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Executives

Scott Sider - Executive Vice President and President of Car Rental & Leasing The Americas

Elyse Douglas - Chief Financial Officer and Executive Vice President

Lois Boyd - Senior Vice President Advantage Rent A Car

Mark Frissora - Executive Chairman, Chief Executive Officer, Member of Executive & Governance Committee, Chairman of Hertz Corp and Chief Executive Officer of Hertz Corp

Leslie Hunziker - Staff Vice President of Investor Relations

Analysts

Fred Lowrance - Avondale Partners, LLC

Richard Kwas - Wells Fargo Securities, LLC

Michael Millman - Millman Research Associates

Christopher Agnew - MKM Partners LLC

Brian Johnson - Barclays Capital

Michael Perez

John Healy - Northcoast Research

Himanshu Patel - JP Morgan Chase & Co

Neil Portus - Goldman Sachs Group Inc.

Jordon Hymowitz

Hertz Global Holdings (HTZ) Q1 2011 Earnings Call April 27, 2011 10:00 AM ET

Operator

Welcome to the Hertz Global Holdings 2011 First Quarter Conference Call. The company has asked me to remind you that certain statements made on 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 this information to reflect changed circumstances.

Additional information concerning these statements is contained in the company's press release regarding its first quarter results issued yesterday and in the Risk Factors and Forward-looking Statement sections of the company's 2010 Form 10-K. Copies of this filing are available from the SEC, the Hertz website or the company's Investor Relations department.

I would now 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 2 p.m. Eastern and running through May 11, 2011.

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 and associated financial information. We've also provided slides to accompany our conference call that can be accessed on our website at www.hertz.com\investorrelations.

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, Inc., the publicly traded company. Results for the Hertz Corporation differed only slightly as explained in our press release.

A quick note about our IR calendar. We'll be attending the Wells Fargo Industrial Conference in New York City on May 10, the Barclays Global Services Conference on May 11 in Boston and we'll be doing some investor marketing around Chicago with Barclays on May 17. So hopefully, we'll see some of you at one of those events.

This morning, in addition to Mark Frissora, Hertz's Chairman and CEO; and Elyse Douglas, our Chief Financial Officer, on the call we have Scott Sider, Executive Vice President and President of Vehicle Rental and Leasing, The Americas; Michelle Taride, Executive Vice President and President of Hertz International; and Lois Boyd, recently appointed Executive Vice President and 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 Frissora

Good morning, everyone, and thanks for joining us. As Leslie mentioned, I have appointed Lois Boyd who previously ran our Advantage business unit to head up our global equipment rental operation. After reviewing her background in the press release we issued, I'm sure you'll agree that Lois has the experience, credentials and track record to take Hertz's performance in the next level. Replacing Lois in an interim position at Advantage is Gary Fulena, who has more than 31 years experience in the rental car industry and has been an Operations Manager with Advantage since 2005. Permanent replacement will be named shortly.

Now in terms of our quarterly report, let's start on Slide 6. I was really pleased with our consolidated operating results in the first quarter after what started out to be a challenging year for U.S. Rental Car, our biggest operating unit. After 3 disruptive winter storms caused travelers in the Northeast to cancel their rental reservations in January and early February, the industry had too much supply and pricing had become competitive in key leisure markets. By mid-February, however, the fleets were right-sized. And as seasonal demand came back, we were able to increase Airport Leisure pricing year-over-year in March. In fact, Leisure Airport was up 4.5% in the U.S. excluding Advantage.

For all of the first quarter, U.S. Rental Car revenue was up 3.6% with fleet up less than 1%, volume was 4.4% higher and the March pricing contribution bringing RPD [revenue per day] near neutral. We estimate the storms had a $15 million negative impact on domestic revenue.

This inter-quarter rebound in U.S. Rental Car, along with improved pricing in European Rental Car and the as expected double-digit volume growth we generated in Equipment Rental all contributed to our strong top line performance of 7.2% revenue growth.

In particular, the U.S. Off-Airport business continues to be a bigger part of our revenue. You can see this on Slide 7. In the first quarter, Off-Airport made up nearly 26% of the total U.S. Rental Car revenue mix, up from 23.5% of the total a year ago. It's 13.1% year-over-year revenue increase in the latest 3 months represented 85% of U.S. Rental Car's total revenue increase. In the first quarter, Off-Airport same-store revenue was up 12.4% as our replacement segment grew more than 15%. We anticipate stronger growth through the remainder of the year due to our increasing share with insurance companies, fleet leasing providers and dealership accounts.

On the next slide, we opened 35 net new Off-Airport locations in the first quarter, bringing the total to 1,963. This is a 9% increase from one year ago. While Off-Airport growth had a negative mix impact on total revenue per day, its contribution to earnings is compelling due to its low cost structure and longer-length rentals.

Our Advantage discount brand also is playing a bigger role with total revenues up 47.6% worldwide, same-store revenue up 16.2% and five new U.S. and two new European locations online in the first quarter. In the U.S., Advantage total revenues is up 42.4%.

In addition to the higher revenue, lower-than-expected rental car depreciation and continued cost savings from Lean and other process improvement programs, those were all key drivers of the resulting profit improvement.

We improved adjusted pretax by 76.9% which equates to a 330 basis point increase in margin.

