Hertz Global Holdings Inc (HTZ) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Hertz Global Holdings First Quarter 2017 Earnings Conference Call. (Operator Instructions)

I would like to remind you that today's call is being recorded by the company.

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

Good morning, everyone. By now, 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.

I want to remind you that certain statements made on this call contain forward-looking information 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 our earnings press release issued last night and in the Risk Factors and Forward-Looking Statements section of our 2016 Form 10-K and our first quarter 2017 Form 10-Q. Copies of these filings are available from the SEC and on the Hertz website.

Today, we'll use certain non-GAAP financial measures, all of which are reconciled with GAAP numbers in our press release and related Form 8-K, which are posted on our website. We believe that our profitability and performance is better demonstrated using these non-GAAP metrics. Our call today focuses on Hertz Global Holdings, Inc., the publicly-traded company. Results for the Hertz Corporation are materially the same as Hertz Global Holdings.

On the call this morning, we have Kathy Marinello, Hertz's CEO; and Tom Kennedy, our Chief Financial Officer. I'll now turn the call over to Kathy.

Thank you, Leslie, and good morning, everyone.

Just two months ago, I shared with you a set of key priorities to drive sustainable, incremental growth in our U.S. rental car business over a multi-year horizon. Today, we remain committed to those priorities. We're realigning and upgrading our fleet mix to reflect customer preference and capture profitable demands. We are promoting loyalty through service excellence; our legacy systems are being updated for greater flexibility, increased productivity and enhanced capabilities; and we are leveraging our brands and capitalizing on our assets to generate growth.

Executing this long-term strategy requires a significant level of investment, and 2017 will take the brunt of the earnings impact with the 2018 better positioned to reap the benefits. Everything we're doing to transform the company is premised on having the right fleet. In the rental car industry, cars matter. Toward that end, we're taking a necessary depreciation hit this year to upgrade our vehicle mix to better match customer preferences, while at the same time, aggressively defleeting to optimize capacity quickly. As such, we knew the first quarter and even the first half of 2017 would be especially tough. What was unexpected, however, was that the typical seasonal upswing in used car values did not occur in February this year, as is usually the case, but was delayed into March, which put added pressure on earnings. Still, we sold 21% more vehicle year-over-year in the first quarter, in keeping with our long-term strategy to closely match fleet to realistic levels of demand to ultimately drive profitable growth. We did not chase demand to solve pre-utilization. In the first quarter, this combination of accelerated dispositions, a richer mix and a weaker-than-expected industry residuals value trends accounted for approximately 60% of the adjusted corporate EBITDA decline. And while revenue pressure continues to reflect the overfleeting across the industry, at Hertz we're committed to setting the stage for long-term value as quickly as possible. And the path to improved profitability has to come through revenue growth. Towards that end, we expect to have the U.S. fleet mix rebalanced and fleet levels optimized for profitable demand by the end of the second quarter. This should allow for utilization improvement in the back half of the year.

Service quality is another key priority for top line growth. We continue to invest in improving customer-facing processes to drive speed and service excellence. These are supported by the enhanced field incentive programs that I talked about on the last call. Additionally, I've created a new senior management position to oversee business process improvement, ensuring we strike a sustainable balance between operating efficiency and customer satisfaction in the field. Defining the right process and delivering it effectively the first time and every time is always the most productive path to generating customer loyalty.

Along those lines, we're investing in our people and our facilities as we ramp up Ultimate Choice. As you may recall, Ultimate Choice redesigns the Hertz rental experience by allowing customers to choose their preferred vehicle on-site with no wait. We introduced the program at an incremental 10 sites in the first quarter and added LaGuardia and LAX last month.

Today, Ultimate Choice is available in 22 of the top U.S. airports, on track for meeting our goal of 30 locations by mid-year, with national coverage expected by year-end. The early feedback from some of our most valued customers reinforces that we're on the right track with this initiative, which addresses both customer preference and improved utilization.

On the marketing front, we're focused on enhanced digital applications to leverage our assets and rebuild brand awareness. Investment in sales and marketing are on track as we remain committed to the strategic marketing plans I shared with you last quarter.

Finally, technology investments will support the success of all of our growth initiatives. As you know, these types of transformations can best be described as slow and steady, and Hertz is no different. I'm pleased with the progress we're making, the partners we team with and the pace of the work. It's never going to happen as fast as we would like, but the team here is thoughtful and forward-thinking and are committed to getting it done right.

In the first quarter, we continued to roll out our new CRM platform, which was launched in last year's fourth quarter. We expanded work on the fleet management and accounting system, which we expect to activate mid-year next year. We're also beginning the buildout of the reservation and rental system for a late 2018 introduction, and we've activated our second revenue management module.

As you'll recall, we launched the first new module last December to give us better segmentation of rates and a faster response time to market rate fluctuations. This second module provides a more accurate demand forecasting with which to better plan fleet capacity. While it will take some time to become fully proficient, we're already managing 70% of our revenue through the new system and expect to complete the deployment next month.

