performance primarily based on Adjusted EBITDA, which is a financial measure not calculated in accordance with U.S. GAAP. We define Adjusted EBITDA as net income before: depreciation and amortization expense; goodwill and intangibles impairment; restructuring charges; provision for income taxes; non-cash stock-based compensation expense; interest expense; loss on extinguishment of debt; 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 and equity-based, long-term incentive plans.

Net Cash Provided from Operating Activities and Free Cash Flow. We focus on measures designed to monitor cash flow, including net cash provided from operating activities and Free Cash Flow. Free Cash Flow is a financial measure that is not calculated in accordance with U.S. GAAP and represents net cash provided from operating activities less property additions.

Number of Home Warranties and Customer Retention Rate. We report on our number of home warranties and customer retention rate as measurements of our operating performance. These measurements are presented on a rolling 12-month basis in order to avoid seasonal anomalies. The number of home warranties is representative of our recurring home warranty customer base and is measured as the number of customers with active contracts as of the respective period end date. Our customer retention rate is calculated as the ratio of the number of end-of-period home warranty contracts to the sum of the number of beginning-of-period home warranty contracts and the number of new home warranty sales and acquired accounts during the respective period.

Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to: revenue recognition; home warranty claims accruals; the valuation of property and equipment, goodwill and intangible assets; useful lives for recognizing depreciation and amortization expense; accruals for current and deferred tax accounts; stock-based compensation expense; and litigation matters. We base our estimates on historical experience and on various other factors and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our most significant estimates and judgments.

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Home Warranty Claims Accruals

Home warranty claims costs are expensed as incurred. Accruals for home warranty claims are made using internal actuarial projections, which are based on current claims and historical claims experience. Accruals are established based on estimates of the ultimate cost to settle claims. Home warranty claims take approximately three months to settle, on average, and substantially all claims are settled within six months of incurrence. The amount of time required to settle a claim can vary based on a number of factors, including whether a replacement is ultimately required. In addition to our estimates, we engage a third-party actuary to perform an accrual analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and information provided by us. We regularly review our estimates of claims costs along with the third-party analysis and adjust our estimates when appropriate. We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved. For example, industry-wide parts and equipment availability challenges and inflation can impact our ability to estimate the cost to settle claims. We believe our recorded obligations for these expenses are consistently measured. Nevertheless, changes in claims costs can materially affect the estimates for these liabilities.

Goodwill and Intangible Assets

Goodwill and indefinite-lived intangible assets are not amortized and are subject to assessment for impairment on an annual basis, or more frequently if circumstances indicate a potential impairment. We perform our annual assessment for impairment on October 1 of every year. Goodwill and indefinite-lived intangible assets are tested for impairment at the reporting unit level. The Company can elect to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the reporting unit does not pass the qualitative assessment, or if the Company does not elect to perform the initial qualitative assessment, then the reporting unit’s carrying amount is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. Failure to achieve these expected results or market multiples may cause a future impairment of goodwill at the reporting unit. Goodwill and indefinite-lived intangible assets are considered impaired if the carrying amount of the reporting unit exceeds its fair value.

In connection with the preparation of our audited consolidated financial statements for the third quarter of 2022, we determined that indicators of a potential goodwill and intangible assets impairment were present for our Streem reporting unit. In particular, we began to shift the focus of our Streem technology platform to primarily concentrate on integrating the technology into our core product offerings. We continue to license this technology to third-party business-to-business customers as a software-as-a-service platform but intend to discontinue this third-party business by the end of 2024. This shift in focus resulted in significantly lower projected revenue for Streem. We performed an interim impairment analysis of the Streem reporting unit as of September 30, 2022. In performing the discounted cash flow analysis, we determined that the carrying amount of the Streem reporting unit exceeded its fair value. An impairment charge of $14 million was recognized during the third quarter of 2022, which comprised the remaining net carrying amount of Streem’s goodwill of $9 million and intangible assets of $5 million.

As of December 31, 2023, we do not believe there are any additional circumstances that would indicate any other 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.

Newly Issued Accounting Standards

New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. See Note 2 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on newly issued accounting standards.

‎

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Results of Operations

________________________________

*   not meaningful

Revenue

We reported revenue of $1,780 million and $1,662 million for the years ended December 31, 2023 and 2022, respectively. The following table provides a summary of our revenue by major customer acquisition channel:

_________________________________

(1)First-year revenue only.

Revenue increased seven percent for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase in renewal revenue primarily reflects improved price realization resulting from our prior pricing actions. The decrease in real estate revenue primarily reflects a decline in the number of first-year real estate home warranties driven by a continuation of the challenging real estate market, offset, in part, by improved price realization from our prior pricing actions. The decrease in direct-to-consumer revenue primarily reflects a decline in the number of first-year direct-to-consumer home warranties, which we believe was driven by a decline in overall category demand for home warranties. The increase in other revenue was primarily driven by growth in on-demand home services.

The following table provides a summary of the number of home warranties, reduction in number of home warranties and customer retention rate:

The reduction in the number of home warranties as of December 31, 2023 was primarily impacted by a decline in the number of first-year real estate home warranties driven by a continuation of the challenging real estate market, as well as a decline in the number of direct-to-consumer home warranties, which we believe was driven by a decline in overall category demand for home warranties.

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Cost of Services Rendered

We reported cost of services rendered of $895 million and $952 million for the years ended December 31, 2023 and 2022, respectively. The following table provides a summary of the changes in cost of services rendered:

The impact of change in revenue is driven by the reduction in number of home warranties, offset, in part, by growth in on-demand home services.

The decrease in contract claims costs primarily reflects a lower number of service requests per customer, including a $30 million favorable weather impact. The favorable impact on contract claims costs of continued process improvement initiatives specifically relating to better cost management efforts across our contractor network and a transition to higher service fees, were offset, in part, by ongoing inflationary cost pressures. Additionally, contract claims costs reflects an $11 million favorable adjustment related to the development of prior period claims, compared to a $12 million unfavorable adjustment in 2022.

Selling and Administrative Expenses

We reported selling and administrative expenses of $581 million and $521 million for the years ended December 31, 2023 and 2022, respectively. The following table provides a summary of the components of selling and administrative expenses:

The following table provides a summary of the changes in selling and administrative expenses:

Sales and marketing costs increased primarily due to our investment in marketing associated with the Frontdoor brand and our direct-to-consumer channel. The decrease in customer service costs was primarily driven by a lower number of service requests. General and administrative costs increased primarily due to increased personnel costs.

Depreciation and Amortization Expense

Depreciation expense was $32 million and $27 million for the years ended December 31, 2023 and 2022, respectively, with the increase primarily driven by incremental capital expenditures in the period. Amortization expense was $4 million and $7 million for the years ended December 31, 2023 and 2022, respectively, with the decrease primarily driven by the impairment to the Streem reporting unit in the third quarter of 2022.

Goodwill and Intangibles Impairment

Goodwill and intangibles impairment was $14 million for the year ended December 31, 2022. There was no such impairment for the year ended December 31, 2023. See “—Critical Accounting Policies and Estimates—Goodwill and Intangible Assets” for further information.

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Restructuring Charges

Restructuring charges were $16 million and $20 million for the years ended December 31, 2023 and 2022, respectively.

In 2023, restructuring charges primarily comprised $10 million in non-cash impairment charges related to the operating lease right-of-use assets and related property and equipment of certain of our leased and company-owned facilities as discussed further in Note 5 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, $2 million of professional fees and $3 million of severance costs. The impairment charges were the result of our decision to exit the leased and company-owned properties. The severance costs related to our continued review and optimization of selling, general and administrative expenses.

In 2022, restructuring charges primarily comprised an $11 million impairment charge related to our prior corporate headquarters facility operating lease right-of-use asset and leasehold improvements, a $2 million impairment of certain internally developed software, $1 million of accelerated depreciation related to the early termination of a lease, and $6 million of severance and other costs. Severance costs of $2 million related to a reduction in workforce of seven percent as part of our completed strategic review of selling, general and administrative expenses.

Interest Expense

Interest expense was $40 million and $31 million for the years ended December 31, 2023 and 2022, respectively. The increase was driven by higher interest rates on our variable rate debt.

Interest and Net Investment Income

Interest and net investment income was $16 million and $4 million for the years ended December 31, 2023 and 2022, respectively. The increase driven was by higher interest rates on our cash and cash equivalent balances.

Provision for Income Taxes

The effective tax rate on income was 25.0 percent and 23.8 percent for the years ended December 31, 2023 and 2022, respectively. The increase in the effective tax rate was primarily due to a reduction in income tax credits in 2023, offset, in part, by the impact of the goodwill and intangibles impairment recorded in 2022 and the impact of a lower pre-tax income in 2022.

