David Crowther - Vice President, Investor Relations
Ronald L. Nelson - Chairman and Chief Executive Officer
F. Robert Salerno - President and Chief Operating Officer
David B. Wyshner - Executive Vice President and Chief Financial Officer
Chris Agnew - Goldman Sachs
Jeffrey Kessler – Lehman Brothers
Christina Woo - Morgan Stanley
Avis Budget Group Inc. (CAR) Q4 2007 Earnings Call February 14, 2008 9:00 AM ET
Welcome to the Avis Budget Group fourth quarter earnings conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the conference over to Mr. David Crowther, Vice President of Investor Relations.
On the call with me today are our Chairman and Chief Executive Officer, Ron Nelson; our President and Chief Operating Officer, Bob Salerno; and our Executive Vice President and Chief Financial Officer, David Wyshner. If you did not receive a copy of our press release, it’s available on our website at www.AvisBudgetGroup.com.
Before we discuss our results for the quarter, I would like to remind everyone that the company will be making statements about its future results which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act.
Statements are based on current expectations in the current economic environment and are inherently subject to significant economic competitive and other uncertainties and contingencies beyond the control of management. You should be cautioned that these statements are not guarantees of future performance.
Actual results may differ materially from those 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 are specified in our 10-K and our earnings release issued last night.
Now I’d like to turn the call over to Avis Budget Group’s Chairman and Chief Executive Officer, Ron Nelson.
Ronald L. Nelson
We pre-announced our results about three weeks ago, given that they came in line with our guidance. I want to spend the first part of my comments explaining exactly why we pre-announced.
Over the course of the fourth quarter and in particular into early January, it became clear that investor anxiety over the issues that were driving industry valuations lower by the day was reaching an almost irrational fever pitch. To be sure, there were legitimate concerns.
Fourth quarter results, leisure pricing, and the used car market, all of which added to the longer festering concerns over the macroeconomic outlook in the ABS financing market. We tried to address each of these topics head-on in our release, with as much company specific factual data as we could.
One, the fourth quarter was in fact challenged, but with an intense focus on cost savings and the continued positive trending of major cost elements, quarter and full year results were in line with our previously announced expectations.
Two, our 2008 business plan calls for growth in revenues and earnings despite a weak economic climate.
Three, our disposition of risk vehicles in the fourth quarter was in line with historical norms, and finally while the ABS term debt market is out of sorts, we are finding more than enough capacity in the bank conduit market to meet our needs. In fact, we announced yesterday that we have commitments on an upside seasonal facility that will satisfy our peak financing requirements for the year.
We will provide more color on these issues as we go through the call today, but clearly we view these as reasonably good news in an environment where the market seemed to be assuming the worst.
To further underscore our conviction, our Board authorized a $50 million share repurchase. Not a lot in the world of multi-billion dollar announcements of late, but close to 5% of our outstanding stock at then prevailing market prices.
With that as a prelude, I do want to talk a little bit about the fourth quarter operating environment, shift to a brief review of our progress against our strategic initiatives in 2007, and then conclude with a discussion of reasons why we are optimistic about 2008.
To be clear, the fourth quarter was not by any measure a buoyant environment. We did achieve volume growth against the backdrop of a challenging leisure pricing environment and weaker than expected enplanements which were flat to down slightly year-over-year, though we did hit our guidance.
The tale of the tape was really on the expense line as we took advantage of every opportunity to cut costs and hold discretionary expenses in abeyance, which, by the way is what you would expect us to do in more difficult times. In looking back on the quarter, there really is the tale of two separate six weeks periods.
The first six weeks which are predominantly a business travel period saw decent demand and only moderately soft pricing on the leisure side. Certainly soft enough to catch our attention and start putting in place measures for a tougher than expected quarter. The last six weeks, which are much more impacted by leisure travel and are always a bit unpredictable, saw light demand, industry over-fleeting, and year-over-year price declines.
On top of that, we were uniquely challenged because of unusually tough pricing comp. We were up close to 7% in domestic pricing in the fourth quarter of last year. These trends did continue into much of January and Bob will give you a better picture of what that looks like and what it means for the quarter in a minute.
But there are reasons to believe that the mid-November to January period will be an anomaly. It may be an annually recurring anomaly, but we don’t think it signals any type of secular change in the business. As the industry moves towards a higher percentage of risk vehicles, its ability to down fleet for its seasonal trough is a bit more limited and as a consequence pricing will be impacted.
Corollary, however, is that you would expect pricing to improve sequentially as volumes pick up month-over-month. This is indeed what we are seeing. In fact, a significant price increase was implemented for February, and each of the four largest car rental companies have adopted it across all brands and all channels.
Our volume and price statistics, aided by a longer LOR, are currently painting a much different picture than we saw in January. There’s a certain amount of irony in that the fourth quarter was aided by our traditional mix of commercial and leisure business by the breadth of manufacturers that we buy fleet from.
These characteristics which hobbled our ability to move quickly to recover fleet cost increases in prior periods ultimately played an important role in allowing us to achieve our goals in a challenging quarter. David is going to comment more on the segment results shortly, but let me spend a minute on our strategic initiatives.
