Frontdoor Inc (FTDR) Q3 2021 Earnings Call Transcript

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Frontdoor Inc (FTDR 0.75%)
Q3 2021 Earnings Call
Oct 28, 2021, 6:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, welcome to Frontdoors Third Quarter 2021 Earnings Call. Todays call is being recorded and being broadcasted on the Internet.

Beginning todays call is Matt Davis, Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call. At this time, well begin todays call. Please go ahead, Mr. Davis.

Matthew S. Davis -- Vice President of Investor Relations & Treasurer

Thank you, operator. Good afternoon, everyone, and thank you for joining Frontdoors Third Quarter 2021 Earnings Conference Call. Joining me today are Frontdoors Chief Executive Officer, Rex Tibbens, and Frontdoors Chief Financial Officer, Brian Turcotte. The press release and slide presentation that will be used during todays call can be found on the Investor Relations section of Frontdoors website, which is located at investors.frontdoorhome.com. As stated on slide two of the presentation, Id like to remind you that this call and webcast may contain forward-looking statements. These statements are subject to various risks and uncertainties, which could cause actual results to materially differ from those discussed here today.

These risk factors are explained in detail in the companys filings with the SEC. Please refer to the Risk Factors section in our filings for a more detailed discussion of our forward-looking statements and the risks and uncertainties related to such statements. All forward-looking statements are made as of today, October 28. And except as required by law, the company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. We will also reference certain non-GAAP financial measures throughout todays call. We have included definitions of these terms and reconciliations of these non-GAAP financial measures to the notes of comparable GAAP financial measures in our press release and the appendix to the presentation in order to better assist you in understanding our financial performance. Ill now turn the call over to Rex for opening comments. Rex?

Rex Tibbens -- President, Chief Executie Officer & Director

Thanks, Matt, and good afternoon, everyone. In the third quarter, Frontdoor delivered strong financial results. While this speaks to the progress our organization has made, theres still much more we are doing to build a strong foundation for the future. Starting on slide four. Since the onset as a public company, Frontdoors vision is to redesign the home services space and become a top provider of residential repair and maintenance solutions, and this vision remains as strong as ever. We believe the total addressable market for U.S. home services is approximately $400 billion, and no one company has yet to provide an ideal homeowner experience. We believe that Frontdoor is well positioned to become the industry leader over time. Home repair represents about 25% of the addressable home services market, and its the most challenging segment to operate in as the customer already has something broken, and thats where we have mainly operated over our 50-year history. Looking ahead, the long-term road map includes expansion into home maintenance services, and eventually, home improvement as a way to appeal to a broader customer base. We are doing this by transforming the way we evolve the customer experience, from a difficult manual process to a seamless and digital best-in-class experience that homeowners will love. Our long-term vision remains the same: to provide excellent service and take the hassle out of homeownership. While the pandemic has presented a number of challenges to us, our contractors, our vendors and our customers, we still have made significant progress over the last few years.

However, were not satisfied at the pace of change and need to accelerate the advancement of our technology initiatives as fast as possible. Ill speak more about that in a moment. Our first priority is to pivot and narrow our near-term focus on improving the customer experience for our core home service plan customers. Well do this by providing digital self-service options and prioritizing a mobile-first strategy. This includes developing an application or app to better interact with our customers, which we are targeting to launch next year. We already offer a self-service option through our mobile web customer portal, but we will further enhance this functionality for our app. Additionally, we will also further leverage the synergies and functionality of Streem, our proprietary remote video communications platform; and ProConnect, our on-demand service across our core business to improve the overall experience. We see a future of a digital-first approach to customer problem solving through Streem as well as providing more maintenance services through ProConnect for a more holistic approach to solving everyday hassles of homeownership. Providing home service plans represents the vast majority of our business today, and our success is due to offering a dual value proposition of providing critical budget protection from unplanned out-of-pocket expenses and the convenience of using our qualified network of providers to complete the appliance or system repair.

Thats why its critical we improve the customer experience to achieve our long-term objectives in the larger home services space. By making it easier and seamless for customers and contractors to do business with us, we will improve the customer and contractor retention, drive revenue growth, improve service efficiency and move further toward a best-in-class offering. Were also expanding into the larger home services market through our on-demand offering, ProConnect, and believe we are well positioned to emerge as the leader in home services space over time. One of the main reasons I joined Frontdoor was the appealing proposition of transitioning an established nationwide network of contractors focused on home service plans to support an on-demand offering, and that is still the case today. We remain on track to deliver over $20 million of on-demand revenue in 2021 as we have expanded the depth of our services in the market. Looking forward, we expect ProConnects growth to continue to be strong. However, it may be somewhat slower than the outlook I shared with you late last year. A lot has changed over the last 1.5 years or so. Building a new business takes time and investment, and we are now moving forward with an intentional balance between cost and growth, especially during this period of continued uncertainty.

Weve had several learnings during the first year of operating ProConnect, and I firmly believe in the symbiotic relationship between our home service plan and on-demand businesses. While we have been driving higher demand through ProConnects stand-alone digital marketing efforts, theres still more we need to do to enhance our overall stand-alone digital sales process. We also would like to create more job leads through our existing and prospective home service plan customer base. Were seeing mid-single-digit repeat business within the ProConnect customer base that is primarily driven by our appliance trade. Our plumbing and electric trade expansions took longer to ramp, but we are now beginning to perform. We are continuing to apply these and other learnings, and well adjust our go-to-market strategy to obtain optimized results. As a result, we are now targeting ProConnects revenue to be more than double in 2022 from the $20 million target in 2021, and we will provide further updates on our outlook in February. Now turning to slide five and a discussion of the historically challenging market dynamics impacting our real estate channel. Similar to past quarters, the National Association of Realtors, or NAR, reported a tight existing home sales market with homes remaining in the market for only 17 days and overall inventory levels at a near record low of 2.4 months.

