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Realogy Holdings (NYSE:RLGY)

Q1 2013 Earnings Call

May 01, 2013 5:00 pm ET

Executives

Alicia Swift

Richard A. Smith - Chairman, Chief Executive Officer, President, Member of Executive Committee, Chairman of Domus Intermediate Holdings Corp., Chairman of Realogy Corporation, Chief Executive Officer of Domus Intermediate Holdings Corp., Chief Executive Officer of Realogy Corporation, President of Domus Intermediate Holdings Corp. and President of Realogy Corporation

Anthony E. Hull - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Anthony Paolone - JP Morgan Chase & Co, Research Division

David Adam Katz - JP Morgan Chase & Co, Research Division

Steven E. Kent - Goldman Sachs Group Inc., Research Division

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Daniel Oppenheim - Crédit Suisse AG, Research Division

David Ridley-Lane - BofA Merrill Lynch, Research Division

Michael S. Kim - CRT Capital Group LLC, Research Division

Freda Zhuo - Barclays Capital, Research Division

Will Randow - Citigroup Inc, Research Division

Operator

Good afternoon, and welcome to the Realogy Holdings Corporation First Quarter 2013 Earnings Conference Call via Webcast. Today's call is being recorded and a written transcript will be made available in the Investors Information section of the company's website tomorrow. The webcast replay will also be made available on the company's website until May 15.

At this time, I would like to turn the conference over to Realogy's Senior Vice President, Alicia Swift. Please go ahead, Alicia.

Alicia Swift

Thank you, Roshanda. Good afternoon, and welcome to the Realogy's First Quarter 2013 Earnings Conference Call. On the call with me today are Realogy's Chairman, CEO and President, Richard Smith; and Chief Financial Officer, Tony Hull. As a reminder for webcast participants, you will need to advance the slides by clicking the forward arrow on the bottom right of the screen beneath the webcast player as we move through today's presentation.

Starting with Slide 3, I would like to call your attention to 2 items. First, you should have access to a copy of our financial results press release for the quarter ended March 31, 2013, which we have filed with the Securities and Exchange Commission. The press release is available on the Information section of our website, as well as a copy of today's webcast slides. Also, certain non-GAAP financial measures will be discussed on this call, and these measures are defined and reconciled to the most comparable GAAP measure in our press release.

Second, the company will be making statements about its future results and other forward-looking statements during this call. Statements about future results made during the call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and the current economic environment. Forward-looking statements and projections are inherently subject to significant economic, competitive and other uncertainties and contingencies, many of which are beyond the control of management. The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements.

For those who listen to the rebroadcast of this presentation, we remind you that the remarks are made herein are as of today, May 1, and have not been updated subsequent to the initial earnings call. Important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements are specified in our earnings release issued today, our 2012 Form 10-K, our form 10-Q filed earlier today and other SEC filings.

Now I will turn the call over to our Chairman and CEO, Richard Smith.

Richard A. Smith

Thank you, Alicia, and good afternoon, everyone. We appreciate you joining our call as we report on our first quarter 2013 financial results and operating performance. We are pleased with our first quarter results, which given the seasonality of our business, is our weakest quarter of any year. And looking at 2 key benchmarks for our performance on Slide 4, both net revenue and adjusted EBITDA improved significantly from the same period a year ago.

Net revenue for the quarter was $957 million, an $82 million increase or 9% improvement over the first quarter 2012. Adjusted EBITDA was $71 million, which was a gain of 34% versus a year ago. We continue to make solid progress in deleveraging our balance sheet. In the month of April, we redeemed a total of approximately $330 million of debt. This constituted all of our outstanding senior subordinated notes and 12% senior notes.

The first quarter improvements in our financial results were largely due to our operational performance, specifically the combined sales volume from the franchise and the Company Real Estate Services segments increased 14% year-over-year, which was at the top end of the transaction volume range we provided during our call in February. With 1 less business day than the first quarter of 2012, our sales volume was adversely affected by about 2 percentage points.

By comparison, on Slide 5, the National Association of Realtors, we often refer to as NAR, reported an 18% year-over-year increase in sales volume on the same basis for the first quarter of 2013. I would note that NAR has downwardly revised its monthly survey transaction volume figures in 10 of the last 14 months.

As we have discussed on previous occasions, over the longer horizon, we expect Realogy's actual results to be more in line with NAR's survey results. However, over the short term, our results may vary based largely on the difference in the mix of business and the market concentrations of our company-owned offices. For instance, if you consider the last 12 months for the period ending March 2013, our volume increase of sides times price was 19%, more closely aligned with NAR's 18% volume increase during that same period.

Despite low inventory levels in the first quarter, transaction volume growth was strong. We are seeing strong demand and exceptional affordability, which is driving higher home sales and higher average homesale prices.

Another factor that had an impact on the first quarter was the delayed closings of many of our open transactions. We believe this is just a timing issue though, because our company-owned offices reported historically low cancellation rates of approximately 9% in the first quarter, which is the lowest rate we have experienced during the first quarter in the past 10 years. Clearly, with the demand for higher -- with demand for inventory so high in many markets at certain price points, buyers are reluctant to walk away from contracts given their concern about finding an alternative home to buy.

Another indication of the strength of the market is the percentage of homesale transactions we are involved in that included multiple offers. Multiple offers appear to be predominantly associated with higher-priced homes. NRT, which has an average sale price of approximately twice the national average, reports that year-to-date through March, 47% of its transactions involve multiple offers.

