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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, welcome to frontdoor's First Quarter 2019 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Matt Davis, Vice President of Investor Relations and Treasury, and he will introduce the other speakers on the call.
At this time, we'll begin today's call. Please go ahead, Mr. Davis.
Thank you, operator. Good morning, everyone and thank you for joining frontdoor's first quarter 2019 earnings conference call. Joining me on today's call are frontdoor's Chief Executive Officer, Rex Tibbens; and frontdoor's Chief Financial Officer, Brian Turcotte.
Before I review the agenda and turn the call over to Rex and Brian, at about 6:00 a.m. Central Time today, frontdoor issued a press release reporting our fourth quarter 2019 financial results. The purpose of today's call is to provide investors with further details regarding Frontdoor's financial results as well as provide a general update on the company's progress. The press release and a slide presentation that will be utilized during today's call can be found on the Investors Relations section of Frontdoor's website, which is located at www.frontdoorhome.com. I would also encourage all of our listeners to visit our website to find out more about our company.
As stated on Slide 2 of the presentation, I'd like to remind you that this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company's filings with the Securities and Exchange Commission. Please refer to the Risk Factors section of our filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements.
All forward-looking statements are made as of today, May 8, and except as required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.
We'll reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release and the appendix of this presentation available on our website. We've also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and the appendix of this presentation in order to better assist you in understanding our financial performance.
Our financial statements include all revenues, costs, assets and liabilities directly attributable to us. Additionally, our financial statements for periods prior to the spin-off, which occurred on October 1, 2018, include allocation of certain costs from ServiceMaster incurred on our behalf. For those following along with the presentation available on our website, I'll walk through the agenda items shown on Slide 3.
Frontdoor's CEO, Rex Tibbens, will lead off by providing a review of our first quarter 2019 summary. He will then provide a business update and discuss our strategic priorities for 2019. Brian Turcotte, Frontdoor's CFO, will follow and will summarize our first quarter 2019 financial results, provide more details in regards to our financial statements and then speak to the full year 2019 outlook. We will then open up the line for questions.
I'll now turn the call over to Frontdoor's CEO, Rex Tibbens, for opening comments. Rex?
Thanks, Matt and good morning, everyone. Let's start with our first quarter 2019 summary shown on Slide 4. I am pleased to report that 2019 is off to a favorable start with first quarter revenue of 10% versus the prior year period to 271 million. While the gross profit margin increased 150 basis points to 47%.
We also reported better than expected adjusted EBITDA of 43 million up 34% over the same period last year. Brian will expand on our results shortly. But the better than expected performance is largely due to lower than expected claims volume driven primarily by mild temperatures in our key markets, as well as earlier than anticipated progress from our business process initiatives.
Further down Slide 4, we continue to grow the number of home service plans by 5% over the first quarter of 2018 to 2.1 million plans. Our customer retention rate remains stable at 75% on a trailing 12 month basis, despite implementing higher than normal price increases late last year.
As mentioned, we continue to make improvements in our core business that are driving sustained business results. I am pleased with the velocity of progress that our entire teams are making as we are seeing the positive momentum from these operational improvements materializing at the bottom line.
On the people front, we filled the remaining open member of our management team in March as we welcome Jen Alessandra as our Chief People Officer. Jen brings significant depth and breadth of experience as a people leader from both public and private companies. Jen most recently served as Senior Vice President and Chief People Officer for SolarWinds, a global IT management software company. Before this, Jen held multiple HR leadership roles at Raytheon and KB Home.
With the last piece of the executive leadership team in place, we are now all laser focused on advancing our strategic objectives. As always, our north star will be helping our customers take the hassle out of owning the home. Finally, we completed the secondary equity offering in March, which resulted in the disposition of ServiceMaster's remaining ownership in Frontdoor.
Moving to Slide 5, let's review our three revenue channels; direct-to-consumer or DTC, real estate and renewals. First year DTC sales continued to grow through our marketing efforts specifically in digital and social media. I should note that the timing of our marketing spin is expected to ramp up a bit more going into the back half of 2019 versus prior year.