Additionally, you can see that NAR reported a significant rebound in existing home sales late last year that contributed to the tight market conditions. In this sellers market, we expect it will continue to be difficult to sell a home service plan as part of the real estate transaction for the next several quarters as this tight market does not show signs of loosening anytime soon. Data from the home service plan industry is limited, but we are confident that most of the decline in our unit sales is due to the unprecedented market dynamics and that similar challenges are being faced by many of our competitors. We also believe that this decline is transitory and that we will see improvements after the housing market reverts to more of a normal supply demand balance. Now turning to the business update on slide six. Let me start by saying that we continue to look for opportunities to mitigate the impact of the sellers market and reinvigorate our revenue growth within our real estate channel. As I mentioned on our last call, we are refining in three ways. First, our D2C channel launched a marketing campaign that is specifically crafted for targeting recent homebuyers. While we are seeing early success from this program, it is very new and will take time to grow.

Second, we have a new real estate channel campaign that is aimed at reinforcing the value proposition of home service plans with both real estate agents and homebuyers. Were also continuing to focus on top brokers and agents to drive growth across our top national accounts. And third, we are focused on expanding our strategic partnership opportunities beyond our current real estate brokerage agreements. Further diversifying our partnership and distribution channels will open new channels for growth as well as help mitigate swings in the real estate market. We remain focused on doing just that by expanding and growing into new segments over the next several years. While we expect the first year real estate channel to decline in the third quarter, we also faced some headwinds in the direct-to-consumer or D2C channel and in renewals. Let me provide details in each of these areas. After a very strong performance in 2020, weve had some challenges in our D2C channel this year as a result of a number of changing dynamics. The good news is that we believe most of these challenges are largely behind us, and we will regain our momentum over the next few quarters. Let me provide some additional context on the challenges we faced. The primary drivers were lower-than-expected customer demand and higher-than-expected advertising costs driven by competition for advertising inventory. For example, we saw a nearly 20% decline in Internet search demand for the home service plan category in the third quarter of 2021 compared to the prior year period as customers emerged from lockdown and drove lower TV viewership and less digital search.

Youll recall that we saw strong marketing efficiency last year as our value proposition resonated extremely well with customers sheltering at home, and advertising rates were very favorable. The transition to the current environment has been more challenging than expected, with our D2C broadcast rate increasing more than 50% during the second and third quarters of 2021 compared with prior year period on a like-for-like basis. This was much more than we anticipated as demand rebounded back from the pandemic-driven lows we saw late last year. In response, we have diversified our demand mix, pivot to find new sources of demand and reevaluate our conversion funnel to improve the sales process. This includes moving to new digital sources and implementing an expanded broadcast strategy. We believe these changes will return customer demand for our products to levels we originally projected. Second, we launched our Good, Better, Best product lineup in the D2C channel, and homeowners love the offerings. However, our sales teams took longer than expected to ramp and become proficient at selling our higher-priced but higher-value new products to customers. We quickly responded and improved how our sales teams positioned our new products through better trading and technology. Weve already seen improvements to expected performance levels from earlier in the year. And third, the transition of technology from our legacy e-commerce platform to a more modern architecture took longer than expected.

While we intended to drive better lead conversion, the initial transition did not optimize our search traffic as well as we had expected. In response, weve improved our e-commerce platform through additional A/B testing and optimization to help drive the higher conversion for customers navigating our website. Finally, the team understands D2C is our biggest lever for new unit growth, and we simply must execute our plan more quickly and flawlessly going forward. This is a channel that can return to double-digit revenue growth next year. But again, it will take a few quarters for our volume improvements to show up in reported revenue. The good news is that we will see more price and mix driving strong revenue growth as unit volume recovers to more normalized levels. We remain laser-focused on improving our customer retention rate. However, our customer retention rate rounded down to 74% in the third quarter. While the decline is mostly due to a drop in new customers, specifically in our real estate channel, it is also being impacted by our dynamic pricing model, continued challenges across the global supply chain and the overall customer experience. As I mentioned before, we are constantly adjusting our dynamic pricing model to adjust for new information and adjust customer pricing. A lot of these changes was to intentionally increase prices for our highest-usage customers.

While our prices continue to be inelastic, we saw more cancels than expected from those higher-usage customers that received the highest price increases. This has impacted our revenue retention rate and customer growth. However, the intentional pruning of our lowest gross margin customers was a contributor to our strong financial performance this quarter, which Brian will review in a moment. While this action may have increased gross profit in the short term, we have since taken a longer view and made changes to our model to reduce the cancellation rate across our highest-risk customers by pacing our price increases out over a longer time frame with only a minimal impact to margins. Additionally, we continue to be faced with sourcing disruptions as a result of a challenging global supply chain, which continues to add friction to the overall customer experience. We are seeing the greatest impact on our appliance trade and with certain HVAC parts. While we are seeing some improvement in parts and equipment availability over the last months, we are still not back to pre-pandemic levels. Global supply chains continue to be very fragile with great uncertainty around transportation, labor and ship availability for at least the next six to 12 months.

Our team continues to do a great job of mitigating the impact as much as they can, but we expect cost inflation and parts and equipment availability challenges to impact our cost and customer experience heading into next year. While Im disappointed we couldnt continue the momentum we generated in increasing the customer retention rate that we began last year, I remain positive that we are doing the right things to improve it going forward. As I mentioned earlier, our number one near-term objective is to improve the customer experience. Our new Chief Digital Officer, Tony Bacos, and his team are extremely focused on improving the customer experience and have developed a set of digital-first tenets to help guide our near-term technology efforts. Customer expectations and comfort using digital tools are increasing. In short, anything our customers can do over the phone, they should be able to do using a mobile app, mobile web or desktop experience. We are committed to providing customers with digital self-service options, with mobile being a priority.

