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Frontdoor, Inc. (FTDR) Q2 2019 Earnings Call Transcript

Motley Fool Transcribing, The Motley Fool
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Frontdoor, Inc. (NASDAQ: FTDR)
Q2 2019 Earnings Call
Aug 07, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, welcome to Frontdoor's second-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 treasurer, and he will introduce the other speakers on the call. At this time, we'll begin today's call.

Please go ahead, Mr. Davis.

Matt Davis -- Vice President of Investor Relations and Treasurer

Thank you, operator. Good afternoon, everyone, and thank you for joining Frontdoor second-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, after the market closed today, Frontdoor issued a press release reporting our second-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 Investor 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 related to such statements. All forward-looking statements are made as of today, August 7, 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 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 to the 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 spinoff, which occurred on October 1, 2018, include allocations 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. Rex will lead off by summarizing our second-quarter performance. He will then provide a business update and discuss our strategic objectives for 2019. Brian will follow.

He will speak to our second-quarter 2019 financial results, provide more details in regard to our financial statements and then update our full-year 2019 outlook. We'll then open up the line for questions. I'll now turn the call over to Rex for opening comments. Rex?

Rex Tibbens -- Chief Executive Officer

Thanks, Matt, and good afternoon, everyone. Let's start with our quarterly summary shown on Slide 4. In the second quarter, revenue increased 9% versus the prior-year period to $388 million. Gross profit margin rose 800 basis points to a second quarter record of 53% on greater-than-anticipated contribution from our business process initiatives and seasonally mild weather.

These factors also helped drive a 44% increase in adjusted EBITDA versus the prior-year period to $105 million. Brian will provide further details on our financial performance and outlook shortly. Further down Slide 4, we continue to grow the number of home service plans by 4% to 2.1 million plans. Similar to last quarter, our customer retention rate remained stable at 75% although we do see some potential headwinds, which we'll discuss later.

We're also starting to realize the benefits of the investments we have made in technology and process improvements. We remain bullish about our core business and continue to see a lot of potential and growth in the future. Recently, we announced the opening of our new technology campus in Denver, Colorado. The new campus will bring additional capacity to our technology and engineering groups based in Memphis and Phoenix.

We feel Denver has the right attributes of talent and culture that will allow us to establish a seamless team environment that emulates our house rules. Also we expanded our service planning coverage to include optional electronics and smart devices. Our customers can now protect an unlimited number of eligible devices in their homes. The feedback from our customers has been strong, and we intend to scale this coverage over the next several months.

Finally, our house rules were fully implemented earlier this year. They are quickly being ingrained in our cultural fabric and hiring practices. Let's now move to Slide 5, where I'll provide a business update for each of our three customer acquisition channels. In our first-year direct-to-consumer channel, we made operational improvements by increasing our call center staffing to support new sales and better align compensation.

We believe this will drive new unit conversion from inbound sales calls in future quarters. We also continue to invest in marketing to drive top-line growth. We not only increased our total dollars spend in this channel, but also worked to improve the efficiency of our marketing dollars. In the first year of real estate channel, macro headwinds have resulted in a slight year-over-year decline in a number of home service plans.

Existing home sales figures from the National Association of Realtors show a decline of 3% in the second quarter. While slowing home sales remains a concern, we believe that the real estate environment could improve heading into the back half of the year as mortgage rates have meaningfully declined. In response to slow and existing home sales, we have been laser focused on growing our base of real estate brokers. I'm pleased to report that we have recently launched a strategic national home service plan program with HomeServices of America, the nation's largest real estate -- residential real estate company based on transaction size.

The Frontdoor real estate team continues to expand our partnerships with most of the major brokerage firms. We now work with nine of the Top 10 real estate brokers in the U.S. These partnerships in an improving macro environment will help us improve real estate units going to the back half of the year. Additionally, we are making operational changes in the real estate channel to improve the efficiency and effectiveness of our sales team in the field.

We're in the process of implementing new technology to better enable our sales team and ensure they have the data to focus on the most productive real estate brokers to drive new units. Turning to renewals, our largest channel. As I mentioned earlier, we recently expanded our product offering to add electronics coverage. This includes everything from personal computers to smart home technologies.

It is a great partnership that also increases the value proposition for our customers. Finally, renewal rates are the new focus of our tiger teams. These rates are under pressure from a mix of poor processes, suboptimal customer experiences last year and reduced plan usage. We see a direct correlation between usage of our home service plan products and customer renewals.

Our tiger teams are digging into the root causes here, which could include cycle time, service or mild weather to reverse this trend. Additionally, while the customer attrition related to pricing is in line with what we modeled, any price increase has a small impact on our renewal rates. Given the nature of our 12-month customer contracts, it takes time for the full impact of any changes to be felt in our customer renewal rates. At this point, we anticipate our blended retention rate could round down 1% to 74% by the end of the year with similar trends in each of our channels.

However, we are optimistic that our tiger team efforts could partly offset the current year impact and increase renewal rates over the course of 2020. Now please turn to Slide 6, where I'll give an update on our 2019 strategic objectives. Let me start by saying that we are making great progress delivering on the promises we laid out to stabilize the core business and grow into the broader $400 billion U.S. home services market.