Additionally, we are benefiting from optimizing our customer acquisition costs on moving some third party services in house and revamping the incentive performance metrics for sales associates in our call centers to drive additional unit sales growth.
In real estate, we are seeing more macro headwinds from a decline in existing home sales. The National Association of Realtors released existing housing figures that were down 7% in the first quarter versus the prior year. We are addressing the slow down through deeper unit growth penetration of our existing broker relationships, as well as adding new brokerage partnerships. Expanding our relationships helps us get into new real estate all offices and in front of new brokers to further explain the value proposition of home service plans, and more specifically Frontdoor.
We are encouraged by some leading indicators in real estate, such as lower interest rates and rising wages that will hopefully result in improving existing home sales in the back half of this year. As always, we will continue to monitor macro market conditions and shift some spin to DTC customer acquisition if the real estate market softness continues.
Renewals, our largest channel grew 13% in the first quarter versus the first quarter last year, as we target retaining more of our existing customers. One way we do this is by adding new products. For example, we are expanding our HVAC tune-up pilot to meet the growing demand for this service, allowing us to have another touch point with our customers. The amount of whether this past quarter allowed us to better leverage this program to provide value to our customers, while creating a new avenue for keeping our contractors busy in a slower environment. We are currently using our Tiger team approach to look for additional opportunities to drive customer retention.
Now please turn to Slide 6, where I'll give an update on each of our 2019 strategic objectives laid out on our fourth quarter earnings call in February. First, improving the customer experience, as I mentioned earlier, we are constantly focused on enhancing the customer experience. We're doing this through a multi prong efforts to improve communication, technology and service delivery. We're also making it more convenient for our customers and contractors to interact with frontdoor when a service order is placed.
We are continuing to roll out our new workflow based software called customer service central or CSC in our customer care centers. CSC provides a more seamless service experience that allows our customer service agents to more quickly address customer needs, leading to a faster time to resolution while also providing a lower cost of service delivery.
Heading into our peak claims and call volume season during the summer months, we're adding hundreds of new customer service agents. CSC allows them to get on boarded more quickly through a more modular based approach to training. As mentioned, our Tiger teams are also working on a number of projects to improve our customer experience in order to increase retention rates, improving the way we obtain customer contact details.
We can then use the data to increase customer outreach and reduce claim resolution cycle times. Our cycle time or the time it takes for a customer's service work order to be fully completed is being completely reevaluated as it touches several different elements of our business that are due to be updated. As we work to redesign our processes. We plan to automate certain aspects of the customer service experience and contractor dispatch, allowing our systems to reduce wait time for our customers and have the most delightful customer experience possible.
Further, the customer retention Tiger teams were formed will make progress on enhancing the customer onboarding experience, reducing payment friction by expanding conversion of evergreen contracts in the auto payment and adding more services to the home service plan. This is a multi-quarter endeavor. We're all excited about improving the overall customer experience.
Our second strategic objective is related pricing. As mentioned on our last earnings call, we raised prices for all products across all channels, including first year DTC and renewals in November of last year, and first year real estate in February of this year. The overall average price increase was in the mid-single digit range. We have seen some favorable impacts from the price increases with attrition rates consistent where we modeled them.
As previously mentioned, we expect to realize about half the price increase benefits in 2019 with full benefit coming in 2020 as it takes a full 12 months to roll through our entire book of business.
Now turning to dynamic pricing, we're on track to have dynamic pricing fully rolled out over the course of 2019. This objective is expected to increase our overall gross margin by 100 basis points in 2020. As a reminder, dynamic pricing will allow us to model our cost and price sensitivity down to the Zip code plus four digit level, in contrast to the historic industry practice of pricing at the state only level.
Our third objective is to improve our business processes and contain costs. Early win from our Tiger teams is improving our contractor selection algorithms to ensure better utilization of our preferred contractor network. This allows us to capitalize on labor rates that are nearly half that of contractors outside of our network. We are starting to see the benefits from this effort as we increase our service work orders to preferred contractors.