Net Income

Net income was $171 million and $71 million for the years ended December 31, 2023 and 2022, respectively, with the increase primarily driven by the operating results discussed throughout “—Results of Operations” above.

Adjusted EBITDA

Adjusted EBITDA was $346 million and $214 million for the years ended December 31, 2023 and 2022, respectively. The following table provides a summary of the changes in our Adjusted EBITDA:

The impact of change in revenue reflects improved price realization, offset, in part, by the reduction in number of home warranties.

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The decrease in contract claims costs primarily reflects a lower number of service requests per customer, including a $30 million favorable weather impact. The favorable impact on contract claims costs of continued process improvement initiatives specifically relating to better cost management efforts across our contractor network and a transition to higher service fees, were offset, in part, by ongoing inflationary cost pressures. Additionally, contract claims costs reflects an $11 million favorable adjustment related to the development of prior period claims, compared to a $12 million unfavorable adjustment in 2022.

Sales and marketing costs increased primarily due to our investment in marketing associated with the Frontdoor brand and our direct-to-consumer channel. The decrease in customer service costs was primarily driven by a lower number of service requests. General and administrative costs increased primarily due to increased personnel costs.

The increase in interest and net investment income was driven by higher interest rates on our cash and cash equivalent balances.

A reconciliation of Net Income to Adjusted EBITDA is as follows:

_________________________________

(1)We exclude goodwill and intangibles impairment and restructuring charges from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability.

(2)We exclude non-cash stock-based compensation expense from Adjusted EBITDA primarily because it is a non-cash expense and because it is not used by management to assess ongoing operational performance. We believe excluding this expense from Adjusted EBITDA is useful to investors in aiding period-to-period comparability.

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Liquidity and Capital Resources

Liquidity

A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement contains 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 of December 31, 2023, we were in compliance with the covenants under the Credit Agreement. We do not believe current macroeconomic conditions will affect our ongoing ability to meet our debt covenants.

Cash and cash equivalents totaled $325 million and $292 million as of December 31, 2023 and 2022, respectively. Our cash and cash equivalents include balances associated with regulatory requirements in our business. See “—Limitations on Distributions and Dividends by Subsidiaries.” As of December 31, 2023 and 2022, the total net assets subject to these regulatory restrictions were $157 million and $145 million, respectively. As of December 31, 2023, there were $2 million of letters of credit outstanding under our $250 million Revolving Credit Facility, and the available borrowing capacity under the Revolving Credit Facility was $248 million. The letters of credit are posted in lieu of cash to satisfy regulatory requirements in certain states in which we operate. We currently believe that cash generated from operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility as of December 31, 2023 will provide us with sufficient liquidity to meet our obligations in the short- and long-term.

In March 2023, in connection with the planned phase-out of LIBOR, we amended our Credit Facilities to replace LIBOR with SOFR as the benchmark rate under the Credit Agreement. This change was effective in March 2023 for Term Loan A and the Revolving Credit Facility and in June 2023 for Term Loan B.

We closely monitor the performance of our investment portfolio, primarily cash deposits. 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 have a diversified investment strategy for our cash investments and give priority to the major financial institutions that serve as lenders under the Credit Agreement. Generally, our cash deposits may be redeemed on demand and are maintained with major financial institutions with solid credit ratings, although our holdings exceed insured limits in substantially all of our accounts.

We may, from time to time, issue new debt, 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 new debt issuance, open market debt repurchases, negotiated repurchases, other retirements of outstanding debt and/or opportunistic refinancing of debt. The amount of debt that may be issued, repurchased or otherwise retired or refinanced, if any, and the price of such issuances, repurchases, retirements or refinancings will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations.

On September 7, 2021, we announced a three-year repurchase authorization of up to $400 million of outstanding shares of our common stock. We expect to fund the share repurchases from net cash provided from operating activities. As of December 31, 2023, we have repurchased a total of 8,082,819 outstanding shares at a cost of $281 million, which is included in treasury stock on the consolidated statements of financial position, and we had $119 million remaining available for future repurchases under this program. Purchases under the repurchase program may be made from time to time by the company in the open market at prevailing market prices (including through a Rule 10b5-1 Plan), in privately negotiated transactions, or through any combination of these methods, through September 3, 2024. The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of the company’s stock, general market and economic conditions, the company’s liquidity requirements, applicable legal requirements and other business considerations. The repurchase program does not obligate us to acquire any number of shares in any specific period or at all and may be suspended or discontinued at any time at our discretion.

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.

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Furthermore, there are regulatory restrictions on the ability of certain of our subsidiaries to transfer funds to us. 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. 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 audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K, are summarized in the following table:

Operating Activities

Net cash provided from operating activities was $202 million for the year ended December 31, 2023, compared to $142 million for the year ended December 31, 2022.

Net cash provided from operating activities in 2023 comprised $242 million in earnings adjusted for non-cash charges, offset, in part, by $7 million in payments for restructuring charges and $33 million in cash used for working capital. Cash used for working capital was primarily driven by a decline in the number of first-year real estate home warranties, which are typically paid for upfront at the time of closing on the home sale, and favorable development of prior period claims.

Net cash provided from operating activities in 2022 comprised $151 million in earnings adjusted for non-cash charges, offset, in part, by $5 million in payments for restructuring charges and $5 million in cash used for working capital. Cash used for working capital was primarily driven by the unfavorable impact on deferred revenue of a decline in the number of first-year real estate home warranties, which are typically paid for upfront at the time of closing on the home sale. Cash used for working capital was also impacted by increased accounts payable and accrued liabilities balances due to the impact of inflation on contractor and supplier costs and trade payables.

Investing Activities

Net cash used for investing activities was $32 million and $35 million for the years ended December 31, 2023 and 2022, respectively.

Capital expenditures were $32 million and $40 million in 2023 and 2022, respectively, and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2024 relating to committed, recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately $35 million to $45 million. We have no additional material capital commitments at this time.

Cash flows provided from other investing activities in 2022 were $4 million and consisted of proceeds received from the sale of a prior customer care center in LaGrange, Georgia. There were no cash flows provided from other investing activities in 2023.

Financing Activities

Net cash used for financing activities was $137 million and $77 million for the years ended December 31, 2023 and 2022, respectively.

During the year ended December 31, 2023, we made scheduled principal payments of debt of $17 million and purchased outstanding shares of our common stock at an aggregate cost of $121 million. Repurchases of common stock included associated commissions and taxes of $1 million.

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During the year ended December 31, 2022, we made scheduled principal payments of debt of $17 million and purchased outstanding shares of our common stock at an aggregate cost of $59 million. Repurchases of common stock included associated commissions and taxes of less than $1 million.

Free Cash Flow

The following table reconciles net cash provided from operating activities, which we consider to be the most directly comparable U.S. GAAP measure, to Free Cash Flow using data derived from the audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K.

Contractual Obligations

The following table presents our contractual obligations and commitments as of December 31, 2023:

_________________________________

*     These items are included in the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.

(1)These amounts represent future interest payments related to existing debt obligations based on interest rates and principal maturities specified in the Credit Agreement. Payments related to the Term Loan Facilities are based on applicable variable and fixed interest rates as of December 31, 2023 plus the specified margin in the Credit Agreement for each period presented. As of December 31, 2023, the estimated debt balance as of each year ending from 2024 through 2027 is $581 million, $564 million, $359 million and $355 million, respectively, and the weighted-average interest rate on the estimated debt balances as of each year ending from 2024 through 2027 is 6.0 percent, 7.5 percent, 7.7 percent and 7.7 percent, respectively. There is no estimated debt balance as of the fiscal year ending 2028. See Note 11 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the terms and maturities of existing debt obligations.

(2)These amounts represent future payments relating to real estate operating leases. In August 2023, we entered into a non-cancelable operating lease agreement for a collaboration center located in Scottsdale, Arizona, which commenced in February 2024 and has an initial term of 10 years, unless terminated earlier. We are obligated to make lease payments totaling approximately $8 million over the lease term, with $1 million in 2024 and $7 million in the years thereafter (2025-2033), which are not included in the table above.

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Financial Position

A summary of the significant changes in our financial position from December 31, 2022 to December 31, 2023 is as follows:

Property and equipment, net decreased during 2023, primarily reflecting $5 million in non-cash impairment charges relating to us exiting certain leased and company-owned facilities.

Operating lease right-of-use assets decreased during 2023, primarily reflecting $5 million in non-cash impairment charges relating to us exiting certain leased facilities.

Payroll and related expenses increased during 2023, primarily reflecting an increase in incentive compensation to be paid in 2024.

Home warranty claims decreased during 2023, primarily reflecting the impact of an $11 million favorable adjustment recorded in 2023 related to the development of prior period claims and a lower number of service requests.

