Favorable demographic factors: the number of U.S. households grew from 95 million in 1991 to 111 million in 2007, increasing at a rate of 1% per year on a CAGR basis. According to the Joint Center for Housing Studies at Harvard University, that annual growth trend is primarily resultingexpected to continue albeit at a faster pace through 2015. In recent years, baby boomers have been buying second homes at an increasing rate, and children of baby boomers are now beginning to impact the housing market and are buying houses at a much younger age than previous generations. The U.S. housing market is also expected to benefit from continued immigration, which is fueling minority homeownership and is anticipated to account for almost 70% of the following factors:net U.S. household growth through the next decade, according to the Joint Center for Housing Studies at Harvard University;
Increasing size of February 2007, NAR forecasts ahomes: since 1973, home size has increased by 1% decreaseeach year from an average size of 1,660 square feet to an average size of 2,469 square feet in existing homesales2006, contributing to higher price appreciation and a 2% increase in the median pricegreater homesale commission dollars; and
“Trading up” mentality of existing single-familyhome buyers and sellers, which leads to higher price points for homes in 2007 compared to 2006.sold and increased commission dollars per transaction.
Notwithstanding these fundamentals, we cannot predict when or if the firstmarket and second quarters of 2007 on ayear-over-year basis, NAR expects home sales to resume positive growth in the third quarter of 2007 throughout the end of its forecast period (second quarter of 2008) on a quarterlyyear-over-year basis.
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Value Circle
Our four complementary businesses work together to form our “value circle.” Our value circle is a major driver of our revenue growth.development. This is demonstrated through the following examples:
After becoming a franchisee, we may ask the franchisee, if qualified, to join the Cartus Broker Network, our relocation business referral network, and to work with our title and settlement services business. If qualified, the approved broker would be eligible to receive relocation referrals from our relocation services business, and our relocation services business would receive a fee for the referral. Our franchisees may also enter into marketing or service agreements with our title and settlement services business, which will allow them to participate in the title and settlement services business.
Our Cartus Broker Network is a network of brokers that accepts referrals from our relocation services business. Approximately 94% of the Cartus Broker Network is affiliated with our brands, including both our franchisees and our company owned brokerage business. As such, our real estate franchise systems business, through royalty payments from franchisees and company owned brokerage operations, and our company owned brokerage business, through commissions, earn revenues from the referral.
The majority of our title and settlement services business offices are located in or around our owned brokerage offices and capture approximately 47% of all title and settlement services that originate in those offices.
When our relocation services business assists a transferee in selling his or her home, the transferee frequently uses our title and settlement services business; and, where customary, our title and settlement service business also provides services in connection with the purchase of the transferee’s new home.
Through our 49.9% ownership of PHH Home Loans, we earn 49.9% of any income earned as a result of a referral from our company owned brokerages or our relocation services business. PHH Mortgage, the mortgage subsidiary of PHH Corporation and the 50.1% owner of PHH Home Loans, is the only endorsed provider of mortgages for customers of our franchisees and we receive a marketing fee for promotion in connection with our endorsement.
It is possible that all four of our businesses can derive revenue from the same real estate transaction. An example would be when a relocation services business client engages us to relocate an employee, who then hires a real estate sales associate affiliated with one of our owned and operated real estate brokerages to assist the employee in buying a home from a seller, who listed the house with one of our franchisees and uses our local title agent for title insurance and settlement services and obtains a mortgage through our mortgage venture with PHH Corporation. This value circle uniquely positions us to generate revenue growthdevelopment opportunities in all of our businesses.
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Our brands are among the most well known and established real estate brokerage brands in the real estate industry. As of December 31, 2006,2007, we had approximately 15,90015,700 franchised and company owned offices and 321,000308,000 sales associates operating under our franchise brands in the U.S. and other countries and territories around the world, which includes over 1,000approximately 940 of our company owned and operated brokerage offices. In the U.S. during 2006,2007, we estimate, based on publicly available information, that brokers operating under one of our franchised brands (including our brokers in our company owned offices) represented the buyer or the seller in approximately one out of every four single family homes sale transactions, based upon transaction volume, that involved a broker.
Our real estate franchise brands are listed in the following chart, which includes information as of December 31, 20062007 for both our franchised and company owned offices:
 |  |  |  |  | ||||||
Description | One of the world’s largest residential real estate sales organizations | One of the world’s largest real estate brokerage franchisors | A leading residential real estate brokerage franchisor | Luxury real estate brokerage franchisor | A leader in commercial real estate | |||||
Offices | 8,492 | 3,824 | 2,972 | 346 | 209 | |||||
Brokers and Sales Associates | 146,070 | 123,730 | 38,740 | 7,220 | 2,090 | |||||
U.S. Annual Sides | 716,497 | 960,051 | 190,073 | 27,352 | N/A | |||||
# Countries with Master Franchise Agreements | 45 | 30 | 34 | 15 | 5 | |||||
| Characteristics | • Well-recognized name in real estate • Innovative national and local marketing | • 100-year old real estate company • Pioneer in Concierge Services and a market leader in million-dollar homes | • 30-year old company • Established the first real estate franchise network outside of North America in 1981 | • Well-known name in the luxury market • New luxury franchise model launched by us in 2004 | • Founded in 1906 • Services corporations, small business clients and investors |
 |  |  |  |  | ||||||
Offices | 8,300 | 3,700 | 2,900 | 470 | 220 | |||||
Brokers and Sales Associates | 140,000 | 117,000 | 37,600 | 9,000 | 2,300 | |||||
U.S. Annual Sides | 555,000 | 792,000 | 157,000 | 31,000 | N/A | |||||
# Countries with Owned or Franchised Operations | 58 | 46 | 49 | 30 | 11 | |||||
Characteristics | • Strong brand awareness in real estate
• Innovative national and local marketing | • 100-year old real estate company
• Pioneer in Concierge Services and a market leader in million- dollar homes | • 30-year old company
• Established the first real estate franchise network outside of North America in 1981 | • Well-known name in the luxury market
• New luxury franchise model launched by us in 2004 | • Founded in 1906
• Services corporations, small business clients and investors | |||||
In addition, in the fourth quarter of 2007, we entered into a long-term agreement to license the Better Homes and Gardens® Real Estate brand from Meredith Corporation, and intend to build a new international residential real estate franchise company using that brand name. The licensing agreement between us and Meredith becomes operational on July, 1 2008 and is for a 50-year term, with a renewal term for another 50 years at our option.
Real Estate Franchise Services
Our primary objectives as the largest franchisor of residential real estate brokerages in the world are to sell new franchises, create or acquire new brands, retain existing franchises and, most importantly, provide world-class service and support to our franchisees in a way that enables them to increase their revenue and profitability.
We have generated significant growth over the years in our real estate franchise business by increasing the penetration of our existing brands in their markets, increasing the number of international master franchise agreements that we sell and increasing the geographic diversity of our franchised locations to ensure exposure to multiple areas. We believe that exposure to multiple geographic areas throughout the U.S. and internationally also reduces our risk of exposure to local or regional changes in the real estate market. In addition, our large number of franchisees reduces our reliance on the revenues of a few franchisees. During 2006,2007, our largest independent franchisee generated less than one percent of our real estate franchise business revenues.
We derive substantially all of our real estate franchising revenues from royalty fees received under long-term franchise agreements with our franchisees (typically ten years in duration for domestic agreements). The royalty fee is based on a percentage of the franchisees’ gross commission income earned from real estate transactions. In general, we provide our franchisees with a license to use the brands’ service marks, tools and systems in connection with their business, provide them with educational materials which contain recommended methods, specifications and procedures for operating the franchise, extensive training programs and assistance and a national marketing program and related services. We operate and maintain an Internet-based
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The franchise agreements impose restrictions on the business and operations of the franchisees and requiresrequire them to comply with the operating and identity standards set forth in each brand’s policy and procedures manuals. A franchisee’s failure to comply with these restrictions and standards could result in a termination of the franchise agreement. The franchisees may, in some cases, mostly in the Century 21® brand, have limited rights to terminate the franchise agreements. Prior versions of the Century 21® franchise agreements, that are still in effect but are no longer offered to new franchisees, permit the franchisee to terminate the agreement if the franchisee retires, becomes disabled or dies. Generally, the franchise agreements have a term of ten years and require the franchisees to pay us an initial franchise fee of up to $25,000, plus, upon the receipt of any commission income, a royalty fee, in most cases, equal to 6% of such income. Each of our franchise systems (other than Coldwell Banker Commercial®) offers a volume incentive program, whereby each franchisee is eligible to receive return of a portion of the royalties paid upon the satisfaction of certain conditions. The amount of the volume incentive varies depending upon the franchisee’s annual gross revenue subject to royalty payments for the prior calendar year. Under the current form of franchise agreements, the maximum volume incentive varies for each franchise system, and ranges from 2%zero to 3% of gross revenues. We provide a detailed table to each franchisee that describes the gross revenue thresholds required to achieve a volume incentive and the corresponding incentive amounts. We reserve the right to increase or decrease the percentageand/or dollar amounts in the table, subject to certain limitations. Our company owned brokerage offices do not participate in the volume incentive program. Franchisees and company owned offices are also required to make monthly contributions to national advertising funds maintained by each brand for the creation and development of advertising, public relations and other marketing programs.
Under certain circumstances, forgivable loans are extended to eligible franchisees for the purpose of covering all or a portion of theout-of-pocket expenses for a franchisee to open or convert into an office operating under one of our franchise brands and or to facilitate the franchisee’s acquisition of an independent brokerage or for major renovations.brokerage. Many franchisees use the advance to change stationery, signage, business cards and marketing materials or to assist in acquiring companies. The loans are not funded until appropriate credit checks and other due diligence matters are completed and the business is opened and operating under one of our brands. Upon satisfaction of certain criteria,performance based thresholds, the cash advancesloans are forgiven over the term of the franchise agreement.
In addition to offices owned and operated by our franchisees, we own and operate approximately 1,000940 of the Coldwell Banker®, ERA®, Coldwell Banker Commercial®, Sotheby’s International Realty® and The Corcoran Group® offices through our NRT subsidiary. NRT pays intercompany royalty fees of approximately 6% of its commission income plus marketing fees to our real estate franchise business in connection with its operation of these offices. These fees are recognized as income or expense by the applicable segment level and eliminated in the consolidation of our businesses. NRT is not eligible for any volume incentives and it is the largest contributor to the franchise system’s national marketing funds under which it operates.
In the U.S., and Canada, we employ a direct franchising model whereby we contract with and provide services directly to independent owner-operators. In other parts of the world, we generally employ either a master franchise model, whereby we contract with a qualified, experienced third party to build a franchise enterprise in such third party’s country or region, or a direct franchising model.
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We own the trademarks “Century 21®,” “Coldwell Banker®,” “Coldwell Banker Commercial®,” “ERA®” and related trademarks and logos, and such trademarks and logos are material to the businesses that are part of our real estate business. Our franchisees and our subsidiaries actively use these trademarks, and all of the material trademarks are registered (or have applications pending) with the United States Patent and Trademark Office as well as with corresponding trademark offices in major countries worldwide where these businesses have significant operations.
We have an exclusive license to own, operate and franchise the Sotheby’s International Realty® brand to qualified residential real estate brokerage offices and individuals operating in eligible markets pursuant to a license agreement with SPTC, Inc., a subsidiary of Sotheby’s Holdings, Inc.(“ (“Sotheby’s Holdings”). Such license agreement has a100-year term, which consists of an initial50-year term and a50-year renewal option. In connection with our acquisition of such license, we also acquired the domestic residential real estate brokerage operations of Sotheby’s which are now operated by NRT. We pay a licensing fee to Sotheby’s Holdings for the use of the Sotheby’s International Realty® name equal to 9.5% of the royalties earned by our Real Estate Franchise Business attributable to franchisees affiliated with the Sotheby’s International Realty® brand, including brokers in our company owned offices.
On October 8, 2007, the Company announced that it entered into a long-term agreement to license the Better Homes and Gardens® Real Estate brand from Meredith Corporation. Realogy intends to build a new international residential real estate franchise company using the Better Homes and Gardens® Real Estate brand name. The licensing agreement between Realogy and Meredith becomes operational on July 1, 2008 and is for a 50-year term, with a renewal option for another 50 years at the Company’s option.
Each of our brands has a consumer web site that offers real estate listings, contacts and services. Century21.com, coldwellbanker.com, coldwellbankercommercial.com, sothebysrealty.com and era.com are the official websites for the Century 21®, Coldwell Banker®, Coldwell Banker Commercial®, Sotheby’s International Realty® and ERA® real estate franchise systems, respectively.
Company Owned Real Estate Brokerage Services
Through our subsidiary, NRT, we own and operate a full-service real estate brokerage business in more than 35 of the largest metropolitan areas in the U.S. Our company owned real estate brokerage business operates under our franchised brands, principally Coldwell Banker®, ERA® and Sotheby’s International Realty®, as well as proprietary brands that we own, but do not currently franchise, such as The Corcoran Group®. As of December 31, 2006,2007, we had over 1,000approximately 940 company owned brokerage offices, approximately 8,5007,500 employees and approximately 62,00056,000 independent contractor sales associates working with these company owned offices. From the date of Cendant’s acquisition of 100% of NRT in April 2002 through 2006,December 31, 2007, we acquired 111120 brokerage companies. These acquisitions have been a substantial contributor to the growth of our company owned brokerage business.
Our real estate brokerage business derives revenue primarily from sales commissions, which are received at the closing of real estate transactions, which we refer to as gross commission income. Sales commissions usually range from 5% to 7%6% of the home’s sale price. In transactions in which we act as a broker for solely the buyer or the seller, the seller’s broker typically instructs the closing agent to pay the buyer’s broker a portion of the sales commission. In addition, as a full-service real estate brokerage company, we promote the complementary services of our relocation and title and settlement services businesses, in addition to PHH Home Loans. We believe we provide integrated services that enhance the customer experience.
When we assist the seller in a real estate transaction, our sales associates generally provide the seller with a full service marketing program, which may include developing a direct marketing plan for the property, assisting the seller in pricing the property and preparing it for sale, listing it on multiple listing services, advertising the property (including on websites), showing the property to prospective buyers, assisting the seller in sale negotiations, and assisting the seller in preparing for closing the transaction. When we assist the buyer in a real estate transaction, our sales associates generally help the buyer in locating specific properties
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At December 31, 2007, we operated approximately 87% of our company owned offices under the Coldwell Banker® brand name, approximately 3% of our offices under the ERA® brand name, approximately 5% of our offices under The Corcoran Group® brand name and approximately 5% of our offices under the Sotheby’s International Realty® brand name. Our offices are geographically diverse with a strong presence in the east and west coast areas, where home prices are generally higher. We operate our Coldwell Banker® offices in numerous regions throughout the U.S., our ERA® offices in New Jersey and Pennsylvania, our Corcoran® Group offices in New York City, the Hamptons (New York), and Palm Beach, Florida and our Sotheby’s International Realty® offices in several regions throughout the U.S. We believe that the markets in which we operate generally function independently from one another. The following table provides information about the various regions we serve:
| % of | 2006 | |||||||
| NRT 2006 | Average | |||||||
Major Geographic Regions | Revenue | Homesale Price | ||||||
| Midwest | 15.5% | $ 283,966 | ||||||
| Southern California | 13.5% | $ 985,909 | ||||||
Tri-State(a) excluding New York City | 11.1% | $ 568,216 | ||||||
| Northern California | 10.3% | $ 865,559 | ||||||
| Florida | 8.9% | $ 414,565 | ||||||
| New York City | 7.4% | $1,160,671 | ||||||
| Mid-Atlantic | 6.8% | $ 381,225 | ||||||
| New England | 6.7% | $ 434,547 | ||||||
Sotheby’s International Realty® (all locations) | 7.7% | $1,377,536 | ||||||
All other(b) | 12.1% | $ 301,307 | ||||||
| Total | 100.0% | $ 492,669 | ||||||
We intend to grow our business both organically and through strategic acquisitions. To grow organically, we will focus on working with office managers to recruit, retain and develop effective sales associates that can successfully engage and earn fees from new clients. We will continue to shift from traditional print media marketing to technology media marketing. We also planintend to open new offices while monitoringactively monitor expenses to increase efficiencies.
We have a dedicated group of professionals whose function is to identify, evaluate and complete acquisitions. We are continuously evaluating acquisitions that will allow us to enter into new markets and to
expand our market share in existing markets through smaller“tuck-in” “tuck-in” acquisitions. Following completion of an acquisition, we consolidate the newly acquired operations with our existing operations. By consolidating operations, we reduce or eliminate duplicative costs, such as advertising, rent and administrative support. By utilizing our existing infrastructure to support a broader network of sales associates and revenue base, we can enhance the profitability of our operations. We also seek to enhance the profitability of newly acquired operations by increasing the productivity of the acquired brokerages’ sales associates. We provide these sales associates with specialized tools, training and resources that are often unavailable at smaller firms, such as access to sophisticated information technology and ongoing technical support; increased advertising and marketing support; relocation referrals, and a wide offering of brokerage-related services. In 2006,2007, we acquired 19nine real estate brokerage companies.
Our real estate brokerage business has a contract with Cartus under which the brokerage business provides brokerage services to relocating employees of the clients of Cartus. When receiving a referral from Cartus, our brokerage business seeks to assist the buyer in completing a homesale. Upon completion of a
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PHH Home Loans, our home mortgage venture with PHH, Corporation (“PHH”), a publicly traded company, has a50-year term, subject to earlier termination upon the occurrence of certain events or at our election at any time after January 31, 2015 by providing two years notice to PHH. We own 49.9% of PHH Home Loans and PHH owns the remaining 50.1%. PHH may terminate the venture upon the occurrence of certain events or, at its option, after January 31, 2030. Such earlier termination would result in (i) PHH selling its interest to a buyer designated by us or (ii) requiring PHH to buy our interest. In either case, the purchase price would be the fair market value of the interest sold. All mortgage loans originated by the venture are sold to PHH or other third party investors, and PHH Home Loans does not hold any mortgage loans for investment purposes or perform servicing functions for any loans it originates. Accordingly, we have no mortgage servicing rights asset risk. PHH Home Loans is the exclusive recommended provider of mortgages for our company owned real estate brokerage business.
Relocation Services
Through our subsidiary, Cartus, we offer a broad range of employee relocation services. In 2006,2007, we assisted in over 130,000 relocations in over 150 countries for over 1,100approximately 1,200 active clients including nearly two-thirdsover half of the Fortune 50, as well as government agencies and affinity organizations. Our relocation services business operates inthrough five global service centers on three continents. Our relocation services business is a leading global provider of outsourced employee relocation services with a number one market share in the U.S.
We primarily offer corporate and government clients employee relocation services, such as:
homesale assistance, including the evaluation, inspection, purchasing and selling of a transferee’s home; the issuance of home equity advances to transferees permitting them to purchase a new home before selling their current home (these advances are generally guaranteed by the corporate client); certain home management services; assistance in locating a new home; and closing on the sale of the old home, generally at the instruction of the client;
expense processing, relocation policy counseling, relocation related accounting, including international compensation administration, and other consulting services;
arranging household goods moving services, with approximately 71,000 domestic and international shipments in 2007, and providing support for all aspects of moving a transferee’s household goods, including the handling of insurance and claim assistance, invoice auditing and quality control;
visa and immigration support, intercultural and language training and expatriation/ repatriation counseling and destination services; and
group move management services providing coordination for moves involving a large number of transferees to or from a specific regional area over a short period of time.
The wide range of our services allows our clients to outsource their entire relocation programs to us. We believe we provide our relocation clients with exceptional service.
Under relocation services contracts with our clients, homesale services are divided into two types, “at risk” and “no risk.” Approximately 86%84% of our homesale services are provided under “no risk” contracts. Under these contracts, the client is responsible for payment of all direct expenses associated with the homesale. Such expenses include, but are not limited to, appraisal, inspection and real estate brokerage commissions. The client also bears the risk of loss on the sale of the transferee’s home. We pay all of these expenses and generally fund them on behalf of the client. When we fund these expenses, the client then reimburses us for those costs plus interest charges on the advanced money. This limits our exposure on “no risk” homesale services to the credit risk of our corporate clients rather than to the potential fluctuations in the real estate market or to the creditworthiness of the individual transferring employee. Due to the credit quality of our corporate clients and our history with such losses, we believe such risk is minimal.
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Under all relocation services contracts (regardless of whether the client utilizes the “no risk” or “at risk” homesale service), clients are responsible for payment of all other direct costs associated with the relocation, including, but not limited to, costs to move household goods, mortgage origination points, temporary living and travel expenses. We process all of these expenses and generally fund them on behalf of the client. When we fund these expenses, the client reimburses us for those costs plus interest charges on the advanced money. The exposure for the non-homesale related direct expenses is limited to the credit risk of the corporate clients. We have experienced virtually no credit losses, net of recoveries, over the last three years.
Substantially all of our contracts with our relocation clients are terminable at any time at the option of the client. If a client terminates its contract, we will only be compensated for all services performed up to the time of termination and reimbursed for all expenses incurred to the time of termination.
We earn commissions primarily from real estate brokers and van lines who provide services to the transferee. The commissions earned allow us pricing flexibility for the fees we charge our clients. We have created the Cartus Broker Network, which is a network of real estate brokers consisting of our company owned brokerage operations, some of our franchisees who have been approved to become members and independent real estate brokers. Member brokers of the Cartus Broker Network receive referrals from our relocation services business in exchange for a referral fee. The Cartus Broker Network closed over 68,00071,000 properties in 2006. We derive about2007 and accounted for approximately 6% of our relocation revenue from referrals within our Cartus Broker Network.
About 5% of our relocation revenue is derived from our affinity services, which provide real estate and relocation services, including home buying and selling assistance, as well as mortgage assistance and moving services, to organizations such as insurance companies, credit unions and airline companies that have established members. Often these organizations offer our affinity services to their members at no cost and, where permitted, provide their members with a financial incentive for using these services. This service helps the organizations attract new members and retain current members. In 2006,2007, we provided personal assistance to over 69,00070,000 individuals, with approximately 29,00028,000 real estate transactions.
Title and Settlement Services
Our title and settlement services business, Title Resource Group, provides full-service title and settlement (i.e., closing and escrow) services to real estate companies and financial institutions. We act in the capacity of a title agent and sell title insurance to property buyers and mortgage lenders. We issue title insurance policies on behalf of large national underwriters and through our title insurance venture called Censtar as well as through our wholly owned underwriter, Title Resources Guaranty Company, which we acquired in January 2006. We are licensed as a title agent in 39 states and Washington, D.C., have physical locations in 2423 states and operate mostly in major metropolitan areas. As of December 31, 2006,2007, we had approximately 475420 offices, 325295 of which are co-located with one of our company owned brokerage offices.
Virtually all lenders require their borrowers to obtain title insurance policies at the time mortgage loans are made on real property. For policies issued through our agency operations, we typically are liable only for
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The terms and conditions upon which the real property will be insured are determined in accordance with the standard policies and procedures of the title underwriter. When our title agencies sell title insurance, the title search and examination function is performed by the agent. The title agent and underwriter split the premium. The amount of such premium “split” is determined by agreement between the agency and underwriter, or is promulgated by state law. We have entered into underwriting agreements with various underwriters, which state the conditions under which we may issue a title insurance policy on their behalf.
Our company owned brokerage operations are the principal source of our title and settlement services business. Other sources of our title and settlement services business include our real estate franchise business,
Cartus and PHH Corporation’s mortgage company. Over the past several years, we have increased the geographic coverage of our title and settlement services business principally through acquisitions. When we acquire a title and settlement services business, we typically retain the local brand identity of the acquired business. Our acquisition transactions are often conducted in connection with an acquisition of a brokerage company for our company owned brokerage operations. As a result, many of our offices have subleased space from, and are co-located within, our company owned brokerage offices, a strategy that meets certain regulatory requirements and has proved to be instrumental in improving our capture rates. The capture rate of our title and settlement services business was 47% in 2006.
Certain states in which we operate have “controlled business” statutes which impose limitations on affiliations between providers of title and settlement services, on the one hand, and real estate brokers, mortgage lenders and other real estate service providers, on the other hand. For example, in California, a title insurer/agent cannot rely on more than 50% of its title orders from “controlled business sources,” which is defined as sources controlled by, or which control, directly or indirectly, the title insurer/agent, which would include leads generated by our company owned brokerage business. In those states in which we operate our title and settlement services business that have “controlled business” statutes, we comply with such statutes by ensuring that we generate sufficient business from sources we do not control, including sources in which we own a minority ownership interest.
In January 2006, we completed our acquisition of American Title Company of Houston, Texas American Title Company and their related title companies based in Texas, including Dallas-based Title Resources Guaranty Company (“TRGC”), a title insurance underwriting business. TRGC is a title insurance underwriter licensed in Texas, Arizona, Colorado, Oklahoma, New Mexico, Kansas, Florida, Maryland, Massachusetts, Maine, Missouri, New Jersey, Nevada, Ohio, Pennsylvania, and Virginia. TRGC underwrites a portion of the title insurance policies issued by our agency businesses.
We also manage a national network of escrow and closing agents (some of whom are our employees, while others are attorneys in private practice) to provide full-service title and settlement services to a broad-based group that includes lenders, home buyers and sellers, developers, and real estate sales associates. Our role is generally that of an intermediary managing the completion of all the necessary documentation and services required to complete a real estate transaction.
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We intend to grow our title and settlement services business through the completion of additional acquisitions by increasing the number of title and settlement services offices that are located in or around our company owned brokerage offices and by increasing our capture rates.offices. We also intend to grow by leveraging our existing geographic coverage, scale, capabilities and reputation into new offices not directly connected with our company owned brokerage offices and through continuing to enter into contracts and ventures with our franchisees that will allow them to participate in the title and settlement services business. We also plan to expand our underwriting operations into other states.
Competition
Real Estate Franchise Business.Business. Competition among the national real estate brokerage brand franchisors to grow their franchise systems is intense. Our largest national competitors in this industry include, but are not limited to, The Prudential Real Estate Affiliates, Inc., GMAC Home Services, Inc. and, RE/MAX International, Inc. and Keller Williams. In addition, a real estate broker may choose to affiliate with a regional chain or choose not to affiliate with a franchisor but to remain independent. We believe that competition for the sale of franchises in
the real estate brokerage industry is based principally upon the perceived value and quality of the brand and services, the nature of those services offered to franchisees and the fees the franchisees must pay.
The ability of our real estate brokerage franchisees to compete is important to our prospects for growth. The ability of an individual franchisee to compete may be affected by the quality of its sales associates, the location of its office, the services provided to its sales associates, the number of competing offices in the vicinity, its affiliation with a recognized brand name, community reputation and other factors. A franchisee’s success may also be affected by general, regional and local economic conditions. The potential negative effect of these conditions on our results of operations is generally reduced by virtue of the diverse geographical locations of our franchisees. At December 31, 2006,2007, our real estate franchise systems had approximately 9,500 brokerage offices in the U.S. and approximately 15,90015,700 offices worldwide in 6688 countries and territories in North and South America, Europe, Asia, Africa and Australia.
Real Estate Brokerage Business.Business. The real estate brokerage industry is highly competitive, particularly in the metropolitan areas in which our owned brokerage businesses operate. In addition, the industry has relatively low barriers to entry for new participants, including participants pursuing non-traditional methods of marketing real estate, such as Internet-based listing services. Companies compete for sales and marketing business primarily on the basis of services offered, reputation, personal contacts, and brokerage commissions. Our company owned brokerage companies compete primarily with franchisees of local and regional real estate franchisors; franchisees of our brands and of other national real estate franchisors, such as The Prudential Real Estate Affiliates, Inc., GMAC Home Services, Inc. and, RE/MAX International, Inc.; and Home Services of America; regional independent real estate organizations, such as Weichert Realtors and Long & Foster Real Estate; discount brokerages, such as ZipRealty; and smaller niche companies competing in local areas.
Relocation Business.Business. Competition in our relocation business is based on service, quality and price. We compete with global and regional outsourced relocation services providers, human resource outsourcing companies, and international accounting firms. Human resource outsourcing companies may own or have relationships with other relocation companies. For example, Hewitt Associates, a large human resource outsourcing company, owns its own relocation company. Other human resource outsourcing companies may be seeking to acquire relocation companies or develop preferred relationships with our competitors. The larger outsourced relocation services providers that we compete with include Prudential Real Estate and Relocation Services Inc., Sirva, Inc.GMAC Global Relocation Services LLC. and Weichert Relocation Resources, Inc.
Title and Settlement Services.Services Business. The title and settlement services business is highly competitive and fragmented. The number and size of competing companies vary in the different areas in which we conduct
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Marketing and Technology
National Advertising Fund
Each of our residential brands operates a National Advertising Fund and our commercial brand operates a Commercial Marketing Fund that is funded by our franchisees and our owned real estate brokerage operations. We are the largest contributor to each of these funds, either through commitments through our contracts with our franchisees or by our agreements with our company owned real estate brokerage operations. The focus of the National Advertising Funds is as follows:
Build and Maintain Strong Consumer Brandsmaintain strong consumer brands
The primary focus of each National Advertising Fund is to build and maintain brand awareness. This isAlthough primarily accomplished through television, radio and print advertising.advertising, our Internet promotion of brand
awareness continues to increase. Our Internet presence, for the most part, features our entire listing inventory in our regional and national markets, plus community profiles, home buying and selling advice, relocation tips and mortgage financing information. Each brand manages a comprehensive system of marketing tools, systems and sales information and data that can be accessed through free standing brand intranet sites, to assist sales associates in becoming the best marketer of their listings. In addition to the Sotheby’s International Realty® brand, a leading luxury brand, our franchisees and our company owned brokerages also participate in luxury marketing programs, such as Century 21® Fine Homes & EstatesSMsm, Coldwell Banker Previews®, and ERA International Collection®.
Drive Customerscustomers to Brand Websitesbrand websites
According to NAR, 70%84% of all homebuyers used the Internet in connection with their search for a new home in 2006.2007. Our marketing and technology strategies focus on capturing this consumer and assisting in their purchase. Internet, print, radio and television advertising are used by the brands to drive consumers to their respective websites. Significant focus is placed on developing each website to create value to the real estate consumer. Each website focuses on streamlined, easy search processes for listing inventory and rich descriptive details and multiple photos to market the listing on the brand website. Additionally, each brand website serves as a national distribution point for sales associates to market themselves to consumers to enhance the customer experience.
Proprietary Technology
In addition to the websites, each brand focuses on technology initiatives that increase value to the customer and the franchisee. Beginning in 2005, we began rollingrolled out SearchRouter and LeadRouter. The two technologies complement each other and serve to drive traffic backleads to our franchisees and our company owned real estate brokerage operations. SearchRouter is a proprietary technology (although portions of it are licensed from third parties) that passes the search criteria from one of our national websites to local franchisees’ websites, thereby delivering all local listings from all real estate companies in a particular area. The second proprietary system, LeadRouter, for which a U.S. patent application is currently pending, works with each brand’s national website and other websites as selected by the franchise to deliver Internet consumer leads directly to a sales associate’s cellular phone in real time, which dramatically increases the sales associate’s response rate and response time to the consumer.
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Our company owned real estate brokerage business markets our real estate services and specific real estate listings primarily through individual property signage, the Internet, and by hosting open houses of our listings for potential buyers to view in person during an appointed time period. In addition, contacts and communication with other real estate sales associates, targeted direct mailings, and local print media, including newspapers and real estate publications, are effective for certain price points and geographical locations. Television (spot cable commercials), radio 10-second spots in select markets, and“out-of-home” “out-of-home” (i.e., billboards, train station posters) advertisements are also included in many of our companies’ marketing strategies.
Our sales associates at times choose to supplement our marketing with specialized programs they fund on their own. We provide our sales associates with promotional templates and materials which may be customized for this opportunity.
In addition to our Sotheby’s International Realty® offices, we also participate in luxury marketing programs established by our franchisors, such as Coldwell Banker Previews® and the ERA International Collection®. The programs provide special services for buyers and sellers of luxury homes, with attached logos to differentiate the properties. Our sales associates are offered the opportunity to receive specific training and certification in their respective luxury properties marketing program. Properties listed in the program are highlighted through specific:
signage displaying the appropriate logo;
features in the appropriate section on the company Internet site;
targeted mailings to prospective purchasers using specific mailing lists; and
collateral marketing material, magazines and brochures highlighting the property.
The utilization of information technology as a marketing tool has become increasingly effective in our industry, and we believe that trend will continue to increase. Accordingly, we have sought to become a leader among residential real estate brokerage firms in the use and application of technology. The key features of our approach are as follows:
The integration of our information systems with multiple listing services to:
provide property information on a substantial number of listings, including those of our competitors when possible to do so;
integrate with our systems to provide current data for other proprietary technology within NRT, such as contact management technology.
The placement of our company listings on multiple websites, including:
our NRT operating companies’ local websites;
the appropriate company website(s) (coldwellbanker.com, era.com, sothebysrealty.com and corcoran.com);
Openhouse.com, Realogy’s multi-branded website designed specifically for promoting open houses;
Realtor.com, the official website of NAR; and
real estate websites operated by Google, Yahoo, HGTV, Trulia, Zillow and others.
The majority of these websites provide the opportunity for the customer to utilize different features, allowing them to investigate community information, view property information and print feature sheets on those properties, receive on-line updates, obtain mapping and property tours for open houses, qualify for financing, review the qualifications of our sales associates, receive home buying and selling tips, and view information on our local sales offices. The process usually begins with the browsing consumer providing
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Most importantly, the browsing customer has the ability to contact us regarding their particular interest and receive a rapid response through our proprietary LeadRouter system. Through this program, Internet queries are converted from text to voice and transferred electronically to our sales associates within a matter of seconds, enabling the consumer to receive the information they desire, including an appointment with our sales associate in a timely manner.
Our sales associates have the ability to access professional support and information through various extranet sites in order to perform their tasks more efficiently. An example of this is the nationwide availability of a current “Do Not Call List” to assist them in the proper telemarketing of their services.
Employees
At December 31, 2006,2007, we had approximately 14,60013,400 employees, including approximately 450565 employees outside of the U.S. None of our employees are subject to collective bargaining agreements governing their employment with us. We believe that our employee relations are good.
Sales Associate Recruiting and Training
Each real estate franchise system encourages, and provides some assistance and training with respect to, sales associate recruiting by franchisees. Each system separately develops its own branded recruiting programs that are tailored to the needs of its franchisees.
We encourage our franchisees to recruit sales associates by selectively offering forgivable financing arrangements to franchisees that add sales associates in the early stages of their franchise relationship with us. We typically present these opportunities to unaffiliated brokerages upon conversion to a franchise and when existing franchisees open offices in new markets. For example, a new franchisee may be granted 60 days from the date its brokerage is opened and operating as a franchised business to recruit sales associates in order to increase the opportunity for additional gross revenue that is used as the basis for determining the amount of the forgivable financing arrangement. We will only provide incentives on additional gross commission income from sales associates who were not previously associated with one of our other franchise systems during the past six months.
Each real estate brand provides training and marketing-related materials to its franchisees to assist them in the recruiting process. While we never participate in the selection, interviewing, hiring or termination of franchisee sales associates (and do not provide any advice regarding the structure of the employment or contractor relationship), the common goal of each program is to provide the broker with the information and techniques to help the broker grow their business through sales associate recruitment.
Each system’s recruiting program contains different materials and delivery methods. The marketing materials range from a detailed description of the services offered by our franchise system (which will be available to the sales associate) in brochure or poster format to audio tape lectures from industry experts. Live instructors at conventions and orientation seminars deliver some recruiting modules while other modules can be viewed by brokers anywhere in the world through virtual classrooms over the Internet. Most of the programs and materials are then made available in electronic form to franchisees over the respective system’s private intranet site. Many of the materials are customizable to allow franchisees to achieve a personalized look and feel and make modifications to certain content as appropriate for their business and marketplace.
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Franchise Regulation. The sale of franchises is regulated by various state laws, as well as by the Federal Trade Commission (the “FTC”).FTC. The FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration or disclosure in connection with franchise offers and sales. In addition, several states have “franchise relationship laws” or “business opportunity laws” that limit the ability of the franchisor to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. The states with relationship or other statutes governing the termination of franchises include Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, Virginia, Washington, and Wisconsin. Puerto Rico and the Virgin Islands also have statutes governing termination of franchises. Some franchise relationship statutes require a mandated notice period for termination; some require a notice and cure period. In addition, some require that the franchisor demonstrate good cause for termination. These statutes do not have a substantial effect on our operations because our franchise agreements generally comport with the statutory requirements for cause for termination, and they provide notice and cure periods for most defaults. Where the franchisee is granted a statutory period longer than permitted under the franchise agreement, we extend our noticeand/or cure periods to match the statutory requirements. Failure to comply with these laws could result in civil liability to any affected franchisees. While our franchising operations have not been materially adversely affected by such existing regulation, we cannot predict the effect of any future federal or state legislation or regulation. We may engage in certain lending transactions common in residential real estate franchising and provide loans to franchisees as part of the sale of the franchise.
Real Estate Regulation. The federal Real Estate Settlement Procedures Act (“RESPA”)RESPA and state real estate brokerage laws restrict payments which real estate brokers, title agencies, mortgage brokers and other settlement service providers may receive or pay in connection with the sales of residences and referral of settlement services (e.g., mortgages, homeowners insurance and title insurance). Such laws may to some extent restrict preferred alliance and other arrangements involving our real estate franchise, real estate brokerage, settlement services and relocation businesses. Currently, several states prohibit the sharing of referral fees with a principal to a transaction. In addition, with respect to our company owned real estate brokerage, relocation and title and settlement services businesses, RESPA and similar state laws require timely disclosure of certain relationships or financial interests with providers of real estate settlement services.
On March 14, 2008, the Department of Housing and Urban Development (“HUD”) proposed a new rule intended to simplify and improve the disclosure requirements for mortgage settlement costs under the RESPA. The proposed revisions seek to reduce the overall cost of settlement services to consumers by taking steps to: standardize the Good Faith Estimate (GFE) form; require on page one of the GFE a clear summary of the loan terms and total settlement charges; require more accurate estimates of costs of settlement services shown on the GFE; improve disclosure of yield spread premiums to help borrowers: establish tolerance levels for certain categories of fees and facilitate a comparison of the GFE and the HUD-FHUD-1A Settlement Statements (HUD-1 settlement statement or HUD-1) to measure those tolerances; ensure that at settlement borrowers are made aware of final loan terms and settlement costs, clarify HUD’s current regulations concerning discounts; and expressly state when RESPA permits certain pricing mechanisms that benefit consumers, including average cost pricing and discounts, including volume based discounts. HUD is currently soliciting comments on the proposed rulemaking and it is too early in the process to determine the effect that the rule, if enacted in its current form, would have on our operations.
Our company owned real estate brokerage business is also subject to numerous federal, state and local laws and regulations that contain general standards for and prohibitions on the conduct of real estate brokers and sales associates, including those relating to licensing of brokers and sales associates, fiduciary and agency duties, administration of trust funds, collection of commissions and advertising and consumer disclosures. Under state law, our real estate brokers have the duty to supervise and are responsible for the conduct of their brokerage businesses.
Regulation of Title Insurance and Settlement Services.Services. Many states license and regulate title agencies/settlement service providers or certain employees and underwriters through their Departments of Insurance or other regulatory body. In many states, title insurance rates are either promulgated by the state or are required to be filed with each state by the agent or underwriter, and some states promulgate the split of title insurance premiums between the agent and underwriter. States sometimes unilaterally lower the insurance rates relative to loss experience and other relevant factors. States also require title agencies and title underwriters to meet certain minimum financial requirements for net worth and working capital. In addition, each of our insurance underwriters is subject to a holding company act in its state of domicile, which regulates, among other matters, investment policies and the ability to pay dividends.
Certain states in which we operate have “controlled business” statutes which impose limitations on affiliations between providers of title and settlement services, on the one hand, and real estate brokers, mortgage lenders and other real estate service providers, on the other hand. We are aware of 23 states (Alaska, Arizona, California, Colorado, Connecticut, Hawaii, Idaho, Indiana, Kansas, Kentucky, Louisiana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, Oregon, Tennessee, Utah, Vermont, West Virginia, Wisconsin and Wyoming) that have enacted some form of “controlled business” statute. “Controlled business”
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| Item 1A. | |
You should carefully consider each of the following risk factors and all of the other information set forth in this report.Annual Report. The risk factors generally have been separated into three groups: (i) risks relating to the merger agreement with Apollo affiliates, (ii)(1) risks relating to our businessindebtedness; (2) risks relating to our business; and (iii)(3) risks relating to our separation from Cendant. Based on the information currently known to us, we believe that the following information identifies the most significant risk factors affecting our company. However, the risks and uncertainties are not limited to those set forth in the risk factors described below. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.