Also I want to take a moment to acknowledge the great work that our cross functional teams have done in such a short period of time. We continue to build a culture of ownership, and I could not be more proud of how quickly we stepped up the speed at which we implemented our changes. Our first strategic objective is enhancing the customer experience. We are passionate about delivering a product that delights our customers.

While it's still early, we are consistently working to enhance the overall customer lifecycle experience, which includes improving customer service and outreach at our call centers, adding new products such as HVAC tune-ups and electronics coverage, improving payment processes, reducing cycle time, reevaluating coverages, and limitations in our core plan and improving contractor service and management. We're in the process of making additional investments to address each of these areas as we continue to improve our overall customer experience. Our second strategic objective is pricing. As I mentioned on previous earning calls, our overall average price increase was in the mid-single-digit range this year, with attrition rates consistent with where we modeled them.

By the end of the second quarter, around 50% of our customers have realized a price increase. In regard to dynamic pricing, we're on track for a broad rollout by the end of 2019, and we still anticipate a 100-basis-point gross-margin increase in 2020. Dynamic pricing will allow us to attract customers, who may have been previously outpriced by historic statewide pricing. Our goal here is to better manage our profitability at the customer level.

We will do this by better matching pricing to our cost to ZIP Code plus four-digit level. Let me take a moment to talk about our expectations for margins. I'm thrilled that our business process improvements have allowed us to get closer to our financial targets earlier than expected. Our goal has been to deliver approximately 50% gross margin and adjusted EBITDA margin in the low 20% range.

Our intention is to reinvest all margin in excess of these targets back into the business. We will target those investments to improve the overall customer experience and product coverage. Additionally, we'll use excess margin to further develop our technology capabilities and grow our on-demand product offering. Now turning to our third objective, improving our business processes and cost-containment objectives.

Again, we have made great strides in this area. Some of our largest wins from our tiger teams include increasing our preferred contractor capacity and utilization, improving collection of service fees and reducing the number of contractors dispatched to complete a service request. For example, last quarter, we told you about the changes made to our dispatch algorithm to increase the percentage of preferred contractor utilized. As a second step, we changed our algorithms to redeploy a preferred contractor in the same day if a previous service request was canceled.

These efforts have resulted in preferred capacity arriving to the low 80% range during peak season. This increased utilization reduces our cost as our preferred contractors charges about half the labor rates charged for the retail work. We also continue to roll out our new call center technology solution, Customer Service Central. We're seeing meaningful improvements to customer experience, as well as cost containment with the workflow nature of our new solution.

Finally, we're working to reduce expenses through better procurement leverage. The team is always looking to move our purchasing spend among different OEMs and distributors in order to leverage volume discounts for better service and incremental cost savings. Now moving to our fourth objective which is people. We have fully rolled out our house rules that I have discussed last quarter.

It's great to see our team fully engaged in building a fast-moving culture that enables employees to take ownership of their areas. We believe our investment in people will provide a compounding effect that will continue to pay dividends overtime. Technology is our fifth strategic objective for 2019. As I've mentioned previously, we are making significant improvements to our infrastructure and customer service platform.

Our technology initiatives are currently on track, and I'm pleased with our velocity in this area. The Denver technology campus paired with our great technology teams will serve as an integral driver of our technology transformation. As we move our infrastructure to the cloud and establish more micro services, we'll be able to open up new opportunities to improve our business processes and innovate at an even faster pace. Our sixth strategic objective on demand is still on course to launch our initial product next year.

We have pilots currently under way, and we'll provide more detail on what our offerings will be by the end of the year. Our initial focus continues to be on what we do best, repair and maintenance within our core skill trades. As we continue to develop our on-demand playbook, it's becoming increasingly clear that we can leverage our existing platform and operations. In turn, the process of building the on-demand playbook has helped to improve several aspects of our core home service plan business.

These synergies will allow us to leverage our investments across both businesses and raise the bar for all of Frontdoor. To conclude, I'm extremely pleased with how far we've come on this journey in such a short period of time. We've made tremendous progress on our business process improvements and cost-reduction initiatives. Our north star continues to be taking the hassle out of the home.

We're building a strong foundation that will support future growth and profitability that will benefit all of our stakeholders. I'll now turn the call over to Brian, who will cover our second-quarter 2019 financial results in more detail and discuss our updated full-year 2019 outlook. Brian?

Brian Turcotte -- Chief Financial Officer

Thanks, Rex. Good afternoon, and please turn to Slide 7. And I'll briefly review a few key financial results from the quarter. As Rex mentioned, revenue increased 9% to $388 million, driven primarily by an increase in our home service plans and a higher average price per plan.

Of the 9% revenue growth realized, 5 points came from volume and 4 points from price this quarter. As mentioned on the previous earnings call, we expected our year-over-year revenue growth composition to shift more toward price this year than in the past due to the higher-than-normal price increases we implemented in late 2018 and early 2019. Looking at our three primary customer acquisition channels, revenue derived from customer renewals was up 12% over the prior year, due primarily to growth in the number of home service plans and improved price realization. First year real estate revenue was up 1% versus the prior year, mostly driven by improved price realization that was partly offset by a decline in new sales.