And moving to Slide 6, our business units and the company performed well against our strategic objectives. The first quarter 2013 highlights included the following accomplishments: RFG, our franchise side, generated new franchise sales and sales associates totaling $68 million in gross commission income, or GCI, which was an increase of 42% over the first quarter of last year; our luxury real estate brand, Sotheby's International Realty, recently won Franchise Business Review's Best in Category award for real estate franchisee satisfaction for the sixth year in a row and ranked second overall among all large franchises.

In an annual study conducted by a global market research firm, consumers identified CENTURY 21 as the most respected brand in the real estate industry. CENTURY 21 achieved 96% aided brand awareness, maintaining the lead it has held since 1999.

Coldwell Banker earned distinction for its agent training platform, ranking third overall and #1 among real estate companies on the Training magazine Top 125 list of best training organizations. Cartus and CENTURY 21 also earned top honors.

Earlier today, NRT was ranked as the #1 residential real estate brokerage firm in the nation by REAL Trends for the 16th consecutive year, ranking highest by sales volume and closed transaction sides. NRT's 2012 sales volume of $128.7 billion pro forma for acquisitions is 3x higher than the next largest brokerage firm. In late March and early April, NRT completed 3 accretive tuck-in acquisitions in Florida. These acquisitions enabled NRT to expand its footprint into 2 new markets.

Turning to Slide 7. Cartus signed 32 new clients in the first quarter and also expanded the scope of services provided for 84 of its existing clients, the impact of which is expected to benefit future quarters.

TRG's title and settlement capture rates on NRT homesales improved to 41% in the first quarter. That's up from 39% in the first quarter of last year. TRG's underwriter reported a 22% increase in first quarter net premiums year-over-year, and its underwriting claims experience for the quarter was less than 1%, which continues to substantially outperform the industry average loss ratio. And we are extremely proud to have been named one of the World's Most Ethical companies for the second consecutive year by Ethisphere Institute, a leading international business ethics think tank.

So now let's move on to the current operating environment on Slide 8, specifically the industry forecast for the remainder of 2013. Consistent with our results in the first quarter, NAR is forecasting a 15% increase in sales volume for full year 2013. That's made up of a 7% increase in existing homesale units to 5 million units for the year and an 8% increase in median homesale price to $190,100. Fannie Mae is forecasting a 12% increase in 2013 sales volume. That's comprised of a 7% improvement in existing homesales to 5 million units and a 5% increase in median sale price to $186,000.

Remember in a steady-state, for every 1% increase or decrease in homesale transaction sides or average sales price, there was a corresponding $12 million impact in Realogy's EBITDA in 2012. As the housing market continues to improve, we expect this sensitivity to increase.

NAR's most recent report showed March inventory at 1.93 million units, which is 17% lower than a year ago and equates to a 4.7 month supply, a 24% decrease from the same period a year ago, but a 9% increase from January to March. We are also seeing increases in the majority of our markets, and we expect inventory levels to continue to increase in the second quarter.

There are 2 other factors that should contribute to improved inventory levels: rising home prices and new home construction. CoreLogic reported that 1.7 million homes regained positive equity in 2012 and projects that an additional 1.8 million homes will regain positive equity if home prices rise by another 5%. We believe it is reasonable to expect previously underwater homeowners to move back into the market as sellers.

In its April release, the U.S. Census Bureau reported single-family housing starts at a seasonally adjusted annual rate of 609 -- 619,000 units in March. That's a 29% increase from March 2012 levels. In addition, new single-family homesales were at seasonally adjusted annual rate of 417,000 units from March of 2013, and that's an 18% increase from a year ago.

New homebuyers are generally move-up buyers and when they purchase a new home, they add their previous home to the existing home inventory. According to NAR, in 2012, there were 20 million renters whose income was above the level necessary to qualify to purchase the median home with a 20% down payment. And despite rising home prices, the most recent data from Trulia shows that buying a home is now more affordable than renting in all 100 of America's 100 largest metropolitan areas.

Affordability is driving higher demand for housing, which in turn is leading to higher near-term price gains. On that point, the latest S&P/Case-Shiller Home Price Index released yesterday showed home price increases of 9.3% in February from a year ago, its largest growth rate in nearly 7 years. In addition, all 20 cities in the index posted an increase in prices versus 1 year ago for the second straight month, the first time that has happened since 2005.

On the regulatory front, there is little news. The most pressing near-term issue is the Consumer Financial Protection Bureau's final definition of a qualified residential mortgage, or QRM. The previously announced qualified mortgage definition was not as onerous as some expected, which may indicate similar intentions with respect to QRM. Once the underwriting rules are established and understood, we believe lenders will gradually normalize mortgage underwriting standards, which should make it possible for more creditworthy borrowers to enter the housing market.

As we report today, the future direction of both Fannie Mae and Freddie Mac remain unclear, and we do not see any near-term urgency from Congress or the administration to tackle what clearly will be a long-term issue. In the interim, both a more profitable and a near term represent less of a burden on the American taxpayer. Although we believe substantive and well-considered proposals have been presented, the Bipartisan Policy Center policy proposal on February 25 as an example, we do not expect material near-term changes in how Fannie and Freddie operate.

And on a final note, in June, we announced that Realogy will host the FWD, or Forward Innovation Summit, an invitation-only event designed to attract the best new real estate-related products, technologies and services to compete for top honors, as judged by a panel of real estate experts from the Realogy operating companies. The top honorees will have broad exposure to the Realogy real estate companies, which could accelerate the adoption rate of their service, technology or product. Approximately 20 emerging technology companies are expected to compete for top honors.