Risks Relatingrelating to our indebtedness
Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under the notes.
We are significantly leveraged. As of December 31, 2007, our total long-term debt (including current portion) was approximately $6,239 million (which does not include $525 million of letters of credit issued under our synthetic letter of credit facility and $37 million of outstanding letters of credit). In addition, as of December 31, 2007, our current liabilities included $1,014 million of securitization obligations which were collateralized by $1,300 million of securitization assets that are not available to pay our general obligations. Moreover, under the senior toggle notes, we have the option to elect to pay interest in the form of PIK interest through October 15, 2011. In addition, a substantial portion of our indebtedness bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. In the event we make a PIK interest election or short-term prevailing interest rates increase, our debt will increase.
Our substantial degree of leverage could have important consequences, including the following:
it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, business development, debt service requirements, acquisitions or general corporate or other purposes;
a substantial portion of our cash flows from operations is dedicated to the Merger Agreement with Apollo Affiliatespayment of principal and interest on our indebtedness and is not available for other purposes, including our operations, capital expenditures and future business opportunities;
the debt service requirements of our other indebtedness could make it more difficult for us to completesatisfy our financial obligations under the proposed merger could negatively affect us.
certain of Apollo. There is no assurance that the merger agreement and the merger will be approved by our stockholders, and there is no assurance that the other conditionsborrowings, including borrowings under our senior secured credit facility, are at variable rates of interest, exposing us to the completionrisk of the merger will be satisfied. In connection with the merger, we will be subjectincreased interest rates;
it may limit our ability to several risks, including the following:
25adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt;
we may be vulnerable to a downturn in general economic conditions or in our borrowing costsbusiness, or we may be unable to carry out capital spending that is important to our growth.
Restrictive covenants under our indentures and the senior secured credit facility may restrictadversely affect our accessoperations.
Our senior secured credit facility and the indentures governing the notes contain, and any future indebtedness we incur may contain, various covenants that limit our ability to, capital markets.among other things:
incur or guarantee additional debt;
incur debt that is junior to senior unsecured notes were rated BBBindebtedness and Baa3 by Standard & Poor’s (“S&P”) and Moody’s, respectively, with a negative outlook. Under the terms of these notes, if the rating from Moody’s applicablesenior to the notessenior subordinated notes;
pay dividends or make distributions to our stockholders;
repurchase or redeem capital stock or subordinated indebtedness;
make loans, capital expenditures or investments or acquisitions;
incur restrictions on the ability of certain of our subsidiaries to pay dividends or to make other payments to us;
enter into transactions with affiliates;
create liens;
merge or consolidate with other companies or transfer all or substantially all of our assets;
transfer or sell assets, including capital stock of subsidiaries; and
prepay, redeem or repurchase debt that is decreased to non-investment grade to a ratingjunior in right of Ba1 or belowor if the rating from S&P applicablepayment to the notes is decreased to a rating of BB+ or below, the interest rate will be increased by 0.25% per rating level up to a maximum increase of 2.00%, retroactive to the beginning of the current respective interest period. On March 1, 2007, S&P downgraded the rating on these notes to BB+ from BBB and these notes remain on CreditWatch subject to negative implications. As a result, the interest rate on each of the three series of these notes increased by 0.25% retroactive to the beginning of the current respective interest periods.notes.
As a result of these covenants, we are limited in the increasedmanner in which we conduct our business and we may be unable to engage in favorable business activities or finance future operations or capital needs. In addition, the restrictive covenants in our senior secured credit facility will require us to maintain a specified senior secured leverage ratio. A breach of any of these covenants or any of the other restrictive covenants would result in a default under our senior secured credit facility. Upon the occurrence of an event of default under our senior secured credit facility, the lenders:
will not be required to lend any additional amounts to us;
could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable;
could require us to apply all of our available cash to repay these borrowings; or
could prevent us from making payments on the senior subordinated notes;
any of which could result in an event of default under the notes and our Securitization Facilities.
If we were unable to repay those amounts, the lenders under our senior secured credit facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral under our senior secured credit facility. If the lenders under our senior secured credit facility accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay our senior secured credit facility and our other indebtedness, including the notes, or borrow sufficient funds to refinance such indebtedness. Even if we are able to obtain new financing, it may not be on commercially reasonable terms, or terms that are expectedacceptable to us.
If a material event of default is continuing under our senior secured credit facility, such event could cause a termination of our ability to obtain future advances under and amortization of one or more of the Securitization Facilities.
Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Certain of our borrowings, primarily borrowings under our senior secured credit facility and our securitization obligations under our Securitization Facilities, are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income would decrease. Although we have entered into interest rate swaps, involving the exchange of floating for fixed rate interest payments, to reduce interest rate volatility for a portion of our floating interest rate debt facilities, we cannot assure you such interest rate swaps will eliminate interest rate volatility in its entirety.
Our ability to service our debt and meet our cash requirements depends on many factors, some of which are beyond our control.
Although there can be incurredno assurances, we believe that the level of borrowings available to consummateus, combined with cash provided by our operations, will be sufficient to provide for our cash requirements for the merger (orforeseeable future. However, our ability to satisfy our obligations will depend on our future operating performance and financial results, which will be subject, in part, to factors beyond our control, including interest rates and general economic, financial and business conditions. If we are unable to generate sufficient cash flow to service our debt, we may be required to:
refinance all or a portion of our debt;
obtain additional financing;
restructure our operations;
sell some of our assets or operations;
reduce or delay capital expenditures and/or acquisitions; or
revise or delay our strategic plans.
If we are required to take any of these actions, it could have a material adverse effect on our business, financial condition and results of operations. In addition, we may be unable to take any of these actions, these actions may not enable us to continue to satisfy our capital requirements or may not be permitted under the terms of our various debt instruments, including our senior secured credit facility and the indentures governing the notes. In addition, our senior secured credit facility and the indentures governing the notes will restrict our ability to sell assets and to use the proceeds from the sales. Moreover, borrowings under our senior secured credit facility are secured by substantially all of our assets and those of most of our subsidiaries. We may not be able to sell assets quickly enough or for sufficient amounts to enable us to meet our debt obligations. Furthermore, Apollo, its co-investors and their respective affiliates have no continuing obligation to provide us with debt or equity financing following the Transactions.
We are a holding company and are dependent on dividends and other distributions from our subsidiaries.
Realogy is a holding company with limited direct operations. Our principal assets are the equity interests that we hold in our operating subsidiaries. As a result, we are dependent on dividends and other distributions from our subsidiaries to generate the funds necessary to meet our financial obligations, including the payment of principal and interest on our outstanding debt. Our subsidiaries may not generate sufficient cash from operations to enable us to make principal and interest payments on our indebtedness. In addition, any payment of dividends, distributions, loans or advances to us by our subsidiaries could be subject to restrictions on dividends or repatriation of earnings under applicable local law and monetary transfer restrictions in the jurisdictions in which our subsidiaries operate. In addition, payments to us by our subsidiaries will be contingent upon our subsidiaries’ earnings. Our subsidiaries are permitted under the terms of our indebtedness, including the indentures governing the notes, to incur additional indebtedness that may restrict payments from those subsidiaries to us. We cannot assure you that agreements governing current and future indebtedness of our subsidiaries will permit those subsidiaries to provide us with sufficient cash to fund our debt service payments.
We are controlled by Apollo who will be able to make important decisions about our business and capital structure; their interests may differ from the interests of the holders of our notes and our lenders under our senior secured credit facility.
Substantially all of the common stock of Holdings is beneficially owned by Apollo. As a result, Apollo controls us and has the power to elect all of the members of our board of directors, appoint new management and approve any action requiring the approval of the holders of Holdings’ stock, including approving acquisitions or
sales of all or substantially all of our assets. The directors elected by Apollo have the ability to control decisions affecting our capital structure, including the issuance of additional capital stock, the implementation of stock repurchase programs and the declaration of dividends. The interests of our equity holders may not in all cases be aligned with the interest of the holders of our notes or any other holder of our debt. If we encounter financial difficulties, or we are unable to pay our debts as they mature, the interests of our equity holders might conflict with those of the holders of the notes or any other holder of our debt. In that situation, for example, the holders of the notes might want us to raise additional equity from our equity holders or other investors to reduce our leverage and pay our debts, while our equity holders might not want to increase their investment in us or have their ownership diluted and instead choose to take other actions, such as selling our assets. Our equity holders may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks as a holder of the notes or other indebtedness. Additionally, Apollo is in the business of investing in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us or that may be our customers or suppliers. Apollo may also pursue acquisition opportunities that may be complementary to our business and, as a result, of national and/or global economic and political events aside from the merger), it is possible that the rating agenciesthose acquisition opportunities may further downgrade our debt ratings, which would increase our borrowing costs and therefore could adversely affect our financial results. In addition, it is possible that the rating agencies may downgrade our ratings based upon our results of operations and financial condition. If S&P further downgrades the debt rating applicablenot be available to the existing senior unsecured notes, or Moody’s downgrades the debt rating on those notesus. So long as Apollo continues to below investment grade, the interest rate on those senior notes will be further increased up toown a maximum 2.00% increase from their initial interest rate, depending on the extent the ratings are downgraded, as set forth in the existing notes. On March 1, 2007, S&P indicated that if these notes remain a permanent piecesignificant amount of the Company’s capital structure followingequity of Holdings, even if such amount is less than 50%, Apollo will continue to be able to strongly influence or effectively control our decisions. Because our equity securities are not registered under the pending merger with affiliates of Apollo, the ratingsExchange Act and are not listed on these notes would be further downgradedany U.S. securities exchange, we are not subject to BB. On March 2, 2007, Moody’s indicated that if the pending merger is approved by the Company’s stockholders, Moody’s will lower the ratings on these notes to Ba3. Accordingly, if these downgrades are issued, the interest rate on eachany of the three series of notes will be increased 1.25% from their initial interest rate (or an additional 100 basis points from the current interest rate) retroactive to the beginning of the then current respective interest period. Any downgrade by either rating agency on our current or future senior unsecured notes, whether or not below investment grade, could increase the pricingcorporate governance requirements of any amounts drawn underU.S. securities exchanges.
Risks relating to our syndicated bank credit facilities - namely, the spread to LIBOR increases as our ratings from either S&P or Moody’s decreases. A downgrade in our credit rating below investment grade could also result in an increase in the amount of collateral required by our letters of credit. A downgrade in our senior unsecured rating below BB- from S&P or below Ba3 from Moody’s would trigger a default for our Apple Ridge Funding LLC secured facility. A security rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.
If the merger is consummated, our ability to access the debt and equity markets may be materially impacted by the debt which is expected to be incurred to finance the merger.
Our business and operations are sensitive to general business and economic conditions in the U.S. and worldwide. These conditions include short-term and long-term interest rates, inflation, fluctuations in debt and equity capital markets and the general condition of the U.S. and world economy.
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Our business is significantly affected by the monetary policies of the federal government and its agencies. We are particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the U.S. The Federal Reserve Board’s policies affect the real estate market through their effect on interest rates as well as the pricing on our interest-earning assets and the cost of our interest-bearing liabilities. We are affected by the currentany rising interest rate environment. As mortgage rates rise, the number of homesale transactions may decrease as potential home sellers choose to stay with their lower cost mortgage rather than sell their home and pay a higher cost mortgage and potential home buyers choose to rent rather than pay higher mortgage rates. In addition,As a consequence, the growth in home prices may slow as the demand for homes decreases and homes become less affordable. Changes in thesethe Federal Reserve Board’s policies, the interest rate environment and mortgage market are beyond our control, are difficult to predict and could have a material adverse effect on our business, results of operations and financial condition.
A declineWe are negatively impacted by a downturn in the number of homesalesand/or prices could adversely affect our revenues and profitability.residential real estate market.
The residential real estate market tends to be cyclical and typically is affected by changes in general economic conditions which are beyond our control. The U.S. residential real estate industry is in a significant
downturn due to various factors including downward pressure on housing prices, credit constraints inhibiting buyers, an exceptionally large inventory of unsold homes at the same time that sales volumes are decreasing and a decrease in consumer confidence, which accelerated in the second half of 2007. As a result, our operating results in 2007 were adversely affected compared to our operating results in 2006, which in turn were significantly worse than our operating results in 2005. We cannot predict whether the downturn will worsen or when the market and related economic forces will return the U.S. residential real estate industry to a growth period.
Any of the following could continue to have a material adverse effect on our business by causing a more significant general decline in the number of homesalesand/or prices which, in turn, could adversely affect our revenues and profitability:
periods of economic slowdown or recession; | ||
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rising interest rates;
rising unemployment;
the general availability of mortgage financing, including:
the impact of the recent contraction in the subprime and mortgage markets generally; and
the effect of more stringent lending standards for home mortgages;
adverse changes in local or regional economic conditions;
a decrease in the affordability of homes;
local, state and federal government regulation;
shifts in populations away from the markets that we or our franchisees serve;
tax law changes, including potential limits or elimination of the deductibility of certain mortgage interest expense, the application of the alternative minimum tax, real property taxes and employee relocation expenses;
decreasing home ownership rates;
declining demand for real estate;
a negative perception of the market for residential real estate;
commission pressure from brokers who discount their commissions;
acts of God, such as hurricanes, earthquakes and other natural disasters; and/or
an increase in the cost of homeowners insurance.
A decline in the number of homesales and/or prices could adversely affect our revenues and profitability.
During the first half of this decade, based on information published by NAR, existing homesales volumes rose to their highest levels in history. That growth rate reversed in 2006 and FNMA and NAR both reported a 9% decrease in the number of existing homesale sides during 2006 compared to 2005. FNMA and NAR, as of March 2008, both reported a decline of 13% in existing homesale sides for 2007 compared to 2006. Our recent financial results confirm this trend as evidenced by homesale side declines in our Real Estate Franchise Services and Company Owned Real Estate Brokerage Services businesses. For 2007, our Real Estate Franchise Services and Company Owned Real Estate Brokerage Services segments experienced closed homesale side decreases of 19% and 17%, respectively, compared to 2006.
Based upon information published by NAR, the national median price of existing homes increased from 2000 to 2005 at a compound annual growth rate, or CAGR, of 8.9% compared to a CAGR of 6.2% from 1972 to 2007. According to NAR, the rate of increase of median homesale price of existing homes slowed significantly in
2006 to 1% and turned negative in 2007 to a 1% decrease. This decrease is the first such decline in more than 50 years. For 2008 compared to 2007, FNMA and NAR, as of March 2008, are forecasting a decrease in the median price of existing homes of 6% and 1%, respectively.
The depth and length of the current downturn in the real estate industry has proved exceedingly difficult to predict. FNMA and NAR, as of March 2008, reported a decline in existing homesales of 13% for 2007 compared to 2006 and forecast a decline of 21% and 5%, respectively for 2008 compared to 2007. By contrast to the current forecasts of FNMA and NAR, in March 2007, FNMA and NAR had forecast an 8% decrease and 1% decrease, respectively, in existing homesales for 2007 compared to 2006 and a 1% and 4% increase, respectively, in existing homesales for 2008 compared to 2007.
A sustained decline in existing homesales, any resulting sustained decline in home prices or a sustained or accelerated decline in commission rates charged by brokers, could further adversely affect our results of operations by reducing the royalties we receive from our franchisees and company owned brokerages, reducing the commissions our company owned brokerage operations earn, reducing the demand for our title and settlement services, reducing the referral fees earned by our relocation services business and increasing the risk that our relocation services business will continue to suffer losses in the sale of homes relating to its “at risk” homesale service contracts (i.e., where we purchase the transferring employee’s home and assume the risk of loss in the resale of such home). For example, in 2006,for 2007, a 100 basis point (or 1%) decline in either our homesale sides or the average selling price of closed homesale transactions, with all else being equal, would have decreased EBITDA by $4 million for our Real Estate Franchise Services segment and $15$14 million for our Company Owned Real Estate Brokerage Services segment.
Competition in the residential real estate and relocation business is intense and may adversely affect our financial performance.
Competition in the residential real estate services business is intense. As a real estate brokerage franchisor, our products are our brand names and the support services we provide to our franchisees. Competition among national brand franchisors in the real estate brokerage industry to grow their franchise systems is intense. Upon the expiration of a franchise agreement, a franchisee may choose to franchise with one of our competitors or operate as an independent broker. Competitors may offer franchisees whose franchise agreements are expiring similar products and services at rates that are lower than we charge. Our largest national competitors in this industry include Prudential, GMAC Real Estate, RE/MAX and RE/MAXKeller Williams real estate brokerage brands. Some of these companies may have greater financial resources than we do, including greater marketing and technology budgets. Regional and local franchisors provide additional competitive pressure in certain areas. We believe that competition for the sale of franchises is based principally upon the perceived value and quality of the brand and services, the nature of those services offered to franchisees and the fees the franchisees must pay. To remain competitive in the sale of franchises and to retain our existing franchisees, we may have to reduce the fees we charge our franchisees to be competitive with those charged by competitors, which may accelerate if market conditions deteriorate. Our franchisees are generally in intense competition with franchisees of other systems and independent real estate brokers. Our revenue will vary directly with our franchisees’ revenue, but is not directly dependent upon our franchisees’ profitability. If competition results in lower average brokerage commission rates or lower sales volume by our franchisees, our revenues will be affected adversely.
Our company owned brokerage business, like that of our franchisees, is generally in intense competition with franchisees of other systems, independent real estate brokerages, including discount brokers, owner-operated chains and, in certain markets, our franchisees. We face competition from large regional brokerage firms as well as local brokerage firms, but such competition is limited to the markets in which such competitors operate. Competition is particularly severe in the densely populated metropolitan areas in which we compete. In addition, the real estate brokerage industry has minimal barriers to entry for new participants, including
participants pursuing non-traditional methods of marketing real estate, such as Internet-based
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In our relocation services business, we compete with in house operations, global and regional outsourced relocation service providers, human resource outsourcing companies and international accounting firms. These human resource outsourcing companies may own or have relationships with other relocation companies. For example, Hewitt Associates, a large human resource outsourcing company, owns its own relocation company. Other human resource outsourcing companies may be seeking to acquire relocation companies or develop preferred relationships with one of our competitors. The larger outsourced relocation service providers that we compete with include Prudential Real Estate and Relocation Services, Inc., Sirva, Inc. and Weichert Relocation Resources, Inc.
The title and settlement services industry is highly competitive and fragmented. The number and size of competing companies vary in the different areas in which we conduct business. We compete directly with title insurers, title agents and other vendor management companies. While we are an agent for some of the large title insurers, we also compete with the owned agency operations of these insurers. Competition among underwriters of title insurance policies is much less fragmented, although also very intense.
Several of our businesses are highly regulated and any failure to comply with such regulations or any changes in such regulations could adversely affect our business.
Several of our businesses are highly regulated. The sale of franchises is regulated by various state laws as well as by the FTC.Federal Trade Commission (the “FTC”). The FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration or disclosure in connection with franchise offers and sales. In addition, several states have “franchise relationship laws” or “business opportunity laws” that limit the ability of franchisors to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While we believe that our franchising operations are in compliance with such existing regulations, we cannot predict the effect any existing or future legislation or regulation may have on our business operation or financial condition.
Our real estate brokerage business must comply with the requirements governing the licensing and conduct of real estate brokerage and brokerage-related businesses in the jurisdictions in which we do business. These laws and regulations contain general standards for and prohibitions on the conduct of real estate brokers and sales associates, including those relating to licensing of brokers and sales associates, fiduciary and agency duties, administration of trust funds, collection of commissions, advertising and consumer disclosures. Under state law, our real estate brokers have the duty to supervise and are responsible for the conduct of their brokerage business.
Several of the litigation matters described in this report allege claims based upon breaches of fiduciary duties by our licensed brokers and violations of unlawful state laws relating to business practices or consumer disclosures (e.g. the Grady and Berger matters). We cannot predict with certainty the cost of defense or the ultimate outcome of these or other litigation matters filed by or against us, including remedies or awards, and adverse results in any such litigation may harm our business and financial condition.
Our company owned real estate brokerage business, our relocation business, our title and settlement service business and the businesses of our franchisees (excluding commercial brokerage transactions) must comply with the RESPA. RESPA and comparable state statutes, among other things, restrict payments which real estate brokers, agents and other settlement service providers may receive for the referral of business to other settlement service providers in connection with the closing of real estate transactions. Such laws may to some extent restrict preferred vendor arrangements involving our franchisees and our company owned brokerage business.
Additionally, as noted above, our title and settlement services and relocation businesses must comply with RESPA and similar state insurance and other laws. RESPA and similar state laws require timely disclosure of certain relationships or financial interests that a broker has with providers of real estate settlement services.
There is a risk that we could be adversely affected by current laws, regulations or interpretations or that more restrictive laws, regulations or interpretations will be adopted in the future that could make compliance more difficult or expensive. There is also a risk that a change in current laws could adversely affect our
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In April 2007, the FTC and Justice Department issued a report on competition in the real estate brokerage industry and concluded that while the industry has undergone substantial changes in recent years, particularly with the increasing use of the Internet, competition has been hindered as a result of actions taken by some real estate brokers, acting through multiple listing services and NAR, state legislatures, and real estate commissions, and recommend, among other things, that the agencies should continue to monitor the cooperative conduct of private associations of real estate brokers, and bring enforcement actions in appropriate circumstances.
In 2002, Senator Charles Grassley (R-Iowa) began an inquiry into government agency spending on employee relocation programs. His concerns were prompted by several high profile, high cost government employee relocations. The Senator’s focus has beenwas on relocation data management, relocation oversight, policy design and cost containment by the U.S. General Services Administration and the U.S. Office of Management and Budget. As one of the seven larger relocation service providers to the U.S. government, Cartus our relocation services subsidiary, has been active in providing Senator Grassley’s staff with information and data on government relocation spending and meeting with the Senator and his staff. Cartus has beenwas actively represented on the Government-wide Relocation Advisory Board (the “Advisory Board”), which was established to provide constructive solutions to the U.S. General Services Administration. The Advisory Board recently issued its recommendations which are currentlyremain under consideration by the U.S. General Services Administration, the Office of Management and Budget and the U.S. Office of Personnel Management. Any possible financial impact on Cartus of Senator Grassley’s inquiry is not yet clear. Further, itIt is not clear whether some or all of the Advisory Board recommendations will be adopted, and what, if any, financial impact they will have on Cartus.
In addition, regulatory authorities have relatively broad discretion to grant, renew and revoke licenses and approvals and to implement regulations. Accordingly, such regulatory authorities could prevent or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us if our practices were found not to comply with the then current regulatory or licensing requirements or any interpretation of such requirements by the regulatory authority. Our failure to comply with any of these requirements or interpretations could have a material adverse effect on our operations.
Our title and settlement services and relocation businesses are also subject to various federal, state and local governmental statutes and regulations, including RESPA. In particular, our title insurance business is subject to regulation by insurance and other regulatory authorities in each state in which we provide title insurance. State regulations may impede or impose burdensome conditions on our ability to take actions that we may want to take to enhance our operating results. In addition, RESPA and comparable state statutes restrict payments which title and settlement services companies and relocation services companies may receive in connection with their services. We cannot assure you that future legislative or regulatory changes will not adversely affect our business operations.
We are also, to a lesser extent, subject to various other rules and regulations such as:
the Gramm-Leach-Bliley Act which governs the disclosure and safeguarding of consumer financial information; | ||
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various state and federal privacy laws;
the USA PATRIOT Act;
restrictions on transactions with persons on the Specially Designated Nationals and Blocked Persons list promulgated by the Office of Foreign Assets Control of the Department of the Treasury;
federal and state “Do Not Call” and “Do Not Fax” laws;
“controlled business” statutes, which impose limitations on affiliations between providers of title and settlement services, on the one hand, and real estate brokers, mortgage lenders and other real estate providers, on the other hand;
the Fair Housing Act; and
laws and regulations in jurisdictions outside the United States in which we do business.
Our failure to comply with any of the foregoing laws and regulations may subject us to fines, penalties, injunctionsand/or potential criminal violations. Any changes to these laws or regulations or any new laws or regulations may make it more difficult for us to operate our business and may have a material adverse effect on our operations.
Seasonal fluctuations in the residential real estate brokerage and relocation businesses could adversely affect our business.
The residential real estate brokerage business is subject to seasonal fluctuations. Historically, real estate brokerage revenues and relocation revenues have been strongest in the second and third quarters of the calendar year. However, many of our expenses, such as rent and personnel, are fixed and cannot be reduced during a seasonal slowdown. As a result, we may be required to borrow in order to fund operations during seasonal slowdowns or at other times. Since the terms of our indebtedness may restrict our ability to incur additional debt, we cannot assure you that we would be able to borrow sufficient amounts. Our inability to finance our funding needs during a seasonal slowdown or at other times would have a material adverse effect on us.
Our brokerage operations are concentrated in metropolitan areas which could subject us to local and regional economic conditions that could differ materially from prevailing conditions in other parts of the country.
Our subsidiary, NRT, owns real estate brokerage offices located in and around large metropolitan areas in the U.S. Local and regional economic conditions in these locations could differ materially from prevailing conditions in other parts of the country. NRT has more offices and realizes more of its revenues in California, Florida and the New York metropolitan area than any other regions of the country. In 2006,2007, NRT realized approximately 58%61% of its revenues including revenues related to Sotheby’s International Realty®, from California (27%), Florida (10%) and the New York metropolitan area (21%(25%) and Florida (9%). Including acquisitions, NRT experienced a 17% decline in the number of homesale transactions during 2006,2007, which we believe is reflective of industry trends, especially in Florida, California and Floridathe New York metropolitan area where NRT experienced homesale transaction declines of 41%22%, 15% and 26%4%, respectively, during that period.2007. A continued downturn in residential real estate demand or economic conditions in these regions could result in a further decline in NRT’s total gross commission income and have a material adverse effect on us. In addition, given the significant geographic overlap of our title and settlement services business with our company owned brokerage offices, such regional declines affecting our company owned brokerage operations could have an adverse effect on our title and settlement services business as well.
During 2006, 2005, and 2004 we2007, the Company as a whole generated 24%, 27%21% and 27%8%, respectively, of our consolidatedits net revenues from transactions in California.California, the New York metropolitan area and Florida. A continued downturn in residential real estate demand or economic conditions in Californiathese states could result in a decline in our overall revenues and have a material adverse effect on us.
The pro forma combined financial information in this Annual Report may not be reflective of our operating results following the Transactions and we may be unable to achieve anticipated cost savings and other benefits.
The pro forma combined financial information included in this Annual Report is derived from our historical consolidated statement of operations. The preparation of this pro forma information is based on certain assumptions and estimates. This combined pro forma information may not necessarily reflect what our results of operations would have been had the Transactions occurred on January 1, 2007 or what our results of operations will be in the future. We cannot assure you that the anticipated cost savings or other benefits will be achieved. If our cost savings or the impact of other benefits are less than our estimates or our cost savings initiatives adversely affect our operations or cost more or take longer to implement than we project, our results will be less than we anticipate and the savings or other benefits we projected may not be fully realized.
Changes in accounting standards, subjective assumptions and estimates used by management related to complex accounting matters could have an adverse effect on results of operations.
Generally accepted accounting principles in the United States and related accounting pronouncements, implementation guidance and interpretations with regard to a wide range of matters, such as stock-based compensation, valuation reserves, income taxes and fair value accounting are highly complex and involve many subjective assumptions, estimates and judgments by management. Changes in these rules or their interpretations or changes in underlying assumptions, estimates or judgments by management could significantly change reported results.
We may not have the ability to complete future acquisitions.acquisitions; we may not be successful in developing the Better Homes and Gardens Real Estate brand.
We have pursued an active acquisition strategy as a means of strengthening our businesses and have sought to integrate acquisitions into our operations to achieve economies of scale. Our company owned brokerage business has completed more than 300343 acquisitions since its formation in 1997 and, in 2004, we acquired the Sotheby’s International Realty® residential brokerage business and entered into an exclusive license agreement for the rights to the Sotheby’s International Realty® trademarks with which we are in the process of building the Sotheby’s International Realty® franchise system. In January 2006, we acquired our title insurance underwriter and certain title agencies. As a result of these and other acquisitions, we have derived a substantial portion of our growth in revenues and net income from acquired businesses. The success of our future acquisition strategy will continue to depend upon our ability to find suitable acquisition candidates on favorable terms and to finance and complete these transactions.
On October 8, 2007, we entered into a long-term agreement to license the Better Homes and Gardens® Real Estate brand from Meredith Corporation (“Meredith”). We intend to build a new international residential real estate franchise company using the Better Homes and Gardens® Real Estate brand name. The licensing agreement between us and Meredith becomes operational on July 1, 2008 and is for a 50-year term, with a renewal term for another 50 years at our option. There can be no assurance that we will be able to successfully develop the brand in a timely matter or at all. Our inability to complete acquisitions or to successfully develop the Better Homes and Gardens® Real Estate brand would have a material adverse effect on our growth strategy.
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Integrating acquired companies may involve complex operational and personnel-related challenges. Future acquisitions may present similar challenges and difficulties, including:
the possible defection of a significant number of employees and sales associates;
increased amortization of intangibles;
the disruption of our respective ongoing businesses;
possible inconsistencies in standards, controls, procedures and policies;
failure to maintain important business relationships;
unanticipated costs of terminating or relocating facilities and operations;
unanticipated expenses related to such integration; and
the potential unknown liabilities associated with acquired businesses.
We are also in the process of integrating the operations of our acquired businesses and expect to incur costs relating to such integrations. These costs may result from integrating operating systems, relocating employees, closing facilities, reducing duplicative efforts and exiting and consolidating other activities.
A prolonged diversion of management’s attention and any delays or difficulties encountered in connection with the integration of any business that we have acquired or may acquire in the future could prevent us from realizing the anticipated cost savings and revenue growth from our acquisitions.
Our franchisees and sales associates could take actions that could harm our business.
Our franchisees are independent business operators and the sales associates that work with our company owned brokerage operations are independent contractors, and, as such, neither are our employees, and we do not exercise control over theirday-to-day operations. Our franchisees may not successfully operate a real estate brokerage business in a manner consistent with our standards, or may not hire and train qualified sales associates and other employees. If our franchisees and sales associates were to provide diminished quality of service to customers, our image and reputation may suffer materially and adversely affect our results of operations.
Additionally, franchisees and sales associates may engage or be accused of engaging in unlawful or tortious acts such as, for example, violating the anti-discrimination requirements of the Fair Housing Act. Such acts or the accusation of such acts could harm our and our brands’ image, reputation and goodwill.
Franchisees, as independent business operators, may from time to time disagree with us and our strategies regarding the business or our interpretation of our respective rights and obligations under the franchise agreement. This may lead to disputes with our franchisees and we expect such disputes to occur from time to time in the future as we continue to offer franchises. To the extent we have such disputes, the attention of our management and our franchisees will be diverted, which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
Our relocation business is subject to risks related to acquiring, carrying and reselling real estate.
In a limited number of transactions (approximately 14%16% of our relocation business homesale transactions)transactions for 2007), our relocation business enters into “at-risk”“at risk” homesale transactions whereby we acquire the home being sold by relocating employees and bear the risk of all expenses associated with acquiring, carrying and selling the home, including potential loss on sale. In approximately 45%39% of these “at-risk”“at risk” homesale transactions, the ultimate third party buyer is under contract at the time we become the owner of the home. For the remaining 55%61% of these “at-risk”“at risk” homesale transactions, adverse economic conditions have reduced the value of some of such homes, and could further reduce the value of those and other such homes, and increase our carrying costs, both of which would increase the losses that we may incur on reselling the homes.
Clients of our relocation business may terminate their contracts at any time.
Substantially all of our contracts with our relocation clients are terminable at any time at the option of the client. If a client terminates its contract, we will only be compensated for all services performed up to the
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We may experience significant claims relating to our operations and losses resulting from fraud, defalcation or misconduct.
We issue title insurance policies which provide coverage for real property mortgage lenders and buyers of real property. When acting as a title agent issuing a policy on behalf of an underwriter, our insurance risk is limited to the first $5,000 of claims on any one policy. The title underwriter we acquired in January 2006 generally underwrites title insurance policies on properties up to $1.5 million. For properties valued in excess of this amount, we obtain a reinsurance policy from a national underwriter. We may also be subject to legal claims arising from the handling of escrow transactions and closings. We carryOur subsidiary, NRT, carries errors and omissions insurance coverage for errors made during the real estate settlement process of up$15 million in the aggregate, subject to $35a deductible of $1 million per occurrence. In addition, we carry additional errors and omissions insurance policy for Realogy Corporation and its subsidiaries for errors made for real estate related services up to $35 million in the aggregate, subject to a deductible of $2.5 million per occurrence. This policy also provides excess coverage to NRT creating an aggregate limit of $50 million, subject to the NRT deductible of $1 million per occurrence. The occurrence of a significant title or escrow claim in any given period could have a material adverse effect on our financial condition and results of operations during the period.
Fraud, defalcation and misconduct by employees are also risks inherent in our business. At any point in time,As a service to our customers, we are the custodiansadminister escrow and trust deposits which represent undisbursed amounts received for settlements of real estate transactions. These escrow and trust deposits totaled approximately $500$442 million of cash deposited by customers with specific instructions as to its disbursement from escrow, trust and account servicing files.at December 31, 2007. We carry insurance covering the loss or theft of funds of up to $30 million annually in the aggregate, subject to a deductible of $1 million per occurrence. To the extent that any loss or theft of funds substantially exceeds our insurance coverage, our business could be materially adversely affected.
We would be subject to severe losses if banks do not honor our escrow deposits.
Our company owned brokerage business and our title and settlement services business act as escrow agents for numerous customers. As an escrow agent, we receive money from customers to hold until certain conditions are satisfied. Upon the satisfaction of those conditions, we release the money to the appropriate party. We deposit this money with various banks including Comerica Bank National Association, Wells Fargo Bank, National Association and SunTrust Bank National Association, which hold a significant amount of such deposits in excess of the federal deposit insurance limit. If Comerica, Wells Fargo, SunTrust or any of our other depository banks were to become unable to honor our deposits, we could be responsible for these deposits.
Title insurance regulations limit the ability of our insurance underwriters to pay cash dividends to us.
Our title insurance underwriters are subject to regulations that limit their ability to pay dividends or make loans or advances to us, principally to protect policy holders. Generally, these regulations limit the total amount of dividends and distributions to a certain percentage of the insurance subsidiary’s surplus, or 100% of statutory operating income for the previous calendar year. These restrictions could limit our ability to pay dividends to our stockholders, repay our indebtedness, make acquisitions or otherwise grow our business.
We may be unable to continue to securitize certain of our relocation assets which may adversely impact our liquidity.
At December 31, 2006, $8932007, $1,014 million of debtliabilities was outstanding through various bankruptcy remote special purpose entities (“SPEs”) monetizing certain assets of our relocation services business. We have provided a performance guaranty which guarantees the obligations of our subsidiary, Cartus Corporation, as originator and servicer under these securitization programs with the SPEs. Through these SPEs, we securitize relocation receivables and advances, relocation properties held for sale and other related assets, and the proceeds from the securitization of such assets are used to fund our relocation receivables and advances and properties held for sale and current working capital needs. Our ability to
securitize these assets or receivables depends upon the amount of such receivables and other assets that we hold, the performancesperformance of these assets, the interest of banks and other financial institutions in financing the securitized assets and other factors. Interest incurred in connection with borrowings under these facilities is recorded within net revenues in our consolidated and combined financial statements as related borrowings are utilized to fund relocation receivables and advances and properties held for sale within our relocation business where interest is generally earned on such assets. If we are unable to continue to securitize these assets, we may be required to find additional sources of liquidityfunding which may be on less favorable terms.
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The asset-backed securities market in the courseUnited States and Europe has been experiencing unprecedented disruptions. Current conditions in this market include reduced liquidity, credit risk premiums for certain market participants and reduced investor demand for asset-backed securities, particularly those backed by sub-prime collateral. These conditions, which may increase our cost of funding and reduce our access to the asset-backed securities market, may continue or worsen in the future.
Since we are highly dependent on the availability of the asset-backed securities market to finance the operations of our relocation business, disruptions in each case above certainagreed-upon levels. Certain of the facilities also contain provisions to limit the level of receivable concentrations among our clients that can be advanced againstthis market or any adverse change or delay in the structures. Should we exceed a concentration limit, we must retire the portion of the draw under the facility that relates to the exceeded limit.
We will continue to rely on borrowings under the Securitization Facilities in order to fund the future liquidity needs of our relocation business. If we need to increase the funding available under our Securitization Facilities, there can be no assurance that such funding will be available to us or, if available, that it will be on terms acceptable to us. In addition, if market conditions do not improve prior to the maturity of our Securitization Facilities, we may encounter difficulties in refinancing them. If these sources of funding are not available to us for any reason, including the occurrence of events of default, breach of restrictive covenants and trigger events, including performance triggers linked to the quality of the underlying liquidity facilities to be renewed or replaced;364-day facilities in the case of Apple Ridge Funding LLC and Kenosia Funding LLC and a three-year facility in the case of UK Relocation Receivables Funding Limited. Additionally, we must satisfy certain criteria relating to the servicingassets, disruption of the receivables.
market or otherwise, or upon maturity of our Securitization Facilities, we could be required to borrow under our revolving credit facility or incur other indebtedness to finance our working capital needs or we could be required to revise the securitization markets may also affectscale of our business, which could have a material adverse effect on our ability to continue to securitizeachieve our relocation assets. For example, it is possible that there could be a disruption in the asset-backed commercial paper markets. In this eventbusiness and if new asset-backed commercial paper could not be issued and sold to investors through typical means, the commercial paper conduits would draw on the backup liquidity facilities to fund new commercial paper issuances and existing commercial paper maturities in order to maintain funding levels. In such event, borrowing costs would increase.
We are dependent on our senior management and a loss of any of our senior managers may adversely affect our business and results of operations.
We believe that our future growth depends, in part, on the continued services of our senior management team. Losing the services of any members of our senior management team could adversely affect our strategic and customer relationships and impede our ability to execute our growth strategies.
The cost of compliance or failure to comply with the Sarbanes-Oxley Act of 2002 may adversely affect our business.
As a new reporting company underresult of our registration statement registering the Securities Exchange Act of 1934, as amended (the “Exchange Act”),exchange notes, which were declared effective on January 9, 2008, we arebecame subject to certain provisions of the Sarbanes-Oxley Act of 2002, which2002. This may result in higher compliance costs and may adversely affect our financial results and our ability to retain qualified members of our Board of Directors or qualified executive officers. The Sarbanes-Oxley Act affects corporate governance, securities disclosure, compliance practices, internal audits, disclosure controls and procedures, and financial reporting and accounting systems. Section 404 of the Sarbanes-Oxley Act, for example, requires companies subject to the reporting requirements of the U.S. federal securities laws to do a comprehensive evaluation of its and its consolidated subsidiaries’ internal controls over financial reporting. If the merger is not consummated and we continue as a publicly-traded company, we will beWe are required to provide ourmanagement’s Section 404 evaluation beginning with our annual reportthis Annual Report and an auditor’s attestation onForm 10-K the effectiveness of financial controls over financial reporting beginning with the Annual Report for 2008 (unless the year ended December 31, 2007.deadline is extended by the SEC). The failure to comply with Section 404 when we are required to comply, may result in investors losing confidence in the reliability of our financial statements (which may result in a decrease in the trading price of our securities), prevent us from providing the required financial information in a timely manner (which could materially and adversely impact our business, our financial condition and the trading price of our securities), prevent us from otherwise complying with the standards applicable to us as a public company and subject us to adverse regulatory consequences.
