Cendant Q4 2005 Earnings Conference Call Transcript (CD)

Cendant Q4 2005 Earnings Conference Call Transcript (CD)

February 14, 2006, 11:00 am EST

Executives:

Sam Levinson, SVP of Corporate and Investor Relations
Henry Silverman, Chairman and CEO
Ron Nelson, President and Chief Financial Officer
Hank Diamond, Group Vice President of Investor Relations

Operator:

At this time for opening remarks and introductions, I would now like to turn the call over to Mr. Sam Levinson, Senior Vice President of Corporate and Investor Relations.

Sam Levinson, Senior Vice President of Corporate and Investor Relations.

Thank you Phil. Good morning everyone and thank you all for joining us. On the call with me today are our Chairman and CEO Henry Silverman, our President and Chief Financial Officer, Ron nelson and our Group Vice president of Investor Relations, Hank Diamond. Before we discuss our results for the quarter I would like to remind everyone of four things. First, the rebroadcast, reproduction and retransmission of this conference call and web cast without the express written consent of Cendant Corporation are strictly prohibited.

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

Third, the company will be making statements about its future results and other forward looking statements during this call. Statements about future results made during the call constitute forward looking statements within the meaning of the private securities litigation reform act of 1995. These statements are based on current expectations and the current economic environment. Forward looking statements and projections are inherently subject to significant economic, competitive and other uncertainties and contingencies which are which are beyond the control of management. The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward looking statements.

Important assumptions and other important factors that could cause actual results to differ materially from those in the forward looking statements and projections are specified in the company’s form 10Q for the period ended September 30, 2005 and in our earnings release issued last night and filed on form 8K.

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

Before I turn the call over to our chairman, let me briefly review the headlines of yesterday’s press release.

Revenue for the 4th quarter increased 7% to $4.3 billion. The company reported Q4 earnings per share from continuing operations as adjusted for specified items, of $.23, which met our most recent projection. And we generated free cash flow of $445 million. For the full year 2005, revenue increased 9% to $18.2 billion. Earnings per share from continuing operations as adjusted for specified items, was $1.28 and free cash flow was $2 billion. Over the course of 2005, the company returned over $2.5 billion in value including over 70% of its free cash flow to its shareholders in the form of cash dividends, share repurchases and the PHH spin off. Now I’d like to turn the call over toe Cendant’s Chairman and CEO, Henry Silverman.

Henry Silverman, Chairman and CEO.

Thank you Sam. I will quickly update you on the status of our plan to separate Cendant into four publicly traded pure plays and our search for the new CEO of TDs. Then Ron will discuss our financial results and outlook.

With respect to the timing of the separation, the spin offs are proceeding exactly according to plan. We expect the audited financial statements for real estate and hospitality to be ready around the end of March and Mid-April respectively and to file form 10’s with the SEC soon after the audits are completed. I won’t attempt to handicap the SEC review process, but our best guess is that the first two spins, real estate and hospitality, will take place in June and July respectively and the spin of TVS in October when we cycle the five year tax requirement. As we have previously indicated, we expect to complete the financing for the vehicle rental company in April and to finance the other new companies over the subsequent 3 months so as to repay all of the Cendant corporate debt by the completion of the 2nd spin.

Regarding the search for the new CEO of TDS we have an active process. Ron and I have seen or will see a number of highly qualified candidates this month and I expect that we’ll zero in on 2-3 finalists next month.

So we’ve done a lot, we have much left to do and the coming months will be both challenging and 3exciting for Cendant as we complete the process of launching four new companies.

We are aware that we share your desire to complete the spin offs as quickly as practicable. Our management teams and employees are energized about the long term growth prospects for each of the spin-offs and the benefits we expect to accrue to shareholders of the four new companies. With that, I will turn the call over to Ron.

Ron Nelson, Group Vice president of Investor Relations

Thanks Henry. I’m going to spend just a few minutes talking about our fourth quarter results and then I’d like to talk a little bit about our 2006 outlook, particularly for real estate and car rentals since in a status quo scenario those two businesses would otherwise be pivotal in the direction of Cendant’s earnings in 2006.

I also plan to briefly update you on some of the progress we have made in addressing the challenges at TDS. And then finally, we know from hearing from a number of you this morning that there is some concern and/or confusion over the size of the impairment charge, relative to the guidance we gave in December. So we’ll plan on explaining the nuances of that calculation at the end of our comments just before the Q&A begins.