Beginning of the year there were three items that we laid out as key objectives for us, optimizing our two-brand strategy, expanding our revenue sources, and capturing incremental profit opportunities. We made significant progress in 2007 towards each of these, but like many things in a dynamic environment, we started the year with one set of initiatives underlying these objectives and expanded the list as the competitive landscape changed over the course of the year.
First in terms of expanding our revenue sources, our ancillary revenues grew more than 17% in 2007 led by improved customer recoveries and most notably our Where2 GPS unit which contributed $45 million. Where2 penetration increased month by month, was unaffected by the price increase that we put in over the summer, and finished the year with an overall take rate close to 8% with about 35,000 units deployed.
We exceeded even our aggressive targets for the year and we continue to see opportunity in this area, which I’ll come back to in a moment. Second initiative in this area is off-airport growth. We opened 195 new locations, moved onto insurance companies preferred suppliers lists, grew our revenue nearly 10%, and expanded our insurance replacement business by 25%.
In fairness, this was not as robust of a performance as we expected, but it was essentially our first year in the replacement business. Our ramp up was slower than we had expected, we learned a lot, and we exited the year with solid momentum.
Our plan to capture incremental profit began the year with a focus on improving revenue and margins in truck rental. As difficult as the market was, we accomplished a lot there as well. We expanded our local sales force, we revamped the fleet by adding lift gate trucks and cargo vans, and each of these allowed us to capture significantly more mid-week commercial business.
Our commercial truck business out performed the consumer side with gains in revenue and utilization. We also completed the integration of trucks’ back-office operations, added 17 corporate-owned locations, signed an exclusive agreement with Public Storage that will allow us to open some 200 counters at their outlets, and were added to the Federal government’s suppliers list for the first time.
As an aside, in the fourth quarter our corporate-owned stores had revenue growth of 9% year-over-year, a clear departure from the rest of the market.
Nevertheless, we continue to view turning truck around to be a longer-term proposition, but our work to-date is definitely beginning to bear fruit. Over the course of the year, we added two critical initiatives to our goal of capturing incremental profit. Both rapidly became a strategic imperative.
Our Performance Excellence process improvement initiative which we continue to forecast will reduce our annual operating cost by some $100 to $150 million over the next two to three years and our fleet and pricing optimization initiative which we believe can add in the range of $50 to $100 million during the same three-year period. We remain very excited about our progress on these critical initiatives and Bob will provide some more details about this in a minute.
Putting 2007 and the longer term initiatives aside, most everyone is focused on the tough economic environment that is either in front of us or upon us depending on who you speak to, so I want to focus the rest of my comments this morning on some of the many reasons, 17 to be exact, why we are encouraged by our prospects for 2008.
Number one is our Performance Excellence initiative. We expect that our cost saving efforts will contribute at least $40 million to pretax income this year and that our run rate as we emerge from year-end will be significantly higher than that amount.
Two, Where2 revenues, while we exited 2007 with a take rate close to 8%, our average take rate for the first half of 2007 was only 4.5%. As a result, simply maintaining our current take rate with today’s unit count in 2008 will yield incremental revenue of over $20 million as we lap the startup month, and we believe we can increase the take rate into the double digits as more renters become familiar with the productivity and convenience of the device and as we add new features in the next generation product.
Three, other ancillary revenue growth, in addition to Where2, we’re focused on increasing our sales of insurance products, fuel service options, electronic toll collection, and counter up-sells. All of these are high margin revenue streams that have the potential to add a lot of income, very little incremental revenue.
Over the course of the past year, we have provided professional sales training to over 2,000 of our customer service agents across both brands. Training is starting to build dividends. Customer up-sells were up 15% in 2007, the fuel and insurance penetration, which has been stagnant for the past three years is on the rise. We have also put in place incentive plans to drive and reward sales performance at local management levels.
Four, operating cost reductions, besides our Performance Excellence work, which is focused primarily on process and efficiency, we always look for cost saving opportunities whether through technology or supplier competition. By way of example, we are changing the IT network infrastructure that we use for our local market locations.
Using essentially off-the-shelf technology, once fully rolled out, we should reduce our network operating costs by $5 to $10 million on an annualized basis.
Five, the stability that comes with our commercial account base, we’re continuing to achieve price increases in our commercial business and the increases we achieved in 2007 will benefit 2008 as well. While those increases clearly lagged leisure pricing through a period of substantial fleet cost increases, it did make the difference in the fourth quarter and are expected to continue to do so in 2008.
Six, time and mileage rates per day, we are encouraged by the price increase instituted in January and the higher than usual market acceptance across all companies and brands. While we have built our business plan assuming very modest increases over the course of the year, the potential always exists in a more rational world to over-deliver.
Seven, new marketing partners, as we head into 2008 we will continue to see growth in our affinity relationships. We have added partnerships with Wyndham, Hilton, Choice, RCI, Northeast Airlines, MasterCard, and several others to our stable of existing relationships with AARP, American Express, Delta Airlines, and Sears. These relationships add a captive source of quality demand and represent a win-win-win opportunity for customer affinity partner and company alike.
