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Realogy Holdings (NYSE:RLGY)

Q2 2013 Earnings Call

July 24, 2013 8:30 am 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

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

Anthony Paolone - JP Morgan Chase & Co, Research Division

David Ridley-Lane - BofA Merrill Lynch, Research Division

Will Randow - Citigroup Inc, Research Division

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

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

Stephen S. Kim - Barclays Capital, Research Division

Operator

Good morning, and welcome to the Realogy Holdings Corp. Second Quarter 2013 Earnings Conference Call via webcast. Today's call is being recorded and a written transcript will be made available in the Investor Information section of the company's website tomorrow. A webcast replay will also be made available on the company's website until August 7.

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, Vanessa. Good morning, and welcome to Realogy's second 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 the 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 June 30, 2013, which we have filed with the Securities and Exchange Commission. The press release is available on the Investor 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 the 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 remarks made herein are as of today, July 24, 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 first quarter 2013 Form 10-Q, and other SEC filing. We expect to file our second quarter 2013 Form 10-Q on August 2.

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

Richard A. Smith

Thank you, Alicia, and good morning, everyone. We appreciate you joining our call as we report on our second quarter 2013 financial results and operating performance.

Our second quarter results were very strong, and looking at key benchmarks for our performance on Slide 4. Net revenue adjusted EBITDA and net income improved significantly from the same period a year ago. The material improvement on our second quarter financial results is largely attributable to the strength of our business model, the strong performance of the management, the steps we've taken to de-leverage our balance sheet and the ongoing positive impact of the housing market recovery. Plus importantly, we believe we are well-positioned to continue to capitalize on the housing market recovery, which, we believe, is in its early stages.

The following are the highlights from our second quarter results. Net revenue for the quarter was $1.53 billion, a $224 million increase or 17% improvement over the second quarter of 2012. Our adjusted EBITDA was $278 million, which was an increase of 27% over prior-year results in the same quarter. Net income for the quarter was $84 million, an improvement of $109 million from the second quarter of 2012 after taking into account approximately $67 million of interest expense, $44 million of depreciation, amortization, $43 million of loss on the early extinguishment of debt and $26 million of compensation expense related to the April 2013 issuance of common stock and the phantom value plan.

Our financial position has been greatly enhanced by the dramatic reduction of our net corporate debt by $3.2 billion in the last 12 months. Finally, our basic earnings per share for the second quarter 2013 was $0.58, adjusting for the loss on early extinguishment of debt and the phantom value plan compensation expense, basic earnings per share would have been $1.05.

The significant improvement in our second quarter financial results was driven by our operational performance. Specifically, on a combined basis, total sales volume from the franchise and company-owned real estate services segments increased 21% year-over-year, which was 4 percentage points above the top end of the transaction volume range guidance we provided during our May call. Sales volume is calculated as home sale transaction sides times average home sale price.

At the business unit level, RFG had a 10% increase on home sale transaction sides and a 10% increase in average home sale price year-over-year during the second quarter to approximately $237,000, while NRT, with its concentration in 35 major metropolitan markets, had a 12% increase in home sale transaction sides and a 7% increase in average home sale price to approximately $478,000.

As you can see, transaction volume growth in the second quarter was strong with the improvement in both home sale transaction sides and average sales price. We attribute the increased volume to demand outstripping supply, moderately improved inventory levels and a continued historically high affordability levels despite a rising mortgage rate environment at the end of the quarter. And we see continued strength in sales volume growth going into the third quarter as we will discuss in a moment.

Turning to Slide 5. You see how our results compared to the survey data from the National Association of Realtors. NAR reported a 22% year-over-year increase in sales volumes on the same basis for the second quarter of 2013. We note that NAR survey results would generally vary from our actual sales numbers.

Typically, our franchise results track the NAR survey results, while our company-owned offices don't always correlate to NAR given their geographic concentration and higher priced markets.

For the RFG segment, homesale transaction volume increased 22%, which is consistent with NAR's survey results. On a combined Realogy basis, volume increased 21%. Given our size and scale, we believe Realogy is a barometer to gauge the pulse of the U.S. existing homesale market. Keep in mind the existing homesale market is 10x larger than the new homesales market on a total sales volume basis. Our results operate much broader view the state of the housing market.

Moving to Slide 6. Our business units in the company performed well during the second quarter, highlighted by the following accomplishments. The Realogy Franchise Group, herein after referred to as RFG, generated new franchise sales and agent recruiting totaling $58 million in gross commission income, or GCI. Through the first 6 months of the year, our franchise sales were at $127 million of GCI, turning up 2% over 2012 and our new prospects sales pipeline is strong.

In the first half of 2013, our proprietary LeadRouter lead management system delivered $1.56 million leads to our affiliated brokers and sales associates. Not only is this an increase of 27% from $1.23 million during the same period in 2012, it is a record performance for any 6-month period since LeadRouter's launch in 2004.

As announced in June, sales professionals affiliated with our franchisees and company-owned offices earned 1/3 of the rankings of the 2013 REAL Trends/Wall Street Journal report. This report ranks the Top 1,000 residential real estate agents and teams based on 2012 annual sales volumes and transaction sides. Sales associates affiliated with NRT, our company-owned offices, represented 161 of the overall agents and teams in the Top 1,000, including 35% or 88 of the rankings within the top 250 agents by sales volume category.

In addition, Coldwell Banker placed more agents and teams on the REAL Trends/The Wall Street Journal Top 1,000 list than any other national brand with 155 rankings across the 4 categories and the #1 performing team based on sales volume.