As we continue to make strides in optimizing contractor cost, we're also working to reduce expenses by centralizing more of our procurement and sourcing. Given our growth, we expect to get better procurement leverage than we have in the past. To that end, I moved the procurement function under Brian and into the finance organization. I believe that Brian will bring a fresh perspective and help leverage our total spend to drive cost savings.
Now moving to our fourth objective, which is people, as I mentioned earlier, we filled our executive leadership team with Jen, our Chief People Officer. Jen is very passionate about developing people and building a culture where our employees are empowered to do great things for customers every day. We recently introduced our house rules in the first quarter, which are a set of principles to guide us as we work together every day.
The four house rules are obsess over customers' problems, being owner not a renter, be transparent build trust and do great things every day. Great cultures enable employees and companies to be more successful than ever, especially in a fast paced environment like ours. It is thrilling for me to see these house rules be a rallying point for our associates. We will continue to examine our house rules on an annual basis to ensure our principles aligned to our vision and our mission as a company.
Lastly, relating to frontdoor's culture, our largest brand American Home Shield has been named to Forbes 2019 list of America's best midsize employers. The recognition was based on independence anonymous survey of 50,000 US employees who work full or part time for companies that employed at least 1000 people. This recognition is especially meaningful to me because the award is based on feedback from our associates. This is a tremendous honor and we are looking forward to building on this company culture momentum in the year ahead.
Technology advancement is our fifth strategic objective for 2019. As we've outlined in the past, technology is an area that historically lacked adequate investments and we are now focused on advancing our systems platforms under Piras's leadership as our Chief Technology Officer. Some of our key technology systems were developed in the early 1990s. And over the course of 2019, we will continue to move to a cloud based infrastructure, which will further enhance our ability to grow and scale efficiently.
I am pleased with the velocity in which the team is making improvements and moving forward, but we are still in early innings. We continue to make significant progress in this area and plan to open another technology campus later in the year in a location to be announced.
Our sixth strategic objective on-demand is still on course to launch a pilot and complete the playbook later in 2019. We'll utilize the playbook to expand and scale in key cities in 2020 and then optimize in 2021. As we mentioned before 2019 will be a year of discovery as we build out our strategy for the convenient delivery of home services and information through a digitally driven marketplace.
One of our core connect in this phase, it design a pilot that allows us to move fast and be nimble in order to react to the customer and contractor responses to this new offering. This approach will allow for quick pivoting, enable the team more rapidly redesign improvements as needed. Also, we are looking to leverage the core business as we grow into on-demand. We have a robust set of data customers and contractors that we can utilize and don't need to start from scratch to get where we want to go.
To wrap up, I feel that we are making excellent progress on improving our core business. And this work is just starting to bear fruit. We're continuing to build a strong foundation that strengthens our core business and allows us to build a future on-demand business. We think this foundational work will enable us to grow into new revenue channels and drive value for our shareholders.
I'll turn the call over to Brian who will cover our first quarter 2019 financial results in more detail and discuss our updated full year 2019 outlook. Brian?
Thanks, Rex and good morning. Please turn the Slide 7 and I'll briefly review a few key financial results from first quarter of 2019 and then dive deeper into the adjusted EBITDA drivers later in my comments on Slide 8.
Revenue increased 10% to $271 million, driven primarily by a 5% increase in the number of home service plans and the higher average price per plan. As mentioned on the previous earnings call, we expected our year-over-year revenue growth composition to shift slightly more the price due to the higher than historic price increases we began implementing in the fourth quarter of 2018 and continuing during the first quarter of this year. Of the 10% growth realized, six points came from volume and four points from price.
Looking at our three primary customer channels, revenue derived from customers renewals was up 13% over the prior year, due primarily to growth number home service plans and improved price realization.
First year real estate revenue was up 1% versus the prior year, driven by continued mixed shift towards higher priced home service plan offerings and improved price realization. And first year direct-to-consumer revenue was up 8%, due to the growth in new home service plans resulting from ongoing investments in marketing, as well as improved price realization.
