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Hertz Global Holdings (NYSE:HTZ)

Q2 2012 Earnings Call

July 31, 2012 10:00 am ET

Executives

Leslie Hunziker - Staff Vice President of Investor Relations

Mark P. Frissora - Executive Chairman, Chief Executive Officer, Member of Executive Committee, Chairman of Hertz Corp and Chief Executive Officer of Hertz Corp

Elyse Douglas - Chief Financial Officer and Executive Vice President

Michel Taride - President

Analysts

Adam Jonas - Morgan Stanley, Research Division

Afua Ahwoi - Goldman Sachs Group Inc., Research Division

Michael Millman - Millman Research Associates

Richard M. Kwas - Wells Fargo Securities, LLC, Research Division

Christopher Agnew - MKM Partners LLC, Research Division

John M. Healy - Northcoast Research

Jordon Neil Hymowitz - Philadelphia Financial Management of San Francisco, LLC

Fred T. Lowrance - Avondale Partners, LLC, Research Division

Operator

Welcome to the Hertz Global Holdings 2012 Second 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 that 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 the risk factors and forward-looking statements section of the company's 2011 Form 10-K and 2012 quarterly reports. Copies of these filings are available from the SEC, the Hertz website or the company's Investor Relations department.

I would like to remind you that today's call is being recorded by the company and is also being available for replay starting today at 12:30 p.m. Eastern Time and running through August 14, 2012.

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

Leslie Hunziker

Good morning. You should all have our press release and associated financial information. We've also provided slides to accompany our conference call, that can be accessed on our website at www.hertz.com on the Investor Relations page.

Today, we have 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 of the Hertz Corporation differ only slightly as explained in our press release. With regard to our IR calendar, next month, we'll be hosting our Financial Modeling Workshop and Investor Day in New York City on September 12. The next day, we'll be presenting at the Morgan Stanley Autos & Industrials Conference, also in New York City, and we'll be at the Citibank Industrials Conference on September 19 in Boston.

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; Michel Taride, Executive Vice President and President, Hertz International; and Lois Boyd, Executive Vice President and President of Hertz Equipment Rental Corporation. They'll be on hand for the Q&A session, and now I'll turn the call over to Mark.

Mark P. Frissora

Good morning, everyone, and thanks for joining us. Hertz once again delivered record quarterly results despite softening economic trends in both the U.S. and Europe. As you can see on Slide 6, those records were achieved on many fronts. Consolidated adjusted pretax income and margin were the highest of any second quarter in our history and increased 26.8% and 160 basis points year-over-year, respectively, on a 7.4% revenue gain. However, on a constant currency basis, our revenue and adjusted pretax income growth of 10.3% and 29.8% are even more significant when you consider that global GDP is only forecasted to grow modestly in 2012.

On Slide 7, as you know, we've put in place multiple strategies over the last several years to balance and strengthen our top line and significantly improve the efficiency of our operations and the productivity of our people. Things like fleet leasing contracts, entry into emerging markets, recession-resistant insurance replacement rentals, a growing value brand to complement the Hertz premium brand, technology and innovation and Lean Six Sigma processes improvements all helped insulate our revenue and profitability from macro fluctuations globally.

Let's run through the highlights for the business units, starting with U.S. Rental Car on Slide 8. Total revenues grew 6.7% year-over-year, driven by 10.1% higher volume with transaction days up across all businesses. The strong volume was driven primarily by a 17.4% increase in off-airport rental demand, supported by 103 net new store locations, and a 47.7% increase in advantaged volume. The significant expansion in these markets also helped increase our total average length of rental in the second quarter by 3%, generating greater cost efficiency.

In terms of pricing on Slide 9, you'll see that while rental revenue per day was down 3.1% year-over-year, it was a 130-basis point sequential improvement over the first quarter 2012's RPD. Importantly, airport Leisure pricing for our Hertz Classic brand was up 1.4% in the quarter, benefiting from our dual-brand strategy and tight fleet capacity. Excluding the impact of mix, rental revenue per day was down just 1.9%. We achieved U.S. fleet efficiency of 81.9%, a new second quarter record and 190 basis points better than last year.

