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Realogy Holdings Corp. (NYSE:RLGY)

Q4 2013 Earnings Conference Call

February 25, 2014 08:30 AM ET

Executives

Alicia Swift – SVP, IR

Richard A. Smith – Chairman, CEO and President

Anthony E. Hull – CFO, EVP and Treasurer

Analysts

Mike Dolan – Credit Suisse

David Ridley-Lane – BofA Merrill Lynch

Eli Hackel – Goldman Sachs Group Inc.

Anthony Paolone – JP Morgan Chase & Co

Adam Rudiger – Wells Fargo Securities

Stephen S. Kim – Barclays Capital

Will Randow – Citi

Brandon Burke Dobell – William Blair & Company

Michael S. Kim – CRT Capital Group

Operator

Good morning, and welcome to the Realogy Holdings Corporation Full Year 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 March 12.

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, Sharad. Good morning, and welcome to the Realogy's Full Year 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 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 two items. First, you should have access to a copy of our financial results press release and our webcast slides, which are available on the Investor Information section of our website. 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. Also, we will file our annual report on Form 10-K for the year ended December 31, 2013, with the Securities and Exchange Commission later this week on Thursday, February 27.

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 the remarks are made herein as of today, February 25, 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, as well as our annual and quarterly SEC filings.

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. We entered 2013 with the expectation the housing recovery was growing in strength, and as our results demonstrate that certainly was the case.

As you can see on Slide 4, Realogy posted strong revenue and adjusted EBITDA gains in 2013, capitalizing on the second year of the housing recovery. Our improved homesale transaction volume translated into full-year revenue of $5.3 billion in 2013, an increase of 13% over 2012. In addition our 2013 revenue gains and the prudent management of operating overhead resulted in an 18% increase in full year adjusted EBITDA to $796 million.

This past year we continued to position the company for growth by adding franchisees to our brands and completing accretive acquisitions at a faster pace than we did in 2012, while reducing our debt by approximately $460 million since December of 2012. Specifically, Realogy’s combined full year homesale transaction volume that is transaction sides times average sale price, increased by 18% in 2013. In particular, the volume increase for our franchise operations with its national geographic footprint was 20% in 2013, which exceeded the National Association of Realtors 19% year-over-year volume gain by one point as shown on Slide 5.

In total, our franchise and company owned operations achieved approximately $402 billion in closed sales volume that is up from $340 billion in 2012. On a Realogy-wide basis, we maintained our market penetration rate, which means we were on the buyer sale side with 26% of our US existing homesale transaction volume, involving our real estate brokerage firm in 2013.

We finished the fourth quarter of 2013 with a 7% increase in homesale transaction volume, which was at the midpoint of our guidance for the fourth quarter. We have been expecting a gain of 3% to 4% each on both sides and price in the fourth quarter, but instead our mix of business was more heavily weighted towards average sale price, which was up 5% along with a modest gain in transaction sides, up 2% for the quarter.

Homesale prices were stronger than we anticipated in the fourth quarter, a trend we see continuing into the first quarter this year, prices responding to strong demand and low inventory levels. Given the differences in the results we saw across the country, we thought it would be helpful to take a closer look at the sides and price performance of RFG and select NRT markets for the fourth quarter last year.

For our franchised operations, RFG’s average homesale price gained 7% year-over-year and homesale sides increased 2% during the fourth quarter. With respect to regional color for RFG in Q4, price was the key driver in the West, Midwest and South regions, while the growth in the Northeast was balanced between sides and price. Specifically the Northeast was the strongest RFG region overall in the fourth quarter with a 6% increase in sides, and a 6% increase in price.

The South had a 7% increase in price and a 3% increase in sides, while the Midwest had a 6% increase in price and a 3% increase in sides. In the West region, RFG experienced 11% increase in price. It was partially offset by a 5% decrease in sides. For our company owned brokerage operations, NRT’s average homesale price gained 3% in the fourth quarter of last year, and our homesale sides increased 1% year-over-year.

The Midwest experienced price increases of 7% and sides increases of 5%, while the West region saw a price increase of 2% that was offset by a 6% decrease in homesale sides. The New York Tri-State area that is excluding New York City, experienced a 17% increase in sides and a 2% increase in price. New York City, which includes The Corcoran Group and our Sotheby's International Realty operations was up 2% on sides, and 2% on price, and New England was up 2% on sides, and 7% on price.

In Florida price was up 10% and sides decreased 2%. Our California operating companies reported that their average sale price increased 4% and sides decreased 8%. California in particular is reporting low listing inventory.

Now turning to Slide 6, RFG’s domestic franchise sales efforts generated $256 million in gross commission income or GCI for the full year, which was a 9% increase over 2012. This includes $76 million during the fourth quarter, which marked our strongest franchise sales quarter of 2013, and our best fourth quarter since 2007. RFG continues to build upon its global presence. Our franchisees currently do business in 103 countries and territories around the world with approximately 13,700 offices and 247,800 independent sales associates.

In the fourth quarter, RFG signed agreements with new master franchisors and/or opened franchise operations in Switzerland, Panama, Saudi Arabia, Dubai, Austria, Croatia, Kosovo, and Slovenia. Sotheby's International Realty has been very successful in growing in highly selective global markets and in the first quarter of 2014 has opened a new franchise in Belgium, and signed a franchise agreement with Beijing. Overall, RFG’s franchisee retention rate in 2013 was 98%. That is up from 97% in 2012.

This reflects the rate of our franchisees at the end of 2012 as measured by gross commission income, were retained in 2013 that continues our long track record of retaining our franchisees in the mid to high 90% range.