Eight, the insurance replacement market, we grew our IR business over 30% in the fourth quarter and 25% for the full year 2007 and we continue to see strong growth opportunities as we enter 2008 on many insurance company approved partner lists. As of year-end, we are on insurance companies’ approved lists representing nearly 80% of the insurance replacement market revenue.
Nine, our investment in Carey, this relationship will allow us to provide commercial accounts with the widest range and the highest quality of ground transportation services in our industry and also presents some interesting package opportunities on the retail side of our business. Many of our largest corporate accounts have inquired about the ability to ingrate car rental and limousine service, and we see enormous value in our cross selling with Carey and expect our investment to pay off handsomely.
Ten, risk vehicles, as we noted last quarter, we are increasing the risk portion of our fleet from about 20% in model year 2007 to about 50% in model year 2008. We are the only car rental company that has the opportunity to increase our percentage of lower cost risk vehicles by 150%, driving incremental year-over-year benefits and still maintain much of the fleet flexibility and selectiveness that comes with having a substantial amount of program cars.
Eleven, fleet optimization, we have begun the implementation of what has become the industry standard fleet optimization software. This package will be a key component to managing and optimizing our fleet and should be fully operational by the third quarter. We are expecting significant savings in 2008 and 8-figure savings in 2009 as the system is fully implemented.
Twelve, used car market dynamics, while the used car market generally has seen some pressure in the last few months, the undeniable fact is that the industry is extending hold periods and the consequence is that there are simply fewer cars to be sold in the one-year-old market segment.
This supply decline should alleviate pricing weakness brought on by economic softness. Moreover, because we have diversified our fleet mix over the last few years, we’re less prone to a single manufacturer problem as may have been seen with Chrysler this past quarter.
Thirteen is interest rates. While we hedge a large portion of our interest rate exposure, the recent declines in LIBOR trough rates will lower the cost of our seasonal borrowing and should also offset the higher spreads when we tap the term debt market.
Fourteen is share repurchase. In light of the sharp decline in our stock within the last few months, the vastly oversold levels in our humble opinion, we believe that deploying some of our free cash flow to reduce outstanding shares at these levels is a very sound and smart investment. Since the Board authorized our share repurchase plan, we’ve purchased over 1.4 million shares at an average price of $11.88.
Fifteen is free cash flow. Our free cash flow generation remains strong, giving us the flexibility for capital deployment and returning value to shareholders. Our share repurchase is an effective dividend to our existing holders, and our Board will continue to evaluate opportunities to balance that distribution of value between better borrowing costs through debt reduction and share repurchase dividends.
Sixteen, our employees, in 2007 we had over 2,200 employees celebrate anniversaries with us of more than 20 years, which is just one measure of the extraordinary spirit and loyalty our employees bring to our locations each day. Our senior operating management, starting with Bob and extending to each of our international territories and our five operating regions, some 12 to 13 people have on average 32 years of experience in the car rental industry. There is very little they haven’t experienced in their car rental careers and it gives us a tremendous advantage in uncertain times.
And seventeen and finally, our brands and our customers, Avis and Budget brands give us not only the leading share at airports in the United States but elsewhere around the globe. The marketing agreement between Avis Europe and ourselves allows us to market seamlessly to our respective global customers both in business and leisure despite the difference in ownership.
They each mirror the Avis and Budget brands in terms of territorial reach which allows us to attract and serve value-conscious and premium service seeking customers around the globe. We retained more than 98% of our large commercial accounts last year, which speaks volume about our company.
So in summary, we have many reasons to be excited about the foundation we laid in 2007 for growth in 2008. As you consider this list, the key element that I would like you to remember is that almost all of the items on this list we control. That means we can execute against them regardless of the macroeconomic environment.
With that, let me turn the call over to Bob.
F. Robert Salerno
We’re going to spend my time discussing some topics that clearly are important to achieving our plan in ‘08 and not coincidentally are also the topics that are foremost on your mind, those being fleet costs, used car market, our Performance Excellence process improvement initiative and the first quarter environment.
In the area of fleet costs, we are continuing to forecast a 4% to 6% per unit fleet cost increase for 2008. We should be clear about what is included in that number. For us, this is our all-in cost, which includes not only depreciation but incentives, gain and loss on disposals, auction fees and other disposition costs.
If you are comparing one company to the next, this is an important clarifying issue. If we just look at just depreciation alone for model year 2008, our per-unit cost will be flat year-over-year which we believe is in line or favorable to what the rest of the industry has disclosed.
Turning to the used car market, as we disclosed last month, our experience in the fourth quarter was as we expected and in line with historical performance. Risk vehicle disposition averaged 76% to 78% of cap costs, consistent with what we typically see. I would note that as we hold cars longer, this percentage will decline slightly just due to simple math.
Again, the devil is in the detail. As Ron mentioned and as noted by Adesa in their recent report, the supply of one-year-old cars entering the market is declining. This is the exact opposite of what happened in ‘01 to ‘03 timeframe which makes that event-driven economic downturn in which the used car market declined a poor proxy for the current situation.
