Avis Budget Group, Inc. (NASDAQ:CAR)
Q2 2008 Earnings Call
August 7, 2008 9:00 am ET
David Crowther – IR
Ronald Nelson – CEO
David Wyshner – EVP & CFO
Robert Salerno – President & COO
Chris Agnew - Goldman Sachs
William Truelove - UBS
Michael Millman – Millman Research
Good morning and welcome to the Avis Budget Group second quarter earnings conference call. 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; please go ahead sir.
Good morning everyone and thank you all for joining us. On the call with me today are our Chairman and Chief Executive Officer, Ronald Nelson; our President and Chief Operating Officer, Robert 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.
Such statements are based on current expectations and the current economic environment and are inherently subject to significant economic, competitive, and other uncertainties and contingences 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 than those in the forward-looking statements are specified in our 10-K and the earnings release issued last night.
Now I would like to turn the call over to Avis Budget Group’s Chairman and Chief Executive Officer, Ronald Nelson.
Thanks David and good morning to everyone. It’s been a fairly tumultuous quarter to say the least and this morning we’re going to try and focus our discussion not only on the quarter’s results but on the issues that seem to swirling in the haze of the current macroeconomic environment. Needless to say we’re always disappointed when we report down earnings, especially when our forecast was for growth. But given the headwinds brought on by oil prices specifically and there follow-on affect on airlines, OEMs, and consumers, we do think our business model demonstrated its resilience in a difficult time.
Much of the impact of these headwinds was out of our control, notably declines in commercial travel volumes and in car rental industry pricing. These issues overwhelmed at least in the second quarter, significant benefits we’ve realized from executing our strategy. Our progress on that front has been substantial and successful in developing incremental distribution channels, we’ve won new customer accounts, we’ve grown our ancillary and off-airport revenues, and we’ve adjusted the size and composition of our fleet and we’re generating millions in savings from our process improvements through our Performance Excellence initiatives.
Unfortunately all of this seems, at least temporarily to being lost in the strong currents of an economic downturn. So while we continue to see many signs of progress, innovation, improved efficiency, and positive efforts that to me, offer reassurance that we are positioned to achieve success over the long-term, its probably more important at this juncture to discuss what we’ve seen in recent months, what has changed since our last call, what hasn’t changed, and what we’re doing about it.
That’s what all of us are going to use your time for today. I’m going to address the current environment; Robert will provide some specifics related to fleet matters and cost savings; and David will discuss the second quarter results by segment and then focus on the proverbial elephants in the room, our financing strategy and our debt covenant coverage.
As I’m sure you’re aware we preannounced at the beginning of July that the second quarter would be below last year, so hopefully our results last night should not have been a surprise. The good news is that we remain a growing and profitable company. We are continuing to actively and aggressively lower or cost base. We are continuing to invest in our business and to market our brands. We are continuing to focus on delivering superior customer service and we are continuing to focus on executing against our strategic plans.
These priorities haven’t changed. While our priorities didn’t change the environment we operate in did. The most obvious change was energy costs. Oil prices hit new highs almost every day, but when crude topped $125 a barrel and gas moved above $4 a gallon in May, the reaction was swift. Airlines began to cut capacity and announced significant capacity reductions for the fall, our own gas expenses increased costing us some $3 million of margin in Q2 alone, and customers increasingly moved towards reserving smaller more fuel efficient vehicles which at the moment, tend to have lower time and mileage rates per day.
In addition as you might expect in a difficult economy people became more careful about their spending. Fewer renters bring cars back that need refueling so the offset to our gas expense is lower, and while spending for GPSs and insurance is up nicely, it’s not quite as nice as we projected it to be. By pricing it doesn’t take much of a shortfall at 80 plus percent margins to impact your quarter.
Most importantly though, we began to see a falloff in demand. In the first quarter demand had remained reasonably strong for both commercial and leisure travelers as we discussed on our last call. In fact, both outpaced enplanements which were approximately flat. As we moved into April we did experience some weaker leisure pricing due more to the shift of Easter from Q2 to Q1 but demand continued to hold up nicely.
However when oil topped $125 a barrel in early May, commercial demand started to decline particularly in the larger corporate accounts and continued its downward trend into June. As a result our on-airport commercial transactions were down 3% in the second quarter. The challenge that presented was obviously on the revenue line; one from the reduction of volume and two from the impact on pricing of an industry-wide imbalance between inventory and demand.
We clearly wouldn’t eliminate fleet before our peak earnings months and so as you would expect the impact of the over fleeting reflected itself in price. Leisure transactions on the other hand were not an issue. They’ve been up respectively given the environment all year long and were up 1% on-airport in the second quarter, even with the shift of Easter.