Moving to Slide 9. In the first quarter, we generated $83 million of efficiency savings or 26% of our updated full year goal of $325 million. Our global Lighthouse project was a significant catalyst to these results. We have now transformed 15 U.S. airport locations and are working on turning six more into faster more efficient operations with higher customer satisfaction and keeping with the Lighthouse methodology.

A first quarter highlight was a 35% improvement in damage collection at our Miami facility, which is now sharing its process map for this issue with other Lighthouse locations.

In Europe Rental Car, as a result of Lighthouse, February's overall Net Promoter Score increased 73% over last year with a 24% improvement in the staff courtesy component for the six locations currently in the sustainment phase.

In Equipment Rental, our Lighthouse locations generated a 45.1% corporate EBITDA margin in the latest period. We now have 13 Lighthouse projects completed in Equipment Rental, 10 of which were implemented in the first quarter.

Another catalyst to the improved profit was lower depreciation expense driven in part by higher residual values. As you know, the industry is getting peak resale value for used cars in the U.S. This is on Slide 9. Our residual values from January through March were a first quarter record for us since becoming a publicly traded company. Residuals were up more than 400 basis points year-over-year.

The higher values are being driven by four items. The first one is the lack of new vehicle leasing over the past two years resulting in a tight off-lease used supply vehicle condition. We expect this to continue for at least another 2 to 2.5 years. Also, lower OEM production levels combined for tight supply, a higher mix of risk vehicles for Hertz and our strategic shift towards more profitable remarketing channels.

Moving to Slide 11. Our direct-to-consumer car sales are up 23% from a year ago and direct-to-dealer sales are at 90% higher, representing 45% of all vehicles sold. In addition to a 7.3% improvement in U.S. monthly depreciation per unit, we achieved a first quarter record for fleet efficiency of 78.3%. And we did this despite the weather issues in the first six weeks of 2011. Keep in mind that historically, the first quarter is the lowest quarter for rental demand. This is on Slide 12.

Our record achievement is a testament to our ability to flex our fleets quickly and evidence the benefit of Off-Airport's longer rental length and the synergies of fleet sharing between Hertz and Advantage.

While U.S. Rental Car is clearly the catalyst for the company's improving financial and operating performance, it's certainly not the only contributor. For the first time in a long time, we've seen positive momentum simultaneously across all 3 business units and around the globe. The pace and level of contribution may vary but the traction is equally encouraging.

From a financial perspective, we completed the refinancing of our corporate credit facilities in the first quarter which Elyse will talk about. From a very high level, over the past 12 months, we've refinanced $10 billion of debt at an overall lower blended interest rate. Over the 3-year period through 2013, the enhancements to our capital structure should generate approximately $70 million in lower total interest savings.

Today, 2011 is trending ahead of plan, and as a result, we've raised our guidance for the full year. I'll give you some perspective in the revised assumptions in my outlook but suffice to say that we're very optimistic that things continue on the current course.

Now, let me turn it over to Elyse for a more detailed financial review.

Elyse Douglas

Thanks, and good morning, everyone. Let me begin on Slide 15. As Mark said, we're very pleased with our first quarter financial performance. On a consolidated basis, we generated $1.8 billion of revenue, up 7.2% or $119 million over the same period last year. And as Mark mentioned, adjusted pretax improved by $53.2 million. This was achieved through lower depreciation expense and strong cost controls evidenced by reduced adjusted operating expenses as a percent of revenue in spite of higher maintenance spending in Hertz.

GAAP earnings improved in the quarter with a reported EPS loss of $0.32 per share versus the loss of $0.37 per share in 2010. The improvement occurred in spite of debt refinancing costs which had a negative $0.15 per share negative impact in the quarter. Excluding these costs, GAAP EPS would have improved 54% instead of the 13.5% improvement reported.

Now let me give you some more detail on the performance trends by business units starting with Worldwide Rental Car on Slide 16 through 21.

Worldwide Rental Car generated 6.2% more revenue than last year despite the rough start in the U.S. and some economic volatility in Europe. Revenue in Worldwide Rent-A-Car was made up of 31% Airport Leisure business, 28% corporate business and 30% Off-Airport rentals. The balance comes from international revenue.

Worldwide Rental Car adjusted pretax income of $61.3 million increased 126% year-over-year. Adjusted direct operating and SG&A expenses were flat in Worldwide Rent-A-Car. Higher gasoline expense, payroll taxes and vehicle licensing expenses were offset by lower vehicle damage, lower insurance expense and improved labor productivity.

Our Worldwide Rental Car fleet was 73% risk at the end of first quarter compared with 66% risk in the first quarter of the 2010.

Now, let's turn to the results of our Equipment Rental business on Slide 22 through 25. Hertz's first quarter revenue increased 13.2 % year-over-year. Volume was up 14.3%, with pricing roughly flat in the quarter but up 0.7% in March. I should point out that we calculate pricing a bit differently than our public competitors. Those differences are laid out on Slide 23. Using competitor A method, our pricing for the first quarter would be up 2%.

The industrial segment continues to lead the recovery for the equipment rental industry as spending was forecasted to be up 20% in the first quarter according to industrial information resource. Our industrial revenue grew 23%, outpacing the industry. This demand, along with growth in our other specialty services such as pump and power, entertainment and the government markets, helped drive time utilization 130 (sic) [830] basis points higher to 58.3% and total dollar utilization increased 340 basis points to 30.4% over last year.