In addition, there is a natural tendency in difficult times to over read car rental risks into the published Manheim consulting indexes. As Manheim points out in their January brief, and I quote, “We caution readers on over-interpreting the trends. The changes in the index are often driven by shifts in mix, mileage, and condition of the vehicles sold.”
What does this mean? It means that the index on the surface will not necessarily be a good indication of how our risk cars are faring upon disposition. You must remember that one-year-old cars, which is what we’re selling, are a very small piece, we believe only 6% of the overall used car market.
Clearly the reduction in supply of one-year-old used vehicles is a favorable development and the dynamics of the general market and the dynamics of the one-year-old market are not always in lock step. Furthermore, we select cars to purchase on a risk basis in a way that limits the residual risk we take.
In general, we avoid as risk cars vehicles which have higher residual volatility, new models, SUVs, pickup trucks and larger luxury units. In general, the profile of what we buy at risk includes established middle of the road models, four and six cylinder vehicles and high residual experience brands by which we primarily mean Asian OEMs. From time to time a model will stand out with exceptional residuals and we will convert a program car to a risk car to take advantage of that gain.
In the fourth quarter, we did see Chrysler vehicles under perform the other domestic manufacturers and the market as a whole. But with Chrysler risk vehicles representing only about 6% of our fleet, the impact on us was negligible and was offset by other vehicles because of the manufacturer diversity we have.
Declining used car prices is the sort of thing that we consider from a contingency planning perspective. In such a situation, we would hold cars longer and the longer a car is held the cheaper it becomes for us. We would also try to take advantage of the mix of models that we have. As you have probably noticed, different car segments behave differently and even within segments not all cars are equal. The optimization of our fleet plans would allow us to further mitigate the effects of a weaker market.
Finally we can shift cars to the off-airport market where mileage accretion is lower than the airport for even longer hold periods. The art of fleet planning is maintaining flexibility to be able to react and take advantage of market conditions either on the demand side or in the remarketing arena.
Turning to our Performance Excellence process improvement initiative which we call PEX, we launched this program in August and are already seeing significant benefits. We took high-potential managers from throughout the organization, gave them specialized training and asked them to re-examine operational processes to make sure we are executing in the most effective manner, and then standardize and replicate these changes across the system.
Since our August launch, we have had this initial team of people focusing on identifying opportunities across the company and implementing process change. We have already proven our original thesis, that process improvement tools could help us achieve significant savings at a given location.
The first group of people have identified and tested over 20 projects that we feel could be rolled out across our operation. These initial tests have allowed us to begin the year at a run rate of $8 million of annualized savings. This $8 million is only the initial savings as it is prior to replicating the changes in other locations. With replication, we expect that the savings this year will total $40 million, and that the run rate will be much higher as we exit ‘08 and go into ‘09.
We have now doubled the size of our PEX team to focus on replicating these re-engineered processes at the hundred largest airports in the U.S., which represent about 70% of our domestic revenues. These new people are in addition to those who are continuing to look for further process opportunities that we know are there.
Let me give you a few examples. We re-engineered how we assign cars to be moved from one location to another. We did this originally in Cincinnati and Detroit, and achieved sustainable savings of $154,000, in and of itself, not that much. However, we will now be replicating this process across our other locations and feel confident this will give us additional annual savings of $3.6 million this year.
We are standardizing the check-in process which should improve gas collections, damage identification, lost keys and so forth. Annual savings at O’Hare where we first put this in is over $300,000 and after replicating it across our system we believe that the savings will be in excess of $5 million.
We have performed three different projects surrounding shuttling at three different airports, Philadelphia, Orlando, and San Francisco. Each was slightly different and the savings at each averaged over $200,000. This is an area we are very focused on and see tremendous opportunity going forward. Replicating these projects should produce an additional $5 to $6 million in annualized savings.
We’re reducing the down time of our buses and optimizing the schedules at which the buses run. At LAX annualized savings of over $500,000 was achieved and while this project only applies to locations where we operate our own buses, we believe that replication across this system here is worth an additional $1.5 to $2 million in annualized savings.
Our turn back is another area for process improvement. One is just the time it takes to turn the car back. The second is optimizing which car is turned back. We have annualized savings from this project of over $750,000 from Dallas and Miami. After replication, we believe this project will save an additional $5 million across the system annually.
This is just a sample of the processes we are improving. As you can see, the multiplying effect of replication can be very powerful. Our focus is on ensuring that we have the skills and resources to take full advantage of the opportunity the replication represents.
Turning to the first quarter operating environment, we have about half the quarter in the books and thus far it has been playing out as we expected. The weaker leisure pricing continued through most of January, but then late in the month the pricing on our forward reservation build for February and March began to improve substantially from the January levels.
This was due to the rate increase that Ron mentioned earlier which was matched by everyone in the industry to a greater extent than we have seen in a couple of years. Currently our reservation build for February is positive year-over-year for both price and volume.
And we had positive rental-day growth in January despite what we think was a weak month for enplanements. So in short we are seeing decent demand, and pricing has been improving. For the full quarter, however, you should expect increased volume but weak pricing comparisons to last year mostly due to the comps.
