Frontdoor, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q, the audited consolidated financial statements and related notes thereto included in our 2023 Form 10-K and with the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2023 Form 10-K. The cautionary statements discussed in “Cautionary Statement Concerning Forward-Looking Statements” and elsewhere in this report should be read as applying to all forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this report, particularly in “Cautionary Statement Concerning Forward-Looking Statements” and “Risk Factors” as well as the risk factors discussed in Part I, Item 1A. “Risk Factors” in our 2023 Form 10-K and Part II, Item 1A. “Risk Factors” of this Quarterly Report on Form 10-Q. 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 Frontdoor app empowers homeowners by connecting them in real time through video chat with qualified experts to diagnose and solve their problems. As of September 30, 2024, we had approximately two million active home warranties across all brands in the United States. For the three months ended September 30, 2024 and 2023, we generated revenue, net income and Adjusted EBITDA of $540 million, $100 million and $165 million, respectively, and $524 million, $71 million and $128 million, respectively. For the nine months ended September 30, 2024 and 2023, we generated revenue, net income and Adjusted EBITDA of $1,461 million, $226 million and $394 million, respectively, and $1,414 million, $163 million and $302 million, respectively. For a reconciliation of Adjusted EBITDA to net income, see “—Results of Operations—Adjusted EBITDA.” For the nine months ended September 30, 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 nine months ended September 30, 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 service plan 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. Acquisition of 2-10 HBW On June 3, 2024, we entered into the Purchase Agreement to acquire 2-10 HBW 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 as of the closing of the transaction. 2-10 HBW is a leading provider of new home structural warranty protection plans, which are insurance-backed offerings that provide builders’ coverage for structural failures. 2-10 HBW also provides direct-to-consumer home warranties. The transaction is supported by a fully committed bridge facility under our existing Credit Agreement and cash. Permanent financing is expected to consist of new term loan borrowings. The applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, expired on July 17, 2024, at 11:59 p.m. Eastern Time, and applicable regulators in Florida and the District of Columbia have approved the transaction subject to customary regulatory conditions. The transaction is anticipated to close in the fourth quarter of 2024, subject to additional regulatory approval and other customary closing conditions. 19 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 the nine months ended September 30, 2024 as compared to the nine months ended September 30, 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 high interest rates combined with low home inventory levels, continue to constrain demand for home warranties. • 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. • 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 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 the third quarter of 2024 as compared to the third quarter of 2023 resulted in a lower number of 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 could increase the costs of our parts, appliances and home systems. 20 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. 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 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. For example, on June 3, 2024, we entered into the Purchase Agreement to acquire 2-10 HBW, a leading provider of new home structural warranty protection plans. See “—Acquisition of 2-10 HBW” for additional information related to the pending 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: • revenue, • operating expenses, • gross profit, • gross profit margin, • 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. 21 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 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), 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 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. Critical Accounting Policies and Estimates Our critical accounting policies and estimates are described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2023 Form 10-K. There have been no material changes to our critical accounting policies for the nine months ended September 30, 2024. 