In the quarter, we reduced the Equipment Rental business' adjusted direct operating and SG&A cost as a percent of revenue by 110 basis points over last year. Revenue growth and cost controls offset an incremental $6 million of fleet maintenance to support the older equipment and to get underutilized equipment available for rent to meet rising demand. This helped corporate EBITDA margin to 34.1%, up slightly year-over-year.

At March 31, our worldwide equipment fleet age was 49 months, in line with the fourth quarter of 2010. First quarter equipment gross CapEx was $171.6 million and disposals was $52.3 million or $127 million on a first cost basis. We expect net CapEx for fleet to be between $300 million and $400 million for the full year.

Moving to Slide 26. For the first quarter 2011, interest expense net of interest income was $195 million, an increase over 2010 of $16.2 million. Net cash interest was up $5 million as the lower rates associated with our refinancing were more than offset by the loss benefit of the 2009 rate buydown of an ABS interest rate swap, adverse foreign exchange and slightly higher EURIBOR [Euro inter-bank offered rate] rate.

Noncash interest was up $11 million driven by the write-off of unamortized net cost associated with the refinancing of our corporate credit facility and redemption of high yield notes.

Restructuring and restructuring-related charges in the latest quarter were $5.4 million compared with the first quarter 2010 of $16 million. And for the first quarter, the GAAP effective income tax rate was 18.8% compared with 7% in 2010. Cash income taxes paid in the quarter were $11.6 million. The GAAP effective income tax rate is lower than the statutory tax rate primarily due to losses in certain non-U.S. jurisdictions for which no tax benefit is realized.

On an adjusted basis, we continue to use the normalized tax rate of 34%. We estimate cash taxes to be $48 million to $53 million for the full year of 2011.

Now turning to Slide 29. You can see that we continue to capitalize on strong credit markets in the quarter. As many of you know, the bank loan markets were robust during the first quarter. We use the opportunity to refinance our $1.8 billion senior asset-based revolver and our $1.6 billion senior term loan. The maturities on these facilities were extended to 2016 and 2018, respectively.

We were able to obtain significantly greater operational and financial flexibility in the new credit facilities, including the elimination of financial maintenance covenants while achieving best-in-class pricing.

Slide 31 shows you our updated debt maturities schedule. You'll note that 2014 reflects the pro forma impact of the April redemption of 8 7/8% notes.

Turning to the next slide. Previously, we estimated the full year cash interest expense would increase $25 million to $35 million over 2010. We are lowering this estimate by $10 million as a result of achieving more favorable terms on refinancing our corporate credit facilities than forecasted and due to the $500 million high-yield redemption in April. For the full year, we now expect 2011 cash interest expense to increase by only $15 million to $25 million over the 2010 level.

As Mark mentioned, the refinancing activity completed over the last 12 months will drive future interest savings. The favorable refinancing rates achieved on the U.S. fleet debt on the high-yield notes were partially offset by higher international fleet cost and higher interest on the corporate credit facilities.

The net savings is about $24 million in the year. However, in 2011, the year-over-year cash interest savings was offset by the loss of interest benefit related to the interest rate buydown on the swap that expired in 2010.

We ended the quarter with a total net corporate debt of $3.8 billion, total net fleet debt of $5.4 billion and $1.4 billion of unrestricted cash on our balance sheet. This is on Slide 33.

However, we carried an excess cash and debt of about $500 million related to the March add-on to the 6 3/4% notes which paid down a portion of the 8 7/8% notes in April. At the end of the quarter, we had pro forma of $1.8 billion of corporate liquidity available to fund growth initiatives. With that, I'll turn it back to Mark.

Mark Frissora

Thanks, Elyse. Although the beginning months of the year were challenged by severe weather in the U.S., we entered the first quarter stronger as a result of quick actions to tighten our fleet, higher residual values and a continued company-wide focus on cost management. Confidence among U.S. consumers climbed in April from a 16-month low, indicating job gains are helping the Americans cope with the rising fuel cost.

According to economists, consumers are taking the increase in the gas prices relatively well. They say that as long as the labor market continues to heal, consumers will continue to spend. At Hertz, we haven't seen an impact from the higher gas prices yet. And until it affects the GDP, we don't expect it to affect us. Remember, a rental car accounts for only about 15% of a consumer's vacation budget and gas is a small portion of the overall rental cost. So we don't anticipate a headwind on this front.

We do expect to continue to benefit from the higher used car residual values that we saw in the first quarter. In fact, we're anticipating a short-term bubble in the second and third quarters from incrementally stronger resale prices as new car production stalls due to the supply chain disruptions.

For the full year, we now expect worldwide monthly depreciation per unit to be down 6% to 7% compared with our original guidance of down 4%, in addition to the tight used car supply, reduced OEM production levels and more profitable remarketing channels.

We've added more economical cars to our fleet as well to serve our expanding Off-Airport and Advantage value operations. In terms of the fleet situation, industry fleets are a little loose right now. Operators are bringing in cars for the peak season but also keeping some of the cars they had targeted for sale as a safety cushion against potential shortages.

For Hertz, despite the recent pressure on automakers' inventories, we believe we'll have a sufficient number of cars to meet demand this year. We've been able to secure incremental fleet from auto dealers and other OEMs, so we feel good about our ability to meet peak summer demand while also capitalizing on the strong car sales market.