In closing, I want to reiterate our belief in the strength of the housing recovery. The trends we saw develop the second quarter of last year were strengthened by the market conditions of both the third and fourth quarters and continued into 2013, contributing to the results we are reporting today. We continue to be bullish on the recovery and the long-term prospects for housing.

So with that, I'll turn the call over to Tony.

Anthony E. Hull

Thank you, Richard. Let me make some brief comments on Slide 9 before I discuss the results for the first quarter of 2013 in detail.

For the first quarter of 2013, Realogy's net revenue is $957 million, a 9% increase compared to the first quarter of 2012 and adjusted EBITDA was $71 million, an increase of 34% year-over-year. Revenue increased 9% compared to volume increases of 14%.

Revenue increases did not align, and certainly did not align in the first quarter, with volume increases because first of all, NRT volume and revenue increased 11% and it has the biggest impact on our revenue number. Second, Cartus revenue is flat in the quarter versus last year. RFG's net effective rate declined versus Q1 2012, and that put modest pressure on revenue compared to volume as well. The adjusted EBITDA margin improved 100 basis points from the first quarter a year ago, and incremental margins were 22% on the $82 million revenue increase.

The first quarter EBITDA of every year is historically the smallest contributor to the four quarters due to seasonality. In 2012, Q1 represented only 18% of volume and revenue and 8% of adjusted EBITDA for the full year 2012. Fixed costs, conversely, of the business were spread evenly throughout the year.

The second and third quarters are Realogy's largest EBITDA contributors. Also, average sales price is typically the lowest in the first quarter of every year and sequentially, you will see declines in average sales price from Q4 of the previous year into the first quarter. Finally, Realogy's net debt at March 31, was $4.1 billion, and the company had 145.4 million shares outstanding.

Next, I will discuss our key revenue drivers in Slide 10.

RFG homesale sides increased 6% year-over-year in Q1, and average homesale price increased 9%. RFG's price increase was influenced by the mix of Sotheby’s International Realty, where sides increased 19% from Q1 2012 to Q1 2013. The increase in sides would have been 8% with the same number of business days in 2012, equal to NAR's reported Q1 increase.

NRT homesale sides increased 5% year-over-year in Q1 compared to 2012, 7% on the same number of business days basis, and its average homesale price increased 6%. The greatest growth in unit sales occurred in NRT's lower priced markets. Salt Lake City, Columbus, Cincinnati, Philadelphia and Denver all experienced sides increases between 20% and 35%, while price -- with price increases ranging from flat to the high-single digits.

California, where inventory levels are substantially lower than a year ago, is seeing sharp increases in average sales price. Northern California saw units decline 1% but average sale price increased 16%, and Southern California saw sides increase 5% and average sale price increase, 18%.

NRT's New York City operations experienced an average sale price decline due to the absence of a $126 million sale that closed in the first quarter of 2012 and the shift in mix as low interest rates and high rental rates created additional demand at the lower end of that market. Sales of homes priced under $1 million grew 9% in New York City, while home sales over $1 million grew by only 3%. These last items dampened NRT's overall price gains for the first quarter. Just as an aside, Connecticut, Westchester, Dallas, Chicago and Atlanta for NRT also experienced 20% plus volume gains if you combine sides and price.

For the second quarter of 2013, based on April results as well as what we are seeing in our pending contracts, we expect to see between a 7% and a 9% increase in transaction sides year-over-year for RFG and NRT combined. Average sales price looks like it will increase between 7% and 8% on a combined basis. As a result, Q2 transaction volume is expected to be up between 14% and 17% on a combined basis.

Average broker commission rates for Q1 2013 increased 1 basis point for NRT to 2.52% and were flat at 2.56% for RFG year-over-year, both despite increasing average sales prices. Also, the Realogy Franchise Group's net effective royalty rate declined 18 basis points to 4.57% as its larger affiliates continued to achieve incentives for higher-volume levels.

RFG's top 250 companies represented 58% of total franchisee revenue in Q1 2013 versus 55% in 2012. The net effective royalty rate should be looked at sequentially, and we expect that the net effective rate will remain at this approximate level during 2013.

Cartus referrals for Q1 increased 10% and relocation initiations decreased 4%. We are seeing a modest shift from traditional relocation activity to stronger results from referrals. As the year progresses, increased relocation activity from our existing and new clients should lead to incremental relocation revenue. Our current expectations for Cartus revenue in the second quarter is that it will be flat to a slight increase.

At TRG, Q1 2013 purchase unit volume increased 5%, which was consistent with NRT homesale gains. TRG's refinance units increased 11% in Q1 2013 compared to 2012. Now let's look at revenue and EBITDA by business unit for Q1 2013 as shown on Slide 11.

Total revenue at RFG increased to $6 million in Q1 2013 versus '12, while EBITDA increased $11 million. The 5% revenue increase was due to the increase in homesale sides and average price, partially offset by a decrease in the net effective royalty rate discussed earlier. RFG's EBITDA margin increased to 53% from 40% -- from 47% in Q1 of 2012, driven by the revenue increase combined with lower legal expenses and employee-related costs.

Revenue at NRT increased $69 million or 11% due to increased homesale transaction volume. NRT EBITDA was up $9 million and its margin improved by 200 basis points year-over-year. As we said before, NRT EBITDA in the first quarter has historically been negative as we generate our lowest revenue during the quarter, whereas our fixed operating costs are spread evenly throughout the year.

Commission splits increased 83 basis points to 67% in Q1 year-over-year. NRT has been trending toward adjusting agent splits on anniversary dates rather than all at the beginning of the year for competitive reasons, so you'll see less variability during the year.