The global technology transformation remains an important strategic driver for us and a significant level of investment will be allocated here over the next 2 years. As you can see, we're executing on several important initiatives in the U.S. to drive revenue growth through customer preference. While some strategies are just being seeded and others are already beginning to take root, I'm confident that the long-term opportunities for our company are intact. Structurally, there is no reason that our margins won't return to competitive levels, especially given the contribution of our international operations and the Donlen leasing business. And with the incremental advantages we have, including the strength of the Hertz brand, our industry-leading loyalty programs, a portfolio of coveted partnerships, the new Ultimate Choice offering, a robust retail car sales network and, soon, a state-of-the-art technology system, you can easily see a path toward outperformance once again.

In the meantime, we're going to remain focused on our priorities in order to deliver a best-in-class customer experience with every rental.

Now let me turn it over to Tom for a walk through the first quarter results, some insight into what we're seeing in the second quarter as we continue the fleet alignment and other investments and an update on our balance sheet management initiatives. Tom?

Thank you, Kathy, and good morning, everyone.

Before I turn to the details of the quarter, let me provide you some context how we saw the quarter play out.

As you may recall, during our year-end 2016 call in February, we outlined for you the challenges we anticipated for the first half of 2017, including the following. We entered the year with more vehicles than optimal, began the early onboarding of full and premium vehicles in the fourth quarter of 2016 to correct our fleet mix. We indicated that we we'd be accelerating U.S. RAC fleet sales in the first half of '17, but would not have the optimal mix and capacity until the end of the second quarter; and as such, our vehicle costs would be higher than the prior year quarter.

We also said that U.S. RAC revenue will be lower in the first quarter as we continue to experience an unfavorable customer mix and be negatively impacted by the timing of Easter and leap year. We cautioned that the higher fleet costs and lower revenue would result in lower adjusted corporate EBITDA in the first quarter versus prior year. And despite this, we're going to continue to invest in our 4 key areas important to our turnaround strategy: fleet, service, marketing and technology, because we believe these are the areas that will deliver customer preference and revenue growth long term and ultimately enable us to generate competitive industry margin while positioning us for incremental future profitability.

For the most part, our expectations were met. The single largest variance, however, was that the seasonal strengthening residuals in the U.S., usually experienced from around President's Weekend in February through the end of the quarter, did not materialize until late March. As such, in light of the weaker residuals, we faced 2 choices. We could hold vehicles, wait for the residential market to improve in order to not take losses on those vehicles and then lower rental price to [bill] this extra capacity and drive utilization, or we could execute our long-term investment strategy, including enhancing the vehicle mix and optimizing capacity by continuing to sell into a weak market and, as such, realize higher losses on sales of those vehicles. We chose the latter, as evidenced by our 15% increase in U.S. RAC vehicle unit costs, driven in part by additional wholesale losses, a decline in transaction days and a decline in total rentable vehicle utilization as we move vehicles out of rentable fleet and into the remarketing channels. And while, admittedly, our U.S. fleet capacity is not yet optimal, we sold 21% more vehicles than last year despite the weaker residual market. Given this, as Kathy pointed out, nearly 60% of the decline in our year-over-year adjusted corporate EBIT earnings was driven by higher vehicle costs.

With this recap, I'd like to provide some additional details on the quarterly results and our perspectives on the second quarter. Let's start with the U.S. RAC segment. Total revenues declined 4%, driven by 1% decline in transaction days and a 3% decline in total revenue per transaction days. The reduction in year-over-year volume was driven in part by tougher comps due to last year's extra day for leap year, lower insurance replacement and [Florida] volumes due to a warmer winter; and the timing of our debit card policies, which has had a negative impact on revenue. Timing our debit card policy over has a positive contribution overall due to lower direct operating expenses as a result of fewer accidents, thefts and late vehicle returns. The 3% decline in total revenue per transaction day was driven primarily by a challenging price environment, as we believe the industry continued to work with excess fleet relative to demand. Pricing was also impacted by the loss of high-yield leisure rentals related to Easter calendar shift, which we estimate had an approximate 1 percentage point impact as well as an unfavorable customer mix, which included the increase in rentals to ridesharing customers that, despite the lower pricing, has a positive earnings contribution to the extended rental length.

On the fleet side, we continue to take actions in the U.S. to optimize vehicle capacity and mix. For the first quarter, total utilization declined 310 basis points year-over-year to 75%. Year-over-year decline was driven primarily by weaker-than-expected demand in February and March due to a milder winter which impacted our off-airport insurance replacement and [border] businesses, the early onboarding of additional new full-size vehicles beginning the fourth quarter into the first to rebalance the fleet mix and, as I mentioned, a 21% increase in vehicle risk sales resulting in more vehicles in various [stage] of remarketing channels. As a reminder, as new vehicles are in-fleeted but not yet rented or existing vehicles are de-fleeted but not yet sold, these cars are still included in our capacity calculation even though they cannot be rented.

