Avis Budget Group, Inc. (NASDAQ:CAR)
Q3 2009 Earnings Call
November 3, 2009 9:00 am ET
David Crowther – Vice President of Investor Relations
Ronald Nelson – Chairman, Chief Executive Officer
Robert Salerno – President, Chief Operating Officer
David Wysher – Executive Vice President, Chief Financial Officer
John Healy – North Coast Research
Emily Shanks – Barclays Capital
[Yoma Abebe – J. P. Morgan]
Michael Millman – Millman Research Associates
Welcome to the Avis Budget Group third quarter earnings conference call. (Operator Instructions) At this time for opening remarks and introductions I would like to turn the call over to Mr. David Crowther, Vice President of Investor Relations.
Good morning everyone and thank you all for joining us. On the call with me are our Chairman and Chief Executive Officer, Ron Nelson, our President and Chief Operation Officer Bob Salerno, our Executive Vice President and Chief Financial Officer, David Wysher. If you did not receive a copy of our press release, it’s available on our website at avisbudgetgroup.com.
Before we discuss our results for the quarter, I would like to remind everyone that the company will be making statements about its future results and expectations which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Such statements are based on current expectations and the current economic environment and are inherently subject to significant economic, competitive and other uncertainties and contingencies beyond the control of management.
You should be cautioned that these statements are not guarantees of future performance. Actual results may differ materially from those express 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 are specified in our 10-K and in our earnings release issued last night. Also, certain non-GAAP financial measures will be discussed and these measures are reconciled to the GAAP numbers in our press release which is posted on our website.
Now I’d like to turn the call over to Avis Budget Group’s Chairman and Chief Executive Officer, Rob Nelson.
Good morning to all of you. My comments this morning are going to focus on two subjects; first some of the strategy behind our third quarter results and second, some of the dynamics we’ve seen develop over the course of the year and expect to continue to see for the foreseeable future and what this may mean for us in 2010.
I’m then going to finish up with a brief summary of some of the more important initiatives we have underway to evolve our business and enhance the car rental experience we offer our customers, which is arguably the equal if not more important dynamic for the future prosperity of our business.
But first, the third quarter; for starters, I think the take away from our results is straightforward. Over the course of the quarter, we saw and seized an opportunity to aggressively trade off fleet and volume in favor of price with an overall profit positive impact. We’re clearly pleased with how this has driven our results.
But let me be clear about what it means. One, market demand was by no means down by the 23% that our volume would suggest, but structurally it was down probably in the low teens, so if you compare the margin impact of the incremental loss of volume we incurred, let’s call it 10%, again for the 9% gain in price we posted, margin write offs are pretty compelling.
Just to remind you, we model $0.90 of every dollar of price to follow the bottom line, whereas in the comparable number on $1.00 volume is $0.30.
Two, to realize the desired benefits fleet had to be reduced and we were aided by a healthy used car market. Those sales did result in gains, but the majority of the gain was the result of over depreciating cars in the first half of the year. Remember, our fleet costs were up well more than others, some 15% to 16% on a per unit basis in the first half of the year.
So the gains we realized in the third quarter were by and large, and inadvertent shift of the fleet costs into the second quarter. Given the average life of our fleet is seven months, it would be a mistake to view these gains as anything other than fleet costs.
Three, we’re continuing to consciously restrain volume in segments and channels where we can’t realize profit positive rentals. Our educated guess is that this move, which is part of our five point plan cost us somewhere in the neighborhood of three to four points of volume.
And four, none of this is related to capital or fleet constraints. Of the more than $2 billion of conduit capacity that we had, we never drew more than $1.4 billion during our summer peak, and currently there’s nothing outstanding under this facility.
In short, this is all about opportunity and profit maximization. At the core of this is fleet strategy which inevitably drives pricing and the differences among competitors are relatively stark this quarter. Bob will talk more about how we positioned ourselves last quarter and how we plan to position ourselves for the rest of this year.
As for the argument that we may be giving up share in pursuit of short term price, our view for the record is that much of volume we are leaving on the table is price sensitive and very transient in nature. We, or for that matter, any of our competitors can grab share at the margin simply by lowering price.
For us, we concluded that lowering price to gain share in a market like we are experiencing this year was not the right strategy; one, because fleets are very liquid over the summer so there was no issue in adjusting fleet to optimize pricing, two, there’s always the risk you won’t take enough share to compensate for the price reduction and three, and this is really a general comment, in the end it essentially implies that an airport traveler has an equivalent price convenience alternative, not a theory we subscribe to.