In terms of gross profit, gross profit dollars increased 13% to 128 million. Gross margin increased 150 basis points from 45% in the first quarter of 2018 to just over 47% this year. The increase was driven by a lower number of claims due to milder temperatures, especially in Texas, and early progress from cost containment and business process improvement initiatives.
Net income was $13 million or 3% lower than last year as the $15 million favorable impact from higher revenue conversion and $6 million of lower spin off charges were offset by a $15 million increase in interest expense and a $7 million increase in selling, administrative expense, which includes our planned investments in sales and marketing and technology.
First Quarter 2019 adjusted EBITDA of $43 million was $11 million or 34% higher than prior year, driven by the aforementioned increase in gross profit, which more than offset the increase in selling, administrative expense and the quarter.
The adjusted EBITDA Bridge on Slide 8 shows the drivers of change from first quarter of 2018 to first quarter 2019. And I'll walk you through the details. Starting on the left, and as previously mentioned, we had $15 million of favorable revenue conversion versus prior year. As a reminder, we calculate revenue conversion as revenue from new home service plans minus the estimated related claims costs of those plans, plus the impact of additional revenue from our price increases.
Continuing to the right, claims costs were $3 million lower, primarily due to the aforementioned mild temperatures, as well as the cost reduction initiatives, partially offset by an increase in the underlying cost of repairs.
Sales and marketing cost increase $2 million due to planned incremental investments made to drive the 5% increase in the number of home service plans versus prior year while delivering on our cost per sale targets. The spin-off dis-synergies of $2 million led primarily to the costs associated with the separation of frontdoor technology systems from ServiceMaster.
And the $4 million of other costs are mainly related to technology related investments in the business and higher professional fees, incentive compensation and bad debt expense versus prior year.
Please turn to Slide 9 for a review of our cash flow and cash position. Net cash provided from operating activities was $52 million for the quarter compared to $49 million from the same period in 2018. This increase was driven primarily by the favorable impact of working capital, which was slightly higher than the prior year period.
Net Cash used for investing activities was $5 million for the first quarters of both 2019 and 2018, primarily due to the net activity in our available for sale securities offset by other investing activities. Net cash used in financing activities was $2 million for the first quarter of 2019 compared to $37 million for the same period in 2018.
Current year activity was driven by debt payments, while the prior year activity is driven by net transfers to our then parent or ServiceMaster has since ceased.
Free cash flow between which we calculate as net cash provided from operating activities minus property additions, was $47 million for the first quarter 2019 compared to $44 million in the prior year period. This increase was due primarily to a higher adjusted EBITDA and positive working capital contributions partially offset by higher cash payments for interest and taxes.
I should note that the adjusted EBITDA conversion of free cash flow was a very strong 109% for the first quarter of 2019, which is typically the case in the first quarter of every year due to seasonality. We project that full year EBITDA conversion of free cash flow will be approximately 50%, still strong, but lower than previous years do the higher interest expense, cash taxes and capital expenditures.
We ended the first quarter of 2019 with $348 million in cash and marketable securities, a $42 million increase from December 31, 2018. On that total $197 million were considered to be restricted net assets to remain in compliance with the regulatory requirements of certain states, which is a $10 million increase from year end. The increase in restricted cash is somewhat outside of our typical rule of thumb calculation that we've given in the past due primarily to timing of available equity settlements from state level entities to the corresponding parent entity.
Turning the Slide 10, I'll cover our second quarter and updated full year 2019 outlook. Full year revenue is now expected to be between $1.36 billion and $1.38 billion. And this reflects our continued expectations that the high single digit organic revenue growth exhibited in the first quarter will continue throughout 2019.
We now expect full year gross margin to be approximately 46%, driven by our increased projections for revenue, the impact of our process improvement efforts and some first quarter weather capability flowing through. For those of you wondering why gross margin will be projected higher. Please note that there was significant offset relating to the ongoing claims costs inflation, including approximately $10 million in projected tariff related costs. I should note this excludes potential impact of additional tariffs proposed by the administration this past weekend.