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Our relocation services business operates worldwide, and to a lesser extent, our real estate franchise services and company owned real estate brokerage businesses have international operations. Revenues from these operations are approximately 2% of the total revenues. Our international operations are subject to risks not generally experienced by our U.S. operations, and if such risks materialize our profitability may be adversely affected. The risks involved in our international operations that could result in losses against which we are not insured and therefore affect our profitability include:
exposure to local economic conditions;
potential adverse changes in the diplomatic relations of foreign countries with the U.S.;
hostility from local populations;
restrictions on the withdrawal of foreign investment and earnings;
government policies against businesses owned by foreigners;
investment restrictions or requirements;
diminished ability to legally enforce our contractual rights in foreign countries;
restrictions on the ability to obtain or retain licenses required for operation;
foreign exchange restrictions;
fluctuations in foreign currency exchange rates;
withholding and other taxes on remittances and other payments by subsidiaries; and
changes in foreign taxation structures.
We are subject to certain risks related to litigation filed by or against us, and adverse results may harm our business.business and financial condition.
We cannot predict with certainty the cost of defense, the cost of prosecution or the ultimate outcome of litigation and other proceedings filed by or against us, including remedies or damage awards, and adverse results in such litigation and other proceedings may harm our business.business and financial condition. Such litigation and other proceedings may include, but are not limited to, actions relating to intellectual property, commercial arrangements, employment law or other harm resulting from negligence or fraud by individuals or entities outside of our control, including franchisees and independent contractors, such as sales associates. In the case of intellectual property litigation and proceedings, adverse outcomes could include the cancellation, invalidation or other loss of material intellectual property rights used in our business and injunctions prohibiting our use of business processes or technology that is subject to third party patents or other third party intellectual property rights. In addition, we may be required to enter into licensing agreements (if available on acceptable terms or at all) and pay royalties. We are generally not liable for the actions of our franchisees; however, there is no assurance that we would be insulated from liability in all cases.
We are reliant upon information technology to operate our business and maintain our competitiveness, and any disruption or reduction in our information technology capabilities could harm our business.
Our business depends upon the use of sophisticated information technologies and systems, including technology and systems utilized for communications, procurement, call center operations and administrative systems. The operation of these technologies and systems is dependent upon third party technologies, systems and services, for which there are no assurances of continued or uninterrupted availability and support by the applicable third party vendors on commercially reasonable terms. We also cannot assure you that we will be able to continue to effectively operate and maintain our information technologies and systems. In addition, our information technologies and systems are expected to require refinements and enhancements on an ongoing basis, and we expect that advanced new technologies and systems will continue to be introduced. There can be no assurances that we will be able to obtain new technologies and systems, or replace or introduce new
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In addition, our information technologies and systems are vulnerable to damage or interruption from various causes, including (i) natural disasters, war and acts of terrorism, (ii) power losses, computer systems failure, Internet and telecommunications or data network failures, operator error, losses and corruption of data, and similar events and (iii) computer viruses, penetration by individuals seeking to disrupt operations or misappropriate information and other physical or electronic breaches of security. We maintain certain disaster recovery capabilities for critical functions in most of our businesses, including certain disaster recovery services from International Business Machines Corporation. However, there can be no assurances that these capabilities will successfully prevent a disruption to or material adverse effect on our businesses or operations in the event of a disaster or other business interruption. Any extended interruption in our technologies or systems could significantly curtail our ability to conduct our business and generate revenue. Additionally, our business interruption insurance may be insufficient to compensate us for losses that may occur.
The weakening or unavailability of our intellectual property rights could adversely impact our business.
Our trademarks, domain names, trade dress and other intellectual property rights are fundamental to our brands and our franchising business. We generate, maintain, utilize and enforce a substantial portfolio of trademarks, domain name registrations, trade dress and other intellectual property rights. We use our intellectual property rights to protect the goodwill of our brand names, to promote our brand name recognition, to protect our proprietary technology and development activities, to enhance our competitiveness and to otherwise support our business goals and objectives. However, there can be no assurances that the steps we take to obtain, maintain and protect our intellectual property rights will be adequate and, in particular, there can be no assurance that we own all necessary registrations for our intellectual property or that any applications we have filed to register our intellectual property will be approved by the appropriate regulatory authorities. Our intellectual property rights may not be successfully asserted in the future or may be invalidated, circumvented or challenged. We may be unable to prevent third parties from using our intellectual property rights without our authorization or independently developing technology that is similar to ours. Our intellectual property rights, including our trademarks, may fail to provide us with significant competitive advantages, particularly in foreign jurisdictions that do not have or do not enforce strong intellectual property rights. In addition, our license agreement with Sotheby’s Holdings, Inc. for the use of the Sotheby’s International Realty® brand is terminable by Sotheby’s Holdings, Inc. prior to the end of the license term if certain conditions occur, including but not limited to the following: (i) we attempt to assign any of our rights under the license agreement in any manner not permitted under the license agreement, (ii) we become bankrupt or insolvent, (iii) a court issues non-appealable, final judgment that we have committed certain breaches of the license agreement and we fail to cure such breaches within 60 days of the issuance of such judgment or (iv) we discontinue the use of all of the trademarks licensed under the license agreement for a period of twelve consecutive months.
Risks Relatingrelating to Our Separation from Cendant
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The historical financial information included herein for periods prior to our separationin this Annual Report does not necessarily reflect the financial condition, results of operations or cash flows that we would have achieved as a separate publicly tradedindependent company for such periods presented or those that we will achieve in the future primarily as a result of the following factors:
Prior to our separation from Cendant, our business was operated by Cendant as part of its broader corporate organization, rather than as an independent company. Cendant or one of its affiliates performed various corporate functions for us, including, but not limited to, cash management, tax administration, certain governance functions (including compliance with the Sarbanes-Oxley Act of 2002 and internal audit) and external reporting. Our historical financial results for such periods reflect allocations of corporate expenses from Cendant for these and similar functions. These allocations are less than the comparable expenses we believe we would have incurred had we operated as a separate independent company.
Prior to our separation from Cendant, our business was integrated with the other businesses of Cendant. Historically, we have shared economies of scope and scale in costs, employees, vendor relationships and customer relationships.
The cost of capital for our business is higher than Cendant’s cost of capital prior to our separation from Cendant because Cendant’s credit ratings were higher than our credit ratings as of December 31, 2007. Other significant changes may occur in our cost structure, management, financing and business operations |
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Under the Separation and Distribution Agreement dated July 27, 2006 (the “Separation and Distribution Agreement”) among Realogy, Cendant, Wyndham Worldwide Corporation (“Wyndham Worldwide”) and Travelport Inc. (“Travelport”), and other agreements, subject to certain exceptions contained in the Tax Sharing Agreement dated as of July 28, 2006 among Realogy, Wyndham Worldwide and Travelport, we and Wyndham Worldwide have each assumed and are responsible for 62.5% and 37.5%, respectively, of certain of Cendant’s contingent and other corporate liabilities including those relating to unresolved tax and legal matters and associated costs and expenses. More specifically, we generally have assumed and are responsible for the payment of our share of: (i) liabilities for certain litigation relating to, arising out of or resulting from certain lawsuits in which Cendant is named as the defendant, including but not limited to theCredentials litigation referred to elsewhere in this Annual Report, in which in September 2007, the court granted summary judgment against Cendant in the amount of approximately $94 million plus attorneys’ fees and Cendant’s motion for reconsideration of that judgment is pending, (ii) certain contingent tax liabilities and taxes allocated pursuant to the Tax Sharing Agreement for the payment of certain taxes, (iii) Cendant corporate liabilities relating to Cendant’s terminated or divested businesses and liabilities relating to the Travelport sale, if any, (iv) generally any actions with respect to the separation plan or the distributions brought by any third party and (v) payments under certain identified contracts (or portions thereof) that were not allocated to any specific party in connection with the separation.our separation from Cendant. In almost all cases, we are not responsible for liabilities that were specifically related to Avis Budget, Wyndham Worldwideand/or Travelport, which were allocated 100% to the applicable company in the separation. In addition, we agreed with Wyndham Worldwide to guarantee each other’s obligations (as well as Avis Budget’s) under our respective deferred compensation plans for amounts deferred in respect of 2005 and earlier years. At our separation from Cendant, we recorded $843 million relating to ourthis assumption and guarantee. The majority of the $843 million of liabilities have been classified as due to former parent in the Consolidated and Combined Balance Sheetconsolidated balance sheet included elsewhere in this Annual Report as the Company is indemnifying Cendant for these contingent liabilities and therefore any payments are typically made to the third party through the former parent. At December 31, 2006,2007, the due to former parent balance had been reduced to $648 million, primarily as a result of the settlement of certain Cendant legacy legal matters and the favorable resolution of certain Cendant federal income tax matters.
If any party responsible for such liabilities were to default in its payment, when due, of any such assumed obligations related to any such contingent and other corporate liability, each non-defaulting party (including Cendant) would be required to pay an equal portion of the amounts in default. Accordingly, we may, under certain circumstances, be obligated to pay amounts in excess of our share of the assumed obligations related to such contingent and other corporate liabilities including associated costs and expenses.
An adverse outcome from suchany of the unresolved Cendant legacy legal proceedings or liabilities or other proceedingsliabilities for which we have assumed partial liability under the Separation and Distribution Agreement could be material with respect to our earnings in any given reporting period.
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The distribution of Realogy shares in connection with our Separationseparation from Cendant was conditioned upon Cendant’s receipt of an opinion of Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden Arps”), substantially to the effect that the distribution, together with certain related transactions, should qualify as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. The opinion of Skadden Arps was based on, among other things, certain assumptions as well as on the accuracy of certain factual
representations and statements that we and Cendant made to Skadden Arps. In rendering its opinion, Skadden Arps also relied on certain covenants that we and Cendant entered into, including the adherence by Cendant and us to certain restrictions on our future actions. If any of the representations or statements that we or Cendant made were, or become, inaccurate or incomplete, or if we or Cendant breach any of our covenants, the distribution and such related transactions might not qualify as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. You should note that Cendant did not and does not intend to seek a ruling from the Internal Revenue Service (“IRS”), as to the U.S. federal income tax treatment of the distribution and such related transactions. The opinion of Skadden Arps is not binding on the IRS or a court, and there can be no assurance that the IRS will not challenge the validity of the distribution and such related transactions as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or that any such challenge ultimately will not prevail.
If the distribution of Realogy shares together with the related transactions referred to above, or together with the Merger (the tax consequences of which are discussed below under “The Merger might be characterized as part of a plan.”), were to fail to qualify as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, then Cendant would recognize gain in an amount equal to the excess of (i) the fair market value of our common stock distributed to the Cendant stockholders over (ii) Cendant’s tax
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We might not be able to engage in desirable strategic transactions and equity issuances.
Our ability to engage in significant stock transactions could be limited or restricted in order to preserve the tax-free nature of the distribution of our common stock to Cendant stockholders on July 31, 2006. Even if the distribution, together with the related transactions referred to above, or together with the Merger (the tax consequences of which are discussed below under “The Merger might be characterized as part of a plan.”), otherwise qualifies as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, the distribution would be taxable to Avis Budget (but generally not to Avis Budget stockholders) under Section 355(e) of the Code if the distribution were deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquired directly or indirectly stock representing a 50% or greater interest, by vote or value, in the stock of either Avis Budget or Realogy.
Current U.S. federal income tax law creates a presumption that the distribution would be taxable to Avis Budget, but not to its stockholders, if either Realogy or Avis Budget were to engage in, or enter into an agreement to engage in, a transaction that would result in a 50% or greater change, by vote or value, in Realogy or Avis Budget’s stock ownership during the four-year period that began two years before the date of the distribution, unless it is established that the transaction is not pursuant to a plan or series of transactions related to the distribution. Treasury regulations currently in effect generally provide that whether an acquisition transaction and a distribution are part of a plan is determined based on all of the facts and circumstances, including, but not limited to, specific factors described in the Treasury regulations. In addition, the Treasury regulations provide that a distribution and subsequent acquisition can be part of a plan only if there was an agreement, understanding, arrangement, or substantial negotiations regarding the acquisition or a similar acquisition at some time during the two-year period ending on the date of the distribution, and also provide a series of “safe harbors” for acquisition transactions that are not considered to be part of a plan. These rules may prevent Realogy and Avis Budget from
entering into transactions which might be advantageous to their respective stockholders, such as issuing equity securities to satisfy financing needs or acquiring businesses or assets with equity securities.
We believe that neither the share repurchase program that we engaged in during 2006 nor the pending Merger with affiliates of Apollo will affect the tax-free nature of our separation from Cendant. However, both determinations are based upon a facts and circumstances analysis and facts and circumstances are inherently difficult to assess.
The Merger might be characterized as part of a plan.
Under the Tax Sharing Agreement, Realogy agreed not to take certain actions during the period beginning the day after the distribution date and ending on the two-year anniversary thereof. These actions include Realogy selling or otherwise transferring 50% or more of its gross or net assets of its active trade or business or 50% or more of the consolidated gross or net assets of its business, or entering into a merger agreement or any Proposed Acquisition Transaction, as defined in the Tax Sharing Agreement (generally, a transaction where Realogy would merge or consolidate with any other person or where any person would acquire an amount of stock that comprises thirty fivethirty-five percent or more of the value or the total combined voting power of all of the outstanding stock of Realogy), without the receipt of a private letter ruling from the IRS, or an
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The proposed Merger is a Proposed Acquisition Transaction as defined in the Tax Sharing Agreement. In connection with the proposed Merger, Skadden Arps issued an opinion (the “Opinion”) to us, Cendant and Wyndham Worldwide, stating that, based on certain facts and information submitted and statements, representations and warranties made by Realogy and Apollo, and subject to the limitations and qualifications set forth in such Opinion, the Merger with affiliates of Apollo will not result in Distribution Taxes. Each of Cendant and Wyndham Worldwide confirmed that the Opinion is reasonably satisfactory. The Opinion is not binding on the IRS or a court. Accordingly, the IRS may assert a position contrary to the Opinion, and a court may agree with the IRS’s position. Additionally, a change in the tax law or the inaccuracy or failure to be complete of any of the facts, information, documents, corporate records, covenants, warranties, statements, representations, or assumptions upon which the Opinion is based could affect its conclusions. Pursuant to the Tax Sharing Agreement, Realogy is required to indemnify Cendant against any and all tax-related liabilities incurred by it relating to the Distributiondistribution to the extent caused by Realogy’s actions, even if Cendant has permitted us to take such actions. Cendant did not and does not intend to seek a private letter ruling from the IRS.
If the Merger causes the distribution to fail to qualify as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, the resulting taxes would be significant and would have a clear material adverse effect. Cendant would recognize gain in an amount equal to the excess of (i) the fair market value of our common stock distributed to the Cendant stockholders over (ii) Cendant’s tax basis in such common stock. Under the terms of the Tax Sharing Agreement, in the event the distribution of the stock of Realogy or Wyndham Worldwide were to fail to qualify as a reorganization and (x) such failure was not the result of actions taken after the distribution by Cendant, us or Wyndham Worldwide, we and Wyndham Worldwide would be responsible for 62.5% and 37.5%, respectively, of any taxes imposed on Cendant as a result thereof or (y) such failure was the result of actions taken after the distribution by Cendant, us or Wyndham Worldwide, the party responsible for such failure would be responsible for all taxes imposed on Cendant as a result thereof. In addition, in certain circumstances, the Cendant shareholdersstockholders who received Realogy stock in the distribution would be treated as having received a taxable dividend equal to the fair market value of Realogy stock received. If the distribution were to qualify as a reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, but acquisitions of Cendant stock or Realogy stock after the distribution were to cause Section 355(e) of the Code to apply, Cendant would recognize taxable gain as described above, but the distribution would be tax free to stockholders (except for cash received in lieu of a fractional share of Realogy common stock).
| ITEM 2. | PROPERTIES |
Corporate Headquarters. Our corporate headquarters is located in leased offices at One Campus Drive in Parsippany, New Jersey. The lease expires in 2013 and can be renewed at our option for an additional five or ten years.
Real Estate Franchise Services. Our real estate franchise business conducts its main operations at our leased offices at One Campus Drive in Parsippany, New Jersey. There are also leased facilities at regional offices located in Atlanta, Georgia, Mission Viejo, California Scottsdale, Arizona and Boston, Massachusetts.
Company Owned Real Estate Brokerage.Brokerage Services. As of December 31, 2006,2007, our Company Owned Real Estate Brokeragecompany owned real estate brokerage segment leases over 7.37 million square feet of domestic office space under 1,4101,400 leases. Its corporate headquarters were relocated in February 2007 from 339 Jefferson Road, Parsippany, New Jersey to the Realogy headquarters located at One Campus Drive, Parsippany, New Jersey. As of December 31, 2006,2007, NRT leased approximately 20 facilities serving as regional headquarters; 6050 facilities serving as local administration, training facilities or storage, and approximately 1,000940 offices under approximately 1,2001,250 leases serving as brokerage sales offices. These offices are generally located in shopping centers and small office
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Relocation Services. Our relocation business has its main corporate operations in a leased building in Danbury, Connecticut with a lease term expiring in 2015. There are also fivefour leased regional offices located in Mission Viejo and Walnut Creek, California; Chicago, Illinois;Illinois and Irving, Texas, and Bethesda, Maryland, which provide operation support services. International offices are leased in Swindon and Hammersmith, United Kingdom; Hong Kong; Singapore and Shanghai, China.
Title and Settlement Services Business.Services. Our title and settlement services business conducts its main operations at a leased facility in Mount Laurel, New Jersey pursuant to a lease expiring in 2014. This business also has leased regional and branch offices in 23 states and the District of Columbia.
We believe that all of our properties and facilities are well maintained.
| ITEM 3. | LEGAL PROCEEDINGS |
Legal — Litigation Related to the Merger.
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The following litigation relates to Cendant’s Real Estate business, and pursuant to the Separation and Distribution Agreement, we have agreed to be responsible for all of the related costs and expenses.
Berger v. Property ID Corp., et al., (CV 05-5373 GHK (CTx) (U.S.D.C., C.D. Cal.)). The original complaint was filed on July 25, 2005. Mark Berger filed an amended, class action lawsuit against Cendant, Century 21, Coldwell Banker Residential Brokerage Company, and related entities, among other defendants, who are parties to joint venture agreements with Property I.D. Corporation, which markets and sells natural hazard disclosure reports in the state of California. The First Amended Complaint alleged violations of RESPA, which prohibits direct or indirect kickbacks from real estate settlement service providers for the referral of business to other providers, and further alleged unlawful business practices under the California Business and Professions Code. Berger alleges that the joint ventures are sham arrangements that unlawfully receive kickbacks or referral fees in exchange for business.
On November 23, 2005 the Court granted defendants’ motion to dismiss the First Amended Complaint on the ground that Berger inadequately pled equitable tolling and equitable estoppel. On December 7, 2005 Berger filed a Second Amended Complaint adding two additional plaintiffs and three additional defendants, including additional allegations regarding equitable estoppel and equitable tolling, and adding a breach of fiduciary duty claim against the broker defendants. On January 6, 2006, defendants filed a motion to dismiss the revised
pleading on the grounds that Berger still failed to adequately plead equitable tolling and estoppel and failed to obtain Court approval to add new parties, which motion was denied. Defendants’ motion to bifurcate discovery into two phases, class discovery and merits discovery was denied. Discovery is currently proceeding.
On May 2, 2007, plaintiffs filed a motion to amend their complaint to add additional plaintiffs, and to name additional defendants, including certain Realogy subsidiaries and several Prudential Real Estate companies, which also had joint venture relationships with Property I.D. All defendants opposed the motion. On May 25, 2007, Plaintiffs filed a reply in further support of their motion. Plaintiffs’ motion was granted and the Fourth Amended Complaint was filed on June 8, 2007 and served on the Defendants. Plaintiffs’ also filed a Fifth Amended Complaint by stipulation which was to correct the identity of certain defendants unrelated to Realogy. We filed a motion to dismiss on July 9, 2007, which was subsequently denied by the court.
Mediation was held on August 14, 2007. On September 1, 2007, plaintiffs filed a Sixth Amended Complaint adding a non-Realogy entity. On October 1, 2007, plaintiffs filed a motion to strike defendants’ affirmative defense that asserts that national hazard disclosure reports are not settlement services. HUD filed a Statement of Interest advising the court that it may file pleadings relevant to the motion to strike. Defendants have opposed the motion but the court has yet to rule. The mediation continued on October 23 and 24, 2007. Another day of mediation will be scheduled for January 2008.
On November 8, 2007, HUD filed its Statement of Interest advising the court that it considers natural hazard disclosure reports to be settlement services. On November 20, 2007, plaintiffs filed a supplemental submission responding to the Statement of Interest and in further support of their motion to strike. On November 28, 2007, we filed a response to the Statement of Interest and further opposition to plaintiffs’ motion to strike.
On November 10, 2007, the Court entered an amended scheduling order that provides that plaintiffs must file their motion to certify a class by December 10, 2007 and extended the fact and expert discovery deadline through May 9, 2008. Plaintiffs filed their motion to certify a class on December 10, 2007. Defendants filed their opposition to class certification on January 9, 2008.
On January 18, 2008, the Court struck the opposition filed by defendants on January 9, 2008 and ordered that Defendants file joint opposition to plaintiffs’ motion for class certification, instead of individual opposition. Defendants’ joint opposition was filed on February 5, 2008 and Plaintiffs reply to the joint submission was filed on February 27, 2008. On March 7, 2008, the court denied the parties joint stipulation to extend expert discovery so the parties exchanged their expert disclosures on March 10, 2008.
Frank K. Cooper Real Estate #1, Inc. v. Cendant Corp. and Century 21 Real Estate Corporation,(N.J. Super. Ct. L. Div., Morris County, New Jersey). Frank K. Cooper Real Estate #1, Inc. filed a putative class action against Cendant and Cendant’s subsidiary, Century 21 Real Estate Corporation (“Century 21”). Cendant and Century 21 were served with the complaint on March 14, 2002. The complaint alleges breach of certain provisions of the Real Estate Franchise Agreement entered into between Century 21 and the plaintiffs, as well as the implied duty of good faith and fair dealing, and certain express and implied fiduciary duties. The complaint alleges, among other things, that Cendant diverted money and resources from Century 21 franchisees and allotted them to NRT owned brokerages; Cendant used Century 21 marketing dollars to promote Cendant’s Internet website, Move.com; the Century 21 magazine was replaced with a Coldwell Banker magazine; Century 21 ceased using marketing funds for yellow page advertising; Cendant nearly abolished training in the areas of recruiting, referral, sales and management; and Cendant directed most of the relocation business to Coldwell Banker and ERA brokers. On October 29, 2002, the plaintiffs filed a second amended complaint adding a count against Cendant as guarantor of Century 21’s obligations to its franchisees. In response to an order to show cause with preliminary restraints filed by the plaintiffs, the court entered a temporary restraining order limiting Century 21’s ability to seek general releases from its franchisees in franchise renewal agreements. On June 23, 2003, the court determined that the limitations on Century 21 obtaining general releases should continue with respect to renewals only. Consequently, as part of any ordinary course transaction other than a franchise renewal, Century 21 may require the franchisee to execute a general release, forever releasing Century 21 from any claim that the
Century 21 franchisee may have against Century 21. The court also ordered a supplemental notice of the progress of the litigation distributed to Century 21 franchisees.
Plaintiffs filed their motion to certify a class on October 1, 2004. The parties conducted discovery on the class certification issues. On January 31, 2006, defendants filed their opposition to the class motion. Plaintiffs’ reply to the class motion was filed on May 2, 2006. The court heard oral argument on the motion on May 26, 2006. Plaintiffs’ motion to certify a class and defendants’ cross motion to strike the class demand were denied on June 30, 2006. On August 1, 2006, plaintiffs filed a motion for leave to appeal the denial of class certification. On August 24, 2006, the Appellate Division denied plaintiff’splaintiffs’ motion for leave to appeal. The court issuedheld a notice setting the case for trial on March 5, 2007.
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Grady v. Coldwell Banker Burnet Realty.This is a putative class action lawsuit filed against Burnet Realty, Inc., d/b/a Coldwell Banker Burnet in the Hennepin County District Court, Minneapolis, MN, on behalf of a class consisting of all persons who were customers of Coldwell Banker Burnet in residential real estate transactions that closed in specific Minnesota counties since February 21, 2001, where the customers were referred to Burnet Title for title insurance and/or settlement services, and where the customers paid Burnet Title for those products and services. The named plaintiffs, filedKenneth and Dylet Grady, were first-time homebuyers for whom Coldwell Banker Burnet acted as their broker, and who used Burnet Title to close the buyers’ side of the transaction. The Grady transaction closed on June 3, 2003.
The complaint alleges various legal theories for breach of fiduciary duty and for violation of the Minnesota Consumer Fraud Act. Under Minnesota law, real estate brokers and agents are fiduciaries to their customers. The complaint alleges that these fiduciary duties impose higher and stricter standards of conduct than RESPA or other statutes with respect to an amended complaint on July 21, 2006affiliated business relationship between a real estate brokerage and a second amendedtitle company. The complaint on August 1, 2006, adding RICO claims and withdrawing its claims to seek class certification.that Coldwell Banker Burnet breached its fiduciary duties to its customers by referring them to Burnet Title when there are other comparable title companies that would provide the same products and services allegedly at lower prices. The complaint alleges that consumers should be expressly told that Burnet Title is an expensive provider, and that consumers should be given the names of multiple, lower-cost providers, so that they can make an informed choice. The complaint claims that Coldwell Banker Burnet agents are pressured and incentivized to refer customers to Burnet Title instead of to other title companies, and that such incentives violate the agents’ fiduciary obligations and must be disclosed to the customer. For its claim under the Minnesota Consumer Fraud Act, the complaint alleges that consumers should be told about Coldwell Banker Burnet’s alleged conflict of interest, about the alleged fact that Burnet Title is an expensive provider, about the names of other, lower-cost providers, and about any incentives provided to agents to encourage them to refer Burnet Title. The complaint seeks the following relief: (1) an injunction prohibiting Coldwell Banker Burnet from continuing its allegedly wrongful practices; (2) disgorgement of all compensation, including commissions, that Coldwell Banker Burnet received from class members; (3) damages for the alleged overpayment by class members for title insurance and/or settlement services from Burnet Title; (4) attorneys’ fees and costs, which can be awarded under the Minnesota Consumer Fraud Act; and (5) other unspecified equitable relief.
Coldwell Banker Burnet denies the allegations in the complaint, and contends that the factual allegations that are the premise for the causes of action in the complaint are inaccurate and wrong. On March 30, 2007, Coldwell Banker Burnet filed anits answer andto the complaint. On October 5, 2007, plaintiff filed their motion to certify a class. On October 24, 2007, we filed our opposition to the class certification motion. Plaintiffs filed a reply on October 30, 2007. Oral argument was held by the court on November 2, 2007. On December 14, 2007, the court denied plaintiffs’ motion to certify a class.
On January 29, 2008, Defendants filed a motion for summary judgment. Plaintiffs have cross moved for summary judgment. Oral argument on the motions for summary judgment was held on March 4, 2008, following which the Court held a brief settlement conference. The court has stayed proceedings for 30 days and referred the case to dismiss the RICO claims on August 14, 2006.mediation. The case is set forto go to trial on April 8, 2013.
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On January 15, 2008, the Supreme Court held inStoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., that secondary actors cannot be held liable under Section 10(b) if their acts are not disclosed to the investigating public because Section 10(b) plaintiff cannot establish the necessary element of reliance with respect to such actors. On January 16, 2008, we made a written request that plaintiff withdraw its appeal in light of theStoneridge ruling, to which we received no response. We are waiting for the ninth circuit to issue a new opinion or to otherwise act on the pending appeal in light of theStoneridge decision; which is expected sometime in late March 2008.
Leflore County, Mississippi Cases (Civil Action No. 2003-115-CICI, Leflore County, Mississippi). Between June 18, 2003, and August 31, 2004, 30 civil actions were commenced in the State Courts of Leflore County, Mississippi against Coldwell Banker Real Estate Corporation, and others. Two of these actions have been removed to Federal Court. Plaintiffs allege fraud among the defendants in connection with the purchase of approximately 90 homes in Leflore County. Specifically, plaintiffs allege that defendants made false representations to each plaintiff regarding the value and/or condition of the properties, which false representations led plaintiffs to borrow money, at unreasonable rates and with the aid of false documentation, to purchase the properties. Plaintiffs seek actual damages ranging in amounts from $100,000 to $500,000, an unspecified amount of punitive damages, attorneys’ fees and costs. Coldwell Banker aggressively has pursued discovery from the plaintiffs; sought severance of plaintiffs’ claims, one from another; and the dismissal of plaintiffs’ claims due to their failure to cooperate in discovery and comply with the Court’s orders regarding discovery. On April 5, 2006, the Court entered consent orders dismissing 21 of the pending state court matters, and only one State Court claim remains outstanding.
In 2005, the same plaintiffs as in the state court actions and about 30 others, commenced a series of parallel actions in the United States District Court for the Northern District of Mississippi. Between July 18, 2005 and July 29, 2005, 21 civil actions were commenced in Federal Court alleging the same state law fraud and
misrepresentation claims as were alleged in the prior-filed State Court actions, as well as claims arising under the Federal Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. § 1964, et seq. Coldwell Banker timely filed Motions to Dismiss these Federal actions due to plaintiffs’ failure to state any viable RICO claims and a lack of federal jurisdiction over plaintiffs’ State law fraud and misrepresentation claims. On March 20, 2006, in four RICO motions, Coldwell Banker’s Motions to Dismiss were denied. On March 27, 2006, Coldwell Banker filed Motions for Reconsideration of those denials, which were denied. A trial schedule has been set for all federal matters. Each case will be tried individually, one per quarter, over a five-year period. The first case is set for trial on October 20, 2008.
Various lenders in the federal matters have moved to compel arbitration based on arbitration clauses included in the mortgage documents. So far, 11 motions have been granted. Two were denied because the lender did not countersign the document containing the arbitration provision. One additional motion is still pending. Coldwell Banker has moved to join these arbitrations, or in the alternative, to stay the court proceedings pending the resolution of the arbitration. All of Coldwell Banker’s motions were granted and 11 matters will proceed to arbitration. Not all transactions may be subject to arbitration. To date, Coldwell Banker is aware of at least ten matters where the mortgage documents do not contain arbitration provisions.
Additionally, on January 11, 2005, a putative class action was commenced in the United States District Court for the Northern District of Mississippi relating to the same allegations of fraud and misrepresentation in connection with the purchase of residential real estate in Leflore County, Mississippi. Specifically, plaintiffs have sought certification of a class consisting of the following: “All persons who purchased or sold property within the state of Mississippi while utilizing the services of Coldwell Banker First Greenwood Leflore Realty, Inc., who were misled about the value or condition of the property, or who were misled by Coldwell Banker or its agents concerning the sales price of the real property, or who were promised repairs and/or renovations to the property which were not made or completed, or who, with the active involvement of Coldwell Banker or its agents entered into loans, secured by collateral in the form of real property, who were charged excessive and/or unnecessary fees, charges and related expenses.” The Class Complaint asserted claims for false advertising, breach of fiduciary duty, misrepresentation, deceptive sales practices, fraudulent concealment, fraud in the inducement, intentional infliction of emotional distress, negligent infliction of emotional distress, breach of public policy, negligence, gross negligence, and fraud. The Class Complaint sought unspecified compensatory and punitive damages, attorneys’ fees and costs. On March 31, 2005, plaintiffs filed a Motion for Class Certification. On April 15, 2005, Coldwell Banker Real Estate Corporation filed its Opposition to Plaintiffs’ Motion for Class Certification. The Court did not rule on Plaintiffs’ Motion for Class Certification. Instead, plaintiffs’ voluntarily withdrew their claim to have a class certified, which was approved by the court by Order dated July 13, 2006. The individual plaintiffs, Clemmie Cleveland, et al., filed a second amended complaint on August 1, 2006, adding RICO claims and withdrawing its claims to seek class certification. Coldwell Banker filed an answer and a motion to dismiss the RICO claims on August 14, 2006.
A mandatory settlement conference scheduled for all matters was held from January 14 through 16, 2008. A settlement was reached in principle, under which Coldwell Banker Real Estate Corporation will pay the plaintiffs an immaterial amount, substantially less than the cost of defense. The settlement agreement is fully executed and the court entered orders of dismissal with prejudice on March 6, 2008.
Proa, Jordan and Schiff v. NRT Mid-Atlantic, Inc. d/b/a Coldwell Banker Residential Brokerage et al. (Case No. 1:05-cv-02157 (AMD), U.S.D.C., District of Maryland, Northern Division). On August 8, 2005, plaintiffs Proa and Jordan filed a lawsuit against NRT Mid-Atlantic, Inc., NRT Incorporated (now known as NRT LLC) and Angela Shearer, Branch Vice President of Coldwell Banker Residential Brokerage’s Chestertown, Maryland office. On October 27, 2005, plaintiffs filed an amended complaint that includes Schiff as a plaintiff, names Sarah Sinnickson, Executive Vice President and General Sales Manager of Coldwell Banker Residential Brokerage as an individual defendant and asserts eight claims. Plaintiffs’ claims involve alleged conduct arising from the plaintiffs’ affiliation with NRT’s Chestertown, Maryland office as real estate agents on an independent contractor basis. The plaintiffs allege violations of Title VII of the Civil Rights Act and violations of the Civil Rights Act of 1866 claiming discrimination and retaliation on the basis of race, religion, ethnicity, racial heritage
and/or ethnic or racial associations. The plaintiffs are also seeking declaratory relief on behalf of themselves and a putative class that they are common law employees as opposed to independent contractors. The plaintiffs are also alleging various breach of contract, wrongful discharge and negligent supervision claims. In addition, plaintiffs are alleging that defendant Shearer made false and defamatory remarks about plaintiffs Proa and Jordan to their co-workers.
The plaintiffs are seeking compensatory and punitive damages in an amount to be determined at trial, as well as attorneys’ fees. On November 14, 2005, the defendants filed an answer to the plaintiffs’ amended complaint. Defendants have filed a motion to dismiss the claim for declaratory judgment based on lack of subject matter jurisdiction as well as a motion for judgment on the pleadings as to Jordan’s Title VII claim based on the statute of limitations. Plaintiffs agreed to voluntarily dismiss the defamation claims without prejudice. A stipulation of voluntary dismissal of the defamation claim against Angela Shearer was entered on January 18, 2006. At the direction of the Court, on September 5, 2006, we re-filed our Motion for Partial Dismissal. On October 5, 2006 we filed our reply brief. On March 13, 2007, the Court granted defendants’ motion to dismiss with prejudice Jordan’s Title VII claim for failing to file suit within the statute of limitations. The court also granted defendants’ motion to dismiss with prejudice plaintiffs’ declaratory judgment claim, which sought to obtain a declaration that real estate agents are not independent contractors. The court dismissed the declaratory claim because there is no actual controversy that requires declaratory relief and because there is no claim that is appropriate for class relief as pled by plaintiffs. The court then ordered discovery to commence immediately. On March 21, 2007, plaintiffs filed a motion for leave to file a third amended complaint attempting to add class-wide FLSA claims for unpaid minimum wages, overtime and benefits that employees receive. Defendants filed their opposition to the motion on April 9, 2007. On May 8, 2007, the court denied the motion. Accordingly, Plaintiffs’ complaint is no longer a putative class action. On May 16, 2007, the court issued a Scheduling Order setting the matter for trial on May 8, 2008. Discovery was set to close on January 28, 2008, however, various discovery motions are pending before the court. Dispositive motions were filed on February 29, 2008. Trial is scheduled to begin May 12, 2008. A court ordered mediation held on March 10, 2008 was unsuccessful.
We cannot give any assurance as to the final outcome or resolution of these unresolved proceedings. An adverse outcome from certain unresolved proceedings could be material with respect to earnings in any given reporting period. However, we do not believe that the impact of such unresolved proceedings should result in a material liability to us in relation to our consolidated financial position or liquidity.
Additionally, from time to time, we are involved in certain other claims and legal actions arising in the ordinary course of our business. While the results of such claims and legal actions cannot be predicted with certainty, we do not believe based on information currently available to us that the final outcome of these proceedings will have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Legal — Legal—Cendant Corporate Litigation
Pursuant to the Separation and Distribution Agreement dated as of July 27, 2006 among the Company,Cendant, Realogy, Corporation, Wyndham Worldwide Corporation and Travelport, each of Realogy, Wyndham Worldwide and Travelport have assumed under the Separation and Distribution Agreement certain contingent and other corporate liabilities (and related costs and expenses), which are primarily related to each of their respective businesses. In addition, Realogy has assumed 62.5% and Wyndham Worldwide has assumed 37.5% of certain contingent and other corporate liabilities (and related costs and expenses) of the CompanyCendant or its subsidiaries, which are not primarily related to any of the respective businesses of Realogy, Wyndham Worldwide, Travelportand/or the Company’s Cendant’s vehicle rental operations, in each case incurred or allegedly incurred on or prior to the date of the separation of Travelport from the Company.Cendant. Such litigation includes the litigation described below under this heading of Cendant Corporate Litigation. As discussed in “Item 7 — Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations”, certain of these Cendant litigation matters werehave been settled, in the fourth quarter of 2006, resulting in a reduction in amounts “Due to former parent” set forth on our Consolidated and Combined Balance Sheet atincluded elsewhere in this Annual Report.
In Re Cendant Corporation Litigation, Master File No. 98-1664 (WHW) (D.N.J.)(the “Securities Action”). On December 31, 2006.
After satisfying obligations to various parties, including the plaintiff class members in the Securities Action and in the PRIDES securities class action and certain officers and directors of HFS Incorporated, Cendant received approximately $128 million of net proceeds under the settlement agreement. Cendant distributed all of those net proceeds as follows: approximately $80 million to Realogy (or 62.5% of such net amount) and approximately $48 million to Wyndham Worldwide (or 37.5% of such net amount), in accordance with the terms of the Separation Agreement.
The settlement of this matter concluded all but one of the more than 70 cases that had been brought against Cendant and other defendants after the April 15, 1998 announcement of the discovery of accounting irregularities in the former CUC business units and prior to the filing of this Annual Report onForm 10-K, approximately 70 lawsuits claiming to be class actions and other proceedings were commenced against Cendant and other defendants, of which a number of lawsuits have been settled. Approximately five lawsuits remain unresolved in addition to the mattersCUC International, Inc. The Credentials matter described below.
The Securities Action was a consolidated class action brought on behalf of all persons who acquired securities of Cendant and CUC, except the PRIDES securities, between May 31, 1995 and August 28, 1998. Named as defendants arewere Cendant; 28 current and former officers and directors of Cendant, CUC and HFS Incorporated; and Ernst & Young, LLP, CUC’s former independent accounting firm.
On December 7, 1999, Cendant announced that it had reached an agreement to settle claims made by class members in the Securities Action for approximately $2,850 million in cash plus 50 percent of any net recovery Cendant receives from Ernst & Young as a result of Cendant’s cross-claims against Ernst & Young as described below. Thisabove. Such settlement with the class members received all necessary court approvals and was fully funded on May 24, 2002.
On January 25, 1999, Cendant had asserted cross-claims against Ernst & Young that alleged that Ernst & Young failed to follow professional standards to discover and recklessly disregarded the accounting irregularities and is therefore liable to Cendant for damages in unspecified amounts. The cross-claims assertasserted claims for breaches of Ernst & Young’s audit agreements with Cendant, negligence, breaches of fiduciary duty, fraud and
49
On March 26, 1999, Ernst & Young had filed cross-claims against Cendant and certain of Cendant’s present and former officers and directors that alleged that any failure by Ernst & Young to discover the accounting irregularities was caused by misrepresentations and omissions made to Ernst & Young in the course of its audits and other reviews of Cendant’s financial statements. Ernst & Young’s cross-claims assertasserted claims for breach of contract, fraud, fraudulent inducement, negligent misrepresentation and contribution. Damages in unspecified amounts arewere sought for the costs to Ernst & Young associated with defending the various shareholderstockholders lawsuits, lost business it claims isclaimed was attributable to Ernst & Young’s association with Cendant, and for harm to Ernst & Young’s reputation. On June 4, 2001, Ernst & Young filed amended cross-claims against Cendant asserting the same claims. Prior to being settled, the case had been scheduled for trial in March 2008.