22 Results of Operations Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023 % of Revenue Three Months Ended Increase Three Months Ended September 30, (Decrease) September 30, (In millions) 2024 2023 % 2024 2023 Revenue $ 540 $ 524 3 % 100 % 100 % Cost of services rendered 235 256 (8 ) 43 49 Gross Profit 306 268 14 57 51 Selling and administrative expenses 154 152 1 29 29 Depreciation and amortization expense 10 9 4 2 2 Restructuring charges 3 5 (33 ) 1 1 Interest expense 10 10 (4 ) 2 2 Interest and net investment income (5 ) (4 ) 14 (1 ) (1 ) Income before Income Taxes 134 96 40 25 18 Provision for income taxes 34 24 39 6 5 Net Income $ 100 $ 71 40 % 19 % 14 % Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 % of Revenue Nine Months Ended Increase Nine Months Ended September 30, (Decrease) September 30, (In millions) 2024 2023 % 2024 2023 Revenue $ 1,461 $ 1,414 3 % 100 % 100 % Cost of services rendered 655 706 (7 ) 45 50 Gross Profit 806 708 14 55 50 Selling and administrative expenses 456 439 4 31 31 Depreciation and amortization expense 28 28 — 2 2 Restructuring charges 5 6 (28 ) — — Interest expense 29 30 (2 ) 2 2 Interest and net investment income (15 ) (12 ) 22 (1 ) (1 ) Income before Income Taxes 303 217 39 21 15 Provision for income taxes 77 54 41 5 4 Net Income $ 226 $ 163 39 % 15 % 12 % 23 Revenue We reported revenue of $540 million and $524 million for the three months ended September 30, 2024 and 2023, respectively, and $1,461 million and $1,414 million for the nine months ended September 30, 2024 and 2023, respectively. The following tables provide a summary of our revenue by major customer acquisition channel: Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023 Three Months Ended September 30, Increase (Decrease) (In millions) 2024 2023 $ % Renewals $ 422 $ 406 $ 16 4 % Real estate (1) 36 40 (4 ) (10 ) Direct-to-consumer (1) 49 54 (5 ) (10 ) Other 34 24 10 41 Total $ 540 $ 524 $ 16 3 % (1) First-year revenue only. Revenue increased three percent for the three months ended September 30, 2024 compared to the three months ended September 30, 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 decreases in real estate revenue and direct-to-consumer revenue primarily reflect a decline in the number of home warranties driven by the challenging real estate market and the impact of inflation on consumer sentiment. The increase in other revenue was driven by growth in on-demand home services, primarily new HVAC sales. Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 Nine Months Ended September 30, Increase (Decrease) (In millions) 2024 2023 $ % Renewals $ 1,141 $ 1,083 $ 58 5 % Real estate (1) 99 115 (16 ) (14 ) Direct-to-consumer (1) 135 157 (22 ) (14 ) Other 86 59 26 45 Total $ 1,461 $ 1,414 $ 47 3 % (1) First-year revenue only. Revenue increased three percent for the nine months ended September 30, 2024 compared to the nine months ended September 30, 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 decreases in real estate revenue and direct-to-consumer revenue primarily reflect a decline in the number of home warranties driven by the challenging real estate market and the impact of inflation on consumer sentiment. The increase in other revenue was driven by growth in on-demand home services, primarily new HVAC sales. The following table provides a summary of the number of home warranties, reduction in number of home warranties and customer retention rate: As of September 30, (In millions) 2024 2023 Number of home warranties 1.95 2.04 Reduction in number of home warranties (4 ) % (6 ) % Customer retention rate 77.7 % 76.2 % The reduction in the number of home warranties as of September 30, 2024 was primarily driven by the challenging real estate market and the impact of inflation on consumer sentiment. 24 Cost of Services Rendered We reported cost of services rendered of $235 million and $256 million for the three months ended September 30, 2024 and 2023, respectively, and $655 million and $706 million for the nine months ended September 30, 2024 and 2023, respectively. The following tables provide a summary of the changes in cost of services rendered: Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023 (In millions) Three Months Ended September 30, 2023 $ 256 Impact of change in revenue — Contract claims costs (21 ) Other (1 ) Three Months Ended September 30, 2024 $ 235 The decrease in contract claims costs primarily reflects a lower number of service requests per customer, which was primarily driven by a favorable weather impact of $14 million, as milder weather drove a lower number of service requests in the HVAC trade. The decrease also included the impact of higher trade service fees, which favorably impacted the net cost per service request, and continued process improvements, 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 $3 million favorable adjustment related to the development of prior period claims, compared to a $9 million favorable adjustment in the third quarter of 2023. Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 (In millions) Nine Months Ended September 30, 2023 $ 706 Impact of change in revenue (1 ) Contract claims costs (48 ) Other (2 ) Nine Months Ended September 30, 2024 $ 655 The decrease in contract claims costs primarily reflects the impact of higher trade service fees, which drove a lower number of service requests per customer and a lower net cost per service request, a favorable weather impact of $10 million, as milder weather drove a lower number of 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 $4 million favorable adjustment related to the development of prior period claims, compared to a $9 million favorable adjustment in the first nine months of 2023. Selling and Administrative Expenses We reported selling and administrative expenses of $154 million and $152 million for the three months ended September 30, 2024 and 2023, respectively, and $456 million and $439 million for the nine months ended September 30, 2024 and 2023, respectively. The following table provides a summary of the components of selling and administrative expenses: Three Months Ended Nine Months Ended September 30, September 30, (In millions) 2024 2023 2024 2023 Sales and marketing costs $ 80 $ 81 $ 231 $ 228 Customer service costs 27 27 79 80 General and administrative costs 48 44 147 131 Total $ 154 $ 152 $ 456 $ 439 25 The following tables provide a summary of the changes in selling and administrative expenses: Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023 (In millions) Three Months Ended September 30, 2023 $ 152 Sales and marketing costs (1 ) Stock-based compensation expense (2 ) Acquisition-related costs 3 Other general and administrative costs 3 Three Months Ended September 30, 2024 $ 154 Acquisition-related costs are related to 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 professional fees and personnel costs. Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 (In millions) Nine Months Ended September 30, 2023 $ 439 Sales and marketing costs 3 Customer service costs (2 ) Acquisition-related costs 9 Other general and administrative costs 7 Nine Months Ended September 30, 2024 $ 456 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 related to 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 $9 million and $8 million for the three months ended September 30, 2024 and 2023, respectively, and $26 million and $24 million for the nine months ended September 30, 2024 and 2023, respectively. Amortization expense was $1 million for each of the three months ended September 30, 2024 and 2023 and $2 million and $3 million for the nine months ended September 30, 2024 and 2023, respectively. Restructuring Charges We had restructuring charges of $3 million and $5 million during the three months ended September 30, 2024 and 2023, respectively, and $5 million and $6 million for the nine months ended September 30, 2024 and 2023, respectively. For the three months ended September 30, 2024, restructuring charges include $3 million of severance costs. For the nine months ended September 30, 2024, restructuring charges include $4 million of severance costs and $1 million of expenses related to the exit of certain operating leases. For the three and nine months ended September 30, 2023, restructuring charges primarily include a $2 million impairment charge related to our Phoenix, Arizona customer service center’s operating lease right-of-use asset and the related fixed assets and $2 million of professional fees, with the balance comprised of severance costs. The impairment charge was the result of our decision to exit the leased property. Interest Expense Interest expense was $10 million for each of the three months ended September 30, 2024 and 2023 and $29 million and $30 million for the nine months ended September 30, 2024 and 2023, respectively. 26 Interest and Net Investment Income Interest and net investment income was $5 million and $4 million for the three months ended September 30, 2024 and 2023, respectively, and $15 million and $12 million for the nine months ended September 30, 2024 and 2023, respectively. The increases were driven by higher interest rates on our cash and cash equivalent balances. Provision for Income Taxes The effective tax rate on income before income taxes was 25.1 percent and 25.3 percent for the three months ended September 30, 2024 and 2023, respectively, and 25.3 percent and 25.1 percent for the nine months ended September 30, 2024 and 2023, respectively. Net Income Net income was $100 million and $71 million for the three months ended September 30, 2024 and 2023, respectively, and $226 million and $163 million for the nine months ended September 30, 2024 and 2023, respectively. The increases were driven by the operating results discussed throughout “—Results of Operations” above. Adjusted EBITDA Adjusted EBITDA was $165 million and $128 million for the three months ended September 30, 2024 and 2023, respectively, and $394 million and $302 million for the nine months ended September 30, 2024 and 2023, respectively. The following tables provide a summary of the changes in our Adjusted EBITDA: Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023 (In millions) Three Months Ended September 30, 2023 $ 128 Impact of change in revenue 17 Contract claims costs 21 Sales and marketing costs 1 General and administrative costs (3 ) Interest and net investment income 1 Other 1 Three Months Ended September 30, 2024 $ 165 The impact of change in revenue is