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Hertz Global Holdings, Inc. (NYSE:HTZ)

Q4 2013 Earnings Conference Call

March 18, 2014 10:00 AM ET

Executives

Leslie Hunziker – Staff Vice President of Investor Relations

Mark P. Frissora – Executive Chairman, Chief Executive Officer

Thomas C. Kennedy – Senior Vice President and Chief Financial Officer

Scott P. Sider – Group President of Rent A Car, Americas Region

Michel Taride – Group President of Rent-A-Car International

Lois Boyd – Group President of Hertz Equipment Rental Corporation

Analysts

Brian Arthur Johnson – Barclays Capital, Research Division

Afua Ahwoi – Goldman Sachs Group Inc.

Michael Millman – Millman Research Associates

Hamzah Mazari – Credit Suisse

Adam Jonas – Morgan Stanley

Christopher Agnew – MKM Partners LLC, Research Division

Richard Michael Kwas – Wells Fargo Securities, LLC, Research Division

Yilma Abebe – JPMorgan Securities LLC

Kevin M. Milota – JPMorgan Securities LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Hertz Global Holdings Fourth Quarter and Full-Year 2013 Earnings Conference Call.

The company has asked me to remind you that certain statements made in this call contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are not guarantees of performance and, by their nature, are subject to inherent uncertainties. Actual results may differ materially. Any forward-looking information relayed on this call speaks only as of this date, and the company undertakes no obligation to update that information to reflect the changed circumstances.

Additional information concerning these statements is contained in the company's press release regarding its fourth quarter and full-year results issued this morning and in the Risk Factors and Forward-Looking Statements section of the company's 2012 and 2013 Forms 10-K and 2013 Form 10-Q quarterly reports. Copies of these filings are available from the SEC, the Hertz website or the company's Investor Relations department.

I’d like to remind you that today's call is being recorded by the company and is also being made available for replay starting today at 12:30 PM. Eastern Time and running through April 1, 2014.

I would now like to turn the call over to our host, Leslie Hunziker. Please go ahead.

Leslie Hunziker

Good morning. You should all have our press release and associated financial information. We've also provided slides to accompany our conference call that can be accessed on the IR page of our website.

Today, we'll use certain non-GAAP financial measures, all of which are reconciled with GAAP numbers in our press release and at the back of the slide presentation, both of which are posted on our website. We believe that our profitability and performance is better demonstrated using these non-GAAP metrics. Our call today focuses on Hertz Global Holdings Incorporated, the publicly traded company. Results for the Hertz Corporation differ only slightly, as explained in our press release.

With regard to our IR calendar, we'll be next presenting at the Bank of America Merrill Lynch Auto Summit in New York City on April 16, and then Wells Fargo Industrial and Construction Conference on May 8 also in New York City.

This morning, in addition to Mark Frissora, Hertz's Chairman and CEO; and Tom Kennedy, our new Chief Financial Officer; on the call, we have Scott Sider, Group President of Rent-A-Car, The Americas; Michel Taride, Group President of Rent-A-Car International; and Lois Boyd, Group President of Hertz Equipment Rental Corporation. They'll be on hand for the Q&A session.

Now I'll turn the call over to Mark.

Mark P. Frissora

Good morning, everyone, and thanks for joining us. Let me start by welcoming Tom Kennedy to the earnings call. As you know Tom joined Hertz in mid-December as our new Chief Financial Officer based in Naples. With his compatible industry background having worked at Northwest Airlines, Vanguard Car Rental which owned National and Alamo and most recently Hilton. Tom was able to hit the ground running on day one. He’s already made a big contribution. I look forward to having you meet him when we are on the road next.

This morning, I am going to give you a quick overview of our 2013 performance on Slide 5. We continue to successfully drive both record revenue and earnings growth by leveraging industry leading rental car brands, capitalizing on strategic acquisitions, penetrating new markets and equipment rental, and being relentless on efficiency programs and cost management. As a result, you can see on Slide 6 that in 2013 we increased revenue 19% while operating expenses as a percent of revenue decline slightly driving margin expansion.

On a consolidated basis adjusted pretax income and corporate EBITDA rose 29% and 26% respectively. In 2013, Donlen, the equipment rental business and International Rental Car all performed in line with our expectations, hitting our profit targets in each business respectively. Unfortunately, the U.S. rental car operation wasn’t able to overcome the burden of carrying too much fleet in the fourth quarter, which caused us to miss our earnings guidance last year.

If you turn to Slide 7, as we previously discussed in detail, after experiencing negative volume growth impacted by the sequester for the Hertz brand on airport in the third quarter, we went into October significantly over-fleeted, but we made the conscious decision to try to rent some of these cars rather than sell them all in histrionically weakest residual period of the year.

The carryover effect of the excess fleet in the U.S. had a more pronounced impact on operating expenses and fleet efficiency than we had expected in the fourth quarter. The excess fleet also made it more difficult to optimize pricing. We estimate the unusual expenses caused by the surplus fleet to total roughly $0.12 per share.

In the fourth quarter, U.S. rental car pricing was down 1.4% year-over-year as we move fleet to lower price segments where we saw greater pockets of demand. This caused worldwide pricing for the full-year to come in only about a 0.5% up year-over-year versus our guidance of 1% improvement. You will recall that a 1% change in revenue per day worldwide had a $67 million effect on adjusted pretax income in 2013, so the half point swing versus guidance was impactful.

The good news is that we maintained year-over-year pricing growth for the Hertz Classic brand on the airport in the fourth quarter, and we instituted two successful price increases in early December in the U.S. for 2014 rentals. So far, through the end of February, for the Hertz brand on airport, we have realized an average increase of 250 basis points of revenue per day as result.