During the second quarter, NRT completed 3 accretive tuck-in acquisitions: 2 in Florida, 1 in Connecticut. And overall, NRT's footprint currently includes approximately 710 offices and 41,500 sales associates.

Turning to Slide 7. Cartus signed 29 new clients for the second quarter, and also expanded the scope of relocation related services provided for 102 of its existing clients, the impact of which is expected to benefit future quarters.

Cartus' results in the quarter benefited from its affinity business, which reflects its strong and growing position in serving large affinity or membership organizations. TRG's title and settlement capture rates on NRT homesales improved to 44% in the second quarter, that's up from 42% in the second quarter of last year. TRG's underwriter reported a 45% increase in the second quarter net premiums year-over-year, and it's underwriting claims experience for the quarter continued at less than 1%, which is a substantially better than the average loss ratio for the industry.

In conjunction with Apollo's sale of its remaining shares which closed this past Monday, 2 Apollo designated directors, Ali Rashid and Travis Hennings who resigned from our Board. They followed Scott,also an Apollo designated director, who resigned on June 26. We thank them for their service and contributions.

I am pleased to report that with the late June appointments of Jessica Bibliowicz and Fiona Dias, the Realogy Board of Directors is now comprised of majority of independent directors, 5 of 7 directors are independent. Jessica brings to the board a vast and highly successful track record as the CEO of a diverse publicly traded financial services company, while Fiona's extensive e-commerce experience in both traditional brick-and-mortar and Internet-based business models will add depth to our strategic planning.

Let's move onto the current operating environment on Slide 8, specifically, the industry forecast for the remainder of this year. Consistent with our second quarter results, NAR is forecasting a 19% increase in sales volume for the full year 2013. That's made up of a 9% increase in existing homesale units to 5.1 million units for the year and a 10% increase in May in homesale price to $194,800.

Fannie Mae is forecasting a 15% increase in 2013 sales volume, comprised of a 7% improvement in existing homesales to 5 million units and 8% increase in media and sale price to $191,000.

For the past 2 quarters, the focus on housing has centered around low inventory levels. The reasons we have previously discussed, rising home prices, seasonality, the reduction on the number of underwater equity homes and increased levels of new home production through the builders have positively impacted the level of sellable inventory.

NAR's most recent report showed June inventory at 2.19 million units, which is only 8% lower than a year ago and equates to a 5.2-month supply. However, from January to June, inventory levels have increased by 24%. As we anticipated, we continue to see inventory increases in the majority of our markets, and we expect inventory levels to steadily improve in the third quarter.

More recently, there has been renewed focus on rising mortgage rates and what impact rising rates will have on the housing recovery. Our first observation is that rising rates have impacted mortgage refinancing volume, more so than existing homesales. Secondly, we view rising rates as a reflection of an improving economy and while a 50 to 100 basis point increase in mortgage rates may put near-term pressure on marginal credit worthy homebuyers, that needs to be viewed in the broader context of affordability.

In a recent report, Goldman Sachs analyzed the impact of higher rates on affordability. They used the assumption that a typical homebuyer has an annual household income of $50,000, makes a 20%, downpayment and obtains a 30-year fixed mortgage. Under this scenario, even a 30-year mortgage -- even if a 30-year mortgage rates rose to 6%, the model shows that the average priced home would continue to be at affordable to medium borrowers.

Mortgage rates have declined modestly in the past 3 weeks and Freddie Mac expects 30-year fixed rates in the year around 4.6%. NAR's most recent Home Affordability Index was 172.7, which means that the average family has 172% of the medium income necessary to purchase a home at the May medium sales price of $208,700, with a 20% downpayment.

According to our calculations, for every 50 basis point of mortgage rate increase, affordability drops approximately 10 points and for every 6% increase in the home price, the index falls 10 points as well.

In response to the higher 30-year fixed rates, we have already seen consumers increased their usage of lower cost, adjustable rate mortgages as an alternative. The Mortgage Bankers Association reports a doubling of our usage from 4% in March to 8% in early July.

Pending homesales have been above prior-year levels for 25 months. And according to NAR, May rose to highest levels since 2006. Again, existing homesales are projected by NAR to increase 9% in 2013, reaching about 5.1 million units which would be the highest sales total recorded since 2007.

An important indicator we track closely, particularly at NRT, is cancellation rates. When a borrower signs an agreement to purchase a home, if mortgage rates rise beyond the borrower's expectations, under most circumstances the contract can be canceled. The NRT cancellation rates remained near historically low levels between 12% and 13%. And we are experiencing continuing declines this year, even through the middle of July. Our takeaway on rising mortgage rates is that they must be considered in the context of affordability which remains at historic levels.

All considered, demographics as one of the main drivers of the housing demand, and we are encouraged by the household growth projections released by the Harvard Joint Center for Housing Studies earlier this summer. The latest Joint Center projections indicate that household growth should average $1.16 million per year in the decade leading up to 2020.

On the legislative front, bills recently have been introduced in Congress calling for the eventual line down of Fannie Mae and Freddie Mac. We believe, as your advisors, that this major policy issue is unlikely to advance through Congress prior to the midterm elections in 2014.

Regardless of timing, it is our opinion that the complete shutdown of Fannie and Freddie is impractical as little support and is highly unlikely. The developing news as of yesterday, regulators in Washington D.C. now appear to be in serious discussions about several key changes to Dodd-Frank, which would lead to what we believe would be a new and better definition of QRM or qualified residential mortgage. The regulators are strongly considering removing the 20% down payment rule and the lender 5% base value retention rule, except in rare circumstances. We believe these rules would be positive steps towards easing, otherwise, over restrictive lending standards. This is far from final, but encouraging nonetheless.