Adjusting for this impact, at our first quarter, rental utilization was down 170 basis points versus the first quarter 2016.

Turning to depreciation expense. As I mentioned in my opening, we faced residual pressures in the first quarter. That, coupled with the investment in upgrading the fleet mix, significantly impacted our fleet costs, resulting in a 15% year-over-year increase in unit depreciation rate to $348 per unit per month in the quarter. As previously discussed, in the face of the weaker residual market, we continued to sell vehicles. This resulted in a meaningful wholesale loss in the quarter. We also continue to invest in the right fleet mix as evidenced by our [compact] mix declining over 200 basis points from year-end '16 to the quarter ended in the first quarter. And versus prior year, our compact mix declined 400 basis points in first quarter of '16 versus first quarter of '17.

Finally, we revised our full year residual assumption decline from a 3% decline to 3.5% decline given the first quarter sales experience. In face of the residual pressures, we are not passably sitting by, but rather working diligently to offset these challenges by steadily improving our overall quality of our vehicle mix, which should lead to stronger and more desirable mix of cars from future sales; working with our OEM partners to ensure our model year 2018 purchases' pricing reflect the reality of the residual environment; expanding our [ride-daily] rentals, which we provide through second-use vehicles with extended holding periods; and increasing sales through alternative marketing channels. During the first quarter, retail sales channels grew by 20% and Dealer Direct sales channels volumes increased 18% year-over-year. Overall, nonauction sales represented 65% of our [nonprogram] vehicle sales in the quarter.

As Kathy indicated, cars matter in the rental car business. We are keenly focused on achieving optimal mix and capacity level that leads to customer preference and ultimately improving profitability and competitive margins in the U.S. RAC segment.

Looking now at the international RAC segment, total revenue decreased 5% year-over-year to $411 million. Excluding a $6 million unfavorable currency impact, international RAC revenue decreased 4%. Transaction days grew 1% year-over-year, including a roughly 1% negative impact from the 2016 leap year comparables. The volume improvement was driven by strong demand in the Asia Pacific region as well as strong leisure demand in Europe, including a double-digit increase in long-haul inbound business.

International pricing decreased 4% year-over-year, driven primarily by the Easter shift in this second quarter. The international segment net fleet depreciation per unit decreased 1% from the prior year, [indiscernible] vehicle utilization improved 30 basis points year-over-year, driven by improved fleet management processes, including strategic procurement and greater use of alternative disposition channels. A higher proportion of our fleet purchases have moved towards program cars in country where there is residual value risk, in particular the U.K. Total fleet carrying costs for the quarter decreased modestly by 1 percentage point.

In total, the international segment's reported adjusted corporate EBITDA declined to $8 million year-over-year to $3 million, driven by the impact of revenue from the Easter shift, an increase in fleet financing costs and an increase in PLPD costs as a result of an adverse experience in case development.

Now I'd like to provide an update on our free cash flow, corporate liquidity and recent financings activities. Adjusted free cash flow for the quarter was negative $31 million compared to $12 million in the prior year. Corporate liquidity may remain strong at $1.7 billion. This was comprised of $785 million in unrestricted cash and $939 million of availability on our senior revolving credit facility at quarter end.

In addition, subsequent to the quarter end, we executed 3 financings totaling $1.25 billion to increase our committed vehicle financing capacity. Two separate transactions added $750 million in revolving U.S. RAC capacity and we successfully closed a $500 million term ABS transaction, which supports our commercial fleet leasing operations at our Donlen subsidiary. With this additional capacity, we are confident we have the secured liquidity necessary to cover our vehicle needs through next summer's 2018 peak season.

As discussed in our last call in February, we amended the financial maintenance covenant in our senior revolving credit facility to a first lien leverage ratio, which is tested on a quarterly basis. This is the only financial maintenance covenant that we have in any of our debt agreements. Our first quarter ratio was 2.4x, which was well inside the 3.25x maximum allowed.

Slide 17 of our posted presentation illustrates the calculation of this ratio. The covenant trailing 12-month adjusted corporate EBITDA used in the denominator is larger than the trailing 12-month adjusted corporate EBITDA reported in our press release. For purposes of the covenant calculation, we can add back items that are onetime, unusual or related to business optimization actions. As we pointed out, we are incurring significant costs related to our initiatives to modernize our IT platform, upgrade our fleet and improve our overall -- and, overall, improve our operational and customer fulfillment capabilities. Many of the costs are onetime in nature and can be added back to our trailing 12-month adjusted corporate EBITDA for covenant purposes.

We are currently comfortable that we can manage the ongoing financial maintenance covenant compliance. While we noted our strong corporate and fleet liquidity position, we are considering additional actions that we may take or could take to further improve our liquidity position. For example, in moving to a first lien covenant, we created the ability to utilize junior lien and unsecured corporate debt or subordinated ABS notes to refinance first lien corporate obligations and create additional permanent room under the first lien-to-leverage covenant. We will also consider utilizing financing of this nature to potentially refinance unsecured debt and further extend our corporate debt maturity profile. Both of these actions would continue to extend a liquidity runway that allows us the ability to invest in the business and improve our operating performance.