And while we were still pricing four brands independently through 2013, we’re currently rolling out a pricing optimization system that allows us to yield price for all four brands simultaneously across all segments. In terms of the fleet, we’ve been aggressively selling cars over the last two months as the season for used car demand ramps up. We’re confident that we’ll have our fleet aligned with transaction day growth by the end of this month as projected. I’ll give you some more insight into the current quarter in just a minute, so first let me talk a little about cash flow we generated in 2013.

Turning to Slide 8, you can see that the fleet situation also negatively impacted cash flow. We would have easily exceeded our free cash flow target had we not had the excess fleet, which locked up cash and lowered cash earnings versus our target. Despite this, we generated $449 million of free cash flow last year, a 189% increase over the prior year. The year-over-year earnings growth and the significant improvements in overall working capital offset [$16] (ph) million of higher net investments.

The free cash flow was deployed to rapidly increase our position in China and repurchase $390 million of convertible notes. We also bought back approximately $90 million of common stock in the fourth quarter. As you know from our press release, our Board has approved a new larger stock buyback program that reflects the confidence we have in our ability to drive earnings growth by continuing to work on our strategic initiatives.

Now, let me turn the call over to Tom to give you some details on the fourth quarter.

Thomas C. Kennedy

Thanks Mark, and good morning everyone. Having joined Hertz – the Hertz team recently, I want to say how excited I am to be here today and how much I look forward to closely working with you all. Before we look at the numbers, I also want to reiterate Mark’s earlier comment that the challenges the company faced during the fourth quarter were unusual and temporary in nature and that we already have a fix in place.

We’ve identified and started to implement actions in 2014 to improve our yield management and fleet optimization capabilities that I believe will better position the company as the year progresses. And as Mark highlighted, the excess fleet situation is nearly behind us. With that, let me run through some details of the fourth quarter starting with the U.S. Rental Car results on Slide 10.

Fourth quarter revenue was up 14% from last year driven by a 16% increase in volume, despite the government sequester and associated 16-day shutdown that occurred in October. The higher transaction days benefited from incremental volume and synergies related to Dollar Thrifty acquisition, 75 net new off-airport locations, and expanded penetration of existing insurance accounts.

Insurance and placement volumes were up 8% year-over-year on a tough year-over-year comp due to Hurricane Sandy in 2012. Total revenue per day in the quarter was down 1.4%, primarily due to the temporary over-fleeting and the mix issue we already discussed. As Mark pointed out, however, we are encouraged by the fact that our Hertz Classic brand maintained its positive price performance on the airport during the fourth quarter with a 60 basis point improvement.

Turning to Slide 11 for the U.S. rental car business, adjusted pre-tax margin was impacted by lower fleet efficiency as well as increased labor and logistic costs as we move fleet into higher demand regions of the country. Maintenance costs were also up in the fourth quarter due to extended holding period and a higher number of damage claims as a result of accelerated growth in the Leisure segment.

We should expect to see similar trends in the expenses associated with excess fleet in the first quarter as we are still carrying the surplus for the majority of the three months. But after that those costs will be behind us.

Moving on to international rental car, for the international rental car business on Slide 12, we generated 5.8% revenue growth compared to the same quarter last year. This growth was primarily driven by the continued improvement in the economic conditions in Europe and the development of our value brands there. Strong growth in New Zealand as that country continues to recover and our Ace brand expansion into Australia.

In the fourth quarter, Europe represented approximately 76% of our total international revenue segment. Europe transaction days grew 8.4% in the quarter driven by Hertz classic brand and our value brand expansion, as well as the contribution from CCL Vehicle Rentals, which is our off-airport acquisition completed in June 2013.

Along with solid growth, we reported improved pricing driven by higher ancillary sales and royalty fees increase with the expansion of our Dollar Thrifty brands to new and existing Hertz franchisees. Cost controls were also evident in the quarter as Europe experienced an improvement in direct operating and SG&A expenses along with reductions in fleet carrying costs.

Before moving to equipment rental, let me give you a quick update on Leasing business. Donlen delivered 8.4% revenue growth in the fourth quarter, 12.4% for the full-year versus an overall industry growth that was flat to up 1% by expanding the customer base for its core leasing and maintenance services. We are offering more value to our corporate accounts by cross-selling vehicle rental and leasing products. As a result of higher revenue and reduced operating expenses, Dollar recorded its eighth consecutive quarter of double-digit adjusted pre-tax income growth, as well as continued margin expansion.

For equipment rental on Slide 13, last year’s fourth quarter rental revenue in North America was up against a tough comparison due to increased rental activity at the end of 2012 related to Hurricane Sandy and Isaac. This also caused an unfavorable mix of the equipment on rent year-over-year. North America rental revenue made up 93% of the worldwide Hertz total revenue.

Despite this headwind in North America we increased total rental revenue 6.1% in the fourth quarter excluding currency, on top of 24% growth generated in the similar period in 2012. North American volume was up 9.8% and pricing was 2.7% higher in the latest quarter.

The incremental growth was primarily driven by solid construction activity especially at the local contractor level and growth in our Entertainment Services business. This was partially offset by difficult weather-related comps as well as changes to the timing and scope of expected industrial plant upgrades. We anticipate that the deferral of facility upgrades is mostly a timing issue and we expect that these projects will be back on track in the next 12 months.

On Slide 14 in North America you can see that time utilization was up 50 basis points in the quarter while dollar of utilization was off 110 basis points. The impact in dollar utilization was due to the year-over-year comparison to last year’s storm related mix of the equipment of car rent and as a result of a cautious decision we made to pre-buy by less expenses fleet ahead of a new Tier 4 emissions standards. On growth fleet spend was approximately $130 million in the fourth quarter for 2013.