NRT continued to grow our company-owned brokerage through a series of strategic acquisitions in 2013, most of which were small to mid-size firms. For the full year NRT closed on 15 transactions, representing approximately 86 million in accretive GCI. As a result of these transactions, NRT added 1000 independent sales associates across seven states last year, and the largest transaction in 2013 was the Frank Howard Allen acquisition in Northern California, which occurred in the fourth quarter and we spoke about that in our fourth quarter call.

Our brokerage acquisition pipeline remained strong. So far in the first quarter of 2014, NRT has acquired approximately 72 million in GCI, with four brokerage acquisitions adding more than 500 sales associates to its operations in the Southwest and Northeast. This activity was highlighted by NRT’s strategic entry into Houston with the acquisition of Martha Turner Properties, a luxury brokerage firm with six offices and more than 220 sales associates, which now operates as Martha Turner Sotheby's International Realty.

In 2013, Martha Turner achieved its strongest year with more than $2 billion in closed sales volume. According to REAL Trends, Martha Turner Properties ranked as Number 8 in the nation in 2012, based on closed sales volume per agent with an average of more than $7 million in sales volume per agent.

As the nation’s largest residential real estate brokerage company for each of the past 16 years, NRT now operates in more than 40 of the 100 largest metropolitan areas in the United States, and has approximately 42,300 independent sales associates.

Moving to Slide 7, Cartus assisted in approximately 166,000 relocations in more than 150 countries with more than 1000 active clients last year that includes half of the Fortune 50. A key contributor to the Realogy value circle, Cartus delivered real estate referral leads to our company-owned and franchise brokerage affiliates, resulting in 57,000 closings in 2013.

TRG’s strategic focus on improving its capture rate for purchased title and closing units on NRT home sales proved highly effective than 2013. The company increased its capture rate on NRT sales to 42%, a 2 percentage point improvement over 2012. For full-year 2013, TRG’s underwriter reported a 17% increase in net premiums year-over-year, once again TRG’s underwriting claims experience for the year substantially outperformed the industry average loss ratio of 6% to 7%.

As we move into 2014, we believe that we continue to be in the early stages of the housing market recovery, and that there is a long runway ahead for continued growth. As evidenced by current industry forecasts however, the rate of growth is expected to moderate in 2014 as compared to a very strong 2013. The National Association of Realtors is currently forecasting a 5% year-over-year increase in homesale transaction volume in 2014, with the gains being entirely driven by sale price increases.

Fannie Mae is forecasting an approximately 8% increase in volume for 2014 with almost 2 points coming from unit growth, and 7 points from price gains. While these two forecasts are below last year’s pace at 19% volume increase, on average they are consistent with the long-term historical volume growth rate for the existing homesale market, which brings us to the current operating environment.

The first quarter is seasonally the slowest in the year and we believe it is not a good litmus test for the full year. It is too early to know how the year will progress, but we remain optimistic that the strength in homesale prices will continue to have a positive effect on homebuyer and seller confidence, and that inventory levels will increase as we move into the spring selling season.

With an improving economy, declining unemployment, low mortgage rates, and the expected increase in listing inventory, the existing homesale market should continue to grow year-over-year in 2014. We were recently encouraged to see the announcement that Wells Fargo, the nation’s largest mortgage lender, plans to lower its minimum credit score for certain mortgages.

The bank will begin originating purchase loans with credit scores as low as 600, down from its previous limit of 640, a sign that mortgage lending standards maybe starting to normalize. With respect to the first quarter, it is fair to say that the weather patterns across much of the country have had an impact on homesales this winter, and we believe this is a timing issue. The metrics we follow remain strong and we believe the impact will be temporary.

One measure of the pent-up demand is consumer search activity on the Internet. In a four-month period from October 2013 to January 2014, the number of unique visitors to our brand websites was 10% ahead to the same period in late 2012 and early 2013. By the same measure, RFG website traffic in January was up 42% month-over-month from December. These metrics are an indication of how the Spring housing market may evolve over the next months.

In conclusion, we are pleased with the strength of our financial and operating results for 2013. It was a terrific year for our company, our shareholders, our franchisees, clients and employees. Our management team has executed well against our short and long-term strategic goals. Long-term we remain bullish on housing and continue to believe that Realogy is the best pure play investment for those interested in the long term prospects of the US housing market.

With that I will turn the call over to Tony Hull, our CFO. Tony?

Anthony E. Hull

Thank you, Richard. Let me first talk about some brief highlights from 2013, starting on Slide 8. Revenue was up 13% driven by higher homesale transaction volume in NRT and RFG. Full year 2013 adjusted EBITDA increased by 18% to $796 million. Net income for the company totaled $438 million, and includes an approximately $240 million income tax benefit due to a $341 million benefit from the reversal of our domestic tax valuation allowance, offset by approximately $100 million for the current year book tax expense.

In addition 2013 net income includes charges of $68 million for earliest extinguishment of debt and $47 million related to stock-based payouts under the Phantom Value Plan. Realogy free cash flow totaled $421 million for the year, or $2.89 per share due primarily to the strong gains in operations, and lower interest expense. This was not impacted by the reversal of the tax valuation allowance or book tax expense.

Our financial leverage, which was 5.9 times at the end of 2012, improved to 4.6 times at the end of the year. It was below the 4.7 times we forecasted this past November.

Next I will discuss our key revenue drivers for the full year on the far right on Slide 9. RFG homesale sides increased 10% year-over-year in 2013, and average homesale price gained 9%. RFG's royalty per side increased to $276 in 2013, which we expect will continue to increase in the housing recovery. In 2013, our 250 largest franchisees continued to perform exceptionally well and represented 60% of RFG royalty compared to 57% in the full year of 2012. Due to the shift in mix of business, RFG’s full year net effective royalty rate was 4.49%. Based on our current outlook, we continue to forecast that our 2014 net effective rate will be approximately 4.5% as a result of management actions, as well as adjustments we made to the rebate threshold for 2014.