In first year, direct-to-consumer revenue's at 8% due to the growth in new home service plans, driven primarily by increased investments in marketing. Gross profit dollars increased 29% to $205 million in the second quarter. Gross profit margin increased 800 basis points versus the prior year to 53%. The increase was driven by our business process improvement and cost-containment initiatives, as well as seasonally mild weather that had a favorable impact on claims incidents.

Net income was $60 million or 34% higher than last year. This increase was driven by a 23 million-dollar favorable impact from higher revenue conversion, $24 million of lower claims cost and $7 million of lower spinoff charges. This favorability more than offset a 17 million-dollar increase in selling and administrative expense, a 15 million-dollar increase in interest expense and a 5 million-dollar increase in income tax expense. Second-quarter adjusted EBITDA of $105 million was up $32 million or 44% versus the prior-year period, driven primarily by the aforementioned increase in gross profit.

Let me now walk you through the adjusted EBITDA bridge on Slide 8, which shows the drivers of change from second-quarter 2018 to second-quarter 2019. So starting on the left, we had $23 million of favorable revenue conversion versus prior year. As a reminder, we calculate revenue conversion at the estimated gross margin impact from volume growth plus the impact of price increases. This quarter, price represented $13 million of the change and volume was $10 million.

Continuing to the right, claims costs were $24 million lower than the prior-year period. The breakdown of lower cost include: first, a 13 million-dollar benefit from our process improvement and cost-containment initiatives, which we previously discussed; second, we had a 10 million-dollar benefit related to the favorable impact of mild weather on claims incidents. During the second quarter of 2019, cooling degree days in the U.S. were about 40% lower as compared to the historical average and 28% lower than the second quarter of 2018.

As a background, a cooling degree day is a reference for energy use based on the maximum and minimum temperature. The more cooling degree days, the more demand is placed on air conditioners and other cooling systems. We saw a similar temperature trend in the geographic areas, where we have our highest customer concentration, including the southern U.S. where we experienced a 14% decline in cooling degree days.

In addition, cooling degree days in the Western U.S. were down about 43% compared to the second quarter of 2018. While we're still refining the algorithm that correlates heating and air-conditioning claims by geography to the mean outdoor temperature variances, we are certain that the seasonally mild weather did play a meaningful role in lowering our claims incidents in the second quarter of 2019. And third, we had a 12 million-dollar net favorable impact of adjustments related contract claims cost development, which comprises a 5 million-dollar adjustment in the second quarter of 2019, primarily related to favorable development of prior quarter claims and a net 7 million-dollar adjustment in the second quarter of 2018 related to adverse development of claims.

The aforementioned benefits were slightly offset by $3 million in tariff- related costs and $8 million in other inflation in this quarter. Now turning back to the bridge. Sales and marketing costs increased $7 million due to planned incremental investments made to drive home service plan unit growth, primarily in a direct-to-consumer channel. Next, the spinoff dissynergies of $1 million relate primarily to the costs associated with the separation of Frontdoor technology systems from ServiceMaster.

And finally, the $7 million of other costs include higher insurance related cost of $3 million, annual incentive compensation of $2 million and general and administrative expense of $2 million. The higher G&A expense primarily consist of professional fees and an increase in bad debt expense, offset in part by an increase in interest and net investment income versus the prior-year period. Please now turn to Slide 9 for a review of our cash flow and cash position. Net cash provided from operating activities was $140 million for the first six months of 2019, compared to $122 million for the same period in 2018.

This increase was primarily driven by our favorable earnings and improved working capital over the prior year period. Net cash used for investing activities was $12 million for the first six months of 2019, compared to $16 million for the same period in 2018, primarily due to lower capital expenditures. Capital expenditures, or capex for short, decreased to $10 million, compared to $17 million in the prior-year period, which included spin-related technology costs. Please note that despite the relative low amount of capex through the first half of the year, we continue to target full-year capex of between $30 million and $40 million.

Net cash used for financing activities was $4 million for the first six months in 2019, compared to $74 million for the same period in 2018. Current year activity was driven by debt payments, while the significantly higher activity in 2018, which driven by net transfers to our then parent ServiceMaster that ceased after the spin-off in October. Free cash flow, which we calculate as net cash provided from operating activities minus property additions, or capex, was $130 million for the second quarter 2019, compared to $105 million in the prior-year period. This 24% increase is due primarily to higher adjusted EBITDA, positive working capital contributions and lower capex, partially offset by higher cash payments for interest expense.

I should note that adjusted EBITDA conversion to free cash flow for the first half of 2019 was 87%. We projected full-year 2019 adjusted EBITDA conversion to free cash flow will be in the 50% to 60% range due to interest expense, cash taxes and capex that are more heavily weighted toward the back half of the year. We ended the second quarter of 2019 with $425 million in cash and marketable securities, a $120 million increase from December 31, 2018. Of that total, $203 million were considered to be restricted net assets to remain in compliance with the regulatory requirements of certain states, which is a 16 million-dollar increase from year end.