Switching to Equipment Rental on Slide 35. While demand for nonresidential construction equipment has shown only low single digit growth so far, it's beginning to percolate in certain regions where local lending is becoming less restrictive, particularly in California and Florida. And we should see additional pick-up as we approach the peak season of our business cycle later in the year. The Dodge Report currently is projecting nonresidential construction spending will be down 1.2% in the second quarter year-over-year, up 1% in the third quarter and up 11.5% in the fourth quarter.

Meanwhile, we'll continue to capitalize on our shift towards industrial business and refresh our fleet as demand builds. In the second quarter, we are forecasting our first year-over-year price improvement in four years. The corporate EBITDA margin for Equipment Rental is on track to achieve our goal of 42% for the full year as incremental revenue flows through at a higher rate and savings from process improvements partially offset the higher maintenance spending in the first half.

Moving on to Slide 36. As you saw, we increased our annual guidance. The main drivers of the improvement are increased cost savings and lower depreciation expenses. Today, direct operating expenses are running lower than planned as returns from our Lighthouse efficiency projects are occurring at higher level than expected.

We believe residual values in the U.S. will continue to be strong for the remainder of the year. However, they won't be as strong as in the third quarter which is seasonally our highest period for resale prices. At today's run rate, total cost savings should be about $25 million more than our original target.

Now let me make a couple of brief comments with regard to Dollar Thrifty transaction so that later we can use our Q&A time more productively. Seven months ago, there was no deal between Avis and Dollar Thrifty. They only announced that they would work together to obtain FTC [Federal Trade Commission] clearance of an eventual deal. Seven months later, there's been no ruling or even a comment from the FTC regarding the matter in the U.S., or in Canada, nor has Avis announced the merger agreement or launched the tender offer. Against that background, it is difficult to answer all the what if questions we've been getting. When the shareholders voted down our proposal in September 2010, everyone urged us to stay in the deal until the end of the year when there would finally be certainty about Avis' antitrust status. In hindsight, it was a smart move for us to pull out of the deal as there is still no certainty and we've been able to concentrate 110% on running our business and increasing shareholder value. Our lawyers continue to believe that either a brand or a similarly sized asset sale will be required by Avis before the FTC will agree to a merger. Is that what's going to happen? Who knows. We'll just have to continue to monitor the situation. Having said that, I'd like to keep today's Q&A focus on Hertz's successful operations and save any merger follow-up until there's something concrete to talk about.

Finally, in terms of guidance, and consistent with past practices, we're a bit conservative in our revised expectations because of continued macroeconomic uncertainty. Today, we feel comfortable with the new ranges but we have set the bar higher and we'll work hard to executing these increased targets. However, as I've told you in the past and you can see on Slide 37, a 1% change in operating metrics has a substantial impact in Rental Car due to its transactional nature. On the cost front, we'll continue to leverage our process-oriented culture to drive more revenue to the bottom line. In summary, if the economy cooperates this year, I'm very optimistic for investors. Let's open it up to questions now. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Brian Johnson from Barclays.

Brian Johnson - Barclays Capital

I want to focus on Slide 7 and just get some of the color around the pricing trends in each segment. Thank you again for breaking it out by segment because the minus 1% overall covers the number of different stories. So may be starting with the airport, can you differentiate between the Leisure and the corporate business and in particular how you're getting positive pricing in any segment of corporate business at this point?

Mark Frissora

You want to know if we're getting positive pricing in corporate?

Brian Johnson - Barclays Capital

Yes.

Mark Frissora

Answer is no, we're not getting positive pricing in corporate at let's say the Fortune 300 accounts. We're getting that certainly in the small business segment but we don't expect commercial segment to be up this year. We'll probably continue to forecast down 1% roughly for the commercial segment overall. But we are getting -- every single month it changes. It's hard for us to predict what the competitive reactions are every single time we go in to bid. But at this point, we want to make sure that we tell you what we think can happen. And we expect commercial probably down 1% overall for the year.

Brian Johnson - Barclays Capital

Okay. So that would imply within that retail was up about a couple of percents?

Mark Frissora

Leisure on airport was up 1.3%. Business airport was down 1.8%. Off-Airport was actually up in Q1, 0.8%. So those are the moving pieces.

Brian Johnson - Barclays Capital

And the decline in Advantage, is that pricing related or is that the tied to rental length and the discounts given for longer rental length.

Mark Frissora

It's more related to the maturity of the Advantage brand and the geographic, new geographic dispersion that we have. As you might imagine, Brian, in Florida, the rates are much lower than what they would be in, let's say, Chicago or what they may be in any Midwest city where we have heavy business. Even in Atlanta, the RPD is much higher. So as we mature in the leisure markets and we get more share in leisure, RPD will naturally go down. So that's what's driving it. It's just the maturation in leisure markets of the Advantage brand. That's most of it. A little bit of pricing pressure, but I would say the primary drop is just the maturation of the brand in those markets that are lower priced.

Brian Johnson - Barclays Capital

And just a related question on efficiency, a very impressive utilization statistics. Any way to bucket the year-over-year gain between the contribution of vehicles sharing across Off-Airport and Advantage and then on-airport efficiency measures and just then support bucket with the longer rental length times overall?

Mark Frissora

No, I don't have that data available and probably won't give it to you because -- it changes so much and there's so much variability to it. It would be difficult for you to even track it and model it. I mean, we certainly can find that kind of information but that's so granular that it wouldn't allow us to be productive on the calls. But I mean, in general, the trend for utilization will continue to improve and it will be improved due to the higher mix of business with longer rental length coupled with, as you mentioned, the Advantage piece. What I can try to do is for you in the future is maybe we can show you some examples of airports with Advantage and what they were like before Advantage and what they're like after Advantage. And we'd be happy to share those examples so you can get a feel for what the impact Advantage has. Off-Airport, again, that business is so percolated now and integrated into our business that it's very difficult to pull it out separately and show the impact. It's actually now become part of the fabric of our whole DNA in every single fleet that we have around the country.