Now, I'd like to spend a moment to address questions we're receiving related to the impact of residual value declines on our rental car securitization financings. Those financings, at their core, are financing the residual value of the fleet. As such, it stands to reason that as the residual values decline, so should the amount of debt one can raise against them. So as residual values decline and we recognize that in the securitizations in the form of incremental depreciation, which drives down book values, our fleet debt balances will decline proportionately. This impact should be expected to occur on a timely basis, since our U.S. securitizations are subject to monthly third-party mark-to-market requirements, which will adjust advanced rates for a loan-to-value down to the extent and only extent that we have now already addressed the residual value decline through increases in depreciation. There will be timing differences, but ultimately the cash flow impact that the company would incur from this is approximately equivalent to changes in GAAP depreciation we record. As previously provided, an approximate 1% point change in residuals is equivalent to $60 million of incremental depreciation.

Importantly, this is the only significant financing impact of the declining residual values in our rental car securitizations. We do not have any other triggers or other provisions embedded in our securitizations that would cause margin calls or other cash requirements in excess of the decline we are actually experiencing in the used car market.

Finally, let me give you some color on what we are seeing as we look ahead to second quarter and our peak earnings season. We will continue to invest aggressively in fleet, service, marketing and technology in the second quarter. These investments will be a significant headwind throughout the year, but we expect to start seeing some benefits from achieving an optimal fleet mix and capacity level heading into the peak earnings season. We expect to continue selling U.S. fleet at elevated levels in the quarter which, combined with the now revised 3.5% decline in residuals this year, will result in higher vehicle costs. While pricing may be down again in second quarter, we are cautiously optimistic that pricing will ultimately improve to levels that are reflective of a higher fleet cost environment.

The early stages of a turnaround are always challenging as the right processes are seeded and incremental investments gain traction. In the near term, our focus is to get the fleet right and continue investing in service, marketing, technology to better -- to best position the company heading into the peak earnings seasons, where we traditionally earn approximately 60% of our annual adjusted corporate EBITDA.

With that, Greg, we'll open up the call for questions. Thank you.

(Operator Instructions)

Your first question comes from the line of Dan Levy from Barclays.

Just a couple of questions on fleet costs here. On the $348 that you reported in 1Q, how much of that was due to losses on disposed vehicles? And how much supplemental depreciation is in that? How long does that last? Just trying to get a sense of what a more normalized fleet cost level would be without all these aggressive disposals.

Thank you, yes. So the bridge that we would provide roughly is that our wholesale losses, given rate and volume year-over-year, the loss on unit and the increase in volume contributes approximately $20 per unit of the increase. The core residuals is approximately $30 of the increase, approximately $10 of mix, and we had favorability of about $16 through our retail and channel and other initiatives. So that gives you the rough bridge. Again, I would caution folks to indicate we do expect to continue to sell at elevated levels in the second quarter. I can't estimate that the losses will continue there. We expect them to decline as residuals have improved. As you know, the Manheim rental index declined 2% in April. That's an improvement from March. So we're seeing sequential improvement as we head into the second quarter. So I wouldn't necessarily want to give -- we're not going to provide any guidance for the second quarter or full year fleet costs, but recall, we are selling a lot of model year '16 cars. They didn't have the cap cost reductions when those were negotiated. The model '17 cars make up a higher component of our fleet mix in the second half of the year. Those that did have cap cost reductions in them, and will have less of an impact for the declining residual market that we would have experienced in the first half of the year.

Okay. And then just a follow-up also on -- but more on fleet size. The 4% within the quarter, obviously, you aggressively defleeted, but you ended up with higher fleet. And presumably, this played into your weaker pricing to some extent. If you could just talk to the extent to which this was driven by timing. And as we're thinking about the full year, how should we think about what size of fleet growth you'll have?

Yes. Again, we're not going to give full year guidance on capacity, to be clear. Yes, from a [excellent] reporting perspective, 4% was elevated. Keep in mind, we are having growth in our ride-sharing partnerships that is adding fleet. So our core fleet business is not growing at that level, so there is a comparable issues year-over-year. We're having growth in fleet specifically segment into that ride-sharing business which is contributing to the overall growth. We did enter the quarter at elevated fleet levels. You may recall that in 2015, we were able to get out about 67,000 program cars. In '16 in fourth quarter, we had less program eligibility. So we only got about 27 cars -- on about 27 program cars in '16. So it takes longer to get out of fleet, clearly, when you have more risk and there's more risk of getting out of that fleet. So we did enter the quarter with an elevated fleet, that coupled with we were taking higher-value cars in the fourth quarter despite knowing that, that would have elevated fleet in the first quarter, because our focus was to fix the fleet mix and not be concerned so much on our low -- level of our fleet in the first quarter, our utilization. So that was another factor that drove our elevated fleet levels. But we expect, again, as we've said, publicly and even after the year-end call that by the end of second quarter, we should have the optimal mix and capacity that we believe is appropriate heading into the peak earnings season.