With that, let me turn it over to David.
David B. Wyshner
This morning I would like to discuss our recent results, our ABS financing strategy, and our outlook. All the EBITDA and pretax numbers I discuss will be excluding the impact of separation-related and impairment costs. Our earnings release last night provides the relevant reconciliations to our GAAP results.
In the fourth quarter, revenue increased 4% to $1.4 billion, EBITDA was $86 million and pretax income was $36 million. EBITDA declined slightly from the pro forma $88 million we reported in fourth quarter 2006 and pretax income was equal to the prior year.
For the full year, revenue grew 5% to a record $6 billion. EBITDA of $409 million was in line with both our recent projections and our year earlier results. And importantly, pretax income of $198 million was up 15% versus pro forma 2006.
Turning to our domestic car rental operations, fourth quarter revenue increased 4%, reflecting a 3% increase in rental days, a 2% decrease in time and mileage revenue per day, and a 22% increase in ancillary revenues.
Domestic EBITDA declined slightly for the quarter as the revenue growth and cost savings were offset by lower time and mileage rates per day and increased fleet costs. Time and mileage rates declined 2% as commercial price increases were offset by weaker leisure prices due to industry-wide over-fleeting, which we believe reflects the seasonal dynamics that Ron discussed.
Our length of rental increased 2%, which also contributed to the reported price declines as longer rentals have a lower per day rate.
Our fleet size decreased by 16% from the third quarter to the fourth, and was up 3% year-over-year, in line with our volume increase. Fleet costs increased only 4% on a per unit basis as our risk cars continued to perform well and as you will see in our annual report, we recorded $10 million of savings on certain program cars that were held in excess of one year in order to reflect the terms of the repurchase agreements.
Our direct operating expenses declined by 140 basis points year-over-year as we continue to focus on cost reduction strategies. Key areas of expense reduction were maintenance and damage expenses, down 1% on a per day basis; license and registration costs, down 7% per car; employee cost per transaction, down 2% due to improved productivity; and self insurance expenses, down $15 million as our experience continues to develop favorably.
We benefited from favorable insurance trends on a somewhat delayed basis as our experience feeds into time weighted actuarial models used to determine our accrual rates and reserve balances. Our full year 2007 self-insurance costs on a per day basis were similar to 2006 overall, although there were some timing differences by quarter.
While our gasoline hedges had no effect on the quarter’s results, we were negatively impacted by $6 million by the mark-to-market requirements on our freestanding interest rate derivatives. These are hedges that reduce our economic exposure to interest rates but do not qualify for hedge accounting treatment.
A couple of notes on the full year, our domestic EBITDA increased 11% to $270 million, driven by 4% volume growth and a 17% increase in ancillary revenue, offset to an extent by fleet costs which increased 6% on a per unit basis.
Turning to international car rental operations, revenue increased 20% in Q4, driven by a 3% increase in rental days, a 14% increase in time and mileage rates per day which was all due to foreign exchange, and increased ancillary revenues.
EBITDA increased 40%, driven by moderating fleet costs which were flat year-over-year on a per unit basis excluding the impact of exchange rates; lower maintenance and damage expenses, which are down 7% on a per day basis; and significantly reduced self-insurance costs.
For the full year, international revenue increased 15%, driven by a 3% increase in rental days; a 10% increase in time and mileage rates per day, which was 2% excluding foreign exchange impacts; and a 26% increase in ancillary revenues. EBITDA increased 18% versus full year 2006, a figure which was reduced by foreign exchange earnings hedges we put in place in early 2007, meaning that we will see some benefits of 2007 exchange rate movements in 2008.
And finally our truck rental segment, revenue declined 11% in the quarter due to a 16% decline in time and mileage revenue per day, offset by a 2% increase in rental days, lower fleet costs, and increased utilization. The decline in T&M per day reflected lower pricing across all channels magnified by a decline in the proportion of one-way rentals which typically carry the highest daily rates. We believe the volume decline reflects continued softness in consumer demand due to the decline in housing activity.
Our focus on midweek commercial business is progressing well. In the quarter, commercial revenue increased 12% year-over-year and we increased utilization over 200 basis points while we expanded the commercial fleet. Lower fleet costs reflect updates made to depreciation rates based on better residual values on the trucks and longer expected hold periods.
Our experience with trucks that we purchased subsequent to our acquisition of Budget in late 2002 is turning out to be better than we had previously estimated which benefited our results in the fourth quarter and will also result in significant cost savings in future periods.
So let’s be clear about the substance of our 2007 results. Our car rental operations, which comprise over 92% of our revenue and 95% of our EBITDA, grew revenue by 8% and increased EBITDA by 15% year-over-year.
In total, looking at 2007, we had EBITDA of $409 million, depreciation and amortization of $84 million, net corporate interest expense of $128 million, and pretax income of $197 million, all in line with our previous projections.
On the tax line, our full year tax rate excluding unusual items was about 42%. In 2008, we project our GAAP tax rate to be approximately 40% and our cash tax rate will be substantially lower as we’re not a meaningful Federal cash taxpayer but do pay some state and international cash taxes.