At Cartus, revenue was down $1 million year-over-year, while EBITDA increased $6 million. Revenue decreased because of lower relocation volume, partially offset by higher referrals. The referral business generally produces higher margins. Also positively impacting EBITDA were lower employee-related costs and favorable currency exchange rate gains. As a result, margins increased to 11% in the first quarter from 5% in the first quarter of 2012.

At TRG, revenue increased $12 million or 14% as a result of increases in resale and refinance units and underwriter revenue. EBITDA increased $2 million and its margin increased 200 basis points to 4% due to higher volume.

Turning to other items on Slide 12. With the $500 million financing we completed last week and the proceeds being used to redeem our 11.5% notes in May, cash interest should be about $300 million in 2013. Capital expenditures will be about $55 million to $60 million for the year. Cash taxes will be approximately $15 million to $20 million. This relates to foreign, state and alternative minimum taxes. Cash legacy payments will be about $10 million to $20 million, and working capital is expected to be a use of $25 million to $35 million in 2013.

In conjunction with the secondary offering, 62% of the Phantom Value Plan became payable in the second quarter. The 8 senior executives who participated all elected to take stock in lieu of cash. These payments will have no effect on adjusted EBITDA but will be reflected as compensation expense in EBITDA. We expect our shares outstanding in the second quarter to be approximately 146 million after reflecting this transaction.

As to the near term, based on the visibility we have into the coming months, we anticipate overall transaction volume to gain 14% to 17% in the second quarter of 2013 on a combined basis compared to Q2 of 2012. As the market improves, we continue to stay focused on keeping expenses under control, growing profitable market share and deleveraging with our free cash flow.

With that, I'll turn it over to the operator, who will open up the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Adam.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

First, I was -- Tony, you mentioned on that -- the 67% commissions as a percentage of the expenses was supposed to moderate a little bit and you -- I didn't quite understand the explanation about the anniversary-ing of things. And last quarter, I think when we talked you alluded to that was somewhat of an issue that you were working on because last quarter was around 69%. So could you just talk about what transpired too, to lead to the sequential change?

Anthony E. Hull

Sure. The -- we were just -- I think the increase looks much larger if you compare the first quarter of last year to the first quarter of this year, and one of the reasons for that is there was a lot of volatility last year. It went up pretty significantly as the year progressed. And one change we made last year is in a lot of the markets -- a lot of the agents sort of reset on January 1 every year. That became a competitive issue because all of our competitors knew that the agents were vulnerable on the first day of the year. So it's -- we moved a lot of those markets to anniversary of the agent's employment -- or excuse me, not employment, but the agent working with one of our brokers. And so that's going to spread -- the resets, instead of happening all on Jan 1, they're going to be spread during the year. So you'll see a much more stable split rate as the year progresses as opposed to going from 64% in the first quarter down -- up to 69% in the fourth quarter. It should stay more equal during the year as a result of that change.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay. And then on the net effective royalty rate, just to make sure we understand, was the decline -- is it just purely the top producers getting their incentives and their rebates? And was there anything else at RFG that impacted the disconnect between the volume and the revenue growth?

Anthony E. Hull

Well, the only other thing that created disconnect, which is I didn't mention, but the marketing revenue that's recognized as equivalent to the marketing expense we spent in the quarter, this is the advertising funds we have on behalf of our various brands. So we spent -- we just -- because of the brand's marketing plans, we spent less in the first quarter of this year than we did in the first quarter of last year. So consequently, we recognized less revenue in the first quarter this year than we -- versus last year. So that also had -- that on top of the net effective royalty rate sort of dampened the RFG revenue versus the volume.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay. And then was the decline in the royalty rate just the incentives in the larger producers?

Anthony E. Hull

It's really just a fact that the top 250 continued to outperform. Again, as I mentioned, the top 250 represented 58% of the revenue that we earn royalties on versus 55% a year ago.

Operator

Your next question, sir, comes from the line of Tony Paolone from JPMorgan.

Anthony Paolone - JP Morgan Chase & Co, Research Division

If we look at the NAR data for the -- or their projection for the full year, it seems like sides and price up about 15%, and that's kind of the zip code of where you guys were in the first quarter and kind of where you guys seem to be trending for the second quarter. So it suggests that to hit those types of numbers, the second half will look pretty similar to the first half in terms of growth. And so my question is, what type of macro backdrop do you think we need to see as we go into the back half of the year to kind of support this continuation of this sort of mid-teens volume growth?

Richard A. Smith

Tony, it's Richard. I think a continuation of what we're seeing now, as you know, we don't spend a lot of time factoring in GDP growth inflation, unemployment rates, et cetera. We tend to look at the raw operating data. So we see nothing but a continuation of what we have now because that's essentially what NAR is doing. I think Fannie Mae does that to some degree. I think we should see that Fannie Mae is accurately forecasting the year. We may vary, as you well now, based on the data that we provided. But it's a sort of a continuation of what we see now. We're not expecting unemployment rates to change. We're sort of settled in to where we are, and we don't see a lot changing. So -- and that's good. We're also not considering any particular change in the regulatory environment. So I think all things being equal, steady as she goes. This is -- this current environment should produce what both NAR and Fannie Mae are forecasting.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. And then Tony, on sort of the subject of incremental margins, I mean, just doing the math in the first quarter, it's about 22%, but I know that's one quarter and it's based on the adjusted numbers. How should we look at that as we go into 2Q and 3Q, just because they're meteor quarters? And I know that the rule of thumb, the $12 million is kind of an annual number. Just trying to get a little bit more precision in sort of these second and third quarters.