To be sure there are times when a share strategy makes sense, but when fleets are tight generally around the industry, and the use for our market strong, we believe that playing for price was the right move.
So our strategy left us with the advertised metrics, volume down 23%, pricing of 9% and per unit fleet cost down 5%. The combination of those three variables along with cost savings that are now approaching a $400 million annual run rate resulted in reasonably significant year over year growth and profitability for the quarter.
To understand the positive effects of these actions on our earnings, it helps to look at the year over year comparison. The prior year quarter, Q3 ’08, was not a bad quarter. The recession was fairly mild at that point and payments were only down slightly. Our revenues were about flat year over year and there was little indication that we would soon be seeing the double digit volume declines that produced the exceptionally weak third quarter results.
If you fast forward to 2009, while nearly everyone expected us to have positive year over year earnings comparisons in the fourth quarter, showing EBITDA growth in the third quarter against a real comparison is something that can be labeled a real accomplishment, and a good one at that.
For sure, our results highlight the work we have done to reduce costs, manage our fleet, increase pricing and boost profitability, even in the face of sharply reduced volumes. But more importantly, we think they showcase the benefits of our business model and in fact, may suggest the possibility of a changed environment in car rental.
What characterizes this changed environment is less focus on share and more focus on driving sustainable profitability. Our own experience mirrors what we see generally.
The first indicator is the overall price increases we saw, especially in a challenging market, and in particular in leisure pricing. For us, it was even more robust than in earlier quarters where the composite leisure pricing gain across both brands of 13%. Budget drove greater gains than Avis, but both were substantial.
It’s worth noting by the way that for the second quarter in a row, commercial pricing actually contributed modestly to overall RPD gains this quarter, up about 5%, but most of the strength in the under $1 million accounts.
The second important element in the pricing equation and a very key element of our profitability are domestic ancillary revenues which were up 13% per rental day. Even in a tough environment, there is a greater share of wallet to be had with our customers and it’s attainable simply by providing the proper sales trainings to customer facing personnel.
The biggest component of these benefits is actually car class up sells, which isn’t part of the 13%. It’s part of the RPD increase. We suspect that one to two points of our leisure price growth results from up sells.
Another key driver is fleet size and fleet cost, both of which for us and the industry generally were down. We trimmed our domestic fleet by 23% which we think allowed us to optimize pricing. Even more importantly, fleet costs declined year over year a quarter earlier than we had anticipated due in part to the continued strength in the used car market.
And last, but certainly not least, is the focus on cost savings. The onslaught of the recession only accelerated our and everyone’s efforts to produce the best possible experience for the lowest possible cost. Our cost reduction initiatives developed well ahead of our plans and we ended the third quarter with a run rate of over $400 million a year.
Generally speaking, we expect the trends evident in the third quarter, strong pricing, weak volumes, per unit fleet costs that are down year over year and rigorous cost controls, will again be apparent in our fourth quarter results. While it’s still early in the quarter, it is encouraging that in a period of traditional de-fleeting, price has been holding.
So, stepping back, our third quarter results and the actins we are taking to position our business and our brands for the future, reflect the broader dynamics we’re seeing. At this point however, the one trend that has yet to emerge is a strong rebound in economic activity or travel demand.
Clearly comps are getting better, but a large proportion of that comes as we lap the challenges we faced in the fourth quarter of last year. There are some early signs that commercial activity has picked up a little but, but nothing that would rise to the level of the strong rebound.
Despite that, we believe that the underlying intermediate term dynamics for our business are quite positive. Why do we say that? Well, largely because of the manner in which we’ve reshaped our company along with favorable market forces don’t require a strong rebound for us to have a positive outlook on the fourth quarter or even 2010.
The first reason for this is U.S. fleet, both access and cost. We as a company and as an industry now have the best access ever to a broader array of high quality mid priced vehicles produced by reasonably healthy manufacturers who all seem comfortable with, maybe even a little hungry for, a higher level of sales to the car rental industry.
We believe that everyone in the industry will be reporting declines in per unit fleet costs over the course of the next year and for us, one point of decline in fleet cost, drops approximately $12 million to the bottom line. And just as important, if we see demand rising above fleet, there are a variety of options we have to increase fleet commensurate with demand.