CSI Investment et. al. vs. Cendant et. al., (Case No. 1:00-CV-01422 (DAB-DFE) (S.D.N.Y.) (“Credentials Litigation) is an action for breach of contract and fraud arising out of Cendant’s acquisition of the Credentials
business in 1998. The courtCredentials Litigation commenced in February 2000 and was filed against Cendant and it senior management. The Stock Purchase Agreement provided for the sale of Credentials Services International to Cendant for a set price of $125 million plus an additional amount which was contingent on Credentials’ future performance. The closing occurred just prior to Cendant’s April 15, 1998 disclosure of potential accounting irregularities relating to CUC. Plaintiffs seek payment of certain “hold back” monies in the total amount of $5.7 million, as well as a contingent payment based upon future performance that plaintiffs contend should have been approximately $50 million. The case has setbeen delayed or impeded over time as a deadlineresult of June 27,the Cendant securities case and the criminal proceedings against certain former CUC management.
In early 2007, for discovery by the parties moved for summary judgment on various aspects of the case. In a written opinion issued on September 7, 2007, the Court granted Cendant’s motion for summary judgment except with respect to Counts 3 and 4 of the case. On Count 4, plaintiffs’ claim for hold back monies, the Court granted plaintiffs’ motion for summary judgment. On Count 3, plaintiffs’ claim for breach of contract for failing to perform in good faith and pay the contingent fee, the Court, on its own accord, granted summary judgment for the plaintiffs. Including pre judgment interest, the Court entered judgment in favor of plaintiffs in the amount of $94 million plus attorneys fees.
On September 21, 2007, Cendant filed a trial datemotion for reconsideration. On October 22, 2007, plaintiffs opposed the motion and cross moved for reconsideration of March 8, 2008.
Regulatory Proceedings
The Department of Housing and Urban Development (“HUD”) is conducting a regulatory investigation of the activities of Property I.D. Associates, LLC (“Associates”), a joint venture between Property I.D. Corporation, Cendant Real Estate Services Group LLC and Coldwell Banker Residential Brokerage Corporation, an NRT subsidiary. This regulatory investigation also includes predecessor joint ventures of Associates, as well as other joint ventures formed by Property I.D. Corporation. Associates and its predecessors provide hazard reports in the California market. For reasons unrelated to the investigation, the joint venture was terminated by us effective July 1, 2006. (HUD had been conducting the investigation jointly with the FTC. On October 24, 2006, the FTC issued a letter to us advising us that no further action is warranted by the FTC with regard to this matter.)
Subpoenas were issued seeking documents and information from Cendant, Coldwell Banker Residential Brokerage Corporation, Coldwell Banker Residential Brokerage, and Century 21. According to these subpoenas, this investigation concerns whether the activities of Associates violate RESPA, 12 U.S.C. § 2607 et seq., and Section 5 of the Trade Commission Act, 12 U.S.C. § 45. CendantRealogy has cooperated in the investigation, has responded to requests for information and document requests as well as produced employees for deposition. Based on the information currently available, we believe that the eventual outcome of the regulatory investigation will not have a material adverse effect on our consolidated financial position or results of operations.
On May 23, 2007, HUD filed a lawsuit in the Central District of California, United States District Court, against Realogy, NRT, Coldwell Banker Residential Brokerage, Property I.D., several Prudential Real Estate franchisees, and the joint venture entities between Property I.D. and these former joint venture partners. The lawsuit alleges that Natural Hazard Disclosure Reports (NHD Reports) are settlement services under RESPA although acknowledging that they are not an enumerated service identified in the statute, or identified in the regulations. Because NHD Reports are allegedly settlement services, HUD further alleges that the defendants violated RESPA in their operation of the various joint ventures. On July 9, 2007, we filed a motion to dismiss the action on the basis that RESPA does not authorize HUD to seek disgorgement and that there is no further alleged unlawful activity to enjoin. On January 18, 2008, plaintiff filed opposition to the motions to dismiss that were filed by all defendants. On February 22, 2008, the Defendants filed their reply to HUD’s opposition.
HUD also is conducting a regulatory investigation of Coldwell Banker Burnet (“Burnet”) and Burnet Title of Minnesota to determine whether either gave something of value to agents in exchange for referrals of real estate settlement services in violation of RESPA. Specifically, HUD is investigating whether Burnet had incentive programs that did not comply with RESPA to encourage agents to refer closing and title business to Burnet Title. HUD has issued an Information and Document Request to Burnet and Burnet Title. Both responded to the Request on July 11, 2007.
On November 13, 2007, the Minnesota Department of Commerce issued an administrative subpoena to plaintiffs’ counsel in theGrady case requesting all pleadings and copies of all documents produced by any party. On November 20, 2007, the Office of Inspector General for HUD in Minnesota issued an administrative subpoena identical to the subpoena served by the Department of Commerce seeking the same materials relating to theGrady case. The Department of Commerce has advised Burnet Realty and Burnet Title that it is conducting a market exam of the insurance industry in Minnesota, and that the target of the exam is neither Burnet Realty nor Burnet Title, but it feels theGrady materials will be probative of the issues it is investigating. On November 21, 2007, plaintiffs’ counsel in theGrady case filed a motion for relief from the Protective Order so they could produce confidential materials sought in the subpoenas to the Department of Commerce and the OIG for HUD. Burnet Realty and Burnet Title have opposed that motion. On December 14, 2007, the court denied plaintiffs’ motion to amend the Protective Order to respond to the subpoenas from the Department of Commerce and HUD.
Under the Tax Sharing Agreement, we are responsible for 62.5% of any payments made to the IRS to settle claims with respect to tax periods ending on or prior to December 31, 2006. Our Consolidated and Combined Balance Sheet at December 31, 20062007 reflects liabilities to Cendantour former parent of $367$353 million relating to tax matters for which we have potential liability under the Tax Sharing Agreement.
Cendant and the Internal Revenue Service (“IRS”) have settled the IRS examination for Cendant’s taxable years 1998 through 2002, during which the Company was included in Cendant’s tax returns. The settlement includes the favorable resolution of the shareholderstockholder litigation issue, which as discussed in “Item 7 — 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is reflected in the reduction in amounts “Due to former parent”Former Parent” set forth on our Consolidated and Combined Balance Sheet at December 31, 2006.2007. The Company was adequately reserved for this audit cycle and has reflected the results of that examination in these financial statements. The IRS has opened an examination for Cendant’s taxable years 2003 through 2006, during which the Company was included in Cendant’s tax returns. Although the Company and Cendant believe there is appropriate support for the positions taken on its tax returns, the Company and Cendant have recorded liabilities representing the best estimates of the probable loss on certain positions.
The Company and Cendant believe that the accruals for tax liabilities are adequate for all open years, based on assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.
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| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
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| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
We are a wholly-owned subsidiary of Common Stock
Since the New York Stock Exchange (“NYSE”) under the symbol “H”. At February 20, 2007, the number of stockholders of record was approximately 5,972. The following table sets forth the quarterly high and low sales prices per shareAcquisition, we have paid no cash dividends in respect of our common stock as reported bystock. Our senior secured credit facility and the NYSE from August 1, 2006, the date on which we commenced “regular way” trading on the NYSE following the consummation ofindentures governing our separation from Cendant.
| High | Low | |||||||
2006 | ||||||||
| Third Quarter | $ | 26.16 | $ | 19.90 | ||||
| Fourth Quarter | $ | 31.11 | $ | 22.25 | ||||
2007 | ||||||||
| First Quarter (through February 20, 2007) | $ | 30.30 | $ | 29.42 | ||||
| Number of Shares | Approximate Dollar | |||||||||||||||
| Total Number | Purchased as Part | Value of Shares that | ||||||||||||||
| of Shares | Average Price | of Publicly | May Yet Be | |||||||||||||
| Purchased | Paid per Share | Announced Plan(b) | Purchased Under Plan | |||||||||||||
October 1 – 31, 2006(a) | 38,177,000 | $ | 23.12 | 38,177,000 | $ | 9,823,000 | ||||||||||
| November 1 – 30, 2006 | — | — | — | — | ||||||||||||
| December 1 – 31, 2006 | — | — | — | — | ||||||||||||
Total | 38,177,000 | $ | 23.12 | 38,177,000 | $ | 9,823,000 | ||||||||||
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| August 1, | December 31, | |||||||
| 2006 | 2006 | |||||||
| S&P 500 | $100.00 | $112.56 | ||||||
| Realogy Corporation | 100.00 | 116.17 | ||||||
Other Real Estate Service Companies(a) | 100.00 | 125.34 | ||||||
| ITEM 6. | SELECTED FINANCIAL DATA |
The following table presents our selected historical consolidated and combined financial data and operating statistics. The consolidated and combined statement of incomeoperations data for each of the years in the three-year period ended December 31, 20062007 and the consolidated and combined balance sheet data as of December 31, 20062007 and 20052006 have been derived from our audited consolidated and combined financial statements included elsewhere herein. The combined statement of incomeoperations data for the years ended December 31, 20032004 and 20022003 and the combined balance sheet data as of December 31, 2005, 2004 2003 and 20022003 have been derived from our combined financial statements not included elsewhere herein.
Although Realogy continued as the same legal entity after the Merger, the consolidated financial statements for 2007 are presented for two periods: January 1 through April 9, 2007 (the “Predecessor Period” or “Predecessor,” as context requires) and April 10 through December 31, 2007 (the “Successor Period” or “Successor,” as context requires), which relate to the period preceding the Merger and the period succeeding the Merger, respectively. The results of the Successor are not comparable to the results of the Predecessor due to the difference in the basis of presentation of purchase accounting as compared to historical cost. The consolidated statement of operations data for the period January 1, 2007 to April 9, 2007 are derived from the unaudited financial statements of the Predecessor included elsewhere in this Annual Report, and the consolidated statement of operations data for the period April 10, 2007 to December 31, 2007 are derived from the unaudited financial statements of the Successor included elsewhere in this Annual Report. In the opinion of management, the statement of operations data for 2007 include all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of operations as of the dates and for the periods indicated. The results for periods of less than a full year are not necessarily indicative of the results to be expected for any interim period or for a full year.
The selected historical consolidated and combined financial data and operating statistics presented below should be read in conjunction with our annual consolidated and combined financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein. Our annual consolidated and combined financial information may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would
53
| As of or For the Year Ended December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (In millions, except per share data and operating statistics) | ||||||||||||||||||||
Statement of Income Data: | ||||||||||||||||||||
| Net Revenue | $ | 6,492 | $ | 7,139 | $ | 6,549 | $ | 5,532 | $ | 4,117 | ||||||||||
| Total Expenses | 5,888 | 6,101 | 5,548 | 4,672 | 3,574 | |||||||||||||||
| Income before income taxes | 604 | 1,038 | 1,001 | 860 | 543 | |||||||||||||||
| Provision for income taxes | 237 | 408 | 379 | 285 | 186 | |||||||||||||||
| Minority interest, net of tax | 2 | 3 | 4 | 6 | 9 | |||||||||||||||
| Net Income | $ | 365 | $ | 627 | $ | 618 | $ | 569 | $ | 348 | ||||||||||
| Earnings per share - basic and diluted | $ | 1.50 | $ | 2.50 | $ | 2.47 | $ | 2.27 | $ | 1.39 | ||||||||||
Balance Sheet Data: | ||||||||||||||||||||
Secured Relocation Assets(a) | $ | 1,190 | $ | 856 | $ | 497 | $ | 485 | $ | 101 | ||||||||||
| Total Assets | 6,668 | 5,439 | 5,015 | 4,769 | 4,051 | |||||||||||||||
| Secured Relocation Obligations | 893 | 757 | 400 | 400 | 80 | |||||||||||||||
| Long-term debt | 1,800 | — | — | — | — | |||||||||||||||
| Mandatorily redeemable preferred interest | — | — | — | — | 375 | |||||||||||||||
Stockholders’ equity(b) | 2,483 | 3,567 | 3,552 | 2,973 | 2,405 | |||||||||||||||
Operating Statistics: | ||||||||||||||||||||
Real Estate Franchise Services | ||||||||||||||||||||
Closed homesale sides-franchisees(c),(d) | 1,515,542 | 1,848,000 | 1,814,165 | 1,686,434 | 1,571,535 | |||||||||||||||
Closed homesale sides — NRT pre-acquisition(c),(e) | 111,363 | |||||||||||||||||||
Average homesale price(f),(g) | $ | 231,664 | $ | 224,486 | $ | 197,547 | $ | 175,347 | $ | 169,727 | ||||||||||
Average homesale brokerage commission rate(f),(h) | 2.47 | % | 2.51 | % | 2.56 | % | 2.62 | % | 2.65 | % | ||||||||||
Net effective royalty rate(f),(i) | 4.87 | % | 4.69 | % | 4.69 | % | 4.77 | % | 5.04 | % | ||||||||||
Royalty per side(j) | $ | 286 | $ | 271 | $ | 247 | $ | 228 | $ | 216 | ||||||||||
Company Owned Real Estate Brokerage Services(k) | ||||||||||||||||||||
Closed homesale sides(c) | 390,222 | 468,248 | 488,658 | 476,627 | 347,896 | |||||||||||||||
Average homesale price(g) | $ | 492,669 | $ | 470,538 | $ | 407,757 | $ | 341,050 | $ | 314,704 | ||||||||||
Average homesale brokerage commission rate(h) | 2.48 | % | 2.49 | % | 2.53 | % | 2.58 | % | 2.63 | % | ||||||||||
Gross commission income per side(l) | $ | 12,691 | $ | 12,100 | $ | 10,635 | $ | 9,036 | $ | 8,535 | ||||||||||
Relocation Services | ||||||||||||||||||||
Initiations(m) | 130,764 | 121,717 | 115,516 | 111,184 | 112,140 | |||||||||||||||
Referrals(n) | 84,893 | 91,787 | 89,416 | 82,942 | 83,317 | |||||||||||||||
Title and Settlement Services(o) | ||||||||||||||||||||
Purchasing title and closing units(p) | 161,031 | 148,316 | 144,699 | 143,827 | 101,252 | |||||||||||||||
Refinance title and closing units(q) | 40,996 | 51,903 | 55,909 | 117,674 | 60,450 | |||||||||||||||
Average price per closing unit(r) | $ | 1,405 | $ | 1,384 | $ | 1,262 | $ | 1,033 | $ | 1,096 | ||||||||||
Statement of Operations Data: Net revenue Total expenses Income (loss) before income taxes and minority interest Provision for income taxes Minority interest, net of tax Net income (loss) Balance Sheet Data: Securitization assets (a) Total assets Securitization obligations Long-term debt Stockholder’s equity (b) Successor Predecessor As of or For
the Period
April 10
Through
December 31,
2007 Period From
January 1
Through
April 9,
2007 As of or For the Year Ended December 31, 2006 2005 2004 2003 (In millions, except operating statistics) $ 4,474 $ 1,493 $ 6,492 $ 7,139 $ 6,549 $ 5,532 5,708 1,560 5,888 6,101 5,548 4,672 (1,234 ) (67 ) 604 1,038 1,001 860 (439 ) (23 ) 237 408 379 285 2 — 2 3 4 6 $ (797 ) $ (44 ) $ 365 $ 627 $ 618 $ 569 $ 1,300 $ 1,190 $ 856 $ 497 $ 485 11,172 6,668 5,439 5,015 4,769 1,014 893 757 400 400 6,239 1,800 — — — 1,200 2,483 3,567 3,552 2,973
| For the Year Ended December 31, | ||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||||||
Operating Statistics: | ||||||||||||||||||||
Real Estate Franchise Services | ||||||||||||||||||||
Closed homesale sides—franchisees (c),(d) | 1,221,206 | 1,515,542 | 1,848,000 | 1,814,165 | 1,686,434 | |||||||||||||||
Closed homesale sides—average homesale price (e) | $ | 230,346 | $ | 231,664 | $ | 224,486 | $ | 197,547 | $ | 175,347 | ||||||||||
Average homesale brokerage commission rate (f) | 2.49 | % | 2.47 | % | 2.51 | % | 2.56 | % | 2.62 | % | ||||||||||
Net effective royalty rate (g) | 5.03 | % | 4.87 | % | 4.69 | % | 4.69 | % | 4.77 | % | ||||||||||
Royalty per side (h) | $ | 298 | $ | 286 | $ | 271 | $ | 247 | $ | 228 | ||||||||||
Company Owned Real Estate Brokerage Services (i) | ||||||||||||||||||||
Closed homesale sides (c) | 325,719 | 390,222 | 468,248 | 488,658 | 476,627 | |||||||||||||||
Average homesale price (e) | $ | 534,056 | $ | 492,669 | $ | 470,538 | $ | 407,757 | $ | 341,050 | ||||||||||
Average homesale brokerage commission rate (f) | 2.47 | % | 2.48 | % | 2.49 | % | 2.53 | % | 2.58 | % | ||||||||||
Gross commission income per side (j) | $ | 13,806 | $ | 12,691 | $ | 12,100 | $ | 10,635 | $ | 9,036 | ||||||||||
Relocation Services | ||||||||||||||||||||
Initiations (k) | 132,343 | 130,764 | 121,717 | 115,516 | 111,184 | |||||||||||||||
Referrals (l) | 78,828 | 84,893 | 91,787 | 89,416 | 82,942 | |||||||||||||||
Title and Settlement Services | ||||||||||||||||||||
Purchasing title and closing units (m) | 138,824 | 161,031 | 148,316 | 144,699 | 143,827 | |||||||||||||||
Refinance title and closing units (n) | 37,204 | 40,996 | 51,903 | 55,909 | 117,674 | |||||||||||||||
Average price per closing unit (o) | $ | 1,471 | $ | 1,405 | $ | 1,384 | $ | 1,262 | $ | 1,033 | ||||||||||
| (a) | Represents the portion of relocation receivables and advances, relocation properties held for sale and other related assets that collateralize our | |
| (b) | For |
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| Cendant and our repurchase of $884 million (approximately 38 million shares) of Realogy common stock offset by $1,454 million of distributions received from Cendant’s sale of Travelport and net income earned during the year ended December 31, 2006. In 2007, stockholder’s equity is comprised of the capital contribution of $2,001 million from affiliates of Apollo and co-investors offset by the net loss for the year. | ||
| (c) | A closed homesale side represents either the “buy” side or the “sell” side of a homesale transaction. | |
| (d) | These amounts include only those relating to third-party franchisees and do not include amounts relating to the Company Owned Real Estate Brokerage Services | |
| (e) | ||
| Represents the average selling price of closed homesale transactions. |
| (f) | Represents the average commission rate earned on either the “buy” side or “sell” side of a homesale transaction. |
| (g) | Represents the average percentage of our franchisees’ commission revenues (excluding NRT) paid to the Real Estate Franchise Services segment as a royalty. |
| (h) | Represents net domestic royalties earned from our franchisees (excluding NRT) divided by the total number of our franchisees’ closed homesale sides. |
| (j) | Represents gross commission income divided by closed homesale sides. |
| (k) | Represents the total number of transferees served by the relocation services business. |
| (l) | Represents the number of referrals from which we received revenue from real estate brokers. |
| (m) | Represents the number of title and closing units processed as a result of a home purchases. The amounts presented for the year ended December 31, 2006 include 31,018 purchase units as a result of the acquisition of Texas American Title Company on January 6, 2006. |
| (n) | Represents the number of title and closing units processed as a result of homeowners refinancing their home loans. The amounts presented for the year ended December 31, 2006 include 1,255 refinance units as a result of the acquisition of Texas American Title Company. |
| (o) | Represents the average fee we earn on purchase title and refinancing title units. |
In presenting the financial data above in conformity with general accepted accounting principles, we are required to make estimates and assumptions that affect the amounts reported. See “Critical“Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” included elsewhere herein for a detailed discussion of the accounting policies that we believe require subjective and complex judgments that could potentially affect reported results.
Between January 1, 20022003 and December 31, 2006,2007, we completed a number of acquisitions, the results of operations and financial position of which have been included from their acquisition dates forward. See Note 4 — Acquisitions“Other Acquisitions” to our consolidated and combined financial statements for a discussion of the acquisitions made in the annual periods ended 2007, 2006 and 2005, and 2004, respectively. In 2003, we acquired 19 real estate brokerage operations for approximately $109 million of cash, which resulted in goodwill of $96 million that was assigned to our Company Owned Real Estate Brokerage Services segment. In 2002, we acquired NRT for $230 million, which resulted in approximately $1.6 billion of goodwill, and 19 other residential real estate brokerage operations for $377 million, including Arvida Realty Services and The DeWolfe Companies, which collectively resulted in $288 million of goodwill. NRT generated net revenue of approximately $893 million and net loss of $55 million from January 1, 2002 through April 17, 2002 (the date we acquired NRT).
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis presents a review of Realogy Corporation and its subsidiaries (collectively, “we” or the “Company”).subsidiaries. This discussion should be read in conjunction with our consolidated and combined financial statements and accompanying notes thereto included elsewhere herein. Unless otherwise noted, all dollar amounts are in millions and those relating to our results of operations are
55
On April 10, 2007, Domus Holdings Corp., a Delaware corporation (“Holdings”) and an affiliate of Apollo Management, L.P. (“Apollo”), completed the acquisition of all of the outstanding equity of Realogy in a merger transaction for approximately $8,750 million (the “Merger”). In connection with the Merger, Holdings established a direct, wholly owned subsidiary, Domus Intermediate Holdings Corp. (“Intermediate”) to own all of the outstanding shares of Realogy.
Although Realogy continues as the same legal entity after the Merger, the Consolidated Statements of Operations and Cash Flows are presented for two periods: January 1 through April 9, 2007 (the “Predecessor Period” or “Predecessor,” as context requires) and April 10, 2007 through December 31, 2007 (the “Successor Period” or “Successor,” as context requires), which relate to the period preceding the Merger and the period succeeding the Merger, respectively. The combined results for the period ended December 31, 2007 represent the addition of the Predecessor and Successor Periods as well as the pro forma adjustments to reflect the Transactions as if they occurred on January 1, 2007 (“pro forma combined”). This combination does not comply with U.S. GAAP, but is presented because we believe it provides the most meaningful comparison of our results. The consolidated financial statements for the Successor Period reflect the acquisition of Realogy under the purchase method of accounting in accordance with Statement of Financial Accounting Standard (‘SFAS”) No. 141, “Business Combinations” (“SFAS No. 141”). The results of the Successor are not comparable to the results of the Predecessor due to the difference in the basis of presentation of purchase accounting as compared to historical cost. The pro forma combined results do not reflect the actual results we would have achieved had the Merger been completed as of the beginning of the year and are not indicative of our future results of operations.
The aggregate consideration paid in the Merger has been allocated to state the acquired assets and liabilities at fair value as of the acquisition date. The preliminary fair value adjustments (i) increased the carrying value of certain of our assets and liabilities, (ii) established or increased the carrying value of intangible assets for our tradenames, customer relationships, franchise agreements and pendings and listings and (iii) revalued our long-term benefit plan obligations and insurance obligations, among other things. Subsequent to the Merger, interest expense and non-cash depreciation and amortization charges have significantly increased. Finalization of the adjustments to state the assets and liabilities at fair value will be completed by April 10, 2008, within 12 months of the merger date. We expect additional changes to the preliminary allocation and such changes could be material.
During the fourth quarter of 2007, the Company performed its annual impairment review of goodwill and unamortized intangible assets. This review resulted in an impairment charge of $667 million ($445 million net of income tax benefit). The impairment charge reduced intangible assets by $550 million and reduced goodwill by $117 million. The impairment charge impacted the Real Estate Franchise Services segment by $513 million, the Relocation Services segment by $40 million and the Title and Settlement Services segment by $114 million. The impairment is the result of the continued downturn in the residential real estate market in 2007 as well as reduced short term financial projections. The impairment charge is recorded on a separate line in the accompanying consolidated statements of operations and is non-cash in nature.
As discussed under the heading “Industry Trends”, the domestic residential real estate market is in a significant downturn. As a result, our results of operations in 2007 have been adversely affected compared to our operating results in 2006, which were significantly worse than our 2005 operating results. Although cyclical patterns are not atypical in the housing industry the depth and length of the current downturn has proved exceedingly difficult to predict. Despite the current downturn, we believe that the housing market will continue to benefit from expected positive long-term demographic trends, such as population growth and increasing home ownership rates, and economic fundamentals including rising gross domestic product and historically moderate interest rates. We believe that our size and scale will enable us to withstand the current downward trends and enable us to benefit from the developments above and position us favorably for anticipated future improvement in the U.S. existing housing market.
Overview
We are thea global provider of real estate and relocation services and operatereport our businessoperations in the following four segments:
• | Real Estate Franchise Services | ||
• | Company Owned Real Estate Brokerage Services | ||
Relocation Services (known as Cartus) primarily offers clients employee relocation services such as home sale assistance, home finding and other destination services, expense processing, relocation policy counseling and other consulting services, arranging household goods moving services, visa and immigration support, intercultural and language training and group move management services.
Title and Settlement Services (known as Title Resource Group or TRG)—provides full-service title, settlement and vendor management services to real estate companies, affinity groups, corporations and financial institutions with many of Directors ofthese services provided in connection with our real estate brokerage and relocation services business.
Realogy was incorporated on January 27, 2006 to facilitate a plan by Cendant approved a planCorporation (“Cendant”) to separate Cendant into four separateindependent companies—one for each of Cendant’s real estate services, travel distribution services (“Travelport”), hospitality services (including timeshare resorts) (“Wyndham Worldwide”) and vehicle rental businesses. In furtherance of this plan, Cendant transferred all ofbusinesses (“Avis Budget Group”). Prior to July 31, 2006, the assets and liabilities of itsthe real estate services businesses of Cendant were transferred to Realogy and on July 31, 2006, Cendant distributed all of the shares of our common stock held by it to the holders of Cendant common stock issued and outstanding as of the close of business on July 21, 2006, the record date for the distribution. Pursuant todistribution, which was July 21, 2006 (the “Separation”). The Separation was effective on July 31, 2006. The sale of Travelport occurred on August 23, 2006 and the separation plan, Cendant also (i) distributed all of the shares of common stock of Wyndham Worldwide Corporation (“Wyndham Worldwide”), thefrom Cendant subsidiary that directly or indirectly holds the assets and liabilities associatedoccurred simultaneously with Cendant’s hospitality services (including timeshare resorts) businesses, on July 31, 2006 and (ii) sold all of the common stock of Travelport, the Cendant subsidiary that directly or indirectly holds the assets and liabilities associated with Cendant’s travel distribution services businesses, on August 23, 2006. Realogy common stock commenced “regular way” trading on the New York Stock Exchange (“NYSE”) under the symbol “H” on August 1, 2006. On August 29, 2006, Cendant announced that it had changed its name to Avis Budget Group, Inc.
Before our separation from Cendant, we entered into a Separation and Distribution Agreement, a Tax Sharing Agreement and several other agreements with Cendant and Cendant’s other businesses to effect the separation and distribution and provide a framework for our relationships with Cendant and Cendant’s other businesses after the separation. These agreements govern the relationships among us, Cendant, Wyndham Worldwide and Travelport subsequent to the completion of the separation plan and provide for the allocation among us, Cendant, Wyndham Worldwide and Travelport of Cendant’s assets, liabilities and obligations attributable to periods prior to our separation from Cendant. Under the Separation and Distribution Agreement, in particular, we were assigned 62.5% of certain contingent and other corporate assets, and assumed 62.5% of certain contingent litigation liabilities, contingent tax liabilities, and other corporate liabilities, of Cendant or its subsidiaries which are not primarily related to our business or the businesses of Wyndham Worldwide, Travelport or Cendant’s vehicle rental business, and Wyndham Worldwide was assigned 37.5% of such contingent assets and assumed 37.5% of such contingent liabilities. The contingent assets of Cendant or its subsidiaries include assets relating to rights to receive payments under certain tax-related agreements with former businesses of Cendant and rights under a certain litigation claim. We have not quantified the value of the contingent assets as these assets are subject to contingency in their realization and GAAP does not allow us to record any of the Cendant contingent assets on our balance sheet. The contingent liabilities of Cendant or its subsidiaries include liabilities relating to (i) Cendant’s terminated or divested businesses, (ii) liabilities
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The actual amount that we may be requiredaccompanying consolidated and combined financial statements of the Company and Predecessor reflect the consolidated operations of Realogy Corporation and its subsidiaries as a separate, stand-alone entity subsequent to payJuly 31, 2006, combined with the historical operations of the real estate services businesses which were operated as part of Cendant prior to July 31, 2006. These financial statements include the entities in which Realogy directly or indirectly has a controlling financial interest and various entities in which Realogy has investments recorded under these arrangements could vary depending upon the outcomeequity method of any unresolved matters, whichaccounting.
Our combined results of operations, financial position and cash flows for periods prior to August 1, 2006, may not be resolved for several years. In addition, if anyindicative of its future performance and do not necessarily reflect what its combined results of operations, financial position and cash flows would have been had the other parties responsible for all orCompany operated as a portion of such liabilities were to defaultseparate, stand-alone entity during the periods presented, including changes in its payment of costs or expenses related to any such liability, each non-defaulting party (including Cendant) would be required to pay an equal portion of the amounts in default. Additionally, generally accepted accounting principles prohibit usoperations and Cendant from recording amounts for any contingent assets that we may be entitled to receive upon favorable resolution of certain unresolved matters. The benefit resulting from such matters will not be recorded within Realogy’s financial statements until realization is assured beyond a reasonable doubt.
Certain corporate and general and administrative expenses, including those related to executive management, information technology, tax, insurance, accounting, legal and treasury services and certain employee benefits have been allocated for periods prior to the date of certainSeparation by Cendant legacy legal matters and the favorable resolution of federal income tax matters associated with Cendant’s 1999 shareholder litigation position regarding the deductibility of expenses associated with the shareholder class action litigation resulting from the merger with CUC. In addition, the due to former parent balance of $648 million includes approximately $40 million of health and welfare claims that were administrated and paid by Avis Budget since separation, for which the Company reimbursed Avis Budget in January 2007.
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Merger Agreement with Affiliates of Apollo Management VI, L.P.
On December 15, 2006, we entered into an Agreementagreement and Planplan of Mergermerger (the “Merger Agreement”) with Domus Holdings Corp., (“Domus Holdings”) and Domus Acquisition Corp., which are affiliates of Apollo Management VI, L.P.
At the effective time of the merger,Merger, each issued and outstanding share of our common stock outstanding immediately prior to the Merger (other than shares held in treasury, shares held by Holdings, Merger Sub or any of the Company will be canceledour or their respective subsidiaries, shares as to which a stockholder has properly exercised appraisal rights, and will be automaticallyany shares which are rolled over by management) was cancelled and converted into the right to receive $30.00 in cash, without interest. In addition, atcash. The Merger was subject to approval by the effective dateholders of not less than a majority of our common stock outstanding, which stockholder approval was obtained on March 30, 2007. Investment funds affiliated with Apollo and an investment fund of co-investors managed by Apollo, as well as members of the merger,Company’s management who purchased Holdings common stock with cash or through rollover equity, contributed $2,001 million (the “Equity Investment”) to Realogy to complete the Merger.
In connection with the Merger, pursuant to the existing terms of our share based awards, all outstanding equity awards will becomeoptions to acquire our common stock and stock appreciation rights (“SARs”) became fully vested and will beimmediately exercisable. All such options and SARs not exercised were, immediately following such conversion, cancelled in exchange for the excess of $30.00 over the exercise price per share of common stock subject to such option or SAR multiplied by the number of shares subject to such option or SAR. At the effective time of the Merger, all of the outstanding restricted stock units (“RSUs”) became fully vested and except as otherwise agreed by a holder and Domus Holdings, converted intorepresented the right to receive a cash payment. For restricted stock units except as otherwise agreed by a holder and Domus Holdings, the cash payment will be equal to the number of units multiplied by $30.00. For stock options and stock appreciation rights, except as otherwise agreed to by the holder and Domus Holdings, the cash payment will be equal to the number of shares or rights underlying the awardof common stock previously subject to such RSU multiplied by $30.00 for each share, less any required withholding taxes. At the amount, if any,effective time of the Merger, all of the deferred amounts held in the unit account denominated in shares (the “DUAs”) represented the right to receive cash with a value equal to the number of shares deemed held in such DUA multiplied by which $30.00 exceeds the exercise price.
The Company incurred indebtedness in connection with the transaction, the aggregate proceeds of which will bewere sufficient to pay the aggregate merger consideration, repay the then outstanding indebtedness (if it so chooses) and pay all related fees and expenses. ConsummationSpecifically, the Company entered into a senior secured credit facility, issued the notes and refinanced the credit facilities governing the Company’s relocation securitization programs (collectively, the “Transactions”). See “—Liquidity and Capital Resources” for additional information on the Transactions. In addition, investment funds affiliated with Apollo and an investment fund of co-investors managed by Apollo, as well as members of the merger is not subjectCompany’s management who purchased Holdings common stock with cash or through rollover equity, contributed $2,001 million to the Company to complete the Transactions, which was contributed by Holdings to us and treated as a financing condition, but is subjectcontribution to various other conditions, including receipt of the affirmative vote of the holders of a majority of the outstanding shares of Realogy, insurance regulatory approvals, and other customary closing conditions. We currently believe that the merger will close in early to mid-April 2007. However, the merger may be delayed or may not be completed at all due to a number of contingencies.
Industry Trends and Our Strategy
Our businesses compete primarily in the domestic residential real estate market.market which currently is in a significant downturn due to various factors including downward pressure on housing prices, credit constraints inhibiting buyers, an exceptionally large inventory of unsold homes at the same time that sales volumes are decreasing and a decrease in consumer confidence, which accelerated in the second half of 2007. Although cyclical patterns are not atypical in the housing industry the depth and length of the current downturn has proven exceedingly difficult to predict. Residential real estate brokerage companies typically realize revenues in the form of a commission that is based on a percentage of the price of each home sold. As a result, the real estate industry generally benefits from rising home prices (and conversely is harmed by falling prices) and increased volume of homesales. We believe that long-term demand for housing and the growth of our industry is primarily driven by the economic health of the domestic economy, positive demographic trends such as population growth and increasing home ownership rates, interest rates and locally based dynamics such as demand relative to supply.
During the first half of this decade, based on information published by National Association of Realtors (“NAR”), existing homesales volumes have risen to their highest levels in history. That growth rate has reversed in 2006 and Federal National Mortgage Association (“FNMA”) and NAR are both reporting,2007 as of
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| 2007 vs. 2006 | 2006 vs. 2005 | |||||
Number of Existing Homesale Sides | ||||||
NAR | (13 | %)(a) | (9 | %) | ||
FNMA | (13 | %)(a) | (9 | %) | ||
Real Estate Franchise Services | (19 | %) | (18 | %) | ||
Company Owned Real Estate Brokerage Services | (17 | %) | (17 | %) |
| (a) | Data for 2007 is as of March 2008 for FNMA and NAR. |
Existing homesale volume was reported by NAR to be approximately 5.7 million homes for 2007, down from 6.5 million homes in 2006 vs. the high of existing homesale sides during 2006 compared to7.1 million homes in 2005. Our recent financial results confirm this trend as evidenced by our homesale side declines in our Real Estate Franchise Services and Company Owned Real Estate Brokerage Services businesses during 2006businesses. For 2008 compared to 2005.2007, FNMA and NAR, as of March 2008, forecast a decline of 21% and 5%, respectively, in existing homesale sides.
While NAR is a good barometer of the direction of the residential housing market, we believe that homesale statistics will continue to vary between us and NAR mainly due to differences in calculation methodologies and the geographical differences and concentrations in the markets we operate in versus the market nationally. For 2006,instance, comparability is impaired due to NAR’s utilization of seasonally adjusted annualized rates whereas we report actual period over period changes and NAR’s use of median price for its forecasts compared to our Real Estate Franchise Services anduse of average price. Also, NAR uses survey data but we use actual results. Further, differences in weighting by state may contribute to significant statistical variations.
For the year ended December 31, 2007, our Company Owned Real Estate Brokerage Services businesses experienced, without adjusting forrealized approximately 61% of its revenues from California (27%), the effects of acquisitions, closed homesale side decreases of 18%New York metropolitan area (25%) and 17%Florida (9%), respectively, compared to 2005. Inand in 2006, our Company Owned Real Estate Brokerage Services businesses realized approximately 58% of its revenues from California (27%), the New York metropolitan area (21%) and Florida (10%). We believe that the declinedeclines of 17% in the number of homesale sides for each of the years ended December 31, 2007 and 2006, is generally reflective of industry trends, especially in Florida, California and Californiathe New York metropolitan area where our Company Owned Real Estate Brokerage Services segment experienced homesale side declines of 41%22%, 15% and 26%4%, respectively, during 2006. As of February 2007, FNMA and NAR forecast a decline of 8% and 1%, respectively, in existing homesales forthe year ended December 31, 2007 compared to 2006.
Based upon information published by NAR, the national median price of existing homes increased from 2000 to 2005 at a compound annual growth rate, or CAGR, of 10.1%8.9% compared to a CAGR of 6.4%6.2% from 1972 to 2006. ThisAccording to NAR, this rate of increase slowed significantly in 2006 and declined for the first time in 50 years as reflected in the table below.
| 2007 vs. 2006 | 2006 vs. 2005 | |||||
Price of Existing Homes | ||||||
NAR | (1 | %)(a) | 1 | % | ||
FNMA | (5 | %)(a) | (3 | %)(a) | ||
Real Estate Franchise Services | (1 | %) | 3 | % | ||
Company Owned Real Estate Brokerage Services | 8 | % | 5 | % |
(a) | Data for 2007 is as of March 2008 for FNMA and NAR. FNMA revised 2006 vs. 2005 price from a 1% increase to a 3% decrease in February 2008. |
For 2008 compared to 2007, FNMA and NAR are reporting, as of February 2007,March 2008, forecast a 2%decline of 6% and 1% increase in median homesale price, respectively.
According to NAR, the median home sale pricenumber of existing homes for sale increased from 3.45 million homes at December 31, 2006 asto 3.97 million homes at December 31, 2007. This increase in homes represents an increase of 2.3 months of supply from 6.6 months at December 31, 2006 to 8.9 months at December 31, 2007. At October 31, 2007, supply was 10.5 months, which represents the highest level since record keeping began by NAR in 1999. The high level of supply could add downward pressure to the price of existing homesales.
During the current downturn in the residential real estate market, certain of our franchisees have experienced operating difficulties. As a result, for the fourth quarter of 2007, compared to 2005. Duringthe fourth quarter of 2006, we have had to increase our resultsfranchisee bad debt reserve incrementally by $3 million and our reserves for development advance notes and promissory notes by $16 million. In addition, we have confirmed thathad to terminate franchisees more frequently due to their performance and non-payment. We are actively monitoring the growthcollectability of receivables and notes from our franchisees due to the current state of the housing market and this assessment could result in an increase in our bad debts reserves in the average pricefuture.
The business is affected by interest rate volatility. As mortgage rates fall, the number of homesale transactions may increase as home owners choose to move instead of stay in their existing homes sold has slowedor renters decide to purchase a home for the first time. As mortgage rates rise, the number of homesale transactions may decrease as potential home sellers choose to stay with their lower cost mortgage rather than sell their home and pay a higher cost mortgage and potential home buyers choose to rent rather than pay higher mortgage rates. In addition, the recent contraction in comparisonthe subprime mortgage market, the increase in default rates on mortgages and the introduction of more stringent lending standards for home mortgages generally is adversely affecting the general mortgage market. The number of homesale transactions executed by our franchisees and company owned
brokerages may continue to 2005. FNMA and NAR expect this trend will continuedecrease in the near term as they are forecasting, as of February 2007,if there is a decrease of 2% and an increase of 2%, respectively,continued contraction in the median price of existing homes for 2007 compared to 2006.
Despite the near term decline in the number of existing home sales and moderationdecrease in median existing homesale prices, we believe that the housing market will continue to benefit from expected positive long-term demographic trends, such as population growth and increasing home ownership rates, and economic fundamentals including rises inrising gross domestic product (“GDP”) and historically moderate interest rates.
Key Drivers of Our Businesses
Within our Real Estate Franchise Services segment and our Company Owned Real Estate Brokerage Services segment, we measure operating performance using the following key operating statistics: (i) closed homesale sides, which represents either the “buy” side or the “sell” side of a homesale transaction, (ii) average homesale price, which represents the average selling price of closed homesale transactions, (iii) average homesale broker commission rate, which represents the average commission rate earned on either the “buy” side or “sell” side of a homesale transaction and (iv) in our Company Owned Real Estate Brokerage Services segment, gross commission per side which represents the average commission we earn before expenses.