Deferred revenue decreased during 2023, reflecting a decline in the number of first-year real estate home warranties, which are typically paid for upfront at the time of closing on the home sale.

Long-term debt decreased during 2023, reflecting scheduled debt payments.

Deferred tax liabilities, net decreased during 2023, reflecting timing differences associated with depreciation of fixed assets, certain incentive compensation expense and right-of-use assets.

Total shareholders’ equity was $136 million as of December 31, 2023 compared to $61 million as of December 31, 2023. The increase was primarily driven by net income, offset, in part, by repurchases of our common stock. See the audited consolidated statements of changes in equity (deficit) included in Item 8 of this Annual Report on Form 10-K for further information.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. The cautionary statements discussed in “Cautionary Statement Concerning Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K should be read as applying to all forward-looking statements wherever they appear in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K, particularly in “Cautionary Statement Concerning Forward-Looking Statements” and “Risk Factors” included in Item 1A of this Annual Report on Form 10-K.

For a discussion of our results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our 2021 Annual Report on Form 10-K filed with the SEC on February 24, 2022, which specific discussion is incorporated herein by reference.

Overview

Frontdoor is the leading provider of home service plans in the United States, as measured by revenue, and operates primarily under the American Home Shield brand. Our customizable home service plans help customers protect and maintain their homes, typically their most valuable asset, from costly and unplanned breakdowns of essential home systems and appliances. Our home service plan customers usually subscribe to an annual service plan agreement that covers the repair or replacement of major components of more than 20 home systems and appliances, including electrical, plumbing, HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops, as well as optional coverages for electronics, pools, spas and pumps. Our operations also include on-demand home services and Streem, a technology platform that uses augmented reality, computer vision and machine learning to, among other things, help home service professionals more quickly and accurately diagnose breakdowns and complete repairs. As of December 31, 2022, we had 2.1 million active home service plans, which were offered nationally.

For the year ended December 31, 2022, we generated revenue, net income and Adjusted EBITDA of $1,662 million, $71 million and $214 million, respectively. For the year ended December 31, 2021, we generated revenue, net income and Adjusted EBITDA of $1,602 million, $128 million and $300 million, respectively. For a reconciliation of Adjusted EBITDA to net income, see “—Results of Operations for the Years Ended December 31, 2022 and 2021—Adjusted EBITDA.”

For the year ended December 31, 2022, our total operating revenue included 72 percent of revenue derived from existing customer renewals, while 11 percent and 13 percent were derived from new home service plan sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and three percent was derived from other revenue channels. For the year ended December 31, 2021, our total operating revenue included 69 percent of revenue derived from existing customer renewals, while 16 percent and 13 percent were derived from new home service plan sales made in conjunction with existing home real estate transactions and direct-to-consumer sales, respectively, and three percent was derived from other revenue channels.

Key Factors and Trends Affecting Our Results of Operations

Macroeconomic Conditions

Changes in macroeconomic conditions, including inflation, global supply chain challenges and the persistence of the COVID-19 pandemic, especially as they may affect existing home sales, interest rates, consumer confidence or labor availability, may reduce demand for our services, increase our costs and adversely impact our business. While these macroeconomic conditions generally impact the United States as a whole, we believe our nationwide presence limits the impact on us of poor economic conditions in any particular region of the United States.

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During 2022, our financial condition and results of operations were adversely impacted by the following:

The challenging home seller’s market, driven, in part, by extremely low home inventory levels and rising interest rates, continued to constrain demand for home service plans in the first-year real estate channel.

Consumer sentiment declined in 2022 as higher inflation eroded real personal income. We believe this environment, combined with our higher prices for a home service plan, impacted our ability to add customers, especially in the direct-to-consumer channel.

Our contractors continued to be impacted by inflation, including higher labor, fuel and parts and equipment costs. We continue to take actions to mitigate these impacts, including increasing the share of parts and equipment our contractors source through us at lower costs, increasing the percent of service requests completed by lower-cost preferred contractors and accelerating contractor recruitment efforts.

Industry-wide parts availability gradually improved in the later part of 2022; however, global supply chain challenges continued to drive costs higher than pre-pandemic levels.

Due to labor availability challenges, we continued to experience workforce retention issues, including difficulties in hiring and retaining employees in customer service operations and throughout our business. We believe our contractors are experiencing similar workforce challenges.

Impact of the COVID-19 Pandemic

The ultimate implications of the COVID-19 pandemic on our results of operations and overall financial performance remain uncertain. Moreover, as a result of the increase in remote or hybrid working arrangements in response to the pandemic, which trend may continue to persist even as the pandemic continues to subside, a significant number of people may continue to spend greater time at home, which may result in a continued increase in usage of home systems and appliances and demand for our services and a resulting increase in service-related costs. Industry-wide supply chain challenges may also continue to contribute to increased costs and impact the customer experience, which may affect customer retention. Accordingly, the COVID-19 situation remains very fluid, and we continue to adjust our response in real time. It remains difficult to predict the overall continuing impact the COVID-19 pandemic will have on our business.

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 HVAC work orders in the summer months. In 2022, approximately 21 percent, 29 percent, 29 percent and 21 percent of our revenue, approximately 2 percent, 47 percent, 39 percent and 12 percent of our net income, and approximately 12 percent, 36 percent, 37 percent and 15 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, typically in the winter and summer months, can lead to an increase in service requests related to home systems, particularly HVAC systems, resulting in higher claim frequency and costs and lower profitability, while mild temperatures in the winter or summer months can lead to lower home systems claim frequency. For example, unfavorable weather trends in the fourth quarter of 2022 as compared to the fourth quarter of 2021 negatively impacted contract claims costs, while favorable weather trends in the first quarter of 2022 as compared to the first quarter of 2021 favorably impacted contract claims costs.

While weather variations as described above may affect our business, major weather events and other similar Acts of God, or natural disaster such as typhoons, hurricanes, tornadoes or earthquakes, typically do not increase our obligations to provide service. Generally, repairs associated with such isolated events are addressed by homeowners’ and other forms of insurance as opposed to the home service plans that we offer.

Tariff and Import/Export Regulations

Changes in U.S. tariff and import/export regulations may impact the costs of parts, appliances and home systems. 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 parts, appliances and home systems.

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Competition

We compete in the U.S. home service plan category and the broader U.S. home services industry. The home service plan category is highly competitive. While we have a broad range of competitors in each locality and region, we are the only home service plan company providing home service plans nationwide. The broader U.S. home services industry is also highly competitive. We compete against businesses providing on-demand home services directly and those offering leads to contractors seeking to provide on-demand home services. The principal methods of competition, and by 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. We believe our nationwide network of approximately 15,000 pre-qualified professional contractor firms, in combination with our large base of contracted customers, differentiate us from other platforms in the home services industry.

Acquisition Activity

We anticipate that the highly fragmented nature of the home service plan category will continue to create strategic opportunities for acquisitions. Historically, we have used acquisitions to cost-effectively grow our customer base in high-growth geographies, 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 industry. We have also used acquisitions to enhance our technological capabilities and geographic presence. For example, in 2019, we acquired Streem to enable home service professionals to more efficiently interact with customers and complete repairs, and, in 2020, we acquired a business to expand on-demand home services via their intellectual capital and know-how, technology platform capabilities and geographic presence.

Non-GAAP Financial Measures

To supplement our results presented in accordance with U.S. GAAP, we have disclosed non-GAAP financial measures 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 measures of Adjusted EBITDA and Free Cash Flow. See “—Results of Operations for the Years Ended December 31, 2022 and 2021—Adjusted EBITDA” for a reconciliation of net income to Adjusted EBITDA and “—Liquidity and Capital Resources—Free Cash Flow” for a reconciliation of net cash provided from operating activities to Free Cash Flow, as well as “Key Business Metrics” for further discussion of Adjusted EBITDA and Free Cash Flow. Management uses Adjusted EBITDA and Adjusted EBITDA margin to facilitate operating performance comparisons from period to period. We believe these non-GAAP financial measures provide investors, analysts and other interested parties useful information to evaluate our business performance as they facilitate company-to-company operating performance comparisons. Management believes Free Cash Flow is useful as a supplemental measure of our liquidity. Management uses Free Cash Flow to facilitate company-to-company cash flow comparisons, which may vary from company to company for reasons unrelated to operating performance. While we believe these non-GAAP financial measures are useful in evaluating our business, they should be considered as supplemental in nature and are not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies, limiting their usefulness as comparative measures.

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.

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Revenue. The majority of our revenue is generated from annual home service plan contracts entered into with our customers. 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 home service plan sales, customer retention and acquisitions. We derive substantially all of our revenue from customers in the United States.