On Slide 10, total U.S. Rental Car adjusted pretax income was up nearly 20% in the quarter, and the margin was 210 basis points higher than a year ago. In addition to the top line leverage, the next biggest contribution to the profit expansion was a 180 basis points decline in adjusted direct operating and SG&A expenses as a percent of sales. Monthly depreciation per unit, which excludes Donlen, improved 2.9% year-over-year to $213 per unit.

Turning to Slide 11, our residual values in the quarter were up 170 basis points year-over-year compared with an average 2.4 point decline in the Manheim Index as we continue to improve our strategic procurement and fleet disposition processes. Of our used cars sales in the quarter, 35% were sold direct to dealer, 300 basis points higher year-over-year, and 13% were sold direct to consumer, a 590-basis point increase. When compared with the price quoted at auction, alternative remarketing channels offer much higher returns for us.

On the next slide, let me take a quick minute to update you on our Advantage Discount brand, which had an outstanding quarter with U.S. revenues up 42% and up 31% on a same-store basis. Advantage increased its U.S. fleet efficiency 590 basis points with average rental length 5% greater than last year. Adjusted direct operating and SG&A expenses as a percent of sales were down 910 basis points. All of this, coupled with lower depreciation, led to a 920 basis points expansion in adjusted pretax margin for Advantage versus last year. In total, it was a strong quarter across all segments for U.S. Rental Car.

In Europe, things are more challenging. Moving to Slide 13. While Europe was profitable in the second quarter with a 7.2% adjusted pretax margin, resulting from 8% lower direct operating and SG&A expenses year-over-year, adjusted pretax margin was down 150 basis points. Soft demand and falling residual values resulted in excess industry fleet and pricing pressure. We took our European fleet down 3.1% year-over-year, improving fleet efficiency by about 1%. However, monthly depreciation per unit was 6.6% higher than last year, driven by weaker residuals. Rental revenue per day declined 3.5% on a constant currency basis as positive commercial pricing was more than offset by negative leisure pricing, and the mix of volume shifted to a more lower-price Advantage business. Excluding Advantage, rental revenue per day was down 1.6% currency adjusted.

On a more positive note, beginning on Slide 14, our Equipment Rental business reported continued improvement across all metrics in the second quarter. In the U.S., revenue was up 18.8%. And in North America, the 15.2% revenue improvement benefited from both stronger volume and pricing. Non-North America revenue represented just 8.6% of worldwide Equipment Rental revenue. North American volume was up 13.5% and U.S. volume was up 12.3% over the last year, driven by general industrial demand, infrastructure projects and growth in our Pump & Power businesses. In North America and the U.S., our Equipment Rental pricing was up approximately 4% and 6%, respectively, in the quarter.

Of total North American Equipment Rental revenue, 56% came from national accounts in the second quarter. While this is a higher contribution, more stable business, the contracts limit our ability to raise prices opportunistically. In terms of noncontract accounts, however, we secured a 9.4% domestic price increase in the latest period.

In North America, dollar utilization was up 230 basis points. Time utilization increased 430 basis points in the second quarter, reflecting consistent sequential monthly improvements, a trend we expect will continue throughout the year.

Corporate EBITDA for the worldwide Equipment Rental rose 12.1% over the 2011 second quarter or 14.2% excluding the impact of currency as higher revenue and lower adjusted direct operating expense margin more than offset investments and sales force expansion and advertising spending.

In a minute, I'll give you some thoughts on operating trends for the back half of the year. But first, let me turn over to Elyse to provide more details on our financial performance.

Elyse Douglas

Thanks, Mark. Good morning, everyone. Let me begin on Slide 16 by reviewing our financial results on both a GAAP and on adjusted basis. As Mark mentioned, we achieved record earnings for the quarter with adjusted pretax income of $233.9 million, up $49.5 million year-over-year. Adjusted earnings per share improved 34.6% to $0.35 a share over the prior year earnings of $0.26 a share. The diluted share count for the quarter was 447.4 million shares.