NRT homesales sides increased 9% year-over-year compared to 2012, and its average homesale price gained 6%. As we have discussed previously, this difference in volumes compared to RFG or even NAR is due to NRT’s concentration in major metropolitan areas and higher than average national sales price.

The general trend for NRT over the year was that growth in sides outpaced growth in price due to mix shift; a greater number of homes are being sold in NRT's comparatively lower priced markets. For the first quarter of 2014, we expect to see overall homesale transaction volume to increase by 8% to 12%. Like [Indiscernible] in Fannie Mae’s forecasts, we expect our first quarter volume to be driven primarily by average sales price based on closed activity and month to date in February. Along with January and February open contracts, we expect transaction size to be down 2% to 5% year-over-year and average sales price to be up 13% to 15% for RFG and NRT combined.

Inventory levels are still low and continue to put upward pressure on sales price as demand is outstripping supply. Still the first quarter is seasonally our slowest quarter and is generally not a benchmark for full-year results.

At Cartus, initiations for 2013 increased 5% and referrals increased 15%. We continue to see growth in the affinity business and international relocation services, both of which generate lower revenue per initiation than domestic relocation services. This is why our initiations are up without commensurate revenue growth.

At TRG, 2013 purchase unit volume increased 10%, which was consistent with NRT homesale gains and reflects improved capture rates. TRG's refinance title and closing units decreased 15% in 2013 compared to 2012, which was expected given the lower refinancing trend. This will continue to be a difficult comparison in the first half of 2014. Average fee per transaction improved 10%, given the shift in mix to homesale transaction from refinancing transactions.

Now let's look at revenue and EBITDA for the business units for full year 2013, as shown on Slide 10. Our overall revenue growth of 13% was driven by NRT, which contributed about 70% of the company's total revenue for the year and grew by 15%. RFG revenue, which represents about 12% of total company revenue, grew 14%. Cartus revenue was down 1%, while TRG revenue increased 11%.

Revenue increases do not mirror transaction volume increases due to the heavy influence of NRT in our total revenue and the differing growth rates at TRG and Cartus. EBITDA at RFG improved $84 million in line with its revenue gains of $86 million. RFG's EBITDA margin increased to 65% in 2013 from 60% in 2012, primarily driven by higher revenue, lower legal expenses, primarily due to the settlement of legal matters in 2012, and reduced bad debt expense compared to 2012.

NRT EBITDA increased $41 million and its margin remained flat for the year. NRT’s margins were adversely impacted by the decrease of $36 million in our equity and earnings related to our PHH Home Loans joint venture and overall commission split increases of 55 basis points to 68.2% for the year compared to last year.

Excluding the PHH Home Loans JV earnings, NRT’s margins improved by 2 percentage points from 3% to 5%, showing the continued operating leverage in the business. As a result of the actions management continues to take, we forecast that NRT commission splits to be approximately 68% in 2014. As we indicated last quarter, PHH Home Loans, our joint venture with mortgage originated on PHH, has taken a number of cost-cutting actions that will add to stabilize its earnings over the coming year.

However, we expect comparison to the first half of 2014 to be difficult due to the strong refinance activity that drove JV earnings in the first half of 2013. Cartus EBITDA in 2013 increased $1 million from 2012, because the revenue decrease was offset by lower operating expenses due to our volumes. In 2013, Cartus saw a decrease in employer sponsored relocation volume. This decline was offset by an increase in non-relocation referral business.

Non-relocation referrals generate real estate transactions through affinity programs and among our network brokers, from which Cartus earns a referral fee as a referring broker. As the economy continues to improve and corporate clients’ business prospects improve, we expect to see growth in our corporate relocation business. TRG EBITDA increased $12 million, or 32% in 2013 due to higher purchase transaction volume, higher average fees and an increase in underwriter premiums.

On the next couple of slides, we take a more in-depth look at incremental margins for the year at RFG and NRT. On Slide 11, which relates to RFG, we have excluded marketing fund revenue since it has no impact on EBITDA. You can see that for the year, after adjusting for that, the incremental margin for RFG was 100%. The incremental margin benefited in 2013 from a decrease in legal expenses year-over-year. In 2012, legal expenses were non-realized, the incremental margin for RFG was 80%. In addition, in 2014 we will continue to invest in RFG’s business, which we believe will drive profitable growth over the long term, or will modestly impact short-term margins.

On Slide 12 you can see that NRT's incremental margin was 19%, factoring out the decrease in PHH Home Loans earnings, and the year-over-year split rate increase. Looking at 2014, NRT has a number of technology initiatives underway that are expected to improve search engine optimization and help generate incremental referral leads and improve commission scores. While we believe this will modestly impact NRT’s incremental margins in 2014, we believe the investment in the business to generate incremental EBITDA in 2015 and beyond.

2014’s incremental margin will also be impacted by added employees and brick and mortar costs from the larger acquisitions completed over the past few months. We will highlight these beginning next quarter.

Looking at Q4 results on Slide 13, revenue increased 3% and adjusted EBITDA declined 10% in 2013 compared to the fourth quarter of 2012. As we indicated during our last call, results in the fourth-quarter faced some challenging comparisons to the strength in the fourth quarter of 2012, and strong refinance volume and sales volume particularly at NRT related to year-end 2012 tax motivated selling of high-end homes.

In the fourth quarter of 2013, the 3% increase in revenue was heavily influenced by NRT sales volume growth of 4%, offset by declines in refinance related revenue at TRG. The EBITDA decrease was further impacted by a $15 million reduction in our share of PHH Home Loans’ revenues in Q4.