In closing, we remained confident in the ongoing strength of the housing recovery, both near and long-term, looking ahead to the third quarter of 2013, based on the visibility we have from our open contracts in June and July, and our close sales to date, we anticipate that our homesale transaction volume will increase 17% to 19% year-over-year from the third quarter of 2012, which will translate into continued strength in our third quarter revenue and EBITDA.

With that, I'll turn the call over the call to Tony to review in more detail the second quarter financial results. Tony?

Anthony E. Hull

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

For the second quarter of 2013 Realogy's net revenue was $1.53 billion, a 17% increase compared to the second quarter of 2012 and adjusted EBITDA was $278 million, up 27% year-over-year. Revenue improved 17% compared to the volume increase of 21%. Revenue gains did not align with volume gains because NRT revenue was up 19% in line with its volume growth. Cartus revenue was essentially flat in the second quarter of '13 versus second quarter of '12. And RFG's marketing revenue declined $6 million versus the second quarter of 2012, along with related spending due to the timing of spending in the year.

The adjusted EBITDA margin improved approximately 140 basis points from the second quarter a year ago. And incremental margins were 26% calculated by dividing the $224 million of incremental revenue into $59 million of incremental adjusted EBITDA.

Net income for the quarter was $84 million, an improvement of approximately $109 million compared to the second quarter of 2012 due to the improved operating results and lower interest expense. Basic earnings per share for the second quarter of 2013 was $0.58, adjusting out the loss on early extinguishment of debt and phantom value plan compensation expense. Basic earnings per share were $1.05.

Realogy's net debt at June 30 was $4 billion with $140 million drawn on the revolver. As of today, the revolver has been reduced to $95 million, and we expect it to be fully repaid by the end of the third quarter. Finally, the company had a 145.8 million shares outstanding at June 30.

Next I will discuss our key revenue drivers from Slide 10. RFG3 sides increased 10% year-over-year in Q2, and average homesale price also gained 10%. RFG's price increase was influenced by the higher portion of -- higher price of international reality volume in the mix. Its size increased 26% during Q2 2013 versus Q2 2012.

NRT homesale sides increased 12% year-over-year in Q2 compared to 2012 second quarter, and its average homesale price gained 7%. NRT continues to see the same shift in mix it has experienced since late 2011 to more volume in its lower priced markets, which is why sides growth outperformed average sales price growth.

The greatest increases in unit sales occurred in Connecticut, Westchester, New Jersey, Chicago, Salt Lake City, Philadelphia and Denver. These NRT markets all experienced sides increases between 20% and 40%, with price improvements ranging from flat to the high-single digits. Florida sales volume was up 22%, evenly split between sides and price. New England had low single digit sites in price increases, although open contract volume for the quarter was up 19%. So we'll see the results of that later in the year. Southern California, which had inventory declines of 20% year-over-year, experienced sides increases of 3%, with an average sale price increase of 19%.

In Northern California, which has inventory declines only in the single digits, sides were up 7% and prices were up 9%. Through the third quarter of 2013, based on what we're seeing in our July closings, as well as our pending contracts, we expect to see a 9% to 10% increase in transaction sides year-over-year for RFG and NRT combined. Average sales price is indicated up 8% to 9% on a combined basis. As a result, we expect our transaction volume to increase between 17% and 19% on a combined basis in the third quarter, which includes the impact of one additional business day in Q3 2013.

Remember that in the second half of 2012, the housing market experienced significant improvement, so the volume increases for Q3 2013 are building upon the strong gains in Q3 2012. This will also impact fourth quarter 2013 comparative results.

Average broker commission rates for both NRT and RFG were flat year-over-year, both despite increasing average sales price. Also, the Realogy Franchise Group's net effective royalty rate declined 13 basis points to 4.51% as its larger affiliates continue to achieve incentives for higher volumes. RFG's top 250 companies represent 61% of total franchisee gross commission income, or GCI, in Q2 of 2013 versus 58% in 2012 as larger companies continue to grow at a quicker rate than our smaller franchisees.

Cartus referrals for Q2 increased 19% and initiations increased 5%. We continue to see stronger results from our affinity business. As the year progresses, increased relocation volume for existing and new corporate clients should lead to incremental relocation revenue.

At TRG, Q2 2013 purchased unit volume increased 14%, which was consistent with NRT homesale gains. TRG's refinance title and closing units increased 30% in Q2 2013 compared to 2012. However, with rising mortgage rates, we expect to refinance activity to moderate in the second half of 2013 compared to the same period in 2012.

Now let's look at revenue and EBITDA by business unit for the second quarter of 2013 as shown on Slide 11. Total revenue at RFG increased $23 million in Q2 2013 versus '12, while EBITDA improved $34 million. The 14% revenue increase was due to higher homesale sides and average price, partially offset by a decrease in marketing revenue that matches marketing funds expanded and varies from last year to the timing of spending within the year. RFG's EBITDA margin increased to 69% from 58% in Q2 2012, driven by higher revenue and lower legal expenses.

The largest component of the company's revenue line is NRT. In the second quarter, NRT revenue increased $188 million or 19% in line with its higher homesale transaction volume. NRT EBITDA increased $24 million and its margin increased by 100 basis points year-over-year. Improved revenue was partially offset by $138 million increase in commission expense paid to real estate agents as a result of the increase in volume.