The second reason is that the entire car rental industry relies principally on car rental for their profits. We all have to profitably rent cars to generate returns for our shareholders. This dynamic is crystallized over the last six to nine months as volumes dropped and financing became more dear in terms of availability and cost.
Our rental companies raised pricing, indeed needed to raise pricing to help offset the volume decline and resulting revenue drop. The ah ha moment in all of this was that as prices rose 8%, 10% even 12%, it would be hard to say that the available customers sought other alternatives.
We all may have traded a tenth of a share point here and there, but the competitive balance in the market place was really undisturbed.
The third reason why we believe the industry is better positioned is the learning that we have taken away from the adverse conditions we faced over the last year. With the cost of vehicles having increased and the cost of financing vehicles having risen as well, the cost of idle vehicles has grown.
The car rental demand is inherently uneven. Midweek demand outstrips week end demand, volumes move sizably from week to week and month to month, and each geographic market has its own anomalies depending on when the leaves change color, when sporting events or conventions come to town or what the weather is like.
Of course this unevenness in demand is nothing new. But has changed, and what I think we and others have realized is that the cost of fully adjusting fleet levels to shifting levels of demand is now greater than it was when cars were cheap and manufacturer re-purchase programs were essentially free, and when financing was available on every street corner at 50 basis points over LIBOR.
As a result, we have consciously operating this year with fleet levels below peak demand levels. We have seen similar actions by competitors. This trend is a favorable one for our ability to earn an economic return on our capital.
We believe these changes in the dynamics of our industry are all positives and what the could and should mean for the Avis Budget Group is an opportunity to increase our margins in the coming years.
One of our principal goals is absolutely to get our car rental margins back to historical levels. We see nothing that has changed structurally within the industry or our company that precludes this from occurring.
With our cost cuts in place we have changed the inflection point of margin growth within the company so that we don’t need to return to 2007 levels of volume to achieve historical profitability. Our objective is not only to grow revenues and earnings when the volumes were down a bit, but also to grow our margins.
So what does all this mean for 2010? While, we’re not going to be providing specific guidance, I do want to walk through some of the key areas to assist you in your thinking and modeling of 2010.
Starting with fleet costs, Bob is going to provide some detail in a minute, but the headline is that our model year 2010 negotiations are largely done. We expect that per unit fleet holding costs will decline in the mid single digits next year. As I said earlier, each point of reduction is equivalent to about $12 million of domestic EBITDA.
In addition, we anticipate keeping fleet levels in line with profitable demand so overall fleet levels will be dependent on how the market evolves.
On cost savings, we expect to realize incremental cost savings in 2010 versus 2009. Some will just be the impact of annualizing actions taken in 2009. Others will be new items that we are continuing to find. The combination of these items should contribute some $40 million to $60 million to the bottom line.
We’ve worked very hard to get these cost reductions and our goal is not to let these costs creep back into the system. With that being said, given our variable cost structure, and to the extent that volume rebounds, we would naturally add headcount in our field operations to service the rental increases. But as we said before, none of the $400 million or so of cost cuts running through the P&L include reductions for variable personnel.
On the ancillary revenue front, we expect the growth we have seen in this area to continue albeit at a diminished pace. Although we start to annualize the sales training efforts as we move into 2010, we should still garner some additional benefits on this front from both new product offerings and better execution.
There are some offsets even though we think they are more than covered by the positives. First on that list is vehicle interest. The good news as David will discuss is that our $900 million of AVS offerings and our recent renewal of our conduit facility, being that we have refinanced substantially all of our near term domestic fleet financing maturities.
It will cost us more to finance our fleet next year as risk has been repriced in the marketplace. The cost of our recent term debt issuances is some two points higher than the debt they are replacing and still give rise to a $20 million to $25 million negative impact even if interest rates in fleet levels are constant year over year.
Next, despite the depth and breadth of our cost saving initiatives, our fleet cost savings and other benefits, there are still inflationary pressures though modest, of roughly $2 billion of non fleet expenses we have. We expect to offset some of these through productivity and other gains, but at the end of the day, it is reasonable to assume a point or two of inflation here.
With these two areas covered, the last open items are naturally the most important and difficult to answer; pricing and volume. Since demand is largely out of our control and highly dependant on the timing and the depth of the U.S. economic recovery, pricing is somewhat dependant on competitive factors, we have previously decided not to publish rate projections and the heightened levels of variability that we’ve seen of late, really gives us no reason to change course with respect to providing those estimates.