In either case demand outpaced enplanements. Even though June data from BTS has not been released we expect enplanements will end the quarter down approximately 4%. That is the largest quarterly drop since the 9-11 impact.
So on the demand side the second quarter was truly all about commercial. Commercial accounts are our bread and butter. They typically yield higher daily rates, so a slowdown in this segment has its own ripple affect on our overall T&M per day rate. We were able to compensate for some of the volume loss with incremental leisure volume, but the mix shift lowers the average rate we achieve.
The retail price increase we discussed on our last call held reasonably well through the second quarter. While the time and mileage rate per rental day for the quarter was down slightly, this was more due to lower commercial volumes and a 2.5% increase in our length of rental then anything else.
The Easter shift to the first quarter also put downward pressure on our T&M per day rate. But with the length of rental gains in May and June, combined with daily rates evening out versus last year, our revenue per transaction increased nicely in the mid single-digits. Gains in revenue per transaction are generally a positive metric provided the fleet is properly in balance.
As an interesting aside, we have been seeing longer length of rental all year, but in particular over the summer months. I think the headline as we move through the summer months is that transactions are down, but length of rental across both brands has increased, largely offsetting the decline in transactions.
Price is up and the tradeoff vis-à-vis lower then expected volume is generally a positive one. Our revenue per transaction has been showing gains in the mid single-digits since early June. Budget has been much stronger Avis owing I suspect to its brand positioning in the market, the environment we find ourselves in, and Avis’ commercial skew.
Taking it down a level, we continued to see softer commercial demand in July, and expect that pattern to continue into August. This is putting some additional pressure on our third quarter earnings although we are taking steps to further reduce costs to mitigate the impact. As we noted in our release last night, we have not changed our guidance for the full year. We are still forecasting earnings for the year to be in the $350 million range.
On the leisure side, summer volume has been okay. Budget better then Avis with good price but overall we have taken measured steps to constrain our fleet in light of the demand and dynamics we are seeing. In fact, we think industry fleet levels were fairly tight compared to demand in July and this trend should continue into August in many areas of the country.
Looking forward beyond the summer months, our forecast is built around the premise that fleet levels will loosen up during September and October as the industry de-fleets from the summer peak, and that year-over-year commercial transaction comparisons will continue to be negative. All of this will likely impact pricing. As we have discussed on prior calls, we have expected [shoulder] period pricing to be weaker and peak demand period pricing, which was already strong, to be even stronger.
This has been driven to a large extent by the industry shift to more risk fleet. So far this has by and large played out as we expected. Overall we expect that price should be up for the third quarter on a year-over-year basis, but the volumes will decline slightly as our continued off-airport growth will be offset by softer commercial demand.
Q4 pricing will likely be negatively impacted my demand and fleet levels but we think the year-over-year pricing comp is a relatively low one as pricing was down 2% in last year’s fourth quarter. As I mentioned, we have intentionally constrained our fleet and passed on some volume in favor of price this quarter and we may continue to do that in the future, with a particular focus on low margin channels.
We’re monitoring demand trends in airline capacity carefully to determine what the ultimate impact will be. It’s a particularly difficult environment to predict but we do think there are several reasons why the reduction in demand could be significantly less then the higher end capacity reductions that have captured the most media attention.
First, our analysis of OAG statistics indicates that the number of seats on scheduled fourth quarter flights is down approximately 8%, not the double-digit numbers reported in the media. Certainly timing can play a role, but as of August that’s what the data says.
Second, load factors in the fall are relatively low meaning that airlines to an extent can reduce capacity without negatively impacting volumes.
Third, it appears that the biggest capacity reductions will be on routes to secondary and tertiary cities. Since people are still going to need to travel to and from these destinations, it is possible we will be seeing people getting there by car rental; by flying into the closest major airport and then driving.
And fourth there is an extent to which the marginal traveler, who will be squeezed out by higher airfares and/or reduced capacity, is relatively unlikely to be a profitable car rental customer. Nonetheless airline capacity reductions are a fourth quarter reality and they will likely affect our volume.
In light of the fairly extraordinary swings in airline capacity projections, fuel prices, commercial travel volumes, consumer vehicle preferences, it can be easy to lose sight of the items that haven’t changed since our last call.
First and perhaps most importantly, the residual values on risk cars on a combined basis continue to be in line with or better than our forecast, despite the falloff in SUV prices which Robert will discuss further in a minute.
Second, despite the weakness in commercial bookings, the overall summer bookings are good especially on the price side. As I mentioned earlier pricing in July was solid, up 3%, versus last July and August appears to be tracking in a similar fashion.
Third, ancillary revenues, principally GPS and insurance, continued their strong growth increasing 13% in both the second quarter and year-to-date.