Also, overall commission splits increased to 68% in the quarter. We expect that the commissions, what we saw in Q2 will hold for the full year. Other items impacting EBITDA, royalties to RFG increased $12 million. Operating expenses increased $6 million, due primarily to the absence of legal reserve reductions recorded in 2012. Employee-related costs increased $5 million due primarily to the phantom plan charge and higher branch manager incentive accruals. Finally, our equity and earnings related to PHH HL decreased to $3 million.

Drilling down to the incremental margin at RFG and NRT combined for the quarter, EBITDA for the 2 businesses increased $59 million on revenue of $212 million. This equates to an incremental margin of 28%. NRT's incremental margin alone in the second quarter was 13%. This is below the 20% to 25% expected for 2 reasons. First, it was adversely affected by commission splits which increased approximately 100 basis points from Q2 of '12 to Q2 of '13. This decreased NRT's incremental margin by approximately 5 percentage points. The higher share of commissions to our agents is due to the fact that our Top 2 quartile sales associates continue to conduct more of NRT's overall transaction volume.

Second, PHH Home Loans joint venture earnings decreased by $3 million in Q2 of '13 versus Q2 of '12 due to lower margins on originations. This negatively impacted incremental margins by 2 percentage points.

At Cartus, revenue was down $1 million year-over-year and EBITDA decreased $3 million. Revenue decreased because of lower relocation volume, although it was partially offset by higher referrals. EBITDA declines were driven by lower revenue in the absence of a $2 million net reduction and insurance lost reserves recognized in 2012.

At TRG, revenue improved $24 million or 23% as a result of increases in resell and refinancing transactions and underwriting revenue. EBITDA increased $6 million to $20 million, and margins gained 200 basis points to 15%. TRG revenue and EBITDA benefited from the addition of lender channel clients last year, which will continue to the rest of the 2013. This increased volume should help mitigate any overall decrease in the refinancing transactions.

Corporate and other EBITDA decreased $60 million to negative $78 million, primarily due to a $43 million loss from the early extinguishment of debt related to the redemption of the notes in April. In addition, the company recorded a $4 million restructuring charge due to headquarter's relocation and $17 million related to the phantom -- to the corporate portion of the compensation expense recognized under the phantom value plan for the secondary offering that was completed in April.

Turning to Slide 12. Cash interest expense should be about $300 million in 2013, which includes of the higher-cost debt, which was paid down during -- paid down. In April of '13. Annual run rate cash interest expense is now approximately $255 million, with the current capital structure reflecting all the pay downs and refinances. Refinancing is completed in the second quarter. Capital expenditures will be about $60 million for the full 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 $5 million to $10 million. Working capital is expected to be a use of $60 million to $65 million in 2013, which includes the premiums we paid on the debt retirement.

And finally, Apollo's July box sale of its remaining sales in Realogy common stock will result in a phantom value plan charge of $18 million in the third quarter. No further shares will be issued under the plan.

Turning to Slide 13. Our anticipated growth of 17% to 19% in Q3 transaction volume factors in the current mortgage rate environment and reflects our belief in the continuing strength of the housing recovery. We remained committed to de-leveraging any marketable profit share and keeping cost contained. This, along with the long-term forecast of housing market improvements, will enable us to continue utilizing free cash flow to reduce debt and move toward our goal of reducing leverage 3x net debt to EBITDA over the next several years.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Adam Rudiger from Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Can you go back over a little bit the commission split you were talking about? I didn't follow it as well as I would've liked. I think in the fourth quarter, you talked about some of that pressure being increased by competitors knowing when contracts were up and so you're going to stagger things. And that seem to be have a positive impact in the first quarter than number fell down a bit and that it change back up a bit this quarter. Can you explain all the puts and takes? And then just to reiterate, you said you'll expect that number to be the same for the rest of the year, so is that mid-68 number?

Anthony E. Hull

Yes, we expect it be 68. I mean, the discussion we had on -- we're obviously looking for ways to keep the split rate as -- under in check, and NRT management works hard to do that. One of the ways that you referred to was at one point many of our markets had an annual sort of reset on sales associates commission split and all of our competitors knew that, that was the date they could basically go after those agents to try to recruit them away from us and one of the things that NRT did to come back that was move the reset dates on agents' commission plan to their anniversary date as opposed to January 1, or instance, a January 2. So therefore, it was less more difficult for our competitors to try to recruit away our agents. So that's one of many initiatives that NRT has in place to keep the commission split in check.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Right. As you said, 68% is where it came in. It was about 100 basis points worse than the year earlier. Again, because more of the top-producing agents are doing more the business, they're more productive with technology that sort of thing. And we're using technology ourselves to -- if we have an issue in place to lease management that sort of thing to mitigate the increases that are coming from our top quartile agents.

I mean, is there anything else driving that increase because it looks like the fourth quarter or last year in this quarter looks like as far back as the data that we have, those are the 2 highest numbers we've seen. I mean those top quartile producers doing an outsized portion relative to

Anthony E. Hull

Well, the top 2 quartiles do 90% of our revenue, so top 50% of our agents do 90% of the revenues. So and with technology, they become more productive and it isn't, it's a win-win -- it's great for us if they are more productive because we are making incremental dollars on all their business. So it's kind of a high-class problem, but it's something that we obviously focus on regardless, so.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay. And then just another question related more to your visibility. How quickly for your pending contracts before when a buyer puts down a deposit or signs a purchase and sale agreement, does that information filter up to the data that you see?

Richard A. Smith

It's immediate. I mean, as soon as it opened, as soon as they sign it, it's in their -- it's an energy [ph] system.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

So when you're giving your guidance, I mean, you have visibility into activity even this past weekend?

Richard A. Smith

Yes.