Brian Johnson - Barclays Capital

Have you made improving utilization and explicit management goal? Was it before or -- we get the sense that's sort of holding in around 75%, 76% was the typical mode of operations. So to see this increase, I'm wondering if you're explicitly managing the business differently?

Mark Frissora

We're explicitly managing the business differently in terms of, yes, utilization. The whole goal is to get up -- this is a low quarter, right? So we hit a historic high in the quarter that seasonally has the lowest utilization. Usually, the first quarter and the fourth quarter are the lowest utilization quarters, typically it's the first quarter. So even in this low utilization quarter with all the misses due to over fleeting, due to weather, we still hit a historic high. So you're going to see significant utilization improvement this year from us. Our goal internally is to hit something north of 86%, 87%. That's an internal goal over the next several years as we switch our business mix. But I mean, that's the kinds of numbers as we move to a higher risk fleet in a different business model with Leisure as well as with Off-Airport. That's the kind of numbers we think we can experience.

Operator

[Operator Instructions] Next we'll go to the line of Himanshu Patel from JPMorgan.

Himanshu Patel - JP Morgan Chase & Co

Mark, could you update on us on kind of the level of shortfalls you were seeing from Japanese OEMs over the next few months in terms of the orders you guys are putting in for future vehicles?

Mark Frissora

Yes. We pretty much assume we're not going to get any vehicles from them although we will get some. I was letting you know that we had anticipated a month ago that it'd be difficult to get vehicles from them. We've had some cancellations. We're not through negotiations yet with some of the Japanese in terms of what the final outcome will be and what vehicles we get. In general, I think, there's been a lot of just recent press around Toyota. I don't have -- whatever you've heard, which we've heard and talked to, it's the same everywhere. So we don't have anything new to report on what's going on with Toyota. And so we're kind of position for ourselves right now where we've had some cancellations but we've been able to make up those cancellations with buying cars direct from dealers in some cases. Secondly, we've got some U.S. manufacturers actually to step up with some extra cars. So we're in really good shape in terms of supply for the rest of the year in the summer season. So we feel pretty good that mitigating any of those cancellations that we've received. But again, it's still a little unclear as to which how many cars we will get from some of the Japanese manufacturers. We are in the middle of negotiating with them. As you might imagine, we're the largest customer in the world of one of them, and so we do have some influence. And we're using that the best we can to make sure we get as many cars as we can for the summer season.

Himanshu Patel - JP Morgan Chase & Co

And just on a related point, you're talking about the strengthening and potentially a short-term-bubble on residual values here. Are you seeing that across the board on all brands or is it really isolated to the Japanese brands at this stage?

Mark Frissora

I think we're seeing it across the board. Scott, go ahead

Scott Sider

Yes, Mark, we're seeing it across the board. I mean, the imports are higher on residual value on year-over-year basis, but we're seeing improvements on all makes and models.

Mark Frissora

Yes, I guess one of the things that I think people, at least investors that I've seen, have missed is off lease volumes is -- we're in a down cycle, right? So right now, if you look at 2010, there were about 2.6 million vehicles. 2011, they're expecting to be only about 2.1 million, '12 they expect to be down to 1.6 million, '13 it goes down again to like about 1.5 million. So this trend, we got this trend of off lease volumes that's going to last through the end of '13 and this will bode well because it will release less cars into the used car market and create that type of situation. In fact, I mean, if you look at '11 to '12, it's the biggest drop that's been forecasted. So we expect residual values to hold in there. Due to that trend alone, let alone this tight supply situation that's going on because of the Japanese tsunami. So we're pretty bullish on the fact that through the end of the year, we'll have strong residuals. But second quarter is always the peak. So what we don't want people to do is straight line it because second quarter always is the highest. And I think that some people are trying to do that and straight line and you can't do that because this is a seasonal peak for us, it's a bubble.

Himanshu Patel - JP Morgan Chase & Co

And one last question. You guys have been putting out a few press releases on kind of a revamp of some of your car sharing efforts. I know it's a modest portion of the total business, but can you update us on kind of what you're doing here and sort of the timing of some future actions that you may be thinking of?

Mark Frissora

Yes, I mean, in car sharing, we're very committed to the market and we think it's an element of our overall strategy which is to deliver rental cars to anyone at any time whether they want to rent it for an hour, a day or a month. So our overall strategy is really to be really flexible and to be able to do that in the most economical and cost-effective way. So again people in and out of the cars faster. I mean, one of the things if you look at car sharing, there have been a lot of inconveniences in car sharing. And we're attacking those inconveniences. One of those inconveniences is you have a problem with the car, you can't talk to customer service right away. Well, you can do that with Hertz. Another one is that you couldn't rent one way rentals you had to return it to the same spot. Again, we saw that issue and we continue to expand that flexibility. Another one is not having enough places to pick up a car. Well, right now, we've announced 100. That's going to explode. It's going to be a lot more very quickly. In the next 60 days, we'll be announcing hundreds of more locations that you'll be able to actually pick up a car in New York City. We have not penetrated Boston. We're going after Boston next and that will happen very quickly. So that's a big market potential for us and we will exploit that market as fast as possible. So, again, in terms of our car sharing initiative, it's part of a broader overall theme of being more flexible and fast to make convenience a factor in car sharing like it hasn't been before.