On a GAAP basis, pretax income improved 67.8% to $158.7 million. GAAP net income improved 68.9%, resulting in GAAP diluted earnings per share of $0.21. The record earnings performance was driven by strong top line growth, lower U.S. fleet costs and $107 million of incremental cost savings.

Moving to Slide 17, approximately 48% of the savings came from direct operating expenses, which as a percent of revenue, declined 390 basis points from the prior-year period, benefiting from favorable trends in vehicle damage collection in Europe, reductions in vehicle licensing expense and Donlen's low operating cost structure relative to its revenue.

Our Lighthouse efficiency program on Slide 18 was implemented at another 10 locations worldwide in the second quarter. We now have 108 of our global Rental Car and Equipment Rental locations, representing 43% of total revenue having gone through the Lean Six Sigma program. This program drives improved customer service and employee productivity, as well as increased revenue.

In the quarter, average Net Promoter Score for the Rental Car division improved by 40 basis points, and consolidated employee productivity was up about 2%. SG&A margin was flat year-over-year as streamlined operations and reduced staff levels in Europe were offset by higher legal expenses and the expansion of our equipment rental sales force to address that market's favorable demand trend. We're now on track to deliver $350 million of cost savings this year, which is a $50 million -- which is $50 million more than our prior estimate. These additional savings will counter any potential impact from the increasing macroeconomic risks.

Now before I move on to the business units, I want to address the recent volatility of currencies around the world, especially the euro against the U.S. dollar on Slide 19. At Hertz, we have a natural hedge in that our revenue and our expenses are incurred in the same currencies. In the second quarter, foreign exchange decreased consolidated revenue by $61 million, but impacted debt pretax by only $2.7 million. Our foreign exchange exposure is primarily to the euro, Canadian dollar, the British pound and the Australian dollar.

Starting on Slide 20, I'll briefly run through the business operations. Since Mark already covered the Rental Car business pretty thoroughly, I'll take this opportunity to quickly update you on our Hertz On Demand hourly rental service. In the second quarter, global Hertz On Demand revenues was up 58% year-over-year, with global membership up 250%. Revenue per vehicle was up more than 46% worldwide on 50% more fleet.

During the quarter, we expanded our operations into Washington D.C., Miami Beach and San Antonio. We also increased our base fleet in New York City by more than 80%, reflecting the greater number of users and higher usage rates.

In addition to geographic and fleet expansion, we have the opportunity to dramatically grow our Hertz On Demand customer base as we implement programs to enroll gold members into the hourly rental program. Today, there are more than 4 million Hertz gold members worldwide.

Now let's move to Slide 22 with an update on Donlen. Donlen revenue in the 2012 second quarter was $115.4 million. Its results are included in our worldwide Rental Car results. You'll recall that we acquired Donlen in September of 2011, so all of this quarter's revenue is incremental.

However, on a pro forma basis, Donlen revenue increased 16.9% year-over-year, and just as a reminder, depreciation represents about 80% of the revenue. The integration between Hertz and Donlen continues to go smoothly, and we're realizing synergies in both revenue and operational cost areas. Among the synergy opportunities are cross-selling opportunities, procurement-related savings, vehicle remarketing efficiencies and other operational improvements.

We also continue to focus on developing product offerings that further differentiate both of us from competitors. Let me give you a few examples. First, Hertz value lease has been successfully rolled out and offers Donlen customers a lower cost alternative by enabling them to lease low-mileage, high-quality, pre-driven vehicles pulled directly from the Hertz rental fleet. We're also developing fixed-term equipment leasing solutions for Hertz construction and industrial clients. And finally, our plan to share telematics technology and IT platforms will enable both Hertz and Donlen to achieve accelerated growth in savings and provide superior fleet management solutions to our customers.