Turning to other items on Slide 14. We continue to delever our balance sheet at a meaningful pace. Our net corporate debt was down to $3.7 billion at the end of the year and we ended the year with a 4.6 ratio of net debt to adjusted EBITDA. The benefit of $2.1 billion in net operating losses at the end of 2013, which minimized cash payments for income taxes, and so the NOL utilized will help us enhance cash flow, and reach our target leverage goal more quickly.

Moving to Slide 15, here are some cash flow guidance for 2014. Capital expenditures are expected to be about $65 million. Cash interest expense is expected to be $240 million. Working capital is expected to be a use of $40 million to $60 million. This includes a temporary use of about $40 million in funds to support our Cartus securitizations primarily due to the single large [improvement] by one of our clients.

Cash legacy items are expected to be $10 million to $20 million. For the full year 2013, the company recorded an income tax benefit of $242 million that was primarily due to $341 million release of the domestic deferred tax valuation allowance, partially offset by approximately $100 million in 2013 book income taxes.

Going forward, we expect to incur a book income tax rate of approximately 41% for federal and state taxes, however, our $2.1 billion of NOLs will continue to shield us from being a significant tax payer. We will continue to pay federal alternative minimum tax, state and foreign tax from earnings with approximately $10 million to $15 million estimated for 2014.

Turning to Slide 16, our sides and price volume for Q1 2014 guidance of up 8% to 12% is driven by continued price gains. While we expect higher transaction volume to be a positive driver in the first quarter, it is important to remember that in the first quarter of 2013 we benefited from a favorable refinance environment, which aided earnings at our PHH JV and at TRG, which will not be present this year.

Looking ahead at full year 2014, we draw your attention to existing homesale volume forecast detailed on Slide 17, from NAR and Fannie Mae. As you can see, as was mentioned in NAR’s forecast, the 5% volume growth for 2014 and Fannie is at 8%. While you can pick which one to follow, it is clear they both look like to continue gains in 2014.

Volume growth along with strong free cash flow generation will allow us to delever further in 2014 to get closer to our goal of returning capital to shareholders when our net debt to adjusted EBITDA reaches 3 times. Simultaneously, we will continue to focus on margin improvement from modestly investing in the business to enhance our profitability over the long term.

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

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from Dan Oppenheimer with Credit Suisse.

Mike Dolan – Credit Suisse

Hi, it is actually Mike Dolan for Dan.

Richard A. Smith

Hi Mike.

Mike Dolan – Credit Suisse

Hi. I was hoping you could follow on those last comments about the industry forecasts for 2014 and kind of relative to your guidance for 1Q and some of the comments you made suggesting, you know, the seasonally low, there are weather impacts, we think things will get better, do you think, if you look at NAR, if you look at Fannie Mae, do you think they are well right now, would your expectation be that Realogy will outperform those numbers in ’14?

Richard A. Smith

Well, that is always our hope. That is to be determined. We are not – this is Richard, we’re not – and listen, this is the worst time of the year to forecast a year in good and bad times. It is just – just given the seasonality in the business it is just not the best time to forecast the year. It is somewhat compounded with the bad weather. So, listen I – we think our volume guidance for the first quarter is at the right range, and at the close of the first quarter as we see inventory levels build, we will have a better feel for what the balance of the year is going to look like.

I think you can just stand to reason between NAR and Fannie and also Freddie that it’s probably about a range that they are comfortable with now. But that is going to be subject to all those dynamics that will play out over the next, certainly the end of this quarter, and early part of the second quarter, so to be determined.

Mike Dolan – Credit Suisse

Thanks, and I guess on the – on the 1Q guidance specifically, could you, the numbers you talked about breaking down regional for 4Q were really helpful, could you help us understand if there is anything impacting, whether it is geographic mix impacting that price forecast, just, you know, that again it is a bit higher than some of the other data that has been out there.

Richard A. Smith

No, it is a great question. Real estate is starting to revert to the norm, which essentially means it is subject to local market dynamics, and that is apparent. And of all the price forecasting around the country, California as an example has – some markets is at pretty severe inventory level declines, and that is reflected in the price. New York City is another example that – so it is –it varies by market; there is nothing that stands out as a national issue. Price and sides are reacting to local market dynamics, population growth, income growth, job growth, unemployment rates, per capita income growth, all those things that are important to valuing real estate. So we gave the color because this could become more and more apparent as time passes and even in a strong recovery you are going to see metrics are going to change literary market by market, state by state and this is the beginning of that.

Mike Dolan – Credit Suisse

But there is nothing that’s kind of a big shift towards the West given the tougher weather that you are seeing in other parts of the country?

Richard A. Smith

No, I mean the Northeast and the Midwest are clearly impacted by weather. This is an industry that is in fact impacted by weather trends. So other than that I don’t see and the inventory shortages which we mentioned, other than that I don’t see anything moving in the market one way or the other.

Anthony E. Hull

I would add one thing to that which is if you look at the NAR release in January, the first time buyers were down like 26%, they were 30% pretty much all last year, they should be at 40%. So I think one of the reasons why you are seeing the trend that we gave you guidance in the first quarter is it is a mix shift to higher priced terms. I mean there are fewer sides and there is move up buyer et cetera buying more of the homes so that’s having a pretty dramatic impact on price, 13% - 15%. So I think in terms of – if there is any national trend, I think it is lack of inventory and first time buyers, hopefully some of the things that Wells Fargo is doing and others are doing will help that as the year progresses but at least as far as the first quarter is concerned that’s why you are seeing such an extreme spread between sides and price.