Weve made significant progress on certain aspects of the experience, such as our appliance and contractor portals, but we intend to do more to transform the entire experience into a digital one. We want us to evolve quickly, and the team is focused on reducing friction points across our system and increasing digital and mobile interactions with our customers over the course of the next 12 to 18 months. While we face some near-term challenges, our long-term vision remains as strong as ever. We are still delivering strong profitability and growth despite unprecedented real estate market conditions, a difficult supply chain and ongoing challenges from the pandemic that will last until 2022. Well continue to look for opportunity to grow faster while transforming our service experience into a digital one. We are playing the long game, and we are focused on strengthening our foundation to deliver strong and consistent growth in the future. Ill now turn the call over to Brian. Brian?

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Thanks, Rex, and good afternoon. Lets now turn to slide seven, and Ill review our third quarter 2021 financial results. Revenue increased 7% versus the prior year period to $471 million, primarily driven by higher pricing in our home service plans and strong year-over-year growth in both ProConnect and Streem. Tight price accounted for 5% of our revenue growth, while volume accounted for 2% of our growth, primarily from ProConnect and Streem as the number of home service plan customers remained relatively flat versus the prior year period as volume gains and renewals were offset by challenges in the first year real estate channel. Looking at our home service plan channels. Revenue derived from customer renewals was up 8% versus the prior year period due to improved price realization and growth in the number of renewed home service plans. First year real estate revenue was down 5% versus the prior year period, primarily due to a decline in the number of home service plans in this channel as a result of the tight existing home sales market, partly offset by improved price realization. Direct-to-consumer or D2C channel revenue was up 7% versus the prior year period, primarily due to improved price realization, driven by both our new product mix and normal rate increases. As a reminder, our new Good, Better, Best product mix in the D2C channel was launched earlier this year and consists of the Silver, Gold and Platinum offerings.

These are higher-priced but more inclusive coverage products compared to our previous offerings, and we believe it will drive greater customer satisfaction and higher retention. Revenue reported in our other channel increased $6 million over the prior year period, primarily due to continued growth at ProConnect and Streem. ProConnect revenue was $4 million and Streems revenue was $3 million in the third quarter. September year-to-date, ProConnect revenue was $14 million and Streems revenue was $7 million. As Rex mentioned earlier, ProConnect is tracking to generate more than $20 million of revenue for full year 2021. We plan to more than double that amount of revenue in 2022. Gross profit increased 18% in the third quarter versus the prior year period to $254 million. And our gross profit margin was 54%, approximately 500 basis points higher than the prior year period and our highest gross profit margin over 15 years. One of the primary drivers of this improvement is the favorability of contract claims costs over the prior year period, primarily due to a lower number of service requests across all trades and the continued flow-through of process improvement benefits. Some of these benefits include dynamic pricing, improved contractor deployment, technology enhancements in our service software and cross-functional team efforts across our platform.

Higher margins flowed through net income which was $76 million for the third quarter. Adjusted net income increased 55% from the prior year period to $78 million. Adjusted EBITDA was $122 million in the third quarter or 34% higher than the prior year period. This exceeded our guidance range by more than $20 million as a result of improved gross profit margin as well as better-than-expected results from our cost-management initiatives. Lets move to the table on slide eight, and Ill walk through the adjusted EBITDA bridge from third quarter 2020 to third quarter 2021. Starting at the top. We had $24 million of favorable revenue conversion in the third quarter versus the prior year period. As a reminder, revenue conversion includes the impact of the change in the number of home service plans as well as the impact of year-over-year price changes. The impact of the change in the number of home service plans considers the associated revenue on those plans less an estimate of contract claims cost based on margin experience in the prior year period. Contract claims costs slipped in the third quarter to a favorable variance of $16 million versus the prior year period, but excluding the impact of the change from higher revenue. As a reminder, contract claims costs include the impact of changes in the number of service requests and cost inflation.

As I mentioned, the favorability of contract claims costs over the prior year period was primarily due to a lower number of service requests across all trades and process improvement benefits. Were lapping the higher-than-normal COVID-19-related contract claims in the third quarter 2020 and also have lower HVAC service requests due milder temperatures across Texas and the Southeast. These benefits were partly offset by higher cost inflation, including unfavorable cost trends due to industrywide parts and equipment availability challenges. In regard to weather, during the third quarter, we noted the U.S. was approximately 3% cooler than the prior year period, and we benefited in key HVAC markets, as I just mentioned. We estimate the stable weather impact on claims costs in the third quarter to be approximately $4 million. Sales and marketing costs increased $7 million in the third quarter versus the prior year period and primarily included investments in the D2C channel. On our previous earnings call, we told you that we anticipated spending $13 million more this quarter versus the prior year period. But due to the transition in our marketing tactics, we pulled back on our spending and shifted more into fourth quarter to ensure a more efficient deployment of our resources. Customer service costs decreased $1 million in the third quarter versus the prior year period due to a lower number of service requests and challenges in hiring and retaining customer service staff.