Fourth our off-airport revenues increased 10% year-over-year in the second quarter driven by 30% growth in our insurance replacement business. Year-to-date our off-airport and insurance replacement businesses have grown 12% and 31% respectively.
And fifth our process excellence plus our performance excellence process improvement initiative continues on track to deliver $40 million of pre-tax savings this year. Through July we are tracking at a run rate well north of $40 million and have over 500 project replications either completed or in process at locations throughout the world.
Remember replication is where we have proven the single site savings and are extending the process change to replicate the benefit of other locations. Key replication projects have tackled our check-in standardization, service island standardization, shuttling and where2 inventory management processes.
All of our business units globally are involved. We remain committed to the $100 million to $150 million savings target when this initiative is fully implemented.
So the looming question is what are the impact of these trends and external events and what are we as a management team doing about it? First as we’ve discussed before we have an operating model that has roughly 70% variable costs. This allows us to focus on a great many things that we can control. Our largest expense, fleet, can be adjusted to reflect changes in demand.
For sure it’s gotten more difficult with the growth of risk cars, but our fleet is only 50% risk which still provides us ample opportunity to adjust to current conditions. The proof, even though we’ve lowered our volume forecast by two to five percentage points for the year in the space of the last quarter, our fleet growth remains in line with rental day growth.
Second, our next largest cost is labor and in both our field and headquarters areas we have taken actions to reduce these costs and will continue to do so as conditions dictate. The proof, overall operating expenses as a percentage of revenue declined in spite of significant cost increases in energy and we are still achieving our key internal productivity measures versus our business plan targets.
Both of these show that our business model is operating as it should and we expect that we will continue to be able to make progress on these fronts. Now and in the longer term we simply have to be smarter about running our business. I think the rules are changing relative to fleet acquisition and management, and how they relate to yield management.
For example, in a risk car environment mileage is the key factor in the depreciation curve, so mileage driven per rental day has become much more important. A low rate weekend rental that may appear attractive when measured on an incremental basis may actually cost margin if the renter drives the car excessive miles.
There is a growing realization that not all business is good business, particularly in the pricing environment we occasionally find ourselves in. You should not draw from all of this that we are pressing the panic button; we are not.
But we are trying to be realistic and proactive about the short-term challenges that the environment has thrown in our way. Hope is not a viable strategy and we are acting now to control our destiny later. At the same time we are trying to balance our actions with the longer term view that requires investing and key strategy initiatives that offer significant paybacks, such as our new fleet optimization system, sales training for our counter agents, new and dramatically improved avis.com website which we expect to rollout by year end, and of course, continuing our ongoing process improvement initiatives just to name a few.
Longer term we are believers in the US economy and believers in our company. We do not face any serious obsolescence risk, as our society is becoming more mobile not less. We have a product that has very significant pricing elasticity and the balance between cost and convenience; we are far and away the best of alternatives when a traveler arrives in an airport.
We have two strong brands that appeal to the spectrum of car rental customers from value to premium. While the actions we are taking to respond to the current environment are significant, the silver lining is that in doing so, we believe we are building a stronger foundation for longer term growth and prosperity.
With that, I’ll turn the call over to Robert Salerno.
Thanks Ronald and good morning. Today I’m going to discuss the trends we are seeing in the used car market, provide an update on our model year 2009 fleet negotiations, and describe what we’re doing to respond to the challenging conditions facing us.
As Ronald mentioned, the prices we realized on used cars in Q2, were where we expected them to be, and perhaps a bit better. We sold more than 33,000 risk units in the quarter principally through traditional wholesale auctions. We are also continuing to see significant growth in our direct to dealer wholesale ecommerce channels; Open Lane, Smart Auction, and Manheim OVE.
In fact during the quarter, nearly 10% of our sales came through these channels. More importantly we had good experience across all the channels. To monitor this we compare the actual monthly cost per car on the risk units we sold, to what our expectations were when we purchased these cars in the range of 12 to 16 months ago.
In the second quarter our actual depreciation costs on model year 2007 vehicles were within 3% of our initial expectations. In fact, through depreciation as measured after the sale came in at about $7 per car a month less than our original assessment.
For those who look at the headline numbers regarding used vehicle prices, our favorable results may be surprising. For those who look at components of the used car market and understand our risk vehicle strategy, I think our results are actually to be expected for two principal reasons.
First, as we have mentioned on the last several calls, we and others in our industry are holding cars somewhat longer then we did in the past. Therefore, while the average number of vehicles operated by rental companies has remained relatively unchanged, Manheim reports that the number of new vehicle purchased by rental companies declined by 17% in the first half of 2008.