Anthony E. Hull

Yes. I mean, there's no precise science to this, but the first quarter sensitivity is a little bit lighter than the full year and it's sort of made up in the second and third quarter. So obviously, we didn't get the full benefit of it. I think last year it was -- I think it was like $10 million in the first quarter versus $12 million for the first year -- for the full year of 2012. So it should be a little more robust in the second, third quarter and probably a little bit lower in the fourth quarter. But -- so it's probably, I don't -- don't hold me to this, but it's 10 13 13 11 or 12 will be the quarterly, then you'd have to divide all those numbers by 4 obviously, but that's kind of the spread across the year.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. But for the full year, you guys have talked about I think 25%, 30% sort of incremental margins and that's something you still feel pretty good about?

Anthony E. Hull

We don't give forecasts, if you were trying to get a forecast out of me. But I guess we sort of know -- I mean, I think the first quarter gave you a good sense of expenses for the year because it cleans out the Apollo Management fee, and the retention that we had last year is -- was not in the first quarter. So it gives you a good basis to reflect the full year fixed cost. So then it really is a factor of is NAR right or Fannie Mae right for the remainder of the year.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. And then just last question on the net effective royalty rates. I guess, what do the conditions need to be for these sort of, I guess, other types of offices with, I guess, the lower producers, if you will, to kind of start ticking in here and averaging that number up? And I guess, along the same lines, like what's -- I guess what's -- is there a difference in the profile of those types of offices at this point? Like either regionally or size that's driving them?

Richard A. Smith

Great question. I don't think it's at all dependent on the profile of the offices. It's really dependent on timing in the year. So the first quarter is not the best quarter to judge that. The second and third quarter becomes a far more robust quarter from that perspective, so more of the Tier 3 and 4 agents now participate...

Anthony E. Hull

[indiscernible]

Richard A. Smith

Yes, so franchisees. So you'll see that, that will occur in the second and third quarters and become less pronounced again in the fourth quarter, so...

Anthony E. Hull

But again, I think it's not going to happen -- as I say, we sort of gave you guidance -- we didn't sort of, we gave you guidance on where we expect the net effective royalty rate to be for the year. So we wouldn't expect -- it's going to take a few years. It's not so much a quarterly thing. It's going to take a few years for the smaller franchises to play catch-up. So at some point, the larger franchisees will have grown so much, but they're sort of naturally limited to the sort of market growth at that point, the NAR growth at that point. And then the other ones, that's when they'll play catch-up. And in a few years out, you'll start -- I think it will take a few years to see some improvement in net effective royalty rate. It won't be second, third quarter. It will be a '14, '15 type of thing. It does -- it's a ship that turns slowly.

Operator

Your next question, sir, comes from the line of Dave Katz from JPMorgan.

David Adam Katz - JP Morgan Chase & Co, Research Division

So 2 quick questions. The first was, I know you don't provide guidance, but given the 14% to 17% transaction volume that you had, prior to that, you had said kind of mid -- low to mid-teens. Putting the numbers behind it, does that really indicate any change in thoughts on the second quarter?

Anthony E. Hull

No, I think when we gave the -- whatever we said in the flash, low to mid-teens or whatever, I mean, it was still -- it was just early. We didn't have April -- opens in April results, so now we do. So we just have much better clarity into the second quarter than we did even 3 weeks ago or 4 weeks ago, whenever we gave that guidance. So we just -- we said then we're going to refine the number, and this is the refinement of the number.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. That makes sense. And then secondly, given that the company is now able and is generating strong free cash flow and following your newly proven ability of the refinance at low coupon levels, what's the company's thoughts on tendering for the 1.5 liens given that they're expensive debt within the next year? And then do you have any thoughts on paying down the term loan year early?

Anthony E. Hull

I think we go after whether it's -- some of that 1.5 lien that becomes callable early '15, we could tender for it. I mean obviously, we're always looking, as I think we proved by what we just did last week, we're always looking to figure out ways to get our interest expense down as quickly as possible. And we'll continue to do that. Whether -- how we do it is TBD. I always have to think about all those things. But I think paying down the term loan is probably last on the list, even though it is more expensive than the 3-year deal we did last week. But still -- so it's probably the lowest priority on our list of what we go after.

Richard A. Smith

I like the way you're thinking, however.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. But to clarify, no plans to go after the 1.5 liens until they become officially callable?

Anthony E. Hull

I didn't say that.

Operator

Your next question, sir, comes from the line of Steven Kent from Goldman Sachs.

Steven E. Kent - Goldman Sachs Group Inc., Research Division

Could you just talk a little bit more about why there's not more flow-through on real estate broker offices, especially given the very dramatic expense reductions? Is this just a quarter impact, Q1 is a light quarter for you and we really should be thinking about this over a 12-month period? Or is there something else here, and should we expect to see much greater flow-through over the next several quarters? And then finally, we're seeing many articles written about the lack of inventory in the market. But why don't you think there has been more coming on to the inventory -- coming on to the market? Why does inventory remain so low? And is there anything that you can do as agents, brokers, to accelerate that?