Prior to 2006, the average homesale broker commission rate had been declining several basis points per year, the effect of which was, prior to 2006, more than offset by increases in homesale prices. During 2006 and 2007, the average broker commission rate our franchisees charge their customer and we charge our customer has remained relatively stable (within onefour basis point)points); however, we expect that, over the long term, the modestly declining trend in average brokerage commission rates will continue.
In addition, in our Real Estate Franchise Services segment, we are also useimpacted by the net effective royalty rate, which represents the average percentage of our franchisees’ commission revenues paid to our Real Estate Franchise Services segment as a royalty and royalty per side. Our Company Owned Real Estate Brokerage Services segment has
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Within our Relocation Services segment, we measure operating performance using the following key operating statistics: (i) initiations, which represents the total number of transferees we serve and (ii) referrals, which represents the number of referrals from which we earned revenue from real estate brokers. In our Title and Settlement Services segment, operating performance is evaluated using the following key metrics: (i) purchase title and closing units, which represents the number of title and closing units processed as a result of home purchases, (ii) refinance title and closing units, which represents the number of title and closing units processed as a result of homeowners refinancing their home loans, and (iii) average price per closing unit, which represents the average fee we earn on purchase title and refinancing title sides.
Of these measures, closed homesale sides, average homesale price and average broker commission rate are the most critical to our business and therefore have the greatest impact on our net income (loss) and segment “EBITDA,” which is defined as net income (loss) before depreciation and amortization, interest (income) expense, net (other than Relocation Services interest for securedsecuritization assets and securedsecuritization obligations), income taxestax provision and minority interest, each of which is presented on our Consolidated and Combined Statements of Income.
A sustained decline in existing homesales, any resulting sustained decline in home prices or a sustained or accelerated decline in commission rates charged by brokers, could adversely affect our results of operations by
reducing the royalties we receive from our franchisees and company owned brokerages, reducing the commissions our company owned brokerage operations earn, reducing the demand for our title and settlement services, reducing the referral fees earned by our relocation services business and increasing the risk that our relocation services business will suffer losses in the sale of homes relating to its “at risk” homesale service contracts (i.e., where we purchase the transferring employee’s home and assume the risk of loss in the resale of such home).
The following table presents our drivers for the years ended December 31, 2007 and 2006. See “Results of Operations” below for a discussion as to how the material drivers affected our business for the periods presented.
| Year Ended December 31, | ||||||||||
| 2007 | 2006 | % Change | ||||||||
Real Estate Franchise Services (a) | ||||||||||
Closed homesale sides | 1,221,206 | 1,515,542 | (19%) | |||||||
Average homesale price | $ | 230,346 | $ | 231,664 | (1%) | |||||
Average homesale broker commission rate | 2.49 | % | 2.47 | % | 2bps | |||||
Net effective royalty rate | 5.03 | % | 4.87 | % | 16bps | |||||
Royalty per side | $ | 298 | $ | 286 | 4% | |||||
Company Owned Real Estate Brokerage Services | ||||||||||
Closed homesale sides | 325,719 | 390,222 | (17%) | |||||||
Average homesale price | $ | 534,056 | $ | 492,669 | 8% | |||||
Average homesale broker commission rate | 2.47% | 2.48 | % | (1 bps) | ||||||
Gross commission income per side | $ | 13,806 | $ | 12,691 | 9% | |||||
Relocation Services | ||||||||||
Initiations | 132,343 | 130,764 | 1% | |||||||
Referrals | 78,828 | 84,893 | (7%) | |||||||
Title and Settlement Services | ||||||||||
Purchase Title and Closing Units | 138,824 | 161,031 | (14%) | |||||||
Refinance Title and Closing Units | 37,204 | 40,996 | (9%) | |||||||
Average price per closing unit | $ | 1,471 | $ | 1,405 | 5% | |||||
| (a) | Includes all franchisees except for our Company Owned Real Estate Brokerage Services segment. |
The following table presents our drivers for the years ended December 31, 2006 and 2005. See Results of Operations section for a discussion as to how the drivers affected our business for the periods presented. The following table reflects our actual driver changes, however, it isamounts are adjusted in the footnotes to reflect organic changes.
| Year ended December 31, | ||||||||||||
| % | ||||||||||||
| 2006 | 2005 | Change | ||||||||||
Real Estate Franchise Services | ||||||||||||
Closed homesale sides(a) | 1,515,542 | 1,848,000 | (18)% | |||||||||
| Average homesale price | $ | 231,664 | $ | 224,486 | 3% | |||||||
| Average homesale broker commission rate | 2.47% | 2.51% | (4 bps) | |||||||||
| Net effective royalty rate | 4.87% | 4.69% | 18 bps | |||||||||
| Royalty per side | $ | 286 | $ | 271 | 6% | |||||||
Company Owned Real Estate Brokerage Services | ||||||||||||
Closed homesale sides(b) | 390,222 | 468,248 | (17)% | |||||||||
| Average homesale price | $ | 492,669 | $ | 470,538 | 5% | |||||||
| Average homesale broker commission rate | 2.48% | 2.49% | (1 bps) | |||||||||
| Gross commission income per side | $ | 12,691 | $ | 12,100 | 5% | |||||||
Relocation Services | ||||||||||||
| Initiations | 130,764 | 121,717 | 7% | |||||||||
| Referrals | 84,893 | 91,787 | (8)% | |||||||||
Title and Settlement Services | ||||||||||||
Purchase Title and Closing Units(c) | 161,031 | 148,316 | 9% | |||||||||
Refinance Title and Closing Units(c) | 40,996 | 51,903 | (21)% | |||||||||
| Average price per closing unit | $ | 1,405 | $ | 1,384 | 2% | |||||||
| Year Ended December 31, | ||||||||||
| 2006 | 2005 | % Change | ||||||||
Real Estate Franchise Services (a) | ||||||||||
Closed homesale sides (b) | 1,515,542 | 1,848,000 | (18%) | |||||||
Average homesale price | $ | 231,664 | $ | 224,486 | 3% | |||||
Average homesale broker commission rate | 2.47 | % | 2.51 | % | (4 bps) | |||||
Net effective royalty rate | 4.87 | % | 4.69 | % | 18 bps | |||||
Royalty per side | $ | 286 | $ | 271 | 6% | |||||
Company Owned Real Estate Brokerage Services | ||||||||||
Closed homesale sides (c) | 390,222 | 468,248 | (17%) | |||||||
Average homesale price | $ | 492,669 | $ | 470,538 | 5% | |||||
Average homesale broker commission rate | 2.48 | % | 2.49 | % | (1 bps) | |||||
Gross commission income per side | $ | 12,691 | $ | 12,100 | 5% | |||||
Relocation Services | ||||||||||
Initiations | 130,764 | 121,717 | 7% | |||||||
Referrals | 84,893 | 91,787 | (8%) | |||||||
Title and Settlement Services | ||||||||||
Purchase Title and Closing Units (d) | 161,031 | 148,316 | 9% | |||||||
Refinance Title and Closing Units (d) | 40,996 | 51,903 | (21%) | |||||||
Average price per closing unit | $ | 1,405 | $ | 1,384 | 2% | |||||
| (a) | Includes all franchisees except for our Company Owned Real Estate Brokerage Services segment. |
| (b) | These amounts include only those relating to our third party franchise affiliates and do not include amounts relating to the Company Owned Real Estate Brokerage Services segment. In addition, the amounts presented for the year ended December 31, 2005 include 24,049 sides related to acquisitions made by NRT of our previously franchised affiliates |
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| subsequent to January 1, 2005. Excluding this amount, closed homesale sides would have decreased 17% for the year ended December 31, 2006. |
| (c) | The amounts presented for the year ended December 31, 2006 include 16,298 sides as a result of certain larger acquisitions made by NRT subsequent to January 1, 2005. Excluding this amount, closed homesale sides would have decreased 20% for the year ended December 31, 2006. |
| (d) | The amounts presented for the year ended December 31, 2006 include 31,018 purchase units and 1,255 refinance units, as a result of the acquisition of Texas American Title Company, which was acquired on January 6, 2006. Excluding these amounts, purchase title and closing units and refinance title and closing units would have decreased 12% and 23%, respectively, for the year ended December 31, 2006. |
The following table represents the impact of our revenue drivers on our business operations.
The following table sets forth the impact on segment EBITDA for the year ended December 31, 20062007 assuming actual homesale sides and average selling price of closed homesale transactions, with all else being equal, increased or decreased by 1%, 3% and 5%.
| (thousands) | ||||||||||||||||||||||||||||||||
| ($ millions) | Homesale | Decline of | Increase of | |||||||||||||||||||||||||||||
| Segment | Sides/Average | ($ millions) | ||||||||||||||||||||||||||||||
| EBITDA | Price(1) | 5% | 3% | 1% | 1% | 3% | 5% | |||||||||||||||||||||||||
Homesale Sides change impact on: | ||||||||||||||||||||||||||||||||
Real Estate Franchise Services(2) | $ | 613 | 1,516 | sides | (22 | ) | (13 | ) | (4 | ) | 4 | 13 | 22 | |||||||||||||||||||
Company Owned Real Estate Brokerage Services(3) | 25 | 390 | sides | (73 | ) | (44 | ) | (15 | ) | 15 | 44 | 73 | ||||||||||||||||||||
Homesale Average Price change impact on: | �� | |||||||||||||||||||||||||||||||
Real Estate Franchise Services(2) | 613 | $ | 232 | (22 | ) | (13 | ) | (4 | ) | 4 | 13 | 22 | ||||||||||||||||||||
Company Owned Real Estate Brokerage Services(3) | 25 | $ | 493 | (73 | ) | (44 | ) | (15 | ) | 15 | 44 | 73 | ||||||||||||||||||||
| Homesale Sides/ Average Price (1) | Decline of | Increase of | ||||||||||||||||
| 5% | 3% | 1% | 1% | 3% | 5% | |||||||||||||
| (units in thousands) | ($ millions) | |||||||||||||||||
Homesale Sides change impact on: | ||||||||||||||||||
Real Estate Franchise Services (2) | 1,221 sides | (18 | ) | (11 | ) | (4 | ) | 4 | 11 | 18 | ||||||||
Company Owned Real Estate Brokerage Services (3) | 326 sides | (68 | ) | (41 | ) | (14 | ) | 14 | 41 | 68 | ||||||||
Homesale Average Price change impact on: | ||||||||||||||||||
Real Estate Franchise Services (2) | $ | 230 | (18 | ) | (11 | ) | (4 | ) | 4 | 11 | 18 | |||||||
Company Owned Real Estate Brokerage Services (3) | $ | 534 | (68 | ) | (41 | ) | (14 | ) | 14 | 41 | 68 | |||||||
| (1) | Average price represents the average selling price of closed homesale transactions. | |
| (2) | Increase/(decrease) relates to impact on non-company owned real estate brokerage operations only. | |
| (3) | Increase/(decrease) represents impact on company owned real estate brokerage operations and related intercompany royalties to our real estate franchise services operations. |
RESULTS OF OPERATIONSResults of Operations
Discussed below are our consolidated and combined results of operations and the results of operations for each of our reportable segments. The reportable segments presented below represent our operating segments for which separate financial information is available and which is utilized on a regular basis by our chief operating decision maker to assess performance and to allocate resources. In identifying our reportable segments, we also consider the nature of services provided by our operating segments. Management evaluates the operating results of each of our reportable segments based upon revenue and EBITDA. Our presentation of EBITDA may not be comparable to similarly-titled measures used by other companies.
For periods prior to our separation from Cendant, EBITDA includes cost allocations from Cendant representing our portion of general corporate overhead. For the years ended December 31, 2006 2005 and 2004,2005, Cendant allocated costs of $24 million $38 million and $33$38 million, respectively. Cendant allocated such costs to us based on a percentage of our forecasted revenues or, in the case of our Company Owned Real Estate Brokerage Services segment, based on a percentage of revenues after agent commission expense. General corporate expense allocations include costs related to Cendant’s executive management, tax, accounting, legal and treasury services, certain employee benefits and real estate usage for common space. The allocations are not necessarily indicative of the actual expenses that would have been incurred had we been operating as a separate, stand-alone public company for the periods presented.
Pro Forma Combined Statement of Operations
The following pro forma combined statement of operations data for the year ended December 31, 2007 has been derived from our historical consolidated financial statements included elsewhere herein and has been prepared to give effect to the Transactions, assuming that the Transactions occurred on January 1, 2007.
The unaudited pro forma combined statement of operations for the year ended December 31, 2007 has been adjusted to reflect:
the elimination of certain costs relating to the Merger;
61
the elimination of certain revenues and expenses that resulted from changes in the estimated fair value of assets and liabilities (as discussed in more detail below) as a result of purchase accounting;
additional indebtedness incurred in connection with the Transactions;
transaction fees and debt issuance costs incurred as a result of the Transactions;
incremental interest expense resulting from additional indebtedness incurred in connection with the Transactions; and
incremental borrowing costs as a result of the relocation securitization refinancings.
The pro forma combined statement of operations for the year ended December 31, 2007 does not give effect to the following non-recurring items that were realized in connection with the Transactions: (i) the amortization of a pendings and listings intangible asset of $337 million that was recognized in the opening balance sheet and is amortized over the estimated closing period of the underlying contract (in most cases approximately 5 months), (ii) merger costs of $104 million which is comprised primarily of $56 million for the accelerated vesting of stock based incentive awards granted by the Company, $25 million of employee retention and supplemental bonus costs incurred in connection with the Transactions and $19 million of professional costs incurred by the Company in connection with the Merger, (iii) the expense of certain executive Separation benefits in the amount of $50 million and (iv) the elimination of $18 million of non-recurring fair value adjustments for purchase accounting.
In addition, the unaudited pro forma combined statement of operations do not give effect to certain of the adjustments reflected in our Adjusted EBITDA, as presented under “EBITDA and Adjusted EBITDA.
Assumptions underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with this pro forma combined statement of operations.
Management believes that the assumptions used to derive the pro forma combined statement of operations are reasonable given the information available; however, such assumptions are subject to change and the effect of any such change could be material. The pro forma combined statement of operations has been provided for informational purposes only and is not necessarily indicative of the results of future operations or the actual results that would have been achieved had the Transactions occurred on the date indicated.
Realogy Corporation and the Predecessor
Unaudited Pro Forma Combined Statement of Operations
For the Year ended December 31, 2007
| Predecessor | Successor | |||||||||||||||
(In millions) | Period from January 1 Through April 9, 2007 | Period From April 10 Through December 31, 2007 | Transactions | Pro Forma Combined | ||||||||||||
Revenues | ||||||||||||||||
Gross commission income | $ | 1,104 | $ | 3,409 | $ | — | $ | 4,513 | ||||||||
Service revenue | 216 | 622 | 11 | (a) | 849 | |||||||||||
Franchise fees | 106 | 318 | — | 424 | ||||||||||||
Other | 67 | 125 | (2 | )(b) | 190 | |||||||||||
Net revenues | 1,493 | 4,474 | 9 | 5,976 | ||||||||||||
Expenses | ||||||||||||||||
Commission and other agent-related costs | 726 | 2,272 | — | 2,998 | ||||||||||||
Operating | 489 | 1,329 | (7 | )(a) | 1,811 | |||||||||||
Marketing | 84 | 182 | — | 266 | ||||||||||||
General and administrative | 123 | 180 | (47 | )(c) | 256 | |||||||||||
Former parent legacy costs (benefit), net | (19 | ) | 27 | — | 8 | |||||||||||
Separation costs | 2 | 4 | — | 6 | ||||||||||||
Restructuring costs | 1 | 35 | — | 36 | ||||||||||||
Merger costs | 80 | 24 | (104 | )(d) | — | |||||||||||
Impairment of intangible assets and goodwill | — | 667 | — | 667 | ||||||||||||
Depreciation and amortization | 37 | 502 | (318 | )(e) | 221 | |||||||||||
Interest expense | 43 | 495 | 104 | (f) | 642 | |||||||||||
Interest income | (6 | ) | (9 | ) | — | (15 | ) | |||||||||
Total expenses | 1,560 | 5,708 | (372 | ) | 6,896 | |||||||||||
Income (loss) before income taxes and minority interest | (67 | ) | (1,234 | ) | 381 | (920 | ) | |||||||||
Provision for income taxes | (23 | ) | (439 | ) | 145 | (g) | (317 | ) | ||||||||
Minority interest, net of tax | — | 2 | — | 2 | ||||||||||||
Net income (loss) | $ | (44 | ) | $ | (797 | ) | $ | 236 | $ | (605 | ) | |||||
See Notes to Unaudited Pro Forma Combined Statement of Operations.
Notes to Unaudited Pro Forma Combined Statement of Operations
(in millions)
| (a) | Reflects the elimination of the negative impact of $18 million of non-recurring fair value adjustments for purchase accounting at the operating business segments primarily related to deferred revenue, referral fees, insurance accruals and fair value adjustments on at risk homes. |
| (b) | Reflects the incremental borrowing costs for the period from January 1, 2007 to April 9, 2007 of $2 million as a result of the securitization facilities refinancings. The borrowings under the securitization facilities are advanced to customers of the relocation business and the Company generally earns interest income on the advances, which are recorded within other revenue net of the borrowing costs under the securitization arrangement. |
| (c) | Reflects (i) incremental expenses for the period from January 1, 2007 to April 9, 2007 in the amount of $3 million representing the estimated annual management fee to be paid by Realogy to Apollo (as described in “ Item 13—Certain Relationships and Related Transactions, and Director Independence—Apollo Management Agreement and Transaction Fee”), and (ii) the elimination of $50 million of separation benefits payable to our former CEO upon retirement, the amount of which was determined as a result of a change in control provision in his employment agreement with the Company. |
| (d) | Reflects the elimination of $104 million of merger costs which are comprised primarily of $56 million for the accelerated vesting of stock based incentive awards granted by the Company, $25 million of employee retention and supplemental bonus payments incurred in connection with the Transactions and $19 million of professional costs incurred by the Company associated with the Merger. |
| (e) | Reflects an increase in amortization expenses for the period from January 1, 2007 to April 9, 2007 resulting from the values allocated on a preliminary basis to our identifiable intangible assets, less the amortization of pendings and listings. Amortization is computed using the straight-line method over the asset’s related useful life. |
(In millions) | Estimated | Estimated | Amortization | |||||
Real estate franchise agreements | $2,019 | 30 years | $ | 67 | ||||
Customer relationships | 467 | 10-20 years | 26 | |||||
License agreement—Franchise | 42 | 47 years | 1 | |||||
Estimated annual amortization expense | 94 | |||||||
Less: | ||||||||
Amortization expense recorded for the items above | (75 | ) | ||||||
Amortization expense for non-recurring pendings and listings | (337 | ) | ||||||
Pro forma adjustment | $ | (318 | ) | |||||
| (f) | Reflects incremental interest expense for the period from January 1, 2007 to April 9, 2007 in the amount of $104 million related to the indebtedness incurred in connection with the Merger which includes $6 million of incremental deferred financing costs amortization and $2 million of incremental bond discount amortization relating to the senior notes, senior toggle notes and senior subordinated notes. |
For pro forma purposes we have assumed a weighted average interest rate of 8.24% for the variable interest rate debt under the term loan facility and the revolving credit facility, based on the 3-month LIBOR rate as of December 31, 2007. This variable interest rate debt is reduced to reflect the $775 million of floating to fixed interest rate swap agreements. A 100 bps change in the interest rate assumptions would change pro forma interest expense by approximately $24 million. The adjustment assumes straight-line amortization of capitalized financing fees over the respective maturities of the indebtedness.
| (g) | Reflects the estimated tax effect resulting from the pro forma adjustments at an estimated rate of 38%. We expect our tax payments in future years, however, to vary from this amount. |
EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA
EBITDA is defined as net income before depreciation and amortization, interest (income) expense, net (other than relocation services interest for securitization assets and securitization obligations), income taxes and minority interest, each of which is presented in our audited consolidated and combined statements of operations included elsewhere in this Annual Report. Pro Forma Combined EBITDA is calculated in the same manner as EBITDA but is based on the pro forma combined results for 2007. Pro forma combined Adjusted EBITDA is calculated by adjusting Pro Forma Combined EBITDA by the items described below. We believe EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA are useful as supplemental measures in evaluating the performance of our operating businesses and provides greater transparency into our consolidated and combined results of operations. EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA are measures used by our management, including our chief operating decision maker, to perform such evaluation, and are factors in measuring compliance with debt covenants relating to certain of our borrowing arrangements. EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA should not be considered in isolation or as a substitute for net income or other statement of operations data prepared in accordance with U.S. generally accepted accounting principles. Our presentation of EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA may not be comparable to similarly titled measures used by other companies. A reconciliation of Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA to net income is included in the table below.
We believe EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA facilitate company-to-company operating performance comparisons by backing out potential differences caused by variations in capital structures (affecting net interest expense), taxation and the age and book depreciation of facilities (affecting relative depreciation expense), which may vary for different companies for reasons unrelated to operating performance. We further believe that EBITDA is frequently used by securities analysts, investors and other interested parties in their evaluation of companies, many of which present an EBITDA measure when reporting their results. EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA are not necessarily comparable to other similarly titled financial measures of other companies due to the potential inconsistencies in the method of calculation. In addition, Pro Forma Combined Adjusted EBITDA as presented in this table corresponds to the definition of “EBITDA” used in the senior secured credit facility and the indentures governing the notes to test the permissibility of certain types of transactions, including debt incurrence. See also “Financial Obligations—Covenants Under Our Senior Secured Credit Facility and the Notes.”
EBITDA, Pro Forma Combined EBITDA and Pro Forma Combined Adjusted EBITDA have limitations as analytical tools, and you should not consider them either in isolation or as substitutes for analyzing our results as reported under GAAP. Some of these limitations are:
these EBITDA measures do not reflect changes in, or cash requirement for, our working capital needs;
these EBITDA measures do not reflect our interest expense (except for interest related to our securitization obligations), or the cash requirements necessary to service interest or principal payments, on our debt;
these EBITDA measures do not reflect our income tax expense or the cash requirements to pay our taxes;
Pro Forma Combined Adjusted EBITDA includes pro forma cost savings and the pro forma full year effect of NRT acquisitions and RFG acquisitions/new franchisees. These adjustments may not reflect the actual cost savings or pro forma effect recognized in future periods;
these EBITDA measures do not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments;
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and these EBITDA measures do not reflect any cash requirements for such replacements; and
other companies in our industry may calculate these EBITDA measures differently so they may not be comparable.
A reconciliation of pro forma combined net income (loss) to Pro Forma Combined Adjusted EBITDA is set forth in the following table:
| Pro Forma Combined For the Year Ended December 31, 2007 | ||||
Pro forma combined net income (loss) | $ | (605 | ) | |
Minority interest, net of tax | 2 | |||
Provision for income taxes | (317 | ) | ||
Income (loss) before income taxes and minority interest | (920 | ) | ||
Interest expense (income), net | 627 | |||
Depreciation and amortization | 221 | |||
Pro forma combined EBITDA | (72 | ) | ||
Impairment of intangible assets and goodwill | 667 | |||
Better Homes and Gardens start up costs | — | |||
Former parent legacy costs (benefit), net, separation costs and restructuring costs (a) | 50 | |||
Incremental securitization interest costs (b) | 5 | |||
Integration and conversion costs (c) | 1 | |||
Non-cash charges (d) | 61 | |||
Pro forma proceeds from contingent assets (e) | 12 | |||
Pro forma cost savings (f) | 63 | |||
Sponsor fees (g) | 15 | |||
Pro forma effect of NRT acquisitions and RFG acquisitions/new franchisees (h) | 14 | |||
Pro forma combined Adjusted EBITDA | $ | 816 | ||
| (a) | Consists of $36 million of restructuring costs, $8 million for former parent legacy costs and $6 million of separation costs. |
| (b) | Incremental borrowing costs incurred as a result of the securitization facilities refinancing. |
| (c) | Represents the elimination of integration and conversion costs related to NRT acquisitions. |
| (d) | Represents the elimination of non-cash expenses including $35 million for the change in the allowance for doubtful accounts and reserves for development advance notes and promissory notes, $14 million of incremental reserves for “at risk” homes, $10 million of stock based compensation expense, $1 million for foreign exchange hedges and $1 million of non-cash rent expense. |
| (e) | Wright Express Corporation (“WEX”) was divested by Cendant in February 2005 through an initial public offering (“IPO”). As a result of such IPO, the tax basis of WEX’s tangible and intangible assets increased to their fair market value which may reduce federal income tax that WEX might otherwise be obligated to pay in future periods. WEX is required to pay Cendant 85% of any tax savings related to the increase in fair value utilized for a period of time that we expect will be beyond the maturity of the notes. Cendant is required to pay 62.5% of these tax savings payments received from WEX to us. |
| (f) | Represents actual costs incurred that are not expected to recur in subsequent periods due to restructuring activities initiated during the year ended December 31, 2007. From this and other restructuring, we expect to reduce our operating costs by approximately $68 million annually on a run-rate basis and estimate that $5 million of such savings were already realized in 2007. |
| (g) | Represents the elimination of annual management fees payable to Apollo. |
| (h) | Represents the estimated impact of acquisitions made by NRT and RFG acquisitions/new franchisees as if they had been acquired or signed, respectively, on January 1, 2007. We have made a number of assumptions in calculating such estimate and there can be no assurance that we would have generated the projected levels of EBITDA had we owned the acquired entities or entered into the franchise contracts on January 1. |
Pro Forma Combined Revenues and EBITDA by Segment
The reportable segments information below for 2007 is presented on a pro forma combined basis and is utilized in our discussion below of the 2007 annual operating results compared to 2006. The pro forma combined financial information is presented for information purposes only and is not intended to represent or be indicative of the consolidated results of operations or financial position that we would have reported had the Transactions been completed as of January 1, 2007 and for the period presented, and should not be taken as representative of our consolidated results of operations or financial condition for future periods.
| Revenues (a) | |||||||||||||||||||
| Pro Forma Combined | Transactions | Successor | Predecessor | ||||||||||||||||
| Year Ended December 31, 2007 | Period From April 10 Through December 31, 2007 | Period From January 1 Through April 9, 2007 | Year Ended December 31, 2006 | ||||||||||||||||
Real Estate Franchise Services | $ | 818 | $ | — | $ | 601 | $ | 217 | $ | 879 | |||||||||
Company Owned Real Estate Brokerage Services | 4,571 | — | 3,455 | 1,116 | 5,022 | ||||||||||||||
Relocation Services | 531 | 9 | 385 | 137 | 509 | ||||||||||||||
Title and Settlement Services | 372 | — | 275 | 97 | 409 | ||||||||||||||
Corporate and Other (b) | (316 | ) | — | (242 | ) | (74 | ) | (327 | ) | ||||||||||
Total Company | $ | 5,976 | $ | 9 | $ | 4,474 | $ | 1,493 | $ | 6,492 | |||||||||
| (a) | Transactions between segments are eliminated in consolidation. Revenues for the Real Estate Franchise Services segment include intercompany royalties and marketing fees paid by the Company Owned Real Estate Brokerage Services segment of $316 million and $327 million for the year ended December 31, 2007 and 2006, respectively. Such amounts are eliminated through the Corporate and Other line. Revenues for the Relocation Services segment include $52 million and $55 million of intercompany referral and relocation fees paid by the Company Owned Real Estate Brokerage Services segment during the year ended December 31, 2007 and 2006, respectively. Such amounts are recorded as contra-revenues by the Company Owned Real Estate Brokerage Services segment. There are no other material inter-segment transactions. |
| (b) | Includes the elimination of transactions between segments. |
Real Estate Franchise Services Company Owned Real Estate Brokerage Services Relocation Services Title and Settlement Services Corporate and Other Total Company Less: Depreciation and amortization Interest expense, net Income (loss) before income taxes and minority interest EBITDA (a) (b) Pro Forma
Combined Transactions Successor Predecessor Year Ended
December 31,
2007 Period From
April 10
Through
December 31,
2007 Period From
January 1
Through
April 9,
2007 Year Ended
December 31,
2006 $ 5 $ 13 $ (130 ) $ 122 $ 613 24 27 44 (47 ) 25 52 23 17 12 103 (93 ) 7 (96 ) (4 ) 45 (60 ) 97 (81 ) (76 ) (11 ) (72 ) 167 (246 ) 7 775 221 (318 ) 502 37 142 627 104 486 37 29 $ (920 ) $ 381 $ (1,234 ) $ (67 ) $ 604
| (a) | Includes $36 million of restructuring costs, $8 million of former parent legacy costs and $6 million of separation costs for the year ended December 31, 2007 compared to $66 million, $46 million and $4 million of separation costs, restructuring costs and merger costs, respectively, offset by a benefit of $38 million of former parent legacy costs, for the year ended December 31, 2006. |
| (b) | 2007 EBITDA includes an impairment charge of $667 million which reduced intangible assets by $550 million and reduced goodwill by $117 million. The impairment charge impacted the Real Estate Franchise Services segment by $513 million, the Relocation Services segment by $40 million and the Title and Settlement Services segment by $114 million. |
Pro Forma Combined Year Ended December 31, 2007 vs. Year Ended December 31, 2006
Our pro forma combined results comprised the following:
| Year Ended December 31, | |||||||||||
| Pro Forma Combined 2007 | 2006 | Change | |||||||||
Net revenues | $ | 5,976 | $ | 6,492 | $ | (516 | ) | ||||
Total expenses (1) | 6,896 | 5,888 | 1,008 | ||||||||
Income (loss) before income taxes and minority interest | (920 | ) | 604 | (1,524 | ) | ||||||
Provision for income taxes | (317 | ) | 237 | (554 | ) | ||||||
Minority interest, net of tax | 2 | 2 | — | ||||||||
Net income (loss) | $ | (605 | ) | $ | 365 | $ | (970 | ) | |||
| (1) | Total expenses for the year ended December 31, 2007 includes an impairment charge of $667 million which reduced intangible assets by $550 million and reduced goodwill by $117 million, $36 million of restructuring costs, $8 million of former parent legacy costs and $6 million of separation costs. Total expenses for the year ended December 31, 2006 include $66 million of separation costs, $46 million of restructuring costs and $4 million of merger costs offset by a benefit of $38 million of former parent legacy costs. |
Net revenues decreased $516 million (8%) for 2007 compared with 2006 principally due to a decrease in revenues for our Company Owned Real Estate Brokerage segment, reflecting decreases in transaction sides volume across the real estate industry, partially offset by growth in the average prices of homes sold.
Total expenses increased $1,008 million (17%) primarily due to the following:
an impairment charge of $667 million which reduced intangible assets by $550 million and reduced goodwill by $117 million;
incremental depreciation and amortization expense of $79 million primarily from the amortization of the intangible assets established from the merger with Apollo;
incremental interest expense of $585 million from the increased level of debt;
a decrease in the former parent legacy benefit of $46 million due to the favorable resolution of certain legacy matters in 2006 compared to 2007;
an increase of $42 million in general and administrative expense primarily due to incremental stand-alone corporate company expenses for a full year rather than four months in 2006;
offset by:
a decrease of $337 million in commission expenses paid to real estate agents;
a decrease in separation costs of $60 million in 2007 compared to 2006; and
lower restructuring costs of $10 million.
Our effective tax rates for the year ended December 31, 2007 was 34% compared to 39% for the year ended December 31, 2006. The tax benefit realized for 2007 was reduced by tax expense related to non-deductible transaction costs incurred in connection with our acquisition by Apollo and the impairment of non-deductible goodwill.
Following is a more detailed discussion of the results of each of our reportable segments for the years ended December 31:
| Revenues | EBITDA (b) | Margin | |||||||||||||||||||||||||||||
| Pro Forma Combined 2007 | 2006 | % Change | Pro Forma Combined 2007 | 2006 | % Change | Pro Forma Combined 2007 | 2006 | Change | |||||||||||||||||||||||
Real Estate Franchise Services | $ | 818 | $ | 879 | (7 | ) | $ | 5 | $ | 613 | (99 | ) | 1 | % | 70 | % | (69 | ) | |||||||||||||
Company Owned Real Estate Brokerage Services | 4,571 | 5,022 | (9 | ) | 24 | 25 | (4 | ) | 1 | — | 1 | ||||||||||||||||||||
Relocation Services | 531 | 509 | 4 | 52 | 103 | (50 | ) | 10 | 20 | (10 | ) | ||||||||||||||||||||
Title and Settlement Services | 372 | 409 | (9 | ) | (93 | ) | 45 | (307 | ) | (25 | ) | 11 | (36 | ) | |||||||||||||||||
Corporate and Other (a) | (316 | ) | (327 | ) | * | (60 | ) | (11 | ) | * | |||||||||||||||||||||
Total Company | $ | 5,976 | $ | 6,492 | (8 | ) | (72 | ) | 775 | (109 | ) | (1 | %) | 12 | % | (13 | ) | ||||||||||||||
Less: | |||||||||||||||||||||||||||||||
Depreciation and amortization | 221 | 142 | |||||||||||||||||||||||||||||
Interest expense net | 627 | 29 | |||||||||||||||||||||||||||||
Income (loss) before income taxes and minority interest | $ | (920 | ) | $ | 604 | ||||||||||||||||||||||||||
| (*) | not meaningful |
| (a) | Revenues includes the elimination of transactions between segments, which consists of intercompany royalties and marketing fees paid by our Company Owned Real Estate Brokerage Services segment of $316 million and $327 million during the year ended December 31, 2007 and 2006, respectively. EBITDA includes unallocated corporate overhead. In 2006, the Company incurred four months of stand alone corporate costs compared to the full year for 2007. |
| (b) | 2007 EBITDA includes an impairment charge of $667 million which reduced intangible assets by $550 million and reduced goodwill by $117 million. The impairment charge impacted the Real Estate Franchise Services segment by $513 million, the Relocation Services segment by $40 million and the Title and Settlement Services segment by $114 million. |
As described in the aforementioned table, EBITDA margin for “Total Company” expressed as a percentage to revenues decreased thirteen percentage points for 2007 compared with 2006 primarily as a result of the impairment charge of $667 million for intangible assets and goodwill and lower operating results discussed below. EBITDA for 2007 includes $36 million of restructuring costs, $8 million of former parent legacy costs and $6 million of separation costs. EBITDA for 2006 includes $66 million of separation costs, $46 million of restructuring costs and $4 million of merger costs offset by a benefit of $38 million of former parent legacy costs. Certain of these costs were specific to the business segments and therefore contributed to the change in EBITDA for each of the segments discussed below.
On a segment basis, the Real Estate Franchise Services segment margin decreased sixty nine percentage points to 1% from 70% in 2006. The year ended December 31, 2007 included a $513 million impairment of intangible assets (accounted for 62 percentage points of the margin decrease) as well as a decrease in the number of homesale transactions partially offset by an increase in the net effective royalty rate and the average homesale broker commission rate. The Company Owned Real Estate Brokerage Services segment margin increased one percentage point to 1%. The year ended December 31, 2007 reflected a decrease in the number of homesale transactions partially offset by an increase in the average homesale price and reduced restructuring costs and separation costs compared to 2006. The Relocation Services segment margin decreased ten percentage points to 10% from 20% in the comparable period primarily driven by a $40 million impairment of intangible assets and goodwill (accounted for 7 percentage points of the margin decrease) as well as increased costs related to “at risk” homesale transactions, partially offset by a reduction in separation costs of $12 million recognized in 2006 and an increase in international revenue. The Title and Settlement Services segment margin decreased thirty six percentage points to (25%) from 11% in 2006. The decrease in margin profitability was mainly attributable to a $114 million impairment of intangible assets and goodwill (accounted for 31 percentage points of the margin decrease) as well as reduced homesale and refinancing volume.
The Corporate and Other revenue elimination for the year ended December 31, 2007 was ($316) million compared to ($327) million in the same period in 2006. The Corporate and Other EBITDA reduction was due to incremental stand-alone corporate company expenses incurred for the full year in 2007 compared to only four months in 2006, a reduction in the former parent legacy benefit of $46 million and $15 million of management fees payable to Apollo, partially offset by a reduction of $22 million of corporate separation costs recognized in 2006.
Real Estate Franchise Services
Pro forma combined revenues and pro forma combined EBITDA decreased $61 million to $818 million and $608 million to $5 million, respectively, in 2007 compared with 2006.
We franchise our real estate brokerage franchise systems to real estate brokerage businesses that are independently owned and operated. We provide operational and administrative services, tools and systems to franchisees, which are designed to assist franchisees in achieving increased revenue and profitability. Such services include national and local advertising programs, listing and agent-recruitment tools, training and volume purchasing discounts through our preferred vendor programs. Franchise revenue principally consists of royalty
and marketing fees from our franchisees. The royalty received is primarily based on a percentage of the franchisee’s commissions and/or gross commission income. Royalty fees are accrued as the underlying franchisee revenue is earned (upon close of the homesale transaction). Annual volume incentives given to certain franchisees on royalty fees are recorded as a reduction to revenue and are accrued for in relative proportion to the recognition of the underlying gross franchise revenue. Franchise revenue also includes initial franchise fees, which are generally non-refundable and are recognized by us as revenue when all material services or conditions relating to the sale have been substantially performed (generally when a franchised unit opens for business). Royalty increases or decreases are recognized with little or no corresponding increase or decrease in expenses due to the significant operating leverage within the franchise operations. In addition to royalties received from our third-party franchisees, our company owned real estate brokerage services segment continues to pay royalties to the Real Estate Franchise Services segment. However, these intercompany royalties, which approximated $299 million and $327 million during 2007 and 2006, respectively, are eliminated in consolidation through the Corporate and Other segment and therefore have no impact on consolidated and combined revenues and EBITDA, but do affect segment level revenues and EBITDA. See “Company Owned Real Estate Brokerage Services” for a discussion as to the drivers related to this period over period revenue decrease for real estate franchise services.
Apart from the decrease in the intercompany royalties noted above, the decrease in revenue is primarily driven by a $67 million decrease in domestic third-party franchisee royalty revenue which was attributable to a 19% decrease in the number of homesale transactions from our third-party franchisees and 1% decrease in the average price of homes sold. These decreases were partially offset by an increase in the average broker commission rate earned by our franchises to 2.49% in 2007 from 2.47% in 2006. The average brokerage commission rate has remained stable (within four basis points) for 2006 and 2007. Partially offsetting the revenue decline due to lower sides, the overall net effective royalty rate we earn on commission revenue generated by our franchisees increased to 5.03% in 2007 from 4.87% in 2006 as a result of lower annual volume incentives being earned by our franchisees.
Consistent with our international growth strategy, international revenues increased $14 million to $31 million in connection with the licensing of our brand names in certain countries or international regions, and an increase in revenue from foreign franchisees of $7 million, of which $3 million is incremental revenue related to the acquisition of the Coldwell Banker Canada master franchise.
We also earn marketing fees from our franchisees and utilize such fees to fund advertising campaigns on behalf of our franchisees. In arrangements under which we do not serve as an agent in coordinating advertising campaigns, marketing revenues are accrued as the revenue is earned, which occurs as related marketing expenses are incurred. We do not recognize revenues or expenses in connection with marketing fees we collect under arrangements in which we function as an agent on behalf of our franchisees.
The decrease in EBITDA for 2007 compared to 2006 is principally due to a $513 million impairment of intangible assets, the net reduction in revenues noted above as well as an increase in bad debt expense and reserves for development advance notes and promissory notes of $23 million and an increase of $13 million for sales related expenses, personnel related costs and costs for customer service activities. These decreases are partially offset by a $3 million reduction in administrative costs and an $11 million reduction in separation costs.
Company Owned Real Estate Brokerage Services
Pro forma combined revenues decreased $451 million to $4,571 million and pro forma combined EBITDA decreased $1 million to $24 million for 2007 compared with 2006.
As an owner-operator of real estate brokerages, we assist home buyers and sellers in listing, marketing, selling and finding homes. We earn commissions for these services, which are recorded upon the closing of a real
estate transaction (i.e., purchase or sale of a home), which we refer to as gross commission income. We then pay commissions to real estate agents, which are recognized concurrently with associated revenues. The decrease in revenues from our Company Owned Real Estate Brokerage Services segment was partially offset by incremental revenues attributable to larger acquisitions made subsequent to January 1, 2006. Together these acquisitions contributed incremental revenues of $38 million and EBITDA of $6 million to 2007 operating results (the EBITDA contribution of $6 million is net of $2 million of intercompany royalties paid to the Real Estate Franchise Services segment).