With rental companies being the primary manufacturers of one year old cars, the supply of late model vehicles has been shrinking. As a result, even if the overall demand for used vehicles is down in today’s economic climate, the segment on the market that we sell in, one year old cars is responding to that reduced demand more from the standpoint of a reduction in supply then from a reduction in sales price.
As Manheim recently said, and I quote, “Little wonder then that the late model used car prices have held up reasonably well.”
Second, there is a major mix affect occurring in the face of rising gas prices. While used vehicle prices overall are down about 6%, prices for mid sized cars are essentially flat compared to a year earlier and prices for compact cars are up nearly 13%. Prices for large pick-up trucks and SUVs on the other hand are down substantially; nearly 25%.
Now we have mentioned several times that the composition of our risk fleet skews significantly toward smaller, more fuel efficient vehicles. In fact, about two-thirds of our current risk fleet is mid size or smaller. As a result most of our risk cars are in the market segments where prices are up, not down.
Currently the number of large SUVs like Chevrolet Suburban or Ford Exposition that we own at risk is zero. We do own a group of mid size SUVs like a Chevrolet Trailblazer or a Ford Explorer. These total about 4.5% of our fleet. While these vehicles have encountered a significant decrease in value, we believe that the worst of the value deterioration is over.
These units are still quite young and as a result, we will be able to keep them in the fleet for several more months. We plan to dispose of them in an orderly fashion between October and early spring, taking advantage of the normal seasonal upturn for this type of vehicle.
The impact of marking these vehicles’ depreciation to market is expected to be less then one-half of a point on total fleet costs, given that we can offset this charge with favorable positive adjustments from other units in our fleet.
I think the amount of supplier diversity in our fleet is also a positive in terms of mitigating our risk to any one manufacturer. We have seen this play out in 2008 where downside with respect to residual values of one OEM’s cars has been more then offset by strong results in other brands.
Lastly on the topic of fleet costs, in order to try and avoid any confusion, I should address why our per-unit fleet cost increased 9% Q2 if the used car market was performing so well. In short, this is more of a timing issue than anything else. As we mentioned on our first quarter call, there were certain program car benefits that we recorded predominantly in the second quarter last year, versus being split between the first and second quarters this year.
With a constantly changing fleet with hundreds of thousands of cars across 11 different manufacturers, some noise in quarter-over-quarter comparisons is not unusual. We think that our year-to-date per-unit fleet cost increase tells the story. It is 5.9% which is in line with our expectations.
Turning to the model year 2009 fleet purchase, we are well along in negotiations with the OEMs as is customary for this time of the year, and we have a pretty good sense of where our purchase agreements will end up. Access to cars is very good and we are looking to have even further manufacturer diversification of our fleet.
We are still working through the final risk program mix, but expect the risk car portion of the fleet will remain flat with this year at about 50%. Once again, our risk fleet is expected to be weighted towards small and mid size vehicles as we negotiate our fleet mix overall to tend more towards smaller cars to reflect changing consumer preferences.
Importantly we should also have a smaller SUV component in our fleet. In terms of per-unit fleet costs our estimate is an increase in the 2% to 3% range. This is our preliminary estimate and we will have a more refined look once we have completed all the negotiations.
Now I’d like to talk more broadly about our business. As any of our managers who have joined Ronald, David or I at one of our conference tables in the last few months know, we are being aggressive in trying to address the issues we are facing. We don’t want to put the long-term strength of our brands at risk but we’re not going to be timid about doing what needs to be done.
In particular, we have reduced staffing levels in all areas of the company from field operations to shared services to headquarters functions. We have implemented an energy recovery fee of $0.47 to $0.70 per day in most states to try to offset the impact of higher energy prices on our business.
We have trimmed our fleet, not only to reflect reduced demand, but also to support our strategy of achieving higher prices per rental day. We have significantly reduced our incentive plan accruals starting at the executive level and running through almost all levels of the organization.
We have dramatically curtailed discretionary spending and reduced our capital spending. We continue to push hard for margin improvement through increased sales of ancillary products and increased productivity of our people and our tangible assets.
And while we are fortunate to have many long standing and outstanding relationships with commercial accounts, vendors, marketing partners, service providers, and others, we have no choice but to take a hard line in our negotiations with them in order to preserve our economics.
These items that I have listed amount to savings measured in the tens of millions of dollars on an annual basis. All of this is in addition to the savings we have been telling you that we are achieving through our performance excellence initiative. [inaudible] is process improvement and strategic while the actions I have outlined above are tactical responses to our existing operating environment.
None of these actions are easy, but they are what should be done and that’s why we’ve taken them and expect to continue to take them.
Now I’ll turn the call over to David.