Separation related items had very little impact on our bottom line in 2007 and are not expected to be significant going forward. At year-end, our diluted share count was approximately 104 million.
We continue to invest in our brands and our infrastructure. Capital spending totaled $24 million in the fourth quarter primarily for rental site renovations and information technology assets bringing our full year CapEx to $94 million.
Our reported free cash flow for the year was $89 million which includes separation related outflows of $39 million. Excluding these separation related items, which primarily reflect the payment for items that were expensed at the time of separation, our free cash flow was $128 million. This is equal to about 70% of our pretax income and over 100% of our net income.
As a result, based on yesterday’s closing price, our after-tax free cash flow yield is 11%. To break our 2007 cash flow into components, we paid $13 million in state and international cash taxes, and our capital spending was a bit more than our D&A expense, both of which were items we expected.
What caused free cash flow not to be 85% or more of pretax income in 2007 was that working capital rather than being a slight positive to help offset cash taxes and the difference between CapEx and depreciation was a negative primarily due to differences between when we record expenses and incur cash outlays.
We continue to believe that over time our free cash flow should approach our pretax income. In 2008, we expect to pay cash taxes of $20 to $25 million, and our capital spending will be greater than our depreciation expense. We will pursue opportunities in working capital management and the structure of our vehicle programs with the goal of having free cash flow exceed 85% of pretax income.
With respect to taxes, we do not expect to be a regular Federal cash taxpayer for several years, but we could become a partial cash taxpayer in 2010 or 2011 under the AMT.
As we previously announced, given the market value of our stock at year-end versus our book value per share, we were required to record a goodwill write-down of approximately $1.2 billion which is roughly equivalent to the difference between our equity book value and our equity market value at year-end. I should reiterate that despite this accounting requirement, our projections continue to call for revenue growth, margin expansion, and increased earnings over time.
Turning to our ABS financing, peak fleet financing requirements in 2008 should be fully satisfied through the facilities we have in place and the $800 million seasonal facility which we are on track to close by the end of this month. In fact, our financing needs throughout 2008 and 2009 should be almost completely satisfied by the combination of existing debt and the renewal of annually maturing facilities since we have only around $400 million of term debt coming due in 2009.
We may opportunistically seek to issue intermediate term asset backed debt in 2008 if market conditions improve, but we’re happy that venturing into the debt markets is an option, not a necessity for us this year.
We also continue to have no borrowings under our $1.5 billion corporate revolving credit facility. The recent Federal Reserve interest rate cuts will reduce the interest on our seasonal borrowings so that even with higher spreads, the cost could actually be lower than what we anticipated back in August.
Turning to our outlook, our 2008 business plan assumes a modest economic environment with no major travel interruptions and positive domestic enplanement growth for the year. We expect that our on-airport rental day growth will approximate enplanement growth, and we expect off-airport volumes to continue to grow rapidly, bringing our overall increase in domestic car rental days to 3% to 5% year-over-year.
Our domestic price assumptions call for a modest increase in daily time and mileage rates. While leisure pricing has been challenging, we have achieved price increases on commercial account renewals in 2007 and thus far in 2008 that will benefit us throughout the year. At the same time, our growth off-airport where length of rental is longer but daily rate is typically lower will drag the average price down a bit.
On the ancillary revenue front, our Where2 GPS product roll out has been completed with take rates ending the year around 8%, roughly three times the take rate at the beginning of the year. Where2 generated more than $45 million of revenues and $35 million of pretax income in 2007. 2008 results should at a minimum benefit from a full year of operating at current take rates as Ron said with efforts under way to continue to increase penetration.
We’re also focused on growing other high margin ancillary revenue streams such as from electronic toll collection, gas, and insurance products. We also expect growth in our international and truck rental segments. In truck rental in particular, we expect increased commercial rentals, our relationship with Public Storage, lower fleet costs, and the actions we have been taking throughout 2007 will all provide benefits, so that truck rental EBITDA will improve in 2008.
Based on these assumptions, we expect to grow our revenues, EBITDA and pretax income in 2008 despite a softer macroeconomic environment in the first half of the year.
While we are not going to provide specific projections at this time similar to our approach in 2007, we will help you with your models by confirming that the sensitivities of our pretax income to changes in volume, pricing, or utilization remain consistent with our previous estimates. As we look at these dynamics and our 2007 results on a quarterly basis, we expect a particularly tough comparison in the first quarter with stronger growth in the middle quarters.
Our first quarter results are expected to be down year-over-year due to the combination of weak enplanements and weak pricing in January magnified by the mark-to-market impact of recent interest rate cuts on certain of our hedges. We expect our results in the remainder of the year to be up compared to 2007 and that we will again generate more than 40% of our full year EBITDA in the third quarter.
More importantly, we believe that our leading market positions, fleet management strategies, and process improvement work will allow us to grow our revenues and earnings in 2008. As a management team, we share the positive views that Ron enumerated with respect to our outlook, and we are eager to take advantage of the many growth opportunities we are identifying.
