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Cendant Corporation (CD)

Q2 2006 Earnings Conference Call

August 10, 2006 11:00 am ET

Executives

Henry R. Silverman - Chairman of the Board, Chief Executive Officer

Ronald L. Nelson - President, Chief Financial Officer

Sam Levenson - Senior Vice President, Corporate and Investor Relations

Analysts

Jeffrey Kessler - Lehman Brothers

[Zafar Azim] - JPMorgan Chase & Co.

Chris Gutek - Morgan Stanley

Michael Millman - Soleil Securities

Michael Connelly - T. Rowe Price

Jennifer Pinnick - Morgan Stanley

Presentation

Operator

Good morning, and welcome to the Cendant Corporation second quarter 2006 conference call. Today's conference is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Sam Levenson, Senior Vice President of Corporate and Investor Relations. Please go ahead, sir.

Sam Levenson

Thank you, Darryl. Good morning, everyone, and thank you all for joining us. On the call with me today are: our Chairman and CEO, Henry Silverman; and our President and Chief Financial Officer, Ron Nelson.

Before we discuss our results for the quarter, I would like to remind everyone of four things.

First, the rebroadcast, reproduction and retransmission of this conference call and webcast without the express written consent of Cendant Corporation, are strictly prohibited.

Second, if you did not receive a copy of our press release, it is available on our website at www.cendant.com, or on the first call system.

Third, the company will be making statements about its future results and other forward-looking statements during this call. Statements about future results made during the call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements are based on current expectations and the current economic environment. Forward-looking statements and projections are inherently subject to significant economic competitive and other uncertainties and contingencies, which are beyond the control of management.

The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements.

Important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements and projections are specified in the company's quarterly report on Form 10-Q, for the period ended June 30, 2006, including under headings such as Risk Factors, and in our earnings release issued last night and filed on Form 8-K.

Finally, during the call the company will be using certain non-GAAP financial measures as defined by under SEC rules. Where required, we have provided a reconciliation of those measures for the most directly comparable GAAP measures in the tables in the press release and our website.

Before I turn the call over to our Chairman, let me briefly review the major points from yesterday’s press release: Revenue for the quarter increased 2% to $4.3 billion; Second quarter earnings per share from continuing operations were $0.17, and EPS from continuing ops, excluding separation and restructuring costs, and the foreign tax charge, was $0.24. These do not include results from discontinued operations, associated primarily with the company’s Travelport business, which is being sold.

Now I would like to turn the call over to Cendant’s Chairman and CEO, Henry Silverman.

Henry R. Silverman

Thank you, Sam. As you know, this is our last earnings call for Cendant, a company that no longer exists as it did in the past, since our plan to separate the company is now virtually complete. Realogy and Wyndham Worldwide were spun off to our shareholders on July 31st, and each is now an independent public company trading on the NYSE.

The sale of Travelport to Blackstone is proceeding as planned and it is scheduled to close on August 23rd. As previously announced, the net proceeds from that sale will be used primarily to reduce debt at Realogy and Wyndham.

Once the sale is completed, the only remaining business at Cendant will be Avis Budget. On August 29th, shareholders will vote on a proposed one for 10 reverse stock split and a proposal to rename Cendant as Avis Budget Group, which will then trade on the NYSE under the ticker symbol CAR.

So what was once a services conglomerate will shortly be four independent pure play companies, three publicly traded and one privately held. Each is a leader in its respective industry, and all are well-positioned to grow and prosper over the long-term.

I know that the respective management teams and employees are motivated and excited to move forward its independent companies and create long-term value for their respective shareholders, especially if the template we have had with the prior separations of Jackson Hewitt, Right Express, and PHH is any indication.

Before I turn the call over to Ron, I want to again personally thank our shareholders. We believe that the separation of the company will ultimately reward investors once the market awards each new company appropriate valuations. I look forward to speaking with many of you on the first Realogy call.

With that, I will turn the call over to Ron.

Ronald L. Nelson

Thank you, Henry. Given the completion of the spin-offs of Realogy and Wyndham Worldwide, and the pending sale of Travelport, my comments today will be relatively brief and limited to a discussion of the second quarter results of Realogy, Wyndham Worldwide, and Avis Budget, as well as the outlook for Avis Budget.

While I will not be discussing the outlook for Realogy and Wyndham Worldwide, since they are no longer part of Cendant, I would direct you to the 8-K that each of them filed last night, providing supplemental financial information.

You should also note that while Realogy and Wyndham Worldwide will not be holding separate earnings calls, they will be filing their own 10-Q’s later this month.

Starting with Realogy, if we strip out separate and restructuring cost, EBITDA was down 19% as forecast. Across Realogy’s owned and franchised brokerage offices, price continued to show increases in line with historical averages, up 5%, while sides volume declined 16% at franchise and 13% at NRT.

Excluding the impact of brokerage acquisitions, the relationship flips, with NRT sides declining 17% while franchise’s decline was 14%.

What is being reflected in the reported numbers is the result of NRT acquiring two large franchisees late in 2005 in Phoenix and Hawaii, and the impact of shifting those sides from franchise to owned.

There are two observations to be gleaned from this data:

  1. The trends in the second quarter continue to be indicative of a moderating real estate market, particularly in what had been some of the more heated regions, like California and Florida; and
  2. Buyers and sellers’ expectations have yet to find an equilibrium, and as a result, prices remain relatively strong while volumes are weakening.

As to the latter issue, history along with economics would suggest price will moderate further but be offset as volumes respond and start to pick up. That is not yet apparent based on purchase mortgage applications in Tuesday’s Fannie Mae Forecast.

The EBITDA decline reflects the operating leverage, both positive and negative, inherent in Realogy’s operating model. As we discussed in our first quarter call, Realogy has worked to rationalize NRT’s fixed costs through office consolidation, headcount reduction and other moves, and expects to generate a $50 million annual run-rate benefit from these actions beginning in the back-half of the year. The $11 million severance and facility closure costs incurred in the second quarter were a prelude to achieving that goal.