Now let's turn to Equipment Rental on Slides 23 through 27. Our Equipment Rental business in North America had a strong second quarter revenue growth of 15.2%. Even higher growth rates were generated in specialty categories like Entertainment Services, Pump & Power and the energy sectors.

Moving to Slide 25, in the second quarter, adjusted pretax income of $42.5 million for worldwide equipment rental improved 27.2% over the prior-year period. The adjusted pretax margin was 12.7%, a 160-basis point improvement over last year, reflecting strong revenue growth, improved fleet efficiency and a 6% increase in employee productivity.

Revenue flow-through to corporate EBITDA was 40.8% in the second quarter, negatively impacted by weakness in overseas operations and higher costs in the quarter. These costs were related to higher insurance claims, legal settlement costs and, as we mentioned in the first quarter, acquisition integration costs. Excluding these costs, the flow-through would have been 59.1%. For the full year, we currently expect corporate EBITDA flow-through to be roughly 50% to 55%, including the impact of acquisitions and the unusual second quarter settlements.

In terms of fleet investments for the second quarter, we purchased about $250 million of equipment rental fleet, which can be seen on Slide 26. This brings our year-to-date spend to over $400 million. We continue to expect to spend about $700 million in gross new fleet in 2012, so we're at about 60% of our goal.

The recent purchases helped reduce the average fleet age to 44 months, which is 3 months less than the first quarter level and 6 months younger than last year's fleet. We continue to see improvement in sales of used equipment. In fact, retail residual values now are on par with prerecession levels.

Moving to Slide 28, consolidated interest expense for the second quarter was $152.2 million, representing a $13.6 million decrease compared to the same period in 2011. Cash interest expense declined $7.1 million year-over-year due to lower rates associated with our refinancing efforts and a favorable foreign currency translation, which more than offset higher fleet levels and the addition of the Donlen debt. Noncash interest declined by $6.5 million, primarily due to write-offs associated with refinancing activity last year. We now expect full year cash interest expense to be favorable versus 2011.

Restructuring and restructuring-related charges are outlined on Slide 29. In the second quarter, we incurred charges of $21.1 million compared with the prior year's $36.5 million. This quarter, we continued efforts to rationalize our European business in light of the recessionary environment there and took reductions related to process and organizational redesign throughout the company.

On the next slide, cash flow from operations for the quarter was $666.4 million, an improvement of $145.1 million over the prior year, primarily due to higher earnings. The higher earnings, along with increased fleet advance rates, contributed to $107.8 million improvement in corporate cash flow despite incremental investments in fleet year-over-year. For Hertz, we spent a net $116.5 million more this period than we did a year ago, and our worldwide rental car fleet levels were up 4.6% excluding Donlen.

On June 30, we had approximately $1.4 billion of corporate liquidity available as outlined on Slide 31. Our net corporate debt leverage ratio was 2.8x, an improvement from last year's 3.3x. During the quarter, we executed several financing transactions. We increased our existing variable funding ABS note facility by $250 million. We also added an EUR 85 million seasonal revolving credit facility, similar to the EUR 100 million facility we did a year ago, which will cover our peak fleet requirements.

In addition, we reduced pricing and secured an extension on our EUR 220 million revolving credit facility that now matures in June 2015. Finally, we renewed and amended a 1-year CAD 200 million securitization facility. Subsequent to quarter end, we extended our European securitization at the same terms as the previous facility, which will now mature in July 2014.

For the balance of the year, we anticipate refinancing several facilities that mature in the fourth quarter or early next year. These include renewing our U.S. and Australian securitization conduits and the U.K. fleet facility. In addition, we continue to work on adding a term ABS financing for Donlen. Work has commenced on these projects and we do not anticipate any issues with closing these deals.

With that, I'll turn it back to Mark.

Mark P. Frissora

Thanks, Elyse. Let's move to Slide 33. As you know, downside risk to the weakening global environment continue. You've got the usual pull between the lack of resolution on the Eurozone crisis and doubts about the strength of the U.S. economy. With the macro so volatile, it's tough to predict what's ahead, but as of right now, things are still pretty good for us. Even in these uncertain times, we're continuing to execute and deliver on our robust strategies.