Operator

Our next question comes the line of Chris Agnew from MKM Partners.

Christopher Agnew - MKM Partners LLC

Can I ask about Rent2Buy interesting opportunity to structurally lower fleet costs. What's the consumer reaction been? What do you plan to do to increase consumer awareness? And maybe on a per vehicle basis, what do you think the opportunity is for savings and how is that tracking versus your initial expectations?

Scott Sider

A couple of things on the Rent2Buy. First of all, the consumer reaction has been very, very positive. They like the idea that it's set pricing. That they could pick up the car basically at any of our Hertz location. So the convenience of it is excellent. They can do the paperwork from home. So everything is great on the customer service piece. We're making some significant changes to our website and those will be launched in early May which will make it easier for customers to book the vehicles, make it a better, smoother transaction. Once we do that, then we're going to do more advertising for Rent2Buy. But the increase in business has been substantial. We've been up year-over-year almost 70%, 80% and we think that will continue. Right now, we're in 30 states and by the end of the year we'll be in 37 states. But the 30 states we're in today represents probably 85% of our fleet. In terms of the economics, the economics are significantly better. I mean, it's a retail sale versus a wholesale sale. So the profit difference, you're looking at about $500 to $600 net profit difference. That's profit difference per vehicle, so it's substantial.

Operator

Our next question is from the line of Rich Kwas from Wells Fargo Securities.

Richard Kwas - Wells Fargo Securities, LLC

Mark, on the guidance here you upped the benefit from depreciation per unit. You upped the euro assumption here. Pricing was kept level in both segments. What would you consider to be -- what segment of the guidance would have the most potential for upside?

Mark Frissora

Pretty much everything.

Richard Kwas - Wells Fargo Securities, LLC

Okay.

Mark Frissora

I mean, I think there's a volume upside. I think there is maybe a little bit of upside in pricing depending on how tight the fleets get in the third quarter. We kind of anticipating some tightness here. And then, I certainly think cost reduction has some upside to it. So our biggest concern, frankly, is gasoline prices, are they going to impact the economy the GDP growth rate? We tied to that. So of all the things, that's what I look at as the things that would be the risk could now offset some of the positives we're seeing right now. As I said in my call, the economy cooperates and we continue to see some progress with the economy. GDP growth that people are anticipating will be in great shape, and there will be upside. My fear is that there's still a -- it's a fragile economy still here in the U.S. and in Europe. So we don't want to bake in the upside until we know it's there, little more visibility into the year. I mean, this is pretty early for us to come up with the guidance improvement like this. And so we just want to wait till we get more visibility in the third quarter.

Richard Kwas - Wells Fargo Securities, LLC

What's your GDP growth assumption, still 2%?

Mark Frissora

Yes.

Richard Kwas - Wells Fargo Securities, LLC

Okay.

Mark Frissora

Yes, that's exactly that.

Richard Kwas - Wells Fargo Securities, LLC

Okay. And then just on pricing since that has the most impact. It seems like you did say fleet is kind of loose here in RAC, but for the industry that probably gets tighter, right? So...

Mark Frissora

That's right. Let's just go over that seasonal, I didn't say loose. But it's seasonally usually loose because people are right now building for the increased demand that they see towards May and June. So it's always a little loose right at this period of time. We think it maybe a little looser because also people are also holding cars in anticipating of not getting some cars for summer delivery. So I think there may be some looseness that's contributory in that area.

Richard Kwas - Wells Fargo Securities, LLC

But incrementally, do you expect fleet to get tighter over the next few months?

Mark Frissora

Absolutely, yes. It's going to get, we think much tighter over the next 60 days, yes.

Richard Kwas - Wells Fargo Securities, LLC

Okay, great. And then on HERC pricing, I appreciate the comparison with your competitors. You still have 0 to 1 there. I know you kind of indicated there is potential upside. What do you -- of the segments, where are you seeing the most opportunity within HERC in terms of non-resi, aerial, industrial? Where do you have the most pricing opportunity there?

Mark Frissora

In all of them, aerial is probably pretty big. I think there's some upside there. And pretty much all segments. We're putting in some new pricing discipline ourselves in our organization. That should help us pull price. But as you said, one of our competitors became very apparent on how they do their pricing. We used the same methodology and we showed in the first quarter we actually pulled 2% price increase. So we use that same methodology, we compare pretty favorably. And again, we're turning now in the second quarter, we'll definitely be positive. So that's certainly an area of upside for us.

Richard Kwas - Wells Fargo Securities, LLC

Okay, great. All right, thanks. Thanks for the color.

Operator

Next we'll go to the line of John Healy from Northcoast Research.

John Healy - Northcoast Research

Mark, the call today seems like it isn't the most bold that you've been on holding cost in quite some time. I wanted to get your thoughts on where you think that per unit vehicle depreciation expense could maybe go over the next couple of years for the company factoring in all the different things you're doing with the disposal fleet as well?