As to Realogy’s franchise business, while management is vigilant about costs, there is a somewhat greater challenge to trim costs in a business which operates with 70% plus EBITDA margins.

Turning then to Wyndham Worldwide, the stand-out performer was again timeshare resorts, which continues to generate double-digit revenue and EBITDA growth. The true strength of timeshare’s results may not be readily apparent. Excluding two items, the effect of a required accounting change in the first quarter, which impacts the timing of when timeshare companies recognize revenue expenses, and a gain on the sale of some land in the second quarter of last year, revenue would have been up 24% and EBITDA would have been up 39%.

All of timeshare’s metrics -- tours, close rates, and average price, improved year over year, reflective of a number of important management initiatives, such as the decision to pursue a new Trendwest in-house sales program -- a program which helped drive an over 20% increase in tours at Trendwest.

Turning to hospitality services, revenue grew 15%, and again, if you strip out the impact of the foreign tax accrual with the European vacation rental group, separation costs, and a small restructuring charge, EBITDA would have increased 6%. Margins contracted because the Wyndham acquisition contributed revenue but not EBITDA, since fully 80% of its revenue related to pass-through reimbursement of our property management company expenses.

In fact, the top-line drivers of Wyndham Worldwide’s legacy businesses were strong. Its lodging franchise business again grew its RevPAR, excluding the Wyndham hotels and Baymont acquisitions, by 10%.

Trip Rewards, our loyalty program, grew its revenue by 43% year over year, reflecting an increase in both member stays and members. This loyalty program typically operates on a break-even basis, as the incremental revenue is generally reinvested in the program.

In addition, year-over-year growth in subscribers in cottage weeks sold, resulting in an increased in subscription and transaction for Wyndham’s vacation exchange and rental business.

I will spend the balance of my time on Avis Budget, which of course will be the remaining Cendant business following the close of the Travelport sale.

In the second quarter, car rental revenue grew 12%, driven primarily by a 9% increase and price. The price increase came mostly from the leisure side, as the leisure price increases instituted over the past year have been holding. Keep in mind that year-over-year change in price is more dramatic in the second quarter, as the second quarter of 2005 represented a low point in pricing for the last two years.

As we begin to lap price increases that commenced in June of last year, year-over-year price change will be meaningful, but certainly not as dramatic. In addition, commercial price increases, which have been slower to come, contributed to year-over-year pricing growth.

The first six months have been very competitive in the commercial market but Avis has maintained its airport share, and at the same time, increased price. Rental day volume ended the quarter growing 3%, reflecting lower-than-expected domestic on-airport demand, driven by flat enplanements through April and a negative year-over-year trend for May and June based on the preliminary data posted by the Airline Transport Association, reflecting the reduced capacity in the airline industry.

With enplanements declining and our year over year growth being off of a base in 2005, which was some 13% or 14% higher than 2004, we would not characterize our performance in this environment as laagered.

With regard to pricing in the quarter, we believe that the leisure side of the market has generally reached equilibrium, with pricing now covering model year 2006 fleet costs increases. The same cannot be said on the commercial side, and the increase in interest rates has only exacerbated the margin compression.

As a consequence of rising fleet costs, EBITDA declined year over year, as we had indicated it would during our investor day meeting in March. The look-forward on fleet cost is not much rosier. We have nearly completed the negotiations on the model year 2007 purchase, and expect that per unit fleet costs will increase approximately 20%.

We are hopeful of driving our composite increase a few percentage points lower through a variety of actions, including increasing the amount of risk cars in our fleet, adjusting where possible the mix of cars and manufacturers, and extending the holding period of cars in the fleet.

Historically, we have been among the most conservative with regard to the risk component of our fleet. In 2006, risk vehicles comprised only 6% of our total purchases. For the 2007 model year, we anticipate an approximate doubling of the risk portion to between 10% and 15%.

While each of these initiatives can have an impact on fleet costs, the message to take away here is that the car rental industry, including our two competitors, who are expected to go public in the fall, will need increased pricing across the board, both leisure and commercial, to continue to grow profitably. Fleet and interest costs currently account for approximately 30% of our overall cost structure, so the math on the composite increase required becomes fairly easy.

So let me spend a minute on the back-half of the year.

Based on the trends that are evident in our second quarter results, the outlook for Avis Budget in the second-half is clearly a mixed bag. On the opportunity front, we are continuing to see year-over-year improvement in pricing. As noted, it will not be as dramatic as it was in the first half, as we are lapping last year’s increases, but it will continue to increase.

We believe we are holding our market share and at the same time, we have been pushing to achieve price increases, and we are actively managing our infrastructure and fleet levels to reduce expenses.

From a balance sheet perspective, we have the second-highest credit rating among the car rental companies, and our liquidity profile is very strong, with over $1 billion of unused capacity in our revolving credit agreements.

We will introduce towards the end of the quarter a new GPS product, with features we believe will leapfrog the competition. Priced at $9.95 a day, our Where-To mapping unit matches all the features that the competitors provide, but in addition, downloads traffic data and automatically reroutes the driver around congestion.

The product is both a timesaver and comfort to corporate and leisure travelers alike. More importantly, it should provide incremental high-margin revenues.

In our local rental initiative, we opened 89 new off-airport stores through July, and have an additional 53 in the Q for the third quarter. We remain on track for our target of approximately 200 new stores this year.

Our off-airport locations are performing well. Same-store sales are up 22% in the second quarter, and our overall growth rate in this segment is approaching 26%.

Our branded websites, which are our lowest cost distribution channel, continue to perform well, with second quarter reservations up 11% and revenue up 20% year over year.