With that, Ron, Bob, and I would be pleased to take your questions.
(Operator Instructions) The first question comes from Chris Agnew - Goldman Sachs.
Chris Agnew - Goldman Sachs
Off-airport business, you’re seeing good growth particularly in insurance replacement. What gives you confidence you can continue to grow in 2008? What is the reaction from Enterprise, obviously the dominant player there in terms of are they reacting in terms of price?
The truth of the matter is this is our first year in the business. We’re a relatively small factor in the business and I think we can continue to grow with big percentages for a fairly long time before we even become a significant digit in terms of Enterprise’s control over that market.
We have not seen any real impact from Enterprise in terms of either pricing or competitive moves. Frankly from a strategic standpoint, we’re not going after the Allstates or the huge insurance companies, which are their bread and butter accounts. We’re actually going for the middle ones where we can refine our service delivery process and then move over to assume some of the other businesses.
We’re clearly not primary on these accounts. There are two other suppliers. And so happiness in some respects is a small base in this business, so I think we can continue to grow pretty nicely on a percentage basis without creating any competitive problems.
Chris Agnew - Goldman Sachs
And then next question is on the fleet costs, and maybe just a bit of clarification from a couple comments that Bob made. I think you said that you’re expecting 4% to 6% in 2008, but did I hear you mention that if you just look at the depreciation cost, it’s flat on a year-over-year basis? Maybe could you expand a little bit more on that?
I had been thinking that because you’re making the move and increasing your risk cars from 20% to 50% and those are cheaper that actually you would be able to manage your overall fleet cost increases down below the 4% to 6%, so maybe if you wouldn’t mind providing a little bit more color around those points?
F. Robert Salerno
The difference is that on the 4% to 6%, this includes our turn-back costs, what we’re getting for incentives, what it costs to ship it there, the cost of the auction fees, and all of those other things, whereas the flat was just strictly our depreciation. So strict depreciation, the deal we cut with the manufacturers is effectively flat year-to-year. That’s the difference.
Chris Agnew - Goldman Sachs
And that flat number, does that also on a per unit basis, is that also taking into account the effect of increasing your risk mix, holding cars longer?
F. Robert Salerno
Certainly, that’s true.
Your next question comes from Jeffrey Kessler - Lehman Brothers.
Jeffrey Kessler - Lehman Brothers
Firstly separation costs, they were about $10 million in 2007, obviously down. Do you expect them to go away completely? Are we done with separation costs for 2008?
By and large, we are. Certainly from a substantive perspective, there shouldn’t be anything. There is a possibility if there are tax items that they would show up as separation costs. But in that case, the reimbursement of any tax items in prior periods by Realogy and Wyndham could show up as an inflow from our perspective. But other than that, we don’t expect anything, and if there is anything significant, we’ll obviously break it out because we don’t view it as a regular part of our business.
Jeffrey Kessler - Lehman Brothers
On two of your what we’ll call other ancillary revenue areas. Number one, clearly there is a take rate limit that you can get to with a number of these products, and I realize we’re not just talking about take rates on Where2. We’re talking about obviously increasing take rates on other products that you have. What do you think over the next two or three years you can get the ancillary revenues number up to?
Number two, along with that, you’re going to be hopefully adding in more of Carey to your business. Carey has from what we have seen, at least from any of the disclosures we have seen, higher EBITDA margins than Avis does as a whole. Is Carey going to be a material contributor to earnings in 2009?
On the ancillary revenue question, anecdotally we have heard that Hertz NeverLost has had a penetration rate in the low to mid teens. And we certainly think that we ought to be able to achieve that, particularly now as we have the ability to include NeverLost in the profile of our corporate customers. Though up until the fourth quarter, they essentially had to come to the counter to ask for it. That really inhibits the ability to ramp up the segment.
I think the other thing that will drive the life cycle on that product is the new features that we’re going to continue to add every year. We haven’t really released that yet in concert with Garmin, but there’s going to be an upgrade in features in that Garmin will add yet again another benefit that will increase the productivity of the business traveler and will make this product even more attractive.
I think on insurance and fuel service penetration, clearly the things we’re doing on PEX are going to help the gas revenue and the fuel service revenues. I think insurance, you’ve got to be careful with percentages because in a number of our corporate accounts, insurance is included, so penetration of that base isn’t going to be quite as robust as it would otherwise be if we were pure leisure where we have the ability to solicit 100% of our customers.
That being said, we do think that there is a couple, three points out there that we’re not getting in terms of penetration and we think we can get that over the next couple years. So without really providing any numbers, I think that you can take those percentages and back into the numbers.
In terms of Carey, I think we said in our press release when we acquired it that we fully expect to be able to double the revenue of Carey over the next five years, and that is primarily based on increasing the penetration of corporate accounts.
But they also have a really terrific events business. Matter of fact, they probably do a better job in the event business than we do, and with every event not only is there a limousine business, but there’s also a fair amount of car rental business. So the packaging opportunities here just don’t begin and end with the corporate customers.