Thanks Robert and good morning everyone. I’d like to discuss our recent results, our liquidity and debt covenants, free cash flow and our update outlook for 2008.
In the second quarter revenue increased 4% to $1.6 billion, EBITDA was $77 million and pre-tax income was $25 million. EBITDA declined from the $87 million we reported in second quarter 2007 due to domestic results that were impacted by increased fleet costs, higher gasoline costs, and lower pricing.
In our domestic car rental operations second quarter revenue increased 4%, reflecting a 3% increase in rental days, slightly lower time and mileage revenue per day and a 13% increase in ancillary revenues.
Rental volumes increased despite a decline in enplanements largely due to our gross off-airport where rental days increased 9%. On-airport rental days were flat with commercial volumes down slightly and leisure volumes increasing a bit.
The data we have seen so far indicates that our volumes were in line with market trends, most notably a decline in domestic enplanements and weak commercial travel volumes. Domestic EBITDA for the quarter benefited from the volume growth from increased ancillary revenues and from cost savings from process improvement and favorable self insurance experience.
But the benefits of growth and productivity were fully offset by slightly lower time and mileage rates per day and inflationary pressures impacting gasoline, wage and fleet costs. Even with significant progress in reducing non-fleet expenses, it is difficult for us to grow our earnings when pricing is declining year-over-year.
Domestic fleet costs increased 9% on a per-unit basis, primarily due to timing issues as Robert discussed, but are up only 6% on a year-to-date basis in line with our expectations of 4% to 6% growth in per-unit fleet costs this year.
Our direct operating expenses decreased by 30 basis points year-over-year due to lower self insurance costs and other cost savings despite significantly increased gasoline expense. SG&A expenses remain flat as a percentage of revenue.
To recap this our domestic EBITDA decline of $13 million was primarily due to a $29 million increase in per-unit fleet costs and a $3 million increase in net gasoline expense offset by cost savings and ancillary revenue growth.
Our self insurance experience continues to develop favorably, which has reduced our insurance expense by $15 million year-to-date. And the penetration rate of where2 GPS rentals was more than 40% higher this year than in the second quarter of 2007.
Turning to international car rental operations, revenue increased 14% in Q2 driven by a 3% increase in rental days and 8% increase in time and mileage rates per day which was all due to foreign exchange and an 11% increase in ancillary revenues excluding foreign exchange.
EBITDA increased 19% driven by revenue growth, moderating fleet costs which were flat on a per-unit basis excluding the impact of exchange rates, increased ancillary revenues and lower self insurance costs.
The second quarter was the eight consecutive quarter of year-over-year revenue and earnings growth for our international segment.
In our truck rental segment, revenue declined 8% in the quarter due to a 10% decline in time and mileage revenue per day offset by a slight increase in rental days. EBITDA declined as the volume growth, lower fleet costs, and operating cost savings were more than offset by the decline in pricing.
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 carried our highest daily rates. Despite the positive rental day volume from commercial and local consumer business, one-way rentals which are directly correlated to the housing market continued to suffer.
We continue to invest prudently in our brands and our infrastructure. Capital spending totaled $24 million in the second quarter primarily for rental site renovations and information technology assets. The substantial majority of our CapEx is infrastructure related and as Robert mentioned, we are aggressively cutting back on discretionary items.
Our free cash flow year-to-date was $160 million reflecting both our efforts to focus on cash generation and a typical assortment of timing issues, particularly with respect to our fleet. We continue to target free cash flow of 85% or more of pre-tax income in 2008.
We are pursuing opportunities in working capital management and in our vehicle programs to reach this target. We expect to pay cash taxes of $20 million to $25 million in 2008 and our capital spending will be a bit higher than our depreciation and amortization expense.
More importantly based on our current projection for pre-tax earnings in 2008, our free cash flow target translated into a free cash flow yield on our equity nearly 20%. As we mentioned in our release, we have capacity to repurchase stock or bonds of approximately $110 million under restrictive covenants in our credit facility and we have $17 million remaining under our existing authorization to repurchase common stock.
We did not repurchase any stock in the second quarter as commercial travel volumes declined in May and June. The next step for us is to re-evaluate how we want to deploy cash flow and our capital structure. In the context of significantly different market prices for both our stock and our corporate debt then even a few months ago.
To be clear though, we consider liquidity to be particularly valuable in this environment and our cash flow deployment is likely to be measured. I want to turn now to our financing strategy and debt covenants.
From a funding perspective we believe that we continue to be reasonably well positioned in what is an unusually difficult credit environment. We are tapping both new and established sources of financing. For instance, in April we extended our borrowing capacity through a new lease facility through which we can finance up to $300 million of program vehicles.