Nonetheless, under most scenarios, the net effect of the points that I have highlighted is an expectation of meaningful growth in 2010 compared to 2009. But the ultimate level of growth is depending on pricing and volume.
We are excited about our recent results and about many of the trends we see in our business, and with a reasonable economic recovery we are well positioned for earnings growth not only in 2010 but beyond as we look to expand our margins.
Before I turn this over to Bob and David, let me spend a minute talking about a few of the customer initiatives we have going on in the company. We’ve taken a lot of steps this year to increase the profitability of each transaction rental day and we usually talk about them in the context of fleet, volume, pricing and cost reductions.
But we’ve also launched a number of programs to enhance the car rental experience we provide which in the end, can have an even greater impact on long term profitability. Just a reminder for everyone when you have 20 plus million transactions and nearly 100 million rental days as multipliers, small changes can have large impacts.
We are working on several areas of opportunity. Just to name a few, smoke free fleet, kiosks, new ancillary products and services, pre-paid rentals and direct connect technology. Let me give you a quick flavor of how they benefit us.
We are the first, and so far the only, major car rental company to provide a completely smoke free fleet. We took this step for a number of reasons. For starters, the most frequent customer complaint we receive is about the smell of smoke in cars, despite extensive cleaning efforts on our part, so by being smoke free, we have eliminated our number one customer complaint.
Anytime a business can eliminate its number one customer complaint at virtually no cost, we view that as a win win situation. In addition, we save time and money on cleaning cars. And lastly, I believe that this policy change may generate more revenue than it might cost us as customers will appreciate knowing that whatever car they book will be smoke free.
Next, we have a kiosk pilot running right now. The early returns are positives and when rolled out more widely, this provides yet another service enhancement to speed checkouts and at the same time generate cost savings for us.
While we’re certainly not the first to do this, we have spent significant time developing the pilot to ensure that we can capture ancillary revenue sales efficiently and effectively for the use of kiosks.
Turning to ancillary revenue products, besides the usual insurance coverage’s and our highly successful where to and e-toll programs, we will have two new offerings. The first is an emergency roadside product which covers the renter for costs associated with lost or locked in car keys, running out of gas and similar occurrences.
While mundane, these things happen more than one would think, and these are items that the renter would otherwise have to bear the cost of. We started offering this coverage in the past few months and have been pleased with the initial acceptance level.
The second new product offering is expected to be portable satellite radio. Many people have this service in their own cars, and this will allow them to get it while on the road. Like our where to GPS, this unit will be portable so that all renters and all fleets have the opportunity to add satellite rental to their rental.
And like where to, the customer will receive the service only if they pay for it. We will begin piloting this in the next 60 days or so.
Separately we’ve been offering pre-paid rentals on the Budget website for about eight months and are rolling out pre-paids on Avis as well. By offering a discount to buying now, we provide potential customers with an additional value option that helps us reduce no shows and better manage the fleet.
The last example I want to mention is on the technology side. We’re expanding the use of direct connect technology which allows our system to connect directly with third party booking sources and by-pass the GDS systems, and thereby eliminate the GDS fee associated with these types of transactions.
Some of these items are fully in place today. Some are in pilots and others will be rolling out in the near future. Most importantly, what this means is that while we have been very cost conscious this past year, we have not stopped investment in innovation to grow profitability and enhance our customers’ car rental experience. In the end, the product we provide is service. We can’t lose sight of that in our quest to grow our margins.
With that, let me turn the call over to Bob.
Good morning. On most of these calls I talk about how we tailor the fleet to the demand that was in the marketplace. This wasn’t the case during this quarter. We entered the quarter with a strategy of maximizing the pricing in the marketplace. To take advantage of this, we opted to run the fleet below where we thought demand might be.
Additionally, as we got into the quarter, we found ourselves confronted with the unique car sales market that we also opted to take advantage of. All this led to our average domestic fleet being down 23% for the quarter.
This strategy, which added de-fleeting in our domestic operations at higher than normal levels before and during the summer, had other benefits. It did help up achieve a 9% increase in price which was a few points higher than what we expected going into the quarter. We achieved this primarily by not having to find volume at discounted levels to soak up fleet.