Anthony E. Hull

Well, 2 things on the flow-through. I mean, of the $12 million -- 12 million per point, 10 million relates to NRT and 2 million relates to RFG. NRT was up 11% in the first quarter. So -- and as I mentioned earlier, that $12 million number, however you split it between NRT and -- it's not quite that high in the first quarter. So you put all those things together, you can't -- it's going to be hard to do that calculation for just the first quarter. But it probably -- in the future, even on an annual basis, it's probably helpful to think about the $12 million in its 2 pieces, which is 10 million for NRT and 2 million for RFG. So I -- there's nothing that changes our view on that number, obviously, because we always say that number is all other things remain constant like net effective royalty rate and splits and all that kind of stuff. So -- but the $12 million was good for -- was a good number for 2012 and as we've said, we expect that number to improve just because of operating leverage as the market continues to improve. And there's nothing -- on an annual basis, and there's nothing that would make us think that, that number is going to go anything -- any way but flat or up depending -- assuming the market goes -- is flat or up. So I'm not concerned about flow-through. Richard's going to address the inventory.

Richard A. Smith

Yes, as to inventory, you're right. I mean, there's pressure on inventory. That's been demonstrated by just about everybody who follows the business. We mentioned the 2 sort of incremental contributors to improve the inventory. That materializes over time, both the underwater equity homes now coming into the money and respectively, coming back to the market as new inventory. The builders have to build new inventory so that the first-time homeowner can trade up. The move-up market is very important to increased inventory levels. We're also seeing -- as I indicated in our comments, we're seeing an improvement in our inventory levels in the various markets in which we operate. So much of the media that we've seen up to now sort of old news. It's not reflecting what people are seeing today. But really on a real-time basis, inventory levels are improving. Now the real question is, by what margin are they going to improve? Early indications right now on a weekly basis, because we monitor this weekly, is we're seeing good high single-digit improvements in inventory levels. So we expect that to continue to build into the second quarter. Hopefully that was responsive to your question.

Operator

Your next question, sir, comes from the line of Brandon Dobell from William Blair.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Maybe some color on the expected contribution in the second quarter from the recent acquisitions, and then also if you could address kind of how the retention of gross commission income has gone and kind of how it's trending these days. I mean, you mentioned obviously you're people are kind of looking at some of your agents, trying to get a feel about how you think about holding on to your people these days?

Anthony E. Hull

The retention of GCI continues to be strong, and I think agent -- we're very focused on agent recruitment. So I think that's -- when you have 42,000 agents, you're going to lose some and you're going to gain some. But the bottom line is NRT is very focused on having a net pick-up in not only number of agents, but the revenue those agents produce. So nothing has changed in those 2 categories. The acquisitions we did in Florida will add about $20 million of revenue to NRT and about $1 million of EBITDA, and those will start -- so it's not a huge -- obviously it's not a huge number. But we paid about 4x for those -- 4x sort of run rate EBITDA for those. So obviously, good return on investment and very accretive. But not big enough to move the needle that much, unfortunately. But important to NRT and definitely the local Florida company because it got them in 2 markets and they're fantastic acquisitions for them, for the local operators in Florida.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. And then maybe if you could address the, let's call it, volumes within TRG relative to volumes across the broader business from a purchase point of view. Should -- overall multiple quarter point of view, should we expect TRG volumes to track pretty close to the number of sides? Or was there some kind of a, I mean, a kind of market share dynamics going on?

Anthony E. Hull

Yes, the only things that they can capture, they being TRG can capture of NRT business, which is all they do capture because they don't work with our franchisees, they just work with NRT. Obviously, when someone's buying a home, that's when they need the title and closing services. The seller isn't involved in that. So -- but having said that, assuming an equal buyer and seller universe at NRT, you'd expect that their capture -- their volume should go -- their purchase volume should go up equivalently to NRT's transaction volume, and that's what we've seen. I mean, the only thing is that their capture rate, that's where they're really working hard to grow faster than NRT. Their capture rate was at 41% of that transaction universe that they're eligible to be involved in. It's 41% versus 39% in the first quarter last year. So they're making good inroads into improving that capture rate. Just probably due to rounding or whatever, it doesn't quite move the percentages, but it should be -- the percentages should be a -- if they're continuing to include their capture rate, the percentages should be a little bit higher than -- percentage growth of their purchase transaction should be a little bit higher than NRT's growth and sides.

Operator

And your next question, sir, comes from the line of Dan Oppenheim with Crédit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

One quick question in terms of the agents that you're seeing, given the improvement in the market, Are you seeing more -- some new agents come into it, which would potentially help your split -- your agent split over time in the NRT business?

Richard A. Smith

Yes, you're very intuitive. As the market improves, people who have shied away from the business get back into the business. NRT, in particular, has a very concerted effort to recruit -- continue recruiting top-producing agents and also entry-level agents for the obvious reasons The splits are far more attractive as they start producing, and that has the expected impact on our retained dollar. Not only are we doing that, but our franchisees start doing the exact same thing sort of on their own, independent of us. So they're recruiting aggressively. Now listen, it's what the market will bear. So they'll recruit agents as long as the volume is there and the upside is there. So we see that developing, and it will continue into the -- deep into the second and third quarter. So we welcome that, and that's a very good question.

Anthony E. Hull

Yes, as we've talked about before, the footprint for NRT's offices is about a 60% capacity utilization. So we can do a lot of recruiting and not have incremental fixed costs.

Richard A. Smith

Our franchises are pretty much in the same boat. They can accommodate the same kind of growth.

Daniel Oppenheim - Crédit Suisse AG, Research Division

Okay. And in terms of the PHH business, is there any color in terms of the numbers. Obviously if we think about sort of the refi environment and such going down a bit, how should we think about that business in terms of the results there and as you look about -- look at that moving forward?

Anthony E. Hull

It was pretty flat. I think it was down like $1 million in the first quarter. So refi volume -- so it obviously helped -- you saw that TRG's refi volume was up 11%. So despite gloom and doom forecasts from all the experts on refi volume, it continues to be very strong. So it's outperforming what the forecasts were, so that's a good thing. So it's holding up better than we thought and we expect that to continue throughout the year.