With that being said, we are comfortable with our current 2012 guidance. And our 3-year plan on Slide 34 is on track, which we feel good about considering the weaker European assumptions. Barring a free fall in the global economy, we remain confident on our ability to achieve our long-term goals.

Near term on Slide 35, in Europe Rent-A-Car, we expected to see signs of recovery in the back half of the year on easier comps and the stabilization we saw in early May. So far, that hasn't occurred. As said, there's now uncertainty around exchange rate fluctuations to add to the challenging condition overseas. However, as I mentioned earlier, we're aggressively pursuing revenue and cost-saving initiatives to stem the tide, and those are helping.

In U.S. Rental Car, a tight fleet in the third quarter, consistently strong utilization improvements and incremental growth initiatives are helping fortify our resiliency. We're more focused than ever on delivering speed and value at all customer levels. For Equipment Rental, we are continuing to perform at or even a bit above plan and we don't expect that to change. Overall market demand is stable. We expect our utilization to continue to increase as fleet logistic processes improve through the Lighthouse program as we service incremental demand in new markets and new geographies. Recent equipment rental acquisitions are exceeding our internal plan.

Moving to Slide 36, I want to take another minute to address the what-if question surrounding residual values that seems to be keeping some investors up at night. We continue to hear from Wall Street that strong residual values are artificially boosting profit in U.S. rental car, implying that if residual values moderate, earnings would be significantly and adversely affected. This just isn't the case for reasons both historically fact-based and strategic. Many of our key performance metrics are codependent and therefore have a self-leveling effect on profitability. Historically, our business model has proven its flexibility time and again. Typically, when one metric move down, another move in tandem to counterbalance our operations from external volatility.

Let me give you a couple of examples. On Slide 37, we've compared the Manheim Index, which reflects average used car selling price, to the new car CPI, which reflects OEM selling price. What this shows you is that when residual values decline, for the most part, so did pricing for new cars. Certainly, there's going to be 1 quarter or 2 where timing has an impact, but essentially, when you have to sell for less, you also get to buy for less. So the downside is counterbalanced by the upside. The correlation between Manheim and the new car CPI is strong with an R squared coefficient of 0.81.

On Slide 38, we compare our U.S. RPD change annually to changes in fleet costs. From 2003 to 2011, you can see that when fleet costs decline, pricing declined, and when fleet costs rose, pricing rose. Because fleet costs represent less than 1/3 of our U.S. Rental Car total car costs, you'd only need, for example, a 1% increase in price to offset a 3% increase in fleet costs. They don't need to move proportionally.

As a result of these and other correlating factors that offset movements in residual values, history, experience and externally published research show you that there's no one thing ever impacting profits today. No single metric moves in isolation. That's the beauty of this business.

For rental car companies, you can see on Slide 39 that we have an added benefit of favorable supply-demand trends that should extend this strong residual period for us. The reduced supply of off-lease vehicles is expected to continue at levels below 2011 through at least 2015 according to Manheim Consulting. And you can see on the right side of that slide that pent-up demand for replacement vehicles has doubled from recessionary levels. We're in good position, one that we don't think is going to change significantly anytime soon.

If you turn to Slide 40, you can see that Moody's is forecasting that Manheim Index declines just 5 points from 2012's peak before leveling off in 2015. We agree with this projection, which translates into a 2- to 3-point dip in residual values, not very significant. Regardless, what do we do about it? Well, in addition to purchasing a less expensive fleet to next year and raising rental pricing, you can see on Slide 41 that we have multiple internal tactics that we should more than offset a decline in residuals. The most beneficial should be the increased penetration of sales channels with higher, less variable returns.

Slide 42 shows you that over the next 2 years, we're planning to nearly double our penetration into direct-to-consumer channels, which generate a substantially higher return in any operating environment.

So just to summarize, in addition to the growth of new and more stable revenue streams, the flexibility of our model and the self-leveling effect of various performance metrics have on one another, those things all protect our profitability during volatile economic periods. Residual values are not artificially propping up earnings.

