Second presentation of the day. With us today, we are lucky enough to have Hertz. We think everybody knows is a global leader in the industry. Joining us today is, Mark Frissora, who is always kind enough to participate in our conferences. We really thank Mark and his team for spending the time on his busy schedule. With him today is, David Rosenberg, the Interim CFO, and of course Leslie Hunziker, the Investor Relations Head.
We would like to have is kind of an open dialogue when Mark is done with his prepared remarks, so please feel free to ask any questions. We have 29.5 minutes, and without further ado, I'll kick it off to Mark. Thank you.
Great. Thank you and good morning, everyone. I want to give you an update on the company's progress and transformation over the last five to seven years. First, we have some forward-looking statements and then disclosures on the financials in the presentation.
Then just talking about the investment proposition here for a moment, we've strategically done an awful lot to really change the company in terms of making it less cyclical on a lot of different markets, so we now are very diverse, very global on our portfolio. We have a new leasing company. We have Dollar Thrifty, which is a leisure brand, less cyclical than the Commercial segment. We also think that with the changes that we have made both, the investments over the last five years as well as some of our current strategies DTG integration, in Donlen that we have a lot of growth yet to come in the company, so we feel very positive about that.
The culture here at Hertz that we have been able to put in over the last seven years is one of execution with discipline. We have Six Sigma as well as all kinds of lean techniques are live and growing our company. With that 28 quarters in a row of year-over-year improvement in employee productivity. We are already advanced technology leader, we think, in terms of using mobility as well as using technology to enhance rental experience, high touch experience. Then in terms of cash flow generation, we continue to improve every year in our operating cash flows. If you look at LTM Q3:13, where revenues are up 20.9%, adjusted pre-tax income was 39.4%.
On this slide, you can see the different pieces. They all have different rhythms to them of the two different businesses globally, where first one is the Rent a Car, which is now LTM, a $9 billion business for us. Then Equipment Rental is now $1.5 billion business. Still not at the peak of where it was in 2007, so a lot of room to grow there as well.
Revenues are back to peak levels. Most of that's driven by Rent a Car, but as you can see on the slide, Hertz is still $272 million below its 2007 peak. However the Rent a Car business is exceeding in peak and has been exceeding it for several years now. Now, we have all the pieces in place for really optimizing results as well as optimizing cash flow going forward and these different pieces that are in place had some very important brands that we've introduced or that we have repurchased and we feel that, again, our strategy now is one of execution with discipline forward thinking and taking the different pieces and making them work more efficiently together.
The four big drivers of growth in the company, as you look at kind of the path forward, start with the off airport market. In an off airport, we are using our strategy of getting more insurance replacement business, where there is a very large competitor that has very high share 75% share. We now have become a second a legitimate second competitor and we are growing double-digit in this market segment every single quarter. We are using technology like 24/7 to drive that. You are able to get a car anywhere, any place, any time. With this technology inside the car, you are actually able to not have to go to the counter. You just go inside the car and the counter as well as the res systems rates are all in the car itself.
Vehicle leasing, we have Donlen. In addition to Donlen, we are driving that strategy with an integration of Hertz, and we are now selling solutions versus just selling car rental rate and those solutions have to do with an awful lot of a telematics in the car. DriverPoint is one of their sophisticated software program, that Donlen has that allows you to manage, if you will, all of the diagnostics in the car and whether or not your drivers are productive or not.
On the Rental Car Leisure segment side, Dollar Thrifty offers us huge opportunities in synergies both, on the revenue as well as the cost side. Then on the Equipment Rental side, Hertz 360, we made about 11 acquisitions over last three years, $240 million of investment a lot of acquisitions were in segments that we wanted to grow in, that were less cyclical.
If we just switch gears and just move into one of these, which is off airport, you can see why we are pretty excited by, again, $11 billion dollars is now as big as the airport market. Our shares at 14% and it's important to note that roughly 14 years ago, our share was zero, so we've grown 14% share a market very profitability I might add.