Your next question comes from the line of David Tamberrino from Goldman Sachs.

My first question is just on the pricing side. You've been seeing residual values decline now for a while, I think, over -- for 9 months. We haven't really seen the industry respond to that as vehicle depreciation expense has gone up. So I'm just curious as to what you believe is really impacting and weighing on your pricing.

Well, I guess I would say, from our vantage point, we did show a slightly lower utilization levels, and that reflects the fact that we are not managing to utilization levels. We're managing to real profitable demand. And I think, as the rest of the industry starts reflecting that same approach as well as we start looking at, and seeing the normal recurrence of eventually the pricing matching the cost of the fleet, I mean, this is a business and there's just so long you can under-price and continue to take that hit of accelerated depreciation expense. So as we are very aggressively, as Tom and I have both mentioned, getting out of fleet, again, 21% more in the first quarter, The same level of intensity we'll have in getting out of fleet the second quarter. We believe we'll be in a great position to manage profitable demand and to manage back up to a normal utilization rate. But we are focused on, regardless of the expense at this point, getting the fleet right. And as Tom mentioned, we are bringing in higher quality prestige, full-size, more features and functions to reflect what our customers want to rent, and we'll continue to do that.

And if I could add, David, one of the things that might also be contributing to the industry situation in addition to what Kathy said, is the amount of program content in the industry is less, at least for some of the players than it was the last time we went through the cycle. It takes strong conviction to sell risked cars in a declining residual market and to rebalance your capacity. When you have more program eligibility, there's less risk at realigning your capacity and then trying to get capacity down and drive up price. So you might have a longer term lag effect. Historically, it's been about a 9-month lag between fleet costs and pricing realization, and I think everybody in the industry is clearly rational. So ultimately, as I've said many times in the prior year, eventually the industry gets -- everyone is rational. They'll price to recover rising ownership costs, but there may be some implications on this, more percentage of risk in people's fleets that causes folks to pause longer before defleeting in this environment.

That's helpful. And let me just follow up with Kathryn. I think you mentioned within your response a competitor under-pricing. Is that what I heard?

No, I didn't mention a competitor underpricing. What I basically said was, is we are not managing to utilization. We're managing to profitable demand. And that's why you saw a reduction -- or one of the contributing reasons why you saw a fairly low -- relatively low utilization rate. So you can -- the industry can take the approach as you have weaker demand and a larger fleet and you don't want to be aggressive in getting out of that fleet because of residual values, there could be a tendency to manage to utilization versus profitable demand, but we're not going to do that. I'm just making the point that, that's not something we're doing and it's not something we're going to do. And I think our numbers reflect that, to a great extent.

Your next question comes from the line from Chris Agnew from MKM Partners.

You talked about getting fleet rightsized for the end of the second quarter. What gives you confidence, both on maybe the demand side and supply side, that you can make that happen? And then what options do you have at that time to adjust if you're not rightsized?

I think that we have -- the demands in the next -- second quarter tends to be fairly predictable, pricing less so, both on what we can sell cars for and what the industry is going to be pricing at. But we have a very aggressive selling schedule. We have been consistent in meeting -- we have in 80 locations where we sell retail cars. We sell them at our off-airport locations. As Tom said, we're able to sell 65% in a more profitable way, avoiding total sales at the auctions. So we have been on track. We sold over 70,000 cars in the first quarter. We will keep that rate up, and we will have, by the end of the second quarter, a fairly good utilization level based on the cars we have and the demand we're seeing.

And to add, Chris, we establish our fleet plan. We don't make commitments to 100% of the [model year buy] 2017. So not only are we getting to an appropriate level relative to demand through dispositions, but we have uncommitted buys we're not committing to. And then from an optionality standpoint, we believe what we're establishing as a fleet plan that allows us to flex up as demand materializes as opposed to which we historically I think (inaudible) to, a strategy which perhaps is more of a flex-down strategy, which is more difficult to react to. And to be able to flex up, the leverage you have to pull there is hold fleet longer and take an additional deliveries that we had not committed to. So we kept a large open hole in our 2017 buy to allow for that flexibility. And so as you go into 2Q, that's the hole that's basically not having to take deliveries of model '17 that helps build some of that capacity.

And we will not be holding cars for long periods of time as the way to meet demand. We -- I found over the years that there's a lot of people out there that love to sell cars and would love to sell cars to us, particularly in this market, as there is some pressure on car sales. So we believe that fleeting up is a lot easier to do and a lot more profitable to do as versus trying to rapidly get out of cars that you don't have the demand for. And that's going to be our approach going forward.

And if I could just follow up. You talked a lot about brands. And can I ask about Dollar and Thrifty brands and how you feel they are positioned? What investments you're making to support them? And as -- from a top-down perspective, it appears the price point for those brands has fallen. Are you experiencing more pressure around Dollar and Thrifty?