Richard A. Smith

That’s simply a great point on the first time buyer but noticeably absent from this stage of the recovery. There are number of factors we think are creating that circumstance. So we are hopeful and optimistic that that will improve. The other point Tony makes is a very good one, there are markets where you’ve had a big run up in price and as a result price is moderating and it is not going to be as strong as other markets so that’s not a national issue nor a structural issue, that’s a local market issue. But I think Tony is correct, the only structural issue is the first time buyer which we have watched closely and we have started talking about that in the last half of last year.

Mike Dolan – Credit Suisse

Really appreciate the color, thanks.

Richard A. Smith

Yes sir.

Operator

Your next question comes from David Ridley-Lane of Merrill Lynch.

David Ridley-Lane – BofA Merrill Lynch

Sure. Could you maybe describe the reason why you saw the decline in home sales in the West Coast, is it the home prices there are stopping out the first time home buyers or is it just extremely low inventory? Or maybe would you put it down to the tough comp particularly in California?

Richard A. Smith

It depends on the market in California, I think the State is burdened with a very low inventory levels. Some markets that have had big run ups and price and that’s reflected in their current pricing forecast for the balance of the year. So I think it’s principally - we don’t think there is any other issue, it’s not a structural issue it’s literary a lack of inventory.

David Ridley-Lane – BofA Merrill Lynch

Got it, and then you talked about inventory coming now and inventory levels increasing in 2014. Is this a story of underwater home owners getting back to positive equity or is it an increased more in the prevalence of move-up type buyers? Any such comment over there?

Richard A. Smith

Yes, that’s a great question; it’s a little bit of that. CoreLogic produces a great report on the foreclosure inventory and also the shadow inventory. I think the more relevant point is that percentage of homes emerging from the negative equity category and that has improved rather materially year-over-year. And we make the assumption that some of those folks will get back in the real estate market but none of our forecast depends on that entirely. It is helpful and I think valuable that the foreclosure inventory is declining dramatically, it’s down 31% nationally as of the latest CoreLogic report. And I think what’s particularly important about negative equity is about half of what it was several years ago. So those improving metrics will lend well to increase inventory and purchase activity in the year but none of our forecast depend on that entirely.

David Ridley-Lane – BofA Merrill Lynch

Got it. Thank you very much.

Richard A. Smith

Yes sir.

Operator

The next question comes from Eli Hackel with Goldman Sachs Group Inc.

Eli Hackel – Goldman Sachs Group Inc.

Thanks. Good morning, one maybe just first you Tony, you talked little bit about incremental investments both in NRT and RFG. Can you just provide a little bit more context about the magnitude of some of these investments, you talked about lower incremental but just a little bit, just maybe try to understand what about the magnitude there?

Anthony E. Hull

Sure. It’s a couple three million dollars for each of them I think at the end of the day, maybe a little bit more for RFG but it’s not a huge amount of money. And we think the returns, the returns are very strong for some of these investments. So a good example is home based is being rolled out for our franchisees, so I think that is going to be an important long term driver for HI sales as well as we retaining our existing franchisees. I think that’s a modest investment that RFG is looking for to roll out this coming year. I don’t think we will see a return from that this coming year but I think over the next couple of years we will see a nice return from that.

They have some other projects, another initiative that they had last year, and prior to last year that was very successful as they looked to bear certain low quartile franchisees FC 21 and started focusing on them much more they had in the past. And it yielded very strong results in terms of improvement of royalties that were paid from those franchisees. So they are stepping up that project this year that is going, that kind of thing is very modest investment in a couple of employees that sort of thing. But you know driving those players and add up pretty significantly into improve the EBITDA. And it also has some manufacturing royalty there obviously, those are mostly 6% players.

So those are the types of things, the big story that I see is really what I talked about is that they have 3-4 initiatives to improve the search optimization on the website and also to we have talked about before delivering leads to agency specialized in dealing with what we call e-leads. And those sales associates have more favorable splits that helps affect manufacture royalty rates but obviously it turns as leads much more effectively into cash as supposed to just leads that never get fall upon that sort of thing. So modest investments and great return over the next couple of years.

Eli Hackel – Goldman Sachs Group Inc.

Great. And then maybe just one additional one. Clearly the M&A environment seems to have heated up franchise sales are doing very well. Can you just give an overview of what your backlog looks like for a M&A and maybe for a 4 years, I think you sort of commented in the past M&A recruitment is about sort of 1% to 2%. Is that what you think the case could be for 14 or maybe plus that --?

Anthony E. Hull

I think it’s in that, I don’t think its outside that range, I think its 1% to 2% both in NRT and RFG.

Richard A. Smith

Tony is right, I agree with that, one point I would make is it’s a strong pipeline. Brokerage firms that come into realization they have whether the storm, they have improved their P&L and their Balance Sheet looks a little better than as historically and they are at the age where they would like to exit. So we have been watching and monitoring for quite some time and as you know we have been acquisitive over the years. So we know the market quite well and it’s -- and it’s a very healthy pipeline for ‘14 and beyond.

Eli Hackel – Goldman Sachs Group Inc.

Great. Thank you very much.

Richard A. Smith

Welcome.

Operator

And your next question comes from Anthony Paolone with JP Morgan.

Anthony Paolone – JP Morgan Chase & Co

Thanks. Good morning. You mentioned your fourth quarter size and price came in your guidance but the components were a bit different. I am just trying to understand like what changed and when because it seems like when you gave your guidance you probably had some pretty good visibility and you probably just had it seems like maybe December last. Was it December that changed the whole bunch just trying to understand like how quick the business maybe shifted on you?