As a result of our adjusted EBITDA growth and increasing cash balances, our net debt-to-adjusted EBITDA leverage ratio improved to 2.8 times at the end of the second quarter. We're now lowering our net leverage ratio target to 2 times to 2.5 times. I should also note that we will consider flexing our leverage ratio up a bit if the right acquisition opportunities arose. Turning to Slide 10.

I'll cover our updated full-year 2019 outlook. We continue to believe that full-year revenue will range between $1.36 billion and $1.38 billion, despite the impact of lower growth in the real estate channel. We now expect full-year gross margin to be approximately 49%. This reflects our process improvement and cost-reduction efforts, as well as the favorable impact of milder weather in the first half of the year.

Full-year adjusted EBITDA is now anticipated to range between $290 million and $300 million. And I would like to take a moment to provide some additional color on this outlook. Our adjusted EBITDA growth in the back half of 2019 is lower than the first half, largely due to weather and timing of our selling and administrative expenses. For example, we had about $18 million of mild weather impact on claims cost in the first half of the year, and we're assuming normal seasonal weather patterns for the remainder of 2019.

Additionally, we expect a meaningful increase in our selling and administrative expenses in the second half of the year versus the first half. This ramp up is due to timing of our investments in technology, sales and marketing, customer service, staffing levels, and other corporate costs. At this point, we're estimating our full-year 2019 selling and administrative expenses to be approximately $400 million, as we continue to invest in the business to build a stronger foundation for the future. I should also note that third-quarter 2019 adjusted EBITDA is anticipated to range between $95 million and $100 million.

Moving down the table, I previously covered the capex range. In the full year, annual effective tax rate is expected to remain at approximately 25%. In summary, we continue to invest for growth in a great business that generate strong cash flow. Our long-term targets remain the same.

We expect revenue to grow in the upper single digits with gross margins of approximately 50% and adjusted EBITDA margins in the low 20% range. With that, I'll turn the call back over to Matt to open the question-and-answer session. Matt?

Matt Davis -- Vice President of Investor Relations and Treasurer

Thanks, Brian. [Operator instructions] But please note that guidance is limited to the outlook we provided in our press release and webcast presentation. Operator, let's open the line for questions.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from Ralph Schackart with William Blair. Please state your question.

Ralph Schackart -- William Blair and Company -- Analyst

Good afternoon. Two questions, if I could. Rex, on the call you talked about reinvesting any potential cash flow upside once you've achieved your margin objectives. Just curious if the on-demand product, which I think contemplates a 10 million-dollar investment, would sort of garner potential in that reinvestment.

And then maybe just little bit broader, what sort of projects which you have are initiatives that you think would warrant the incremental investment? And then I have a follow-up. Thanks.

Rex Tibbens -- Chief Executive Officer

Sure. Yes. So from a gross-margin perspective, I think there is opportunity to continue to invest in the business, as well in the EBITDA margin. Specifically, for on-demand, we're pretty comfortable with the investment we laid out earlier in the year.

So about $10 million of opex spend. I think we'll still kind of come in that range. But in terms of other things to spend money on, certainly we have a long way to go. We're on a journey from a customer service perspective.

We just implemented our Customer Service Central platform, still more work to do around helping customers. And then from a technology perspective, as we continue to evolve a company that I think there is also opportunities to spend there, as well. And then lastly, we're always looking for ways to improve our products. So whether that's adding additional services or strengthening the services that we already provide today, those are the areas we're looking at.

Ralph Schackart -- William Blair and Company -- Analyst

Great. And then on the call, you've talked about blended retention rates maybe being down around a point or so and then increasing renewals in 2020. Just curious what the levers you could pull or what you're sort of contemplating to remind your consumers or the people purchasing this the value that it holds for them? Thank you.

Rex Tibbens -- Chief Executive Officer

Yeah, yeah. Great question. So the one thing is, I think we're going to -- we potentially might round down to 74%, so I wouldn't view it as a 100-basis-point drop. The things that we're working on with the tiger teams, enhancing our onboarding process, so we really ramped up welcome calls.

Obviously, if customers don't fully appreciate the product that they have, then they don't it. And in our business usage equals retention. We're really -- have spent a lot of time reducing payment frictions. So a little over two-thirds of our customers are on auto pay.

It's ensuring that there is no credit card hiccups on that front and other frictions from a renewal perspective we worked on. And then from a broader perspective, adding more services and products, we talked about rekey this year, but -- or last year. HVAC tune-up is another area that we have been focused on from a products perspective. And then lastly, really enriching our core service experience.

So CSC, the platform will really begin to be the kind of underpinnings, if you will, or the foundation to help us move to self- service. And we think self-service provides a better overall customer experience and it also should be less costly to handle customers' claims.

Ralph Schackart -- William Blair and Company -- Analyst

Great. Thank you, Rex.

Rex Tibbens -- Chief Executive Officer

Sure.

Operator

Our next question comes from Justin Patterson with Raymond James. Please state your question.

Justin Patterson -- Raymond James -- Analyst

Great. Thank you very much. Two, if I can. First, just a big picture, one on sales and customer acquisition.