Full year adjusted EBITDA is now anticipated to range between $250 million and $260 million. I should mention that even with the increase in the adjusted EBITDA outlook, we continue to plan significantly higher SG&A spend in 2019 as we invest in technology, sales and marketing, customer service, and on-demand to drive top and bottom line growth and build a stronger foundation for the future.
Moving down the table, capital expenditures are expected to remain in the $30 million to $40 million range and the full year annual effective tax rate is now expected to be approximately 25%. Though, not part of our normal annual outlook updating process, we thought it may be helpful to provide color for the current quarter as well. To that end, please note that second quarter 2019 adjusted EBITDA is anticipated to range between $75 million and $80 million, an increase versus $73 million in the prior year period, driven by continued strong revenue growth and process improvements.
With that, and I'll turn the call back over to Matt to open the question-and-answer session. Matt?
Thanks, Brian. As a reminder during the question-and-answer session, we encourage you to ask any questions that you may have, but please note that guidance is limited to the outlook we provided in our press release and webcast presentation. Operator, let's open up the line for questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]
Thank you. Our first question comes from a line of Jamie Clement with Buckingham Research. Please proceed with your question.
Gentlemen, thanks a lot for taking my questions. Good morning.
Good Morning.
Good morning.
Good morning. Hey, Rex, if I could start with you, there was some speculation kind of towards the end of last year and even in the beginning of this year that when your industry was faced with higher claims costs last year, perhaps some of your competitors were - how should I put this –less willing to maybe honor their side of the bargain on when you all work dragging their heels that kind of thing. When you look at the direct-to-consumer channel, do you have a way of knowing whether some of your new customers came from other home warranty plans or this was their first foray into the industry? And you said some market share gains that kind of thing.
Yeah, we don't have the ability to see if they're moving from one company to another, but given we're four times larger than our closest competitor. I'm not sure why you wouldn't just come to us first.
Yeah. Okay, fair thought. Brian, just moving to you and then I'll get back into queue. It looked to me and maybe I'm looking at this the wrong way. When I look at your EBITDA Bridge for the quarter your revenue conversion to EBITDA was at a very high very strong rate this quarter. Am I correct on that and what really drives that?
Well, remember there's two things, there's organic volume growth in that and also we add price to revenue conversion and based on the higher price increases, that Rex as alluded to mid-single digits this year that's driving the conversion as well.
Okay. All right, thanks very much, guys.
Thank you.
Our next question comes from the line of Youssef Squali with SunTrust. Please proceed with your question.
Hi, this is Sagar on for Youssef. I just have a quick question. I wanted to know more about the progress of the on-demand product and just kind of understanding how big the beta is and any insight into the level of demand you guys have seen in the business model and just more on the timing of when we may see it kind of expand and go more to a broader audience?
Yeah, so 2019 is really the R&B year, right. So just to be clear, we don't have anything in market today. We have the team assembled and we have a variety of things and want to kind of test and learn around. So 2019 is about deciding what is the offer we want to bring to market, 2020 is really picking the key cities to then kind of launch into and then 2021 would be a year to really scale and optimize. So this is really about discovering and learning this year. Given the $400 billion market half being in home improvement, a little over a quarter being in repair and the balance being in maintenance, we think we will start where we have the most leverage and that's around repair maintenance. So as we as we get closer toward the end of the year and we tend to know what the offer looks like, we'll be happy to provide you additional details and what we think the opportunity looks like.
Great, thanks.
Our next question comes from the line of Ralph Schackart with William Blair. Please proceed with your question.
Good morning. Rex, on the call today you talked quite a bit about the Tiger team contributions and initiatives within the organization. Maybe if we just take a step back, can you frame some of the biggest near term impacts that the team has made to date? And then maybe a little bit more longer term where do you think the biggest levers or contributions the team can make? And then a follow up to that I know you've been brought on board to roll out some broader technology initiatives and changes and you talked about the customer service experience today getting some traction, but maybe sort of frame the technology opportunities and how you think it will impact the business. Thank you.