And finally, general and administrative costs increased $3 million in the third quarter versus the prior year period due to higher personnel costs and investments in technology. Please now turn to slide nine for a review of our cash flow and cash position for third quarter 2021 compared to the prior year period. Net cash provided from operating activities was $142 million for the nine months ended September 30, 2021. It was comprised of $207 million in earnings adjusted for noncash charges, offset in part by $65 million of cash used for working capital. Cash used for working capital was driven by normal seasonality and the impacts on deferred revenue related to a decline in the number of first year real estate home service plans and a higher proportion of monthly paid customers. As a reminder, in the real estate channel, we typically collect the annual value of the home service plan upfront through the closing process when the home is sold, and these funds are reported as deferred revenue on the balance sheet until recognized. The decline in first year real estate plans is the primary driver for our lower deferred revenue balance. Net cash used for investing activities was $23 million and was primarily comprised of technology-related capital expenditures. Net cash used for financing activities was $407 million, reflecting a debt reduction in refinancing in the first half of the year and share repurchases in the third quarter.

As we announced in September, our Board of Directors approved a 3-year $400 million share repurchase program, and we repurchased $25 million worth of stock during the third quarter. Free cash flow, calculated as net cash provided from operating activities minus property additions, was $119 million for the nine months ended September 30, 2021, compared to $127 million for the prior year period. We ended the third quarter of 2021 with $309 million in total cash, which included restricted net assets of $178 million and unrestricted cash of $131 million. Our unrestricted cash, combined with $248 million of available capacity under our revolving credit facility, provides us with a solid available liquidity position of $379 million. As we continue to generate robust free cash flow, were targeting a full year 2021 adjusted EBITDA conversion to free cash flow of approximately 55% or a range of $170 million to $175 million. Going forward, our capital allocation strategy remains the same. First, well invest for growth, which includes organic investments and acquisitions. Were focused on finding the right balance of organic investment to drive both higher revenue growth and consistently strong margins. In terms of acquisitions, we continue to evaluate opportunities in the larger home services space as well as in technology to drive the demand side or the supply side of our business.

Our second objective is to provide a prudent debt structure for the long term, and we achieved our objective with the debt repayment and refinancing completed in June. The benefits of this refinancing show up on our balance sheet and on the interest expense line, which is half of the prior year level. Our third capital allocation objective is to return cash to you, our valued shareholders. With the refinancing completed, our capital allocation strategy progressed to the point where we instituted the aforementioned share repurchase program in September. Its our intention to return the majority of our excess cash to shareholders in the near term, but we would pause that program for an acquisition or other considerations detailed in our public filings. Ill now conclude my prepared remarks with our fourth quarter and full year 2021 financial outlook on slide 10 and our current thoughts regarding 2022. We expect our fourth quarter revenue to be within a range of $330 million to $340 million. This includes mid-single-digit growth in our D2C and renewal channels, along an approximate 20% decrease in our real estate channel. Ill also mention the fourth quarter is typically the lightest quarter of the year in terms of revenue as a result of the seasonal adjustments to revenue related to claims cost pacing.

Fourth quarter adjusted EBITDA is expected to range between $40 million and $45 million. Turning to full year 2021. Revenue is projected to be within the range of $1.59 billion to $1.6 billion and implies a year-over-year revenue growth rate of approximately 8%, in line with our historical growth rates as a stand-alone company. Our full year 2021 gross profit margin is expected to increase to approximately 50%. This implies a roughly 46% gross profit margin for the fourth quarter as we expect the favorable trends I previously discussed to continue for the rest of the year. Were targeting full year 2021 SG&A to be approximately $520 million, $5 million to $15 million lower than the outlook range we provided last quarter due in part to better cost management. Ill also note for those of you trying to bridge from 2021 SG&A to our adjusted EBITDA outlook that we expect noncash stock-based compensation to increase approximately $8 million in 2021 versus the prior year. Additionally, our SG&A projection includes approximately $30 million of combined operating expense for ProConnect and Streem as we invest to ramp their size and scale heading into 2022. Weve increased our full year 2021 adjusted EBITDA outlook to be between $310 million and $315 million, a $20 million to $25 million increase from the midpoint of our previous annual guidance range due to continued gross profit margin favorability in our cost-management activities.

The updated range also implies an impressive increase of 15% to 17% compared to our full year 2020 adjusted EBITDA total of $270 million. Based on our current view of the full year 2022 revenue outlook, we believe a high single-digit revenue growth rate is achievable. This is a similar growth rate to both 2020 and 2021 and considers the continued unprecedented market challenges in the real estate channel and lower-than-expected unit growth throughout 2021 and the corresponding recognition of revenue over a 12-month period. In terms of our full year 2022 gross profit margin outlook, while we believe well continue to see the benefits from dynamic pricing, the process improvements continuing into next year, were trying to balance inflationary cost pressures that appear to be increasing as we exit 2021, particularly around raw materials, transportation and labor. In addition, well need to estimate the level of service requests for 2022 based on history and recent trends.

An example of inflationary cost pressures include water heater OEMs announcing six separate price increases over the course of 2021 due to rising steel prices. As Ive mentioned on previous calls, our strategic sourcing team has done a tremendous job mitigating inflationary pressures for parts and equipment throughout the pandemic, and I expect them to continue their great work in 2022. I hope this early view of 2022 is helpful and look forward to providing our detailed outlook on our fourth quarter and full year 2021 earnings call in February. In conclusion, were tackling the challenges that will make us a better company in the long run and are delivering strong cash flows that were now returning to shareholders. We have a lot of opportunities ahead of us, and I remain optimistic that we will achieve great things in the years to come. With that, Ill turn the call back over to Matt to open the question-and-answer session. Matt?

Matthew S. Davis -- Vice President of Investor Relations & Treasurer

Thanks, Brian. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have, but please note that guidance is limited to the outlook weve provided. Operator, lets open the line for questions.

Questions and Answers:

Operator

[Operator Instructions] We ask the first question on the phone lines today from Jeff Schmitt of William Blair. Sir, Jeff. Please go ahead. Ive opened your line.