Many of our digital competitors are encountering headwinds from both Google search engine marketing cost being inflated, as well as SEO headwinds. As you execute on the digital transition and start acquiring more customers through digital channels, how do you think about the appropriate marketing mix? And then I've got one follow-up to that.

Rex Tibbens -- Chief Executive Officer

So we kind of view the world in kind of three buckets, renewals, which is our largest channel, if you will, and then real estate and direct-to-consumer. From a true direct consumer, I believe that's where your question is focused, we're working on a couple of different things when it comes to that area. One, we've moved some work in-house, so trying to build a little more ad tech or experience in that area so that we have more control over our spend, trying to get closer to the efficient frontier. And then we've made a lot of changes in terms of compensation structures and how we're rolling out incremental sales people from an inbound sales perspective.

But from an SEO's -- Google SEO perspective, overall, we're actually not seeing the level of headwinds that we did last year. It seems to be the same headwinds. So we haven't yet experienced anything abnormal, if you will.

Justin Patterson -- Raymond James -- Analyst

Got it. Thanks, Rex. And then Brian, I wanted to elaborate on your comment on M&A. Could you just remind us what your M&A philosophy is? And how you want to think through returns associated with any investment you'd pursue? Thanks.

Brian Turcotte -- Chief Financial Officer

Sure. Great question. I'll ask Rex to chime in, as well. But we talked about our available cash and capital allocation.

First and foremost, we're reinvesting in the business to grow it. And then second in the pecking order would be bolt-on opportunistic M&A, whether it's home service plan related or a technology platform or something that could help us get to where we want to go even faster with on-demand or any of our other services in the future. So -- and return-wise, that's kind of a mixed bag. On a technology side, I would measure it different than I would on a home service plan side as far as short-term expected returns because they're just -- it would be different levers to pull.

Rex, you want to chime in at all?

Rex Tibbens -- Chief Executive Officer

Sure. On the technology space, it's more build versus buy. And what helps us from a speed-to-market perspective or if there is a technology portfolio that would allow us to build a different mode around our business from a patent perspective.

Justin Patterson -- Raymond James -- Analyst

Great. Thank you.

Operator

Thank you. Our next question comes from Ian Zaffino with Oppenheimer & Co. Please state your question.

Mark Zhang -- Oppenheimer and Company -- Analyst

Hey, guys. This is Mark on for Ian. Thanks for taking our questions. So just a quick one.

The number one for Brian. On the M&A front, you said you would be comfortable flushing your leverage beyond where you are or your target is. Can you just give a little bit more details on where, I guess, like you would be comfortable with getting up to? And then how quickly would you like to get it back down? Thanks.

Brian Turcotte -- Chief Financial Officer

Yes. We -- Thanks, Mark, good question. Well, you know how we generate cash. So anything we would do, we quickly build up cash again on the balance sheet to offset anything we do.

Again we're talking in bolt-on range here. So haven't really defined how high we would go because we're just not thinking and drastically changing the ratio at this point. But we started at 3.9, I think, back in the good old days when we were spun out, and we've brought it down to 2.8. So in a way we built cash and grow EBITDA, that will be a lot lower by next year or so.

I don't know, Rex, we haven't really talked about a ceiling on how high we go, but it wouldn't be dramatically different.

Rex Tibbens -- Chief Executive Officer

I think it's fair, to Brian's point, in less than a year, we've brought down a full turn. So I don't think we're looking to do something so dramatic. So that -- it puts us in parallel, so to speak.

Mark Zhang -- Oppenheimer and Company -- Analyst

OK. Great, thanks. And then just another one on things versus going through the on-demand and what you guys are doing there. But is there any sort of updates on initially those with partnerships with utility companies or partnerships with third parties that you -- I guess, like are working on or could progress quickly by 2020? Thanks.

Brian Turcotte -- Chief Financial Officer

Are you talking about specifically for on-demand or for our core business, as well?

Mark Zhang -- Oppenheimer and Company -- Analyst

I guess, a little bit of both, but more on the just core business? Thanks.

Rex Tibbens -- Chief Executive Officer

Sure. So core business, really excited about our strategic partnership with HomeServices of America, the leading -- from a transaction volume, leading real estate brokerage firm. So that's in very early stages. So we think that will definitely bear fruit.

And then we're looking at a lot of -- we've powered it with some of the -- kind of the iBuyer type of firms, can't give names there just yet. But we're exploring a lot of different partnerships in broad areas. We don't have a specific utility play that comes to our core business, but we have been working with utilities as it comes to how to leverage our business to help them. So more to come, but we have a very aggressive BD arm, and we're focused in those areas.

Mark Zhang -- Oppenheimer and Company -- Analyst

OK, great. Thanks, Rick.

Operator

Our next question comes from Mike Ng with Goldman Sachs. Please state your question.

Mike Ng -- Goldman Sachs -- Analyst

Thank you very much for the question. I just have two, if I could. The first is --

Rex Tibbens -- Chief Executive Officer

Hi, Mike.

Mike Ng -- Goldman Sachs -- Analyst

Hi. I was just wondering if you'd be able to provide an updated view on tariffs for 2019 and 2020 following the increase in tariffs from 10% to 25%? And whether or not there is any additional impact from list for tariffs if they were implemented on September 1st? Thanks.