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 healthcare; contractor costs; parts, appliances and home systems 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, if any, of stock options, performance options (which are stock options that become exercisable upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement), restricted stock units (“RSUs”), performance shares (which are contractual rights to receive a share of our common stock (or the cash equivalent thereof) upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement) and restricted stock awards (“RSAs”) are reflected in diluted earnings per share by applying the treasury stock method.

Adjusted EBITDA and Adjusted EBITDA margin. We evaluate our operating and financial performance primarily based on Adjusted EBITDA, which is a financial measure not calculated in accordance with U.S. GAAP. We define Adjusted EBITDA as net income before: depreciation and amortization expense; goodwill and intangibles impairment; restructuring charges; provision for income taxes; non-cash stock-based compensation expense; interest expense; loss on extinguishment of debt; 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 and equity-based, long-term incentive plans.

Net Cash Provided from Operating Activities and Free Cash Flow. We focus on measures designed to monitor cash flow, including net cash provided from operating activities and Free Cash Flow, which is a financial measure not calculated in accordance with U.S. GAAP and represents net cash provided from operating activities less property additions.

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 the number of ending home service plans to the sum of the number of beginning home service plans, new home service plan sales and acquired accounts for the applicable period. These measures are presented on a rolling, 12-month basis in order to avoid seasonal anomalies.

Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to: revenue recognition; home service plan claims accruals; the valuation of property and equipment, goodwill and intangible assets; useful lives for recognizing depreciation and amortization expense; accruals for current and deferred tax accounts; stock-based compensation expense; and litigation matters. We base our estimates on historical experience and on various other factors and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our most significant estimates and judgments.

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Home Service Plan Claims Accruals

Home service plan claims costs are expensed as incurred. Accruals for home service plan claims are made using internal actuarial projections, which are based on current claims and historical claims experience. Accruals are established based on estimates of the ultimate cost to settle claims. Home service plan claims take approximately three months to settle, on average, and substantially all claims are settled within six months of incurrence. The amount of time required to settle a claim can vary based on a number of factors, including whether a replacement is ultimately required. In addition to our estimates, we engage a third-party actuary to perform an accrual analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and information provided by us. We regularly review our estimates of claims costs along with the third-party analysis and adjust our estimates when appropriate. We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved. Given the current operating environment, which includes industry-wide parts and equipment availability challenges and inflation, our ability to estimate the cost to settle claims is further challenged. We believe our recorded obligations for these expenses are consistently measured. Nevertheless, changes in claims costs can materially affect the estimates for these liabilities.

Goodwill and Intangible Assets

Goodwill and indefinite-lived intangible assets are not amortized and are subject to assessment for impairment on an annual basis or more frequently if circumstances indicate their carrying amounts may not be recoverable. We perform our annual assessment for impairment on October 1 of every year. Goodwill and indefinite-lived intangible assets are tested for impairment at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the reporting unit does not pass the qualitative assessment, then the reporting unit’s carrying amount is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. Failure to achieve these expected results or market multiples may cause a future impairment of goodwill at the reporting unit. Goodwill and indefinite-lived intangible assets are considered impaired if the carrying amount of the reporting unit exceeds its fair value.

In connection with the preparation of our condensed consolidated financial statements for the third quarter of 2022, we determined that indicators of a potential goodwill and intangible assets impairment were present for our Streem reporting unit. In particular, we will now be more focused on integrating Streem’s technology into the core business and will be less focused on selling this technology platform to third-party business-to-business customers as a software-as-a-service platform. This shift in focus resulted in significantly lower projected revenue for Streem. We performed an interim impairment analysis of the Streem reporting unit as of September 30, 2022. In performing the discounted cash flow analysis, we determined that the carrying amount of the Streem reporting unit exceeded its fair value. An impairment charge of $14 million was recognized during the third quarter, which comprised the remaining net carrying amount of Streem’s goodwill of $9 million and intangibles of $5 million.

As of December 31, 2022, we do not believe there are any circumstances 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. Other than the impairment to our Streem reporting unit discussed above, there were no goodwill or trade name impairment charges recorded during the years ended December 31, 2022 or 2021. See Note 4 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information related to our goodwill and intangible assets.

Newly Issued Accounting Standards

New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. See Note 2 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on newly issued accounting standards.

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Results of Operations for the Years Ended December 31, 2022 and 2021

________________________________

*    not meaningful

Revenue

We reported revenue of $1,662 million and $1,602 million for the years ended December 31, 2022 and 2021, respectively. Revenue by major customer acquisition channel is as follows:

_________________________________

(1)First-year revenue only.

Revenue increased four percent for the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase in renewal revenue reflects improved price realization and growth in the number of renewed home service plans. The decrease in real estate revenue primarily reflects a decline in the number of first-year real estate home service plans driven by a continuation of the challenging home seller’s market. The increase in direct-to-consumer revenue reflects improved price realization and a mix shift to higher priced products, offset, in part, by a decline in the number of first-year direct-to-consumer home service plans. The increase in other revenue was primarily driven by growth in on-demand home services.

Number of home service plans, reduction in number of home service plans and customer retention rate are presented below.

The reduction in number of home service plans as of December 31, 2022 was primarily impacted by a decline in the number of first-year real estate home service plans, which was driven by a continuation of the challenging home seller’s market.

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Cost of Services Rendered

We reported cost of services rendered of $952 million and $818 million for the years ended December 31, 2022 and 2021, respectively. The following table provides a summary of changes in cost of services rendered:

The increase in contract claims costs primarily reflects inflationary cost pressures, including rising contractor-related expenses and higher parts and equipment costs. In addition, contract claims costs for the year ended December 31, 2022 include a $12 million unfavorable adjustment related to the adverse development of prior period claims.

Selling and Administrative Expenses

We reported selling and administrative expenses of $521 million and $511 million for the years ended December 31, 2022 and 2021, respectively. The following table provides the components of selling and administrative expenses:

The following table provides a summary of changes in selling and administrative expenses:

The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel. The decrease in customer service costs was primarily driven by lower labor costs due to a lower number of service requests. The increase in general and administrative costs was primarily driven by higher personnel and insurance costs and increased professional fees.

Depreciation and Amortization Expense

Depreciation expense was $27 million and $24 million for the years ended December 31, 2022 and 2021, respectively, with the increase driven by depreciation associated with capital expenditures in the period. Amortization expense was $7 million and $11 million for the years ended December 31, 2022 and 2021, respectively, with the decrease driven by certain intangible assets becoming fully amortized during 2021.

Goodwill and Intangibles Impairment

Goodwill and intangibles impairment was $14 million for the year ended December 31, 2022. There was no such impairment for the year ended December 31, 2021. See “—Critical Accounting Policies and Estimates—Goodwill and Intangible Assets” for further information.

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Restructuring Charges

Restructuring charges were $20 million and $3 million for the years ended December 31, 2022 and 2021, respectively.

In 2022, restructuring charges comprised an $11 million impairment charge related to our prior corporate headquarters operating lease right-of-use asset and leasehold improvements, a $2 million impairment of certain internally developed software, $1 million of accelerated depreciation related to the early termination of a lease, and $6 million of severance and other costs. Severance costs of $2 million related to a reduction in workforce of seven percent as part of our completed strategic review of our selling, general and administrative expenses.

In 2021, restructuring charges comprised $1 million of accelerated depreciation of certain technology systems driven by efforts to enhance our technological capabilities and $1 million of severance and other costs.

Interest Expense

Interest expense was $31 million and $39 million for the years ended December 31, 2022 and 2021, respectively. The decrease was primarily driven by our debt reduction and refinancing activities in 2021.

Interest and Net Investment Income

Interest and net investment income reflects income of $4 million and $1 million for the years ended December 31, 2022 and 2021, respectively. The increase was primarily driven by higher interest rates on our cash and cash equivalent balances.

Loss on Extinguishment of Debt

Loss on extinguishment of debt was $31 million for the year ended December 31, 2021. Amounts relate to our debt reduction and refinancing activities in 2021. There were no such charges for the year ended December 31, 2022.

Provision for Income Taxes

The effective tax rate on income was 23.8 percent and 23.4 percent for the years ended December 31, 2022 and 2021, respectively.

Net Income

Net income was $71 million and $128 million for the years ended December 31, 2022 and 2021, respectively, with the decrease driven by the operating results discussed above.

Adjusted EBITDA

Adjusted EBITDA was $214 million and $300 million for the years ended December 31, 2022 and 2021, respectively. The following table provides a summary of changes in our Adjusted EBITDA.

The increase in contract claims costs primarily reflects inflationary cost pressures, including rising contractor-related expenses and higher parts and equipment costs. In addition, contract claims costs for the year ended December 31, 2022 include a $12 million unfavorable adjustment related to the adverse development of prior period claims.