Despite the tough comps and the pre-buy in the fourth quarter if you take a look at Slide 15 you will see the full year was quite noteworthy. In North America incremental rental revenue excluding currency increased 13% on a year-over-year basis which was nearly double ARA projections. Pricing was up 3.4% over 2012 and volume increased 15%.

On a worldwide basis the equipment rental corporate EBITDA increased 16% with margin up a 180 basis points versus 2012. Our full year growth fleet worldwide – fleet spend worldwide was $685 million and on a net basis full year capital expenditure was approximately $535 million. At year end we had one of the youngest fleets in the industry with an average age of 43 months worldwide and 42 months in North America. For 2014, we expect gross fleet investments to be between $600 million and $675 million.

Switching now to the balance sheet on Slide 16 as December 31, our net corporate debt to corporate EBITDA leverage ratio was 2.9 times and our liquidity position was nearly $1.6 billion at the end of the quarter. We have been active in the capital markets, three large fleet debts financing during the fourth quarter.

All three extended maturities on our fleet debt, but more importantly one established a new improved U.S. rental car ABS platform, another represented our first Donlen term ABS issuance, and a third one resulted in a 4.108% improvement on our fleet financing notes, resulting in more than $20 million in annual interest expense savings.

Now, before I turn back to Mark, I want to provide you some additional background the delay in our 10-K filing. As we indicated during our second half 2013 we implement a new enterprise resource system to enhance the financial control environment and improve the efficiency of our back office operations, which support the North American rental car and equipment rental businesses.

As you are likely aware the ERP system implications are complicated. There are numerous examples of challenges companies have had during their systems and limitations in integration. Hertz unfortunately was not the exception, we encountered complications related ERP system installation that required us to put in place enhanced year-end review controls and more substantive testing.

Further we identified certain adjustments related to prior periods that reported us revise certain of our previously issued financials. These adjustments did not have a material impact on the previously reported results of operations, financial condition or liquidity. So, I feel very good about what we’re today.

We are through a North American financial system implementation for Hertz, most of the issues around ERP have been resolved ahead of the Dollar Thrifty systems migration, we have obviously learned quite a bit from our experience and will move forward better equipped to manage the next stage which I am confident will go smoothly.

With that, I will turn it back over to Mark.

Mark P. Frissora

Thanks Tom. And let’s move to Slide 18. We made substantial progress towards our strategic priorities including integrating Dollar Thrifty, co-branding Hertz with the Hertz market share leader in China, transforming Europe and growing rapidly in U.S. off-airport, Donlen Leasing and equipment rental.

While our strategies are on track and their potential is as robust as ever we’re resetting our financial performance targets for 2014. Our guidance reflects a more conservative approach based on our earnings sensitivity outlined on Slide 19. For example, based on a 1% change in U.S. rental car residual values, we could have as much as an $83 million opportunity or headwinds pretax profits versus our forecast. We expect to be able to tighten the guidance range, as we get more visibility during the year.

If you turn to Slide 20, I’ll run through some of the assumptions behind our initial guidance. For 2014, we expect U.S. and international rental car revenue to increase 6% to 8% and 5% to 7% respectively year-over-year. We believe Europe will continue to deliver steady growth, as it’s economy stabilize and we further penetrate the market value – the full value market with new Thrifty and Firefly locations.

In the U.S. we are planning for another year of double-digit volume expansion in the off-airport market as our insurance replacement operation builds on last year’s growth and captures a greater share of existing account business. In fact, Hertz has recently expanded its position with one of the largest insurance carriers in the U.S. being upgraded to its primary rental car vendor.

On the U.S. airport, we now have 22 Firefly locations open in the top leisure destinations across the country that will drive incremental volume and adding Dollar Thrifty to our corporate and commercial partnership agreements will further boost the top line. We should also benefit from the anniversary of the government sequester at the end of this month. From a rental car pricing perspective, we remain positive on both comments. However, we do expect to see an unfavorable pricing impact from mix as we accelerate growth in our discount segments, where margin contributions are strong.

For our Hertz classic airport brand, our assumption is for a 1% increase in revenue per day in the U.S. I single out the Hertz brand, because as the pricing and market share leader on airport is the best gauge of how well our pricing strategy is working. It’s also our largest segment with exposure to both commercial and leisure customers consisting of more than 20 different sub-segments which we track continuously. And it’s a clean number, it’s not skewed by mix. Under the pricing umbrella, the Hertz premium brand should act as a catalyst for higher revenue per day across all segments of the industry.

We expect international rental car unit fleet costs to be down low single-digits this year. In the U.S., rental car monthly depreciation should be about $260 per unit in 2014, driven higher in part by our assumption of a 200 basis points decline in residual values year-over-year. You will recall Slide 21, where we showed you that there were multiple factors that could impact – that can impact depreciation rates with residual values having the greatest effect.

After seeing a significant rate adjustment already in January, which will show up in our first quarter depreciation expense, we’ll monitor new car inventories and the supply of all fleet vehicles closely throughout the year and keep you abreast of any changes we see versus our assumptions. In terms of the cadence, we anticipate U.S. monthly depreciation expense will be greatest in the first quarter at around $275 to $280 per unit due to car sale losses as we rationalize our fleet through the auctions, as well as the rate adjustment I just mentioned.

After that we should see improvement in the middle part of the year as we increased our program mix and then a slight seasonal uptick in the fourth quarter. Fleet utilization should progressively improve starting in the second quarter, we expect to get back to the 2012’s 80% plus rate this year. Not only will we be more productive sharing fleet due to the benefits of the consolidated counter system in the second half of the year, but we expect to have a 125 retail sales lots in operation by year end, providing us with even more resources for higher returns on fleet sales.