Yeah. Sure. So Tiger teams are assembled cross functional teams that come together. Brian and myself and majority of our leadership team meet weekly around kind of these Tiger team initiatives. And so for - the first one, it was really about cost containment. We talked a little bit last time about some of the bigger wins were around things like improving our dispatch algorithm to make sure that the algorithms, for lack of better terms, a little more greedy when it comes to our preferred contractor network. Our preferred contractors are roughly half the cost from a labor perspective of our network contractor. So as we saw better weather this quarter that algorithm improvement really helped us as well. I'm looking forward to stress testing a little bit more as we move into the summer months.
Some of the other initiatives they've worked on is really around cost containment in terms of how we're onboarding our contractors, how our system set up to collect fees from customers, company payments and there's a variety of things, its six to eight different works streams going anytime. Since that time - our next kind of mountain to climb that we're starting this quarter is around retention. So either takes about four to six weeks to really get down into the analytics of where are the biggest opportunities. So we think that's around like I mentioned earlier around our auto pay and some of the evergreen issues that we've worked on. We're looking at how we add more services to do our first year real estate product and then really just enriching the core service experience around self-service and continuing to go down the journey of customer experience. So still early days for those teams, but that's kind of how the Tiger teams are set up.
In terms of your question around technology, I think it's still somewhat early innings in terms of the amount of work ahead of us, but really pleased with the velocity of changes that occurred within the team. So we're moving a lot of our core systems and infrastructure to the cloud, really moving more into micro services environment, which allows us to then as you think about on-demand, be able to, to develop other micro services or systems around our core products. So lot of moving parts, but that's hopefully a quick snapshot of what we're doing.
That's really helpful. Thanks, Rex.
Sure.
Our next question comes from the line of Chris Gamaitoni with Compass Point. Please proceed with your question.
Good morning, guys.
Good morning.
Good morning.
Can you give us an update on what percentage of your portfolio has received or hardly reflects the price increase?
Well, as we mentioned on the call, I think it was Rex had covered it that we began rolling out the price increases in the fourth quarter of last year continued in Q1. But it takes time to flow through as customers renew as well. So I don't know whether we think Rex how much.
Again we can make a pricing increase in January, about half of that will flow through and I think roughly we're expecting to see maybe half or a little more than half closer this year, so like we're a quarter late for that progress.
Okay. On the gross margin improvement, is there any way to dissect percentage points wherever you want to the improvement that came from just beneficial weather versus underlying process improvement?
Yeah, that's a great question, Chris. Ball parking it I would say the same ability, two thirds driven by whether, the lower incidence rates due to the mild temperatures, especially to the south in Texas and the other third process improvement. Does that help?
Absolutely, it's super helpful. And then I guess two more, on the on-demand services, do you have an estimated range of how much you spent for that investment in this quarter in the SG&A line and maybe what your thought is about investment spend throughout the year occupancy in R&D here?
Well, as we told you on the fourth quarter call we were going to spend about 5 million on OpEx, about 5 million CapEx. As far as OpEx in Q1, I don't know, less than $1 million.
Alright, and one final one, as it relates to customer engagement and, improving retention rates usability, is there any thoughts of launching like a native iOS or Android app in the future?
Potentially, certainly, I'm a big believer that. People aren't going to download an app unless there's a burning need to use it and I don't think we've created that yet, right. So as we think about on-demand and certainly that's something that we're thinking about as we think about the pilots what we're testing I don't think we're going to start with a with a native App or just bootstrap it.
Okay, thank you so much.
Our next question comes from a line of Robert Coolbrith with Wells Fargo. Please proceed with your question.
Good morning. Thanks for taking our questions, a couple of we could. Another question on the gross margin improvement, the weather and process improvement benefits versus the buying cost inflation trends, wondering if you might be able to tease that out a bit. And then specifically on process improvements, you highlighted the contractor selection optimization. Wonder if there's anything you can tell us about the runway for further improvement there. Sounds like there may be a little bit of attention upcoming here versus the cycle times and any progress on the repair versus replacement trends. And then, secondly on on-demand. Just wondering if there's anything early on that you're doing or could tell us about planning go-to-market with the frontdoor brand, anything you're doing in advance of the launch to help familiarize existing member base with a new brand, any early learnings if there are any. Thank you.