The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel. The decrease in customer service costs was primarily driven by lower labor costs due to a lower number of service requests. The increase in general and administrative costs was primarily driven by higher personnel and insurance costs and increased professional fees.

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The following table reconciles net income, which we consider to be the most directly comparable U.S. GAAP financial measure, to Adjusted EBITDA.

_________________________________

(1)We exclude goodwill and intangibles impairment, restructuring charges and loss on extinguishment of debt from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability.

(2)We exclude non-cash stock-based compensation expense from Adjusted EBITDA primarily because it is a non-cash expense and because it is not used by management to assess ongoing operational performance. We believe excluding this expense from Adjusted EBITDA is useful to investors in aiding period-to-period comparability.

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Liquidity and Capital Resources

Liquidity

A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement contains 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 of December 31, 2022, we were in compliance with the covenants under the Credit Agreement that were in effect as of this date. Based on current conditions, we do not believe the acceleration of inflationary cost pressures, global supply chain challenges and the persistence of the COVID-19 pandemic will affect our ongoing ability to meet our debt covenants.

Cash and cash equivalents totaled $292 million and $262 million as of December 31, 2022 and 2021, respectively. Our cash and cash equivalents include balances associated with regulatory requirements in our business. See “—Limitations on Distributions and Dividends by Subsidiaries.” As of December 31, 2022 and 2021, the total net assets subject to these third-party restrictions were $145 million and $175 million, respectively. As of December 31, 2022, there were $2 million of letters of credit outstanding under our $250 million Revolving Credit Facility, and the available borrowing capacity under the Revolving Credit Facility was $248 million. The letters of credit are posted in lieu of cash to satisfy regulatory requirements in certain states in which we operate. We currently believe that cash generated from operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility as of December 31, 2022 will provide us with sufficient liquidity to meet our obligations in the short- and long-term.

We closely monitor the performance of our investment portfolio. 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.

On September 7, 2021, we announced a three-year repurchase authorization of up to $400 million of outstanding shares of our common stock. We expect to fund the share repurchases from net cash provided from operating activities. As of December 31, 2022, we have purchased a total of 4,478,194 outstanding shares at an aggregate cost of $162 million under this program, which is included in treasury stock on the consolidated statements of financial position, and we had $238 million remaining available for future repurchases under the program. Purchases under the repurchase program may be made from time to time by the company in the open market at prevailing market prices (including through a Rule 10b5-1 Plan), in privately negotiated transactions, or through any combination of these methods, through September 3, 2024. The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of the company’s stock, general market and economic conditions, the company’s liquidity requirements, applicable legal requirements and other business considerations. The repurchase program does not obligate us to acquire any number of shares in any specific period or at all and may be suspended or discontinued at any time at our discretion.

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.

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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. In Texas, we are relieved of the obligation to post 75 percent of our otherwise required reserves because we operate a captive insurer approved by Texas 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 for the years ended December 31, 2022 and 2021, as reflected in the audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K, are summarized in the following table.

Operating Activities

Net cash provided from operating activities was $142 million for the year ended December 31, 2022, compared to $185 million for the year ended December 31, 2021.

Net cash provided from operating activities in 2022 comprised $151 million in earnings adjusted for non-cash charges, offset, in part, by $5 million in payments for restructuring charges and $5 million in cash used for working capital. Cash used for working capital was primarily driven by the unfavorable impact on deferred revenue of a decline in the number of first-year real estate home service plans, which are typically paid for upfront at the time of closing on the home sale. Cash used for working capital was also impacted by increased accounts payable and accrued liabilities balances due to the impact of inflation on contractor and supplier costs and trade payables.

Net cash provided from operating activities in 2021 comprised $223 million in earnings adjusted for non-cash charges, offset, in part, by $38 million in cash used for working capital. Cash used for working capital was primarily driven by the impacts on deferred revenue of a decline in the number of first-year real-estate home service plans and a shift in the mix of annual-pay customers to monthly-pay customers.

Investing Activities

Net cash used for investing activities was $35 million and $31 million for the years ended December 31, 2022 and 2021, respectively.

Capital expenditures were $40 million and $31 million in 2022 and 2021, respectively, and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2023 relating to recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately $35 million to $45 million. We have no additional material capital commitments at this time.

Cash flows provided from other investing activities in 2022 were $4 million and consisted of proceeds received from the sale of a prior customer care center in LaGrange, Georgia.

Financing Activities

Net cash used for financing activities was $77 million and $489 million for the years ended December 31, 2022 and 2021, respectively.

During the year ended December 31, 2022, we made scheduled principal payments of debt and finance lease obligations of $17 million and purchased outstanding shares of our common stock at an aggregate cost of $59 million.

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During the year ended December 31, 2021, we borrowed $638 million, net of discount, under the Term Loan Facilities, made scheduled principal payments of debt and finance lease obligations of $10 million and redeemed the remaining outstanding principal amounts of $634 million of the Prior Term Loan Facility and $350 million of the 2026 Notes. In connection with the repayments, we paid a “make-whole” redemption premium of $21 million on the 2026 Notes and debt issuance costs of $8 million. In addition, we repurchased $103 million of common stock.

Free Cash Flow

The following table reconciles net cash provided from operating activities, which we consider to be the most directly comparable U.S. GAAP measure, to Free Cash Flow using data derived from our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

Contractual Obligations

The following table presents our contractual obligations and commitments as of December 31, 2022.

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*     These items are included in the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.

(1)These amounts represent future interest payments related to existing debt obligations based on interest rates and principal maturities specified in the Credit Agreement. Payments related to the Term Loan Facilities are based on applicable variable and fixed interest rates as of December 31, 2022 plus the specified margin in the Credit Agreement for each period presented. As of December 31, 2022, the estimated debt balance as of each fiscal year ending from 2023 through 2027 is $598 million, $581 million, $564 million, $359 million and $355 million, respectively, and the weighted-average interest rate on the estimated debt balances as of each fiscal year ending from 2023 through 2027 is 5.7 percent, 5.7 percent, 6.5 percent, 6.6 percent and 6.6 percent, respectively. See Note 11 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the terms and maturities of existing debt obligations.

(2)These amounts represent future payments relating to real estate operating leases.

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Financial Position

The following discussion describes changes in our financial position from December 31, 2021 to December 31, 2022.

Intangible assets, net decreased during 2022, reflecting scheduled amortization and a $5 million impairment of intangibles related to our Streem reporting unit. See “—Critical Accounting Policies and Estimates—Goodwill and Intangible Assets” for further information.

Accounts payable increased during 2022, primarily reflecting the impact of inflation on our contractor, supplier and trade payables.

Home service plan claims increased during 2022, primarily reflecting the impact of inflation on our contractor and supplier costs.

Deferred revenue decreased during 2022, reflecting a decline in the number of first-year real estate home service plans, which are typically paid for upfront at the time of closing on the home sale.

Long-term debt decreased during 2022, reflecting scheduled debt payments.

Other long-term liabilities decreased during 2022, reflecting the change in the valuation of our interest rate swap.

Total shareholders’ equity was $61 million as of December 31, 2022 compared to $2 million as of December 31, 2021. The increase was primarily driven by net income and the change in valuation of our interest rate swap, offset, in part, by repurchases of our common stock. See the audited consolidated statements of changes in equity (deficit) included in Item 8 of this Annual Report on Form 10-K for further information.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. The cautionary statements discussed in “Cautionary Statement Concerning Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K should be read as applying to all forward-looking statements wherever they appear in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K, particularly in “Cautionary Statement Concerning Forward-Looking Statements” and “Risk Factors” included in Item 1A of this Annual Report on Form 10-K.

For a discussion of our results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of our 2020 Annual Report on Form 10-K filed with the SEC on February 23, 2021, which specific discussion is incorporated herein by reference.

Overview

Frontdoor is the leading provider of home service plans in the United States, as measured by revenue, and operates under the American Home Shield, HSA, OneGuard and Landmark brands. Our customizable home service plans help customers protect and maintain their homes, typically their most valuable asset, from costly and unplanned breakdowns of essential home systems and appliances. Our home service plan customers usually subscribe to an annual service plan agreement that covers the repair or replacement of major components of more than 20 home systems and appliances, including electrical, plumbing, central HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops, as well as optional coverages for electronics, pools, spas and pumps. Our operations also include our ProConnect on-demand home services business and Streem, a technology platform that uses augmented reality, computer vision and machine learning to, among other things, help home service professionals more quickly and accurately diagnose breakdowns and complete repairs. As of December 31, 2021, we had 2.2 million active home service plans across all 50 states and the District of Columbia.