In 2013, we sold 27,000 cars through our retail channels, which is up 36% from 2012. This year we expect to increase that amount by 65%, and in fact in January and February year-to-date January and February our retail sales are actually up 64% year-over-year. For worldwide equipment rental among our assumptions for 2014, price improvement of 2% to 3% and 6% to 8% higher volume. EBITDA flow-through should be in the range of 55% to 60%.

Now quickly let me tell you what we are seeing in the first quarter is outlined on Slide 22. As I mentioned in the U.S. the Hertz rental car brand on airport total revenue per day was up about2.5% year-to-date through February. Despite the excess fleet in a tough year-over-year comp on pricing. However, overall rental car pricing maybe unfavorable due to the mix impact as we grow our value brands on and off airport.

U.S. rental car volumes year-to-date are also coming in better than expect even with the disruptive weather conditions. Obviously later this month we will have to Easter affect to deal with but so far volumes are encouraging up over 8% through February. While the excess fleet situation is nearly rectified we estimate its impact on the first quarter was about 7% to 8% share. For the company in total we expect first earnings per share between – to be between 7% and 9% – $0.09 per share.

Moving to Slide 23 among our priorities this year we plan on capitalized on the operating leverage or global network, maintaining disciplined pricing strategies and leveraging the power of our brands to deliver another year of double-digit earnings growth. We also will be focused on driving fleet efficiency in U.S. rental car and improving productivity across the organization. And as you saw from our press release this morning will be unlocking incremental value for our shareholders as we work to separate the car and equipment rental businesses into successful standalone entities.

Turning to Slide 24, Hertz has been to a significant transformation since becoming a public company. Even having weather to recession in 2006 we’ve generate 34% revenue growth taken nearly $3 billion out of our cost structure and delivered a 470 basis point improvement an adjusted pretax earnings. This was accomplished through a series of initiatives that included strategic acquisitions, technology development, adjacent market penetration and geographic expansion.

We made similar progress in fortifying our balance sheet and access to the global capital markets. For example, we’ve successfully extended our corporate debt maturity profile lowered our financing costs and developed a broad investor base. Likewise, from the fleet depth side, we've revamped and improved our rental car ABS platform in the U.S. and established a time tested funding platform in Europe.

As a result each of our businesses is now positioned as an industry leader with a strong brand portfolio, geographic foundation and technology platform to successfully capitalize of future growth opportunities.

Let me show you what I mean on Slide 25, over the last seven years we have grown our equipment rental operation into one of the largest business its kind in the world, we taken a single brand with a primarily non-residential construction focus in 2006 and expanded it’s products and service offerings since 2010 through more than 10 tuck-in acquisitions and an international joint venture.

Today HERC has more diversified with revenue from industrial and fragmented markets making up 62% of the total revenue compared with 48% in 2006. Serving a wider variety of strategic industries price revenue increases our value proposition among customers and supports earning stability. HERC also as extended its operational footprint into growing regions of the world. And they’ve done it an asset light way by successfully franchising locations in South and Central America, the Middle East and Asia.

We've been equally focused in leveraging technology in equipment rental with logistics tools, telematics solutions, and state of the art pricing optimizations system among others. These innovations improved efficiency and support our customers need. Our focus on systems and product advancements has helped to further differentiate our brands and drive revenue growth and cost efficiencies.

By the equivalent rental industries is still in the early stages of the economic recovery to HERC transformation has been underway since late 2010, has delivered noteworthy results as highlighted on Slide 26. Corporate EBITDA over the last three years has grown 18% annually on a 13% annual increase in revenue driving 580 basis points of margin expansion. once with non-residential construction business comes back, we would expect those numbers to return to peak levels and beyond.

Moving to Slide 27, since our initial public offering in 2006, we have transformed the rental car company from a single brand addressing only the premium segment of the market to multi-brand share leader with a mobility solution in place of any customer in any segment who travels. And while with long hold had a footprint on airport you can see that our expansion off-airport has been noteworthy with a compounded revenue growth rate of more than 7% annually in an 860 basis point 6margin increase.

We expect to continue to grow through share gains with important insurance replacement customers, as well as leveraging our new 24/7 industry leading technology to drive off-airport returns. In addition to adjacent market penetration we’ve expanded our footprint geographically through franchise and industry partnerships. Rental car has grown its international revenue by expanding this product offering, developing its franchise network and broadening this exposure in emerging markets.

Last year we took a roughly 19% stake in the market share leader in China allowing us to gain access to their substantial domestic self drive market, and generate referrals from the world’s largest outbound travel source. Today Hertz and China auto rental are co-branded at more than 300 rental car locations across the country in China. Our rental car has long been a technology leader with the introduction of Gold service in 1989, more recently we’ve been first to market with innovations like Hertz 24/7, video kiosk, and e-return among others. We’ll continue to reinvent the car rental experience with 10 patents registered worldwide and 16 pending setting the stage for future expansion and share growth.

On the Slide 28, as a result of these strategic initiatives, worldwide rental car has increased revenues over 5% annually and delivered 660 basis points of margin growth since we started our journey. As we’ve recapped on Slide 29, the initiatives we’ve undertaken over the last seven years have been transformational for our businesses. Today, the financial strength and market leadership positions they’ve achieved give them the platforms to successfully operate as standalone businesses with extremely right prospects.

As such our Board of Directors and management team believe that separating the company's now will unlock the greatest value for shareholders. And so today we announced our intent to split Hertz into two independent public companies, new equipment rental and Hertz rental car. This is outlined on Slide 30.

Last summer, we submitted an IRS – an application to the IRS for a tax-free spinoff and recently received on March 8, a favorable private letter ruling. Hertz shareholders will receive a tax-free distribution of shares at the time of the separation, which we expect will take place by early 2015.