It does provide a huge growth opportunity for us as it continues to grow as we get bigger pieces, insurance replacement, but also when we are in the neighborhood more and more peoples become aware of us and rental are often done by convenience and there is an untapped demand in the off airport market that as we put stores in place, we see come close to our stores. If you look at 2007, we had 1,580 stores. In Q3 '13, 2,710, a 72% increase.
Very strong margin contribution in off airport. Why? You can look at this kind of mini P&L here, where the labor costs are lower, the direct operating expenses are lower, the SG&A is lower, the utilization is higher. A lot of this is just driven by the fact that the cars that are used in off airport are less expensive, they are older, they are smaller and their rental length is usually 13 days versus about a three-and-a-half day a rental length than airport.
Switching gears again to leasing in Donlen, again, very sophisticated selling techniques used and we have combined the Donlen capability with the Hertz capability, so that when we go in and talk to a large customer, we can talk to them not only about renting cars, but actually leasing cars and managing their fleet, and it supported us to get probably 8 to 10 major customers, new customer on the Donlen side and Donlen is growing double-digit. It's growing anywhere from I'll take two to three times the industry growth rate and has been since we bought them.
So as you look at the U.S. entire Car Rental Leisure segment, you can see that Hertz Now has representation in all segments, strong brands in the mid-tier with Dollar Thrifty, strong brand with value and Firefly and it's a similar three tier strategy in Europe.
We've talked on our earnings call the last time, we had word about our acquisition, synergies and gave a lot a more detail on where those synergies are coming from both, on the revenue side as well as on the cost side, so here we have kind of broken it out for you and the timing of this where we are probably whatever is left. After this year, we'll get about 65% of it next year and 35% in the third year which would be 2015.
Equipment Rental growth drivers, again, you look at the macros, they are all positive on industrial spending. Non-res construction starts have been going up for the most part. Then on the non-res construction in general, it's still a double-digit growth driver in our overall business model.
2007 peak revenue, again, was $1.76 billion, corporate EBITDA was $834 million, and so we are still on a corporate basis almost $200 million left before we start peaking to what we were in '07 and we have taken out a lot of fixed cost, we believe that margins will be higher as we peak in this non-res recovery versus the last one.
In terms of investments, in the Equipment Rental business, we refreshed the fleet this year. You know, spent probably another $700 dollars, roughly, on equipment to fund the growth. The fleet is getting younger and younger. Time used has been going up every single quarter. The tuck-in acquisitions on your right have driven a much more stable and less cyclical footprint for us in terms of the markets that we are in.
Our profitability trend has been fairly significant if you look at the consolidated Hertz. Again, this shows what our adjusted pre-tax margin was in '09 and '10, '11, '12. As you look at this LTM adjusted pre-tax is up 80% over 2007 prerecession levels and worldwide Hertz steals profit 23% below our peak in '07, so in spite of for Hertz not exactly at its peak and not recovered, we are still up 80% in pre-tax.
On cash flow improvement, we have calculated here for you cash flow from operations, excluding one-time items. In 2009 at $1.69, 2010 $2.21, $2.33 in '11, '12. $2.72, our year-over-year change of $0.39 in '12, and in '13, we told people that we will generate free cash flow of $500 million and $600 million, again, a significant improvement over last year.
As we complete our investments in ERP in worldwide, what I would call, human resource systems as well as worldwide financial systems, as we finish out those investments in 2014, we will be able to generate a lot of cash flow acceleration. We are also as you know funding peak HERC growth and as that growth begins to level off and the fleet becomes more and more refreshed and the aging becomes where it should be, then the need for investment starts to slowdown and then that generates also increased cash flow, so we are focused on improved revenue growth, Lean Sigma fleet management and also better capital management.
Most of everything we do run through the filter of asset-light and we do this in a way, where we don't have to invest in capital asset. That was the idea behind the 24/7 technology is you don't need bricks-and-mortar to expand. All you need is the car and you can put that car in a parking lot of a retailer or partner. In essence, you let them monetize their parking lot and let us not have to invest in bricks-and-mortar, so our better fleet management has driven a lot of nice returns. Our fleet strategy is to move as much of our feet and selling of our fleet into retail channels. We're selling in more profitable channels and have shown and demonstrated on this slide our ability to increase our mix into channels that are more profitable.