Brian Turcotte -- Chief Financial Officer

Sure. This is Brian. I'll start on that. As you know, we estimated about a 10 million-dollar unfavorable impact in 2019 from the tariffs on the Chinese steel.

And that's holding pretty true to form and subsequently, I think, they announced an increase from 10% to 25%, and our prices are locked in for 2019, so no impact on that for the balance of the year, although we'll begin negotiating soon with our OEMs and parts distributors on prices for 2020. Whatever the increase is going to be, we don't think it's linear because we have leverage to negotiate with our providers on our products whether it be appliances or systems or parts. So that's to be determined, Mike. We've got to start the negotiations soon for 2020.

The recent announcement, I believe, is more consumer products and didn't impact our industry.

Mike Ng -- Goldman Sachs -- Analyst

Great. Thank you. And my second question is on weather. I understand that weather will always be an exogenous factor that could impact claims cost, but could you talk a little bit about some of the changes you're making in the core business to better withstand those outside service and claim requests? And any initial view on what you're assuming in terms of the weather impact for the third quarter, given July was fairly extreme?

Rex Tibbens -- Chief Executive Officer

Yes. This is Rex. When it comes to weather, obviously we're looking for the perfect crystal ball. We have definitely improved our ability to forecast.

We're working with a couple of different services and trying to inform our own models. We are -- when it comes to weather, the biggest thing that we do is our game is preferred contractor capacity. So our -- the algorithm changes that we made last quarter, as well as the capacity algorithm changes we've made over the course of last quarter and this quarter has really allowed us to dispatch more preferred capacity. And so as we look at these models and we see that there is a potential for warmer or colder weather, what we then do is reach out to our preferred contractor network to see if they can take on incremental capacity ahead of the storm, so to speak.

Luckily, this year weather has been much more favorable than last year. We have baked in into our guidance what we think weather is going to come out for the back half of this year, but we think this is going to be a, quote-unquote, more normal year than last year.

Mike Ng -- Goldman Sachs -- Analyst

Great. Thank you very much.

Brian Turcotte -- Chief Financial Officer

Michael, this is Brian. And by the way, you did a great piece on weather, and that was very well done. I do want to say -- you asked about July, and July was not atypical for us as May and June were. It was not that extreme.

We haven't seen our third-party data yet on the degree cooling days. But to your question, it was not abnormal for us, and we weren't surprised by the weather.

Mike Ng -- Goldman Sachs -- Analyst

Great. Thank you very much for the follow-up, Brian.

Operator

Our next question comes from Cory Carpenter with J. P. Morgan. Please state your question.

Cory Carpenter -- J.P. Morgan -- Analyst

Thanks for taking the questions. Two for me, as well. Maybe first on dynamic pricing. I know you've mentioned you're on track to finish the rollout by the end of the year.

Could you just update us on where you are on that today and any flow through you're starting to see on gross margins? And then as a quick follow-up on on-demand, anymore color you could provide on the pilots that you're currently running would be helpful. Thanks.

Rex Tibbens -- Chief Executive Officer

Sure. So in terms of dynamic pricing, we'll finish the majority of the tech work by the end of the year. So no, I would say, material gross margin impact from that today although we do use our models to inform our overall pricing. So I think that as we finish it up toward mid to late Q4, that's when we'll see the impact in -- over 2020.

And then from an on-demand perspective, we have a lot of people on the phone, who aren't analysts -- or generally a lot of people on our phone calls who aren't analysts, so we're being a little bit discrete in terms of how we're talking about the models, but I can tell you that things we're piloting is around where, I think, we have a lot of leverage and that's repair and maintenance services. So we have kind of pilots running in different markets around those things. There are small pilots that are more aimed at kind of learning what customers appreciate, how we're working with our contractor community, who have been very responsive to these pilots, which is a great, great sign for us. But I can't give you specific details on cities or the exact things that we're piloting just because there is a lot of outside interest in kind of what we're doing.

Cory Carpenter -- J.P. Morgan -- Analyst

Thank you.

Operator

Our next question comes from Chris Gamaitoni with Compass Point. Please state your question.

Chris Gamaitoni -- Compass Point -- Analyst

Good afternoon, everyone.

Rex Tibbens -- Chief Executive Officer

Good afternoon.

Chris Gamaitoni -- Compass Point -- Analyst

I wanted to follow-up on the direct -- on your direct-to-consumer goals, you mentioned expansion of marketing spend. Just high-level, what is that intended for? Are you pushing further into less penetrated states, is it more focused on where you have density today? Any color would be great.

Rex Tibbens -- Chief Executive Officer

Yes. So we're focused on where we have -- I look at more in terms of where we -- first, where we have capacity. So states where we have a good or a great supply positions, so lots of preferred contractors. And then secondly, we grow where we see opportunity.

So we've made some headway from a real estate perspective in the Northeast. So that's also -- as we build supply there, that gives us an opportunity from a direct-to-consumer perspective. So it's kind of really a two-pronged strategy of where we have supply and good penetration, if you will. And then secondly, as we're adding supply for real estate and we're leveraging direct consumer to try to sell-through in those areas, as well.