Jeff Schmitt -- William Blair -- Analyst

Hi. Good afternoon. Question on ProConnect. And it sounds like its on track to hit the $20 million of revenue this year. I think you previously said that would be kind of 80,000 service requests at a cost of $250 per request. Was curious if its tracking to that. And then you assume -- you think revenue will double next year? Like how does that unit cost -- does the cost per request go up in your assumptions, I guess, as you kind of roll out higher-cost services?

Rex Tibbens -- President, Chief Executie Officer & Director

Yes. Thanks for your question, Jeff. I dont believe we ever said $250 per request, maybe back into that number. But certainly, 80,000 service requests for this year. In terms of next year, were certainly targeting doubling revenue. It really comes down to the mix. So thats why Im a little hesitant to back into the $250 number because we plan on having the -- expanding our trades with appliance and electric plumbing and HVAC. And so that number will be, I think, somewhat fluid based on the type of work we do. We also plan on expanding our maintenance services, of HVAC tune-ups, upgrades, that type of thing. So its going to really be dependent on the mix. So I think itd be hard to give a concrete dollar amount for each service request.

Jeff Schmitt -- William Blair -- Analyst

Okay. And then the investments in ProConnect and Streem, just to scale them, I think you mentioned it would be around $30 million of SG&A. Is that all going to hit this year? Or I guess how much are you expecting? Is that going to be the majority of the cost? Or should we expect more in next year to scale those?

Rex Tibbens -- President, Chief Executie Officer & Director

Well, thats -- the number that Brian indicated earlier are for this year. Certainly, as we move into next year, I think the majority of the cost will be around marketing. So I think that we need to look at a couple of different things. One is, certainly, well continue to use search and digital for ProConnect. I think theres also a great opportunity to cross-sell to our existing AHS customers, which is certainly a great way to lower our acquisition cost. And then Id also look at -- were really trying to drive more major services as well, which will also lower our CAC. And then the last thing I would point out is, which I made in my prepared remarks, is that at least in the appliance trade, were seeing mid-single-digit repeat business. And thats one of the key indicators, I think, one for success in the program; but two, to also lower our overall marketing cost. And so that will really help us scale going into 2022.

Jeff Schmitt -- William Blair -- Analyst

Okay. Great. Thank you for the color.

Rex Tibbens -- President, Chief Executie Officer & Director

Okay.

Operator

Thank you. We now have a question on the line from Cory Carpenter of JPMorgan. Sir, Cory. Your line is open.

Cory Carpenter -- JPMorgan -- Analyst

Great. Thanks for the question. I had two. Just one on claims. Clearly, I know they came in lower than you were expecting. But just curious, I mean, are those basically back to pre-pandemic levels today or maybe even below pre-pandemic levels? And what are you -- what expectations are you assuming for that next year? And then on ProConnect, Rex, maybe could you just provide a little more detail around kind of why you made the decision here to balance more profit in growth next year? Any more color you could provide there would be helpful. Thanks.

Rex Tibbens -- President, Chief Executie Officer & Director

Sure, Cory. Ill start with ProConnect, and then Ill hand it over to Brian to talk about kind of overall gross margin or cost. As I stated in my prepared remarks, I think were growing well. As you recall, were in 35 cities. Our plumbing and electric trade expansions took a little longer to ramp than we anticipated, but were continuing to apply these and our other learnings to our go-to-market strategy. And so what we dont want to do is kind of overheat the market from a marketing perspective if were not ready from an expansion perspective. So thats why we -- thats what we mean by kind of balancing the market, if you will. And then as we consider expanding into our current base, kind of the cross-sell initiatives, we want to make sure we have enough offerings in terms of maintenance services for our customers as well. So I think everything is kind of -- is growing well. We just want to make sure that we have enough selection for customers to drive that repeat

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Sure, Rex. Thanks. And Cory, thanks for the question. Service request trended pretty close to pre-pandemic levels in Q3, which is a great trend for us. And we really saw no impact from the Delta surge that we anticipated. So that was good news as well. And looking forward, I think were cautiously optimistic about Q4 and then going into 2022, but were going to watch the trends really closely. But at this point in time, the trends look pretty good as far as service request across trades, especially the pandemic trades of plumbing and appliance.

Cory Carpenter -- JPMorgan -- Analyst

Great and thank you all.

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Thank you.

Operator

Thank you. We have another question on the line from Ian Zaffino from Oppenheimer. Sir, Ian. Please go ahead.

Ian Zaffino -- Oppenheimer -- Analyst

Hi, thank you. You guys, I believe you mentioned labor shortages. Can you just talk a little bit more about that? How are you going about getting around that? Where is that actually hurting your business? And what type of inflation should we expect from that?

Rex Tibbens -- President, Chief Executie Officer & Director

Sure. Ill take that. This is Rex. So certainly -- well, one of the things were very proud of is our contract relations team has done a phenomenal job of continuing to strengthen the community we have with our contractors. Our percent of preferred this year is one of the highest levels its, I think, been as -- since our -- certainly as a stand-alone company and maybe overall. One of the areas where we are seeing signals, anyway, from our contractors is in our network contractor. So those who we kind of use sparingly and trying to kind of grow them and becoming more of our direct dispatch or our preferred contractors. And so certainly, those contractors are beginning to feel the squeeze from a labor perspective. They tend to be smaller players for us and I think in the industry overall. And so continuing to be able to recruit skilled tradespeople, I think, is beginning to create an issue for them. I think the great thing for us is that because we have this relationship with our preferred providers, we seem to be weathering that storm pretty well. I think the only thing from a preferred perspective that maybe causing some issues are things like office staff, but I think the team has done an incredible job of really kind of working our way through whats certainly a very tight labor market.