Mark Frissora

Yes, I mean, that's a very difficult question to answer. I mean, it's going lower and we know it will go lower this year. We think there's a little bit of upside in what we gave you for this year. And again, it depends on the residual values. But we've also told people that it will go lower next year as well and we haven't really forecasted how much. And that's difficult to do until we finish our 2012 bonds. And we'll be finishing those over the next, I'll say, 3 months. In the U.S. and in Europe, you don't really finish them and until the end of the year beginning of the new year, so very difficult for me to give you a feel for that. But it's definitely going lower and it will be a driver of improved profitability throughout the end of next year.

John Healy - Northcoast Research

Okay, great. And then just one housekeeping question. The rental days on airport down about 1.8% for the Hertz legacy brand. Do you think that was reflective of the market or do you guys think maybe you outperformed or underperformed the market transaction days metric?

Mark Frissora

Weather, it was weather related and I think that was part of it. And we have a lot of -- a big piece of our business is business travel, right? And so you need to understand that we get hit on weather harder than our competitors oftentimes. They are more leisure than we are. So a business travel cancels fast and it gets impacted because of what happened with the FAA [Federal Aviation Administration] and the new penalties. I don’t think the penalties are like $35,000, $40,000 per passenger, $2.5 million a plane, anything over 3 hours on the tarmac. So, I mean, this caused unbelievable log jams and created a big drain on our volume. So that's I think why we may have had a bigger impact. And I'm not sure, I mean, I don't know what the competitors are going to show on weather. But we had a big impact from weather and it was definitely a big driver of that decline you saw.

Operator

Next, we'll go to the line of Fred Lowrance from Avondale Partners.

Fred Lowrance - Avondale Partners, LLC

Just a brief question kind of following up to the earlier ones we've gotten. Just on Equipment Rental, I know in recent weeks and recent months really you quoted some pretty bullish sounding numbers on, I assume, which is volume recovery in that Equipment Rental business. You sort of break it down by West Coast, Central U.S., East Coast. Just kind of wondering since you didn't change your volume assumptions for the Equipment Rental business, if you can give us a little color as to what the hesitation is there to take up volume assumptions or may be what it is that I'm not clear on about sort of the last 7 or 8 months of the year that might be holding back those volume growth numbers?

Mark Frissora

No, I think the big issue is that we are in a seasonally industrial ramp up period right now. So industrial as a market segment, this is the season for that to ramp up. So our increases year-over-year are more dramatic now than they will be as we go into the non-res construction season. So if you imagine our business, it kind of runs in cycles by industry code. So in the beginning of the year through the first, let's say, 4 months, you're looking at industrial and the way it ramps up. And so it's been very strong as you know. Industrial has been much stronger the non-res construction as an industry. So we've been showing and I've been talking about some numbers unfairly high. As we move into non-res construction season, which is a big piece of our business, the numbers aren't going to be as high because non-res construction is percolating at mid-single digit, low single digit, whereas industrial is percolating at double digit, high double digit, 20%, 30% improvement. So that's why we're a little bit more tepid. We're experiencing numbers that are fairly good right now but we expect them to come down due to the seasonality and due to the fact that non-res construction then starts to percolate. And we think it will percolate as high of increases as we saw in industrial. So, I mean, to give you a hand, West Coast was up 20% last week, Central was up 20%, East was up 10%. But having said that, that will come down as we move into the season for non-res construction because that's more of an industrial. Q4 is kind of when industrial starts to pick up again and moving into the first quarter. Non-res starts to pick up now and moves into the third quarter. So again, we're just expecting a little bit lower run rate as we move into a more non-res part of the business, still mid-teens in the U.S., though. U.S. is doing well. We've got this European piece which is not doing well right now. Europe is in fact flat to down, and Canada is up a little bit but not very much. But U.S. is still looking good and we still expect that to be kind of in the mid-teens. Okay?

Fred Lowrance - Avondale Partners, LLC

Yes. Thanks, Mark.

Operator

Next, we'll go to the line of Neil Portus from Goldman Sachs.

Neil Portus - Goldman Sachs Group Inc.

Mark, I may have missed this and I may just be asking the last question a little bit differently. But you raised your revenue guidance but your volume and pricing guidance for both Rental Car and HERC on Slide 37, they're unchanged. So what -- could you speak to what is driving the higher revenue guidance again?

Mark Frissora

Yes, mostly foreign exchange. We changed our assumption from -- to $1.30 and $1.35. So we went from $1.30 to $1.35, that's most of it. So pretty straightforward the way we did it. Again, that's why I've said that I'm hopeful that we got upside if we don't end up having gas prices go up but not to affect GDP we'll clearly have some upside on the revenue guidance that we did give.

Neil Portus - Goldman Sachs Group Inc.

Okay. Great. And is there a Manheim Index level or another benchmark that you use to forecast when you put together your depreciation guidance?

Mark Frissora

Typically, we don't use Manheim because they don't track the unique car class that we sell separately. It's usually a number that sometimes is more ambitious, sometimes less ambitious. Scott you want to help answer it?

Scott Sider

Normally we Yes, normally we don't use Manheim. We keep track. I think in the slide that we used from 2007, we used the residual value based on our history of how long we keep the cars. So Manheim doesn't track because of the age of the cars that we sell versus what the general public would sell.

Operator

Next we'll go to the line of Emily Shanks from Barclays Capital.

Michael Perez

It's actually Mike Perez on behalf of Emily. Thanks for taking my question. On HERC, regarding your current purchases, have there been any changes in availability in payment terms with the OEMs?

Mark Frissora

No, none.