Another advantage was, by cycling out of vehicles earlier, and replacing these with less expensive 2010 models, we not only reduced costs but we also gained the benefit of a younger average fleet age. At less than seven months old, we believe our fleet is currently the youngest in the industry and we still have preserved the opportunity going forward to lengthen the age of the fleet which would provide us with some additional incremental cost savings.
On our last call we were expecting modest per unit fleet cost increases in the third quarter and a decline in per unit cost in the fourth quarter. Our assumptions for the fourth quarter have not changed, but in executing the strategy I just talked about, we achieved a decline in per unit fleet costs this quarter, a full quarter earlier than we had anticipated.
The strength in used car prices during the quarter will also benefit us going forward. While we expected a rebound in the used car market, the market improved even more than we anticipated. During the third quarter we sold over 6,300 risk units which was 50% more than last year. Our online vehicle sales in the quarter set another record with about 10% of our sales going through these channels as we continue to increase the volume of vehicles sold through this lower cost method.
We believe that participation rates will continue to grow as more dealers will take advantage of time savings and cost savings that this channel has to offer.
Manheim has reported that used vehicle values were up nearly 7% in September which is the fifth consecutive month of year over year increases and the ninth consecutive month over month increase. The index of used vehicle value has increased more than 20% on a mix and mileage adjusted basis from the end of 2008.
While this string of consecutive increases obviously will not continue forever, we believe generally strong used car prices are likely to persist for some time.
The most important factor supporting used car values is supply. We purchased nearly 30% fewer cars in model year 2009 than we did in model year 2008 and we plan to buy fewer models in 2010 than we did in ’09. With Odessa reporting that new car sales to rental companies are down almost 40% for the first half of the year, the rest of the car rental industry appears to be acting similarly. Needless to say, this will have a significant impact on supply of late model used vehicles into the future.
In addition, Cash for Clunkers had the effect of clearing out new car inventories which is providing near term support for late model used car demand, and because clunkers had to be scrapped, the program did not increase the supply of used cars at all.
A more important long term factor is that auto makers have reduced capacity and scaled back production and the past ways of producing too many vehicles and then dumping the vehicles with attractive incentives, under leases or car rental can no longer be supported in today’s higher cost of capital environment.
Manheim believes that the unbuilt new cars of 2008 and 2009 will constrain used vehicle supply in 2011 and 2012 and buyers of late model used cars will find fewer of them available. For these reasons we believe the current dynamics support long term strength in late model used car pricing.
It is important to note however, we don’t need the used car market to be as strong as its been over the last few months to do just fine on our risk car disposals.
Now I’d like to provide you with an update on our 2010 fleet deals. At this point we’ve completed our negotiations with the manufacturers on our core purchases. We expect our manufacturer fleet mix will be a record low 55% to 60% domestic and correspondingly record high 40% to 45% foreign as we have intensified our efforts to diversify our fleet, reduce our reliance on any one manufacturer and to enhance our bargaining power.
In model year 2010 we will have cars from seven foreign owned manufacturers with the largest components coming from Hyundai, Nissan, Kia and Toyota. In terms of diversification, we’ve hit our target of not having any one manufacturer be more than 25% t0 30% of our fleet buy, and we reached this target at least a year earlier than we expected.
Most importantly, we are projecting that our per unit fleet costs will actually be down in the range of mid to high single digits for model year 2010, more than offsetting the higher buying costs in this environment that Rob mentioned earlier.
While the model year 2010 costs will be down in the high single digit range, fiscal year costs are impacted by three model years, ’09, 2010 and 2011 vehicles, so the model year cost decline that we can predict won’t always line up point for point with fiscal year figures.
After a difficult period for fleet in the back half of ’08 and the first half of ’09, I am encouraged by the longer term trends in the used car market, the OEM negotiations and by our ability to nimbly manage our fleet for opportunities and the expected benefits of lower fleet costs in 2010.
With that, let me turn the call over to David Wysher.
Good morning everyone. I would like to discuss our recent results and our financing activity. Starting with our results, excluding unusual items, in the third quarter revenue fell 14% to $1.5 billion. EBITDA was $165 million and our pre-tax income was $102 million.
EBITDA increased 17% from $141 million we reported in third quarter 2008 and our EBITDA margin improved by three points to 11%. On a constant currency basis, all three of our operating segments reported growth in EBITDA this quarter which clearly reflected our company wide cost reduction efforts.