We have put here what those channels represent in terms of improved profitability versus being in auction, assuming auctions flat, on-line auction $25 better per car, dealer direct $450 and retail and Rent2Buy, which is an online service is 1,100, so we continue to make progress on this and again allows us to mitigate any concerns around residual risk in the market when we sell at retail.
Lean Six Sigma productivity improvements continue. Again, you can see here that, we every single quarter, even during the recession and when we had a sales shrinkage of 16% in one year, we still improved revenue per employee. We are not doing this through any kind of big outsourcing. Any outsourcing we did was over five years ago, so this is just pure old-fashioned productivity improvement every single quarter since we have been a company 28 quarters in a row, so we think we have got a really good cultural transformations taken place on the Lean Six Sigma and always figuring out how to do it cheaper, faster and better.
Higher return investments in technology and innovation, again our investments are not willy-nilly. We put them into things that we think have higher customer satisfaction features to them and improve the asset utilization as well, so when you look at some of these, I mean some of the more exciting one on the Express Rent kiosk is an actual video kiosk patented and you talk to a live customer service person, they see you, you see them. They can scan your license and you can get on your way in five minutes or less without having to talk to anyone. We are putting those kiosks in place in a lot of our partnerships that we have with different hotel as well as with auto rental dealerships and it's a way for us to expand our footprint with again not having to invest in our bricks-and-mortar.
On Mobile Gold Alerts, I mean, this is an exciting thing. If your are gold member, you know what I am talking about. When you win, you get texted and you say your car is in slot 55 and they pop up on the screen, right on your, whatever it is an iPhone or Z10, whatever you may have in your pocket, what will pop up are two other cars that you can choose from in addition the car that you reserved and you are going to just press the picture of the car that shows up, that's an alternative and that car will be ready for you when you arrive at the airport, so this has been a very positive thing. It has improved our customer satisfaction quite a bit this year.
In terms of 2013 financings and improving the capital structure, we have been hard at work. We have been very successful this year in further strengthening our balance sheet. Overall, we have extended our maturity in lower to average interest rate. On the fleet side, our recent European fleet refinancing saved us $20 million a year in expense and it was by the way the lowest coupon ever for a single B-rated company, so we are proud of that fact.
If we take a look at debt maturities in 2018 on the corporate debt, I think you know what you should note on '16 that the actual interest rate on this debt is 7.5%, so we have an opportunity here, so on the corporate side we are very high cost corporate debt and we may take advantage of timing on this and refinance some of these earlier than needed in order to take advantage of a good environment. Good news is, again, we have, I think, some opportunity and some runway here.
On the fleet debt side, we have accomplished an awful lot already in 2014. We have gone ahead, if you will, and if you can see on the slide in the little box in the bottom half, already in the Q4 financing activity we reduced requirement by $3.7 billion, so that number is much smaller, pretty much about the same rates, so there hasn't been much change in the rate change there. Consistently improving trends, five years of a great track record and we expect to continue that track record as we move forward to next three years.
Now all the pieces are in place and hopefully we will be able to continue to show investors great execution on our business plan and the pieces that we put in place to make us the most successful rental car company in the world.
I would like to open it up for questions now.
While you have materially mitigated the residual risk it's still there and I wondered whether you could perhaps talk towards that subject and what's going on with The Manheim Index, and how are you managing through the interim to get to the point where you feel, so that will no longer be an issue that meaning the swings and residuals risks.
Yes. So, residuals at a high level are still very strong from what they have been historically. Moody's and Black Book, two people that we use to kind of benchmark our own residual forecast, over the next couple years are both predicting that there will about one to two points of the maybe further decline in 2014 and 2015 and then actually start to trend back up again in '16. This is consistent with everything we have seen. Residuals are still very strong at retail. The only place that they are little weaker actually are at auction, and so we had to sell a lot of cars as fast that's where you can you can have pressure.