For the year ended December 31, 2021, we generated revenue, net income and Adjusted EBITDA of $1,602 million, $128 million and $300 million, respectively. For the year ended December 31, 2020, we generated revenue, net income and Adjusted EBITDA of $1,474 million, $112 million and $270 million, respectively.

For the year ended December 31, 2021, our total operating revenue included 69 percent of revenue derived from existing customer renewals, while 16 percent and 13 percent were derived from new home service plan sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and three percent was derived from other revenue streams. For the year ended December 31, 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 home service plan sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and one percent was derived from other revenue streams.

The Spin-off

On October 1, 2018, Terminix completed the Spin-off. Frontdoor was formed as a wholly-owned subsidiary of Terminix on January 2, 2018 for the purpose of holding the Separated Business in connection with the Spin-off. During 2018, Terminix contributed the Separated Business to Frontdoor. The Spin-off was completed by a pro rata distribution to Terminix’s stockholders of approximately 80.2 percent of our common stock. Each holder of Terminix common stock received one share of our common stock for every two shares of Terminix common stock held at the close of business on September 14, 2018, the record date of the distribution. The Spin-off was completed pursuant to a separation and distribution agreement and other agreements with Terminix related to the Spin-off, including a transition services agreement, a tax matters agreement, an employee matters agreement and a stockholder and registration rights agreement. See Note 10 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information related to these agreements to the extent they are still in effect.

On March 20, 2019, Terminix agreed to transfer its remaining 16,734,092 shares of Frontdoor stock to a financial institution pursuant to an exchange agreement. Subsequent to that date, the financial institution conducted a secondary offering of those shares. The transfer was completed on March 27, 2019, resulting in the full separation of Frontdoor from Terminix and the disposal of Terminix's entire ownership and voting interest in Frontdoor.

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Key Factors and Trends Affecting Our Results of Operations

Impact of the COVID-19 Pandemic

The implications of the COVID-19 pandemic on our results of operations and overall financial performance remain uncertain. In response to the COVID-19 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 fully transitioned all of our customer service agents to work remotely from their homes, ensuring uninterrupted customer service. The majority of our remaining workforce, including those at our Memphis corporate headquarters and other locations, are also working remotely.

Increased Customer Communications. Our contractor network was designated by the U.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 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 commercial partners, we 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.

Increased Contractor Education and Communication. Because our contractor network provides essential services, it is generally operating normally despite varying state and local conditions. We are leveraging the Centers 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 within CDC 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.

Managing Supply Chain. We continue to experience global supply chain challenges, which has led to industry-wide price increases for parts and equipment as well as availability challenges across our trades as demand has outpaced production. We continue to see an elevated level of appliance service requests compared to pre-pandemic levels as customers spend more time at home in light of the COVID-19 pandemic. As a result, we have deepened and expanded our supplier relationships, improved access to appliances with the highest demand, increased speed of parts acquisition and expanded our service provider network. We continue to closely monitor the distribution of parts and replacement units and are working with our suppliers to increase availability to us. We believe our multi-vendor strategy will help mitigate these impacts on our business.

Financial Impact to our Business. During 2021, our financial condition and results of operations were adversely impacted by the COVID-19 pandemic as follows:

The tight existing home sales market continued to constrain demand for home service plans in the first-year real estate channel. Additionally, due to the annual nature of our home service plan agreements and the corresponding recognition of revenue over this annual period, real estate revenue was adversely impacted by the decline in U.S. existing home sales that occurred in 2020.

We continued to experience an increase in appliance claims compared to pre-pandemic levels primarily due to increased usage driven by customers spending greater time at home in response to COVID-19. Industry-wide parts availability challenges have caused increased cost pressure and have continued to drive elevated appliance replacement levels due to lack of parts availability, further contributing to the increased costs. In addition, during the second half of the year, we experienced rapid increases in contractor labor and contractor-supplied parts and equipment. These industry-wide challenges also impacted the customer experience, which was reflected in our customer retention rate.

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We incurred incremental customer service wages due to a higher number of service requests in the appliance trade compared to pre-pandemic levels, which was primarily a result of customers spending greater time at home in response to COVID-19. Additionally, due to labor availability challenges, we continued to experience workforce retention issues, including difficulties in hiring and retaining employees in customer service operations and throughout our business, and we believe our contractors are experiencing similar workforce challenges.

Although the economy has improved since the initial outbreak of the pandemic, we are unable to predict the time required for a widespread sustainable economic recovery to take hold. Given the wide disparities in vaccination rates driven by continued vaccine hesitancy, combined with the emergence of COVID-19 variants and surges in COVID-19 cases, we expect that a significant number of people will continue to spend greater time at home, which may result in a continued increase in usage of home systems and appliances and demand for our services and a resulting increase in service-related costs. We also expect that industry-wide supply chain challenges will continue to contribute to increased costs and impact the customer experience, which may affect customer retention. Accordingly, 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 the COVID-19 pandemic will have on our business.

Macroeconomic Conditions and Inflation

Macroeconomic conditions that may affect customer spending patterns, and thereby our results of operations, include home sales, consumer confidence and employment rates. The COVID-19 pandemic has increased economic uncertainty in these areas. We believe our ability to acquire customers through the direct-to-consumer channel helps to mitigate the effects of challenges in the real estate channel, while our nationwide presence limits the risk of poor economic conditions in any particular geography. Additionally, global supply chain challenges, ranging from raw material inflation to transportation delays and labor shortages, impact our costs and customer experience, and we continue to take actions to mitigate these impacts.

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 2021, we continued to experience additional variations as the COVID-19 pandemic resulted in an elevated level of service requests in the appliance trade compared to pre-pandemic levels as our customers spent more time at home. In 2021, approximately 21 percent, 29 percent, 29 percent and 21 percent of our revenue, approximately 4 percent, 31 percent, 60 percent and 5 percent of our net income, and approximately 12 percent, 38 percent, 41 percent and 9 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, unfavorable weather trends in the first quarter of 2021 as compared to 2020 negatively impacted contract claims costs, while favorable weather trends in the third quarter of 2021 as compared to 2020 favorably impact contract claims costs.

While weather variations as described above may affect our business, major weather events and other similar Acts of God, such as hurricanes, flooding and tornadoes, typically do not increase our obligations to provide service. Generally, repairs associated with such isolated events are addressed by homeowners’ and other forms of insurance as opposed to the home service plans that we offer.

Tariff and Import/Export Regulations

Changes in U.S. tariff and import/export regulations may impact the costs of parts, appliances and home systems. 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 parts, appliances and home systems.

Competition

We compete in the U.S. home service plan category and the broader U.S. home services industry. The home service plan category is highly competitive. The principal methods of competition, and by 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.

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Acquisition Activity

We anticipate that the highly fragmented nature of the home service plan category will continue to create strategic opportunities for acquisitions. Historically, we have used acquisitions to cost-effectively grow our customer base in high-growth geographies, 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 industry. We have also used acquisitions to enhance our technological capabilities and geographic presence. In 2019, we acquired Streem to support the service experience for our customers, reduce costs and create potential new revenue opportunities across a variety of channels. We expect to use Streem’s services in our core home service plan business and in ProConnect’s on-demand business to deliver a superior service experience and reduce our costs.

Non-GAAP Financial Measures

To supplement our results presented in accordance with U.S. GAAP, we have disclosed non-GAAP financial measures 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 measures of Adjusted EBITDA and Free Cash Flow. See “Results of Operations—Adjusted EBITDA” for a reconciliation of net income to Adjusted EBITDA and “Liquidity and Capital Resources—Free Cash Flow” for a reconciliation of net cash provided from operating activities to Free Cash Flow, as well as “Key Business Metrics” for further discussion of Adjusted EBITDA and Free Cash Flow. Management uses Adjusted EBITDA and Adjusted EBITDA margin to facilitate operating performance comparisons from period to period. We believe these non-GAAP financial measures provide investors, analysts and other interested parties useful information to evaluate our business performance as they facilitate company-to-company operating performance comparisons. Management believes Free Cash Flow is useful as a supplemental measure of our liquidity. Management uses Free Cash Flow to facilitate company-to-company cash flow comparisons, which may vary from company to company for reasons unrelated to operating performance. While we believe these non-GAAP financial measures are useful in evaluating our business, they should be considered as supplemental in nature and are not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies, limiting their usefulness as comparative measures.

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. The majority of our revenue is generated from annual home service plan agreements entered into with our customers. 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 home service plan sales, customer retention and acquisitions. We derive substantially all of our revenue from customers in the United States.

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 healthcare; contractor costs; parts, appliances and home systems costs; tariffs; insurance premiums; and various regulatory compliance costs.

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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, restricted stock units (“RSUs”), performance shares (which are contractual rights to receive a share of our common stock (or the cash equivalent thereof) upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement) and restricted stock awards (“RSAs”) are reflected in diluted earnings per share by applying the treasury stock method.