Anthony E. Hull

I think what happened in the fourth quarter on sides we didn’t want to get into this level of weeds in the script. But we sort of lost the business day, that’s kind of the way we look at it we came with a couple of points, up on sides, 4 points up on sides, 3% to 4%. And every business days is about 2 points so we came [Indiscernible] and we deduct, reduced from that and we lost the business day. And we really lost the business day was because first of all thanksgiving was at the end of the month as supposed to it is usually a week earlier, Christmas and New Year as were on a Wednesday as supposed to a Thursday or a Friday. So you put all that we just didn’t, in whatever seven years we haven’t seen that kind of lineup of business days and holidays and stuff like that. So that sort of think that influenced sides piece of it but obviously it also was impacted by the stuff we are seeing in the first quarter which was low inventory and obviously price came a lot better than we thought. So I think those were kind of factors that we didn’t anticipate in early November when we reported, we started 2 months to go at that point.

Anthony Paolone – JP Morgan Chase & Co

Okay, got you. And then it is helpful to watch some of the put and takes on the incremental margins and NRT. I am just trying to sum it all up, like this 2014 incremental margins NRT [Indiscernible] 19% for ‘13.

Anthony E. Hull

Yeah it will depend, I guess it depends on how the year. I mean the one factor that we don’t forecast having as a headwind is split rate because we expect split rate to be very mild. One headwind we are going to have is still PHH [ph] because the first half, we are still have to cost in the first half but we will continue to show with our without that as we progress in the year. These modest investments, the other thing I pointed out and I sort of referred to in the script. And I sort of referred to it in the scripts and we will look at more value out as the year progresses. When we buy two companies very quickly like we do [Indiscernible]. You have the bricks and mortar across those acquisitions kind of end like for the first quarter but got to be as if in it is one quarter before the cost. But obviously in still periods that is going to, you are not going to get a lot of revenue on the fixed cost. So it’s going to have just proportion, you are going to feel, especially in the first quarter. When you get to the second and third quarters you aren’t feeling as much because that’s prime time for NRT so they get the revenues, you won’t really feel the impact much in the second and third quarter. But in the first quarter might be exaggerated a bit, so I think those kind of things, we will keep pointing out as the year progresses but I think that’s, overall everything being equal, we think the incremental margins are still in the high teams like very affinity.

Anthony Paolone – JP Morgan Chase & Co

Okay. And then last time you had mentioned online traffic maybe it’s a potential, early indicator of spring. Is that something that you guys have used historically? Is that been a good indicator?

Anthony E. Hull

It certain ways it was, in certain ways we watched last year and our traffic was way up, obviously our buying was 18% last year. I mean I think we sort of focused on it now because it’s so, the visibility whatever it was 2012, 2011 or 2010 it’s just hard in our business to have other than the forecast from various M&A and etc. it is hard to have visibility beyond the quarter end. So when we end this kind of slow quarter it’s probably the best indicator, I don’t think in the summer, in summer season it is more focused on [Indiscernible], this year the best thing in any winter season of our business it’s kind of best thing to look at to see what consumers are doing and what they are thinking about and they are getting ready to launch activity for spring. And it is usually about 2 to 3 months lag between when the activity increases and when you will start to see in open and then obviously closes 50 days later or whatever.

Anthony Paolone – JP Morgan Chase & Co

Okay. Great. Thank you.

Operator

Your next question comes from Adam Rudiger with Wells Fargo Securities.

Adam Rudiger – Wells Fargo Securities

Good morning. Thank you. I was wondering if you could comment on the impact that seems to be regulatory changes in the GSEs. And then also on the same note I think the NAR when they put up their most recent press release, talked about some flawed insurance issues and packing some buyers, would you want to talk about that impacted the market either?

Richard A. Smith

So let start with flawed insurance, we are well aware of importance of that in the industry and it affects you if you are in those markets, outside of that it has a little impact on you which is as [Indiscernible] operations not in those markets. But as I said there will be House Bill introduced tomorrow on the floor, we think that will be somewhat to the Senate version of that bill. There is a great deal of optimism on the hill that it will be signed into law and we can’t project it that is going to happen or not. But there is a lot of optimism that Flood Bill would be reset and would be not as onerous as it is in the bill that was signed into law by Maxim.

Here is Maxim Waters Bill in 2012 so we are pretty good about that. As to GSE reforms, as you all know very controversial subject you see no chance, a little chance, it will be a resolution of GSE reform before the mid terms. We are doubtful that it will come before the Presidential Election in 2016. But I think the senses of the people will follow this issue and we pay a lot of attention to the consensus says that this will be an issue for the next administration, not the current administration.

So we are seeing no near term issue and by the time it becomes a law at some point that would be a very different version from virtually everything that you have seen flooded in the marketplace. So we have no near term concerns at all with respect to GSE reforms. And no other regulatory issue, the one issue that I hope would be resolved soon is the last remaining issue under [Indiscernible] QRM, Qualified Residential Mortgage. Conclusion as to the required down payment, we are increasingly optimistic that down payment requirements will not be as owner says the original bill required. So we are encouraged by that. I see no other near term regulatory issues that concern us.

Adam Rudiger – Wells Fargo Securities

Okay. That’s helpful. Thank you. Now Tony a couple of follow-up just modeling questions. You mentioned some incremental your higher expenses in the first quarter due to the acquired operations. Can you give us a guidance on what maybe operating expenses and G&A should be and then can you help us what the GAAP interest should be as suppose to the cash interest?

Anthony E. Hull

We don’t give guidance, so it’s hard for me to, having additional offices that we had in this first quarter that we didn’t have last where we can probably back in some numbers there and the interest would be, the GAAP interest probably about 10 million or 15 million, excuse me 20 million higher on the full year than the cash interest. Its fees and amortization.

Adam Rudiger – Wells Fargo Securities

Okay. Thanks.