I think pricing in the industry, in general, has fallen. And in order to maintain being competitive as the industry drops price, we're obviously forced to follow if we're going to maintain sales and share. To that extent, I do believe we have under invested in our brands, and we're working very diligently around how to invest in greater segmentation, greater services and focus on those brands. And going forward, as we have the right fleet in place and make great strides in our service capabilities, we will have a lot more investment in optimizing our digital channel as well as reinvesting in those brands.

Your next question comes from the line of Chris Woronka from Deutsche Bank.

Wanted to ask you if you could maybe -- I know you're not going to give guidance, but maybe if you can bucket some of the investments you're making and give us a general sense as to the scope and timing and how we think about that affecting cash flow kind of on a full year basis, again realizing you're not going to give us specific numbers, but just maybe directionally?

Yes. Chris, this is Tom. So the investments we're making, fleet is a big component this year. I would say, the fleet, the systems, sales and marketing is starting to ramp up, and then we're doing some things on the operations side of the house since Kathy's arrived, from personnel and incentive and things like that. She drives the right behavior, right service levels. So it's across what we think has the greatest levers.

The pace of investments, candidly, is approximately, based on our outlook, approximately equal every quarter. Although as a mix changes, where fleet is heavier weighted in the first part of the year and then it goes to more marketing and service kind of mid-year to the latter part of the year. But the pace of the investment is about the same. We haven't disclosed the amount, but it is approximately in the $70-ish million a quarter impact to EBITDA, with an incremental $150-ish million incremental impact to EBITDA year-over-year. And again, that's a very significant level of investment relative to our overall earnings. But as we stated very clearly, we believe that this focus and this effort is necessary -- critical to drive Hertz to preference and ultimately drive profitable growth. So that gives a little color into the investment. I don't want to give too much details. Again, Kathy's new and into the tenure and that could change, to be clear, but that is kind of our current plan for the year as we go through this year.

Okay, great. And then as we think about pricing, I think there are a couple of things that probably impact comparability year-over-year, right? One is the more rentals to ridesharing companies; the other would be having a larger vehicle. Is there any way to quantify that, just the impact of it, maybe over the year or in the forward quarters?

Yes. I mean, the ridesharing business, again as I indicated previously, it was pretty small in the first quarter of '16. It has been growing pretty rapidly here in the first quarter and has added a good 1.5 to 2 points of fleet capacity to sell for that or provide for that level of demand. So it is a profitable contributing component of the business, because it is an alternative use for fleet that's older. There is a high demand for cars at that price point. So we have looked at a pretty -- detail, it is a profitable piece of business, and we think it is a component of kind of a new opportunity that we want to continue to participate in, but we aren't going to get into too many more details than that.

I guess I would add, we look at pricing and where it's going to go or how we think about it. As pricing becomes more rational through the actual expense of the cars and less around meeting utilization levels, if things follow historically what they've done in the past, we should see more firmness in pricing towards the end of the year.

Your next question comes from the line of Michael Millman from Millman Research.

I guess, a couple of things. He indicated that when some of the competitors reduce prices, you have to go with them, which has always been the story. And yet, it seems not to make a lot of sense in terms of trying to keep the price up. So maybe you can talk about your philosophy there and what it might cost you not to go along. Secondly, when we looked, at least, at the average fleet of -- in the first quarter, it was up 4%, whereas in the fourth quarter, it was up 3%. Maybe you could talk about when -- wherever you expect the fleet to be up, down by the end of the second quarter or by the end of the year; and any other color on kind on where the feet levels should be?

I guess, on your first point, I didn't say we took unprofitable price, but I did say, obviously, if in general the industry is dropping price based on meeting utilization levels, we will have to, in some cases, lower our price, but we don't take unprofitable business to that extent. But it would obviously impact our overall pricing strength and ability. And I'll defer the second part of your question to Tom.

Yes. So the kind of the cadence, Michael, if I'm going from 4Q to 1Q is, as you indicated, one of the components of that is the ridesharing component of our fleet growth, [good growth] fairly significantly 4Q to 1Q. So that's contributing to the overall fleet growth. The core business is down, the year-over-year increase in the quarter from 4Q to 1Q, the core business is down. As we stated, we expect to be at the appropriate level of capacity by the end of second quarter. We're not going to give forward guidance to what that means relative to overall fleet growth, but it just -- as we believe, it is appropriate relative to what we expect our demand to be. And as we've said -- Kathy and I both said, the strategy really has been revised to focus on a flex-up strategy as opposed to a flex-down strategy from an overall supply standpoint.

Related to the fleet, can you give us an idea as to your thinking -- or at least roughly your thinking on the State Farm contract which, we understand, you're renegotiating -- or negotiating currently?

State Farm has been a great partner. It's a great business for us. It's profitable, and we hope to be doing business with them for a long time into the future and we hope that business will grow. We are working hard with that partner to grow that business. We love it.