Ian Zaffino -- Oppenheimer -- Analyst

Okay. Great. Thank you very much.

Rex Tibbens -- President, Chief Executie Officer & Director

Thank you.

Operator

Thank you. We now have a question from Mike Ng from Goldman Sachs. Sir, Mike. Please go ahead when youre ready.

Mike Ng -- Goldman Sachs -- Analyst

Hey. Good afternoon. Thank you very much for the question. I was just wondering if you could provide a little bit more color around your assumptions when you talk about the high single-digit revenue growth rate in 2022. Should we assume that real estate in 2022 realizes a similar decline as youre looking for in the fourth quarter? Any additional information there would be great. And then also on 2022, Im sorry if I missed it, but is the 50% gross margin outlook for 2021 a good way to think about next year? I certainly appreciate that theres cost inflation that youll have to manage there. Thank you.

Rex Tibbens -- President, Chief Executie Officer & Director

Brian, you want to take that one?

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Yes. Im happy to, and please jump in, Rex. The first question about the 22 revenue guide, Mike, thats what I wrote down here. Yes, were guiding toward something similar to the past this year and last, which is sort of in the 8% range. And I think based on the trends in real estate, first year real estate, well have another -- the revenue growth will be negative next year as well in the real estate channel just because of the way the business builds over time. And weve got to rebuild our volume. Well get price and mix, but were going to have volume challenges in the next year until the back half of the year, and then it will begin to grow hopefully toward historic rates. It will be a good year for D2C. We think thats going to rebound nicely, and also renewals will have maybe comparable to this year, maybe a little less, but that will all build toward that 8% revenue growth year-over-year. Is that helpful?

Mike Ng -- Goldman Sachs -- Analyst

Got it. Thank you.

Brian Turcotte -- Senior Vice President & Chief Financial Officer

And then your other question was -- Im sorry, I forgot it already.

Mike Ng -- Goldman Sachs -- Analyst

Gross -- 50% gross margins?

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Yes. The challenge is going to be -- I think, as I mentioned prepared remarks, that I think dynamic pricing will continue to be working very well for us, and all the process improvements were making will flow through. But Im concerned about inflation like every other CFO, that youve probably heard in the past few weeks. We just dont know whats going to happen. We see parts and equipment availability is improving each month and not to pre-pandemic levels. But the inflation on labor, raw materials, transportation, I think, are going to drive prices higher, the parts and equipment heading into next year. So thats a concern. And I really dont have a good feel for global commodities, Mike, whether its steel or copper, resins, what have you. And it just feels like those will be challenged, at least until the back half of next year, which will keep the inflation pressure on. So based on that, thats what were factoring into our gross margin calculus for next year; the benefits of dynamic pricing and process improvements offset by potentially higher inflation.

Mike Ng -- Goldman Sachs -- Analyst

Thank you.

Operator

We now have Youssef Squali from Truist Securities. Sir, Youssef.

Nicholas Harrison Cronin -- Truist Securities -- Analyst

This is Nick Cronin on for Youssef. Just one for me. What role does dynamic played in the margin -- gross margins in the current environment. It looks really good this quarter. So any more color would be helpful.

Rex Tibbens -- President, Chief Executie Officer & Director

Its Rex. Certainly, it played a part. There wasnt, I think, the overarching part. As Brian mentioned before, weve had a lot of process improvements as well as -- I think we also had lower service requests as well. The issue, I think, its a good issue with the price as we continue to optimize our models. This quarter, we -- for our highest-usage, highest-cost customers, we had higher price increases. While its still inelastic, we did see higher-than-expected cancellations for those customers, which again does flow to higher profitability. But I wouldnt say it was the key driver of the profitability this quarter, but certainly helped. And so in terms of dynamic pricing, weve since adjusted those models so that we continue to retain those customers and ramp up the pricing over time so that were able to keep the customer and continue to keep the revenue as well. But the real -- I think the real driver, as Brian pointed out in his prepared remarks outside of dynamic pricing were really around our process improvements, which include higher percent of preferred, some of our technology improvements. Certainly, as we continue to tweak our algorithms around dispatching and some of our customer service software, thats definitely helped us as well. But really the -- its all the cross-functional effort of the team, coupled with good weather and lower service requests, especially for HVAC, were the main drivers this quarter. Brian, feel free to chime in there.

Brian Turcotte -- Senior Vice President & Chief Financial Officer

No. I think you nailed it.

Nicholas Harrison Cronin -- Truist Securities -- Analyst

Got it. Thank you.

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Thank you.

Operator

Thank you. We now have Bryan Wynn of Credit Suisse. Sir, Bryan. Your line is open.

Bryan Wynn -- Credit Suisse -- Analyst

Hey guys. Its Bryan on for Kevin. Our first one here is -- yes, our first one here is just on -- as it relates to the macro environment, you sort of touched on how, obviously, its impacting your competitors as well. So were just curious, have you seen the macro environment cause these step changes in the competitive environment overall? And given you guys are I think four times the size of your next largest peer, do you think maybe these cross-currents could be -- serve as an opportunity for some share gains, recognizing obviously that the TAM overall is pretty underpenetrated. But just any thoughts there.