The challenge, of course, is that we are seeing inflationary type increases in operating costs, higher-than-general inflation increases in fleet costs, and a sharp, year-over-year increase in short-term borrowing costs due to the nine fed rate hikes since last June. At the same time, we are planning for domestic enplanements to remain relatively flat.

In addition, we have recapitalized Avis Budget in conjunction with Cendant’s separation plan in order to put a capital structure appropriate for Avis Budget on a standalone basis. The change in our capital structure, which reduces our reliance on vehicle back-debt through the issuance of Avis Budget corporate debt, reduces our above-EBITDA vehicle related interest expense, increases below-EBITDA corporate interest expense, and most importantly, does increase our aggregate interest expense year over year.

In light of the recapitalization of the business in April 2006, we think some of the most meaningful year-over-year comparisons are made on a pro forma basis. As we initially discussed in March, and disclosed in more detail last month, we expect that our vehicle rental earnings will be down in 2006 compared to 2005. In particular, we currently expect our Avis Budget car rental subsidiaries, pro forma EBITDA less corporate interest expense to be in the range of $260 million to $295 million in 2006, compared to an approximate $356 million in 2005, on an apples-to-apples pro forma basis.

This assumes we can continue to make some progress in achieving price increases and at the same time, that we reduce our operating costs. The projected year over year variance is largely attributable to four items. On the plus side, increases in car rental day volume, car rental pricing, fleet costs and other operating costs, which taken together are boosting earnings modestly year over year, in part due to the cost reduction initiatives we have undertaken, and which we will be continuing.

On the negative side, higher interest rates, which will cause our vehicle back-interest expense to be approximately $45 million higher this year, an increase of $25 million to $30 million in truck fleet costs, which we discussed at our investor day meeting in March, and EBITDA on our truck rental business being down an additional $15 million to $20 million year over year, due to relatively weak demand.

To those who follow our business closely, the new news over the last few months is that model year 2007 cars will cost us more than we had anticipated, and that truck rental demand has been weaker than expected.

Just a couple of words on trucks. Over the course of the last two years, we have enjoyed margins in the high-teens and low-twenties in our truck business, as we have benefited from a low cost but aging fleet acquired in the Budget transaction.

As we have re-fleeted to keep our network of dealers competitive, our margins have naturally declined, as higher-cost new trucks replaced older, lower-cost trucks. In the ordinary course, we would have expected margins to stabilize and the fleet to reach the targeted average life we were shooting for in 2006.

As we noted at our March investor day, we expected that would impact the fleet costs by approximately $25 million to $30 million in 2006. In addition to this, we have experienced softness in the one-way consumer business, and in commercial volumes, somewhat related to the slowdown of the real estate market and somewhat related to the reemergence of U-Haul out of bankruptcy. This is what has contributed to the $15 million to $20 million of additional softness that we expect over the course of 2006.

Clearly we are not happy with our performance and are taking all appropriate actions to remediate.

We also understand the Cendant’s quarterly financial statements, which will be impacted by the separation plan, at least through year-end, may not be helpful for investor and analysts trying to understand the result of our Avis Budget vehicle operations. Accordingly, we have posted a variety of supplemental information, including our full-year projections for Avis Budget, on Cendant’s website to try and enhance the disclosure that is available to you.

Before I close, just a quick word on free cash flow for the quarter, which is described in table 7 of the earnings release. Note that Cendant’s usual measure of free cash flow was highly impacted this quarter by our separation plan, particularly the repayment of vehicle back-debt with Avis Budget corporate debt, which shows up as a significant use of cash in the management program’s line item.

As a result, free cash flow is not comparable to last year, and I would encourage you to focus on the line item free cash flow before management programs as a more meaningful apples to apples comparison.

With that, Henry and I would be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will take our first question from Jeff Kessler from Lehman Brothers. Please go ahead, sir.

Jeffrey Kessler - Lehman Brothers

Thank you very much. I have a number of questions. I will try to get through them quickly.

First, the format, once you sell Travelport, what is the format for getting the money over to the two businesses that are now not formally connected with Cendant?

Ronald L. Nelson

When they were spun off, Jeff, there was contingent notes put inside of each of those companies that require us to take the Travelport proceeds, and there is a waterfall of how they get allocated. There are certain monies that first go to repay Travelport debt, then they go to reimburse Avis Budget for taxes that it might incur on the sale, and then it gets split 5/8, 3/8 between the two companies. It is through those notes that that cash gets distributed to them, and then they will use that to pay off the debt that they incurred to pay off the Cendant debt on July 31.

Jeffrey Kessler - Lehman Brothers

Second question, in looking at -- there is some question about the addition or lack of addition of NRT royalties to the inter-company royalties to the franchise business in Realogy, those $96 million of royalties. Without them, we are talking in terms of something along the lines of $128 million. Formally, when we model this, are we going to be adding those $96 million just as pass-through, or should we be just considering knocking those $96 million of royalties out, because it was not included in the latest, in table 3 in your press release.

Henry R. Silverman

Jeff, it is a limited consolidation, but there are still royalties on an inter-company basis paid from NRT to the franchise group. How you want to model that is up to you, but it is -- we still account for it internally as a royalty at 6% from NRT to real estate franchise group.

Jeffrey Kessler - Lehman Brothers

With regard to guidance on Realogy, I realize that you have said that this is not a Realogy call. However, if you did come out with a filing last night, could you give some idea of whether or not the guidance that has been given along the road show and reiterated for the quarter, does that still extend for the whole year in terms of EBITDA and the net income that was on the road show numbers?

Henry R. Silverman

As you know, the summer is Realogy's Christmas season, so our performance in July and August is going to be crucial to our results for the remainder of the year.

I will tell you that we have not finalized July yet and we have not finalized our open contract information for August, so I am not prepared to comment on our projections at this time.