Following the separation, both companies will have a capital structure appropriate to the needs of their respective businesses. As part of the stand, Hertz rental car will receive a net cash distribution of approximately $2.5 billion from the new Hertz that will be used to pay down debt and fund a new $1 billion share buyback program.

The separation allows each company to pursue distinct strategies, create greater financial flexibility, benefit from a singularly focused management team, and provide greater visibility for investors to value the businesses. Specifically for rental car, on Slide 31, we will continue to deliver the excellent results and superior customer service that are hallmarks of our company. The added visibility will achieve as a pure play company will readily highlight our industry leadership and best-in-class financial profile, including increased earnings capacity and stable cash flow generation.

On the bottom of this slide is the preliminary snapshot of what the rental car and financial profile would look like on a standalone basis, essentially we’ve taken to segment financials and added the entire unallocated corporate overhead expense to come up with a conservative pro forma metrics for this business. A lot of work remains to be done to determine the appropriate cost structures for the separate companies, including analyzing the stranded costs, these simplistic pro forma projections are likely to become more favorable once the analysis is complete.

If you turn to Slide 32, you can see that Hertz pro forma rental car financial performance is best-in-class across all key metrics by removing the cyclicality and greater cash flow needs associated with the equipment rental business, we expect rental cars superior performance to gain greater visibility and more appropriate recognition among stakeholders. Again, on this slide we have included 100% of the unallocated corporate expenses which is a conservative approach reflecting this is a standalone business.

If you look at Slide 33, you can that today as a combined company Hertz stock trades well below standalone counterparts with equipment rental companies trading at average 17 point times future earnings and Avis Budget are only public rental car peer trading at 16.6 times and comparison despite our strong financial performance and significant share price gains we have achieved over the last two years are combined company multiple is significantly lower at about 12.7 times. The separation increased more target investment opportunity we expect to translate in the trading valuation the more accurately reflect the strengths and opportunities of each business.

On Slide 34 we’ve outlined the value drivers that we see that will merit an improved multiple. In fact, we believe there is potential for increased valuation even if both businesses only trade in line with peers.

For Hertz on Slide 35 the separation represents an exciting opportunity to build on the strong position of the equipment rental business and the time when the macro environment for its industries beginning to improved. As a pure play company with greater reporting transparency HERC should generate a more targeted following among investors that will allow its true value to be better appreciated.

Today not a single equipment rental analyst covers HERC. By offering greater visibility into its operating performance and detail strategic plan we believe it too benefit from a fair valuation. For today’s purposes HERC standalone segment financials are used as a placeholder for expected standalone results. I said a minute ago once all of our analysis complete will be able to provide more informative financial profile.

As a separate company the equipment rental business will have the scale and financial strength to expand into new one existing markets capturing share what remains a highly fragmented industry. In addition, to discipline growth HERC will continue to drive the culture of operational excellence and follow clear return criteria for investments.

And the end a separation of Hertz rental car and the equipment rental business will enable us to better optimize to capital structures of each business based on the objectives that each independent company is outlined on Slide 36. The equipment rental business is starting to net debt to EBITDA ratio of 3.5 to 4 times one separated similar to other industry transaction HERC standalone earnings and free cash flow generation will allow for ongoing to leveraging will also providing capacity for growth initiatives.

Hertz’s rental car with target the lower end of the net debt to EBITDA range of 2.5 to 3.5. We believe this is an appropriate to manage our seasonal needs while maintaining financial flexibility. This leverage range is primarily influence by market conditions in our strategic initiatives. The rental car company will be growth oriented, technology driven company that generates premium margin, strong cash flow and high returns on invested capital.

So I mentioned earlier, we announced that our board has approved a new $1 billion share repurchase program, under the new program the majority of the shares are likely be purchase by in a completion of a separation within in our market conditions.

The share repurchase has been reached 20% of Hertz's rental cars outstanding shares of common stock including the $1 billion already approved. We’re very excited about the opportunity this transaction creates for both businesses, I want to conclude on Slide 37 by reiterating three key points first we take the step forward from position of strength.

Our current equipment rental businesses are leaders in the respective markets with valuable assets and tremendous long-term potential. Second in creating two pure play companies that we believe to separation can enhanced the visibility, focus in capitalization of each business by unlocking shareholder value and better aligning valuations. Third we’re committed to a balanced approach to capital allocation that includes a significant return on capital to shareholders over time, we have been and we’ll continue to be active in this regard, as we look forward to building on our track record of growth and success.

With that let’s open it up for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Brian Johnson with Barclays. Please go ahead.

Brian Arthur Johnson – Barclays Capital, Research Division

Yes. Good morning.

Mark P. Frissora

Good morning.

Brian Arthur Johnson – Barclays Capital, Research Division

Just kind of sticking to the current business, can you give us a sense as you kind of roll from 2014 to 2015, just broadly how you are thinking about depreciation, and should we think about it stepping down or stepping up year-over-year?

Mark P. Frissora

Well, I guess in terms of the Black Book, which is what we kind of use as stakeholder, we had a January depreciation reduction based on Black Book, which forecast out through January of next year. We feel that the market is pretty stable in the current, and it’s actually -- that Black Book is actually probably negative kind of versus what we’re seeing in the marketplace right now, but we’ve assumed that negativity in our current guidance so that we’ve accounted for -- the forecast what we seen in 2015 or 2016, Brian, you’re guess is as good as mine, I mean, so in terms of the -- with the marketplace going to prove to be, obviously it will be impacted by the OEMs and what their behaviors is, it will be impacted by the off lease as well, the off lease supply base, what happens in off lease in 2015 and 2016.

Operator

Our next question is from Afua Ahwoi with Goldman Sachs. Please go ahead.