Finally, as it relates to Dollar Thrifty, we continue to believe that a merger is in the best interest of both companies. We remain engaged with the Federal Trade Commission to secure antitrust clearance to potentially acquire Dollar Thrifty, which requires, among other things, the divestiture of our Advantage business. I know that many of you want more information regarding this transaction, but unfortunately due to regulatory reasons, we are prohibited from saying anything further on this topic.

With that, let's go ahead and open the call up for questions, operator.

Question-and-Answer Session

Operator

.

[Operator Instructions] And we'll go to Adam Jonas with Morgan Stanley.

Adam Jonas - Morgan Stanley, Research Division

I want to ask a question about Advantage profitability, and thanks for the extra color on the slide deck where you show the incremental profit. First, can you tell us what total pretax EBITDA margin for Advantage is right now?

Mark P. Frissora

No.

Adam Jonas - Morgan Stanley, Research Division

Okay. Then, just using the information you provided of the 920-basis point margin improvement year-on-year, understanding was that, based on your guidance in part, that business was either profitable or breakeven maybe. But if we assumed it was breakeven last year and we're doing a 900 -- high single-digit margin pretax, would that imply -- are we wrong to kind of assume that, that might imply an EBITDA margin that's not a million miles away from the group average?

Mark P. Frissora

Yes, you're correct. I mean, our profitability on Advantage is very close to U.S. Rent-A-Car's profitability, pretax margin-wise.

Operator

.

And we'll go to Afua Ahwoi with Goldman Sachs.

Afua Ahwoi - Goldman Sachs Group Inc., Research Division

It's Afua Ahwoi, actually. Just a quick question. I wanted to -- can you elaborate on the trajectory of price and volumes in the U.S. and maybe North America as the quarter progressed, I mean, especially because we saw a sequential improvement over last quarter, which is a little atypical to what we saw some of our other companies reports? So I was hoping you could give us some more color in May versus June versus, if possible, July.

Mark P. Frissora

Yes. Well, we can't comment on any forward-looking pricing. There's antitrust issues around that and so we won't. But I will tell you that we did have pricing improve sequentially from the first quarter to the second quarter, and we saw actual price realization. On-airport Leisure pricing went up 1.4 points for us, so we think that was a very encouraging sign, but for a part of our business model.

Operator

.

And next, we'll go to Michael Millman with Millman Research.

Michael Millman - Millman Research Associates

On Hertz, the same-store sales was up 7.3%, which is showing a decelerating growth. Can you talk about why that's occurring and maybe whether we'll see that change around in the short term?

Mark P. Frissora

We don't have those numbers. I don't know -- is that on a sheet somewhere or did you calculate that?

Michael Millman - Millman Research Associates

Well, if you put the current number down and was able to calculate the last.

Mark P. Frissora

We have stores growing and closing stores all the time. We do that every quarter or so, I know FX probably had some impact in both -- in Europe, it had a more dramatic impact than you might think. But in general, we were pretty much right on our growth plan. We didn't have a surprise on growth in our core stores, Michael. So I don't -- the comment is one that says we're decelerating and I don't think that's accurate. I think it would be driven by international, if anything, given the fact that we had the foreign exchange issue. But we could try to back into the number for you and adjust it for foreign exchange and see if you'd see that -- I think you would see it's growing, it's actually not decelerating.

Operator

.

And we'll go to Rich Kwas with Wells Fargo Securities.

Richard M. Kwas - Wells Fargo Securities, LLC, Research Division

Within the outlook -- or Mark, are you assuming that residual values decline year-over-year for the rest of the year? And then, could you just comment on commercial pricing because you said that was a point of weakness this quarter, it was down 3.6% last quarter. Was it worse than last quarter?

Mark P. Frissora

Yes. I guess in terms of our assumptions going into the back half of the year, Elyse, do you want to talk about those?