In May, we solidified our existing financing and we replaced one mono line insurance provider with a higher rated provider on $250 million of asset-backed notes maturing in 2012. As a result, at year end we will have only $360 million of debt, 5% of our total, that is insured by [Sedgwick] or Excel.
Our peak funding need for 2008 likely occurred on July 18th and we met our peak need with $400 million of excess domestic vehicle debt capacity without any borrowings under our corporate revolving credit facility as planned.
From this point forward in 2008 we expect to reduce our fleet size and our associated borrowings. As a result we do not need to be in the ABS term debt market until 2009 although we expect to tap the term market earlier if the opportunity presents itself.
We do have two conduit renewals upcoming; a $1.5 billion renewal in October, and a roughly $1 billion renewal in February. We have ongoing dialogue with the banks in these annually renewing facilities that on average are about 50% drawn. We do not anticipate any rollover issues other then our borrowing spreads will increase by a point or more to current market rates for this type of facility when the renewals occur.
Next I’d like to discuss our debt covenants so that everyone knows where we stand. For what’s its worth, I should remind everyone that Avis Budget is a profitable company with growing revenues. We’re generating positive free cash flow, we are in full compliance with our financial covenants and our projections for 2008 have us staying in compliance with some room to spare.
Our business is a difficult one to project and even though the amount of cushion between our projected financial ratios and the required financial ratios under our credit facility is currently around $45 million its still less then we would like.
The most important financial ratio for us is our leverage calculation which compares the amount of our operating subsidiary’s debt as defined in the credit facility, to its latest 12 month EBITDA also as defined. We are currently required to keep our debt to EBITDA ratio at less than 5 ¼ to 1, and that ratio will step down to 4 ¾ to 1 in December.
For purposes of the credit ratio debt is calculated net of all but $25 million of cash on our balance sheet, so our debt balance as of June 30 was approximately $1.573 billion. EBITDA for purposes of the credit ratio excludes costs incurred at the holding company level of around $15 million a year as well as stock-based compensation of around $15 million a year.
Under that definition our LTM EBITDA as of June 30 was $390 million giving us a leverage ratio of 4 to 1 which is more than a point inside the current requirement and more than a half a point inside of the tighter ratio we will be required to meet in December.
Looking ahead we believe that we would still be in compliance with our financial covenants at December 31, if our EBITDA were $45 million lower then our current projections. In addition we have more corporate funds invested in our AESOP vehicle financing structure then the amount of credit enhancement that is required. These funds could alternatively be used to further reduce our debt as calculated under the credit facility which in turn would reduce the amount of EBITDA required to meet the covenant [test].
In short, while our funding position remains satisfactory we will continue to watch developments in the credit markets very carefully, prepare for the upcoming conduit renewals, look for opportunities to enter the ABS markets, and work to generate cash and earnings to increase the headroom we have in our covenant calculations.
Separately but still in the vein of hypothetical downside scenarios, you may recall that in fourth quarter 2007 we recorded an impairment to our goodwill primarily reflecting a decline in the market price of our common stock. In June, as you know, our stock price declined significantly and we saw a further weakening in July. If these trading prices persist it will likely be an indicator that our goodwill may be impaired in which case we may be required to record an additional non-cash charge to earnings, to further write-down the carrying value of our goodwill.
While such a charge would not impact our cash flows or our credit facility covenant calculations, it would reduce our reported earnings and our book equity. We will continue to monitor this over the remainder of the year.
Turning to our outlook, the weak economic climate, increasing energy costs, continued housing market issues, and airline capacity reductions, will generate headwinds for the remainder of 2008 versus our earlier assumptions of a modest economic upturn. Therefore as we discussed in our press release in early July, we have reduced our projected growth in domestic rental days to zero to 2% in 2008.
This reflects continued off-airport growth including insurance replacement growth offset by weaker commercial demand and the expectation that domestic enplanements will decline in the second half of 2008. We now expect domestic time and mileage rates to be roughly flat in 2008 driven mainly by the mix impact of weaker commercial demand along with off-airport growth with the longer length of rentals will drag the average price down a bit.
On the ancillary revenue front, our revenues from GPS rentals in the first half of 2008 increased $16 million year-over-year with pre-tax margins north of 70%. While we are focused on growing other high margin ancillary revenue streams, such as from electronic toll collection, gas, and insurance products, lower rental day volumes could dampen this growth.
We continue to project growth in our international EBITDA but any growth in our truck rental EBITDA will be modest due to the continued weakness in the housing markets. Based on these expectations, we project that total revenue will increase year-over-year but EBITDA will be approximately $350 million and pre-tax income will be approximately $140 million for full year 2008 excluding any unusual items.