As you know, the long-term outlook for housing remains highly positive, which is driven by demographics. You cannot turn on the TV or pick up the newspapers -- every day you read that the shorter-term macro-environment is highly volatile. We will continue to monitor it.

I know you have not asked this question yet, but I know you will, so let me address the second question you are going to ask, which is our plans for share repurchase at Realogy.

I do not want to speak for Wyndham, obviously, or Cendant/Avis-Budget, but at Realogy, we do expect to de-lever significantly post the sale of Travelport which, as I said earlier, is scheduled to close August 23rd.

At that point, if the Realogy Board of Directors deems it appropriate, we may incur additional debt and use the proceeds for general corporate purposes, including the repurchase of Realogy common stock.

As you probably know from Bob Willem’s call last week, we have the flexibility to buy back a little less than 20% of our stock in the near-term without adversely impacting the tax-free nature of our spin-off.

Jeffrey Kessler - Lehman Brothers

Well, I am glad you gave a little plug to Bob there. In terms of your moving off to Cendant and the auto business, your at-risk cars. Avis has traditionally been well below Hertz, Dollar-Thrifty in the at-risk area.

Yet there are some investors who are a little bit nervous about both Hertz and Dollar-Thrifty potentially and dramatically increasing their at-risk exposure, and the residual exposure that it brings, essentially becoming an investment in the residual value of the automobiles.

How is Avis going to balance number one, the need to go more at-risk because it is going to be cheaper, to the investors’ nervousness over having too much of a risk exposure?

Ronald L. Nelson

I think you are absolutely right, Jeff. It is a fine line that you have to walk, but if you look at the risk cars that are in Hertz and Dollar-Thrifty, they are at least 2X what we are planning to do, and more than that, actually, of what we are planning to do for this year.

I think it is a level of 10% to 15% of the fleet being risk cars. We are able to pick and choose those that we think we will either optimize the gain or minimize the loss, however you think they are going to play out. It really is still the level where we can be very selective, I think, and not take any undue risks.

Jeffrey Kessler - Lehman Brothers

This subject was somewhat of an argumentative, controversial subject when you bought Budget, and I guess because of its performance, it still is. Are you still committed to keeping that truck business? I realize that you are doing a re-fleeting operation. On the other hand, obviously the numbers being shown are not very encouraging. The question is will truck ever be the type of driver that you need inside of Budget to make it worth keeping?

Henry R. Silverman

We think it will be. We did commit last year to the business that we were going to keep it and have it be a permanent part of the Avis Budget portfolio.

I think we were living a little bit on borrowed time over the last couple of years. We had a very cheap fleet. Truck margins were north of 20% in '03 and '04. Last year, they were just a little bit south of 20%.

This is a business that should not operate too much differently from a margins standpoint than car rental. I think we will stabilize somewhere down around the low double-digits when we hit the targeted life for the fleet that we have set out, which we are at.

I think we have some work to do in our truck operation. We have a plan. We are going to put it into effect, but there are only four players in the truck rental business, and we are number two. We think if it is run properly and run well, it could be a source of competitive advantage for us, so we are going to keep it.

Jeffrey Kessler - Lehman Brothers

The $1.875 billion of debt, of corporate debt that you have taken on the balance sheet of CD, will any of that be backed by automobiles, or is that all going to be -- I mean, Hertz has a structure that is similar, secured debt that is not backed by automobiles. Are you going to be, since this was part of your facility that had been asset-backed, will you be using any of this to essentially buy at-risk automobiles, or will it all just be pure corporate debt?

Ronald L. Nelson

All of the cash that we -- the proceeds from those financings did go into the securitization trusts to act as the over-collateralization for the current vehicles that are in that trust. We think our cap structure is going to look, in the long-term, very much like everybody else's, where it is going to consist of a substantial amount of ABS, some corporate debt, and some equity.

Right now, the corporate debt I think you can consider, even though it is unsecured, fully unsecured, it is acting as the collateral for the secured portion of the structure.

Jeffrey Kessler - Lehman Brothers

It is a proxy for those automobiles?

Ronald L. Nelson

Yes, I think it currently is. When or if it stops being a proxy, I think we will break it out, because I think the good thing about this industry is it is going from being all private six months ago to being all public in about four months, so everybody is going to want to be able to do an apples-to-apples comparison, so we will be striving to make sure everybody understands what is backing cars and what is not.

Jeffrey Kessler - Lehman Brothers

Final question, and I will get off. You know there have been some rumors that have been around. You mentioned that the sale of Travelport to Blackstone is scheduled to close on August 23rd. You are highly confident that is going to happen?

Henry R. Silverman

Yes. As of 10:32 this morning, I was in contact with the CEO of Travelport, who had just gotten off a phone call with the Travelport underwriters, who are proceeding with the current timing of closing the order book tonight, and pricing the deal tomorrow. That obviously is after the terrorism alert of this morning, so it may cost a bit more -- that is really not an issue that I am concerned with or involved in, but every indication is that the transaction will close as scheduled on August 23rd.

Jeffrey Kessler - Lehman Brothers

Great. Good luck, and I will be talking to you in the future at your respective companies.

Operator

We will take our next question from [Zafar Azim] from JP Morgan. Please go ahead, sir.

Zafar Azim - JPMorgan Chase & Co.

Good morning. A few questions on the car rental business. First, I was wondering if you could provide us a break-up or separate the price increases that you have on the commercial side of the business, or was it the leisure side?

Ronald L. Nelson

Leisure price increases were over -- the composite increase was 9%. Obviously leisure was higher than that, and business and commercial was lower. You know, we had about a 50-50 mix between business and leisure during the quarter. I do not want to get anymore precise than that.

Zafar Azim - JPMorgan Chase & Co.

The lower price increase in leisure, is that just a function of contracts rolling over time, or is that actually resistance from the commercial customers with respect to price increases.