Yeah, I'm happy. This is Brian. I'm happy to take the first part of that question. And there's two questions. As far as process improvements based on the Tiger team success that Rex mentioned, we did realize some of the process improvement quicker than we thought. And that's what we talked about that one third in the claims cost benefit in Q1 and in the rest of the - for the remainder of the year is baked into our new forecasts. Does that help?
Yes, thanks.
And then from an on-demand perspective, as I mentioned earlier, it's still I think somewhat early days. We're beginning to test and pilot kind of what series of things that we want to test out. So they're not large scale pilots, if you will, so no real need to focus on branding or kind of our go-to-market approach just yet. They'll come later in the - kind of Q4 and Q1 timeframe.
Got it, thank you.
Our next question comes from the line of Justin Patterson with Raymond James. Please proceed with your question.
Great, thank you very much. Rex, you talked about marketing sped ramping over the course of the year to drive growth. Philosophically, could you talk about the factors that would cause you to lean into or pulling back on that spend? And then for Brian, you've got a strong balance sheet and healthy free cash flow generation. In terms of capital allocation, are there any technologies or components of that on-demand product that you think you need to buy versus build? Thank you.
Yeah, so I think that - sorry, can you repeat your first questions? I was focused on the last one.
The first question was more about just marketing spend philosophically. What type of [indiscernible] in terms of leaning into or pulling back on that?
Yeah. So we modeled the year as kind of an increase in terms of the marketing spend, traditionally Q1 is a more of a quiet period for us. So we just kind of modeled it to be ramped up to kind of Q2 through Q4, so that's just how we modeled the business. In terms of the other piece, Brian, you want take that.
About the capital allocation?
Yeah.
Yeah, happy to. You're right, we've got a strong balance sheet, we're generating cash at a very high rate, as I mentioned, we think we're going to convert EBITDA to free cash flow about 50% this year, which based on our guidance is $125 million to $130 million, so what do we do with that? Reinvesting in the business is key to us and Rex can weigh in as well. But if we didn't see a technology that we can acquire to accelerate the on-demand process, we would certainly consider it, but also paying down debt is certainly an option. We've hedged about - we've hedged 350 million of our 650 million term loan B. So that means you got 300 million we can pay down at our discretion. So that's something we're certainly considering.
I would also add that we've always kind of - we are always looking at kind of build versus buy. So that's something that Brian and I are always focused on.
Great, thank you.
Our next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed with your question.
All right. Thank you. Thank you very much. Question would be - Rex, thanks for running us through all the initiatives. Is there an initiative or maybe just some color around maybe initiatives for partnerships with utilities and how we should kind of think about that and the environment surrounding partnerships with utilities.
Yeah, certainly utilities are something that we do some small partnerships with. That's something that Brian Worthington, who runs our real estate sales and business development is focused on. So we're definitely interested and open to utilities. One thing we haven't explored is around utility line protection. That's something that definitely we're thinking about.
Okay. And then question for Brian, on the tariff side, just ask you through what's the sensitivity to your business, your guidance? And then would you anticipate any, like, supply chain disruptions because of that, just any kind of color on that would be helpful. Thanks.
Yeah, in terms I guess you're referring to the tweet over the weekend from the administration. Our prices for 2019 are pretty much locked in as far as manufacturing for water heaters appliances of HVAC or their production scheduling with existing raw materials, interesting prices that we've negotiated. So we'll see how this plays out. But it'll be more of a 2020 issue for us than the 2019 issue, for the most part, but we're digging into pretty deeply right now.
Okay, thank you very much. Good quarter again.
Thank you.
Next question comes from the line of Kevin McVeigh with Credit Suisse. Please proceed with your question.
Great, thanks. Hey, nice job. In terms of the dynamic pricing, it sounds like you're going to fully ramped in the back half of the year. Any sense of where was in kind of the first quarter and how we should expect that kind of progression over the course of the year?