At quarter end our total head count was down nearly 7,000 or nearly 23% compared to a year earlier.
In our domestic segment, EBITDA increased 34% for the quarter due to higher pricing, lower fleet costs per vehicle and the effects of our cost saving initiatives partially offset by lower volume.
Third quarter revenue decreased 16% reflecting a 23% decline in rental days and a 9% increase in time and mileage revenue per day primarily due to price increases for leisure rentals. We believe the increase in time and mileage rate is a testament to the car rental business model which has inventory flexibility that makes it quite different from the hospitality and airline industries.
Our revenue per car increased 9% year over year as we maintained fleet utilization despite the rental day decline. As Ron mentioned, domestic ancillary revenues were up 13% on a per rental day basis in the third quarter as we began to lap our sales training initiatives.
Direct operating expense decline 210 basis points as a percentage of domestic revenue despite the steep decline in volume as we continue to benefit from our cost saving initiatives and also had much better net gasoline costs compared to 2008.
Excluding performance based incentive compensation expense; SG&A costs dropped 30 basis points as a percentage of revenue.
In our international operations, revenue decreased 6% year over year driven by a 9% in rental days and a 4% increase in time and mileage revenue per day on a reported basis. Excluding foreign exchange effects, T&M per day was up 9% and ancillary revenues increased 7% per rental day reflecting our initiatives in this area.
Freight costs rose 10% on a per unit constant currency basis. Including our hedges, foreign exchange had a negative $10 million impact year over year. Excluding FX EBITDA increased 10% year over year as we kept our fleet size and operating costs in line with lower volume levels.
In our truck rental segment, revenue declined 9% versus last year due to a 9% decrease in rental days. Average pricing stayed relatively constant year over year and EBITDA grew due to lower fleet costs, a more favorable mix of business and cost saving initiatives.
We are managing our capital spending judiciously. Expenditures were just $5 million in the third quarter and $19 million year to date, amounts that are both down more than 70% year over year. As I mentioned previously, we have aggressively curtailed discretionary capital items and prioritized projects based on necessity and those that generate returns in less than one year.
We’ve also had the benefit of some airport driven projects starting later than expected. Several of these projects are gearing up now. I expect that Q3 will be the last quarter in which our CapEx is in the single digit millions. As a result, total CapEx for 2009 will be around $40 million to $45 million or about half of 2008 levels.
Our cash balance at quarter end was $470 million and that figure does not include any proceeds from our convertible debt issuance which closed in early October. Our free cash flow year to date is $93 million. In terms of covenant compliance, we exceeded the minimum EBITDA requirement by 118% and ended the quarter with cushion of nearly $100 million.
The next topic I’d like to cover is our financing activity. Since the end of the second quarter we’ve completed four financing transactions totaling more than $3 billion and in the process have taken care of our domestic car rental liquidity needs for the next year.
Let me take you through some of the details. I mentioned during our last earnings call that our plan was to address about $3.5 billion of existing vehicle back debt and/or capacity coming due by the end of 2010.
Based on our actual 2009 and estimated 2010 peak fleet levels, we projected our domestic vehicle refinancing need for 2010 to be around $3.3 billion comprised of a little bit over $1 billion of AVS term debt maturities and the annual maturity of our $2 billion bank conduit facility.
Our term debt maturities are almost entirely covered by the two AVS offerings we’ve recently completed. Each sized at $450 million and one structured to a single A rating and the other two a triple A rating.
In aggregate, the two deals will provide an advance rate of 66% against eligible collateral. Perhaps most importantly, the market appetite for our paper was very strong with each offering generating more than $1 billion of investor orders.
Following the two term AVS deals, we successfully renewed our annually maturing vehicle bank conduit facility for $1.95 billion, consistent with our goal of $1.8 billion to $2 billion renewal. All eight of the lenders who participate in the facility renewed and we were able to reduce the cost of the facility by 100 basis points from 325 basis points over LIBOR last year to 225 over this year.
We also put in place approximately $300 million of operating lease financing in May. In total then, we have arranged all of the $3.3 billion of domestic vehicle bank financing capacity we need for 2010.
While our strong access to multiple sources of liquidity is definitely reassuring, I am most encouraged by our ability to reduce the conduit pricing year over year. To me, this indicates that the financing markets on which we rely are truly beginning to normalize from the anomalous levels we saw in late 2008 and the first half of 2009.