Michael Perez

Okay. And then additionally on HERC, has the industrial business growth been mostly because of new customers or is it just existing customers driving organic volume growth?

Mark Frissora

Existing customers driving volume growth for the most part.

Michael Perez

Great. Do you have any sort of outlook as far as Rental Car is concerned on the availability of repair parts for the Japanese fleet?

Mark Frissora

Yes. I mean, we've checked that and we've had that question quite a bit and we really just don't see. We know what the parts are that are affected and it doesn't really get involved in a lot of repairs that we do. Scott, you want to again...

Scott Sider

Yes, that's exactly right, Mark. I mean, you got to realize the amount of parts that are being affected is a very small percentage. Now, small percentage will impact manufacturing, one part of that manufacturing. But for us the parts that are being affected, we don't anticipate it being any issue in terms of maintaining our fleet.

Operator

Next we'll go to the line of Michael Millman from Millman Research.

Michael Millman - Millman Research Associates

Could you tell us so whether you consider it or where you're going with potentially repot-ing converts, your converts? And also, are you seeing any effect from the use of mobiles on your ancillary revenues for GPSs?

Mark Frissora

Okay, so first question is we're studying converts and what we should do with that, right? I mean that's something that's an ongoing discussion. And we really haven't come to any final decisions on it.

Scott Sider

Right. But we're looking at it.

Mark Frissora

And then your question was on the GPS, the effect like PDAs, mobile devices?

Michael Millman - Millman Research Associates

Yes.

Mark Frissora

Yes, I mean, right now our NeverLost sales are up significantly this year, double digits. So while GDSs over -- I'm sorry, PDAs over time, we believe will have an impact, obviously a negative one. What we've been doing is trying to drive increased functionality of our NeverLost program by -- it's now a touch screen and now you can get flight information, you can do an economy trip. You get weather instantaneously in the area you're at. I mean, it has tremendous amount of functionality that we've been integrating in the new version that has been rolled out to all cars. In terms of handheld devices, we look at that as a positive for us as well for mobile check-in. And we can even -- we're starting to use those handheld devices. We'll be using those in the summer to automatically confirm that you have a car in slot A for Hertz, so you actually know about it. And then we're going to give you an option texted to you that will allow you to pick another car and upgrade if you want. Once you know what car you've been assigned as soon as you land. So we actually look at the usage of these devices as being able to improve our ancillary revenue as we start to get our systems so that they can actually communicate on a real time basis with our gold customers and anyone who signs up with us.

Michael Millman - Millman Research Associates

And could Lois talk about what is the next level for HERC?

Mark Frissora

Next level for HERC? Okay, lots of opportunity. Go ahead, Lois.

Lois Boyd

Yes, there's lots of opportunities there, Michael. So we're going to put in processes and disciplines around the areas, around our people, our fleet and our pricing and we think we can -- and working harder with our customers, et cetera. So there's 's opportunities in all fronts from what we can see around the HERC business. So we're excited to get that moving again, and moving upward. So the team's invigorated and it should be a good result coming from the business.

Mark Frissora

One thing I'll mention also, just want to add this. We had a question obviously from Himanshu about the car sharing. And one of the things I failed to mention was that in car sharing, we waived all fees. So you don't have to sign up as a member. It's free of charge and that's a big deal because in this industry that's been a $60 kind of item, $80 kind of item a year that people have to pay. And when you deal with Hertz Connect, you don't have to pay any fees, any membership fee. You can join for free.

Operator

Next we'll go to the line of Jordon Hymowitz from Philadelphia Financial.

Jordon Hymowitz

Mark and everybody, thank you for the excellent disclosure, first of all. Very quick question, on the Connect by Hertz. Can you give a sense of their revenues because when you look at ZIBS [ph] valuation, I want to kind of figure out, if you had applied the same evaluation, you're clearly discounting an awful lot of your rest of your earnings in your company at this point?

Mark Frissora

I mean, last year, I think we did $6 million which is small, as you know. But once we get this mainstream, that revenue growth will explode for us. And we're allowing returning each car that we have into a Connect car over time so that all of our cars will end up having Connect technology in them and that will allow us to turn the car either into a normal rental or into a Connect rental and you'll be able to do that with a flip of a switch. And we have 320,000 vehicles and our next biggest competitor or our biggest competitor on this has, I think, a number that's much smaller than that. So that will be a big opportunity for growth because we will be able to offer Connect in just about any city we operate. And we'll feature it that way, right? So whatever growth number you're seeing for 2010, which I think we put $6 million, that grew exponentially from nothing. We've only been doing this for 1.5 years. It will explode over the next 2 years, dramatically. And we'd love to get that multiple as we explode that growth. We'd love to get that multiple on just that piece of the business that's Connect.

Operator

Our final question will come from the line of Rich Kwas from Wells Fargo Securities.

Richard Kwas - Wells Fargo Securities, LLC

Just a quick follow up on the $15 million of lost revenues in the first quarter, what was the operating income impact, associated operating income impact? I don't know if you have that number.

Scott Sider

I'd say close to 80%. You have almost all the cost. So it's probably about 80% of that.

Mark Frissora

Yes. The answer to the question on the car sharing was this year we expect to do at least $16 million. So go from $6 million to $16 million this year. So I think that puts a better answer on their question. Operator, any other questions?

Operator

No, please continue.

Mark Frissora

Well, thanks, everyone. Thanks for joining us on the call this morning, and goodbye.

Operator

Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive. You may now disconnect.

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