Your next question comes from the line of Anj Singh from Credit Suisse.

Kathy, a follow-up to an earlier question, asked another way as it relates to your confidence in an improved 2018. It seems that the weak residual environment could persist for some time. The rental car industry does not really seem to be responding to the cost pressure via higher rental rates. So do you think that the industry can ultimately push prices that can offset fleet costs to the degree that it actually increases your margins? And how much of your optimistic outlook is predicated on a better operating environment externally versus internal factors?

Well, first of all, I'm not sure I would call it a realistic outlook as versus optimistic. But I do think that pricing is a function of supply and demand and fleet cost changes. And as we talked about, we are tightening our fleet ahead of the peak, and we're -- we obviously were playing -- will be paying close attention to what the industry looks like at that point. But again, I think, as Tom mentioned, as residual values come down and we go into our 2018 buy, we have to work and look at realistic deals with our OEMs that reflect the pressure we're seeing on residual values. And so I think, to that end, it will depend on consumer demand, car prices, both the depreciation expense we have now as well as the new cars we're going to be buying. And then how we manage that demand on a utilization buy; a smarter approach to fleeting up as versus trying to fleet down, I think, will make a difference in our 2018 outlook as well as at the end of this year.

Okay, got it. And as a follow-up, if we look at your results this quarter, it seems that there wasn't a whole lot of investments impacting the degradation in EBITDA. So is your investment agenda at all constrained by some of the pressures you're seeing on pricing and fleet costs? Or is that just timing, and have you identified any other areas warranting attention aside from the items we've been discussing as it relates to your investment spend?

Yes, Anj, it's Tom. So no, the actual investments, although you saw -- I think you're probably referring to looking at our financials and seeing SG&A down year-over-year, recall that we still have the benefit of our cost savings initiatives which is helping to kind of dampen and offset the investments we're making, so you don't necessarily see it reflected in our GAAP financials. Nonetheless, the level of investment this quarter, as I said, is going to be consistent with every quarter at the $70 million-ish range. Fleet was a disproportionate amount of the investment this quarter impacting us, and that will start to move to -- in the second half of the year, more sales marketing operations is investment in the second quarter. So you're going to see that level of investment kind of consistent throughout the year. And as I said, it's going to be a headwind throughout the year as we go through each quarter.

Now we actually stepped up our investment in our choice rollout. We stepped up our investment in customer-facing service incentives for our employees. We stepped up investments as well in our digital space and in some of our demand and revenue modeling. So we actually -- going throughout the quarter, as I've come across, what I think are very sound growth initiatives as well as service initiatives, we continue to invest. And we haven't backed off on driving the right fleet mix, and that is one of the areas that has impacted a lower utilization level. So if anything, obviously it takes a lot of tenacity, given what we know we were dealing with from a depreciation, to be smart and not basically mortgage our future by making some cuts that make no sense this quarter, because of the timing. But anyway, we'll continue -- we have a plan. We're working the technology, the marketing, the fleet and the service initiatives as aggressively, if not more aggressively, and searching for more investment opportunities to bring growth back to the company. We're -- we can't [touch] the way into creating value, and we understand that. And I think what Tom pointed to is, before I arrived, there were some real smart decisions around infrastructure like outsourcing our legacy systems and some solid productivity improvements that have -- make us, from an operating expense and from those percentages, we're actually very competitive. What is drawing us down from an expense-base perspective is the significant and continuous investment in the business to get back into being a growth company and really taking advantage of the great brands and all the assets this company has.

Your next question comes from the line of James Albertine from Consumer Edge.

Wanted to maybe ask, to the degree that you can share on sort of early second quarter environmental -- sort of operating environment. We're seeing some airline data that suggest that April was a much bigger improvement year-over-year, certainly, and maybe some acceleration in the rate of change as well from prior months. Is there anything that you can provide as to the, again, the early 2Q environment at this stage?

I would say, April year-over-year, the big difference there was Easter was in April. And so that did have an impact. But right now, we are assuming some of the headwinds we've been dealing with will continue into, at least, the early part of the second quarter.

Very good. And if I may, as a follow-up, just ask more of a clarification. I think there have been a few questions on here that I've tried to get to the same question. But to the extent that we could talk sort of pre and now post your taking over leadership role at Hertz, just trying to understand, if we were to look back at 2016, can you help us delineate how much of the underperformance was related to things that were sort of out of Hertz's control relative to some of the things that you mentioned, i.e. underinvestment in Dollar and Thrifty and perhaps, as I read through that comment, perhaps some lost share to peers? Just trying to understand how much of it was sort of exogenous versus self-inflicted?