Operator

And your next question, sir, comes from the line of David Ridley-Lane from Merrill Lynch.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Now that you've seen the price trends on both first quarter and fourth quarter of last year, what do you estimate the mix -- the tax-related mix impact on price was in the fourth quarter?

Anthony E. Hull

Thought about that for a while. I mean, it was probably -- our guess is it probably added about $10 million or $15 million of EBITDA in the fourth -- I mean, sort of bring it down to that level into the fourth quarter that -- maybe what you're getting at it, but I'll say it anyways, that's going to be somewhat -- that's something we have to overcome obviously in the fourth quarter this year. And that will be, particularly at NRT, their price is -- their average sales price is going to come under some pressure in the fourth quarter because it's a tough comp. Because most of those homes were $5 million-plus homes that had $500,000 or more gain in them and that sort of thing. So I think that's where you're going to see the impact the most is on average sales price for NRT in the fourth quarter.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And when would you expect -- in this broader discussion on inventory, I didn't hear you mentioned bank-owned inventory starting to reappear on the market. Is that something you would expect and to be helpful?

Anthony E. Hull

We do expect it, and we keep expecting it. And those folks who run our REO asset management business in Florida keep being told by their clients that it's coming, but we just have not seen it. It's surprising to me because all the legal issues are sort of behind them, and the challenges are behind them and there's a lot of -- there's a ton of inventory. And at the lower price point, it would sell very vigorously. So it's at a price that's much higher than they have on their books, I'm sure, but it's not there. It's still kind of trickling -- it's trickling and it's improving very modestly, but it's not -- certainly not a deluge, and we'd hope to get -- see that pick up during the year. But it's -- right now, it's kind of just modestly up.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And is the $26 million -- I was reading in the 10-Q, $26 million charge for the Phantom stock, where will that be in the P&L in the second quarter?

Anthony E. Hull

It will be in G&A.

Operator

And your next question, sir, comes from the line of Michael Kim with CRT.

Michael S. Kim - CRT Capital Group LLC, Research Division

First question is on M&A. And I noticed you guys made a couple of acquisitions in Florida during the quarter. What are you seeing in terms of M&A opportunities right now? Are you focused on any particular geographies? Or did you get the sense that there's a lot of undercapitalized operators out there still with some sort of motivation to sell? Also, if you could maybe comment on any opportunities in international markets, if any.

Richard A. Smith

Sure. As you know, we've been very acquisitive over the years, principally small tuck-in acquisitions. We continue to be acquisitive. We're also very opportunistic. I think you're coming out of a period where most independent operators have been through a very difficult period. So a multiple of nothing is nothing. They need to get to the point where they actually have EBITDA positive so they can get back to some value creation for themselves. So we see that playing out in the few acquisitions that we've completed so far. We have a very robust pipeline. These are typically very accretive tuck-in acquisitions. We're paying 4 and 5 multiple pre-synergy. We get 1 point, 2 point synergies. And as you know, we don't buy the brick-and-mortar. We just collapse the business into our existing footprint. So the pipeline's building. It's pretty attractive. It represents a number of opportunities on our markets where we clearly need to operate, where we don't, principally the Southeast and the Southwest. So those are attractive sort of market targets for us. We think they represent a lot of upside from a real estate perspective. But that is a skill set we know very well. We acquire well. We synergize the acquisitions extremely well. So that's a news at 11. It's a strong and growing pipeline, and we're very encouraged by what we see up to this point. As to the international markets, we have no current plans to be an owner-operator internationally. We think we need to continue down the path of growing our master franchise extension into those markets, watch and observe for the next 10, 15 years and maybe at some point, we become an acquirer, but no near-term plans to acquire internationally.

Michael S. Kim - CRT Capital Group LLC, Research Division

Understood. Appreciate that. And next question's probably better suited for Tony, but based on any recent conversations with the rating agencies, have they provided any sort of guidance on metrics that they're focused on for their ratings upgrades? You're obviously going to be deleveraging pretty heavily over the next few years, but just curious as to what metrics they might be focused on for upgrades over the near term and perhaps credit metrics that they're focused on for investment grade rating.

Anthony E. Hull

Well, the 2 metrics that they're very focused on are debt to EBITDA in their bizarre calculation of such things [indiscernible] 3 leases and stuff like that and interest coverage ratios. And I think the difference between the 2 is, I think S&P is -- seems to be more forward-looking and gives us credit for having $300 million of interest expense this year, and Moody's doesn't -- they're just much more conservative and they're still looking at 2012 stats as if we didn't pay off $330 million of debt and we're not about to pay off swap debt that costs 11.5 for a debt that costs 3 and 3/8. So it's a constant challenge with them, but we keep fighting the fight. I think S&P is just more forward-looking.

Michael S. Kim - CRT Capital Group LLC, Research Division

Got you. Okay. I guess lastly, just to follow up on the second quarter guidance question, was there anything particular during April that positively impacted the guidance range? I mean, was it more volume or price or any sort of impact from mix between RFG or NRT?

Anthony E. Hull

I mean, it's really -- in this market, it's very market-specific. We're seeing a continuation of the trends that we sort of went into detail on for NRT in the first quarter. I mean, the west, i.e., Northern and Southern California, it's inventory constrained, very strong on price, whereas -- in terms of this trend, we've been seeing it because of affordability for like 6 quarters at this point. But in the Midwest and some of our lower-priced markets, it's more about sides. The only difference is I think the Northeast is showing some more strength on the sides than we've seen in April, maybe because they hit -- I don't like to blame things on weather, but they did have a terrible -- Boston, obviously, had a terrible winter. But we're seeing some good sides growth there. And then Florida, Atlanta, et cetera, it's -- Atlanta is probably our -- which had been one of our most challenged markets for many years is really strengthening, and Florida continues to see growth on both sides and price. So we're a little relieved on inventory in Florida that we're seeing some good sides growth as well as price growth. So it's really market-specific.