To your point, our goal is to take about half of the cars that we sell monthly, and in the U.S. we sell on average about 17,000 a month. If we can get half of those roughly at retail, we get 7,000 cars that we can start selling at retail. When our pipe gets that big and we expect to get there the next 18 months then that really mitigates the risk of auction, because if you lose and I am just saying, if you had a really bad month at auction and you were to lose $1,000 a car, [flee] quickly. If you are able to have at retail a gain of $1,100 a car that really balances out your residual risk, so we are trying to build the pipe of around 7,000 cars a month. That's the goal and we are right marching on that path really well. We'll talk about probably in our fourth quarter call and our first quarter call next year. We'll tell you our progress on the numbers of stores that we have opened and our Rent2Buy acceleration on our on-line sales well.
We do local advertising. Again, this is one that's been one of the more successful things we have done as a company is learning how to sell cars like a lot of people do today, like Localiza in Brazil, like people in like Sixt Car in Germany, so we are just replicating something other people do. It's a big opportunity for us and we think it will mitigate the risk going forward, but in general we don't think the residual risk is that great and we that strategy is to offset it.
I will offer you one more thing about Hertz, it's a little different in terms of the risk around residuals. The offset to that is also are mixed shift. All of our growth right now is coming in off airport and it's coming in Dollar Thrifty and Firefly, all of those take older cars, cheaper cars, less trim package cars, so we are growing into segments that require lower cap cost for fleet, so we are buying the less expensive fleet. In fact, we are even buying used cars now.
We have a target on how many want to hit next year, and as you buy used cars as you know the first six months out of the showroom, the curve flattens dramatically, so we are flattening our curves with the growth into those markets that have much less expensive cars, very helpful for our depreciation rates going forwards. That helps us kind of, if you will, counterbalance this issue of running residual risk is another big driver that helps insulate us. Questions?
Sorry. As your profitability continue to improve, will you just continue de-lever or is there a certain area where you would say okay between three and four times leverage on corporate basis for instance. That's creeping up for us or going to increase debt level again?
Yes. I don't think. We have consistently maintained. We want to get an investment grade status and we believe that's a good strategy, because it saves, if you will, interest expense for us especially in Europe and other areas. We have told investors that we would save probably in the neighborhood of $60 million in interest if we had an investment grade rating, so we are continuing to pursue that. At the same time, we are also very open if we are generating lots of cash flow to making sure that we generate that cash flow and then use it in ways like the share buyback we just recently announced.
If we think that's opportunistic, because we think the stock is undervalued, we will continue with that depending on, again, what our cash flow is, and as we forecasted going forward, what's the best equation for investors, so we are very shareholder-friendly company and we are always looking at the right way to return our earnings, our cash flow to shareholders.
Maybe just secondly, just very briefly if I may, any acquisition or areas for acquisitions that you…
No. We really don't have any acquisition on radar screen. We are pretty much set with what we have. We believe that we have a lot of moving pieces right now. We are working on integrating all those. Absent something small, maybe in China or Brazil or in India, those are markets we are always looking at and there maybe our rental car, a rental small operator somewhere that we may look to buy, but nothing of significance. No significant capital requirement anyway in any large scale acquisition on horizon for us.
Yes. I just had a question. At a recent conference, I think you said that if you guys sold or spun-off HERC that that would change the capital structure [strategy]. Just wonder if you could elaborate on that if investment grade goals only make sense with HERC.
You know, so we've certainly always been open with investors in telling them we would consider any kind of a spin strategy or merger with HERC, and timings has always go to be right when you do something like that and we consistently told that timing has got to be right. Whether or not we were to do any kind of a share buyback program in concert with that that is something yet to be determined. We haven't decided that. We haven't made any suggestions we are going to do it. We said, we'd consider it just like we consider everything. Again, it's all based on timing of the market when we think the right time is to unbundle more value for Hertz.
We think there's an opportunity at some point in time, but we are certainly not predicting or commenting when that's going to happen or how that's going to happen, because that's something obviously we want to have more have more fully baked before we talk about it, so that's the answer I can give you, which is the same answer I have been giving for a while now.