Rex Tibbens -- President, Chief Executie Officer & Director

Yes. I cant -- certainly, I think the biggest thing we have going for us, Bryan, is our scale. When you think about our buying ability, when you think about our supply chain team of how were expanding our parts and replacements availability, I think that certainly, we have greater buying power over our competition. But we dont have any definitive data that would prove that, obviously. But what I do think we have data is, if you look at our gross margin compared to some of our competitors, I do think that were winning that category. And thats through a lot of work that weve done over the last 2.5, three years as it relates to inserting technology where we can further our scale. And thats around dynamic pricing. Thats around improving our supply chain. We now have an appliance portal, have the ability preposition some of our fast living inventory. And really increasing our efforts around customer experience, not only is better for the customer, but some of the things were doing is actually better for gross margin as well. So we think that the real share gains will come as we continue to focus on making the customer or service experience more of a digital one. Were committed to really providing more self-service options, which will hopefully lower cycle time and increase -- a more digital experience, so it should lower cost as well. So its all about removing friction from our processes and making it better for the customer. We think thats how we win overall vis-

-vis our customers.

Bryan Wynn -- Credit Suisse -- Analyst

Makes sense. And then our follow-up here was just obviously a lot of capacity on the balance sheet. And I appreciate the commentary on kind of how you guys are thinking about M&A. But can you just remind us what sort of framework do you employ, be it return hurdle or whatever the case may be, when evaluating potential deals? And if you could just comment on -- in each of the verticals what valuations are looking like from your standpoint? Thanks so much.

Rex Tibbens -- President, Chief Executie Officer & Director

Brian, feel free to chip in here. But certainly, as it relates just to M&A, I mean if you want to, Brian, certainly talk about our overall capital allocation strategy. But as it relates to M&A, were still in the same viewpoint as it relates to looking for technology that helps further that digital experience I just talked about. We think our acquisition of Streem is really starting to pay dividends as it relates to -- especially our appliance customers being able to kind of see what they see virtually and really provide a very different experience. So well continue to look for technology either tuck-ins or adjacencies to help us with that. And then as it relates to kind of a roll-up strategy, if you will, for other home service plan companies, were certainly not against that. We still think that valuations in services overall seems to be still very, very high. And so one of the things that I think that were continuing to deploy is a very disciplined strategy as it relates to making sure were not giving away our synergy values. And so we look at a lot of things, but I think we have a very high bar in terms of if we acquire something, we want to ensure that its truly accretive for our investors. Brian, anything youd add to that?

Brian Turcotte -- Senior Vice President & Chief Financial Officer

I guess Id only add that you mentioned in your question about capital allocation. Overall, Rex, Matt and I have really been laser-focused on capital allocation pre-spin and over the past three years. And weve been investing in the business. Weve made a few small acquisitions, one modest, another modest one in Streem. And we knew at some point we were going to repay debt. We financed our debt. We paid our debt, which we did earlier this year. And while were looking for acquisitions and nothing on the horizon, as Rex mentioned, that we think is the right value for us. So that sort of leads into why we announced the share repurchase plan, was weve got a refinancing debt repayment behind us. Weve been investing strongly in the business. We had a lot of cash on the balance sheet. We generate a lot of cash. I think we mentioned we had generate $170 million to $175 million this year free cash flow. So we thought it was a great time to announce the share repurchase plan that our Board approved and return value to shareholders that way. So hopefully, thats helpful.

Operator

We now have Brian Fitzgerald of Wells Fargo. Sir, Bryan. Ive opened your line.

Brian Fitzgerald -- Wells Fargo -- Analyst

Thanks. Got a lot of questions answered. Maybe one on what you just touched on, the benefits from the process improvement. Im wondering how much runway you see there for additional benefits. And then you just touched on Streem a couple of times. How does that fit into the process improvements? How is it rolling out post your purchasing it? And is it deploying to your playbook? Is it deploying faster? Are you seeing better synergies and more impacts than you originally thought with Streem?

Rex Tibbens -- President, Chief Executie Officer & Director

Ill start with stating that we can talk about the cost side after that. Certainly, this year has been, I think, a good year as it relates to Streem and our ability to integrate it within our business. Weve been rolling it out over kind of our core home service business this year. Customers and contractors, when they use it, seem to really enjoy the ability to really look at or have someone look at kind of what theyre seeing. And we think that is the future of the company as it relates to -- we founded the business 50 years ago, and what hasnt changed as you kind of roll a truck to kind of see whats wrong. That just seems like a really antiquated way when now we can have almost a Zoom-like call with the customer. We can see what they see in terms of problems. But in the future, well be able to predict whats going on, and well be able to understand or predict what is that were looking at. We should be able to understand what our supply position is in terms of the replacement parts or replacement overall. So once we build all the kind of back-end capability of doing that, it becomes a very differentiated tool for not only for Frontdoor, but also for our contractor base in general. So it helps us continue to even build the base within our existing contractor base. But the other thing Im really excited about for Streem is I think its an incredible ESG benefit in that were not rolling trucks to kind of understand the issue. That is far better for our environment and far better for our future world as well.

And so were still very bullish on Streem. The other thing I would say is we purchased Streem primarily for our internal capability, but we continue to focus and add enterprise accounts as well. And anytime you have software, its a great business. So a very small base and we have a long way to go. But considering how early we are into the cycle as well, I think Streem is kind of off and running. Your second question was kind of around -- and keep me honest here, but I think will these gross margin improvements continue into next year? I believe Brian addressed that earlier in terms of -- I think were seeing a lot of improvements this year from dynamic pricing and from our technology and process improvements. The real wild card for us going into next year is going to be the supply chain. Its still very fragile, and we got to really understand what does inflation look like for next year. Its still, I think, too early to call the ball. But certainly, were not taking our foot off the gas as it relates to continuing to find ways to pull cost out from a technology or a process improvement perspective. Its really going to come down to what does inflation look like for next year and how much of that can we mitigate to dynamic pricing. Brian, anything else you would add to that?

Brian Turcotte -- Senior Vice President & Chief Financial Officer

No. That was spot on, Rex.