Afua Ahwoi – Goldman Sachs Group Inc.

Thank you. Just two questions for me. First I think, sticking to the – following up a little on that first question. I think you answered it a little bit, but when you talked about truing up the -- moving from the $250 to $260 for 2014 fleet car guidance, I think you indicated that some of it was market conditions, but I was going to point out that I thought the Manheim actually has been quite stable. So maybe if you can sort of bridge that gap for us, how the numbers still moved up.

And then the other part I was also curious was, could you give us an idea on maybe how much the mix impact will have on the reported price , and I think it's great color to give the Hertz Classic brand, but obviously the reported number will be lower, so maybe an idea of the impact so that we can think about it as we model. Thanks.

Mark P. Frissora

Yes. Again going back to Manheim versus Black Book, Manheim is just current – you are seeing current market conditions which we believe have been favorable compared to our expectations, which is good, but Manheim does not predict the future. They do have future predictors, but we use again Black Book, which indicated in January, third week of January that there was going to be a decline.

So, again, we basically forecasted that decline in our depreciation rate, but we’re hopeful that they are wrong obviously. I mean, the hope is that the Black Book is wrong, but we modeled it into our depreciation curve anyways. So, again, we have a lot of offsetting factors as you know on retail. We are beating our plan right now on the retail sales levels and retail has been strong for us. So we have a lot of offsetting factors as well, but that’s pretty much kind of sums up where we are on residual risk. We think we’ve made the right moves. We looked ahead to see what we think the worst case scenario is, and we’ve built that into our current $60.

So there is, obviously when we look at mix on the pricing side, in general we see anywhere from 120 to 150 basis points range of mix adjustment on an ongoing basis, it kind of ranges, but that’s roughly what it is, on an ongoing basis 120 to 150 basis points. Next question?

Operator

And that’s from the line of Michael Millman with Millman Research. Please go ahead.

Michael Millman – Millman Research Associates

Thank you. I just have two questions. First is, if previously you had talked about the $3 number for 2015. Could you talk about or quantify some of the factors assuming the companies were together as to why you don't see the B post to that at this point.

And secondly regarding the price you indicated, U.S. Rent-A-Car price that you've put in a couple of increases. Avis has talked about continuing increases. ERAC has followed suit. Why would we expect to see even greater increases than you’ve expected considering that ROI seems to be well below where the industry should be or at least believe that it could be?

Mark P. Frissora

Yes, so Michael on the $3 number that was, a year ago, and that was when residuals were at a different point in our history and volume, we didn’t have the third quarter volume impact, so obviously the [$3 in ’15] changes in terms of timing. So we still are focused on the same kind of positive returns out of existing buying levels, so our margin assumptions really haven’t change since we talked to you guys back then in the April time period, but obviously the buying assumptions had changed and that drives obviously a longer period time before we get that $3 number.

In terms of just looking at the overall pricing environment, I think we pretty much put out there in the investor sides that we are seeing the very strong pricing environment, and we have been initiating price increases ourselves historically. We never talk perspectively about pricing though because we think that’s not the right thing to do.

But historically in the last couple months, we’ve seen a very strong pricing environment and I would expect that with any pressure on fleet costs which probably will continue to be some, that the pricing environment will remain strong on that basis but more importantly we will finally have our systems really integrated during the second quarter. We think, we are going to drive large amounts of capacity takeout.

We are going to be driving utilization up in the back half of the year, and as that utilization goes up, we are taking cars out of the market, essentially we are taking capacity out of the market and being their leading off-airport brand that will help, we think, airport pricing dramatically. We believe that Hertz, the reason we tell you that Hertz is a good indicator because that is the umbrella, that’s the price leader and other brands can follow up underneath that price leader. It represents over half our volume in the entire U.S. market.

So it's roughly – I'm giving you rough numbers, but anywhere from $3.3 billion to $3.4 billion business is the Hertz Classic brand on airport. So we think that’s a really good bellwether that’s clean, it is a very clean number on what pricing is doing, and to have that up 250 basis points already to February on top of last year being up 500 basis points, I think it’s a fairly strong indicator we think the pricing environment is strong.

Operator

Our next is from Hamzah Mazari with Credit Suisse. Please go ahead.

Hamzah Mazari – Credit Suisse

Good morning, thank you. Just a two-part question, the first question is just on the spend, could you maybe talk about your ability to potentially buyback stocks sooner versus wait for the spin transaction to take place, as well as maybe how investors should think about additional information, the Management team of HERC, potential share distribution. How we should think about the timing of additional information coming through.

And then lastly, second question, if you could just give us a sense of how the incremental synergies from DTG ramp up and how we should think about what else is remaining there? Thank you.

Mark P. Frissora

I think you asked six questions. So I’ll try to just answer a couple, all right. So, obviously we believe that we will be opportunistic in the marketplace when comes to share buyback. We indicated in our script to you that we were looking to opportunistically take the $2.5 billion and have $1 billion of it and execute that in the near term.

But we could go up to 20% of the shares of the new company, which would indicate that would be higher than $1 billion, again, post separation. So that was our commitment, anything other than that, we haven’t really talked about it from a timing perspective, but we will be opportunistic based on marketplace condition, this was I can answer that question.

In terms of more info on the management team, we’re going to be giving you that information as we get closer to the spin. Obviously, this is a recent event, we didn’t want to talk to investors and so we knew that we had IRS approval. And so, as we’ve been working through these issues for the last since last spring, it’s been a very posi-momentum project, but we’re going through all of the issues, we’re ready to make the announcements for leadership we will be sure to be real-time in that communication.

Operator

Our next question is from Adam Jonas with Morgan Stanley. Please go ahead.