Ronald L. Nelson

I assume you meant commercial on your question. It is a function of contracts rolling over time. As you may recall, we attempted to do mid-contract price increases last October. The competition did not join with us, so for all intents and purposes, it meant that we could not do that.

The commercial market has been very competitive in the first six months of this year. National has been very aggressive in going after commercial business. If you read their S-1, their commercial in the first quarter was up 18%.

We have been keeping our share, so we have not lost any meaningful amount of business. I think they have taken share from the other competitors, but in that environment, it is very difficult to get price increases that are much more north of low-single-digits.

Zafar Azim - JPMorgan Chase & Co.

I see. So on the commercial side, even in contracts which are rolling over, you are not getting price increases sufficient to offset the fleet cost increases. Would that be a…

Ronald L. Nelson

That is a fair conclusion.

Zafar Azim - JPMorgan Chase & Co.

Once you have these price increases, you will then come up against another fleet cost increase, so you will have to wait for the next time you can rollover the same contract on which you just increased prices to get even again?

Ronald L. Nelson

Yes, I think there is a bit of a leapfrog aspect to all of this, but a lot of it depends on what the competition is doing. When fleet costs increase more than 10%, a number of our contracts have re-openers in them. It depends on what your competition is doing.

The good news about Hertz and National going public in the next quarter I believe is that everybody is going to need to show quarter over quarter gains. They are going to need to recover their fleet costs. I think it is going to cause everyone to act rationally when it comes to commercial pricing, particularly given that commercial is a very big part of all three of our rental portfolios.

Zafar Azim - JPMorgan Chase & Co.

If you could just remind us again, what is the average duration of your commercial contracts?

Ronald L. Nelson

Anywhere from one to three years. It really depends on the size of it, size of the customer.

Zafar Azim - JPMorgan Chase & Co.

Then, the increase, the $45 million increase in vehicle debt interest expense in ’06 versus ’05, are you talking about an increase on a pro forma basis, or of the pro forma ’05 number?

Ronald L. Nelson

Yes, it is a pro forma increase.

Zafar Azim - JPMorgan Chase & Co.

What is the pro forma fleet debt interest expense for ’05?

Ronald L. Nelson

I think it is in our disclosure. I think it is around -- it is approximately 4.5%, would be the rate.

Zafar Azim - JPMorgan Chase & Co.

On the truck rental side, I just wanted to confirm -- did you just mention that in ’06, you would have, during ’06, or the remainder of ’06, you would have replaced all of the low-basis trucks with the newer trucks? Would there still be some trucks that need to be replaced in ’07?

Ronald L. Nelson

I think we still have about 20% of our fleet that are in low-basis trucks. I think we are looking very carefully at next year’s fleet purchases as to whether we actually do cycle those out.

It may be more economic, actually, to maintain them and keep them in the fleet a little longer. We will be making some commitments to change the mix of our fleet a little bit. One of the reasons why our commercial business is soft is that we have had too few 24-foot trucks with lift gates, which is what you need to get commercial business, and in particular, mid-week commercial business, which increases your utilization rates. You will see us make commitments in that area but I think we are going to be pretty happy with the fleet as we have it, other than 24-footers, right now.

Zafar Azim - JPMorgan Chase & Co.

The lower-basis trucks, which are 20% of your fleet right now, we should expect those to be in your fleet for the next few years?

Ronald L. Nelson

It is all a tradeoff between maintenance and depreciation. Those that we can maintain and keep in the fleet at a low-basis, we are going to do it. Once you cross over the line, then obviously it just makes good economic sense to replace it.

Zafar Azim - JPMorgan Chase & Co.

If you were to replace these trucks today, what would be the incremental impact on EBITDA, or what is the additional EBITDA that you can expect if you were to replace these remaining 20%?

Ronald L. Nelson

It is hard to say, because you do not know what kind of deals you would strike. I would say last year we bought 7,000 or 8,000 trucks, and replaced 7,000 or 8,000 old trucks, and we took an incremental hit of $25 million or so of depreciation. That is probably not a bad proxy.

Zafar Azim - JPMorgan Chase & Co.

I missed your comment on what the eventual margins in the truck business are expected to be, once these trucks, these low-basis trucks have cycled out. Did you mention low-double-digits?

Ronald L. Nelson

Low-double-digits is what I have said. We have been in the high-teens, low-20’s, sort of cycling down over the last three years.

Zafar Azim - JPMorgan Chase & Co.

So you are talking about EBITDA margins over here?

Ronald L. Nelson

Yes.

Zafar Azim - JPMorgan Chase & Co.

When you say that the truck rental EBITDA is going to decline $45 million in ‘06, you are comparing this to the $103 million in EBITDA that you reported in ’05? Is that the number that you are…

Ronald L. Nelson

That number sounds right.

Zafar Azim - JPMorgan Chase & Co.

Finally, just on the capital structure, are you contemplating any kind of additional debt issuance at the Avis, at the holding company once everything is spun off and you are just left with the car rental business? Are there any thoughts on perhaps issuing more public market debt, perhaps to buy back stock, or useful fees for any other corporate purposes?

Ronald L. Nelson

No. Certainly buying back stock would impact our credit rating, which we actually would like to improve our credit rating a little bit, so stock repurchases I think are not something that we can contemplate at any meaningful size for some time.

As far as another debt issuance, we have over $1 billion of capacity on our revolver. There would be no reason to do anything in the financing markets, and as a consequence, we are not planning anything.

Zafar Azim - JPMorgan Chase & Co.

Thank you very much.

Operator

We will take our next question from Chris Gutek from Morgan Stanley. Please go ahead, sir

Chris Gutek - Morgan Stanley

Thank you. A couple of questions. Henry, starting with the big picture question, Cendant shareholders obviously have not done that well since the break-up was announced last year. Assuming you would agree that the components to the old Cendant are undervalued, I am curious how long you would want to wait or need to wait, or what other considerations you might have that will go into the equation before you would consider proactive and public auction of Realogy?