Brian Fitzgerald -- Wells Fargo -- Analyst

Awesome. Appreciate it guys.

Rex Tibbens -- President, Chief Executie Officer & Director

Thank you.

Operator

Thank you, Brian. We now have a question from Aaron Kessler of Raymond James. Sir, Aaron. Please go ahead.

Aaron Kessler -- Raymond James -- Analyst

Great. Thanks. A couple of questions. One just on the follow-up to the D2C rebound that you kind of said you have good confidence in for 22. Just a couple of factors that give you that strong confidence in that D2C rebounds. Is it easier comps, pricing, etc.? And then maybe just on the follow-up on the inflation costs. Assuming you can kind of adjust dynamic pricing, how quickly can you adjust that if we do see greater-than-expected inflation costs as well? Thank you.

Rex Tibbens -- President, Chief Executie Officer & Director

Sure. Ill take the last one first. As it relates to dynamic pricing, with the exception of real estate, we can make pricing changes fairly quickly. As it relates to renewals, which is 2/3 of our revenue, we can make it in less than a week. So its pretty quick. In terms of your question around D2C, what gives us confidence is, a lot of the things that we talked about for this quarter are truly behind us. I think we have an opportunity to continue to diversify our demand mix. Weve pivoted to new sources of demand. And I think the team is -- I think were seeing the level of execution that we saw previously. We reevaluated our conversion funnel to improve our sales process. Sales teams now understand our new product lineup as it relates to the Good, Better, Best. And weve made a lot of improvements to our e-commerce site through A/B testing and optimization. So those are the things that gives us confidence that direct-to-consumer should rebound next year. Keep in mind that from a unit perspective, it will take a while for it to show the numbers since we recognize revenue 12 in time. But we will well see the added benefit of both better mix and price going into next year as well. So thats what gives us confidence for direct-to-consumer going into 2022.

Aaron Kessler -- Raymond James -- Analyst

Got it. Thank you.

Operator

We now have the final question on the line from Justin Anderson (sic) Justin Patterson of KeyBanc. Sir, Justin. Please go ahead when youre ready.

Justin Patterson -- KeyBanc -- Analyst

Thanks. Havent heard that variation of my last name before. Im sure youre all doing well. Rex, I appreciate that youre rationalizing spend in ProConnect given market conditions. Should we be viewing this as a temporary pause or more of a shift in the business? And perhaps related to that, are there factors that would cause you to ramp up that investment and drive more expansion there again? So thats question one on ProConnect and the investment dynamics. And then just digging into the labor dynamic more. What do you think is the biggest drive -- gating factor toward really broadening out the selection that customers see? Is it really just labor at the existing contractors? Or do you actually need to broaden out the types of contractors youre working with as you go market by market? Thank you.

Rex Tibbens -- President, Chief Executie Officer & Director

Yes. Good to hear from you, Justin. I think taking the last question first, I think we need to continue to expand our maintenance services for our existing customers as well as expand our core trades in our existing ProConnect markets. So just a quick history lesson here. We started with primarily appliance. We moved to Columbia Electric and were in HVAC in a couple of cities. We needed to further expand those, and I really want to see the -- in terms of your question, of what makes you go faster. I want to see greater repeat business. I want to see our ability to cross-sell to our existing AHS customers. All things we have seen, our plumbing and electric trade expansion, like I said, took a little longer to ramp but are beginning to perform because it all really comes down to once we get -- see a lowering of our customer acquisition cost and see repeat business that gives me -- as well as a good customer experience, thats what gives me optimism to pour more money into the market, knowing well get more stickier demand, if you will. So those are the things that we look at and continue to drive with. But keep in mind, its -- were two years into the journey. We went from basically 0 to $20 million the first year. Confident we can double it next year. If we see a greater opportunity, well definitely invest more to grow ProConnect. From a labor perspective, certainly, one of the things we are watching carefully is making sure that there is labor there for these jobs. So far, it hasnt been an issue. But again, its a small base, right? So just like were watching labor very closely in our broader contractor market as it relates to home service plans, were doing the same thing as it relates to ProConnect. And so far, its not a mountain we cant climb.

Justin Patterson -- KeyBanc -- Analyst

Got it. Thank you.

Rex Tibbens -- President, Chief Executie Officer & Director

Thank you.

Operator

Thank you, Justin. As we have no further questions on the line, I would like to hand back to Rex for some closing remarks.

Rex Tibbens -- President, Chief Executie Officer & Director

Thank you, operator. While we are facing some near-term headwinds, our long-term vision remains as strong as ever. We are still delivering strong profitability and growth despite unprecedented real estate market conditions, a difficult global supply chain and ongoing challenges from the pandemic that will last into 2022. We will continue to look for opportunities to grow faster while transforming our service experience into a digital one. We are playing the long game, and we are focused on strengthening our foundation to deliver strong and consistent growth in the future. I look forward to talking to you in our next earnings call.

Operator

[Operator Closing Remarks.

Duration: 63 minutes

Call participants:

Matthew S. Davis -- Vice President of Investor Relations & Treasurer

Rex Tibbens -- President, Chief Executie Officer & Director

Brian Turcotte -- Senior Vice President & Chief Financial Officer

Jeff Schmitt -- William Blair -- Analyst

Cory Carpenter -- JPMorgan -- Analyst

Ian Zaffino -- Oppenheimer -- Analyst

Mike Ng -- Goldman Sachs -- Analyst

Nicholas Harrison Cronin -- Truist Securities -- Analyst

Bryan Wynn -- Credit Suisse -- Analyst

Brian Fitzgerald -- Wells Fargo -- Analyst

Aaron Kessler -- Raymond James -- Analyst

Justin Patterson -- KeyBanc -- Analyst

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