Apart from these acquisitions, revenues decreased $489 million and EBITDA decreased $7 million, respectively, for 2007 compared with the same period in 2006. The decrease in organic revenues was substantially comprised of reduced commission income earned on homesale transactions, which was primarily driven by a 17% decline in the number of homesale transactions, partially offset by an 8% increase in the average price of homes sold. The same store 8% period-over-period increase in average home price is due to the geographic location of our brokerage offices and a change in mix of homesale activity toward higher price point areas. The price increase is expected to moderate and may actually decrease as the price appreciation which has occurred in certain metropolitan regions of the country moderates and is offset by homesales in other regions with lower homesale prices. The average homesale broker commission rate of 2.47% has remained stable for 2006 and 2007. We believe the 17% decline in homesale transactions is reflective of industry trends in the areas we serve.
In addition to the changes discussed in the previous paragraphs, the decrease in EBITDA for the year ended December 31, 2007 compared to the year ended December 31, 2006 was due to:
$9 million of additional storefront costs related to acquisitions;
$10 million of management incentive based compensation:
offset by:
a decrease of $361 million in commission expenses paid to real estate agents as a result of the reduction in revenue and an improvement in the commission split rate as a result of certain management initiatives;
a reduction of $30 million in royalties paid to our real estate franchise business as a result of the reduction in revenues earned on homesale transactions;
a decrease in marketing costs of $22 million due to cost reduction initiatives;
a decrease of $60 million of operating expenses primarily as a result of the restructuring and cost saving activities initiated in the prior year, net of inflation; and
a reduction of $13 million of restructuring and $13 million of separation expenses recognized in 2007 compared to 2006.
Relocation Services
Pro forma combined revenues increased $22 million to $531 million and pro forma combined EBITDA decreased $51 million to $52 million for 2007 compared with 2006.
We provide relocation services to corporate and government clients for the transfer of their employees. Such services include the purchasing and/or selling of a transferee’s home, providing home equity advances to transferees (generally guaranteed by the corporate client), expense processing, arranging household goods moving services, home-finding and other related services. We earn revenues from fees charged to clients for the performance and/or facilitation of these services and recognize such revenue on a net basis as services are provided, except for limited instances in which we assume the risk of loss on the sale of a transferring employee’s home. In such cases, revenues are recorded on a gross basis as earned with associated costs recorded within operating expenses. In the majority of relocation transactions, the gain or loss on the sale of a transferee’s
home is generally borne by the client; however, in approximately 16% of 2007 homesale transactions we assumed the risk of loss. Such risk of loss occurs because we purchase the house from the transferee and bear both the carrying costs and risk of change in home value on the sales to the ultimate third party buyer. When the risk of loss is assumed, we record the value of the home on our Consolidated Balance Sheets within the relocation properties held for sale line item. The difference between the actual purchase price paid to the transferee and proceeds received on the sale of the home is recorded within operating expenses on our Consolidated and Combined Statement of Operations. For all homesale transactions, the value paid to the transferee is either the value per the underlying third party buyer contract with the transferee, which results in no gain or loss to us, or the appraised value as determined by independent appraisers. We generally earn interest income on the funds we advance on behalf of the transferring employee, which is typically based on prime rate and recorded within other revenue (as is the corresponding interest expense on the securitization borrowings) in the Consolidated and Combined Statement of Operations as earned until the point of repayment by the client. Additionally, we earn revenue from real estate brokers and other third-party service providers. We recognize such fees from real estate brokers at the time the underlying property closes. For services where we pay a third-party provider on behalf of our clients, we generally earn a referral fee or commission, which is recognized at the time of completion of services.
The increase in revenues was primarily driven by $21 million of incremental international revenue due to increased transaction volume, $5 million from higher referral fee revenue and $11 million from higher “at risk” homesale service fees primarily due to a larger proportion of homes coming into inventory without a third party buyer, where we earn a higher management fee. This was partially offset by an $8 million negative impact to net interest income primarily due to higher borrowing costs under the new securitization agreements, $3 million due to lower average homesale management fees and lower volume and $2 million less net interest income due to the deterioration of the spread between the prime rate and LIBOR rate which is utilized for asset backed securitization borrowings.
In addition to the revenue changes noted above, the decrease in EBITDA is due to:
$49 million of increased costs related to “at risk” homesale transactions and writedowns of homes in inventory at year end;
$40 million impairment of intangible assets and goodwill;
$8 million of incremental staffing related costs, in part, to support increased transaction volume;
$7 million of increased costs to support the increase in international transaction volumes;
offset by:
a reduction of $16 million of separation and restructuring expenses incurred in 2006;
a reduction of $9 million of incentive based compensation due to the 2007 operating results; and
a reduction of $6 million of expenses due to the restructuring activities implemented in 2006.
Title and Settlement Services
Pro forma combined revenues decreased $37 million to $372 million and pro forma combined EBITDA decreased $138 million to a negative $93 million for 2007 compared with 2006.
We provide title and closing services, which include title search procedures for title insurance policies, homesale escrow and other closing services. Title revenues, which are recorded net of amounts remitted to third party insurance underwriters, and title and closing service fees are recorded at the time a homesale transaction or refinancing closes. We provide many of these services to third party clients in connection with transactions generated by our company owned real estate brokerage and relocation services segments. In January 2006, we acquired multiple title and underwriting companies in Texas in a single transaction. These entities provide title and closing services, including title searches, title insurance, homesale escrow and other closing services.
The decrease in revenues is primarily driven by $36 million of reduced resale and refinancing volume consistent with the decline in overall homesale transactions noted in our Company Owned Real Estate Brokerage Services segment, partially offset by an increase of $3 million in underwriting volume as this business expanded. EBITDA decreased due to a $114 million impairment of intangible assets and goodwill, the reduction in revenues noted above, the absence of a $2 million reduction in legal reserves recognized in 2006 and a $2 million increase in IT infrastructure costs. These decreases were partially offset by $18 million of lower cost of sales for resales and refinancings.
2007 Restructuring Program
During 2007, the Company committed to various initiatives targeted principally at reducing costs, enhancing organizational efficiency and consolidating and rationalizing existing processes and facilities. The recognition of the 2007 restructuring charge and the corresponding utilization from inception are summarized by category as follows:
| Personnel Related | Facility Related | Asset Impairments | Total | |||||||||||||
Restructuring expense | $ | 12 | $ | 19 | $ | 4 | $ | 35 | ||||||||
Cash payments and other reductions | (7 | ) | (4 | ) | (3 | ) | (14 | ) | ||||||||
Balance at December 31, 2007 | $ | 5 | $ | 15 | $ | 1 | $ | 21 | ||||||||
Total 2007 restructuring charges are as follows:
| Costs Expected to Be Incurred | Opening Balance | Expense Recognized | Cash Payments/ Other Reductions | Liability as of December 31, 2007 | ||||||||||||
Real Estate Franchise Services | $ | 3 | $ | — | $ | 3 | $ | (1 | ) | $ | 2 | |||||
Company Owned Real Estate Brokerage Services | 25 | — | 25 | (9 | ) | 16 | ||||||||||
Relocation Services | 2 | — | 2 | (1 | ) | 1 | ||||||||||
Title and Settlement Services | 4 | — | 4 | (3 | ) | 1 | ||||||||||
Corporate | 1 | — | 1 | — | 1 | |||||||||||
| $ | 35 | $ | — | $ | 35 | $ | (14 | ) | $ | 21 | ||||||
Year Ended December 31, 2006 vs. Year Ended December 31, 2005
Our consolidated and combined results comprised the following:
| Year Ended December 31, | ||||||||||||
| 2006 | 2005 | Change | ||||||||||
| Net revenues | $ | 6,492 | $ | 7,139 | $ | (647 | ) | |||||
Total expenses(1) | 5,888 | 6,101 | (213 | ) | ||||||||
| Income before income taxes and minority interest | 604 | 1,038 | (434 | ) | ||||||||
| Provision for income taxes | 237 | 408 | (171 | ) | ||||||||
| Minority interest, net of tax | 2 | 3 | (1 | ) | ||||||||
| Net income | $ | 365 | $ | 627 | $ | (262 | ) | |||||
| Year Ended December 31, | ||||||||||
| 2006 | 2005 | Change | ||||||||
Net revenues | $ | 6,492 | $ | 7,139 | $ | (647 | ) | |||
Total expenses (1) | 5,888 | 6,101 | (213 | ) | ||||||
Income before income taxes and minority interest | 604 | 1,038 | (434 | ) | ||||||
Provision for income taxes | 237 | 408 | (171 | ) | ||||||
Minority interest, net of tax | 2 | 3 | (1 | ) | ||||||
Net income | $ | 365 | $ | 627 | $ | (262 | ) | |||
| (1) | Total expenses for the year ended December 31, 2006 include $97 million related to the following items: $23 million of stock compensation costs, $46 million of restructuring costs, |
costs and $4 million of merger costs offset by a benefit of $38 million due to the resolution of certain former parent legacy matters. Total expenses for the year ended December 31, 2005 include $13 million of stock compensation costs and $6 million of restructuring costs. |
Net revenues decreased $647 million (9%) for the year ended December 31, 2006 compared with the year ended December 31, 2005 principally due to a decrease in organic revenues in our Company Owned Real Estate Brokerage Services,company owned real estate brokerage services, reflecting decreases in transaction sides volume across the real estate industry and moderating growth in the average prices of homes sold partially offset by a $367 million increase in revenues as a result of larger acquisitions consummated subsequent to January 1, 2005.
Total expenses decreased $213 million (3%) principally reflecting a reduction of $503 million of commission expenses paid to real estate agents and a net benefit of $38 million due to the resolution of certain tax and legal accruals related to former parent legacy matters, offset by an increase in expenses of $334 million related to larger acquisitions by NRT Incorporated,LLC, our wholly-owned real estate brokerage business and the acquisition of title and underwriting companies in Texas by the Titletitle and Settlement Servicessettlement services segment, as well as the net change in restructuring costs of $40 million and separation costs of $66 million.
Our effective tax rate for both December 31, 2006 and 2005 was 39%. Isolated items affecting our 2006 tax rate were a tax benefit resulting from the favorable settlement of federal income tax matters associated with Cendant’s 1999 shareholderstockholder litigation position, offset by a tax expense related to equity compensation.
Following is a more detailed discussion of the results of each of our reportable segments for the yearyears ended December 31:
| Revenues | EBITDA | Margin | ||||||||||||||||||||||||||||||||||
| 2006 | 2005 | % Change | 2006 | 2005 | % Change | 2006 | 2005 | Change | ||||||||||||||||||||||||||||
| Real Estate Franchise Services | $ | 879 | $ | 988 | (11) | $ | 613 | $ | 740 | (17) | 70 | % | 75 | % | (5) | |||||||||||||||||||||
| Company Owned Real Estate Brokerage Services | 5,022 | 5,723 | (12) | 25 | 250 | (90) | — | 4 | (4) | |||||||||||||||||||||||||||
| Relocation Services | 509 | 495 | 3 | 103 | 124 | (17) | 20 | 25 | (5) | |||||||||||||||||||||||||||
| Title and Settlement Services | 409 | 316 | 29 | 45 | 53 | (15) | 11 | 17 | (6) | |||||||||||||||||||||||||||
| Total Reportable Segments | 6,819 | 7,522 | (9) | 786 | 1,167 | (33) | ||||||||||||||||||||||||||||||
Corporate and Other(a) | (327 | ) | (383 | ) | * | (11 | ) | — | * | |||||||||||||||||||||||||||
Total Company(b) | $ | 6,492 | $ | 7,139 | (9) | $ | 775 | $ | 1,167 | (34) | 12 | % | 16 | % | (4) | |||||||||||||||||||||
| Less: Depreciation and amortization | 142 | 136 | ||||||||||||||||||||||||||||||||||
| Interest expense/(income), net | 29 | (7) | ||||||||||||||||||||||||||||||||||
| Income before income taxes and Minority interest | $ | 604 | $ | 1,038 | ||||||||||||||||||||||||||||||||
| Revenues | EBITDA | Margin | |||||||||||||||||||||||||||||
| 2006 | 2005 | % Change | 2006 | 2005 | % Change | 2006 | 2005 | Change | |||||||||||||||||||||||
Real Estate Franchise Services | $ | 879 | $ | 988 | (11 | ) | $ | 613 | $ | 740 | (17 | ) | 70 | % | 75 | % | (5 | ) | |||||||||||||
Company Owned Real Estate Brokerage Services | 5,022 | 5,723 | (12 | ) | 25 | 250 | (90 | ) | — | 4 | (4 | ) | |||||||||||||||||||
Relocation Services | 509 | 495 | 3 | 103 | 124 | (17 | ) | 20 | 25 | (5 | ) | ||||||||||||||||||||
Title and Settlement Services | 409 | 316 | 29 | 45 | 53 | (15 | ) | 11 | 17 | (6 | ) | ||||||||||||||||||||
Corporate and Other (a) | (327 | ) | (383 | ) | * | (11 | ) | — | * | ||||||||||||||||||||||
Total Company (b) | $ | 6,492 | $ | 7,139 | (9 | ) | 775 | 1,167 | (34 | ) | 12 | % | 16 | % | (4 | ) | |||||||||||||||
Less: | |||||||||||||||||||||||||||||||
Depreciation and amortization | 142 | 136 | |||||||||||||||||||||||||||||
Interest expense net | 29 | (7 | ) | ||||||||||||||||||||||||||||
Income (loss) before income taxes and minority interest | $ | 604 | $ | 1,038 | |||||||||||||||||||||||||||
| * | Not meaningful. | |
| (a) | Includes unallocated corporate overhead and the elimination of transactions between segments, which consists primarily of (i) intercompany royalties of $327 million and $369 million paid by our Company Owned Real Estate Brokerage Services segment during |
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| 2006 and 2005, respectively, and (ii) intercompany royalties of $14 million paid by our Title | ||
| (b) | Includes $66 million of separation costs, |
As described in the above table, EBITDA margin for “Total Company” expressed as a percentage of revenues decreased four percentage points from 16% to 12% for the year ended December 31, 2006 compared to the prior year. EBITDA for the year ended December 31, 2006 includes $46 million of restructuring costs, primarily related to the Company Owned Real Estate Brokerage Services segment and $66 million of separation costs, offset by a net benefit of $38 million of former parent legacy costs primarily for the resolution of certain tax and legal accruals related to matters that have been settled at December 31, 2006. The majority of the separation costs were incurred in the third quarter of 2006 and primarily related to a non-cash charge of $40 million for the accelerated vesting of certain Cendant equity awards and a non-cash charge of $11 million for the conversion of Cendant equity awards into Realogy equity awards. A portion of these costs were allocated to the business segments and therefore contributed to the decrease in EBITDA margin for each of the segments discussed below.
On a segment basis, the Real Estate Franchise Services segment decreased five percentage points to 70% versus the rate of 75% in the comparable prior period. The year ended December 31, 2006 reflected a decrease in the number of homesale transactions, decreased average commission rate and a slowdown in the growth rate of the average price of homes sold compared to 2005. The Company Owned Real Estate Brokerage Services segment decreased four percentage points from 4% in the prior year. The year ended December 31, 2006 reflected a reduction in commission income earned on homesale transactions and an increase in expenses due to inflation, separation and restructuring expenses and operating costs to support the number of offices in which we operate. While the principal cost of the Company Owned Real Estate Brokerage Services business consists of agents’ shares of commissions that fluctuate with revenue, we have certain costs associated with our store fronts that are fixed in the short term. In 2006, the Relocation Services segment margin decreased five percentage points to 20% from 25% in the comparable period primarily driven by separation and restructuring costs and lower margins on our at-riskat risk homesale business. In 2006, the Title and Settlement Services segment decreased six percentage points to 11% from 17% in the comparable prior period due to reduced organic resale and refinancing volume, separation costs and an increase in IT infrastructure costs.
Real Estate Franchise Services
Revenues and EBITDA decreased $109 million to $879 million and EBITDA decreased $127 million to $613 million respectively, infor 2006 compared with 2005.
The decrease in revenue is primarily driven by a $66 million decrease in third-party franchisees royalty revenue due to real estate brokerage businesses that are independently owned and operated. We provide operational and administrative services, tools and systems to franchisees, which are designed to assist franchiseesan 18% decrease in achieving increased revenue and profitability. Such services include national and local advertising programs, listing and agent-recruitment tools, training and volume purchasing discounts through our preferred vendor programs. Franchise revenue principally consiststhe number of royalty and marketing feeshomesale transactions from our franchisees. Thethird-party franchisees and a decrease in the average broker commission rate earned by our franchises from 2.51% in 2005 to 2.47% in 2006. These decreases were partially offset by a 3% increase in the average price of homes sold and the overall net effective royalty received is primarily based on a percentage of the franchisee’s commissionsand/or gross commission income. Royalty fees are accrued as the underlying franchisee revenue is earned (upon close of the homesale transaction). Annual volume incentives givenrate that increased from 4.69% in 2005 to certain franchisees on royalty fees are recorded4.87% in 2006 as a reductionresult of lower rebates being earned by our franchisees. In addition international revenues increased $5 million to $17 million in connection with the licensing of our brand names in certain countries or international regions. Revenue also increased by $8 million of marketing revenue and are accrued forearned from our franchisees offset by a comparable increase in relative proportion to the recognition of the underlying gross franchise revenue. Franchise revenue also includes initial franchise fees, which are generally non-refundable and are recognized by us as revenue when all material services or conditions relating to the sale have been substantially performed (generally when a franchised unit opens for business). Royalty increases or decreases are recognized with little or no corresponding increase or decrease inrelated marketing expenses due to the significant operating leverage within the franchise operations. In additiontiming of certain expenditures.
The decrease in revenue is also attributable to a decrease in royalties received from our third-party franchisees, our Company Owned Real Estate Brokerage Services segment continues to paywhich pays royalties to the Real Estate Franchise Services segment.our real estate franchise business. However, these intercompany royalties, which approximated $327 million and $369 million during 2006 and 2005, respectively, are
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The decrease in EBITDA for 2006 compared to 2005 iswas principally due to the net reduction in revenues noted above, as well as $11 million of separation costs primarily related to the accelerated vesting of the Cendant equity awards, an increase in bad debt
expense of $7 million of additional bad debt expense related to accounts receivable and notes receivable due to the current market conditions in the residential real estate market, and $3 million of incremental marketing expenses related to Sotheby’s International Realty®.Realty. These decreases arewere partially offset by a $10 million reduction in incentive based compensation as a result of the decrease in operating results in 2006.
Company Owned Real Estate Brokerage Services
Revenues and EBITDA decreased $701 million to $5,022 million and $225 million to $25 million, respectively, in 2006 compared with 2005.
A core part of our growth strategy is the acquisition of other real estate brokerage operations. Our acquisitions of larger real estate brokerage operations subsequent to January 1, 2005 contributed incremental revenues and EBITDA of $233 million and $13 million, respectively, to 2006 operating results (reflected within the EBITDA contribution is $14 million of intercompany royalties paid to the Real Estate Franchise Services segment, which is eliminated in consolidation but does affect segment level EBITDA).
Excluding these acquisitions, revenues decreased $934 million (16%) and EBITDA declined $238 million (95%) in 2006 as compared with 2005. This decrease in same store revenues was substantially comprised of reduced commission income earned on homesale transactions, which was primarily driven by a 20% decline in the number of homesale transactions, partially offset by a 4% increase in the average price of homes sold. We
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Relocation Services
Revenues increased $14 million to $509 million, andwhile EBITDA decreased $21 million to $103 million respectively, in 2006 compared with 2005.
The increase in revenues from our relocation services business was primarily driven by $16 million of incremental management fees and commissions earned in our international services due to increased international transaction volume, $10 million from higher “at risk” homesale service fees driven by a greater proportion of such activity in the moderated real estate market experienced in 2006 plus a $3 million increase in net interest income due to higher interest bearing relocation receivables. This was partially offset by an $11 million decrease in domestic revenue due to lower relocation referral volume. The decrease in EBITDA is principally due to $12 million of separation costs primarily related to the accelerated vesting of Cendant equity awards, $4 million of restructuring costs related to reducing management personnel levels and a $13 million reduction to EBITDA from increased costs related to at-riskat risk homesale transactions. These are partially offset by a $9 million reduction in incentive based compensation as a result of the decrease in operating results in the year ended December 31, 2006, a $5 million increase in EBITDA associated with the incremental
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Title and Settlement Services
Revenues increased $93 million to $409 million, while EBITDA decreased $8 million to $45 million in 2006 compared with 2005.
The operating results of our Titletitle and Settlement Servicessettlement services segment reflect the Texas acquisition, which contributed incremental revenues and EBITDA of $134 million and $13 million, respectively, to 2006 results. Revenue and EBITDA, excluding the Texas acquisition, decreased $41 million and $27 million, respectively, principally from a 12% reduction in resale volume, consistent with the decline in overall homesale transactions noted in the other businesses and a 23% reduction in refinancing volume.
EBITDA further reflects an increase of $4 million in separation costs primarily related to the accelerated vesting of Cendant equity awards, $1 million of restructuring costs and an incremental increase in IT infrastructure costs of $3 million. These are partially offset by the absence of $14 million of royalty payments made to our Real Estate Franchise Services segment for 2006 compared to 2005 as the intercompany royalty agreement is no longer in place and a $3 million reduction in incentive based compensation as a result of the decrease in operating results in 2006.
Separation Costs
The Company incurred separation costs of $66 million for the year ended December 31, 2006. These costs were incurred in connection with theour separation from Cendant and relate to the acceleration of certain Cendant employee costs and legal, accounting and other advisory fees. The majority of the separation costs incurred related to a non-cash charge of $40 million for the accelerated vesting of certain Cendant equity awards and a non-cash charge of $11 million for the conversion of Cendant equity awards into Realogy equity awards. SeeNote 13-Stock Based Compensation13 “Stock-Based Compensation” of the consolidated and combined financial statements for additional information.
2006 Restructuring Program
During the second quarter of 2006, the Company committed to various strategic initiatives targeted principally at reducing costs, enhancing organizational efficiency and consolidating and rationalizing existing processes and facilities. The Company recorded restructuring charges of $46 million in 2006 and an additional $1 million in 2007, of which $39 million is expected to be paid in cash. As of December 31, 2007 and 2006, $34 million and $16 million of these costs have been paid.paid, respectively. These charges primarily represent facility consolidation and employee separation costs.
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| Personnel | Facility | Asset | ||||||||||||||
| Related | Related | Impairments | Total | |||||||||||||
| Restructuring expense | $ | 14 | $ | 25 | $ | 7 | $ | 46 | ||||||||
| Cash payments and other reductions | (8 | ) | (8 | ) | (7 | ) | (23 | ) | ||||||||
| Balance at December 31, 2006 | $ | 6 | $ | 17 | $ | — | $ | 23 | ||||||||
| Rollforward of restructuring liabilities: | ||||||||||||||||
| Cash | Liability | |||||||||||||||
| Payments/ | as of | |||||||||||||||
| Opening | Expense | Other | December 31, | |||||||||||||
| Balance | Recognized | Reductions | 2006 | |||||||||||||
| Real Estate Franchise Services | $ | — | $ | 2 | $ | (1 | ) | $ | 1 | |||||||
| Company Owned Real Estate Brokerage Services | — | 39 | (19 | ) | 20 | |||||||||||
| Relocation Services | — | 4 | (2 | ) | 2 | |||||||||||
| Title and Settlement Services | — | 1 | (1 | ) | — | |||||||||||
| $ | — | $ | 46 | $ | (23 | ) | $ | 23 | ||||||||
| Year Ended December 31, | ||||||||||||
| 2005 | 2004 | Change | ||||||||||
| Net revenues | $ | 7,139 | $ | 6,549 | $ | 590 | ||||||
| Total expenses | 6,101 | 5,548 | 553 | |||||||||
| Income before income taxes and minority interest | 1,038 | 1,001 | 37 | |||||||||
| Provision for income taxes | 408 | 379 | 29 | |||||||||
| Minority interest, net of tax | 3 | 4 | (1 | ) | ||||||||
| Net income | $ | 627 | $ | 618 | $ | 9 | ||||||
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| Revenues | EBITDA | Margin | ||||||||||||||||||||||||||||||||||
| 2005 | 2004 | % Change | 2005 | 2004 | % Change | 2005 | 2004 | Change | ||||||||||||||||||||||||||||
| Real Estate Franchise Services | $ | 988 | $ | 904 | 9 | $ | 740 | $ | 666 | 11 | 75 | % | 74 | % | 1 | |||||||||||||||||||||
| Company Owned Real Estate Brokerage Services | 5,723 | 5,242 | 9 | 250 | 263 | (5 | ) | 4 | 5 | (1 | ) | |||||||||||||||||||||||||
| Relocation Services | 495 | 455 | 9 | 124 | 126 | (2 | ) | 25 | 28 | (3 | ) | |||||||||||||||||||||||||
| Title and Settlement Services | 316 | 303 | 4 | 53 | 62 | (15 | ) | 17 | 20 | (3 | ) | |||||||||||||||||||||||||
| Total Reportable Segments | 7,522 | 6,904 | 9 | 1,167 | 1,117 | 4 | ||||||||||||||||||||||||||||||
Corporate and Other(a) | (383 | ) | (355 | ) | * | — | (2 | ) | * | |||||||||||||||||||||||||||
Total Company(b) | $ | 7,139 | $ | 6,549 | 9 | 1,167 | 1,115 | 5 | 16 | % | 17 | % | (1 | ) | ||||||||||||||||||||||
| Less: Depreciation and amortization | 136 | 120 | ||||||||||||||||||||||||||||||||||
| Interest income, net | (7 | ) | (6 | ) | ||||||||||||||||||||||||||||||||
| Income before income taxes and Minority interest | $ | 1,038 | $ | 1,001 | ||||||||||||||||||||||||||||||||
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| Personnel | Facility | Asset | ||||||||||||||
| Related | Related | Impairments | Total | |||||||||||||
| Restructuring expense | $ | 2 | $ | 3 | $ | 1 | $ | 6 | ||||||||
| Cash payments and other reductions | (1 | ) | (3 | ) | (1 | ) | (5 | ) | ||||||||
| Balance at December 31, 2005 | $ | 1 | $ | — | $ | — | $ | 1 | ||||||||
| Rollforward of restructuring liabilities: | ||||||||||||||||
| Cash | Liability | |||||||||||||||
| Payments/ | as of | |||||||||||||||
| Opening | Expense | Other | December 31, | |||||||||||||
| Balance | Recognized | Reductions | 2005 | |||||||||||||
| Real Estate Franchise Services | $ | — | $ | — | $ | — | $ | — | ||||||||
| Company Owned Real Estate Brokerage Services | — | 5 | (4 | ) | 1 | |||||||||||
| Relocation Services | — | — | — | — | ||||||||||||
| Title and Settlement Services | — | 1 | (1 | ) | — | |||||||||||
| $ | — | $ | 6 | $ | (5 | ) | $ | 1 | ||||||||
FINANCIAL CONDITION
| December 31, | December 31, | |||||||||||
| 2006 | 2005 | Change | ||||||||||
| Total assets | $ | 6,668 | $ | 5,439 | $ | 1,229 | ||||||
| Total liabilities | 4,185 | 1,872 | 2,313 | |||||||||
| Stockholders’ equity | 2,483 | 3,567 | (1,084 | ) | ||||||||
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| Successor | Predecessor | |||||||||
| December 31, 2007 | December 31, 2006 | Change | ||||||||
Total assets | $ | 11,172 | $ | 6,668 | $ | 4,504 | ||||
Total liabilities | 9,972 | 4,185 | 5,787 | |||||||
Stockholders’ equity | 1,200 | 2,483 | (1,283 | ) | ||||||
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2007, our financing needs areto fund operations were largely supported by cash generated from operations with the exception of funding requirements of our relocation business where we issue securedsecuritization obligations to finance relocation receivables and advances and relocation properties held for sale.
Following the Transactions, our primary sources of liquidity are cash flows from operations and LIBOR plus 45 basis points for all borrowings, including outstanding letters of credit, when the borrowings, excluding outstanding letters of credit, are greater than $525 million. The revolving credit facility also has an annual facility fee equal to 10 basis points on the $1,050 million facility, whether used or unused. The $600 million five-year term facility bears interest at LIBOR plus 55 basis points. On July 27, 2006, the Company drew down fully on these facilities with the exception of $750 million under the revolving credit facility. The proceeds received in connection with the $2,225 million of borrowings were immediately transferred to Cendant. In August 2006, the Company repaid the $300 million outstandingfunds available under the revolving credit facility under our senior secured credit facility. Our primary continuing liquidity needs will be to finance our working capital, capital expenditures and $100debt service.
Cash Flows
Year ended December 31, 2007 vs. year ended December 31, 2006
At December 31, 2007, we had $153 million of borrowings under the interim loan facility. In October 2006, the Company repaid the remaining outstanding amount under the interim loan facility with the proceeds of the Notes (as defined below) and cash and cash equivalents, on hand.a decrease of $246 million compared to the balance of $399 million at December 31, 2006. The following table summarizes our cash flows for the year ended December 31, 2007 and 2006:
| Successor | Predecessor | |||||||||||||||
| Period From April 10 to December 31, 2007 | Period From January, 1 to April 9, 2007 | Year Ended December 31, 2006 | Change | |||||||||||||
Cash provided by (used in): | ||||||||||||||||
Operating activities | $ | 109 | $ | 107 | $ | 245 | $ | (29 | ) | |||||||
Investing activities | (6,853 | ) | (40 | ) | (310 | ) | (6,583 | ) | ||||||||
Financing activities | 6,368 | 62 | 427 | 6,003 | ||||||||||||
Effects of change in exchange rates | 1 | — | 1 | — | ||||||||||||
Net change in cash and cash equivalents | $ | (375 | ) | $ | 129 | $ | 363 | $ | (609 | ) | ||||||
During the year ended December 31, 2007, we received $29 million less cash from operations as compared to 2006. Such change is principally due to weaker operating results partially offset by:
the year over year decrease in cash outflows of $199 million from relocation receivables and advances and properties held for sale was driven by the year over year decrease in our homes in inventory;
a net income tax refund of $19 million for the year ended December 31, 2007 compared to a net payment of income taxes of $42 million for the same period in 2006;
incremental accrued interest of $125 million;
$80 million of proceeds from the settlement agreement with Ernst & Young LLP;
$112 million reduction in due to former parent.
During the year ended December 31, 2007 compared to 2006, we used $6,583 million more cash for investing activities. Such change is mainly due to $6,761 million of cash which was utilized to purchase the Company entered into an agreementpartially offset by $112 million of lower cash outflows for acquisition activity at our Company Owned Real Estate Brokerage Services and Title and Settlement Services segments, $21 million of sale leaseback proceeds received related to amend its Apple Ridge Funding LLC borrowing arrangementthe corporate aircraft, $28 million of lower property and equipment additions and $22 million related to increase the borrowing capacity under the facility by $150 million to an amount not to exceed $700 million.
During the Notes together with cash and cash equivalents on hand were utilizedyear ended December 31, 2007 compared to repay all of the outstanding indebtedness under the interim loan facility. The Notes were comprised of three series: $2502006, we received $6,003 million of floating rate senior notes due October 20, 2009 (the “2009 Notes”), $450incremental cash from financing activities. The 2007 cash flows provided from financing activities is the result of $1,999 million of senior notes due October 15, 2011 (the “2011 Notes”), and $500 million of senior notes due October 15, 2016 (the “2016 Notes”). The terms of the Notes are governedcash contributed by an indenture, dated as of October 20, 2006 (the “Indenture”), by and between Realogy and Wells Fargo Bank, National Association, as Trustee. Currently, the Notes are unsecured obligations of Realogy and rank equally in right of payment with all of Realogy’s other unsecured senior indebtedness.
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purchase the $1,200 million of 2006 Senior Notes;
repay the former term loan facility of $600 million; and
pay related debt issuance costs of $157 million.
The 2006 cash flows provided from financing activities is mainly due to BB. On March 2, 2007, Moody’s indicated that if the pending merger is approved$1,436 million of proceeds received from Cendant’s sale of Travelport partially offset by the Company’s stockholders, Moody’s will lower the ratings on these Notes to Ba3. Accordingly, if these downgrades are issued, the interest rate on eachrepurchase of the three series$884 million of Notes will be increased 1.25% from their initial interest rate (or an additional 100 basis points from the current interest rate) retroactive to the beginning of the then current respective interest period.
Year ended December 31, 2006 the Company entered into an agreement to amend its Apple Ridge Funding LLC securitization arrangement to eliminate a $750 million minimum EBITDA requirement and substitute in its place that Realogy maintain a long-term unsecured debt rating of BB- or better from S&P and Ba3 from Moody’s and modified certain performance triggers linked to the quality of the assets underlying the arrangement.
At December 31, 2006, we had $399 million of cash and cash equivalents, an increase of $363 million compared to the balance of $36 million at December 31, 2005. The following table summarizes our cash flows for the year ended December 31, 2006 and 2005:
| Year Ended December 31, | ||||||||||||
| 2006 | 2005 | Change | ||||||||||
| Cash provided by (used in): | ||||||||||||
| Operating activities | $ | 245 | $ | 617 | $ | (372 | ) | |||||
| Investing activities | (310 | ) | (423 | ) | 113 | |||||||
| Financing activities | 427 | (216 | ) | 643 | ||||||||
| Effects of changes in exchange rates | 1 | — | 1 | |||||||||
| Net change in cash and cash equivalents | $ | 363 | $ | (22 | ) | $ | 385 | |||||
| Year Ended December 31, | ||||||||||||
| 2006 | 2005 | Change | ||||||||||
Cash provided by (used in): | ||||||||||||
Operating activities | $ | 245 | $ | 617 | $ | (372 | ) | |||||
Investing activities | (310 | ) | (423 | ) | 113 | |||||||
Financing activities | 427 | (216 | ) | 643 | ||||||||
Effects of changes in exchange rates | 1 | — | 1 | |||||||||
Net change in cash and cash equivalents | $ | 363 | $ | (22 | ) | $ | 385 | |||||
During the year ended December 31, 2006, we received $372 million less cash from operations as compared to the same period in 2005. Such change is principally due to weaker operating results, incremental cash outflows of $121 million for relocation receivables and properties held for sale driven by the year over
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During the year ended December 31, 2006, we used $113 million less cash for investing activities compared to the same period in 2005. Such change is mainly due to decreased cash outflows at our Company Owned Real Estate Brokerage Servicescompany-owned real estate brokerage services segment due to lower acquisition activity, partially offset by the acquisition of title and underwriting companies in Texas by the Company’s Titletitle and Settlement Servicessettlement services segment.
During the year ended December 31, 2006, we received $643 million more cash from financing activities compared to 2005. This is principally due to (i) the issuance $2,225 million of unsecured borrowings to fund the net transfer of $2,183 million to Cendant at separation, (ii) the issuance of $1,200 million of Notes which were used to retire $1,200 million outstanding under the interim financing facility, (iii) the receipt of $1,436 million of net proceeds related to the sale of Travelport and (iv) a change in net funding to Cendant of $694 million. These increases are partially offset by (i) the payment of the interim financing noted above as well as other debt reductions of $425 million, (ii) the repurchase of $884 million of common stock and (iii) lower incremental secured borrowings of $236 million due to the capacity of our secured borrowing arrangements.
Financial Obligations
Revolving Credit and Loan Facilities
On May 26, 2006, the Company entered into a $1,650 million credit facility, which consisted of a $1,050 million five-year revolving credit facility and a $600 million five-year term loan facility, include affirmative covenants, including the maintenance of specific financial ratios. These financial covenants consist of a minimum interest coverage ratio of at least 3.0 times as of the measurement date and a maximum leverage ratio not to exceed 3.5 times on the measurement date. The interest coverage ratio is calculated by dividing Consolidated EBITDA (as defined in the credit agreement) by Consolidated Interest Expense (as defined in the credit agreement), excluding interest expense on Securitization Indebtedness (as defined in the credit agreement), both as measured on a preceding four fiscal quarters basis preceding the measurement date. The leverage ratio is calculated by dividing consolidated total indebtedness (excluding Securitization Indebtedness) as of the measurement date by Consolidated EBITDA as measured on a preceding four fiscal quarters basis preceding the measurement date. Negative covenants in the credit facility include limitations on indebtedness of material subsidiaries; liens; mergers, consolidations, liquidations, dissolutions and sales of substantially all assets; and sale and leasebacks. Events of default in the credit facility include nonpayment of principal when due; nonpayment of interest, fees or other amounts; violation of covenants; cross payment default and cross acceleration (in each case, to indebtedness (excluding securitization indebtedness) in excess of $50 million); and a change of control (the definition of which permitted our separation from Cendant). At December 31,$1,325 million interim loan facility.
On July 27, 2006, the Company wasdrew down $2,225 million of the facilities which were immediately transferred to Cendant. In late 2006, the Company repaid the $300 million then outstanding under the revolving credit facility and the $1,325 outstanding under the interim loan facility utilizing proceeds received from Cendant’s sale of Travelport and $1,200 million of proceeds from the bond offering discussed below under the caption “2006 Senior Notes”.
On April 10, 2007, in complianceconnection with the financial covenants of itsTransactions, the revolving credit and loan facilities.
2006 Senior Notes Realogy, with certain exceptions, may not issue secured debt that exceeds
On October 20, 2006, the Company completed a “basket” equalbond offering pursuant to Rule 144A under the greaterSecurities Act of (1) 20% of its consolidated net worth (as that term is defined in1933, as amended (the “Securities Act”), and Regulation S under the Indenture) calculated on the date the secured debt is incurred and (2) $300 million. The foregoing covenant does not apply to Realogy’s incurrence of secured debt under its relocation securitization programs. In addition, the Notes limit the Company’s ability to enter into sale and leaseback transactions. Under the Indenture under which the Notes were issued, events of default include: (1) a default in payment of the principal amount or redemption price with respect to any Note of such series when such amount becomes due and payable, (2) Realogy’s failure to pay interest (including additional interest) on any Note of such series within 30 days of when such amount becomes due and payable, (3) Realogy’s failure to comply with any of its covenants or agreements in the Indenture or the Notes of such series and its failure to cure (or obtain a waiver of) such default and such failure continuesSecurities Act, for 90 days after proper written notice is given to Realogy, (4) with certain exceptions, a default under any debt by Realogy or its significant subsidiaries that results in acceleration of the maturity of such debt, or failure to pay any such debt at maturity, in an$1,200 million aggregate amount greater than $100 million or its foreign currency equivalent at the time, and (5) certain events of bankruptcy, insolvency or reorganization affecting Realogy or any of its significant subsidiaries. In the case of an event of default, the principal amount of three-, five- and ten-year senior notes (“2006 Senior Notes”) as follows:
$250 million of the 2006 Senior Notes are due in 2009 and have an interest rate equal to three-month LIBOR plus 0.70%, payable quarterly,
$450 million of the 2006 Senior Notes are due in 2011 and have a fixed interest rate of 6.15% per annum, payable semi-annually; and
$500 million of the 2006 Senior Notes are due in 2016 and have a fixed interest rate of 6.50% per annum, payable semi-annually.
On May 10, 2007, the Company offered to purchase each series of the 2006 Senior Notes at 100% of their principal amount, plus accrued and unpaid interest may be accelerated.
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In the third and fourth quarter of 2007, the Company purchased the remaining $197 million principal amount of 2006 Senior Notes in privately negotiated transactions. The Company utilized the delayed draw facility to finance the purchases of the 2006 Senior Notes and to pay related interest and fees. These purchases resulted in a gain on debt extinguishment of $3 million and a write off of deferred financing costs of $7 million. These amounts are recorded in interest expense in the Consolidated and Combined Statements of Operations.
Credit Facility and Senior Notes
The Company also issued $1,700 million aggregate principal amount of 10.50% Senior Notes due 2014, $550 million aggregate principal amount of 11.00%/11.75% Senior Toggle Notes due 2014 and $875 million aggregate principal amount of 12.375% Senior Subordinated Notes due 2015.