Ron, if you could address the question for Avis Budget as well, please.

Henry R. Silverman

I can only speak for Realogy. The company is not for sale. That said, we are a fiduciary, so if somebody wants to come talk to us, we would be happy to listen to any and all proposals.

As you probably know, Chris, under the tax laws, under 355 of the code, in theory we could sell the company tomorrow morning but you would have to make the case, if the IRS were curious, that there were no plans or arrangements pre-spin to sell post-spin. We have no plans or arrangements, but I think the tax lawyers would feel more comfortable waiting a bit longer, so we have not had any -- no one has come to see us yet and we are not making any outbound telephone calls.

Ronald L. Nelson

I am not sure I can say anything different, Chris. I think our task at hand is to manage and operate the company and grow the revenue and EBITDA as best we can. Whatever comes down the pipe, comes down the pipe and we will deal with it when it happens.

Chris Gutek - Morgan Stanley

Just to follow-up on that, to truly avoid the legal questions that might arise, would it not be necessary then to wait a minimum of two year, or would there be a shorter window that would apply?

Henry R. Silverman

There really is no longer a so-called bright line, two-year safe harbor issue. It really is again a matter of passing the smell test. If we announced a deal tomorrow morning, I think that if you were working for the IRS, you could say, how could they have gotten a deal done eight days after their spin-off? They must have been working on it pre-spin.

You want to at least allow enough time between the spin and any announcement to make sure that you can in fact, as I said, pass the smell test that obviously you did not have anything going on before the spin.

Again, speaking only for Realogy, since I just said to Jeff a few minutes ago, that all things being equal, we would be a buyer of our own stock in the market, because we think it is significantly mis-priced. Obviously we would have to get that done first, prior to any dialog with a private equity buyer or any other buyer.

I think from a timing standpoint, you will just have to see how this thing plays out.

Let me just clarify one other point, I think that Jeff Kessler raised. NRT has always been a franchisee of the Real Estate Franchise Group, Jeff. It is treated that way. It pays full royalties, so I am quite sure why there would be any confusion on that issue, but I hope I cleared it up if there is any.

Chris Gutek - Morgan Stanley

Thank you. Just a couple of follow-ups on the Avis Budget side, if I could. Ron, in putting aside any changes in the capital structure for Avis Budget, and just to avoid any confusion over the interest expense, the two different types of debt, maybe focusing at the pre-tax margin line, and putting aside truck, just the auto, what do you think a normalized margin is on a pre-tax basis for Avis Budget auto rental? What do you think the timeframe is to get there? If you think that normalized margin for your company would be different versus your competitors, what would explain that difference.

Ronald L. Nelson

Let me answer the second one first, Chris. I think the difference is going to be in the near-term, those companies that are leisure car renters are going to probably operate at higher margins until we get some equilibrium back in commercial pricing. Over the long-term, I think that should settle out, but I think in the near-term, you are going to see some dislocations like that.

The other thing that I think you have to take into consideration is that if, and I noted this in the S-1 in National and Dollar Thrifty’s results, they have a lot more franchising in come as a percentage of their revenue than we do. That income drops right to the bottom line, so it increases their margins over ours, even though we obviously earn more absolute dollars.

As to where the pre-tax margins are going settle out, I do not think I really want to speculate on that until we get some sense of pricing and fleet costs back into equilibrium. I do not -- our EBITDA margins at the car rental company, putting aside financing, have been in the 8% to 10% range for the last few years, and our pre-tax margins have been a couple hundred basis points lower than that.

I frankly do not see any -- I think once pricing gets back to the equilibrium with fleet costs, I do not see any reason why the structural margins in the industry ought to change.

Chris Gutek - Morgan Stanley

Is there anything in the history of the industry to give you confidence about what that timeframe would be for the pricing to catch up with the costs?

Ronald L. Nelson

Six months ago, I said I thought it would at the back-half of the year, mostly predicated on the view that I thought fleet costs were probably going up 9% to 10% this year.

I think, Chris, and I do not mean to sidestep the question, but I think it is going to be enormously helpful to have us all be public and have the pressure of reporting quarterly earnings increase, because I think it will create a more rational pricing environment. I do not think anybody is going to want to hang out there too long from a competitive standpoint and not move prices when fleet costs move.

Once we are all public, I guess I would say it is going to be faster than it would have been a year or so ago.

Chris Gutek - Morgan Stanley

My final question, as a follow-up to that, Ron, why not take more of a leadership position and focus more on the long-term profitability of the company and the industry, and focus less on short-term market share and be much more aggressive raising prices? It would seem as if the others would follow, given the dynamics you just spoke to. So why not be more aggressive and give up a little bit of share, but meaningfully improve that profitability and set the stage for higher margins for the industry over the longer-term?

Ronald L. Nelson

Let me just give you a real-time example of that. That is exactly what we were talking about in June, and about three days after, we decided we were going to do it. National beat us to the punch and raised prices I think $70 a week, effective October 1. We, Hertz, National, and Alamo matched 100% in every market, and Dollar-Thrifty was moving up. They were at 30, I think, and then they went to 45 or 50. Enterprise was at zero.

After about two or three weeks of posting those price increases, Enterprise moved up to I think it was about 25%, and in those markets where they did not match, they actually lowered prices.

What happened is, and you see this every time you get a pricing increase, there is a decline, a decay curve in that, and everybody started pulling back on their prices because you lose your res build. Losing your res build is going to be more deleterious than hanging in there to try and prove a point on prices, if the industry does not match.

We really do not focus on share. We need volume to cover our fixed costs, but we really cannot ignore what others do.

Operator

We will take our next question from Michael Millman from Soleil Securities. Please go ahead, sir.