Operator

The next question comes from Stephen Kim with Barclays.

Stephen S. Kim – Barclays Capital

Thanks very much guys, encouraging news here on Q1. I wanted to ask you a question about listings because I agree with you that is one of the most interesting aspects of the sides we are seeing because we just haven’t seen a lot of exiting on inventory. But typically in a normal year can you give us a sense of what percent of the total listings that occur in a year, occur in the first quarter, second quarter or third quarter, can you give some sense what that cadence looks like?

Anthony E. Hull

The first quarter is the lowest, the only thing I point out is you can track it on [Indiscernible] sort of monthly inventory numbers. It was encouraging that from December to January it went from I think 4.3 months which was staggering low, I think it was 4.9 months in the latest report last week. So the cadence is it improves as the year goes on and sort of cools off obviously in the fall. But I don’t have anything, we can post something on that.

Richard A. Smith

The only thing that I would add to that if we look for the trend line in the first quarter, so the strength of the increase in inventory would give a strong indication as to how robust it would be in the second quarter and towards getting into third quarter. So we look for the trend line more than anything else and again selling points of our forecast which was a good sort of benchmark if you will for what’s happening with first in inventory.

Stephen S. Kim – Barclays Capital

Great.

Richard A. Smith

If you want to be more granular you can look at the State association that can become sometime bit more granular, you can be market specific. If you look at the California Association of Realtors and a few others they give you a more granular view of what listing inventory looks like in very specific markets and that too can be a good research for determining what is going to happen to listing inventory in the first half of the year.

Stephen S. Kim – Barclays Capital

Okay, great, that’s very helpful. Thanks. And I guess the second question I had related to the NRT incremental. I guess a couple of things, one when I am hearing you talk about the incremental investments being made and let’s say the NRT business. I know you are working on web initiatives and so forth and we also heard you say that the web traffic was up. I mean what that tells me is that that business obviously comes at much higher incremental margins and much lower commission split. It seems to me that there should be some offsets, certainly you are making investments in the web but you’re also getting more web traffic which should sort of being an offset to it.

So I am trying to figure out what the impact obviously because you talked about some weakening impact on the incremental margins and NRT. And I am excluding the PHH segment here, last quarter’s conference call you gave a range and said if splits were flat next year versus this year then you would see a 20% to 25% incremental margin range. I think after that you have sort of talked about within 18% to 22% range if you sort of take into consideration inflation.

And now I hear you say high [Indiscernible] and so I am curious when you say that you are going to have these investments within a temporary depressing incremental, are you talking about an incremental in NRT XPHH, maybe below that 18% range in the first part of the year and then maybe little higher but not up into the 20s in the back half. I am just trying to get some sense of where are you expecting things to be if splits are flat?

Anthony E. Hull

Just to be clear 20%-25% with all house remaining constant and that’s what we talked about initially so that remaining constant, no salary increases. [Indiscernible] and then it seems like we got some push back on using that metric because things don’t remain constant which is true. So with inflation obviously we lowered it and other things that remaining constant we lowered it into the high [Indiscernible]. I don’t think the incremental investments maybe it’s like a point of incremental margins, it’s not a big, these are not big investments, so it is not going to have a big impact. Again to my point before I think the bigger thing we have to that we were focused everyone’s attention on going forward is the impact of M&A especially to large deals on incremental margins.

I should think that is going to be slightly bigger impact. We will keep you posted on, the thing I remember when we do an acquisition like [Indiscernible] the biggest beneficiary of those acquisitions is really RFG because they have 6% off the top. So it helps their incremental margins and obviously they are wealthy from NRT but it kind of leaves the NRT system, right, that first 6%. And we are talking about pretty low margins business to begin with. So you have those 10 offices, you have the expense, you got to pay the agents, you got to pay the 6% so you are not going to see, we do acquisitions NRT its going to have a little bit more than negative impact on their incremental margin. But we get the benefit elsewhere, really we get the benefit of TRG, from sides you get the benefit of cardus from referrals, we get the benefit, obviously a huge benefit NRG from the 6% going over there. I just think it is something because we did, they are not huge but are relatively small but they would be impactful and we will keep you posted as the year progresses and what impact they are having on NRT and how they are benefiting the other business units.

Stephen S. Kim – Barclays Capital

Great. That’s very helpful. Thanks guys.

Operator

Your next question comes from Will Randow with Citi.

Will Randow – Citi

Good morning. Thanks for taking my questions. A lot of my questions have been asked but I am curious in respective of and you talked in the past based on the data you are looking at under the hood. When you see cash sales as percentage of total U.S. home sales as well as distressed an investor activity declining, are you guys seeing kind of, let’s say a benefit or would you expect a difference and law for you relative to any other data because of that shift?

Richard A. Smith

The shift away from investors and more towards cash.

Anthony E. Hull

It’s a good question, I mean first of all we would appoint, RQ has appointed Head of now last year and maybe some of that was because of, we don’t necessarily play in foreclosure. We never messed up to kind of national foreclosure numbers just because we are at higher end in many of our markets. So foreclosures has gone down so that is benefit for us so maybe that’s one of the factors that impacted us being outperforming last year. So I think if foreclosure goes down then it should help, as it continues it should help as well. But obviously franchisee sales NRT also helps them outperform some of these and mix being and certainly helps us at some point at some price. So there are a lot of factors out there and investor side is still, it’s an important developing industry but we are still at a 100,000 whatever units versus the 1.4 million sides we are involved in last year. So it’s not that bigger factor.

Richard A. Smith

Well the investment component in the market is just about back to normal, it is somewhere in the range of 19% to 20%, transactions are investor purchases. So I corrected rather quickly and bear in mind that’s not just institutional investors, that’s literary mom and pop local companies acquiring and holding small properties.