Operator

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

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

So I was just trying to -- I know that you gave a lot of numbers and I appreciate that, but I think I've lost a little bit of the thread there. I'm just curious, looking at the operating costs of $353 million and the general and admin cost of $93 million, what portion of that represented one-time costs? And then as a follow-up to that, where will the $18 million in 3Q -- what line item would that go into?

Anthony E. Hull

Well, at adjusted EBITDA, the $18 -- just to answer your second question first. The $18 million will be adjusted out of adjusted EBITDA, just like it was in the second quarter because it's stock compensation expense, which is added to an adjusted EBITDA. But other than that, it's -- there's a little piece in every business unit because it's relevant to the CEOs of each business unit and then about 3 or 4 people are corporate. So it's spread around on the reported EBITDA. But it's adjusted out overall on the adjusted EBITDA number. It's all -- and it's all in G&A at the end of the day. So and then on your -- the one-time costs were -- there was $4 million restructuring charge taken for basically closing down our 1 campus facility and moving to 175 Park. There was $46 million or $43 million for the premium we paid to take out, mostly it was for all the debt redemptions and the refinancing we did, but most of it was for taking out the 11.5%. The premium we paid to take out 11.5%. And then, there was the phantom charge of $26 million. Those are really the one-time costs.

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

Okay. And then when looking at the interest, it -- interest in the first half was about $156 million cash interest I assume, is less than that. You're guiding to $300 million for the year but you're stating that the annual run rate right now is around $255 million. So just curious, why is the second half going to be so high if the run rate is lower now?

Richard A. Smith

Well, I don't know -- all I know is if you take our current capital structure, I'd have -- and run it out, it's currently at $255 million is the cash. The first half is -- has basically 4 months sort of, or actually 5 months with the 11.5% of the high-cost debt still in it.

Operator

Your next question comes from the line of Anthony Paolone from JPMorgan.

Anthony Paolone - JP Morgan Chase & Co, Research Division

On the royalty rate, I'm trying to understand what's happening there. When franchise agreements come due, and if I recall correctly, I think these are 10-year type deals, are the economics or sort of the breakpoints where they start to get discounts, are those renegotiated? And if so, are we seeing those coming down?

Richard A. Smith

Anthony, those occur at the stage of -- this is Richard. Those occur when you sign the agreement with the franchisee. Their per [ph] Schedules that are disclosed to them and the franchise offerings that are probably documents, they're negotiated again when they renew their franchise agreements on 10 years later. Often they're renewed on the same terms and often not, depending on what that franchisee has done over that 10-year period in terms of growth and expansion. So it is -- and that's essentially the way the industry works. We're not different from any of our competitors in that regard.

Anthony Paolone - JP Morgan Chase & Co, Research Division

I understand. Then as some of these are coming up now that we're in a different real estate market, then perhaps where their volumes were a number of years ago, on balance, are these breakpoints being reduced or?

Richard A. Smith

I don't see any material change. Remember, we renew a very high percentage of our franchisees, they're eligible to renew and they're given 12-month periods in the mid to high '90s. But there's -- I don't see a material change now. What you'll often see is the franchisee asking for consideration to grow the business, which is a good strong positive problem to tackle. But I don't see big changes in their volume discounts.

Anthony E. Hull

I mean, the biggest driver, Anthony, is that, the fact that they're just, they're doing very well, our top 250 franchisees are running their businesses very well and they're doing more of the business. And that's putting pressure on the royalty rate. But, again, they're doing -- they're focusing on recruiting, they can do it. They're focusing on growing their footprint by doing M&A, tuck-ins like NRT does and we're very -- it's a win -- it's just like what with the split rates, it's a win-win, we're making a lot more money when they're doing better, so for giving up a few basis points here and there, on royalty rate, it's a very high-class problem to have.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Yes, I understand but it seems like on the payouts and on the royalty rates, as the recovery continues to unfold, I think the logic here makes sense that you've got a disproportionate amount of activity from your top folks and franchisees. But I'm just wondering at what point do you see those third and fourth quartile start to shift that mix or stabilize those numbers?

Anthony E. Hull

I think, I think it'll be in the middle and latter stages of the recovery. So you'll see it over the next several years. But again, as we -- they'll start the third and fourth quartile agents, will they start to become more productive and that will take pressure off the splits. And our big franchisees, I think they grew in the mid-'20s in the second quarter. And they can't do that forever and at some point, they're going to start having more normalized growth and the -- our smaller franchisees are going to grow more and it'll take pressure off the discount, on or the rebates on the royalty rates so -- it's not going to happen tomorrow and it's probably not going to happen this year, but it's going to certainly happen over time as the recovery continues.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. And then, in your guidance for 3Q, you guys -- for a very good visibilty for 30 days, but as you start to look into, say, September, what kind of assumptions did you make there to get to the 17% to 19%?

Anthony E. Hull

I mean, we have good visibility into September right now because we know what the opens were in June, we know what the opens were in July. The -- July is -- have -- is a -- seems to be a very, very strong month -- so far, and what we are seeing in the month, which is almost completed. And we have 60% of our franchisees giving us their opens. So in those close -- a big shot -- a big proportion of those -- and that others opens close in September. So we have very good stability through September at this point. So we feel very good about that range that we -- that range for Q3 that we gave you.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. And then in NRT, the PHH Homes venture, how much of that is driven by refinancing versus purchase originations?