Adjusted EBITDA and Adjusted EBITDA margin. We evaluate performance based primarily on Adjusted EBITDA, which is a financial measure not calculated in accordance with U.S. GAAP. We define Adjusted EBITDA as net income before: depreciation and amortization expense; restructuring charges; provision for income taxes; non-cash stock-based compensation expense; interest expense; loss on extinguishment of debt; 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 and equity-based, long-term incentive plans.

Net Cash Provided from Operating Activities and Free Cash Flow. We focus on measures designed to monitor cash flow, including net cash provided from operating activities and Free Cash Flow, which is a financial measure not calculated in accordance with U.S. GAAP and represents net cash provided from operating activities less property additions.

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 home service plan sales and acquired accounts for the applicable period. These measures are presented on a rolling, 12-month basis in order to avoid seasonal anomalies.

Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to: revenue recognition; home service plan claims accruals; the valuation of property and equipment, goodwill and intangible assets; useful lives for depreciation and amortization expense; accruals for income tax liabilities and deferred tax accounts; stock-based compensation; and litigation. We base our estimates on historical experience and on various other factors and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our most significant estimates and judgments.

Home Service Plan Claims Accruals

Home service plan claims costs are expensed as incurred. Accruals for home service plan claims are made using internal actuarial projections, which are based on current claims and historical claims experience. Accruals are established based on estimates of the ultimate cost to settle claims. Home service plan claims take approximately three months to settle, on average, and substantially all claims are settled within six months of incurrence. The amount of time required to settle a claim can vary based on a number of factors, including whether a replacement is ultimately required. In addition to our estimates, we engage a third-party actuary to perform an accrual analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and information provided by us. We regularly review our estimates of claims costs along with the third-party analysis and adjust our estimates when appropriate. We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved. Given the current operating environment, which includes industry-wide parts and equipment availability challenges and inflation, our ability to estimate the cost to settle claims is further challenged. We believe our recorded obligations for these expenses are consistently measured. Nevertheless, changes in claims costs can materially affect the estimates for these liabilities.

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Goodwill and Intangible Assets

We assess the impairment of goodwill and indefinite-lived intangible assets annually, or more often if events or changes in circumstances indicate that the carrying value may not be recoverable. Goodwill and indefinite-lived intangible assets are tested for impairment at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If the reporting unit does not pass the qualitative assessment, then the reporting unit’s carrying value is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. Failure to achieve these expected results or market multiples may cause a future impairment of goodwill at the reporting unit. Goodwill and indefinite-lived intangible assets are considered impaired if the carrying value of the reporting unit exceeds its fair value. We conducted our annual impairment tests of goodwill and trade names as of October 1, 2021 and 2020. As of December 31, 2021, 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. There were no goodwill or trade name impairment charges recorded during the years ended December 31, 2021 or 2020. See Note 4 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information related to our goodwill and intangible assets.

Newly Issued Accounting Standards

New accounting rules and disclosure requirements can significantly impact our reported results and the comparability of our financial statements. See Note 2 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information on newly issued accounting standards.

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Results of Operations for the Years Ended December 31, 2021 and 2020

________________________________

*    not meaningful

Revenue

We reported revenue of $1,602 million and $1,474 million for the years ended December 31, 2021 and 2020, respectively. Revenue by major customer acquisition channel is as follows:

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*    not meaningful

(1)First-year revenue only.

Revenue increased 9 percent for the year ended December 31, 2021 compared to the year ended December 31, 2020, primarily driven by higher renewal revenue due to improved price realization and growth in the number of renewed home service plans. The decrease in real estate revenue primarily reflects a decline in the number of first-year real estate home service plans, offset, in part, by improved price realization. The number of real estate home service plans declined due to the historically challenging seller’s market, driven, in part, by record low home inventory levels. The increase in direct-to-consumer revenue primarily reflects improved price realization, a mix shift to higher priced products and growth in the number of first-year direct-to-consumer home service plans, mostly driven by increased investments in marketing. The increase in other revenue was primarily driven by growth in ProConnect and Streem.

Number of home service plans, growth in number of home service plans and customer retention rate are presented below.

The number of home service plans and customer retention rate as of December 31, 2021 were negatively impacted by a decline in the number of first-year real estate home service plans, which was driven by the tight existing home sales market, as well as the impact on customer experience of industry-wide supply chain challenges.

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Cost of Services Rendered

We reported cost of services rendered of $818 million and $758 million for the years ended December 31, 2021 and 2020, respectively. The following table provides a summary of changes in cost of services rendered:

The increase in contract claims costs reflects increased cost pressures across all trades due to industry-wide parts and equipment availability challenges and inflation, offset, in part, by lower service request incidence across all trades and process improvement benefits. Appliance parts availability challenges continued to drive elevated replacement levels, contributing to the increased cost pressures.

Selling and Administrative Expenses

For the years ended December 31, 2021 and 2020, we reported selling and administrative expenses of $511 million and $467 million, respectively, which comprised sales and marketing cost of $245 million and $225 million, respectively, customer service costs of $116 million and $114 million, respectively, and general and administrative expenses of $150 million and $127 million, respectively. The following table provides a summary of changes in selling and administrative expenses:

The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel, ProConnect and Streem. General and administrative costs increased compared to prior year primarily due to increased personnel costs and investments in technology. Prior year general and administrative costs include incremental direct costs related to COVID-19 of $1 million.

Depreciation Expense

Depreciation expense was $24 million and $22 million for the years ended December 31, 2021 and 2020, respectively. The increase was due to depreciation associated with capital expenditures in the period.

Amortization Expense

Amortization expense was $11 million and $12 million for the years ended December 31, 2021 and 2020, respectively. The decrease was due to certain intangible assets becoming fully amortized in the period.

Restructuring Charges

We incurred restructuring charges of $3 million and $8 million for the years ended December 31, 2021 and 2020, respectively.

In 2021, restructuring charges comprised $1 million of accelerated depreciation of certain technology systems driven by efforts to enhance our technological capabilities and $1 million of severance and other costs.

In 2020, restructuring charges comprised $3 million of lease termination costs and severance and other costs related to the decision to consolidate certain operations of Landmark with those of OneGuard, $3 million of severance costs related to the reorganization of certain sales and customer service operations and $2 million of accelerated depreciation related to the disposal of certain technology systems. As of December 31, 2020, these activities were substantially complete.

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Interest Expense

Interest expense was $39 million and $57 million for the years ended December 31, 2021 and 2020, respectively. The decrease was due to a decline in interest rates on the unhedged portion of our variable rate debt, primarily driven by the June 17, 2021 refinancing of the Prior Credit Agreement, the February 17, 2021 partial repayment of the Prior Term Loan Facility and the June 17, 2021 redemption of the 2026 Notes.

Interest and Net Investment (Income) Loss

Interest and net investment (income) loss reflects income of $1 million for the year ended December 31, 2021 and a loss of $1 million for the years ended December 31, 2020. For the year ended December 31, 2021, amounts primarily comprised interest on our cash and cash equivalents balances. For the year ended December 31, 2020, amounts primarily comprised a $3 million loss on investment, offset, in part, by interest on our cash and cash equivalents balances.

Loss on Extinguishment of Debt

Loss on extinguishment of debt was $31 million for the year ended December 31, 2021. Amounts primarily relate to the June 17, 2021 redemption of the remaining outstanding principal amounts of $534 million of the Prior Term Loan Facility and $350 million of the 2026 Notes and include a “make-whole” redemption premium of $21 million on the 2026 Notes and the write-off of $9 million of debt issuance costs and original issue discount. Additionally, $1 million relates to the February 17, 2021 partial repayment of the Prior Term Loan Facility and includes the write-off of debt issuance costs and original issue discount. There were no such charges for the year ended December 31, 2021.

Provision for Income Taxes

The effective tax rate on income was 23.4 percent and 24.5 percent for the years ended December 31, 2021 and 2020, respectively. The decrease in the effective tax rate for the year ended December 31, 2021 compared to December 31, 2020 is primarily due to income tax credits and excess tax benefits for share-based awards, offset, in part, by an increase in state income taxes.

Net Income

Net income was $128 million and $112 million for the years ended December 31, 2021 and 2020, respectively. The increase was driven by the aforementioned operating results, offset, in part, by an increase in the provision for income taxes.

Adjusted EBITDA

Adjusted EBITDA was $300 million and $270 million for the years ended December 31, 2021 and 2020, respectively. The following table provides a summary of changes in our Adjusted EBITDA.