Adam Jonas – Morgan Stanley

Hey, thanks everybody. So first a question on your new corridors for leverage and the new visibility after the reformation of the company. Can you confirm that that does not change in any way your growth ambitions for taking market share off-airport, in particular the insurance replacement business?

And just as a follow-up housekeeping, you provided some residual value sensitivity in your slide deck on page 22, I believe it was – page 19, excuse me, that said that a 1% change in residuals was an $83 million impact on pretax profit and that was about almost four times the magnitude of the $23 million sensitivity on Slide 30 of the capital markets day deck. I was just wondering how we can reconcile those very large differences in that sensitivity. Thanks.

Mark P. Frissora

Okay. In terms of – I wanted to answer the previous caller their question on DTG incremental synergy cadence, we put $120 million in revenues in 2014 and $100 million in costs in 2014. So on the DTG revenue side, it’s $120 for revenues, it’s $100 we built in the guidance for costs, just so you have that.

David J. Rosenberg

Okay. And I can address the residual bridge for you. The number the company used last year that was based on the car sold in the period as opposed to the $83 million is impacting the entire rental car fleet. So that was a segment analysis that was provided previously and based on car sales, and two factors. One is that the total company now has sensitivity, so you can really model against the entire fleet, and it’s on current market conditions as well in the Black Book that Mark referred to earlier.

So there are really kind of two dynamics that have changed. The volume dynamic, number of fleet, and its current market versus what the market was prior distribution of that sensitivity.

Operator

And next to Chris Agnew with MKM Partners. Please go ahead.

Christopher Agnew – MKM Partners LLC, Research Division

Thanks very much. Good morning.

Mark P. Frissora

Morning.

Christopher Agnew – MKM Partners LLC, Research Division

I was wondering if you could talk a little bit more about the pricing optimization tool and the DTG system integration in general. Where are you with it? What do you expect the benefits to be? And how soon do you anticipate seeing them? And then very quickly, just are there any restrictions in buying back stock because of the spin? And do you intend to buy back stock this year? Thanks.

Mark P. Frissora

Okay. So in terms of Dollar Thrifty integration, this again going very well, it’s ahead of our internal plan. We’ve – as I mentioned to you just a minute ago, what we expect to have in our guidance for this year, we gave the DTG numbers. The migration itself is going on right now, I mean, we’re doing the migration. We’re rolling out in April a complete revision for all the pricing, but we’re also migrating the counter systems as well.

We’re doing tests in April on the counter systems. And so the pricing will be done if you will, the pricing integration is done at the end of this month. But the actual counter systems and the financials for DTG will be done over the next couple of months. But we’re actually testing it if you will in different airports and different areas during the month of April and May.

The idea is that by June, we can – June, July time period kind of go 100% live with all locations. But we want to make sure, we test this with really a lot of belts and suspenders making sure that, we run full tests in parallel systems as we move forward with this in the short-term over the next couple of months. There was another question that you had asked, restrictions on share purchases. I guess the only restrictions that we have is the fact that, with the ruling that we have, but we can't buy more than 20% of our outstanding shares. Other than that, there are no restrictions, so it's just market timing and sources and use of capital.

David J. Rosenberg

Yes. Chris, it's a very specific technical matter, you can't have a plan or intent to acquire more than 20% of your shares and that's why, it's clear in our release that why that we set that standard.

Operator

Our next question is from Rich Kwas with Wells Fargo Securities. Please go ahead.

Richard Michael Kwas – Wells Fargo Securities, LLC, Research Division

Hi, good morning everyone. Just Mark, just going back to the earlier question about the mix adjustment, so if Hertz classic is up 1% and that's the assumption for the year, but the mix can be 120 to 150. That would imply that the US RPD – the assumption in the guide is kind of flattish all-in, maybe down slightly. First, is that accurate? Second, off-airport was down 2.8% in the quarter. Any dynamics going on there with your chief competitor? And then finally, the assumption – could you give us the assumption in terms of the mix of retail units sold behind the $260 depreciation per unit per month guidance? Thanks.

Mark P. Frissora

Okay. So let’s start off with the question relating to the first part, which is your RPD mix. You are right, I mean, we are essentially is modeling flat pricing into the – into our model as we normally do, so again that's kind of the assumption in the model for this year. And again, we believe there is obviously upside for that given what we’re seeing in the marketplace, what we have seen and given the fact that where we are going to be taking capacity out of the airport.

So, again, we are bullish on pricing and but we put 0% into the – 0% overall for all brands into the mix. In terms of the air – off-airport pricing, remember that we’re getting bigger shares of the insurance replacement businesses. You remember that off-airport is three segments, so we have a little bit of a mix shift going on in off-airport frankly. There is leisure, there is local commercial business, and that’s the insurance replacement. We’ve been growing share in the insurance replacement segment and that's contracted at a rate that's lower than let's say, the local business is or the commercial business locally.

And because that rates are little lower, it’s still very profitable, of course, very contributory, and we serve it, as you know with smaller cars. And so it’s positive that the growth rate is there, but it does have a mix shift and make the rate look a little lower than what it really is in the different segments, because when we look at the retail segment, for example, we're pretty bullish on the pricing in the retail segment, the walk-up traffic that we get in those stores that we're expanding this year.

So overall, it's – if you mix adjust it, I would – couldn’t give you the actual number today but maybe we will look at doing in the future, but we're not really worried about the rate if you will. It's not because we're entering into kind of a pricing issue with our competitor there.

Operator

We’ll go next to John Healy with West Coast Research. Please go ahead.

Unidentified Analyst

Thank you. Just a few quick questions, Mark I was hoping maybe you could take a step back and kind of remind us of where you were back in November with the fleet issue in terms of units that you felt you were over-fleeted in the US. And maybe kind of in a real-time of where you are at as of the middle of March and kind of how you've moved through, what channels you've moved that fleet?