Michael Millman - Soleil Securities

Thank you. I have also a bunch of car questions, some maybe 30,000 fleet questions. Given, Ron, what you have been talking about in the environment now, why do you think Vanguard and Hertz think this is a good time to do IPO’s?

Ronald L. Nelson

I do not know. You will need to ask them why they think it is a good time.

I understand Hertz’s equipment rental business is doing very well, and so they look pretty good. I think doing IPO’s is sort of in the ordinary course of a private equity. They service brought all on national three or four years ago, it is about the time in the cycle to get their capital out. They are obviously going to be better able to answer that than me.

Michael Millman - Soleil Securities

If you were in that position, would you be doing it now?

Ronald L. Nelson

There are so many factors attendant to that decision. Without really a detailed understanding of what has gone on in their companies, it is hard to say.

Michael Millman - Soleil Securities

The next question is you talk about how you think it will be beneficial having Vanguard and Hertz public, but as you noted in passing, the biggest factor is non-public, and seems to drive to their own drummer. Can you talk a little bit about what you think Enterprise’s goals are, and why they would be wanting to go along with the industry?

Ronald L. Nelson

I think Enterprise is a very tough, very smart competitor. They have, as you know, basically owned the off-airport market, and in particular the insurance replacement market. I think like everybody else, they are trying to grow their business. The logical place for them to go to grow their business is in the on-airport market, so I think they are shifting their focus and competitively coming after us on the airport.

Their share of the airport market I guess is still in the 7% range. They are a long way from our 32, and a long way from Hertz’s 29, but I think that is what their ambitions are. They have a different model for acquiring cars, or fleet than everybody does. They buy virtually everything at-risk. They have a better credit rating.

You have to look at them and consider them a very tough, smart competitor.

At the same time, as you know, we are going very aggressively into the off-airport market and we are trying to grab share in their business. It is competition at its best.

Michael Millman - Soleil Securities

On the off-airport market, can you talk a little bit about what your profitability is there? What average prices per car, compared to airport?

Ronald L. Nelson

Just generally, Mike, you really cannot look at average price, even per day I would venture a guess, broadly is lower, but the length of rental is substantially longer. You have less operating costs attendant to the transaction.

At the margin, our off-airport businesses are more profitable than the on-airport business, just by virtue of the fact that the same level of fixed costs and airport concession payments.

For the most part, all of our -- I want to be careful when I say all -- substantially, all of our off-airport stores are profitable within six months. To the extent that they are not, I think I may have said this before, we have a very modest investment in opening up one of these. It is approximately $40,000 to $50,000 in capital and a one- to two-year lease at $2500 a month for a storefront.

I think our model is a little different than Hertz, and consequently I think at the margin, we probably have a more significant contribution.

Michael Millman - Soleil Securities

When you look at the [FM] data you gave out, it looks like utilization really did not change very much '05 to '04, which seemed to surprise me. Can you talk about why that has not changed? If you can get utilization up, or if it is up this year, and to what extent -- what percentage point of utilization improvement translates to what on the bottom line?

Ronald L. Nelson

Again, let me answer the last one first. About one point of utilization is worth about $15 million of EBITDA.

Michael Millman - Soleil Securities

Did you say 50?

Ronald L. Nelson

One-five -- 15. Utilization has been in a band for us the last two years of between on average 73% and 75%. It is obviously a very critical metric. It is one we watch very closely. I think the challenge is, from your vantage point, is that everybody defines utilization differently. You really do need, if you are going to do comparisons from one company to the other, you really need to ask them how they computer utilization for that purpose.

Michael Millman - Soleil Securities

I was really more asking for Avis Budget, that it has not increased, despite combining the two companies. That was the surprise. Why hasn’t internally utilization increased?

Ronald L. Nelson

Well, it is hard for me to say because I was not here in the pre-Avis Budget days. I think our utilization has gone up two to three points since the acquisition of Budget. Truthfully, about 18 months ago, we made the affirmative decision to really go after some volume on Budget and trade off utilization for volume in order to maximize profit. I think that was a good strategy in ’04 and a good strategy in ’05. I think it remains a good strategy if we had not gotten a little whipsawed by fleet costs. Again, I think that will even out over time.

Michael Millman - Soleil Securities

On the maturing ABS, how is that going to impact interest costs in ’07, ’08? Just on a straight up, going from wherever it is to current market?

Ronald L. Nelson

That is a good question, Mike. Just generally, what is rolling off is around 4%. What would be added is about 6%. That is the current market for ABS.

This actually was a big year for us. We had about a $1.5 billion roll-off. Next year, we have around $900 million roll-off.

Michael Millman - Soleil Securities

Quick question -- the 10-Q suggested that prices were up 10%, U.S. 3%, and international -- why the big difference?

Ronald L. Nelson

International, we are only in Australia, Canada and New Zealand. The biggest market by far for us is Canada. Hertz is very competitive in Canada, and pricing has not moved much there in at least a year. We are the market leader in Australia, and I think the number two and number three car rental companies in Australia are coming after us with price as well.

It has been hard, particularly in those two markets, which are the substantial majority of our international revenues, to get price increases.

Michael Millman - Soleil Securities

Thank you.

Operator

Thank you. We will take our next question from Michael Connelly from T. Rowe Price. Please go ahead, sir.

Michael Connelly - T. Rowe Price

Given the anticipated increases in fleet costs and anticipated volume growth of the car rental fleet, what do you anticipate your net capital expenditures for the car fleet to be in 2006 and 2007?

Ronald L. Nelson

Most of the increase we are getting in fleet cost is coming through a lowering of the repurchase price, so it really affects our depreciation. Cap costs are up modestly but in the low-single-digits, not much higher than that.

It really is a reduction in the repurchase price, where it is coming from.

Michael Connelly - T. Rowe Price

But that should affect your net capital expenditures, your purchases less your resale of cars, should it not?

Ronald L. Nelson

It should, but if you are looking at our net, it would be -- the net would be obviously the gross purchases less the net repurchases, and the repurchase price would be the former gross less the amortization.