Let me start with travel content, where timeshare resorts was clearly the star performer this quarter with revenue increasing 15% and EBITDA increasing 32%. The timeshare industry has gained an enormous amount of visibility and momentum this year, with many of our competitors now showcasing the business as an important part of their growth strategy. We share the other industry participants’ enthusiasm as evidenced by our decision to enter the business 5 years ago through two strategic acquisitions. And we now have a leading position. We are positioned in the broadest part of the industry and somewhat differently than our competition. Our primary customer is a middle income earner with a family. This business produced three income streams. One, the profit on the initial sale, two the financing spread that the majority of our customers pay us and three the upgrade profit we harvest a we mine our customer base of over 750,000 members who are looking to go different places for longer periods of time.

As you know, we merged the management of our two businesses last year and it has proven to be the right change. At TrendWest, TourFlow, CloseRate and Pricing, were all up year over year, contributing to the strength of this year’s results. Given that this remains a relatively under penetrated industry with favorable demographics and a strong value proposition to consumers, we believe that timeshare continues to be a very strong long term growth opportunity.

Our lodging franchise and RCI timeshare exchange business has also continued to perform well. We expanded our franchising portfolio to include an upscale brand with the acquisition of Wyndham in the 4th quarter. We believe Wyndham is a strong brand with significant distribution opportunities. This will enable the reflagging of competitors and attract developer capital for Grove. The pool of capital available for upscale and luxury development is far larger than for economy, where most of our brands are currently positioned.

We’re also running what we have better. Excluding the addition of Wyndham and Ramada international, our lodging brands grew revpar by 11% this year, which as in the 3rd quarter, we believe will exceed the industry average for the economy segment.

RCI, our leading timeshare exchange business, generated another quarter of strong subscriber and transaction growth. The earnings impact of that growth was muted by the restructuring charge we took in the quarter to rationalize the overheads of RCI Europe, with our European vacation rental operation, which was merged into RCI in the second quarter of this year. This charge, which was the difference between the segment being up 16% and down a reported 4%, will begin to immediately add income in 2006.

Turning to vehicle rental, our 17% growth in car rental volume reflects increased airport share for both Avis and Budget. Domestically, commercial volumes were up 14% during the quarter while leisure volumes were up 19%. At the same time, we increased our fleet utilization, despite a 17% increase in fleet size. In general, while we did see strong volume gains and an improved pricing environment, these were not enough to completely offset the fleet related cost increases we bore in the 4th quarter.

There is no question that we have successfully restored the Budget brand to its roots as a value priced, leisure focused but business friendly company. But the real benefit we believe is in having 2 differentiated brands with which to target different pockets of demand for vehicle rentals.

We also continued to expand our local car rental presence. We entered the year having reached a total of 980 domestic off-airport locations, adding over 100 locations in 2005. We plan to add another 200 in 2006. We were just shy of $650 million of revenue from this business in 2005 and continue to believe that the local car rental business remains a good long term growth opportunity for our vehicle rental company.

On the pricing side, there have been three leisure price increases since June of ’05, in order to help offset the higher fleet costs. Generally, the price increases are rolling. On the corporate part of the business however, price increases are going to take longer to achieve as market conditions would suggest, and most car rental companies are waiting until contracts come up for renewal before raising prices. While this substantially accounts for the fact that overall prices were down modestly year over year during the quarter, we did experience positive year over year pricing in December. It was more important however, and I would advise you to focus on, is that overall pricing did increase sequentially from the 2nd quarter 2005 to the third quarter 2005 by 6 percentage points. And finally, from the 3rd quarter of 2005 to the fourth quarter of 2005 by another percentage point. While the increases from the 3rd quarter to the fourth did not seem like much, keep in mind that pricing typically declined seasonally from the third to fourth…

Henry Silverman.

This is Henry. Ron is suffering from a bit of flu, so I’m going to continue on in case you hear a different voice. So let me continue.

However as we cycle more of the costly 2006 model year cars into the fleet, the absence of meaningful corporate price increases will have an impact. As a result, we have modestly reduced our outlook for first quarter car rental pricing which will affect the first quarter EPS by about a penny or maybe two pennies per share. As we have said previously, it will be a challenge for this unit to generate the same level of EBITDA for full year 2006 as in full year 2005. We do believe, however, that price increases will ultimately begin to more than offset higher fleet costs, allowing for EBITDA growth in 2007 and beyond.