Will Randow – Citi

I appreciate that. And then just speaking about the data, it seems as if when it impacted, sorry, extreme inclement weathers impacted sales in some ways quantitatively. When you look at areas like the Mid Atlantic, could you speak about that for example penning home sales actually improving or existing is declining, there’s a backlog. And then are you seeing any uptake in the current recent weeks of sales?

Anthony E. Hull

I don’t know about the Mid Atlantic specifically but I can tell you, I mean it’s pretty, we get obviously opens reports and look at and summarized weekly by region and you can see when there is a big storm in the Mid West. You can see we are down 10% versus forecast and then the weather clears up and all of a sudden a week later we are on forecast. I mean it’s pretty amazing how it reacts but it corrects, it’s not, it seems to be timing, it’s not a permanent issue. When the weather clears up the activities ramps up, so I think that’s why Richard made a comment in his remarks that we think this is timing because we are seeing that kind of evidence, the minute the weather clears up some [Indiscernible] will be right back on forecast. So presumably that will continue.

Will Randow – Citi

Okay. Thanks a lot guys and congrats on a great 2013.

Richard A. Smith

Thank you Weil.

Operator

The last question comes from Brandon Burke Dobell with William Blair.

Brandon Burke Dobell – William Blair & Company

Thanks for sneaking me in. I guess the quantitative way or evidence you can give us to help us understand how much more [Indiscernible] you guys are getting on lead conversions especially through some of the e-channels that you mentioned initiatives that you got going on this year. But I am trying to figure out how much more sophisticated, how much better conversion will become in ‘13 versus ‘12 or maybe on a longer timeframe, trying to get it how efficiently you can do it from marketing knowledge? How efficiently the agents can do with marketing knowledge?

Richard A. Smith

That speaks to the investments that Tony mentioned both in NRT and also RFG. So are leveraging the investments we made over the years and accelerating the perspective impact of various points in technology may have not only our sourcing of leads but more importantly our closure of those leads. So those investments are intended to increase the closure rate. I think we are running this business there are some industry norms as to what the closure rate is generally speaking is fairly low. What we all try to do is figure out how to significantly increase the closure rate and invest or investments. So we are really optimistic as to the perspective impact that will have on closure rates. We haven’t disclosed any of the specific investments for the obvious comparative reasons but we are very optimistic.

Now if you want to just model something through a variety of really dot com they also predict the closure rates for the industry and those are pretty good guidelines for how you like to model the business.

Brandon Burke Dobell - William Blair & Company

Okay and then final one, last quarter on the call you talked about some negotiations around individual agent commission rates and splits especially for the January timeframe but also on anniversaries. Any color on how negotiations or those conversations one generally is moving around those split rates that’s appreciable for the market?

Richard A. Smith

We are forecasting 68% as per this year so that incorporates all those, we are still forecasting it, we haven’t changed our view on that.

Brandon Burke Dobell – William Blair & Company

Okay. Thanks guys, I appreciate it.

Richard A. Smith

You are welcome.

Operator

And at this time there are no further questions, are there any closing remarks? I am sorry we do have one final question and it comes from Michael S. Kim with CRT Capital Group.

Michael S. Kim – CRT Capital Group

Hi, good morning everyone, thanks for taking my question. Nice quarter, operating expenses came in lower than the way we were expecting, if you can talk about embedded operating leverage just based on the composition of your company analytics, presumably most of that operating leverage comes from [Indiscernible]. Are there certain geographies that provide more incremental margin contributions, is it just a higher price coastal regions or would it be more focused on the lower price Mid West regions based on where we are today. How we should think about this?

Anthony E. Hull

The incremental margins are definitely better kind of from the Mid West and East than they are from the Mid West and the West just because of the competitive environments in those markets. You got place to the local market and you can try to vary from that so be competitive in that market. So it’s just historical that [Indiscernible] from the Mid West to East than they are on the West Coast. So if we grow obviously the incremental margins helped by growing on the East Coast rather than the West Coast.

Michael S. Kim – CRT Capital Group

Fine, okay that’s helpful. Thank you. And we are talking of mortgage credibility and I know you find it well making some changes to mortgage lending standards. Do you expect others to follow suit, I mean with refinancing activity down, do you think other originators are going to are going to look to modify their standards to kind of support mortgage credibility? And do you think that the timing of these changes maybe impactful to the time spent on it.

Richard A. Smith

I think the most important point you make is timing. With the substantial decline in refine volume, most lenders are scrambling to replace that book of business with purchase money. So they are I think becoming more reasonable and practical and certainly more normalized than their underwriting standards. So I think that coupled with last [Indiscernible] will make it, I think more practical underwriting and thus more credibility. To be determined but that we see people like worse part of becoming pretty aggressive trying to replace that volume. We expect other lenders to follow.

Anthony E. Hull

And average [Indiscernible] there are reports that they continue to creep down it’s like painful to watch but they were down to 727 in December. So they are going in the right direction, we are always happy have been faster. So it is happening clearly but surely.

Michael S. Kim – CRT Capital Group

Understood. Alright. Great. Thank you very much. I will follow up with my questions.

Anthony E. Hull

Thanks Mike.

Richard A. Smith

Thank you Mike.

Alicia Swift

Okay we thank you for taking the time and joined us on the call and we look forward to speaking with you over the next quarter. I would also like to tell investors that we will be hosting a Realogy Investor Day on Friday May 9th at our Headquarters in Madison, New Jersey. All who are interested in attending should contact Jennifer Pepper, in our Investor Relations office. Thank you.

Operator

Thank you for attending today’s conference call, you may now disconnect.

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