Anthony E. Hull

It's less and less everyday. But it's -- I think last year, it was about 25%. It was refinancing, maybe up to 30% last year and it's probably more like 25% this year and next year, things continue to be 20%. So that's clearly putting pressure on those earnings and we'll see some of that. We saw it a little bit in Q2, their earnings were down $3 million year-over-year. I think that will be more exaggerated, that will be a bigger -- those would be bigger numbers in the future.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. And then just last question. Just accounting wise, how does the expensing of income tax worked on for? I think at some point you guys started to recognize an income tax expense?

Anthony E. Hull

Yes. We, at some -- right now, we have a valuation allowance, so our taxes are minimal. But at some point, when the evidence is there, we will reverse that value -- we will reverse that valuation allowance and we'll be recording taxes at the normal -- at the 40% rate. And after the -- and then, we'll still get -- obviously, we'll still have the NOL benefit from on a cash basis. But that's -- we have to have a few quarters of overwhelming evidence before that happens. But the bottom line is, I mean, the cash taxes will remain regardless of that accounting change, the cash taxes will remain very low for the foreseeable future.

Anthony Paolone - JP Morgan Chase & Co, Research Division

Okay. So it turns down though that you're recognizing income tax -- GAAP taxes at the normal level in 2013 still?

Anthony E. Hull

That's up to the accountants to determine. But I think that's a fair assessment.

Anthony Paolone - JP Morgan Chase & Co, Research Division

And do you think you will use any of the NOLs in 2013, like, given all that stuff that's going on still in the organization?

Anthony E. Hull

We're using the NOLs because we're not -- we have income, we're not paying taxes. So we are using some of the NOLs this year.

Operator

Your next question comes from the line of David Ridley-Lane from Bank of America Merrill Lynch.

David Ridley-Lane - BofA Merrill Lynch, Research Division

The goal of being under 3x net debt to EBITDA, is that the point at which you would start to consider returning cash to shareholders?

Anthony E. Hull

Yes. I mean, that's -- we want to get to that level, to be in a good position for whatever the macro throws at us at that point and have that comfortable leverage ratio. But I think at that point also, we'll be in a position to begin returning capital to shareholders in whatever form we decide to do it at that time. So as we get closer, we'll start looking into that. But that is our goal, is to get to 3x and then start returning -- finding ways to return the capital to the shareholders.

David Ridley-Lane - BofA Merrill Lynch, Research Division

And then, can you talk about acquisition spending in the quarter? I believe there are 1 or 2 tuck-ins in the NRT segment. And then maybe your appetite for acquisition in the remainder of the year or maybe the number of conversations you're engaged in?

Richard A. Smith

This is Richard. There were small tuck-in acquisitions, which we have a track record of doing those extremely well. They're very accretive. We essentially buy assets, we do not buy the stock of these companies. We're buying the agents essentially, we roll them into our existing footprint. They're very synergistic. We can do many of those as we can find. We're very disciplined. We never overpay for any asset and we'll continue that discipline. So if it meets our very high thresholds, then they're accounted for acquisition. We have a very strong pipeline, or probably the strongest pipeline we've ever had of prospective acquisitions. You can appreciate that the targeted acquisitions are enjoying the upside of -- in improving housing market. So they're trying to capitalize on that in the near term and increase the value of their company, at least the value as we might see it in terms of what multiple we might pay. So it's a happy marriage that's working its way through the year and we're pretty encouraged by what we'll see out there.

David Ridley-Lane - BofA Merrill Lynch, Research Division

But the pipeline, just to be the clear, the pipeline is robust, but they're still very accretive tuck-in acquisitions that don't require a lot of capital upfront, and have modest earnouts. But they're -- they would -- out of NRT's overall revenue, you won't see a big impact from those, but they'd certainly help the profitability, the different regions in the offices where they're added. So it's a very disciplined but very productive path we take to grow. It's basically a mass agent recruiting process as opposed to one-on-one recruiting. So it works out well.

Richard A. Smith

What's unique about our ability is our footprint, so these are -- when I said they're very synergistic, we literally collapsed these into our existing operations and enjoy the cost reductions as a result of that. We've been doing this for over 10 years. We know it very well. Again, we're very disciplined. These are -- on a multiple basis, these are incredibly attractive. And we'll continue doing that. But again, on a very disciplined basis, that we've demonstrated for a very long time.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And maybe one last one, if I could. RFG's EBITDA margin in the third quarter is generally flat with the second quarter. Are there any investments you're making in RFG or maybe trends you're seeing in the market that would cause RFG's margin to be significantly different than it was this quarter?

Anthony E. Hull

No.

Richard A. Smith

No.

Operator

Your next question comes from the line of Will Randow from Citi.

Will Randow - Citigroup Inc, Research Division

More -- a lot of the questions specific to the company haven't been asked. So I was curious on the inventory front. And what we're seeing in regards to trends is more inventory coming back to the market year-to-date versus the past number of years which is good, obviously, for volume, do you have any thoughts in terms of where we might be at year end and the impact on volume as well as price?

Richard A. Smith

The problem with inventory -- inventory is improving selling as fast as we can get it. It's about 5.2 months now. It's going to be somewhere in that 5- to 6-month range throughout the year. It's improving, it's up about 24% since January. It's only about 8% trailing last year. So it's going in the right direction. I mean, literally, in most of our markets, as soon as we get the inventory we sell it, so we still have the inventory issue. But it is improving. The underwater equity component is contributing. Builders were adding new inventory, which stimulates the move-up buyer, which makes it possible for first-time buyers to be more involved in the market because they're at pretty low levels right now. So I think it's slowly getting better. I don't know what it's going to be next year, but I think this year, it's going to be in that 5.2 to 6-month range, give or take.

Will Randow - Citigroup Inc, Research Division

Do you have any view on -- so, therefore, you think the price trend can continue kind of where its at through the year end? Is it sounds like?