The fourth quarter residential real estate finally saw reality catch up with expectations. The decline in size that we have been talking about with you began to accelerate, particularly in the last month of the year. Price remains strong, rising 10-12% in our markets, but sides were down approximately 5%. The most affected regions were, not surprisingly, New England, California and Florida, where the most speculation has been reported. Together, these three regions were off on sides a composite of 19% at NRT. That said, the remainder of NRT’s market segments were up 4%, attesting to the value of the size and diversity of our portfolio and more importantly the local nature of the residential real estate business.

Looking into 2006 as we have told you throughout 2005, we continue to expect a soft landing for the real estate market in 2006, with roughly a slightly down market on a dollar volume basis. We expect to outperform the overall market by about 2 percentage points in sides, as a result of the annualization of franchise sales and NRT tuckins completed in 2005 plus additional activity in 2006. Remember, and this is very important to keep in mind, the metric we use to measure the market is GCI; gross commission income, since it is commission dollars that drive our revenues and profitability.

Based on this market outlook for the full year 2006, we expect our real estate businesses other than NRT in aggregate to grow revenue and EBITDA versus 2005. However, we do expect EBITDA in NRT to be down and as a result anticipate our total real estate segment’s revenue to grow but EBITDA to remain flat in 2006 vs. 2005. As you know, NRT is more concentrate in some of the regions on the East and West coast, that are now experiencing double digit declines in closed sides volume. The real estate market in most of the remainder of the country remains healthy, albeit moderating as expected and this accounts for why NRT’s results should be weaker than our larger or geographicly diverse franchise business.

To counter the impact of the slow down at NRT, we have put in place a cost reduction program which principally includes consolidating local offices in order right-size NRT’s cost structure to be in line with reduced volumes. We expect these cost-cutting efforts to positively impact results, beginning in the 2nd half of the year.

Looking at the first quarter, we do not expect our results in real estate to be reflective of the results we anticipate for the full year. Based on current trends, we now expect our first quarter EBITDA to be down 30-40% in real estate, year over year, reducing our first quarter EPS projection by about $.03-$.05. The percentage decline in this quarter is exaggerated significantly by the seasonality of the revenue stream. The first quarter is clearly the slowest quarter, at both NRT and our franchise operations. In fact, NRT traditionally loses money in the first quarter. However, we do anticipate a natural market adjustment that will see sellers bringing prices in line with lower demand, which we believe will allow our real estate results to improve in the back half of 2006. Which, when combined with the cost reduction efforts and seasonal increases in revenue, should result in positive comparisons in the third and fourth quarters.

Turning to travel distribution, both Orbitz and Gulliver’s are growing, are solidly profitable and we believe are performing well versus their competition. During the quarter, our domestic online gross bookings increased 21% on an organic basis.

Our America’s consumer packaging growth also continues to be strong, with gross bookings up 58% for the quarter and 72% for the year. In addition, we increased our domestic merchant hotel mix by 1,000 basis points to 64% during the 4th quarter. Gulliver ended the year with gross bookings up approximately 16% on a constant currency basis to almost $1.3 billion. And while earnings comparisons from ’04 to ’05 aren’t comparable because of the integration costs that we had to incur in 2005, earnings nevertheless increased by almost 25%. This is the asset, quite frankly, we were most enthusiastic about. Gulliver’s was clearly run quite successfully as a true entrepreneurial organization, with the former five principals making all the decisions. Management information systems were fairly rudimentary and yield management non-existent. This coming year, we will begin to introduce database management into the system so that we know what we have and when we have it and begin to overlay yield management techniques on the massive hotel inventory that Gulliver’s controls. Both will add to the 20%+ growth rate we are forecasting for gross bookings in 2006.

With the exception of the brokers, our previous reductions to projections were primarily the result of forecasted revenue synergies proving to be too high; it was not the result of poor performance by these businesses or a failed investment thesis. In fact, we believe both our domestic online business and Gulliver’s will be equated to EPS in 2006. We also continue to expect our overall TDS EBITDA to grow in 2006 vs. 2005 from about $525 million to around a low end of our most recent projection to $575-$625 million.