So you’re right, Carey’s margins are higher than car rental margins. We don’t see any reason now why those margins ought to decline. Even if we do negotiate harder or negotiate corporate rates, there are also cost efficiencies that we can take out of Carey that will offset any margin that we might belay in terms of bundling these things.
So we’re very optimistic about the ability to add to earnings. Is it going to add 30% to our pretax? No. But it’s enough to make a difference.
Jeffrey Kessler - Lehman Brothers
The horizon of new tax programs, obviously from time to time, we get accelerated depreciation tax programs. We get like kind exchange programs, obviously the basis increases on the like kind exchange program to a point at which you’re going to get limited tax relief by around 2011 or so.
If you got a telescopic view on what types of perhaps tax or let’s say capital formation types of programs that you see related to auto rental or others that you might be able to take advantage of that you think Congress might be taking a look at?
The way you’re looking at it is exactly right, Jeff, in that with us not being a Federal cash taxpayer right now or for the next several years, the near term impact on us of any of the things being considered would be fairly limited.
Bonus depreciation though could be helpful to us under the like kind exchange program, and we are looking at that, but the benefits associated with that would really be pushing out further when we become a Federal cash taxpayer. And that’s an awfully intricate and complicated transaction. So we’re working through that right now as more information comes out of Washington, but the impact on 2008 and even 2009 or ‘10 would be pretty limited because of our already attractive tax position.
Jeffrey Kessler - Lehman Brothers
You have been through several recessions already. What is Avis doing specifically, and you’ve gone through some of the programs obviously, but in a general sense, is there anything that you’re doing differently in a downturn now that you have learned or hadn’t done before in the last couple recessions?
F. Robert Salerno
I don’t think there is anything dynamically different, Jeff. I’d just say these couple things. One, that a large portion of our cost structure is variable, about 70%. So if you don’t rent the car, there is a whole series of commissions, concessions, credit card fees, etc., reservation costs that don’t show up.
Two, our largest expense is to a very great extent variable, and that’s the fleet. Though as we look at our forward-looking reservations, we’re weekly watching the fleet, fleet by fleet by fleet, how much we buy, what we do. I will tell you fleet right now across the industry is very tight, and my bet is that that’s going to be the same across the summer.
So we’re look at holding onto some cars which will allow us the opportunity if things go awry economically to shed a good amount of fleet and take out those costs not only on the fleet line but also obviously in the interest.
And third, our second largest cost is salaries, and it’s difficult to say that this could be somewhat variable, but it can, and especially in our hourly operations, we have a lot of turnover at the bottom. We’re fairly stagnant at the top in terms of longevity. But at the bottom, we do have a lot of turnover, and we can easily maneuver our salary and wages down just as we have done in the past.
So those three things Jeff, there might be little nuances that are a little different in there. There might be some other smaller things that we’re watching and doing things differently, and clearly as we have more risk cars in the fleet, we’re playing the fleet a lot different than we have over the past five or six years, but those are the three big things that we’re going to do.
Jeff, one thing I would add to that is the practical reality of a recession from a timing standpoint. You sit here today and think that well, if there is a recession on the forefront, more than likely you’re going to feel it or see it as we end the second quarter and go into the third quarter, and what you would do is you’d down-fleet over the summer because you’re naturally going to down-fleet going into September and October anyway.
So all you’re really doing is accelerating something that you would otherwise do in the fourth quarter. Look, there’s no question you’re going to have less revenue, but I think in terms of being able to flex the fleet from a practical standpoint given where we sit today, timing is not going to be an issue.
Our final question comes from Christina Woo - Morgan Stanley.
Christina Woo - Morgan Stanley
The disposition of the risk cars, you have commented that that process has gone very well. With Chrysler holding less value than some of the other brands, how did you come to that conclusion about Chrysler and perhaps you could tell us your source?
F. Robert Salerno
Quite honestly, we just looked at our results versus the market, and our residuals versus the market. It was our data. Now, you can certainly go out and get broader data, and it’s out there and available to you, but that’s how we got to it.
Christina Woo - Morgan Stanley
Can you give us your one time gain or loss on sale in the quarter from the used vehicles?
Yes, it was a gain of around $3 million.
Christina Woo - Morgan Stanley
In the past your domestic revenue mix has been about split between the leisure business and that revenue coming from corporate contracts. With the softness in the leisure market as evidenced by the decline in leisure pricing both in the fourth quarter and into January of this year, is it still fair to think about your revenue mix as a 50/50 split, or should we be adjusting our thinking for 2008?
I think 50/50 give or take a little bit continues to be right. The changes are on the margin and aren’t going to swing that materially.
Ronald L. Nelson
I’d like to once again thank you all for joining the call. And what I’d like to leave you with is that I hope you’ll think about our Performance Excellence process initiative, the growth in high margin GPS revenues, our strong and growing affinity relationships and our ability to generate free cash flow and our share repurchases and how they’re all going to work together to what we believe will be an improved 2008.
And I think when you add on top of that the depth and experience of our management team, having experienced all types of economic environments, it is how I come to the conclusion and get comfortable with that we’re going to grow in a tough economic environment in 2008. So thank you again for joining the call, and look forward to speaking with you over the course of the quarter.