primarily driven by improved price realization, offset, in part, by the reduction in number of home warranties. The decrease in contract claims costs primarily reflects a lower number of service requests per customer, which was primarily driven by a favorable weather impact of $14 million, as milder weather drove a lower number of service requests in the HVAC trade. The decrease also included the impact of higher trade service fees, which favorably impacted the net cost per service request, and continued process improvements, 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 $3 million favorable adjustment related to the development of prior period claims, compared to a $9 million favorable adjustment in the third quarter of 2023. Other general and administrative costs increased primarily due to increased professional fees and personnel costs. Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 (In millions) Nine Months Ended September 30, 2023 $ 302 Impact of change in revenue 48 Contract claims costs 48 Sales and marketing costs (3 ) Customer service costs 2 General and administrative costs (7 ) Interest and net investment income 3 Other 2 Nine Months Ended September 30, 2024 $ 394 27 The impact of change in revenue is primarily driven by improved price realization, offset, in part, by the reduction in number of home warranties. The decrease in contract claims costs primarily reflects the impact of higher trade service fees, which drove a lower number of service requests per customer and a lower net cost per service request, a favorable weather impact of $10 million, as milder weather drove a lower number of 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 $4 million favorable adjustment related to the development of prior period claims, compared to a $9 million favorable adjustment in the first nine months of 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: Three Months Ended Nine Months Ended September 30, September 30, (In millions) 2024 2023 2024 2023 Net Income $ 100 $ 71 $ 226 $ 163 Depreciation and amortization expense 10 9 28 28 Restructuring charges (1) 3 5 5 6 Acquisition-related costs (1) 3 — 9 — Provision for income taxes 34 24 77 54 Non-cash stock-based compensation expense (2) 6 8 20 21 Interest expense 10 10 29 30 Adjusted EBITDA $ 165 $ 128 $ 394 $ 302 (1) We exclude restructuring charges and acquisition-related costs 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. 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 September 30, 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 totaled $375 million and $325 million as of September 30, 2024 and December 31, 2023, 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 September 30, 2024 and December 31, 2023, the total net assets subject to these third-party restrictions were $161 million and $157 million, respectively. As of September 30, 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, cash available from our committed financing arrangements and available borrowing capacity under the Revolving Credit Facility as of September 30, 2024 will provide us with sufficient liquidity to meet our obligations in the short- and long-term, including the 2-10 HBW Acquisition. We closely monitor the performance of our investment portfolio, primarily cash deposits. 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. 28 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. Acquisition of 2-10 HBW On June 3, 2024, we entered into the Purchase Agreement to acquire 2-10 HBW 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 as of the closing of the transaction. 2-10 HBW is a leading provider of new home structural warranty protection plans, which are insurance-backed offerings that provide builders’ coverage for structural failures. 2-10 HBW also provides direct-to-consumer home warranties. The transaction is supported by a fully committed bridge facility under our existing Credit Agreement and cash. Permanent financing is expected to consist of new term loan borrowings. The applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, expired on July 17, 2024, at 11:59 p.m. Eastern Time, and applicable regulators in Florida and the District of Columbia have approved the transaction subject to customary regulatory conditions. The transaction is anticipated to close in the fourth quarter of 2024, subject to additional regulatory approval and other customary closing conditions. 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 September 30, 2024, we have not made any repurchases under this program. We expect to fund share repurchases from net cash provided from operating activities. On September 7, 2021, we announced a three-year repurchase authorization of up to $400 million of outstanding shares of our common stock over the three-year period from September 3, 2021 through September 3, 2024. At the time of expiration, we repurchased a total of 11,319,091 outstanding shares at an aggregate cost of $400 million under this program, which is included in treasury stock on the condensed consolidated statements of financial position included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 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 are obligated to make funds available to us through the payment of dividends. 