Operator

Your next question, sir, comes from line of Stephen Kim with Barclays.

Freda Zhuo - Barclays Capital, Research Division

This is actually Freda Zhuo on for Stephen. So just another follow-up on M&A. So how would you sort of think about the opportunities for M&A versus just expanding organically and hiring new agents?

Richard A. Smith

Response to that and great question, and we do all the above and we always have. As you know, the acquisitions are not, in terms of the size and scale, are not large acquisitions but in the aggregate, they're very meaningful and very impactful. So we'll continue doing that. Those are -- we call them tuck-in acquisitions. Say, given our footprint, it makes it possible for us to acquire on a very attractive basis. Others, not so, because they don't have the existing operations in which to collapse the acquired assets. So those are very accretive, very attractive and we've done them since '96. We're going to continue doing that. Large regional acquisitions are few and far between. But over the next several years, we expect that some of those will develop as well. As to the balance of what we -- naturally in the business, we grow by recruiting agents. We do that on the franchise side. We sell franchises. We help our franchisees grow. We help them recruit agents, and that's all good old-fashioned pure organic growth, very little, if any, cost to any of that. So the margins are very attractive. On the NRT side, we do the same. NRT, just think of it as one of our franchisees. They grow through acquisitions. They grow by moving into new markets on -- through acquisitions, and they grow by recruiting agents and making them less Tier 3 and Tier 4 agents more productive than they would have been otherwise. So the answer to your question is we have to do all of those, and we have historically and we'll continue doing that.

Freda Zhuo - Barclays Capital, Research Division

Okay. Great. And just turning our attention to Cartus. I mean, in the fourth quarter, you mentioned that the decline initiations was largely due to concerns in Washington. Is this still the case? Any movement on that front? Any additional color on that, and why initiations have continued to decline, would be greatly appreciated.

Richard A. Smith

Well, there are a lot of concerns about Washington, but we can't attribute all those to the concerns at Cartus. Cartus, I think that reflects sort of the environment. Business -- businesses are less apt to commit capital in the way of human capital resources from one city to another and one market to another, until they know what's on the horizon. So I think corporate America's being hesitant and cautious. They're still relocating employees, but perhaps not as robustly as they would otherwise. So they're waiting for sort of the horizon to shape up a little bit and they're in sort of a wait-and-see status, and I don't see any immediate change in that. So I think there's a lot of hesitancy on the part of our clients and as you know, we represent a substantial portion of the Fortune 50. So they're being cautious in their commitment of benefit dollars to move employees between their various locations. So we'll see what that looks like in the second quarter as some of those hesitancy in the fourth quarter continued into the first quarter.

Freda Zhuo - Barclays Capital, Research Division

Okay. And are you expecting that to sort of continue into the second quarter and beyond?

Anthony E. Hull

Well, I think what you're going to see later in the year, is some of the very robust pipeline of new clients and expanding services of existing lines. So I think what we're going to see is the impact of that as the year progresses.

Operator

Okay, sir, we'll take the last question and you do have time for one more, and we have a question from Will Randow from Citigroup.

Will Randow - Citigroup Inc, Research Division

Most of my company-specific questions have been answered. So I guess, how do you think about rising home prices in an environment in which appraiser -- appraisals are -- might somewhat lag that or hold back price appreciation and then lock in negative equity? What are you seeing on the ground in this regard?

Richard A. Smith

That's a great question, and we see that playing out in virtually every market and it is catching up to the current pricing environment. Appraisers, as you know, are very reluctant. They're being told by their lender clients to be very reluctant to price to market, but they're being forced into that because of the rising price environment. So we see the spread between what appraisers are saying that a home's value is in a variety of different markets. That was a major issue in terms of getting loans approved. So the agents, the brokers were spending a lot of time hand-holding to get -- to keep those deals together and get them closed. It's becoming a less -- little less of an issue. And as prices continue to increase, our view, based on the markets in which we operate, is that it will start to improve. So that's not a permanent issue at all. That's a natural adjustment, just it will take time. And it will take time probably this year, maybe a little bit into next year. But we already see evidence of that, and we're encouraged by that.

Will Randow - Citigroup Inc, Research Division

And just one follow-up on the REO discussion just a few minutes ago. It seems like there may be an opportunity to broker institutional pools of homes in the near future as people flip it and take the price appreciation. Are you kind of finding a way to harness that activity from a corporate level? And also, are you seeing that in any specific markets?

Richard A. Smith

I think the way I would address that is that there is only one broker in the United States with size and scale large enough to deliver that service in every market in which they are currently investing. So listen, I wish them all well. They'll all move into the market. They'll all get their appreciated value on those assets. They're all going to exit at some point. And we prospectively could be that turnkey provider. So again, we're opportunistic. We're -- we stay very focused on those kind of market trends, and we are more than capable and certainly willing to assist them when they decided to exit those investments.

Operator

And there are no further questions in queue, sir.

Alicia Swift

Great. We thank you for taking the time to join us on the call, and we look forward to speaking with you over the next quarter. Thank you.

Operator

Thank you for today's participation. This does conclude today's conference call. You may now disconnect.

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