Elyse Douglas

Yes, I mean, we are -- I guess our assumption with residuals is that they're going to remain relatively strong, so we don't see a huge change in residuals for the back half of the year. But obviously, as you know, the second quarter is the peak selling season, so they do come down seasonably throughout the year. In terms of the debt rate versus our original forecast, we do see that up versus our original forecast, and obviously, that's being offset by things like pricing and foreign exchange. Did that answer your question, Rich?

Mark P. Frissora

Yes. Then commercial pricing, Rich, in terms of the weakness that we're seeing there, it's just the continued competitive environment on commercial pricing. We didn't see it slackening, although down in Q2. I mean, for us, when we look at it, we assume it will be constant, but start to improve at some point, hopefully in the fourth quarter when we cycle through contracts. We think the year-over-year comp in the fourth quarter will become a little easier, and so that would be our prediction. But you just don't know. We don't know where competitors are going, and there's been pressure there, as you know, longer than we would have anticipated. But right now, we're feeling that maybe the fourth quarter will be a little bit better on the commercial front.

Operator

.

And we'll go to Christopher Agnew with MKM Partners.

Christopher Agnew - MKM Partners LLC, Research Division

Couple of questions around free cash flow. How should we think about free cash flow over the next couple of years? Is pretax earnings still a good proxy as it's been in the past? And maybe can you outline growth CapEx expectations for HERC? And then just one more on cash flow. Avis Budget have been buying back their convertible bond, I think, over the last couple of quarters. Is that something you would consider or even can consider? And how would that impact your goal to become investment grade in the next couple of years?

Elyse Douglas

Okay, so let me address the cash flow. So on average, we earn about $1 a share in terms of cash flow before acquisitions and fleet growth -- or significant fleet growth. So we do expect to be positive cash flow this year. We have made some acquisitions and we have increased our investment in the HERC fleet, but we do expect to be positive in cash flow for 2012. The investment in HERC, as you know, we did up the investment from our original guidance, so there's about $140 million of incremental cash flow we'll be spending this year that we had in the original plan. With respect to the goal to be investment grade, obviously, that continues to be our goal. We do, however, constantly look at alternative investments for cash, and buying back the converts is actually something that we do look at and consider. So we continue to look at that. We just have not felt that it's the right time given some other strategic issues that we're considering at this point in time.

Operator

.

And we'll go to John Healy with Northcoast Research.

John M. Healy - Northcoast Research

Mark, I was hoping you could give us a little bit of color on the European market. I know you mentioned 2% transaction growth there. What would transaction growth -- transactions grown without the Advantage brand being launched in some of the markets there? And do you feel like you outperformed the market or was the performance by the Hertz Classic brand more in line with the market there?

Mark P. Frissora

Well, in terms of outperformance of the market, yes, we're pretty confident, year-to-date. Our share, and this is on the -- this is looking at share reported into a central group there in Europe, we were up year-to-date, I think, about 0.4%, so almost 1/2 share point up. I think that was through May, if I remember right, but Michel is on the phone. so we don't feel like we have a share issue at all. If anything, we've gained a little share. In terms of the volume issues, they primarily are continuing to be in Spain, and Germany is probably a little bit weaker than we would have anticipated as France is. Those are the 2 of the bigger countries, Italy is doing fairly well, and Benelux has weakened a little bit as well. So that's kind of color, if you will, by country. But in general, we expect the comps to get easier as we move forward in the year, and we're hopeful that we start cycling out of a continued degradation, if you will, of going down, but it's just taking longer for the bottom to kind of start moving up, if you will, and that's been the bulk of the issue there. It's just that it's been a slower return than we would have thought at this point, much more -- the consumer confidence issue has played out in Europe just like it has in the U.S. a little bit.

Michel Taride

And Mark, this is Michel speaking. I think the question was also how much is the weight of Advantage. Advantage accounts for about 1.5% fixed point of the growth.

Operator

.

And we'll go to Jordon Hymowitz with Philadelphia Financial.