I am sorry. I am not following your question.

Michael Connelly - T. Rowe Price

I just want to get an impact, an idea of what you are going to be -- the net spending level on cars for 2006 and 2007 is going to be.

Ronald L. Nelson

If you assume a constant fleet, let’s do that. If you assume a constant fleet, then our gross purchase of vehicles in ’06 was $11 billion. You should expect that number to go up in the low-single digits, because that is the increase in cap costs.

You would expect then the amortization to run through the P&L, right?

Michael Connelly - T. Rowe Price

Yes.

Ronald L. Nelson

So the cash comes through the P&L, it gets added to -- if it were $4 billion of amortization, it would get added to $7 billion to buy $11 billion the following year, plus what whatever cap costs increased.

Michael Connelly - T. Rowe Price

What do you anticipate the sale of fleet, the proceeds from sale of fleet to be in 2006 and 2007?

Ronald L. Nelson

Our depreciation factors in the low-20’s. So again, take the $11 billion, subtract 20% of $11 billion and that would be the net repurchase price.

Michael Connelly - T. Rowe Price

Thank you.

Operator

Thank you. We will take our next question from Jennifer Pinnick from Morgan Stanley. Please go ahead.

Jennifer Pinnick - Morgan Stanley

Good morning. I have a few questions on Realogy. Can you update us where you are in terms of new franchise growth and acquisitions in the first-half of the year?

Henry R. Silverman

We had good franchise sales in the second quarter. We had already reported our first quarter to you on our first quarter conference call. We are running at or ahead of our goal of adding about $600 million of gross commission income each year.

With respect to acquisitions by NRT, we just announced one this morning of a company, the largest independent in Suffolk county, Allen Snider. We would expect that we will be able to meet our goal of buying about $300 million of GCI through NRT, so I think both, Jennifer, are on track.

The issue that obviously we are studying as a buyer is the same issue you are studying as a potential buyer of Realogy, which is where is the market going? Ron mentioned the market is weakening in his comments, so if the company we are looking at has X million of EBITDA, how sustainable is that?

What effectively we are doing is putting a significant portion of the purchase price into an earn-out, which both motivates and incentive-izes and retains the managers and the owners, but also provides our shareholders with some mitigation of risk, in the event that the market continues to go sideways or down, as opposed to recovering in the near-term.

Jennifer Pinnick - Morgan Stanley

Also…

Henry R. Silverman

Jennifer, just to give you a precise number, affiliate franchise sales were up 38% in Q2 versus last year. I am sorry, I did not have that number in front of me when you asked the question. I do now.

Jennifer Pinnick - Morgan Stanley

Great.

Henry R. Silverman

That would be typical of our premise, which is that in a weakening environment, whether it is Stephen Holmes’ franchise sales in hospitality, or Richard’s in the real estate business, but in a weakening environment, franchise sales typically spiked.

Jennifer Pinnick - Morgan Stanley

With regard to the annualized $50 million of costs you are taking out this year at NRT, can you give us some kind of sense of what kind of additional capacity you have to take out of NRT if the residential real estate market remains under pressure for longer than expectations?

Henry R. Silverman

The answer is I do not know. I do not think anyone knows, because the hypothetical question is how bad does it get? Remember, every time you take costs out, which generally is closing offices, you are also losing incremental revenue and therefore potentially incremental EBITDA, and so would there be some more? I am sure there would be but my own sense is the order of magnitude would not be in the $50 million range, but significantly less.

In the current environment, we are down with cost takeouts in NRT. You are speculating about a worse environment. I really do not have a good answer for you on that.

Jennifer Pinnick - Morgan Stanley

Then, the debt for the share repurchase program, would you use your revolver?

Henry R. Silverman

It is not a debt repurchase, it would be a share repurchase. Is that the question you asked?

Jennifer Pinnick - Morgan Stanley

Yes, the debt that you would use. You have three lines of debt -- the interim loan, the term loan, and the revolver.

Henry R. Silverman

There is a bridge loan, which presumably we would pay off, and then we would either, if we wanted to re-lever to some extent to buy back stock, we presumably would either put in place another bridge against permanent financing or if the timing works, simply do permanent financing.

The capital markets are quite receptive. As you know, Realogy is investment-grade graded at DDD, so that is really not an issue for us.

Jennifer Pinnick - Morgan Stanley

Then, in the 8-K that you put out, you noted that on a standalone basis, there would be an extra $10 million of expenses, given the manner in which Cendant managed Realogy and the allocation of corporate expenses. Am I to infer that is the additional public company expenses, or do I layer extra public company expenses on top of that $10 million?

Henry R. Silverman

I think the answer is the latter, that you would layer it with the additional public company expenses, but it is all in the numbers, which we have laid out in our pro forma’s. There is no change. This is not a change from what we had disclosed in the Form 10.

Jennifer, just to complete your thought, if I may, there are some silver linings in a declining environment that really do not involve taking costs out of NRT. One is that the age in commission split thus goes up, because it is based on volume. Second is the royalty rate that our franchisees pay goes up, because again it is based on volume. There are some benefits.

I would much prefer to pay higher commissions and higher royalties in a growing environment, but it is not a total one-for-one decline.

Operator

It appears that we have run out of time. That concludes today’s question-and-answer session. At this time, I would like to turn the conference back over to management for any additional or closing remarks.

Henry R. Silverman

Thank you all for all of your years with us. This is the conclusion of the last Cendant conference call. There will be Realogy, Wyndham and Avis Budget conference calls in the fall, and we all look forward, those of us who will be on those, to speaking with you then.

Operator

Once again, ladies and gentlemen, that will conclude today’s conference. We thank you for your participation. You may now disconnect.

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Source: Cendant Q2 2006 Earnings Conference Call Transcript (CD)
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