The increase in contract claims costs reflects increased cost pressures across all trades due to industry-wide parts and equipment availability challenges and inflation, offset, in part, by lower service request incidence across all trades and process improvement benefits. Appliance parts availability challenges continued to drive elevated replacement levels, contributing to the increased cost pressures.

The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel, ProConnect and Streem. General and administrative costs increased compared to prior year primarily due to increased personnel costs and investments in technology. Prior year general and administrative costs include incremental direct costs related to COVID-19 of $1 million.

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The following table reconciles net income, which we consider to be the most directly comparable U. S. GAAP financial measure, to Adjusted EBITDA.

_________________________________

(1)We exclude restructuring charges from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability.

(2)We exclude non-cash stock-based compensation expense from Adjusted EBITDA primarily because it is a non-cash expense and because it is not used by management to assess ongoing operational performance. We believe excluding this expense from Adjusted EBITDA is useful to investors in aiding period-to-period comparability.

(3)Represents other non-operating expenses, including, for the year ended December 31, 2020, (a) a loss on investment of $3 million, (b) incremental direct costs related to the COVID-19 pandemic 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 $1 million. We have excluded these non-operating expenses from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability.

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Liquidity and Capital Resources

Liquidity

A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement contains 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 of December 31, 2021, we were in compliance with the covenants under the agreements that were in effect on such date. Based on current conditions, we do not believe the COVID-19 pandemic will affect our ongoing ability to meet the covenants in our debt instruments, including our Credit Agreement.

Cash and cash equivalents totaled $262 million and $597 million as of December 31, 2021 and 2020, respectively. Our cash and cash equivalents include balances associated with regulatory requirements in our business. See “—Limitations on Distributions and Dividends by Subsidiaries.” As of December 31, 2021 and 2020, the total net assets subject to these third-party restrictions was $175 million and $180 million, respectively. As of December 31, 2021, there were $2 million of letters of credit outstanding and $248 million of available borrowing capacity under the Revolving Credit Facility. The letters of credit are posted in lieu of cash to satisfy regulatory requirements in certain states in which we operate. Available liquidity was $336 million as of December 31, 2021, consisting of $88 million of cash not subject to third-party restrictions and $248 million of available borrowing capacity under the Revolving Credit Facility. We currently believe that cash generated from operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility as of December 31, 2021 will provide us with sufficient liquidity to meet our obligations I the short- and long-term.

We closely monitor the performance of our investment portfolio. 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.

On February 17, 2021, we repaid $100 million of outstanding principal amount of the Prior Term Loan Facility. In connection with the repayment, we recorded a loss on extinguishment of debt of $1 million, which included the write-off of debt issuance costs and original issue discount.

On June 17, 2021, we entered into the Credit Agreement, providing for the Term Loan A maturing June 17, 2026, the Term Loan B maturing June 17, 2028 and the Revolving Credit Facility, which terminates June 17, 2026. The net proceeds of the transaction, together with cash on hand, were used to redeem the remaining outstanding principal amounts of $534 million of the Prior Term Loan Facility and $350 million of the 2026 Notes at a price of 106.1%. In addition, the Revolving Credit Facility replaced the Prior Revolving Credit Facility. In connection with the repayments, we recorded a loss on extinguishment of debt of $30 million in the second quarter of 2021, which included a “make-whole” redemption premium of $21 million on the 2026 Notes and the write-off of $9 million of debt issuance costs and original issue discount. See Note 13 to the consolidated financial statements included in Item 8 of this report for more information related to our indebtedness.

On September 7, 2021, we announced a three-year repurchase authorization of up to $400 million of outstanding shares of our common stock. We expect to fund the share repurchases from net cash provided from operating activities. As of December 31, 2021, we have purchased 2,560,844 outstanding shares at an aggregate cost of $103 million under this program, which is included in treasury stock on the consolidated statements of financial position. Purchases under the repurchase program may be made from time to time by the company in the open market at prevailing market prices (including through a Rule 10b5-1 Plan), in privately negotiated transactions, or through any combination of these methods, through September 3, 2024. The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of the company’s stock, general market and economic conditions, the company’s liquidity requirements, applicable legal requirements and other business considerations. The repurchase program does not obligate us to acquire any number of shares in any specific period or at all and may be suspended or discontinued at any time at our discretion.

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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. In Texas, we are relieved of the obligation to post 75 percent of our otherwise required reserves because we operate a captive insurer approved by Texas 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 for the years ended December 31, 2021 and 2020, as reflected in the audited consolidated statements of cash flows included in Item 8 of this Annual Report on Form 10-K, are summarized in the following table.

Operating Activities

Net cash provided from operating activities was $185 million for the year ended December 31, 2021, compared to $207 million for the year ended December 31, 2020.

Net cash provided from operating activities in 2021 comprised $223 million in earnings adjusted for non-cash charges, offset, in part, by $38 million in cash used for working capital. Cash used for working capital was primarily driven by the impacts on deferred revenue of a decline in the number of first-year real-estate home service plans and a shift in the mix of annual-pay customers to monthly-pay customers.

Net cash provided from operating activities in 2020 comprised $170 million in earnings adjusted for non-cash charges and $37 million in cash provided from working capital. Cash provided from working capital was primarily driven by an increase in amounts payable to contractors and suppliers, due, in part, to the timing of claims payments as a result of industry-wide availability challenges in the appliance trade, and the timing of trade payables.

Investing Activities

Net cash used for investing activities was $31 million for each of the years ended December 31, 2021 and 2020.

Capital expenditures were $31 million in 2021 and $32 million in 2020 and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2022 relating to recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately $40 million to $50 million. We have no additional material capital commitments at this time.

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Cash payments for business acquisitions, net of cash acquired, were $5 million in 2020. During the second quarter of 2020, we acquired a business to expand our ProConnect on-demand offering for $5 million in cash. There were no acquisitions in 2021.

Cash flows provided from purchases, sales and maturities of securities, net, in 2020 were $7 million and were driven by the maturities of marketable securities. There were no cash flows provided from purchases, sales and maturities of securities in 2021.

Financing Activities

Net cash used for financing activities was $489 million and $7 million for the year ended December 31, 2021 and 2020, respectively.

During the year ended December 31, 2021, we borrowed $638 million, net of discount, under the Term Loan Facilities, made scheduled principal payments of debt and finance lease obligations of $10 million and redeemed the remaining outstanding principal amounts of $634 million of the Prior Term Loan Facility and $350 million of the 2026 Notes. In connection with the repayments, we paid a “make-whole” redemption premium of $21 million on the 2026 Notes and debt issuance costs of $8 million. In addition, we repurchased $103 million of common stock.

During the year ended December 31, 2020, we made scheduled principal payments of debt and finance lease obligations of $7 million.

Free Cash Flow

The following table reconciles net cash provided from operating activities, which we consider to be the most directly comparable U.S. GAAP measure, to Free Cash Flow using data derived from our audited consolidated financial statements.

Contractual Obligations

The following table presents our contractual obligations and commitments as of December 31, 2021.

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*     These items are reported in the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.

(1)These amounts represent future interest payments related to existing debt obligations based on interest rates and principal maturities specified in the associated debt agreements. As of December 31, 2021, payments related to the Term Loan Facility are based on applicable rates as of December 31, 2021 plus the specified margin in the Credit Agreement for each period presented. As of December 31, 2021, the estimated debt balance (including finance leases) as of each fiscal year end from 2022 through 2026 is $615 million, $598 million, $581 million, $564 million and $359 million, respectively, and the weighted-average interest rate on the estimated debt balances as of each fiscal year end from 2022 through 2026 is 3.9 percent, 3.9 percent, 4.0 percent, 2.2 percent and 2.4 percent, respectively. See Note 13 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the terms and maturities of existing debt obligations.

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Financial Position

The following discussion describes changes in our financial position from December 31, 2020 to December 31, 2021.

Cash and cash equivalents decreased during 2021, primarily due to payments of debt, net of borrowings, and repurchases of common stock, offset, in part, by cash provided from operating activities.

Accounts payable increased during 2021, reflecting the timing of trade payables.

Deferred revenue decreased during 2021, reflecting a decline in the number of first-year real estate home service plans and a shift in the mix of annual-pay customers to monthly-pay customers.

Current portion of long-term debt increased during 2021, reflecting the refinancing of our debt.

Long-term debt decreased during 2021, reflecting payments of debt, net of borrowings.

Other long-term liabilities decreased during 2021, primarily due to the change in the valuation of our interest rate swap.

Total shareholders’ equity was a surplus of $2 million as of December 31, 2021 compared to a deficit of $61 million as of December 31, 2020. The increase was primarily driven by the $128 million of net income generated in 2021, offset, in part, by repurchases of common stock. See the audited consolidated statements of changes in equity (deficit) included in Item 8 of this Annual Report on Form 10-K for further information.

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