29 Cash Flows Cash flows from operating, investing and financing activities, as reflected in the condensed consolidated statements of cash flows included in Part I, Item 1 of this Quarterly Report on Form 10-Q are summarized in the following table: Nine Months Ended September 30, (In millions) 2024 2023 Net cash provided from (used for): Operating activities $ 212 $ 139 Investing activities (31 ) (23 ) Financing activities (131 ) (88 ) Cash increase during the period $ 50 $ 28 Operating Activities Net cash provided from operating activities was $212 million and $139 million for the nine months ended September 30, 2024 and 2023, respectively. Net cash provided from operating activities for the nine months ended September 30, 2024 comprised $281 million in earnings adjusted for non-cash charges, offset, in part, by $66 million in cash used for working capital and $3 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 for the nine months ended September 30, 2023 comprised $207 million in earnings adjusted for non-cash charges, offset, in part, by $68 million in cash used for working capital. Cash used for working capital was primarily driven by seasonality, favorable development of prior period claims and 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. Investing Activities Net cash used for investing activities was $31 million and $23 million for the nine months ended September 30, 2024 and 2023, respectively. Capital expenditures were $31 million and $23 million for nine months ended September 30, 2024 and 2023, 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 $40 million. Other than the pending acquisition of 2-10 HBW, we have no additional material capital commitments at this time. Financing Activities Net cash used for financing activities was $131 million and $88 million for the nine months ended September 30, 2024 and 2023, respectively. For the nine months ended September 30, 2024, we made scheduled principal payments of debt of $13 million and purchased outstanding shares of our common stock at an aggregate cost of $120 million. Repurchases of common stock included associated commissions and taxes of $1 million. For the nine months ended September 30, 2023, we made scheduled principal payments of debt of $13 million and purchased outstanding shares at an aggregate cost of $76 million. 30 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 condensed consolidated statements of cash flows in Part 1, Item 1 of this Quarterly Report on Form 10-Q: Nine Months Ended September 30, (In millions) 2024 2023 Net cash provided from operating activities $ 212 $ 139 Property additions (31 ) (23 ) Free Cash Flow $ 181 $ 116 Contractual Obligations Our 2023 Form 10-K includes disclosures of our contractual obligations and commitments as of December 31, 2023. We continue to make the contractually required payments associated with these commitments. On June 3, 2024, we entered into the Purchase Agreement to acquire 2-10 HBW 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 as of the closing of the transaction. The transaction is supported by a fully committed bridge facility under our existing Credit Agreement and cash. Permanent financing is expected to consist of new term loan borrowings. The transaction is anticipated to close in the fourth quarter of 2024, subject to regulatory approval and other customary closing conditions. Financial Position A summary of the significant changes in our financial position from December 31, 2023 to September 30, 2024 is as follows: • Cash and cash equivalents increased during the nine months ended September 30, 2024, reflecting cash provided from operating activities, offset, in part, by capital expenditures, scheduled principal payments of debt and purchases of outstanding shares. • Contract assets increased during the nine months ended September 30, 2024, reflecting the recognition of monthly-pay customer revenue on an other-than-straight-line basis to match the timing of cost recognition. • Accounts payable increased during the nine months ended September 30, 2024, reflecting the timing of trade payables driven by seasonality. • Accrued liabilities—Other increased during the nine months ended September 30, 2024, reflecting an increase in federal income tax payable. • Deferred revenue decreased during the nine months ended September 30, 2024, reflecting recognition of revenue on an other-than-straight-line basis to match the timing of cost recognition and 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 the nine months ended September 30, 2024, reflecting scheduled debt payments. • Total shareholders’ equity was $261 million as of September 30, 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 condensed consolidated statements of changes in equity (deficit) included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. 31