Chris Gamaitoni -- Compass Point -- Analyst

All right. And then I want to follow-up on the favorable adjustment in contracts claim cost. It's -- I get the year-over-year comp, but it seems like there was a net positive benefit. Just kind of what drove those -- the realization on the cost versus previous expectation?

Rex Tibbens -- Chief Executive Officer

Yes. This is a bit of an SAT question, it's a bit complicated. But a year ago, Q2 of '18, we had $12 million originally of unfavorable development from prior periods. Subsequent to that, we had some unfavorable development for Q2, which you net those two numbers they happen to be five, so we netted to $7 million unfavorable development in Q2 of '18.

This year, fast-forward to 2019, we had $5 million of favorable development of prior period claims. So you add those together and that's the $12 million of favorable that I called out in the script. Does that help?

Chris Gamaitoni -- Compass Point -- Analyst

Yeah, that helps with the math. I was wondering what drove the actual $5 million of favorable?

Brian Turcotte -- Chief Financial Officer

It's just we accrued at a certain level and perhaps process improvement for whatever reason when we closed out those claims, they cost less than we had anticipated. So there was a favorable adjustment. We over accrued.

Chris Gamaitoni -- Compass Point -- Analyst

All right. Perfect. Thank you so much.

Operator

Our next question comes from Robert Coolbrith with Wells Fargo Securities. Please state your question.

Robert Coolbrith -- Wells Fargo Securities -- Analyst

Good afternoon. Thanks for taking my question. Following up on Justin's question earlier on. The year-over-year increase in marketing was a bit more pronounced in 2Q versus the first quarter.

Just wondering if there is anything you could tell us about how return on ad spend is tracking in the DTC channel as we're proceeding through the year? And then second, I wanted to ask about the new electronics plan that you're rolling out. Anything you could tell us initially about uptake or cross-sell opportunity and then also since this is being offered with a partner anything you could tell us in broad terms about how revenues are going to be recognized there or margin profile relative to the core of your business?

Rex Tibbens -- Chief Executive Officer

Yes. So many of you asked -- to repeat a few though, but from an electronics perspective, definitely we're recognizing revenue as our take if you will, of that plan. So it's kind of all margin dollars, if you will. The plan -- or the program is fairly new, so we're just ramping it up so I wouldn't say it's material at this point, but we do think it will be material on the back half of this year and into 2020.

In terms of marketing spend, we ramped up -- we had to ramp up our sales force a little higher pace. So that's kind of caused a delay, if you will, for pushing more marketing dollars into the back half of this year. From a -- we don't publish our LTV to CAC ratios, but I will say they haven't really changed. So we're not seeing more marketing spend for less ROI, if you will.

So that's kind of what's driving that.

Robert Coolbrith -- Wells Fargo Securities -- Analyst

Great. Thank you.

Rex Tibbens -- Chief Executive Officer

Yeah.

Operator

Our next question comes from Youssef Squali with SunTrust Robinson Humphrey. Please state your question.

Sagar Vachhani -- SunTrust Robinson Humphrey -- Analyst

Hi, this is Sagar on for Youssef. I think you mentioned marketing is one of the areas where you'd be investing excess margins, but the revenue guidance for the second half doesn't seem to reflect the faster growth we would expect. I was hoping you could speak more to that.

Rex Tibbens -- Chief Executive Officer

Well, as we -- the great thing about our business is, it's subscription based. So as we sell more units, so to speak, we recognize revenue a twelfth at a time. So as you sell more in the back half of the year or you're spending more from a marketing perspective, but from a revenue recognition perspective, you're not seeing the dollars flow through until every month passes, right. So if we sold something in August, you'll recognize a quarter of that revenue versus full 12 months.

Sagar Vachhani -- SunTrust Robinson Humphrey -- Analyst

Makes sense. Thank you.

Operator

Our next question comes from Kevin McVeigh with Credit Suisse. Please state your question.

Kevin McVeigh -- Credit Suisse -- Analyst

Great. Thanks. Hey, Rex, you've alluded to just better leverage of the preferred contractor capacity, any sense of where that was in the quarter? And what we can expect kind of moving forward on that?

Rex Tibbens -- Chief Executive Officer

Yes. So overall for the year, we typically are seeing kind of around 80%. In the summer season, it's uncommon for that to dip on very, very heavy days. So far for heavy days, we're kind of maintaining near that 80%.

So it's a pretty significant change for us. So I think overall we'll be kind of in the low to mid-80s as we continue moving forward. So it's been a great win for us, not just from a changing the algorithm perspective, but also from a capacity perspective to be able to debit and credit, if you will, canceled calls and making sure that we're -- for every canceled call, there was a preferred contractor we're giving them another call. It has been paying dividends for us so far.

Kevin McVeigh -- Credit Suisse -- Analyst

Really nice. And then just obviously really nice EBITDA beat. If we think about the $27 million relative to expectations and you had a nice bridge in there, was it kind of the contract claims that came up big, the revenue conversion, just any thoughts if we were to try to think about again the beat relative to kind of where the guide was?