With the ABS and other financing markets beginning to normalize, we have also relooked at our liquidity and capital structure. As we went through our summer peak this year, we always had several hundred million dollars of available debt capacity to fund incremental fleet as well as significant unused corporate debt capacity.
We ended the quarter not only with $470 million of cash, but also with $320 million of corporate debt and letter of credit capacity, $2 billion of capacity under our vehicle backed financing program and $750 million more collateral in our domestic car rental financing structure than was required. We clearly had ample liquidity.
Nonetheless, our corporate debt ratings are not investment grade. We are reliant on the asset backed financing markets to fund our fleet, and as we’ve all seen over the last 18 months, the credit markets can at times be wildly unpredictable. As a result, in early October we took advantage of an opportunity to access the market to issue $345 million of convertible debt.
These new notes carry a 3.5% interest rate, are covenant light, were issued at the holding company level and give us flexibility to use the proceeds to pay down corporate or vehicle back debt. Since the offering, we have already repaid the $100 million of borrowings that were outstanding under our revolving credit facility.
Initial conversion price for the notes is equivalent to $16.25 a share and as is fairly common in transactions of this type, we entered into a convertible note hedge and warrant transaction that raises the effective conversion price to $22.50 per share.
Going forward, our game plan will continue to pre-fund, renew or refinance upcoming debt maturities in advance of their stated maturity date, and those of you who know us, know that we’ll consider available alternatives from a variety of perspectives as we try to balance cost, risk, capacity, uncertainty and other factors.
Most importantly though, our renewed access to the asset backed term markets and our successful renewal of our nearly $2 billion conduit facility position us well. Our focus as a management team will continue to be on executing against opportunities that we control including containing costs and pursuing a number of very promising process improvement initiatives that have the potential to improve our service offering while at the same time, they help us reduce costs.
We will enter 2010 with two strong and differentiated brands, an outstanding combination of new and long standing customers, the most diversified fleet in our history, a remarkably lean cost structure, and significant opportunities for growth, particularly in income.
With that, Ron, Bob and I will be pleased to take your questions.
(Operator Instructions) Your first question comes from John Healy – North Coast Research.
John Healy – North Coast Research
I wanted to ask a little about fleet heading into 2010. It seems that demand remains low and I was hoping you could provide a little bit of color regarding how you’re thinking about increasing the fleet and maybe your negotiations for buys going into 2010 and if we were to assume that volumes could grow 2% to 3% next year how you would move the fleet accordingly.
I think our strategy for managing the fleet will continue to be what we’ve done throughout 2009 and by that I mean, keeping the fleet very much in line with demand levels and in the process continuing to have utilization relatively constant on a year over year basis.
John Healy – North Coast Research
So you do negotiate with the OEM’s, do you have more or less flexibility compared to 2009 to kind of change your fleet levels as you see demand come on?
We actually have quite a bit of flexibility going across next year. We’ve been very pleased with the negotiations we had with the OEM’s and we think there’s a potential for more cars if we want them and we think there’s a potential to move the fleet around as we need to across the year. So as I said, we feel very good about it.
John Healy – North Coast Research
I might have missed this when you went through the prepared remarks, but did you mention what the gain on position of vehicles was during the quarter?
We didn’t but I can give that to you. In total our gains and losses on vehicles dispositions net of any disposition costs was a gain of $29 million and about 80% of that was in domestic car rental. The remainder was in international.
John Healy – North Coast Research
A big picture question, I know you did the convert transaction, but as you look at having enough enhancement for 2010 time frame, as you elect 2011 and 2012 maturities, how do you feel about the liquidity that you have at the corporate level today? Do you think we’re in a scenario now where enhancement to fund growth in the fleet, is that cash or is that equity comes from what you’re able to generate in terms of the core business or do you see yourself maybe tapping the capital markets again in the future for any other types of transactions. I’m just trying to get your thoughts around how we should think about funding enhancements going forward.
I think the simple answer is we have all the liquidity we need for certainly this year and the markets continue to improve on a day by day basis. You saw how much Hertz’s offering improved from our first offering on the ABS market. So we actually think that we’re going to have more than ample ability to access the capital markets.
I think that putting $350 million of junior capital in place was the right thing to do, but I think at this point in time it’s all we need to do. I think about the momentum we have coming out of the third quarter. Our fourth quarter without giving a forecast is going to be substantially better than it was last year.