Anthony E. Hull

Yes. I think prices are just reacting to demands. So demand is outstripping supply, prices reacting to that, or countless markets where that's evident, that we have very low inventory levels, prices, often in the double-digit range. So I think price is going to continue to react to low inventory levels and the demand that's following. So I think you're going to see a very healthy price market through the balance of this year at the very minimum.

Will Randow - Citigroup Inc, Research Division

And then just as a follow-up on NRT. In regards to tuck-in acquisitions, would you think about specifically targeting augmenting your footprint to a specific region? let's say, the Southeast? Or is it more just, I'd look at that on a one-off basis?

Richard A. Smith

No. We've -- first of all, we're very opportunistic. So we look for those synergistic acquisitions on the markets. The 3 I mentioned, just in the second quarter, 2 are in Florida, and 1 was in Connecticut, those were existing markets. We've said the number of times, over the past year, that, in particular, we're interested in the Southwest and somewhat the Southeast. We're also finding a little bit more interest in the Midwest. So those are the markets that are interesting. But, again, we're very careful, very disciplined and we're looking for those opportunities that will occur over the next several years.

Operator

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

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

Within NRT, any color on where you guys are with the broker headcount and an expectation for that may go this year?

Anthony E. Hull

We added just between Q2 -- I mean, between Q1 and Q2, we added about 300 agents. So that's net of -- if you were recruiting away from us, and but we net that added, so that's obviously moving in a good direction. And there's -- one of NRT's major focuses this year, in addition to the split rate, is recruiting profitable agents. And they -- managers at offices, their -- part of their compensation is tied to recruiting. And so far, that effort is up 10% year-over-year. So it seems to be working and it's just a part of their daily job is to recruit and the NRT management spends a lot of time every month on recruiting calls to make sure everyone's following up on that. And so it seems to be working. So, again, we recruit through M&A, we effectively and we recruit through one-on-one activities of the 700 managers we have throughout the country or in 35 markets that we serve.

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

And as you bring in those new agents in, I guess, kind of tied back to the conversation about splits and commission rates, how much flexibility to give the local guys -- you need to add people, but at a certain commission rate or certain split, and how do you manage that process now?

Anthony E. Hull

Well, they're very sensitive to bringing in new agents based on their existing agents. So they don't -- they manage that very carefully just like they manage the process. Generally, the splits are much better for new agents who are green and when we bring in the new agents, they have inexperienced agents, they have much lower splits, but experienced agents will have the splits. But they're not -- they don't vary from what the -- if they're top quartile agent, they'll be in line with the top quartile agent in that office. And every market is different. So the splits paid in L.A. are much different in the splits paid in New England. So they adhere to whatever the local practice is.

Richard A. Smith

This is Richard. Just also take note of a couple of initiatives: one, there are -- believe it or not, there are agents who do nothing but list. They're not generally active on the buy side. They have built -- dealt their businesses around listings and listing inventory. So we, very specifically to couple of initiatives that NRT are focused on recruiting listing agents. That's often a very, very attractive split basis for us. And also, they're very active in recruiting, training and hiring new agents because they're on a very attractive split basis for us until they mature into the top quartile. So that's sort of balance you look for. You recruit top-producing agents for the business they bring to the company. And then you recruit sort of new entrants to the business which are very attractive, look like we're getting high-quality recruits out of a variety of different business disciplines that are going to come in at very attractive, sort of 50-50 kind of splits and we're encouraged by what the production and that's an initiative that will be ongoing for the next several years in NRT.

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

Okay. And then you mentioned, I guess it's called lead flow, up in the quarter. And how do you think about the, it's called conversion rates and efficiency metrics, are you getting better economics on those leads, so they're converting in at a better rate, I know there's always a tight inventory so it's going to be a pretty tight churn, but how do you guys drive as many or as much economic efficiency into that lead process as you can?

Richard A. Smith

Well, there's 2 ways in looking at that. If you generate a lead that is a lead that then has delivered to an agent because she has, an example, had the listing that the economics are very different from the lead that we generate at the company level, and then distribute on a completely different set of economics. So the leads that are generated in the broad market and are generated by the agent and generated by the local market initiatives that are typical of the business, are generally along the lines of some of the splits that we've been discussing over the years. The leads that are generated by the company through its own initiatives, through its own investment, and then delivered to the agent are delivered on a different set of economics, they're very attractive. The economics are far, far better for us. And there are a couple of major initiatives, at least in NRT, and I know our franchisees do the exact same thing. At NRT, they're generating company leads that have then distributed to agents on a different set of economics. So that is becoming a bigger part of our business, you'll see that in the quarters to come, you'll hear us talk a lot about that. Because to the point that you make, they're one more efficient they're more effective and far more profitable.

Operator

Your next question comes from the line of Michael Kim from CRT Capital Group.

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

I guess, my first question is on Cartus. Just noticing that we're seeing greater composition from referrals and the average relocation fees per transaction has come down from last year as a result, I'm just curious how initiation fees per transaction have been trending? And do you expect better contribution from initiations to relocation services this year? Where we could perhaps see more flat sales for Cartus or even some growth on a year-over-year basis?

Anthony E. Hull

Well, no, we expect revenues to grow at Cartus. I mean, the sort of, Michael -- the initiations were down last year, they were down in the first quarter year-over-year. So it shouldn't come as -- and that was for all the reasons we talked about last year in terms of what was going on with the economy. So the initiations are really good leading indicator of what revenues going to be in the following quarter. So it's not surprising that revenue is off $1 million when initiations were off 5% or 6%, and I forgot what the exact number was in the first quarter. So in the second quarter, initiations were up and the -- we should see the benefit of those initiations in greater revenue in the outlying quarters. So I think it's just a question -- that's a combination of more activity from our base book of business and adding clients earlier in the year that they're going to start to convert into revenue-generating in the latter part of the year.