With respect to E-bookers, that business currently is not profitable and will not be for the balance of 2006 for a variety of reasons, most of which are fixable, although few in the short term. We’re very encouraged by the remediation plan put in place by Mitch Truitt since he took over responsibility for these businesses. First, a new management for the international online assets has been installed and has hit the ground running. Mike Nelson, who is one of the original members of the Orbitz team is running international markets and brings to the job a broad background in market supply relationships and finance. Second, as importantly, the new platform build is processing on time and on budget. This will ultimately automate many manual processes, improve site speed and stability and enhance the product offerings. And third, we are moving aggressively to rationalize the costs of these businesses. Cost savings will come in three primary areas: 1) shifting the business mix online. E-bookers still much web enabled offline businesses that is marginally profitable. We need to affect a shift and remove the associated costs. 2) We need to automate the platform business system processes, which the platform overhaul will accomplish and last, we need to rationalize our investment across Europe. We have to look at the skill of our individual operations and deploy resources to those markets where we have the best opportunity for growth. These actions should start to provide benefits in the back half of 2006, with substantial improvements in 2007.

Before we turn to our outlook for the 1st quarter of 2006, let us briefly comment on the highlights of our full year 2005 results.

For the full year, each of our core reportable segments generated revenue growth ranging from 9-36% and our total core segments revenue growth was 14% including organic revenue growth of 8% in excess of our stated target of 5-6%. In addition, each of our core segments was profitable and our total core segments EBITDA growth was 4% excluding the non-cash impairment charge at TDS. We generated over $2 billion of free cash flow, which exceeded our projections, primarily due to timing benefits. We returned over 70% of this cash to our share holders through $423 million in cash dividends and approximately $1.1 billion of share repurchases, net of option exercises. Together with the spin off of PHH, we returned over $2.5 billion in value to our shareholders.

While we are disappointed that the results of certain of our TDS businesses muted the company’s share price and performance in 2005, we are nonetheless encouraged that each of our businesses grew revenues organically and continue to generate substantial amounts of free cash flow. These attributes won’t go away in each of the four new companies and in fact, if our previous experience with PHH, Write Express and Jackson Hewitt is a guide, they will only improve. We expect that each of the four new companies will be well positioned for future growth and success.

Finally, a few additional words about our outlook.

Our first quarter outlook is described in detail in the press release, and I won’t repeat it here. In terms of our outlook for full year 2006, if Cendant had remained together, we would expect that our total core reportable segments would grow revenue in the high single digits and EBITDA in the low single digits, excluding separation costs and the fourth quarter impairment charge at TDS.

We are clearly in a cycle of reversion of the mean in real estate, but our long term growth objectives remain unchanged.

Last, we plan to hold our investor day on March 21, in New York City. At this investor day, we plan to have presentations by the senior leadership of the first two spin offs, real estate and hospitality. Richard Smith, Steve Holmes and their management teams will describe their businesses and give projections and other financial data for these new companies. We will also update you on the 2006 projections for the rest of Cendant and we then plan to hold a second investor day in late summer or early fall, at which time we’ll have presentations by the senior leadership of TDS and Vehicle Rental and will give projections and other financial details for those two companies.

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

Ron Nelson, Group Vice president of Investor Relations

Before we get started with the questions, let me see if I can tackle the impairment charge for you a little bit. I know you’re all scratching you head on the size of the charge, so let me take a minute to explain some of the nuances of how and why it got to be larger than we expected.

The interaction of FAZ 142 and FAZ 144 is complicated. The first step in the 142 analysis allows you to benefit from a portfolio effect, namely if some assets in a measurement group have a greater fair market value than carrying value, you can use the overages in one to offset shortfalls in another. However, if that first step analysis suggests that the combined value of all the assets in the group is less than their combined carrying value, in other words you fail step one of the test, then step 2 of the process requires analysis at a more detailed level. You have to measure each intangible asset in the measurement group on a stand alone basis to determine if there has been any impairment first in intangibles, then of good will for the group. In general, you lose the portfolio effect of all the assets in this step.

In prior years, TDS was one measurement group. Everything was bundled together for the purposes of measuring step one of the test and resulted in no impairment. This year, with the new acquisitions, we had to redefine the measurement groups and the online business globally became its own measurement group. So we had a combination of recently acquired high multiple assets, combined with recently acquired high multiple assets that underperformed. So as well as some of the businesses are doing, they did not produce enough excess value in step one to overcome the deficits presented by e-bookers and certain other online assets in the group. So now, we’ll move to questions and hopefully that helped explain a little bit why the impairment charge was larger than we thought.

Operator:

Thank you gentlemen. If any of our participants would like to ask a question of our presenters, you may ask that question by pressing the * key followed by “1