Rex Tibbens -- Chief Executive Officer

Yes. Certainly, process improvements and cost-containment initiatives accelerate faster than we expected. Obviously, those algorithm improvements you can model them, but you don't get to see them until they are really out in the wild. And you're handling actual claims and dispatches.

May, June weather was very mild. So after a kind of warmer-than-normal April, that certainly helped us and then the assumed inflation in tariffs would offset prior year out of period. But we saw about $5 million favorable development in Q2 of '19. Any other thoughts, Brian?

Brian Turcotte -- Chief Financial Officer

No, that captures it.

Kevin McVeigh -- Credit Suisse -- Analyst

Awesome. Thank you.

Rex Tibbens -- Chief Executive Officer

Thank you.

Brian Turcotte -- Chief Financial Officer

Thank you.

Operator

Our next question comes from Jamie Clement with Buckingham Research Group. Please state your question.

Jamie Clement -- Buckingham Research Group -- Analyst

Hey, good afternoon, gentle men. Thanks for taking my question. Rex, this maybe a silly question, but your comments about renewal rates. If you go through a stretch where mother nature is favorable and you're not getting as many claims and use of claims, use of your service tends to correlate with renewals.

Is it sort of natural to see a downtick in renewals if mother nature has been cooperative?

Rex Tibbens -- Chief Executive Officer

It is. We have to work on the empirical evidence to prove that, but certainly if you look at our first year real estate renewals are much lower than direct-to-consumer because direct-to-consumer customers have an intend to purchase right. So if you don't use our service, there is a higher probability that you won't renew. So while good weather is certainly good for the quarter, we are ensuring that we're following up with customers to ensure that they understand the value proposition of what they bought.

Jamie Clement -- Buckingham Research Group -- Analyst

And, Brian, if I could follow-up on a prior question or two. I think there is some stories that July was one of the hottest on record in this country. You guys didn't see crazy claims activity, is that what you're saying? It wasn't nuts, was it?

Brian Turcotte -- Chief Financial Officer

Yes. I think it was hot, but it's hot in the places, I think, it's typically hot in the summertime.

Jamie Clement -- Buckingham Research Group -- Analyst

OK.

Brian Turcotte -- Chief Financial Officer

Texas and across the Gulf or what have you. But no, we didn't see unusual activity that we had seen in May and June when it was so mild. It seemed to be right on our FP&A team's forecast.

Jamie Clement -- Buckingham Research Group -- Analyst

OK. Thanks very much. And in terms of like pace of SG&A ramp, I think, Brian, you said approximately $400 million this year. I think that implies, let me just take a quick look here, I don't know.

It looks like it's probably the implication in terms of like your year-over-year increase as a percentage of revenue looks pretty balanced between Q3 and Q4, am I right about that? Or is one going to be kind of more of an increase than the other?

Brian Turcotte -- Chief Financial Officer

The quarters?

Jamie Clement -- Buckingham Research Group -- Analyst

Yeah. Like in terms of -- like if I think about kind of ramping to -- if you get to $400 million for the year, is there more of a spike in Q4 as to Q3? Or is it pretty even?

Brian Turcotte -- Chief Financial Officer

I think it's funny. I'll look at it on a half basis.

Jamie Clement -- Buckingham Research Group -- Analyst

OK.

Brian Turcotte -- Chief Financial Officer

Just thinking through, the -- we typically spend less in marketing in Q4 than Q3. Yes, I would think that I'm spit balling here when I speak – I'll follow-up with the guys, but Q4 typically is less than Q3.

Jamie Clement -- Buckingham Research Group -- Analyst

OK, OK, great. Thank you, all, for your time. I appreciate it.

Brian Turcotte -- Chief Financial Officer

Sure. Take care.

Operator

Ladies and gentlemen, that concludes the question-and-answer session. We will now turn the call back over to Rex Tibbens for some closing remarks.

Rex Tibbens -- Chief Executive Officer

Thank you. It is exciting to see the great progress we're making in our business. We continue to deliver on our promises, and I'm pleased with the velocity of change across the organization. Even with the progress shown in the first half of the year, we are not done.

We still have to do -- we still have to improve the customer experience and our technology platform. We're also working hard piloting new features and remain on track to launch our on-demand business next year. These actions will position us to continue to grow our core business and expand in new services in 2020 and beyond. Thank you again, and we look forward to updating you on our progress on our third-quarter 2019 earnings conference call.

Operator

[Operator signoff]

Duration: 58 minutes

Call participants:

Matt Davis -- Vice President of Investor Relations and Treasurer

Rex Tibbens -- Chief Executive Officer

Brian Turcotte -- Chief Financial Officer

Ralph Schackart -- William Blair and Company -- Analyst

Justin Patterson -- Raymond James -- Analyst

Mark Zhang -- Oppenheimer and Company -- Analyst

Mike Ng -- Goldman Sachs -- Analyst

Cory Carpenter -- J.P. Morgan -- Analyst

Chris Gamaitoni -- Compass Point -- Analyst

Robert Coolbrith -- Wells Fargo Securities -- Analyst

Sagar Vachhani -- SunTrust Robinson Humphrey -- Analyst

Kevin McVeigh -- Credit Suisse -- Analyst

Jamie Clement -- Buckingham Research Group -- Analyst

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