And then additionally I was hoping to get a little color on the free cash flow guidance. Any color you could give us in terms of contribution to that free cash flow from the RAC division as well as the HERC division?

Mark P. Frissora

So where we were in November versus where we are now is a world of difference. We are actually ahead of plan. We’re right fleeted right now. So we actually today are right fleeted. We actually have more demand than we have fleet. So we feel really good about how tight we are right now. We also – versus November, where we were still in the middle of being significantly over-fleeted right in the middle of it. So I guess the characterization, it's kind of night and day where we were in the fourth quarter but where we are now in the quarter.

On January and February as I mentioned to you those are problematic months, but we’ve been able to get the fleet and demand aligned and so that we’re ahead of schedule from what we told investors back last year when we said it would take us six months to work through this through the end of March. So we're a little bit of head of schedule on that – on fleet utilization.

Cash flow for HERC versus RAC outlook, we have disclosed that publicly. We're going to be working on that obviously as we fine-tune the models and separating the company, we’ll be happy to buy that to you in the future.

David J. Rosenberg

And the free cash flow increase I think was also your question, that’s primarily driven by higher earnings, so that’s what’s driving the increase on year-over-year.

Operator

And our next question is from Yilma Abebe with JPMorgan. Please go ahead.

Yilma Abebe – JPMorgan Securities LLC

Thank you. Good morning. My first question is, it seems like with the new leverage target of 2.5 to 3.5 times you are moving away from your investment grade aspirations. Is this a temporary move away from that financial policy or are you permanently taking investment grade ratings off the table, one? And then secondly, if you can perhaps talk about, if it's not too early, what debt you'd like to pay down.

David J. Rosenberg

Yes. I can address that. We did a lot of work and analysis of that investment grade target relative to being close investment grade relative to our cost of capital. And we concluded the cost of getting to investment grade relative to the rewards you get on our cost of capital really was not worth it.

And we concluded that being kind of a high BB – mid-BB range is really our optimal cost of capital, and that’s where we are – that’s how we set our leverage ratios. So, with this transformational event, it kind of created a platform for us to reconsider that position and reset kind of our capital structure and our investment targets that we feel now very comfortable with.

As far as what was the second part of your question excuse me? We haven’t really – we’ve done some preliminary modeling, the likely is the term loan that we would pay down. And that’s in the LIBOR plus what currently in the LIBOR plus 225 range to 275 range with some LIBOR floors in terms of 75 to 100 basis points. So we would look to pay down that term loan most of it if not all of the term loan as part of the distribution that would come from HERC, and then would used to fund the dividend and pay down that debt.

Operator

And next go to Kevin Milota with JPMorgan. Please go ahead.

Kevin M. Milota – JPMorgan Securities LLC

Thank you for your time. Looking at page 30, you have the assumption of $1.7 billion to $1.75 billion in corporate EBITDA for 2015 for the RAC business. Just to confirm, that's assuming no incremental pricing, and maybe if you could give some of the drivers behind that 2015 number?

David J. Rosenberg

Yes, I think it’s fair to say no incremental pricing, it’s conservative approach in terms of volume assumptions as well. So we really tried to put a belt and suspenders on both our fleet depreciation guidance as well as our volume guidance as you know by making sure we have that conservatism we’d better book-end things for investors. So we feel pretty good about that number, felt like the way we arrived at it was through prudent kind of – prudent assumptions around each segment of our volume and around kind of a flattish pricing environment, which we believe will be actually positive.

Operator

We have a follow-up from Rich Kwas with Wells Fargo Securities. Please go ahead.

Richard Michael Kwas – Wells Fargo Securities, LLC, Research Division

All right. Just a follow-up on the retail mix of the dispositions this year, Mark, I think last year the target for 2014 was about 30%. Is that embedded in the $260 per unit per month 30%?

Mark P. Frissora

We don’t – okay, so right now in 2013, retail and rent-to-buy were 15%, we expect 2014 to be at 30%. Like I said, we are beating our plan pretty hardly right now. The retail environment continues, I mean, we’re going to be able to beat it, will help our depreciation obviously. We are selling as I said, we sold 27,000 units and if you can imagine a 64% increase on that it's pretty large. And it does give us some cause to be a little optimistic about things.

So 30% is the 14 goal. We hope – we had on average probably about 30 stores open – 35 stores open last year. This year we'll finish the year, how many stores. 125 and today we have 65 stores open. So its 65 stores open and we’re getting a lot more throughput for per store as their open, then we anticipate we also getting a lot higher margins than we anticipated with F&I. And that's very helpful for us as we continue to make sure we build up insurance against any kind of residual risk.

Operator

And we’ll go to Adam Jonas with Morgan Stanley. Please go ahead.

Adam Jonas – Morgan Stanley

Hi, thanks just wanted to follow-up on the first part of my question, just to confirm that the changing views of leverage and credit rating in your outlook that that will not change your previously stated ambitions to grow the off-airport market share, and in particular, the insurance replacement market share. Thank you.

Mark P. Frissora

No, I mean that our capital structure was designed with sufficient cash flow to fund all of our CapEx needs for our growth plan and we see no – we've got lots of headroom we think capacity for investments and other strategic initiatives if we chose to pursue them so we are very comfortable with that leverage range and still fund the growth initiatives that we have in our plans.

Operator

And that will conclude the Q&A session. I'll turn it back to the presenters for any closing comments.

Mark P. Frissora

Great. Well listen we are excited about our prospects for the future. We hope investors feel good about the upside for the Company. We certainly feel good about all of our market conditions. Going forward and the team is very motivated to making sure that we exceed investor expectations as we move forward. So thanks for joining us on the call today.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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