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

I guess, Richard, you mentioned some potential changes to Dodd-Frank. And I guess, just wondering if you could go over those potential changes that are being discussed and kind of the current timing for advancing discussion. And wondering if you could see this done by year end. And based on your understanding, how long would it take to impact your business in terms of implementation and the flow there?

Richard A. Smith

Great question. We think the inability of the regulators to define certain definitions under Dodd-Frank, specifically QM and the latest, is qualified residential mortgage, QRM, but there's a great article on Wall Street Journal this morning that we became aware of, over the past several days that are giving strong indications to the regulators recognized the 2 provisions under QRM, namely: the 20% down payment requirement to meet the qualified residential mortgage standard; and also the 5% retention rule for lenders if they lended to borrowers outside of the QRM rule. Those 2 are being considered to be revised in a less onerous fashion. Those 2, we believe, led to lenders hind lending to the highest possible underwriting standards. So it becomes so restrictive that it's very, very -- you've seen average pike of scores of 750 plus, which is almost 100 basis points higher than it should be. So the regulators are indicating their desire to resolve this before year end. If that is the case, then you'll start seeing, I think, the benefit of that early next year as lenders adjust their lending -- their underwriting standards to reflect these new guidelines. So late breaking news, but it would hit The Wall Street Journal last night. So that's very encouraging. Our legislative sources and our regulatory sources tell us that the article is fairly accurate. And all indications are that this will be resolved before year end. Remember, this is a regulatory solution, not a legislative solution. So if the regulators get it right, they'll have it done before the end of the year.

Operator

Your final question comes from the line of Stephen Kim from Barclays.

Stephen S. Kim - Barclays Capital, Research Division

Just I had a question regarding the industry volumes. I know we've talked about a lot of the growth opportunities that we see in existing home sales, or in price over the next, it's a year or so. Longer-term though, existing homesale is essentially is just housing turnover, and it really -- there should be some relationship between mobility trends and the overall housing stock and the stock really doesn't change much. So as you look at to that kind of analysis, do you have a sense for where, sort of normalized existing homesales ought to be in your mind when we get to a sort of a midpoint of the cycle, sort of a normalized level of housing turnover?

Anthony E. Hull

Clearly, the normalized run rate needs to be much higher than it is now. So we'll start with that. The normal inventory turns over about 4.5% a year to get back to sort of a normal run rate, which would put this in the high-5s. So if you want to look at what's normal, and nothing's normally lately, but back during the good old days of a normal housing market, turn -- housing stock turned over about 4.5% a year. It's trailing that materially now. So it's got a long ways to go. But given -- what's interesting about the housing market is that, it's not static. I mean, it's not -- this is a very dynamic population. You've got the increased contribution of household formations, you've got traditional admin flow of housing probate, the state, marriage, divorce, household creations, all those things that make it a very dynamic market. So, listen, we've on in this business in '95, we are told that housing units would never exceed 3 million units per year. Well, they failed to take into account all those dynamics. So I assume that we'll be talking about a normal run rate of $6 million plus in just existing home markets in a not-too-distant future.

Stephen S. Kim - Barclays Capital, Research Division

Great, I agree. The last question relates to NRT and the technological improvements you've been making there. And I know you've talked a lot about the lead generation initiatives, which clearly will be beneficial, not only to the top line, but also to your splits. But I was also curious about -- if you could talk about some of the initiatives beyond lead generation? It seem to us that a lot of the technological improvements you've made really do benefit your brokers who have them. It seems right now, I think that you're doing that only in NRT and I was curious is to whether or not you are intending on rolling those out to RFG? And what the long-term goal is for this kind of technological platform, whether it is to simply have all of your brokers gain share? Or if there's some other initiatives, such as reducing overall expenses?

Richard A. Smith

Well, it's a great question. This industry has historically been a paper industry. Everything from the listing, all the way to the closing contract, was a series of documents and papers held by brokers and agents and not to secure fashion. So clearly, it hasn't changed. NRT, several years ago, in conjunction with one of the sister companies, built a system called HomeBase, which literally takes, using cloud technology, the listing all the way to the close, every document held on a web-based format, eliminating the paper processing. That clearly makes NRT far more efficient than 95%, if not higher, of its competitors. It creates greater stickiness, if you will, between the agent and the consumer and the company. It creates a far better marketing venue for us. It's a far more efficient, real business kind of approach to managing the relationship with the buyer/seller and also with the agent. That same technology is being piloted to determine supportability to our franchisees. We think it has broad application to our franchise environment. And we think that it will be unique to us and our -- and will be unique to our brands, and it will make them more efficient than they are today and create the same kind of marketing opportunities and business opportunities enjoyed by NRT today. So we're careful we don't deliver systems like that to our franchisees until all the bugs are worked out. We're doing that now. We're piloting through a number of our brands and we expect to have news along this line some time late this year, early next year. But a great point. It's -- technology's having a very positive impact on our industry, both from the lead generation perspective, but also from the perspective of how we manage the business. So, we're making timely and very constructive investments in terms of technology, both on the NRT side and the franchise side. So thank you for that question.

Operator

There are no further questions at this time. I will now turn the call back over to the presenters for closing remarks.

Alicia Swift

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

Operator

This does conclude today's conference call. You may now disconnect.

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