On April 10, 2007, the total capacity, outstanding borrowingsCompany entered into three separate registration rights agreements with respect to the Senior Notes, Senior Toggle Notes and available capacity underSenior Subordinated Notes. On February 15, 2008, the Company’s borrowing arrangements was as follows:
| Expiration | Total | Outstanding | Available | |||||||||||||
Date | Capacity | Borrowings | Capacity | |||||||||||||
Apple Ridge Funding LLC(1) | November 2007 | $ | 700 | $ 656 | $ | 44 | ||||||||||
Kenosia Funding LLC(1),(4) | May 2007 | 125 | 125 | — | ||||||||||||
U.K. Relocation Receivables Funding Limited(1) | September 2008 | 196 | 112 | 84 | ||||||||||||
Revolving credit facility(2) | May 2011 | 1,050 | — | 951 | ||||||||||||
| Term loan | May 2011 | 600 | 600 | — | ||||||||||||
Senior notes(3) | Various | 1,200 | 1,200 | — | ||||||||||||
| $ | 3,871 | $ 2,693 | $ | 1,079 | ||||||||||||
Securitization Obligations In addition, on April 10, 2007 the Company refinanced its |
Other than noted below with respect to Kenosia Funding LLC (“Kenosia”), each securitization program is a revolving program.program with a five year term expiring in April 2012 and has a commitment fee. The asset backed commercial paper program is backstopped by the sponsoring financial institution. So long as no termination or amortization event has occurred, any new receivables generated under the designated relocation management agreements are sold into the program, and as new relocation management agreements are entered into, the new agreements may also be designated to a specific program. These liquidity facilities are subject to periodic termination at the end of the five year agreement and if not renewed would result in an amortization of the notes.
Each program also has restrictive covenants and trigger events, including performance triggers linked to the quality of the underlying assets, financial reporting requirements and restrictions on mergers and change of control. The Apple Ridge Funding LLCEach program contains cross defaults to the senior secured credit facility, has a requirement that the Company maintain a long-term unsecured debt ratingNotes and other material indebtedness of BB- or better from S&P and Ba3 from Moody’s. The U.K. Relocation Receivables Funding Limited facility has a requirement that the Company generate at least $750 million of income before depreciation and amortization, interest expense (income), income taxes and minority interest, determined quarterly for the preceding twelve month period.Realogy. These covenants, if breached and not remedied within a predefined amount of time,trigger events could result in an early amortization of the notessecuritization obligations and termination of the program. At December 31, 2006,2007, the Company was in compliance with allthe financial covenantscovenant related to the frequency of its financial reporting for the securitization obligations.
All of the relocation management agreements designated for the Kenosia Funding LLC (“Kenosia”) securitization program are at risk contracts where the Company receives a fixed fee from its client relating to the homesale service of an employee relocation and bears the risk of loss upon the sale of transferred employees’ homes. Our U.S. government at risk business as well as at risk business with a few corporate clients comprise the contracts financed by Kenosia, although the U.S. government portion comprises over 90% of the total assets in the program. On March 14, 2008, the Company amended Kenosia (the “Kenosia Amendment”) in connection with its decision to exercise its contractual termination right (See “Business Section—Relocation Services”) with the United States General Services Administration (“GSA”). Prior to the Kenosia Amendment, termination of an agreement with a client which had more than 30% of the asset secured obligations.
We will maintain limited “at risk” activities with certain other customers, but in conjunction with the Kenosia Amendment the borrowing capacity under Kenosia will be reduced to $100 million in mid July 2008, $70 million in mid December 2008, $20 million in mid March 2009 and to zero in mid June 2009. The Kenosia
Amendment also required us to lower the maximum advance rate on the facility to 50% upon execution of the Kenosia Amendment, which caused a reduction in the outstanding balance of the facility of $38 million from $175 million to $137 million. As part of the Kenosia Amendment the borrowing rate spread on the facility was increased by 50 basis points to 150 basis points above LIBOR and certain ratios that could have otherwise resulted in an amortization event as we exit this business were modified in order for us to be able to reduce our “at risk” home inventory without replacing it with new home inventory.
Our decision to exit the U.S. government business and the related Kenosia Amendment is expected to generate approximately $50 million of working capital in 2008 as we liquidate the government “at risk” homes held for sale (and other relocation receivables in Kenosia) and receive the cash we had committed to this activity Kenosia has not been syndicated. Calyon, as the purchaser of the notes under the facility, administrative agent and arranger, and the financial institution acting as the managing agent under the facility’s note purchase agreement, and The Bank of New York, acting as the facility’s indenture trustee and their respective affiliates, have performed and may in the future perform, various commercial banking, investment banking and other financial advisory services for us and our subsidiaries for which they have received, and will receive, customary fees and expenses.
Short-Term Borrowing Facilities
In addition, within our titleTitle and settlement servicesSettlement Services and company owned real estate brokerageCompany Owned Real Estate Brokerage operations, we actthe Company acts as an escrow agent for numerous customers. As an escrow agent, we receive money from customers to hold on a short-term basis until certain conditions of the homesale transaction are satisfied. We do not have access to these funds for our use. However, because we have such funds concentrated in a few financial institutions, we are able to obtain short-term borrowing facilities that currently provide for borrowings of up to $565$550 million as of December 31, 2006.2007. We invest such borrowings in high quality short-term liquid investments. Net amounts earned under these arrangements approximated $11 million $9 million and
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Available Capacity
As of December 31, 2007, the total capacity, outstanding borrowings and $318 million, respectively.available capacity under the Company’s borrowing arrangements is as follows:
| Expiration Date | Total Capacity | Outstanding Borrowings | Available Capacity | ||||||||
Revolving credit facility (1) | April 2013 | $ | 750 | $ | — | $ | 713 | ||||
Senior secured credit facility (2) | October 2013 | 3,154 | 3,154 | — | |||||||
Fixed Rate Senior Notes (3) | April 2014 | 1,700 | 1,681 | — | |||||||
Senior Toggle Notes (4) | April 2014 | 550 | 544 | — | |||||||
Senior Subordinated Notes (5) | April 2015 | 875 | 860 | — | |||||||
Securitization Obligations: | |||||||||||
Apple Ridge Funding LLC (6) | April 2012 | 850 | 670 | 180 | |||||||
Kenosia Funding LLC (6)(7) | April 2012 | 175 | 175 | — | |||||||
U.K. Relocation Receivables Funding Limited (6) | April 2012 | 198 | 169 | 29 | |||||||
| $ | 8,252 | $ | 7,253 | $ | 922 | ||||||
| (1) | The available capacity under the revolving credit facility is reduced by $37 million of outstanding letters of credit at December 31, 2007. |
| (2) | Total capacity has been reduced by the quarterly payments of 0.25% of the loan balance as required under the term loan facility agreement. The interest rate on the term loan facility was 8.24% at December 31, 2007. |
| (3) | Consists of $1,700 million of 10.50% Senior Notes due 2014, less a discount of $19 million. |
| (4) | Consists of $550 million of 11.00%/11.75% Senior Toggle Notes due 2014, less a discount of $6 million. |
| (5) | Consists of $875 million of 12.375% Senior Subordinated Notes due 2015, less a discount of $15 million. |
| (6) | Available capacity is subject to maintaining sufficient relocation related assets to collateralize these securitization obligations. |
| (7) | As described in “Financial Obligations—Securitization Obligations,” effective with the March 14, 2008 amendment, the outstanding balance will be reduced to $137 million from $175 million and capacity will be reduced to zero by mid June 2009. |
Covenants Under Our Senior Secured Credit Facility and the Notes
Our senior secured credit facility and the Notes contain various covenants that limit our ability to, among other things:
incur or guarantee additional debt;
incur debt that is junior to senior indebtedness and senior to the senior subordinated notes;
pay dividends or make distributions to our stockholders;
repurchase or redeem capital stock or subordinated indebtedness;
make loans, capital expenditures or investments or acquisitions;
incur restrictions on the ability of certain of our subsidiaries to pay dividends or to make other payments to us;
enter into transactions with affiliates;
create liens;
merge or consolidate with other companies or transfer all or substantially all of our assets;
transfer or sell assets, including capital stock of subsidiaries; and
prepay, redeem or repurchase debt that is junior in right of payment to the Notes.
As a result of these covenants, we are limited in the manner in which we conduct our business and we may be unable to engage in favorable business activities or finance future operations or capital needs. In addition, the restrictive covenants in our senior secured credit facility, commencing March 31, 2008 and quarterly thereafter, require us to maintain a senior secured leverage ratio not to exceed a maximum amount. Specifically our senior secured net debt to trailing 12 month Adjusted EBITDA, as defined in the credit facility, may not exceed 5.6 to 1 during the first two quarters of the calculation period and that ratio steps down to 5.35 to 1 at September 30, 2008, further steps down to 5.0 to 1 at September 30, 2009 and steps down to 4.75 to 1 at March 31, 2011 and thereafter. At December 31, 2007, the Company’s senior secured leverage ratio was 3.8 to 1. Our obligations under the securitization facilities and the indentures governing the notes are not considered “indebtedness” for the senior secured credit facility leverage ratio. A breach of the senior secured leverage ratio or any of the other restrictive covenants would result in a default under our senior secured credit facility. Upon the occurrence of an event of default under our senior secured credit facility, the lenders:
will not be required to lend any additional amounts to us;
could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable;
could require us to apply all of our available cash to repay these borrowings; or
could prevent us from making payments on the senior subordinated notes;
any of which could result in an event of default under the Notes and our Securitization Facilities.
If we were unable to repay those amounts, the lenders under our senior secured credit facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged the majority of our assets as collateral under our senior secured credit facility. If the lenders under our senior secured credit facility accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay our senior secured credit facility and our other indebtedness, including the Notes, or borrow sufficient funds to refinance such indebtedness. Even if we are able to obtain new financing, it may not be on commercially reasonable terms, or terms that are acceptable to us.
LIQUIDITY RISKLiquidity Risk
Our liquidity position may be negatively affected by unfavorable conditions inthe condition of the real estate or relocation market, including adverse changes in interest rates, access to our relocation asset-backed facilities and access to the capital markets, which may be limited if we were to fail to renew any of the facilities on their renewal dates or if we were to fail to meet certain ratios.
As a result of the increased borrowings that are expected to bewere incurred to consummate the merger (orMerger, the Company’s future financing needs were materially impacted by the Merger and the rating agencies downgraded our debt ratings. In addition, on November 5, 2007, Standard & Poor’s lowered the Company’s corporate credit rating to B from B+ and lowered the Company’s Credit Facility and Senior Notes credit rating from BB to BB- to reflect its expectation that the Company will experience lower than previously expected cash flow generation and weakening credit measures over the intermediate-term resulting from a lengthening downturn in the US residential real estate market. It is possible that the rating agencies may downgrade our ratings further based upon our results of operations and financial condition or as a result of national and/or global economic and political events aside from the merger), it is possible that the rating agencies may further downgradeMerger.
Based on our debt ratings, which would increase our borrowing costs and therefore could adversely affect our financial results. In addition, it is possible that the rating agencies may downgrade our ratings based upon our resultscurrent level of operations and financial condition.forecasts, we believe that cash flows from operations and available cash, together with available borrowings under our senior secured credit facility will be adequate to meet our liquidity needs including debt service over the next 12 months. Funding requirements of our relocation business are satisfied through the issuance of securitization obligations to finance relocation receivables and advances and relocation properties held for sale.
We cannot assure you, however, that our business will generate sufficient cash flows from operations or that future borrowing will be available to us under our senior secured credit facility in an amount sufficient to enable us to pay our indebtedness, including the Notes, or to fund our other liquidity needs. In addition, upon the occurrence of certain events, such as a change of control, we could be required to repay or refinance our indebtedness. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior secured credit facility, and the Notes, on commercially reasonable terms or at all.
Certain of our borrowings, primarily borrowings under our senior secured credit facility, and our securitization obligations are at variable rates of interest and expose us to interest rate risk. If S&P further downgradesinterest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net loss would increase further. We have entered into interest rate swaps, involving the exchange of floating for fixed rate interest payments, to reduce interest rate volatility for a portion of our floating interest rate debt rating applicablefacilities. In addition, for the $550 million of Senior Toggle Notes, the Company may, at its option, elect to pay interest (1) entirely in cash (2) by increasing the existing senior unsecuredprincipal amount of the outstanding Senior Toggle Notes by issuing PIK (payment in kind) notes or Moody’s downgrades the debt rating on those notes to below investment grade, the(3) by paying 50% in cash and 50% in PIK notes. We believe our interest rate on those senior notes will berisk related to our securitization obligations is further increased up to a maximum 2.00% increase from their initial interestmitigated as the rate depending on the extent the ratings are downgraded, as set forth in the existing notes. On March 1, 2007, S&P indicated that if these notes remain a permanent piece of the Company’s capital structure following the pending merger with affiliates of Apollo, the ratings on these notes would be further downgraded to BB. On March 2, 2007, Moody’s indicated that if the pending merger is approved by the Company’s stockholders, Moody’s will lower the ratings on these notes to Ba3. Accordingly, if these downgrades are issued, the interest rate on each of the three series of notes will be increased 1.25% from their initial interest rate (or an additional 100 basis points from the current interest rate) retroactive to the beginning of the then current respective interest period. Any downgrade by either rating agencywe incur on our current or future senior unsecured notes, whether or not below investment grade, could increasesecuritization borrowings and the pricing of any amounts drawn under our syndicated bank credit facilities — namely, the spread to LIBOR increases as our ratings from either S&P or Moody’s decreases. A downgrade in our credit rating below investment grade could also result in an increase in the amount of collateral required by our letters of credit. A downgrade in our senior unsecured rating below BB- from S&P or below Ba3 from Moody’s would trigger a default for our Apple Ridge Funding LLC secured facility. A security rating is not a recommendation to buy, sell or hold securitiesrate we earn on relocation receivables and is subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.
We may need to incur additional debt or issue equity to make strategic acquisitions or investments. We cannot assure that financing will be available to us on acceptable terms or that financing will be available at all. Our ability to make payments to fund working capital, capital expenditures, debt service, strategic acquisitions, joint ventures and investments will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, regulatory and other factors that are beyond our control.
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SEASONALITYSeasonality
Our businesses are subject to seasonal fluctuations. Historically, operating statistics and revenues for all of our businesses have been strongest in the second and third quarters of the calendar year. A significant portion of the expenses we incur in our real estate brokerage operations are related to marketing activities and commissions and are, therefore, variable. However, many of our other expenses, such as facilities costs and certain personnel-related costs, are fixed and cannot be reduced during a seasonal slowdown.
CONTRACTUAL OBLIGATIONSContractual Obligations
The following table summarizes our future contractual obligations as of December 31, 2006.
| 2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | Total | ||||||||||||||||||||||
Secured obligations(a) | $ | 893 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 893 | ||||||||||||||
Unsecured obligations(b) | — | — | 250 | — | 1,050 | 500 | 1,800 | |||||||||||||||||||||
| Capital leases | 11 | 8 | 4 | 1 | — | — | 24 | |||||||||||||||||||||
| Operating leases | 165 | 134 | 106 | 78 | 54 | 83 | 620 | |||||||||||||||||||||
Purchase commitments(c)(d) | 38 | 13 | 10 | 10 | 9 | 1 | 81 | |||||||||||||||||||||
| Total | $ | 1,107 | $ | 155 | $ | 370 | $ | 89 | $ | 1,113 | $ | 584 | $ | 3,418 | ||||||||||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | Total | |||||||||||||||
Securitization obligations (a) | $ | 1,014 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 1,014 | |||||||
Term loan facility (b)(c) | 32 | 32 | 32 | 31 | 31 | 2,996 | 3,154 | ||||||||||||||
10.50% Senior notes (c) | — | — | — | — | — | 1,700 | 1,700 | ||||||||||||||
11.00%/11.75% Senior toggle notes (c) | — | — | — | — | — | 550 | 550 | ||||||||||||||
12.375% Senior subordinated notes (c) | — | — | — | — | — | 875 | 875 | ||||||||||||||
Operating leases (d) | 196 | 169 | 135 | 102 | 71 | 121 | 794 | ||||||||||||||
Capital leases | 15 | 10 | 6 | 4 | 4 | 25 | 64 | ||||||||||||||
Purchase commitments (e) | 21 | 14 | 14 | 14 | 7 | 267 | 337 | ||||||||||||||
Total (f)(g) | $ | 1,278 | $ | 225 | $ | 187 | $ | 151 | $ | 113 | $ | 6,534 | $ | 8,488 | |||||||
| (a) | Excludes future cash payments related to interest expense as the underlying debt instruments are variable rate and the interest payments will ultimately be determined by the interest rates in effect during each period. | |
| (b) | We used $1,950 million of our $3,170 million term loan facility to finance the Transactions and $1,220 million to finance the purchase of the 2006 Senior Notes. Prior to December 31, 2007, the Company had made $16 million of scheduled quarterly payments. |
| (c) |
| (d) | The operating lease amounts included in | |
| (e) | Purchase commitments |
| (f) | On April 26, 2007, the Company utilized $500 million of the $525 million synthetic letter of credit facility to establish a standby irrevocable letter of credit for the benefit of Avis Budget Group in accordance with the Separation and Distribution Agreement and a letter agreement among the Company, Wyndham Worldwide and Avis Budget Group relating thereto. The standby irrevocable letter of credit back-stops the Company’s payment obligations with respect to its share of Cendant contingent and other corporate liabilities under the Separation and Distribution Agreement for which we pay interest of 300 basis points. This letter of credit is not included in the contractual obligations table above. |
| (g) | The contractual obligations table does not include the annual Apollo management fee which is equal to the greater of $15 million or 2% of adjusted EBITDA and does not include $37 million of unrecognized tax benefits as the Company is not able to estimate the year in which these tax positions will reverse. |
CRITICAL ACCOUNTING POLICIESCritical Accounting Policies
In presenting our financial statements in conformity with generally accepted accounting principles, we are required to make estimates and assumptions that affect the amounts reported therein. Several of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future
events. However, events that are outside of our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. If there is a significant unfavorable change to current conditions, it could result in a material adverse impact to our combined results of operations, financial position and liquidity. We believe that the estimates and assumptions we used when preparing our financial statements were the most appropriate at that time. Presented below are those accounting policies that we believe require subjective and complex judgments that could potentially affect reported results. However, the majority of our businesses operate in environments where we are paid a fee for a service performed, and therefore the results of the majority of our recurring operations are recorded in our financial statements using accounting policies that are not particularly subjective, nor complex.
Business Combinationscombinations
A key component of our growth strategy is to continue to acquire and integrate independently-owned real estate brokerages and other strategic businesses that complement our existing operations. We account for business combinations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and related literature. Accordingly, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based upon their estimated
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In determining the fair values of assets acquired and liabilities assumed in a business combination, we use various recognized valuation methods including present value modeling and referenced market values (where available). Further, we make assumptions within certain valuation techniques including discount rates and timing of future cash flows. Valuations are performed by management, or independent valuation specialists, where appropriate. We believe that the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions that marketplace participants would use. However, such assumptions are inherently uncertain and actual results could differ from those estimates.
With regard to the goodwill and other indefinite-lived intangible assets recorded in connection with business combinations, we annually or, more frequently if circumstances indicate impairment may have occurred, review their carrying values as required by SFAS No. 142, “Goodwill and Other Intangible Assets.” In performing this review, we are required to make an assessment of fair value for our goodwill and other indefinite-lived intangible assets. When determining fair value, we utilize various assumptions, including projections of future cash flows. A change in these underlying assumptions could cause a change in the results of the tests and, as such, could cause the fair value to be less than the respective carrying amount. In such an event, we would then be required to record a charge, which would impact earnings.
The aggregate carrying value of our goodwill and other indefinite-lived intangible assets was $3,326$3,939 million and $422$2,270 million, respectively, at December 31, 2006.2007. Our goodwill and other indefinite-lived intangible assets are allocated amongto our four reporting units. Accordingly, it is difficult to quantify the impact of an adverse change in financial results and related cash flows, as such change may be isolated to one of our reporting units or spread across our entire organization. In either case, the magnitude of any impairment to goodwill or other indefinite-lived intangible assets resulting from adverse changes cannot be estimated. However, ourOur businesses are concentrated in one industry and, as a result, an adverse change to the real estate industry will impact our combined results and may result in an impairment of our goodwill or other indefinite-lived intangible assets.
Income Taxestaxes
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets to assess their potential realization and establish a valuation allowance for portions of such assets that we believe will not be ultimately realized. In performing this review, we make estimates and assumptions regarding projected future
taxable income, the expected timing of the reversals of existing temporary differences and the implementation of tax planning strategies. A change in these assumptions could cause an increase or decrease to our valuation allowance resulting in an increase or decrease in our effective tax rate, which could materially impact our results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”), which is an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company adopted the provisions of FIN 48 on January 1, 2007, as required. The Company’s adoption of FIN 48 may resultrequired, and recognized a $13 million increase in the liability for unrecognized tax benefits including associated accrued interest and penalties and a corresponding decrease to stockholders’ equity as of January 1, 2007 of approximately $10 million to $50 million.
Recently Issued Accounting Bulletin No. 108, which provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. The Company applied this
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Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This statement clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, this standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data (for example, a company’s own data). Under this statement, fair value measurements would be separately disclosed by level within the fair value hierarchy.
SFAS 157 is effective for consolidated financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.2007. The Company intends to adoptadopted SFAS 157 effective January 1, 2008 except for the nonrecurring fair value measurements of nonfinancial assets and is evaluatingnonfinancial liabilities as permitted by the Staff Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”) as stated below. The adoption did not have a significant impact of its adoption onto the Company’s consolidated and combined financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits an entity to irrevocably elect fair value (“the fair value option”) as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on aan instrument-by-instrument basis with certain exceptions. The changes in fair value should be recognized in earnings as they occur. An entity would be permitted to elect the fair value option at initial recognition of a financial asset or liability or upon an event that gives rise to new-basis accounting for that item.
SFAS 159 is effective for consolidated financial statements issued for fiscal years beginning after November 15, 2007. The Company intends to adoptadopted SFAS 159 effective January 1, 2008. The adoption did not have a significant impact to the Company’s consolidated and combined financial statements.
In December 2007, the FASB issued SFAS 141(R) “Business Combinations” (“SFAS 141(R)”) and SFAS 160 “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”
(“SFAS 160”). SFAS 141(R) and SFAS 160 introduce significant changes in the accounting for and reporting of business acquisitions and noncontrolling interests in a subsidiary, which require:
Contingent consideration (e.g. earnouts) to be measured at fair value on the acquisition date. Contingent consideration recorded as a liability will subsequently be re-measured until settled, with changes in fair value recorded in earnings. Contingent consideration recorded as equity is not re-measured.
Payment to third parties for acquisition related costs (e.g. consulting, legal, audit, etc.) to be expensed when incurred rather than capitalized as part of the purchase price. Equity issuance and related registration costs for the acquisition will reduce the fair value of the securities issued on acquisition date.
Noncontrolling interests (previously referred to as minority interests) to be initially recorded at fair value at acquisition date, and presented within the equity section instead of a liability or the mezzanine section of the balance sheet.
Any adjustments to an acquired entity’s deferred tax assets and uncertain tax position balances that occur after the measurement period to be recorded as a component of income tax expense rather than through goodwill. This is required of all business combinations regardless of the consummation date.
Subsequent increases or decreases in the ownership interest of a partially owned subsidiary that does not create a change in control to be accounted for as an equity transaction and no gains or losses will be recorded.
These pronouncements are effective for business acquisitions consummated after the fiscal year beginning on or after December 15, 2008, except for the adjustments to deferred tax assets and uncertain tax position balances noted above. In addition, SFAS 160 requires retrospective application to the presentation and disclosure for all periods presented in the financial statements. The Company intends to adopt these pronouncements on January 1, 2009 and is evaluating the impact of its adoption on the consolidated and combined financial statements.
In December 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 110 to extend the use of “simplified method” for estimating the expected terms of “plain vanilla” employee stock options for the awards valuation. The method was initially allowed under SAB 107 in connection with the adoption of SFAS 123(R) “Stock-based Payment” (“SFAS 123(R)”) in order to determine the compensation cost based on the awards grant date fair value. SAB 110 does not provide an expiration date for the use of the method. However, as more external information about exercise behavior will be available over time, it is expected that this method will not be used when more relevant information is available.
In January 2008, the FASB issued SFAS 133 Implementation Guidance No. E23 “Hedging—General: Issues Involving the Application of the Shortcut Method under Paragraph 68” (“E23”). Further to the adoption of SFAS 157 “Fair Value Measurement”, E23 amends paragraph 68 of SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” to permit the use of the shortcut method, which assumes no ineffectiveness at the hedge inception and subsequent periods, in the following circumstances:
Interest rate swaps that have a non-zero fair value at inception, provided that the non-zero fair value at inception is attributable solely to a bid-ask spread.
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Hedged items that have a settlement date after the swap trade date, provided that the trade date of the asset or liability differs from its settlement date because of generally established conventions in the marketplace in which the transaction is executed.
E23 is effective for hedging relationships designated on or after January 1, 2008. The Company adopted the guidance effective January 1, 2008 and the adoption did not have a significant impact to the consolidated and combined financial statements.
In February 2008, the FASB issued FSP SFAS 157-2, “Effective Date for FASB Statement No. 157”. This FSP permits the delayed application of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The Company has chosen to adopt SFAS 157 in accordance with the guidance of FSP SFAS 157-2 as stated above.
| ITEM 7A. | QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK |
We assess our market risk based on changes in interest rates utilizing a sensitivity analysis. The sensitivity analysis measures the potential impact in earnings, fair values and cash flows based on a hypothetical 10% change (increase and decrease) in interest rates. In performing the sensitivity analysis, we are required to make assumptions regarding the fair values of relocation receivables and advances and securedsecuritization borrowings, which approximate their carrying values due to the short-term nature of these items. We believe our interest rate risk is further mitigated as the rate we incur on our securedsecuritization borrowings and the rate we earn on relocation receivables and advances are based on similar variable indices.
Our total market risk is influenced by factors including the volatility present within the markets and the liquidity of the markets. There are certain limitations inherent in the sensitivity analyses presented. While probably the most meaningful analysis, these analyses are constrained by several factors, including the necessity to conduct the analysis based on a single point in time and the inability to include the complex market reactions that normally would arise from the market shifts modeled.
At December 31, 2007 we had total long term debt of $6,239 million excluding $1,014 of securitization obligations. Of the $6,239 million of long term debt, the Company has $3,154 million of variable interest rate debt primarily based on 3-month LIBOR. We have entered into floating to fixed interest rate swap agreements with varying expiration dates with an aggregate notional value of $775 million and, effectively fixed our interest rate on that portion of variable interest rate debt. The variable interest rate debt is subject to market rate risk, as our interest payments will fluctuate as underlying interest rates change as a result of market changes. We have determined that the impact of a 10%100bps (1% change in interest rates and pricesthe rate) change in LIBOR on our earnings, fair values and cash flowsterm loan facility variable rate borrowings would not be material at December 31, 2006.affect our interest expense by approximately $24 million. While these results may be used as benchmarks, they should not be viewed as forecasts.
At December 31, 2007, the fair value of our long term debt approximated $5,319 million, which was determined based on quoted market prices. Since considerable judgment is required in interpreting market information, the fair value of the long-term debt is not necessarily indicative of the amount that could be realized in a current market exchange. A 10% decrease in market rates would have a $116 million impact on the fair value of our long-term debt.
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
See “Index to Financial Statements” onpage F-1.
| ITEM 9. | CHANGES |
None.
| ITEM 9A. | CONTROLS AND PROCEDURES |
| (a) | We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our management, including the Chief Executive Officer and the Chief Financial Officer, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. |
| (b) | As of the end of the period covered by this Annual Report onForm 10-K, we have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective at the “reasonable assurance” level. |
| (c) | There has not been any change in our internal control over financial reporting during the period covered by this Annual Report onForm 10-K that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting. |
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Realogy’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Realogy’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Realogy’s internal control over financial reporting includes those policies and procedures that:
| (ii) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of Realogy’s management and directors; and |
| (iii) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use of disposition of Realogy’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the separation benefits (including post-termination consulting obligationsrisk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Realogy’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in its Internal Control-Integrated Framework.
Based on this assessment, management determined that Realogy maintained effective internal control over financial reporting as of December 31, 2007.
This Annual Report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and payments related thereto) applicable under his existing employment agreement with us, which is described elsewhereExchange Commission that permit the Company to provide only management’s report in this Annual ReportReport.
| ITEM 9B. | OTHER INFORMATION |
On March 14, 2008, the Company amended its Kenosia Securitization Facility in connection with Cartus’ decision to exit the “at risk” government relocation business. For a discussion of this amendment, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition—Financial Obligations—Securitization Obligations” and “Item 1—Business—Relocation Services.”
On March 13, 2008, the Holdings Compensation Committee approved the bonus structure for the 2008 fiscal year under “Item 11 — Executive Compensation — Employment Agreements and Other Arrangements.” Pursuantthe Company’s 2008 Annual Bonus Plan (the “2008 Bonus Plan”) applicable to this letter agreement, Realogy was relieved fromexecutive officers. The 2008 Bonus Plan permits the payment of cash bonuses based upon pre-established performance criteria for 2008. For a contractual obligation to deposit the lump sum amount referred to below into a rabbi trust within 15 days following the occurrence of a Potential Change in Control (e.g. the executiondiscussion of the merger agreement with Apollo affiliates). Rather, this amount will be deposited into a rabbi trust no later than the consummation of a change in control (e.g., no later than the consummation of our merger with affiliates of Apollo). The letter agreement provides for a payment to Mr. Silverman in an amount representing the net value of the Separation Benefits (excluding office space2008 Bonus Plan, see “Item 11—Executive Compensation—Compensation Discussion and personal security benefits described under Item 11) and the consulting payments, no later than one business day following the date of the Qualifying Termination (or, if later, on the earliest day permitted under Section 409A of the Internal Revenue Code). That payment is in lieu of his receiving the Separation Benefits and consulting payments during the time periods provided for in the employment agreement.
PART III
| ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
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The following table sets forth information regarding individuals who currently serve as our executive officers and directors. The age of each individual in the table below is as of December 31, 2006, regarding individuals who are our executive officers.
Name | Age | Position(s) | ||||
Henry R. Silverman | ||||||
| Non-Executive Chairman of the Board | ||||||
Richard A. Smith | 54 | President and Chief Executive Officer | ||||
Anthony E. Hull | ||||||
| 49 | Executive Vice President, Chief Financial Officer and Treasurer | |||||
Marilyn J. Wasser | ||||||
| 52 | Executive Vice President, | |||||
David J. Weaving | ||||||
| 41 | Executive Vice President and Chief Administrative Officer | |||||
Kevin J. Kelleher | 53 | President and Chief Executive Officer, Cartus Corporation | ||||
Alexander E. Perriello, III | 60 | President and Chief Executive Officer, Realogy Franchise Group | ||||
Bruce Zipf | ||||||
| 51 | President and Chief Executive Officer, NRT | |||||
Donald J. Casey | ||||||
| 46 | President and Chief Executive Officer, Title Resource Group | |||||
Dea Benson | ||||||
| 53 | Senior Vice President, Chief Accounting Officer and Controller | |||||
Marc E. Becker | 35 | Director | ||||
V. Ann Hailey | 56 | Director | ||||
Scott M. Kleinman | 35 | Director | ||||
Lukas Kolff | 34 | Director | ||||
M. Ali Rashid | 31 | Director | ||||
Grenville Turner | 50 | Director |
Henry R. Silvermanhas serves as our Non-Executive Chairman of the Board. He served as our Chairman of the Board, Chief Executive Officer and a director since our separation from Cendant in July 2006. It is expected that Mr. Silverman will step down as our Chief Executive Officer effective January 1, 2008, and, subject to Board approval, our Vice Chairman and President, Richard A. Smith, will assume the position of Chief Executive Officer.2006 until November 13, 2007. Mr. Silverman was Chief Executive Officer and a director of Cendant from December 1997 until the completion of Cendant’s separation plan in August 2006, as well as Chairman of the Board of Directors and the Executive Committee from July 1998 until August 2006. Mr. Silverman was President of Cendant from December 1997 until October 2004. Mr. Silverman was Chairman of the Board, Chairman of the Executive Committee and Chief Executive Officer of HFS Incorporated from May 1990 until December 1997.
Richard A. Smithhas served as our President and Chief Executive Officer since November 13, 2007, and continues to serve as a director. Prior to that date, he served as our Vice Chairman of the Board, President and a director since our separation from Cendant in July 2006. Mr. Smith was Senior Executive Vice President of Cendant from September 1998 until our separation from Cendant in July 2006 and Chairman and Chief Executive Officer of Cendant’s Real Estate Services Division from December 1997 until our separation from Cendant in July 2006. Mr. Smith was President of the Real Estate Division of HFS from October 1996 to December 1997 and Executive Vice President of Operations for HFS from February 1992 to October 1996.
Anthony E. Hullhas served as our Executive Vice President, Chief Financial Officer and Treasurer since our separation from Cendant in July 2006. From December 14, 2007 to February 3, 2008, Mr. Hull performed the functions of our Chief Accounting Officer. Mr. Hull was Executive Vice President, Finance of Cendant from October 2003 until our separation from Cendant in July 2006. From January 1996 to September 2003, Mr. Hull served as Chief Financial Officer for DreamWorks, a diversified entertainment company. From 1990 to 1994, Mr. Hull worked in various capacities for Paramount Communications, a diversified entertainment and publishing company. From 1984 to 1990 Mr. Hull worked in investment banking at Morgan Stanley.
C. Patteson Cardwell, IVMarilyn J. Wasserhas served as our Executive Vice President, and General Counsel and Corporate Secretary since our separation from Cendant in July 2006. Mr. CardwellMay 10, 2007. From May 2005 until May 2007, Ms. Wasser was Senior Vice President, Legal responsibleGeneral Counsel and Corporate Secretary for all Cendant Real Estate Services Division legal mattersTelcordia Technologies, a provider of telecommunications software and services. From 1983 until 2005, Ms. Wasser served in several positions of increasing responsibility with AT&T Corporation and AT&T Wireless Services. Most recently, from March 2000 until our separation from Cendant in July 2006. From November 1996September 2002 to March 2000, Mr. CardwellFebruary 2005, Ms. Wasser served as Executive Vice President, Associate General Counsel and Legal CounselCorporate Secretary for our Coldwell Banker®AT&T Wireless Services. She supported M&A activities, wireless opportunities and Coldwell Banker Commercial® brands. From May 1994internet investments and from 1995 until 2002, Ms. Wasser also served as Secretary to November 1996, Mr. Cardwell was an associatethe AT&T Board of Directors and later a partner in the Law Offices of Cohen & Mohr, in Washington, D.C.
David J. Weavinghas served as our Executive Vice President and Chief Administrative Officer since our separation from Cendant in July 2006. Mr. Weaving was Senior Vice President and Chief Financial Officer
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Kevin J. Kelleherhas served as our President and Chief Executive Officer, Cartus Corporation. Mr. Kelleher was President and Chief Executive Officer of Cendant Mobility Services Corporation from 1997 until our separation from Cendant in July 2006. From 1993 to 1997 he served as Senior Vice President and General Manager of Cendant Mobility’s destination services unit. Mr. Kelleher has also held senior leadership positions in sales, client relations, network management and strategic planning.
Alexander E. Perriello, IIIhas served as our President and Chief Executive Officer, Realogy Franchise Group, since our separation from Cendant in July 2006. Mr. Perriello was President and Chief Executive Officer of the Cendant Real Estate Franchise Group from April 2004 until our separation from Cendant in July 2006. From 1997 through 2004 he served as President and Chief Executive Officer of Coldwell Banker Real Estate Corporation.
Bruce Zipfhas served as President and Chief Executive Officer of NRT IncorporatedLLC since March 2005 and as President and Chief Operating Officer from February 2004 to March 2005. From January 2003 to February 2004, Mr. Zipf served as Executive Vice President and Chief Administrative Officer for NRT responsible for the financial and administrative sectors that included acquisitions and mergers, financial planning, human resources and facilities, and from 1998 through December 2002, he served as NRT’s Senior Vice President for most of NRT’s Eastern Operations. From 1996 to 1998, Mr. Zipf served as President and Chief Operating Officer for Coldwell Banker Residential Brokerage - Brokerage—New York. Prior to entering the real estate industry, Mr. Zipf was a senior audit manager for Ernst and Young.
Donald J. Caseyhas served as our President and Chief Executive Officer, Title Resource Group, since our separation from Cendant in July 2006. Mr. Casey was President and Chief Executive Officer, Cendant Settlement Services Group from April 2002 until our separation from Cendant in July 2006. From 1995 until April 2002, he served as Senior Vice President, Brands of PHH Mortgage. From 1993 to 1995, Mr. Casey served as Vice President, Government Operations of Cendant Mortgage. From 1989 to 1993, Mr. Casey served as a secondary marketing analyst for PHH Mortgage Services (prior to its acquisition by Cendant).
Christopher R. CadeDea Bensonhas served as our Senior Vice President, Chief Accounting Officer and Controller since our separationFebruary 2008. Prior to being named Chief Accounting Officer of the Company, Ms. Benson served from Cendant in July 2006. Mr. Cade was Vice President, Corporate FinanceSeptember 2007 to January 2008 as Chief Accounting Officer of Cendant from 2004 until our separation from Cendant in July 2006. From 2002 to 2004, he served as Director, Corporate AccountingGenius Products, Inc., the managing member and Reporting for Public Service Enterprise Group. From 1996 to 2002, Mr. Cade served in multipleminority owner of Genius Products, LLC, an independent home entertainment distributor. For more than 11 years prior thereto, Ms. Benson held various financial and accounting capacitiespositions with increasing responsibilitiesDreamWorks SKG/Paramount Pictures, most recently from November 2002 to January 2006 as Controller of DreamWorks SKG and from February 2006 to December 2006 as divisional CFO of the Worldwide Home Entertainment division of Paramount Pictures, subsequent to Paramount’s acquisition of DreamWorks SKG. Ms. Benson is a certified public accountant.
Marc E. Becker became a director as of the closing of the Transactions. Mr. Becker is a partner of Apollo. He has been employed with Apollo since 1996. Prior to that time, Mr. Becker was employed by Smith Barney Inc. within its Investment Banking division. Mr. Becker also serves on the boards of directors of Affinion Group, Inc., Countrywide plc, Quality Distribution, Inc., and SOURCECORP.
V. Ann Hailey became a director in February 2008. Ms. Hailey is a retired Executive Vice President of LimitedBrands where she served as EVP, Chief Financial Officer from August 1997 until April 2006. She then served as EVP, Corporate Development until September 2007. She also served as a member of the LimitedBrands Board of Directors from 2001 to 2006. Prior to joining Limited Brands in 1997, Ms. Hailey was Senior Vice President and Chief Financial Officer of Pillsbury Company. She is also a Director and Chair of the Audit Committee of the Federal Reserve Bank of Cleveland. Ms. Hailey is a Director of W.W. Grainger, Inc. and serves as a member of its Audit Committee and Board Affairs and Nominating Committee.
Lukas Kolffjoined Apollo in 2006. Prior to that time, Mr. Kolff worked as a vice president at Ripplewood Holdings L.L.C., where he executed private equity investments in the United States, Europe and Japan. Mr. Kolff served on the board of directors and executive committees of several Ripplewood portfolio companies in the United States, Europe and Japan. Prior to joining Ripplewood in 1999, Mr. Kolff worked as a financial analyst in the Mergers & Acquisitions & Restructuring Department of Morgan Stanley & Co in London. Mr. Kolff also serves on the boards of directors of CEVA Group plc and Countrywide plc. Mr. Kolff has a master’s degree in business economics from Rijks Universiteit Groningen, University of Groningen, The Netherlands, where he graduated with highest honors.
Scott M. Kleinman became a director as of the closing of the Transactions. Mr. Kleinman is a partner of Apollo. He has been employed with Apollo since 1996. Prior to that time, Mr. Kleinman was employed by Smith Barney Inc. in its Investment Banking division. Mr. Kleinman also serves on the boards of directors of Hexion Specialty Chemicals, Momentive Performance Materials, Norando Aluminum and Verso Paper.
M.Ali Rashid became a director as of the closing of the Transactions. Mr. Rashid is a principal of Apollo. He has been employed with Apollo since 2000. From 1998 to 2000, Mr. Rashid was employed by the Goldman Sachs Group, Inc. in the Financial Institutions Group of its Investment Banking Division. He is also a director of Countrywide plc, Metals USA, Noranda Aluminum and Quality Distribution, Inc.