We’re positive about next year. Fleet costs are down and we’re going to annualize our expense reductions. With that kind of momentum we think, and given the fact that we don’t need any capital, we actually think we’re in really good shape. The world could change, but I don’t think that we have any concerns at this point in time about raising additional capital or even needing to put any additional capital into our capital structure.
Your next question comes from Emily Shanks – Barclays Capital.
Emily Shanks – Barclays Capital
On your response to the second question that the prior caller asked, the gains are less in used car sales of $29 million. Is that 100% closer to EBITDA?
Yes it is. As Ron mentioned, in many ways the gains or losses that we recognize are really just another component of fleet costs and they show up in fleet costs in our numbers and in a nutshell, the reason we had gains in Q3 is that it turned out that the depreciation rates we had used and estimated in the first half of the year, particularly in the second quarter were a bit conservative in light of where things ended up.
We really just view fleet costs more typically as all combined whether it’s depreciation or gain or loss.
Emily Shanks – Barclays Capital
In your prepared remarks you had made the comment that, I want to make sure my number is right, that there was an incremental $750 million of additional collateral sitting at more than what was needed. Is that pro forma for all of the new conduit facility that’s in place as well as the ABS?
It’s not a pro forma number. It was the actual number, but that number doesn’t really change very much as a result of the other transactions that we’ve done. The conduit renewal has advance rates or enhancement requirements that are very similar to where it was and the other ABS transaction requires a little bit more collateral but again, it only represents about 4% or 5% of our aggregate fleet, so it doesn’t move the number significantly.
Emily Shanks – Barclays Capital
And that incremental collateral in the form of fleet or equity?
Primarily in the form of fleet.
Emily Shanks – Barclays Capital
Longer term as we look at this, because clearly you have a lot of LC’s that are posted to serve as collateral. Is the idea to eventually unwind that or what’s the plan around over collateralization over the next 12 months?
Generally speaking, we will continue to have over collateral or excess collateral in the form of fleet at all times during the year, and then during our seasonal peak or seasonal up fleeting, those are the times when we tend to use some additional letters of credit to support our borrowings.
So there is a minimum LC requirement that’s always there and we use some additional LC’s when we’re at or near our peak. And that strategy I think we expect to continue.
Your next question comes from [Yoma Abebe – J. P. Morgan]
[Yoma Abebe – J. P. Morgan]
Obviously you’re sitting on a lot of cash at the corporate level and as you go forward in terms of any use of cash from the balance sheet and then free cash flow, how do you think about use of cash as it relates to your capital structure on the corporate side?
We are going to be continuing to look at that, but I think our approach is going to be one of being conservative with respect to our liquidity and how we approach cash balances and uses of cash. So I think you should expect to see that we’ll continue to have a fairly decent cash balance and I don’t see us rushing to use that until it makes sense for us to continue to evolve and update the corporate maturities that we have.
Your next question comes from Michael Millman – Millman Research Associates.
Michael Millman – Millman Research Associates
As you suggested is that at least Hertz seems to be focused a little bit more on utilization and price and does that present kind of a lid problem on pricing? Secondly, on depreciation, should we assume or are you assuming the current residuals going forward or are you somewhere between the past and the current? And then do you have any liability from [Realigy]?
Hertz is playing a different game. They’ve been focusing on utilization and I think the only time that you affect pricing in the market is when you really need your fleet and you have excess fleet and you need to soak up demand to put the fleet to work.
We haven’t seen any problem in getting the pricing increases that we have even though obviously there is a big difference between us and Hertz in terms of realized price increases over the third quarter.
Your second questions, related to residual values and the approach there is that no, we have not assumed that the strength of the used car market that existed in the third quarter would persist. Our depreciation rates assume that things will normalize a bit from the strength in Q3 and as a result we have not assumed that level of strength going forward as we set our depreciation rates.
Your third question related to [Realigy]. We continue to hold a letter of credit closed to $500 million through [Realigy] securing all of the liabilities that are contingent or otherwise that flow through our balance sheet for them.
Michael Millman – Millman Research Associates
I guess the concern is if they have to declare bankruptcy.
Then we’ll call down on the letter of credit.
Michael Millman – Millman Research Associates
And that would still be good?
I guess with no other questions we’ll sign off and say thank you for joining the call and we look forward to talking to you at the end of the year.
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