This compares to 2007 revenue of $6 [billion], EBITDA of $409 million and pre-tax income of $198 million, also excluding unusual items. Our focus is on responding to a weaker then anticipated business climate by aggressively relooking at our operating costs, our fleet costs, our SG&A costs, and all of the other components of how we do business to find ways to strengthen our results.
We need every one of our assets to be working longer, harder and smarter to generate more earnings. The tools associated with our performance excellence process improvement initiative as well as our ability to replicate best practices across our organization are extraordinarily helpful.
In the challenging environment that we and others are facing we have seen and are acting upon the need to accelerate our efforts to reduce costs, garner incremental revenues and adjust our business model. In this vein we are making and executing difficult decisions. We are acting with urgency, particularly in the area of cost management. We are [hording] our resources as appropriate. We are asking a lot of our managers, employees, and vendors.
In the process we are positioning the business for longer term prosperity. With that Ronald, Robert and I would be pleased to take your questions.
(Operator Instructions) Your first question comes from the line of Chris Agnew - Goldman Sachs
Chris Agnew - Goldman Sachs
On the timing of your free cash flow through the rest of this year, should we expect the seasonal pattern that we saw last year which is cash flow generated in the third quarter and then cash outflow in the fourth? Also is there—can you give us any indication of changes in the collateral requirements on potential renewal of your conduit facilities and then you talked about reducing the fleet values going into next year, is that just the reduction in the number of vehicles or is there another element such as a reduction in vehicle values and if you could quantify that.
With respect to the timing of cash flow I think the seasonal pattern is fairly typical. The third quarter generally tends to be our strongest cash flow quarter and the only issue that may bounce around a bit this year is the timing related to vehicle programs where as you can see, our cash flows have actually been very strong in the first half of the year. But excluding the vehicle component I would expect our cash flows to be stronger in the third quarter and into October.
With respect to collateral requirements, we are not seeing any significant changes in how the rating agencies are looking at our fleet and at our asset-backed structures. So that remains pretty much the same. And then with respect to fleet values or carrying amounts, I think the only changes there are the normal seasonal changes in the fleet where our fleet will definitely be smaller at the end of the third quarter then it is currently and then again smaller at the end of the fourth quarter due to the seasonal demand patterns that we face and also reflected in that would be any changes in the market environment as well.
We expect to continue to move fleet in our car rental business to match up with demand.
Chris Agnew - Goldman Sachs
Can you comment on what the collateral requirements on the conduit facilities that you’re looking to renew, what they are currently if there’s not going to be any change?
Typically the credit enhancement requirements are in the low to mid 30s which allows us to generate an advance rate on the vehicles or loan to value rate north of 70%.
Chris Agnew - Goldman Sachs
And so because there’s no change, there shouldn’t be any incremental cash drawdown or usage?
Chris Agnew - Goldman Sachs
Just a clarification, in your previous guidance you talked about performance excellence and other initiatives to exceed $40 million and you’re repeating that today, but you’ve stepped up your cost actions, more aggressive cost actions, am I right in thinking that those more aggressive cost actions are really to offset inflationary pressures that have increased through this year or is there any implication in there that your performance excellence initiatives are a little bit disappointing versus where you’d hoped you’d be?
Performance excellence is absolutely not disappointing at all. It is meeting and exceeding our expectations. We’re going to generate $40 million or more from performance excellence alone and the other cost savings that we’re referring to, some of them are projects we had in mind early in the year and others are ones that we’ve developed and accelerated in light of the market environment. Performance excellence is doing everything we expected it to and we’re very excited about what its doing and how it’s doing it in our business. The additional cost savings that we’re working on have really been a response more to the market environment then anything else.
Your next question comes from the line of William Truelove - UBS
William Truelove – UBS
I was just wondering about thinking about the differences between the same store fleet size in terms of how we’re going to track the fleet versus the growth as you move more off-airport, so what’s sort of the net affect of the average year-over-year change in vehicle during the period? Is it still going to continue to increase because you’re growing off fleet or how we should we think about that on a net basis?
As we grow our off-airport, we do track what’s the fleet off-airport and on-airport and we attempt to regulate the size of the fleet for both ends of this business. And so as we talked about today, our off-airport business has been growing rather well and we continue to move cars out there. And on our on-airport business given some of the things that have been going on, it’s been rather stagnant. So we’re fronting the total fleet across both segments.
I think if you look at the total volume that’s in there and the projections that we’ve given you for volume, you could pretty much peg where the fleet is going.
William Truelove – UBS
In terms of the increase in truck fleet size, I was a tad surprised to see it tick up in the second quarter given the continued difficulty in the housing market; can you talk a little bit about what’s going on in the truck division?