Grenville Turner became a director on August 28, 2007. Mr. Turner joined Countrywide plc on August 1, 2006 as an Executive Director and became Group Chief Executive on January 1, 2007 and is also a director of Countrywide Estate Agents. Mr. Turner qualified as a Chartered Banker in 1982 and holds a master’s degree in business administration from Cranfield Business School. He was formerly Chief Executive, Intelligent Finance and Chief Executive, Business to Business at HBOS and previously served as a director of St James Place Capital Plc, Sainsbury’s Bank Plc and Rightmove.co.uk Limited.
The composition of the Board of Directors and the identity of the executive officers of Holdings and Intermediate is identical to those of Realogy.
Committees of the Board
Prior to the Merger, the Company’s board of directors had the following standing committees: an executive committee, an audit committee, a compensation committee and a corporate governance committee. As a privately-held company, our board of directors is not required to have committees and in 2007, for Pharmacia Corporation (now owned by Pfizer Inc.)a period following the consummation of the Transactions, there were no standing committees.
In February 2008, the Holdings Board established a Compensation Committee, whose members consist of Marc Becker (Chair) and Intermetro Industries Corporation,M. Ali Rashid. The purpose of the Holdings Compensation Committee is to:
oversee management compensation policies and practices of Holdings and its subsidiaries, including Realogy, including, without limitation,(i) determining and approving the compensation of the Chief
Executive Officer and the other executive officers of Domus and its subsidiaries, including Realogy (ii) reviewing and approving management incentive policies and programs and exercising any applicable rule making authority or discretion in the administration of such programs, and (iii) reviewing and approving equity compensation programs for employees, and exercising any applicable rule making authority or discretion in the administration of such programs; |
to set and review the compensation of and reimbursement policies for members of the Board of Directors of Holdings, Intermediate and Realogy;
to provide oversight concerning selection of officers, management succession planning, expense accounts and severance plans and policies of Domus, Intermediate and Realogy; and
to prepare an annual compensation committee report, provide regular reports to the Holdings and Realogy Boards, and take such other actions as are necessary and consistent with the governing law and the organizational documents of Holdings.
In February 2008, the Realogy Board of Directors established an Audit Committee, whose members consist of V. Ann Hailey (Chair) and Messrs. Becker and Rashid. The Company is not required to comply with the independence criteria set forth in Rule 10A-3(b)(1) under the Exchange Act as it is not a subsidiary“listed company” with a class of Emerson Electric Company.
The purpose of the Audit Committee is to assist the Board in fulfilling its responsibility to oversee management regarding:
Realogy’s systems of internal control over financial reporting and disclosure controls and procedures;
the integrity of Realogy’s financial statements;
the qualifications, engagement, compensation, independence and performance of Realogy’s independent auditors, their conduct of the annual audit of the Company’s equity securities,financial statements and their engagement to file reports of ownershipprovide any other services;
Realogy’s compliance with legal and changes in ownership on Forms 3, 4 and 5 with the SEC and the NYSE. Officers, Directors and greater than ten percent beneficial owners are required to furnish the Company with copies of all Forms 3, 4 and 5 they file.regulatory requirements;
review of the copiesmaterial related party transactions; and
compliance with, adequacy of, such forms it has received, the Company believes that all its officers, Directors and greater than ten percent beneficial owners complied with all filing requirements applicable to themany requests for written waivers sought with respect to, transactions during 2005.any executive officer or director under, Realogy’s code(s) of conduct and ethics.
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The Board has adopted a code of ethics that applies to all officers and employees, including the Company’s principal executive officer, principal financial officer and principal accounting officer. The Board has also adopted a code of business conduct and ethics for Directors. Both codes of conduct areis available in the “Corporate Governance — Compliance & Ethics”Ethics For Employees section of the Company’s website atwww.realogy.com,. The purpose of these codesthe code of conduct is to promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; to promote full, fair, accurate, timely and understandable disclosure in periodic reports required to be filed by the Company; and to promote compliance with all applicable rules and regulations that apply to the Company and its officers and Directors.
| ITEM 11. | EXECUTIVE COMPENSATION |
973-407-7210 or by writing to us at Realogy Corporation, One Campus Drive, Parsippany, New Jersey 07054, Attn: Investor Relations.
Introduction.Company Background. Realogy became an independent, publicly traded company on the New York Stock Exchange on August 1, 2006, following its separation from Cendant pursuant to its plan of separation. As described more fully in the “Compensation Discussion and Analysis” under Item 11 of our Annual Report on Form 10-K for the year ended December 31, 2006, Realogy’s executive compensation arrangements and programs that were initially put in place upon our separation from Cendant were adopted by Cendant, and approved by Cendant’s compensation committee, in advance of Realogy becoming an independent public company and establishing our own compensation committee (the “Realogy Compensation Committee”). While we were a publicly traded company, the Realogy Compensation Committee reviewed and ratified the arrangements and programs and the initial awards.
In December 2006, Realogy entered into a merger agreement with affiliates of Apollo and that transaction (the “Merger”) was consummated on April 10, 2007. Pursuant to the terms of the merger agreement with Apollo, at the effective time of the Merger on April 10, 2007, each issued and outstanding share of common stock of the Company (other than shares held by Holdings, Domus Acquisition Corp., any subsidiary of Holdings, or held in treasury by the Company, any shares held by any subsidiary of the Company, and shares subject to dissenters’ rights and any shares as to which separate treatment in the Merger was separately agreed by Holdings and the holder thereof) was cancelled and automatically converted into the right to receive $30.00 in cash, without interest. In addition, at the effective time of the Merger, all outstanding equity awards became fully vested and cancelled and converted into the right to receive a cash payment. For restricted stock units and deferred unit awards, the cash payment equaled the number of units multiplied by $30.00. For stock options and stock appreciation rights, the cash payment equaled the number of shares or rights underlying the award multiplied by the amount, if any, by which $30.00 exceeded the exercise price.
Shortly prior to the consummation of the Merger, Apollo, principally through the Holdings Board of Directors (the “Pre-Merger Holdings Board”), whose members then consisted of Apollo’s representatives, Messrs. Marc Becker and M. Ali Rashid, negotiated employment agreements and other arrangements with our named executive officers (other than Mr. Silverman). The named executive officers who entered into these employment agreements were Richard A. Smith, our President, and effective November 13, 2007, our Chief Executive Officer; Anthony E. Hull, our Executive Vice President, Chief Financial Officer and Treasurer; Kevin J. Kelleher, President and Chief Executive Officer of Cartus Corporation; Alexander E. Perriello, III, President and Chief Executive Officer of Realogy Franchise Group; and Bruce Zipf, President and Chief Executive Officer of NRT LLC. Mr. Silverman did not enter into a new employment agreement given that Realogy had previously announced a succession plan, in which Mr. Smith would succeed Mr. Silverman as Realogy’s Chief Executive Officer at the end of 2007.
Upon consummation of the Merger and the delisting of its stock from the New York Stock Exchange, Realogy disbanded the Realogy Compensation Committee, as it no longer needed a separate compensation committee, which had been required under the NYSE listing standards.
Between April 10, 2007 and mid-February 2008, decisions relating to executive compensation were within the province of the post-Merger board of directors of Holdings (the “Holdings Board”) and the Realogy Board of Directors (the “Realogy Board”), both of which were (and are) controlled by Apollo representatives. During that period, the only matters affecting compensation of the executive officers addressed by the Holdings Board or Realogy Board dealt with the approval of technical amendments to the employee benefit plans in December 2007 and the temporary freeze under the Company match to the 401(k) plan and (with respect to new participants or new elections) under the Officer Deferred Compensation Plan in February 2008 discussed below.
In February 2008, the Holdings Board established a compensation committee, whose members consist of Messrs. Becker and Rashid (the “Holdings Compensation Committee”). The Holdings Compensation Committee,
as described under “Item 10—Directors, Executive Officers and Corporate Governance” of this Annual Report, has the power and authority to oversee the compensation policies and programs of Holdings and Realogy.
This Compensation Disclosure and Analysis describes, among other things, the compensation objectives and the elements of the executive compensation program embodied by the agreements negotiated between management and Apollo at the time of the acquisition, which forms the core of the executive compensation program.
Compensation Philosophy and Objectives.The Company’s primary objective with respect to executive compensation is to design and implement compensation policies and programs that efficiently and effectively provide incentives to, and motivate,,officers and key employees to increase their efforts towards creating and maximizing shareholderstockholder value. To accomplish this,In connection with the Company hasMerger, the Pre-Merger Holdings Board developed an executive compensation philosophyprogram designed to assurereward the achievement of specific annual and long-term goals by the Company, and which aligns the executives’ interests with those of our stockholders by rewarding performance above established goals, with the ultimate objective of improving stockholder value. The Pre-Merger Holdings Board evaluated, and following its establishment in February 2008, the Holdings Compensation Committee evaluates, both performance and compensation to ensure the Company maintains its ability to attract and retain superior employees in key positions and that compensation to key employees remains competitive relative to the compensation paid by similar sized companies. We do not rely on peer compensation information in the residential real estate services industry as it is difficult for us to obtain this information as most of these companies are privately held. The Pre-Merger Holdings Board believed, and the Holdings Compensation Committee believes, executive compensation packages provided by the Company to its executives, including the named executive officers, should include both cash and stock-based compensation that reward performance as measured against established goals.
In negotiating the initial employment agreements and arrangements with the named executive officers, Apollo (acting through the Pre-Merger Holdings Board) placed significant emphasis on aligning the management interests with those of Apollo. The named executive officers (other than Mr. Silverman) made significant equity investments in Holdings common stock upon consummation of the Merger and received equity awards that included performance vesting options that would vest upon Apollo and its co-investors receiving reasonable rates of return on its invested capital in Holdings as described below under “Management Equity Investment.” Other elements of compensation, such as base salary, cash-based incentive compensation, perquisites and benefits remained relatively unchanged post-Merger during the balance of 2007 from the arrangements that had been put in place prior to consummation of the Merger.
Role of Executive Officers in Compensation Decisions.Mr. Richard Smith, as our President through November 12, 2007 and our President and Chief Executive Officer since such date, was the principal negotiator representing management in its negotiation of employment agreements and other arrangements in connection with the consummation of the Merger. In addition, Mr. Smith annually reviews the performance of each of the named executive officers (other than his own performance and that of Mr. Silverman, who had served without compensation). Mr. Smith’s performance is reviewed by the Holdings Compensation Committee (and prior to the Merger, was reviewed by the Realogy Compensation Committee). The conclusions reached and recommendations based upon these reviews, including with respect to salary adjustment and annual incentive award target and actual payout amounts, are generally presented to the Holdings Compensation Committee, which has (and prior to the Merger, the Realogy Compensation Committee, which had) the discretion to modify any recommended adjustments or awards to executives. The Holdings Compensation Committee has (and prior to the Merger, the Realogy Compensation Committee had) final approval over all compensation decisions for the named executive officers, including approval of recommendations regarding cash and equity awards to all of our officers.
Setting Executive Compensation.Based on the foregoing objectives, the Pre-Merger Holdings Board structured our annual and long-term incentive cash and stock-based executive compensation programs to motivate our executives to achieve the business goals set by us and to reward the executives for achieving these goals.
Executive Compensation Elements. The principal components of compensation for our named executive officers (other than Mr. Silverman) are: base salary; bonus; management equity investments; management stock option awards; management restricted stock awards; other benefits and perquisites, and in the case of Mr. Silverman, post-retirement benefits.
Base Salary.We provide our named executive officers (other than Mr. Silverman) and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for named executive officers are determined for each executive based on his or her position, scope of responsibility and contribution to the Company’s earnings. The initial base salary for our named executive officers was established in their employment agreements entered into upon consummation of the Merger and equaled the base salary that the named executive officers had been paid at the time of Realogy’s separation from Cendant in 2006, based upon the terms approved by the Compensation Committee senior managementof the Cendant Board prior to the separation plus an approximate 4% increase (or in Mr. Hull’s case, an approximate 5% increase), consistent with the average annual increase provided to other employees in 2007 to reflect merit and adjustments for promotions and increased job responsibilities. The 4% average annual increase in base salary provided to employees in 2007 was based upon management’s view that such an increase was consistent with the average annual salary increase being made in base salaries of employees of companies throughout the U.S. economy.
Salary levels will be reviewed annually as part of our performance review process as well as upon a promotion or other material change in job responsibility. Merit based increases to salaries of the executives are based on the Holdings Compensation Committee’s assessment (and, with respect the named executive officers who received merit increases in 2007, by the Pre-Merger Holdings Board’s assessment based upon recommendations from Mr. Smith) of the individual’s performance. In reviewing base salaries for executives, the Pre-Merger Holdings Board considered (and the Holdings Compensation Committee is expected to consider) primarily the internal review of the executive’s compensation, individually and relative to other officers, and the individual performance of the executive. The Pre-Merger Holdings Board reviewed these criteria collectively but did not assign a weight to each criterion when setting base salaries. The Holdings Compensation Committee considers (and prior to the Holdings Compensation Committee’s formation, the Holdings Board considered) the extent to which the proposed overall operating budget for the upcoming year contemplates salary increases. Each base salary adjustment is generally made by the Holdings Board (or following its establishment, the Holdings Compensation Committee) subjectively based upon the foregoing. In October 2007, Mr. Smith (in consultation with Apollo in lieu of formal Holdings Board action) approved a $25,000 increase in Mr. Hull’s base salary, increasing it to $525,000 to bring it in line with the base salaries paid to the chief financial officers of companies located in Connecticut, Massachusetts, New Jersey and New York with annual revenue between $5-10 billion based upon survey data derived from Mercer LLC, Hewitt Associates LLC, Towers Perrin, Hay Group and Equilar, Inc. In light of the continuing downturn in the residential real estate market, and management’s desire to shift fixed costs to variable costs, where practicable, the Company does not currently expect any increases to the base salaries of the named executive officers in 2008.
Bonus.Our named executive officers (other than Mr. Silverman) participate in an annual incentive compensation program (“Bonus Program”) with performance objectives established by the Holdings Compensation Committee (or with respect to the 2007 Bonus Program, Mr. Smith) and communicated to our named executive officers generally within 90 days following the beginning of the calendar year. Under their respective employment agreements, the target annual bonuses payable to the named executive officers is 100% of annual base salary, or, in Mr. Smith’s case, given his overall greater responsibilities for the performance of the Company, 200% of annual base salary.
During 2007, for Messrs. Smith and Hull, whose efforts were focused on the overall performance of the business, 100% of the eligible bonus was based on one company-wide performance objective (described below). For Messrs. Kelleher and Perriello, 50% and 25%, respectively, of the eligible bonus was based upon the same Realogy company-wide performance objective as that applicable to Messrs. Hull and Smith, and the Human Resources functionother 50% and 75%, respectively, was based upon the performance objectives relating to the business units which they lead
(Cartus and Realogy Franchise Group, respectively). For Mr. Zipf, 100% of the Company work together,eligible bonus was based upon performance objectives relating to the NRT business unit that he leads.
The performance objective utilized for Realogy company-wide performance was EBIT—or earnings before interest and taxes—an objective that Cendant had historically utilized in compensating its chief executive officer and other executives. EBIT is also calculated before separation, restructuring, merger and Cendant legacy costs as they are not viewed as an accurate indicator of Realogy’s operating performance. The 2007 eligible bonus provided for a minimum, target and maximum EBIT with appropriate resourcesthe target bonus payable upon achievement of the target EBIT, and advisors,with a scale sliding upward to 125% of the target bonus and downward to 50% of the target bonus to the extent the EBIT is greater than or less than the target EBIT, but with no bonus payable with respect to this performance objective if the minimum EBIT is not achieved. Under the plans, minimum EBIT for Realogy for the entire 2007 year was established at $549 million, which threshold was not achieved.
The business unit performance objectives applicable to a portion of Messrs. Kelleher and Perriello and to Zipf’s entire eligible bonus are summarized below.
Mr. Kelleher’s business unit performance objective related to business unit EBIT with a floor EBIT, at which 50% of the bonus allocable to the business unit performance (or 37.5% of the entire bonus) would be payable was $110 million, which was not achieved in 2007.
Mr. Perriello’s business unit (Realogy Franchise Group) performance objective also related to business unit EBIT with a floor EBIT at which 37.5% of the bonus allocable to the business unit performance (or 25% of the entire bonus) would be payable was $245 million (excluding royalty revenue from NRT as that revenue relates to the performance of the NRT business unit), which was not achieved in 2007.
With respect to Mr. Zipf’s eligible bonus, 75% was based upon NRT’s EBIT before deducting budgeted intercompany royalties, 12.5% was based upon the percentage of NRT buyer controlled sales that result in mortgage business captured by our joint venture, PHH Home Loans LLC, from referrals from NRT, and the remaining 12.5% was based upon the percentage of NRT buyer controlled sales that result in title and settlement services captured by the Title Resource Group business unit from referrals from NRT, as detailed in the chart below. Mr. Zipf’s minimum eligible bonus was set at 50% of his target bonus amount and his maximum eligible bonus at 125% of his target bonus amount.
Performance Objective | Minimum | Target | Maximum | Weight | Achieved Percent | Basic Payout Percent | |||||||||||||
EBIT before intercompany royalties (dollars in millions) | $ | 212 | $ | 239 | $ | 259 | 75.0 | % | 102.53 | 76.90 | |||||||||
Mortgage Capture Rate | 17.20 | % | 19.20 | % | 21.20 | % | 12.5 | % | 80.00 | 10.00 | |||||||||
Title Capture Rate | 45.40 | % | 47.40 | % | 49.40 | % | 12.5 | % | 70.00 | 8.75 | |||||||||
Total Weighted Average Performance Achieved | 95.6 | ||||||||||||||||||
Based upon the foregoing, in March 2008, the Holdings Compensation Committee determined not to pay a bonus under the Bonus Program to any of Messrs. Smith, Hull, Kelleher and Perriello though the Board had the discretion to determine otherwise. The Holdings Compensation Committee determined that based on the achievement of NRT specific performance objectives, Mr. Zipf would have been entitled to 95.6% of his target bonus. The Holdings Compensation Committee, however, exercised negative discretion related to certain events in one of the NRT operating companies and approved a bonus payment of 84.2% of his target bonus or $433,150 in respect of 2007.
Pursuant to his employment agreement, Mr. Smith was paid a bonus in January 2008 in the amount of $97,000 that he was required to use to purchase the annual premium on an existing life insurance policy. Such bonus payment is an annual obligation of the Company. This benefit is provided to Mr. Smith as the replacement of a benefit previously provided to him by Cendant. In addition, pursuant to his employment agreement, and as partial consideration for the retention of Mr. Smith following the merger, Mr. Smith received a clear, unified and coordinated strategy.
elected to invest in the purchase of shares of Holdings common stock, which is reflected below under “Management Equity Investments.”
On March 13, 2008, the Holdings Compensation Committee recognize that business, industryapproved the bonus structure for the 2008 fiscal year under Realogy’s 2008 Annual Bonus Plan (the “2008 Bonus Plan”) applicable to executive officers. The 2008 Bonus Plan permits the payment of cash bonuses based upon pre-established performance criteria for 2008. The Holdings Compensation Committee approved target bonus payments of 200% of eligible earnings for Richard Smith and economic considerations requiretarget payments of 100% of eligible earnings for the Company to developother named executive officers.
The 2008 Bonus Plan funding will be based solely on EBITDA—or earnings before interest, taxes, depreciation and amortization—performance rather than the EBIT performance objective utilized for the 2007 Bonus Program as the Holdings Compensation Committee believed EBITDA was a new strategy towards compensation issues thatmore accurate indicator of performance. EBITDA is different fromalso calculated before separation, restructuring, merger and Cendant legacy costs as they are not viewed as an accurate indicator of Realogy’s operating performance.
The bonus funding for Messrs. Smith and Hull will be determined by the strategyRealogy’s consolidated EBITDA results (50%) and the weighted average of the Company’s former parent, Cendant. Accordingly, senior managementBusiness Units’ EBITDA results (50%) and the bonus funding for Messrs. Perriello, Kelleher, and Zipf will be determined by the Realogy’s consolidated EBITDA results (50%) and their specific Business Unit EBITDA results (50%).
Pre-established EBITDA performance levels have been set that, if achieved, will result in the 2008 Bonus Plan funding at 15%, 75%, 100%, or 133% of the target funding. We believe that disclosure of the specific performance targets is not required because the targets are not material to an investor’s understanding of the compensation programs for our executive officers and/or that disclosure of these targets will cause us substantial competitive harm. Realogy’s consolidated EBITDA threshold must be achieved before any named executive officer qualifies for any bonus funding. Funding between performance levels will be based on linear interpolation.
Above-target funding for Messrs. Perriello, Kelleher, and Zipf may be approved by the Holdings Compensation Committee discussedif their Business Unit specific 2008 EBITDA achievement exceeds the need to evaluate changes toabove-target performance level and consolidated Realogy exceeds the Company’s compensation policiestarget 2008 EBITDA performance level. Above-target funding for Messrs. Smith and also discussed factors supporting the need to develop a new compensation strategy, including:
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As Realogy President and establishing its own Compensation Committee. In particular, the employment agreements with our Chief Executive Officer, PresidentMr. Smith may recommend to the Holdings Compensation Committee that bonus payments for the named executive officers, other than his own, based on individual performance provided the aggregate funding is not exceeded. Executive Officer bonus payments must be approved by the Holdings Corporation Compensation Committee prior to any payments being made.
Management Equity Investments. Pursuant to individual subscription agreements dated April 20, 2007, the named executive officers (other than Mr. Silverman), and Chief Financial Officer,certain other members of management made equity investments in Holdings through the purchase of Holdings common stock. This equity investment opportunity and the termsequity compensation awards described below are structured to incentivize management to generate substantial equity value and to participate with our investors in the increase in the value of letter agreementsthe Company.
All of the named executive officers (other than Mr. Silverman), together with ourall other executive officers were approved by Cendant in advance of us becoming a public company. The Cendant compensation committee engaged Frederick W. Cook & Company to provide assistance and recommendations with respect to setting the compensation levelscertain other members of our Vice Chairmanmanagement, made an investment in shares of Holdings common stock through a cash investment, the contribution of shares of Realogy common stock in lieu of receiving the Merger consideration, or a combination thereof. The named executive officers elected to invest all or substantially all of the net after-tax proceeds they received as Merger consideration for their Realogy options, restricted stock units and President, Richard A. Smith.stock settled stock appreciation rights. The compensation levels of our othernamed executive officers (other than Mr. Silverman) were determinedeligible to invest (and did invest) substantially all of their equity holdings in Realogy at the time of the Merger in Holdings common stock. In addition, Mr. Smith elected to purchase shares of Holdings common stock with the
after-tax proceeds of the one-time $5 million investment bonus paid to him upon consummation of the Merger as partial consideration for his retention following the Merger. The purchase price of all of the Holdings equity was $10.00 per share.
The initial equity investments made by Cendant seniorthe named executive officers were as follows:
Name | No. of Shares of Holdings Common Stock Purchased (#) | Aggregate Equity Investment ($) | ||
Richard A. Smith | 830,000 | 8,300,000 | ||
Anthony E. Hull | 200,000 | 2,000,000 | ||
Kevin J. Kelleher | 160,000 | 1,600,000 | ||
Alexander E. Perriello, III | 200,000 | 2,000,000 | ||
Bruce Zipf | 160,000 | 1,600,000 |
All equity securities in Holdings purchased by the executives are subject to restrictions on transfer, repurchase rights and other limitations set forth in a security holders’ agreement. See “Item 13—Certain Relationships and Related Transactions, and Director Independence.”
Management Stock Option Awards.On April 10, 2007, pursuant to individual stock option agreements, Holdings granted the named executive officers, as well as certain other management after giving considerationemployees, options to a numberpurchase shares of factors, including compensation levels at companies comparableHoldings common stock under the Domus Holdings Corp. 2007 Stock Incentive Plan (the “Stock Incentive Plan”). The exercise price per share of Holdings common stock subject to the Companyoptions granted to these individuals was equal to $10.00, the same purchase price paid by Apollo in the Merger. The options include both time vesting (tranche A) options and performance vesting (tranche B and tranche C) options. One-half of the options granted to the executives vest and become exercisable in five equal installments on each of the 12th, 24th, 36th, 48th and 60th month anniversaries of the consummation of the Merger (the tranche A options), and one-half of the options are performance vesting options, one half of which vest upon the achievement of an internal rate of return of funds managed by Apollo with respect to industry, sizeits investment in Holdings of 20% (the tranche B options), and our geographic locations (includingthe remaining half of which vest upon the achievement of an internal rate of return of such funds of 25% (the tranche C options). The vesting performance thresholds were negotiated between Apollo and Mr. Smith, on behalf of management, and are consistent with rates of return that Apollo and its co-investors – and other companiesprivate equity investors—expect to realize on their investments. The mix between time vested and performance-based options was arrived at through negotiation.
The option grants made to the named executive officers were as follows:
Name | No. of Options to Purchase Shares of Holdings Common Stock | |
Richard A. Smith | 3,112,500 | |
Anthony E. Hull | 750,000 | |
Kevin J. Kelleher | 600,000 | |
Alexander E. Perriello, III | 750,000 | |
Bruce Zipf | 600,000 |
The number of options awarded to each of the named executive officers (and the other executive officers) was based upon a multiplier of 3.75 times the number of shares purchased under the subscription agreements.
Management Restricted Stock Awards.On April 10, 2007, pursuant to individual restricted stock agreements, Holdings granted each of the named executive officers (excluding Mr. Silverman) and certain other executive officers shares of Holdings restricted stock under the Stock Incentive Plan.
Each restricted stock award vests over time, one-half of the shares subject to each grant vesting 18 months following the date of the award, and the balance vesting 36 months following the date of the award.
The restricted stock awards were made to the named executive officers as follows:
Name | No. of Shares of Restricted Stock | |
Richard A. Smith | 100,000 | |
Anthony E. Hull | 100,000 | |
Kevin J. Kelleher | 25,000 | |
Alexander E. Perriello, III | 50,000 | |
Bruce Zipf | 100,000 |
The number of shares of restricted stock awarded to each of the named executive officers was based upon organizational complexity and contribution to the Company’s results. Given their time vesting provisions, the restricted stock awards were viewed as a retention vehicle as well as a means of providing incentive compensation that were separated from Cendant);could be achieved in the skills, abilities and experiencemid-term—over the 18 to 36 month time period, in contrast to annual incentive compensation or the portion of these officers; real estate industry considerations; and our need to retain our officers during our transition towards establishing ourselves as an independent public company.
The Pre-Merger Holdings Board approved our equity incentive program, including its design and the value of awards granted to our officers and key employeesemployees. Equity awards were made on April 10, 2007, upon consummation of the Merger and in the case of compensation adjustments, promotions or new hires, from time to time during the year. Neither the Holdings Board nor the Holdings Compensation Committee has adopted any formal policy regarding the timing of any future equity awards.
Other Benefits and Perquisite Programs. Immediately following our separation from Cendant, were approved by Cendant’s compensation committee in advance of us becoming a public company. Nevertheless, our Compensation Committee reviewed and ratified the program and the initial awards. Excluding awards granted upon our separation from Cendant and approved by Cendant, none of our executive officers or directors received an equity award in 2006.
Since our separation, the Company has substantially curtailed these programs to reduce operating costs. Specifically, we terminated financial planning perquisites. Further, the Realogy Compensation Committee adopted a policy in December 2006 that limited use of corporate-owned aircraft (only Mr. Smith has access, subject to availability, for personal use and business use is limited to executive officers and subject to further limitations) and the Realogy Compensation Committee adopted a policy that limits first-class air travel for our employees. (Under the revised December 2006 policy, Mr. Silverman also provided input, in particular with respecthad access to design elementsthe corporate-owned aircraft for personal use, subject to availability; following his resignation as Chief Executive Officer, and award values in furtherancethe Company’s payment of his post-retirement benefits, Mr. Silverman use of the corporate-owned aircraft has continued to be subject to availability and Mr. Silverman must reimburse the Company for such use and may only have access to the Company’s goals of providing incentives to, and retaining, key employees following our separation from Cendant. With respect to any future executive officer compensation and equity incentive issues, we expect that ouraircraft when it is available.)
Our executive officers will provide inputmay participate in either our 401(k) plan or non-qualified deferred compensation plan. These plans have provided for a Company matching contribution of 100% of amounts contributed by the officer, subject to a maximum of 6% of eligible compensation—a level that had been established by Cendant and make proposals to the Compensation Committee as necessary and/or reasonably requested by our Compensation Committee.
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defined benefit pension plan (future accruals of benefits were frozen on October 31, 1999, though he still accrued service after such date for the purpose of eligibility for early retirement), and Apollo otherwise agree.
Former Chief Executive Officer Post-Retirement Benefits.Under Mr. Silverman’s employment agreement, we agreed to assume from Cendant the obligation to provide Mr. Silverman with certain post-retirement benefits. At or about the time we executed our agreement with Apollo, and the Realogy Compensation Committee, with Apollo’s consent, our Compensation Committee approved an amendment to Mr. Silverman’s employment agreement in order to provide additional certainty to us regarding these post-retirement obligations and to ensure that the arrangement would comply with the new tax rules governing deferred compensation.
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Severance pay—a multiple of the sum of annual base salary and target bonus—and welfare benefits are payable upon a termination without cause by the Company or a termination for good reason by the executive. The multiple for Mr. Smith, as the Chief Executive Officer, is 300%, for Mr. Hull, as the Chief Financial Officer, 200% and for the balance of the named executive officers, 100% (though in the case of Mr. Silverman, benefits andsuch a consulting agreement following termination of employment under certain circumstances.within 12 months following a Sale of the Company (as defined in the Stock Incentive Plan) or within 12 months of the Merger, their multiple is 200%). The higher multiples of base salary and target bonus payable to Mr. Smith and Hull are based upon Mr. Smith’s overall greater responsibilities for the performance of the Company, and Mr. Hull’s significant responsibilities as the Company’s Chief Financial Officer. Mr. Smith is our only officer who has tax reimbursement protection for “golden parachute excise taxes.taxes”—a benefit he had under his employment agreement that he entered into at the time of Realogy’s separation from Cendant.
The agreements also provide for severance pay—100% of annual base salary—and welfare benefits to each named executive officer in the event his employment is terminated by reason of death or disability. For more information, see “Potential Payments upon Termination or Change in Control.”
The Pre-Merger Holdings Board believed, and the Holdings Compensation Committee believes, the severance pay and benefits payable to the named executive officers under the foregoing circumstances aid in the
attraction and retention of these executives as a competitive practice and is balanced by the inclusion of restrictive covenants (such as non-compete provisions) to protect the value of Realogy and Holdings following a termination of an executive’s employment without cause or by the employee for good reason. In connectionaddition, we believe the provision of these contractual benefits will keep the executives focused on the operation and management of the business. As set forth above, the enhanced severance pay and benefits payable to Messrs. Kelleher, Perriello and Zipf in the event of a termination of employment within one year of the Merger or within 12 months of a Sale of the Company are substantially consistent with the sale of our Companycontractual rights they had prior to Apollo, we do not believe that any of our officers will incur a golden parachute excise tax and thus no tax reimbursement is expected to be necessary.
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Compensation Committee Report
The Holdings Compensation Committee has reviewed and discussed thisthe Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with senior management and, based uponon such review and discussion,discussions, the Holdings Compensation Committee recommended to the Realogy Board (and Holdings Board) that thisthe Compensation Discussion and Analysis be included in Company’sthis Annual Report onForm 10-K for the year ended December 31, 2006.
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| DOMUS HOLDINGS CORP. COMPENSATION COMMITTEE |
Marc E. Becker, Chairman M. Ali Rashid |
The following table sets forth the compensation we provided in 2006 and 2007 to oureach chief executive officer who served in that capacity in 2007, our chief financial officer and the three other most highly compensated executive officers who were serving as executive officers at the end of 2006:
| Change in Pension | ||||||||||||||||||||||||||||||||
| Value and | ||||||||||||||||||||||||||||||||
| Stock Option | Nonqualified | All | ||||||||||||||||||||||||||||||
| and Stock | Deferred | Other | ||||||||||||||||||||||||||||||
| Stock | Appreciation | Compensation | Compen- | |||||||||||||||||||||||||||||
| Name and | Salary | Bonus | Awards | Right Awards | Earnings | sation | Total | |||||||||||||||||||||||||
| Principal Position (1) | Year | ($) (2) | ($) (3) | ($) (4) | ($) (5) | ($) (6) | ($) (7) | ($) | ||||||||||||||||||||||||
Henry R. Silverman | 2006 | 1 | — | — | — | — | 59,839 | 59,840 | ||||||||||||||||||||||||
| Chairman of the Board | ||||||||||||||||||||||||||||||||
| and Chief Executive Officer | ||||||||||||||||||||||||||||||||
Anthony E. Hull | 2006 | 439,846 | 500,000 | 1,505,798 | 108,888 | — | 66,431 | 2,620,963 | ||||||||||||||||||||||||
| Executive Vice | ||||||||||||||||||||||||||||||||
| President, Chief | ||||||||||||||||||||||||||||||||
| Financial Officer and | ||||||||||||||||||||||||||||||||
| Treasurer | ||||||||||||||||||||||||||||||||
Richard A. Smith | 2006 | 842,837 | 97,000 | 3,958,665 | 2,919,796 | — | 83,153 | 7,901,451 | ||||||||||||||||||||||||
| Vice Chairman and | ||||||||||||||||||||||||||||||||
| President | ||||||||||||||||||||||||||||||||
Alexander E. Perriello, III | 2006 | 476,019 | — | 1,433,206 | 188,008 | — | 67,979 | 2,165,212 | ||||||||||||||||||||||||
| President and Chief | ||||||||||||||||||||||||||||||||
| Executive Officer, | ||||||||||||||||||||||||||||||||
| Realogy Franchise Group | ||||||||||||||||||||||||||||||||
Bruce Zipf | 2006 | 478,461 | 93,322 | 1,258,958 | 136,864 | — | 44,121 | 2,011,726 | ||||||||||||||||||||||||
| President and Chief | ||||||||||||||||||||||||||||||||
| Executive Officer, | ||||||||||||||||||||||||||||||||
| NRT | ||||||||||||||||||||||||||||||||
Name and Principal | Year | Salary ($)(2) | Bonus ($)(3) | Stock Awards ($)(4) | Stock Option and Stock Appreciation Rights Awards ($) (5) | Non-Equity Incentive Plan Compensation ($) | Change in Pension Value and Nonqualified Deferred Compensation Earnings (7) | All Other Compensation (8) | Total ($) | |||||||||
Henry R. Silverman (1) | 2007 | 1 | — | — | — | — | — | 50,125,814 | 50,125,815 | |||||||||
Chairman of the Board and Chief Executive Officer | 2006 | 1 | — | — | — | — | — | 59,839 | 59,840 | |||||||||
Richard A. Smith (1) | 2007 | 1,000,000 | 5,097,000 | 1,490,741 | 3,696,373 | — | — | 66,065 | 11,350,179 | |||||||||
Chief Executive Officer and President | 2006 | 842,837 | 97,000 | 3,958,665 | 2,919,796 | — | — | 83,153 | 7,901,451 | |||||||||
Anthony E. Hull | 2007 | 499,037 | — | 1,956,019 | 540,542 | — | — | 49,841 | 3,045,439 | |||||||||
Executive Vice President, Chief Financial Officer and Treasurer | 2006 | 439,846 | 500,000 | 1,505,798 | 108,888 | — | — | 66,431 | 2,620,963 | |||||||||
Kevin J. Kelleher | 2007 | 411,691 | — | 1,775,463 | 494,933 | — | 4,152 | 5,850 | 2,692,089 | |||||||||
President and Chief Executive Officer of Cartus Corporation | 2006 | 381,451 | — | 1,392,816 | 62,500 | 85,500 | 3,975 | 32,167 | 1,958,409 | |||||||||
Alexander E. Perriello, III | 2007 | 514,615 | — | 2,148,148 | 644,709 | — | — | 36,581 | 3,344,053 | |||||||||
President and Chief Executive Officer, Realogy Franchise Group | 2006 | 476,019 | — | 1,433,206 | 188,008 | — | — | 67,979 | 2,165,212 | |||||||||
Bruce Zipf | 2007 | 514,614 | — | 2,268,519 | 599,100 | 433,150 | — | 38,137 | 3,853,520 | |||||||||
President and Chief Executive Officer, NRT | 2006 | 478,461 | — | 1,258,958 | 136,864 | 93,322 | — | 44,121 | 2,011,726 | |||||||||
| (1) | From January 1, 2006 through July 31, 2006, the date of our separation from Cendant, Mr. Silverman provided substantially all of his business time providing services to Cendant and, on August 1, 2006, commenced providing substantially all of his business time providing services to | |
| (2) | The following are the annual rates of base salary paid to each | |
| (3) | ||
| (4) | Each |
these amounts under FAS 123(R) are described in Note 13 |
91
Name | Year | SFAS 123 RSU or Restricted Stock Expense for Realogy and Holdings Awards ($) | SFAS 123 RSU Expense For Cendant Awards ($) | Accelerated Vesting RSU Expense for Cendant Awards ($) | Equitable Conversion RSU Expense for Cendant Awards ($) | Total ($) | ||||||
Henry R. Silverman | 2007 | — | — | — | — | — | ||||||
| 2006 | — | — | — | — | — | |||||||
Richard A. Smith | 2007 | 1,490,741 | — | — | — | 1,490,741 | ||||||
| 2006 | 250,000 | 795,828 | 2,856,656 | 56,181 | 3,958,665 | |||||||
Anthony E. Hull | 2007 | 1,956,019 | — | — | — | 1,956,019 | ||||||
| 2006 | 409,722 | 323,485 | 758,490 | 14,101 | 1,505,798 | |||||||
Kevin J. Kelleher | 2007 | 1,775,463 | — | — | — | 1,775,463 | ||||||
| 2006 | 409,722 | 294,755 | 674,842 | 13,497 | 1,392,816 | |||||||
Alexander E. Perriello, III | 2007 | 2,148,148 | — | — | — | 2,148,148 | ||||||
| 2006 | 472,222 | 278,678 | 669,181 | 13,125 | 1,433,206 | |||||||
Bruce Zipf | 2007 | 2,268,519 | — | — | — | 2,268,519 | ||||||
| 2006 | 472,222 | 250,808 | 525,593 | 10,335 | 1,258,958 | |||||||
| SFAS 123 | ||||||||||||||||||||
| RSU | Accelerated | Equitable | ||||||||||||||||||
| Expense | SFAS 123 | Vesting | Conversion | |||||||||||||||||
| for | RSU Expense | RSU Expense | RSU Expense | |||||||||||||||||
| Realogy | For Cendant | for Cendant | for Cendant | |||||||||||||||||
| Name | Awards ($) | Awards ($) | Awards ($) | Awards ($) | Total ($) | |||||||||||||||
| Henry R. Silverman | — | — | — | — | — | |||||||||||||||
| Anthony E. Hull | 409,722 | 323,485 | 758,490 | 14,101 | 1,505,798 | |||||||||||||||
| Richard A. Smith | 250,000 | 795,828 | 2,856,656 | 56,181 | 3,958,665 | |||||||||||||||
| Alexander E. Perriello, III | 472,222 | 278,678 | 669,181 | 13,125 | 1,433,206 | |||||||||||||||
| Bruce Zipf | 472,222 | 250,808 | 525,593 | 10,335 | 1,258,958 | |||||||||||||||
| (5) | Each |
| SFAS 123 | SFAS 123 | Accelerated | Equitable | |||||||||||||||||
| SAR | Option and | Vesting | Conversion | |||||||||||||||||
| Expense for | SAR Expense | Option and | Option and | |||||||||||||||||
| Realogy | For Cendant | SAR Expense | SAR Expense | |||||||||||||||||
| Name | Awards ($) | Awards ($) | for Cendant ($) | for Cendant ($) | Total ($) | |||||||||||||||
| Henry R. Silverman | — | — | — | — | — | |||||||||||||||
| Anthony E. Hull | 62,500 | 10,937 | 28,696 | 6,755 | 108,888 | |||||||||||||||
| Richard A. Smith | 750,000 | — | — | 2,169,796 | 2,919,796 | |||||||||||||||
| Alexander E. Perriello, III | 83,333 | — | — | 104,675 | 188,008 | |||||||||||||||
| Bruce Zipf | 83,333 | — | — | 53,531 | 136,864 | |||||||||||||||