Yeah. So every quarter it's going to get kind of - it's going to build on itself. Certainly, from a first year direct consumer as well as renewals, renewals are worth me said, we're continue to ramp it up somewhat of a manual process today, but we've focused on our higher expense areas first but because of the manual process we can't roll it out across the US. So every quarter as we build the technology and we get all the systems and pieces in place then you'll see it kind of come on more and more. I don't expect it to be fully finished until the end of quarter, there's a lot of lot of - so at the end of the year there's a lot of things we got to continue to build and for the team.
Got it and then just obviously the EBITDA really nice, it seems like it would come in even stronger, there was a an increase in underlying cost to repairs, was that just not using prime contractors or what drove that kind of underlying increase?
Yeah, we had - this is Brian, we had 12 million of tariff impact. So that's driving part of that.
Super, thank you.
Thank you.
Next question comes from line at Cory Carpenter with JP Morgan. Please proceed with your question.
Thanks for taking the questions. If I may, just following up on the last dynamic pricing question, in the robot, can we see dynamic pricing have an impact on gross margins and the second half of the year? Or is that still more to 2020? I know you mentioned 100 basis points in 2020. And then on the direct-to-consumer channel, you had nice colors this quarter. Just looking ahead, you mentioned the second half marketing spin ramping, and of course you have price increases that will continue to flow through. So I guess my question is, how should we think about the growth in this channel through the year? Is there any reason it wouldn't continue to accelerate? Thanks.
Yeah, certainly, we don't see any reason why direct-to-consumer wouldn't continue to accelerate. And then in terms of terms of the gross margin improvement, I think until we get the systems built you're really not going to see that improvement until 2020. Certainly, as we get some of the other pieces in there might be some small improvement, but I don't think it'll be material.
Okay, thanks.
Sure. Thank you.
Our next question comes from the line of Michael Ng with Goldman Sachs. Please proceed with your question.
Great, thank you for the question. I have two if I may. The first is given the fairly wide range of growth trends across your acquisition channels. Can you think about how much the new price increases played into some of those differences? For instance, is the last year pricing better among renewing customers that get relative to some of the first year new customers? And then should we see real estate revenue accelerate into the rest of the year given that I believe that some of the price increases in real estate didn't kick in until I think earlier this year? Thanks.
Yeah, so in terms of real estate tenants - because it's usually tied to an existing home sales contract tends to be a little less price sensitive. And then - so it's just more about expanding into and deepening our relationships with our existing brokerage firms, adding some of the other leading brokerage firms taking a very analytical approach in terms of who we're targeting. And then for direct-to-consumer certainly, as others begin to follow the price increases, price becomes less of an issue from a competitive perspective. But we're continuing to monitor our - both the renewal channel as well as a direct-to-consumer channel and it has a model. So we're, we're pretty pleased with - given the increase in price relative to our ability to continue to sell we're pretty pleased with the results.
Great and a follow up, if I may, just on whether, should we see more normal weather this year in '19. Should that be helpful to claims costs given that 2018 saw such unusual weather? And could you just remind us, which were the months that were particularly hurtful to claims costs last year? Thanks.
Well, certainly last year, we had a very cold winter and a very hot summer. So I would say that most of 2018 was tough. You think just to back October, October is one of the worst months we've had on record, right. So certainly as we - we're trying to - it's kind of joke with the heavy algorithm for weather, but that's something we're actually trying to develop. I think beyond a quarter it be tough to try to model the year, certainly, most weather services, I think, have difficulty doing that, beyond the kind of 90 day period, but that's something where we are looking at. And as whether gets better that's always a good a good thing for us and then we'll just continue to focus on process improvements and in running the business outside of weather.
Great, thank you very much.
Excellent.
Thank you.
Ladies and gentlemen, that concludes the question answer session. I will now turn the call back over to Rex Tibbens for some closing remarks.
Thank you. Our vision for 2019 and beyond remains the same. We will continue to build a solid foundation to improve the customer experience, drive our financial performance and position us to continue to grow our core business and new on-demand services in 2020 and beyond. Unchanged with our plan is our obsession with taking the hassle out of owning the home for our customers. Thank you again and we look forward to updating you on our progress on our second quarter 2019 earnings conference call. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.