When you mentioned that you are outside of HERC that your fleet will potentially get older, because even if you use the cheaper cars, how do you compete them against your competitors who have new cars and.
Wait a second. We already have the newest fleet, so we are trying to get low enough for our competitors just to make sure you understand what I meant by that, so in off airport our cars are too nice compared to our competitors, so we are actually trying to make them a little worse, right? So, we are over engineered in off airport.
If you rent our competitors' cars, you will find that we are a newer fleet than our competitors and we have trim packages. That means they are more deluxe. They got power buttons, they got leather seats, they got Chrome wheels a lot of times and when we have too much fleet in off airport that is just over engineered, so over time I will be able to move that, so I am very cognizant of customer satisfaction. 25% of my bonus can be discounted if my NPS does not go up every year top 400 managers the same way, so we want to make sure our fleet is the best in any market we serve it will be at or about standards. I don't want you to mistake when I say that maybe I'll let you finish your question.
Okay, so what Leslie is pointing out to me is that, when we engineer the fleet and we combine Dollar Thrifty and HERC and Firefly. That all will be combined by the end of the first quarter with one free system houses, [system].
We are engineering to the fleets 60% of all that fleet will be common among all four of those. Okay? So, you will be able to get - that's how we drive the utilization and so we will have a lot of compacts, a lot of compacts in that mix higher than what we have had in the past, because those market are bigger than we have had in the past, but then there will be fleet like for example, for Hertz business customers will probably have close to, I'll take 20% of our fleet allocated to the commercial side that will be normal Hertz fleet that you have always come to expect and there will be plenty of fleet to serve that market. That would get another 10 on 10 based on different market segments that we serve, but we will have 60% com and that will really help us drive the utilization improvement that we need from the Dollar Thrifty acquisition.
Can you just refresh my memory on who much of your business right now is coming from franchise and also where do you see that going? How big would you be prepared to have that business go, what's the opportunity?
Yes. The decision is market-by-market. We have a lot of people interested in Hertz franchises. We recently signed up Roger Penske in a couple of markets. If we can make more money for shareholders ourselves, versus have our franchisees then we keep it. We do an EBA analysis, so what's happened over the last three years of profitability, our profit margins have proved quite, so the opportunity to franchise has gone down a little bit. We are not added to franchise if our operations actually generate more profit for corporate than they do for franchise operator, right?
At the same time, we are very aggressive with franchising into what we call white spaces, places where we have underserved share, so as we grow, we will be growing more through franchising than corporate locations, so there is big opportunity. It used to be that I have probably close to $1 billion of corporate revenues that I thought I could franchise and we gave that to investors we have that kind of a number of available. That number has probably shrunk in half now.
In terms of what we would franchise, so we continue to franchising strategy, but it's market-by-market and it depends on each particular market how much money we make and what are EBA is it depends on each particular market, 20 they were EBA is our although if you will on that market.
Yes. Dollar Thrifty is in international market, the EMEA for example, we are growing that quite a bit, so that is a big opportunity to expand, if you will. That's kind of what we did in China. We ended up using a model, where we own a 20% ownership of the company, but they are like our franchisees, they are co-branding Hertz with themselves and it's called China Auto Rental, and that was more of a franchise relationships, so as we grow internationally, we are likely to use franchising as an opportunity.
Is the situation kind of the model in other words that you would prefer to be working with large player who is established, solid names that, more diverse group as opposed to smaller, local, regional player…
That's exactly right. We look for high quality operators in almost every case. There are car dealer. That provides a lot of synergies for them and for us, helps leverage that model.
I think, we have about $3 billion of revenues totally to franchisees. I think our forecast is to do somewhere in revenue corporate-wide, I'll say between, I think it's $10.9 billion or $11 billion roughly. I think that's what our guidance is. I can't remember the exact number, but that's corporate and then franchisees and Europe is about $1.6 billion, I think, $1.7. Then if you look at other franchisees around the world, we have some big ones in a couple of Asian countries, where we have like marketing relationships, where they are like a franchisees, and so again about $3 billion roughly in franchisee revenue. Okay?
They are telling me the time is up, so thank you all. Appreciate you coming out.
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