Jordon Neil Hymowitz - Philadelphia Financial Management of San Francisco, LLC

On your Slide 42, this is very helpful. I guess my question is, if you had your druthers, would you put 100% of your cars on auction if it's possible to execute in that regard?

Mark P. Frissora

You mean 100% on risk? At auction? I mean...

Jordon Neil Hymowitz - Philadelphia Financial Management of San Francisco, LLC

I'm sorry, let me ask the question more specifically. If you had the retail ability, would you put 100% of your risk cars that have come to term through retail and none through auction?

Mark P. Frissora

It's probably not 100%, but we would certainly increase this percent of cars that we have at retail. I mean, if we could get it up to 50%, 60%, we think that makes sense. Some of what we do with the dealers is oftentimes trade cars and they're both a source of cars for us as well as a partner where we give them cars, obviously, for their sale. We also have service relationships in place and do off-airport business. So we're never going to get to 100% at retail, but I think a goal of 50% makes a lot of sense.

Operator

.

And we'll go to Adam Jonas with Morgan Stanley.

Adam Jonas - Morgan Stanley, Research Division

I got a second question. Can I ask, does the uncertain there possibly deteriorating macroeconomic environment, any way, change your thinking or alter your stance on pursuing M&A?

Mark P. Frissora

We look at all kinds of factors that determine our thinking about M&A all the time, so that's one factor we always would consider.

Operator

.

And we'll go to Fred Lowrance with Avondale Partners.

Fred T. Lowrance - Avondale Partners, LLC, Research Division

Quick question on franchising. I don't think we got an update from you with this quarterly call as far as -- if you could update us on where you are there with franchising, if we're going to see any sort of movement on that front this year? And then just secondly, as we look to your 2014 targets, that you obviously reaffirmed here today, how much of the franchising opportunity that you've outlined, you know the 415 locations, $600 million in associated revenue. How much of that is actually included in that 2014 plan?

Mark P. Frissora

I think in the 3-year plan, we didn't put a whole lot of franchising in it. Do you guys know how much?

Elyse Douglas

$450 million.

Mark P. Frissora

About $150 million -- I'm sorry, $450 million over that time period. In terms of what we're doing this year, we're -- I think it's safe to say we're sure that we will announce a few deals this year on franchising and they'll be of significance, and we feel confident we'll hit our goals internally on franchising revenues that we think make better sense to have with the local providers than us. So I feel pretty comfortable there.

Operator

.

And we'll go to Rich Kwas with Wells Fargo Securities.

Richard M. Kwas - Wells Fargo Securities, LLC, Research Division

Just a couple of follow-ups. On the nonrecurring stuff, is there any residual impact in the third and fourth quarter? It doesn't seem that way, but just want to clarify that. And then on utilization for HERC, with the added investment, is there going to be any pause in the expansion on time utilization that you've seen recently?

Elyse Douglas

On the unusual items, no, they're just specific to the second quarter.

Mark P. Frissora

And then on time u, we do expect time u to continue to improve in the second half of the year.

Operator

.

And we'll go to Michael Millman with Millman Research.

Michael Millman - Millman Research Associates

Just 2 things. Can you talk about U.S. RAC in July? And secondly, generally, it's acknowledged the fleets have tightened, why do you think that prices revenue per day has not done better?

Mark P. Frissora

First of all, we can't comment on pricing, and really both questions kind of deal with that. So I mean, I can only tell you is that we saw our fleets tightened and we did get rate, if you will, at the airport on Leisure, so that was helpful, and I think it was due to the fleets' tightening. So again, pricing environment is a mixed bag of tricks, obviously, and commercial pricing was really the driver of our issue. So as that improves, and hopefully it will improve, it will improve our overall rate. That's about the best I can tell you because we don't talk prospectively on pricing issues.

Operator

.

And speakers, I'll turn the call back to you for closing comments.

Mark P. Frissora

Okay. Well, thank you, everyone, for joining us this morning. Look forward to telling you more about the Hertz story at upcoming events. Over and out.

Operator

.

Thank you. And as a reminder, this conference will be available for replay. And that does conclude your conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.

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