I think the uptick you’ve seen really has to do with a different kind of truck we’ve put in there; we’ve added some cargo vans to the mix that we think are applicable not only in the truck business but in our car business. In addition to that we’ve opened quite a few stores with public storage and some of our fleet has gone out that way.
But the real uptick in the fleet has just been a change in mix to some smaller cargo vans.
Your final question comes from the line of Michael Millman – Millman Research
Michael Millman – Millman Research
Regarding the performance excellence and other cost, can you talk about what kind of flexibility you have in putting that money back into the company versus putting that money into the bottom line?
With respect to our performance excellence savings, we expect that to drop through to the bottom line. It is real savings and it’s all dropping through. We look at this as what are we bringing to the bottom line, we’re not looking to count some of it here and then push it back in somewhere else. This is real savings that’s hitting the bottom line dollar for dollar.
I do think though you have to consider that we will have wage increases over the course of the year and we are seeing some pressure from higher airport commissions, higher partner commissions that will tend to offset some of the $40 million but in terms of—in a static environment the $40 million will drop right through to the bottom line but our hope is that we’re going to more than offset other increases.
Michael Millman – Millman Research
Taking into account the realities of inflation--
Well I think you’re right, we have a $3 billion cost base independent of fleet and there are, you’re right, there are realities of inflation but I think that if you look over the last three years, we’ve been fairly good at increasing the productivity of our field operating staff and I think we’ve held the inflation down to less then a percent, so its always difficult to prove those savings in an inflationary environment but they do exist and we’re feeling very good about what we’re doing on performance excellence.
Michael Millman – Millman Research
You comment about basically that mileage is a major determinant of the price and you might have to look at long driving rentals in the negative way, if indeed on some weekend pricing you increase pricing to restrict that, can you live with that? Does that hurt your image for other business you’d like to do? That’s a yield management question, how efficient is it?
Well I don’t think anything we’ve said in this area is absolute. I don’t think we’re getting out of the weekend business. A lot of weekend business is very good and very profitable. However as we slice and dice it and look at mileage consumption, there are some bits in places—it’s a weekend business and certain places where we want to change it. How we change it is what we’re going through now. One way is with pricing. One way is with mileage restrictions and we’re looking at that.
I think what we were trying to let on, was that there’s been a belief here, a growing belief that as we have 50% of our fleet at risk, you can’t just consider the time you hold the car as we used to with [term-backed] vehicles that the real depreciation of the car happens a lot with the miles accredited. And so weekends are one place. There are other places we are looking at how the miles come on to the cars. We’re not looking to change our image at all. We’re not looking to drop or completely cut out any bits of business. This is more rifle shot or surgical then broad based.
Michael Millman – Millman Research
Your theory that if enplanements are down or that capacity is down there might be a pick up in certain secondary markets in car rental, how is that playing out in Hawaii which I guess is the leader in capacity reductions?
Well I think Hawaii is a little bit different. It’s a little difficult to drive from a tertiary market in Hawaii to another one, there’s water involved. I think this will play out more as we get into the fourth quarter domestically where you can drive and I’m sure you’ve looked at the same statistics we have on what’s going to go on in the fourth quarter, which airports are going to be losing service and what’s going to happen and so as you think about those airports and the ability to drive to a larger airport, that’s what we believe.
That’s a supposition, it’s yet to be proved out and we’ll see what happens as the fourth quarter comes.
Michael Millman – Millman Research
On a pricing basis, if you can give us a feel for how pricing is by different cars, depreciation I guess bottom line, return on individual cars.
I don’t think we cut it that granularly. Clearly we price the cars in a competitive marketplace and it has really little to do with what they cost and the like. If you look at the current environment it’s hard to even rent an SUV at this environment but SUVs probably cost two or three times as much as the small compact cars that we have that we can rent all day long for increasing prices. So it’s a little hard to generalize it. I think it is a marketplace type of event.
Let me just conclude by thanking you all for joining us today. Under the circumstances pessimism in the marketplace and negativity in the media is a normal reaction. It’s not really surprising. Even in the best of times the good news often gets lost amid the focus of what’s going on in the world. In our case it’s easy to overlook many of the positives that our dedicated employees and experienced management team continue to deliver on each and every day. It’s true we are experiencing headwinds from the macroeconomic environment but its really no different then anyone else. We’re meeting it head on, our flexible business model is performing as it should and we’re doing the things one would expect from a management team in these economic times.
Our outlook for the third quarter is reasonably favorable. For the fourth quarter it’s uncertain, but for the long-term it’s optimistic. We expect to be well positioned for this as we aim to continue to lower our cost base, we rollout new products and services, and continue to execute against our key strategic objectives. We look forward to talking to you next quarter. Thanks again.