It's a great question, and I'm going to be very candid and honest about it. The move down to Estero, Florida, it's not -- we have great talent here, and we've been able to attract great talent here. One of the things that I've really been pleased about is consistently coming across people who are doing great things and are having an impact on the company. The challenge really was, in the move, we lost a significant amount of the people that were running the business. And over the last 2 to 3 years, we've been hiring back that talent and building back that team. But we lost a lot of -- or the company lost a lot of momentum during that time when very significant jobs in marketing and other areas of the company weren't getting done. And so now, the great news for me is I am leveraging the talent and the great ideas that are out there from a top line growth perspective, trying to make sure we prime that pump with more investment and more focus and bring back the type of operating rhythm that this company had in the past, both from a service perspective, but I think more importantly, what we're doing around our digital channel, how we market and how we leverage a really best-in-class loyalty program, and how we really embrace and hold both our corporate customers.

And then I think the final self-inflicted issue was incredibly optimistic demand forecasts around the fleet, and buying a fleet in a couple of bad misdirected ways, buying a lot of cars that weren't of the size and type that we could rent, and buying way too many of them, and not managing more rationally around the summer peak, and buying much too much fleet across the year to manage a couple of months.

And so if you think of everything that I just talked about, it's absolutely self-inflicted. Much of it is behind us, and I think we've been pretty consistent on -- we are going to invest in this company and do the right thing despite some pretty painful headwinds right now. So it's not the operating -- I would say, it's not the environment that I would have loved to walk into. I'd love to have -- pricing is up, fleet costs are down, to do what I have to do right now. But I think we have a team and a plan that we're going to stick to and that we see it bringing some goodness pretty quickly in the future into later this year and into 2018. But as Tom has mentioned, the investments are going to continue for quite a few quarters at this point.

Your next question comes from the line of Hamzah Mazari from Macquarie.

This is Kayvan Rahbar, I'm filling in for Hamzah. Could you walk us through some of your updated thoughts on the Donlen business and how you see synergies playing out between Donlen and the rest of the portfolio?

Well, you may or may not know, for 5 years, my last 5 years at GE, I managed the largest corporate fleet leasing business in the world. And so -- and it was a great business to run, profitable and a lot of great assets and capabilities. I loved the business. They're doing a great job. They've got great growth. They've got some great technology in managing the fleet that we expect to leverage across the car rental industry. It's a great business. We love it.

Your next question comes from the line of Adam Jonas from Morgan Stanley.

Kathryn, first one for you, and kind of a follow-up on the last question. But any thoughts, high-level, on strategic alternatives for the non-U. S. RAC operations, in particular international ops and Donlen, where there are some natural, let's say, logic to be part of the overall company, but perhaps exist in separate enough markets, either geographically or vertical, that could achieve a better valuation for shareholders?

If you look at where -- 2 points. We are a global world, and it is hard to exist in a global world if you don't have a global network. So I think Hertz has built out a very, very competitive, strategic global network with a combination of franchisees and locally owned businesses. And given where the mobility world is going, when I was over in Europe and went through a pretty strong deep dive on some of the technology that's being developed over there, there will be very solid applications to the U.S. business as well as maybe even Donlen. So if you look at the requirements that are being put into place over in Europe around being able to locate a car if it's gotten in an accident, if you're a rental car company, and the applications that, that will be able to use and apply over here in the U.S., once that's launched in 2018, and then you look out into the future around managing large fleets in the autonomous world, I can't -- I don't think there's anybody better positioned in this industry than Hertz with those 3 sets of assets to lead in the future around mobility. We are great at managing fleets, and we're great at it, both large corporate fleets as well as globally, and that is going to be an invaluable set of assets into the future.

Okay. And just a follow-up for Tom or Kathryn about cap structure. You outlined, I think, very briefly, Tom, some of the alternatives to term out those '18 and '19 maturities, which, I think, combined, are about 2/3 of the market cap. I think, over 100% of your caps over the next 3 years. I guess, the question, you didn't mention equity. Where does equity stand? Because one could argue that this business could use a little equity, and I know there's a cost to that, obviously, but is equity totally out of the question or where does that stand in terms of a potential reconfiguration of the cap structure?

Thanks, Adam. Yes, we have no plans or intentions at this time for any equity issuance. We believe that, given our internal expectations on our performance improvements plan and the other acts that we may consider in the second quarter such as a second lien that we will provide -- we have sufficient liquidity now through next summer's peak, as I said, in 2018. And we have -- opportunistically we could pursue other debt instruments such as a second lien to provide further capacity and provide further room. So we don't have any plans for any equity issuance at this point.

Your next question comes from the line of Justine Fisher from Goldman Sachs.

The first question is just a follow-up on that junior lien issue. Can you tell us exactly what this size of your second lien basket is and what the size -- I guess, it wouldn't be a basket for junior ABS issuance, but how much capacity you have to issue Junior ABS and the timing on what you're thinking on that potential issuance?

Yes, Justine. So we don't disclose what the size of the second lien basket could be, but it is fairly significant. So there is quite a bit of capacity there for us. And again, we haven't -- we were ongoing evaluating our options, and we haven't made any decisions as far as timing.

Okay, and then the follow-up question is on the letters of credit. I saw that the letters of credit were up pretty significantly since the end of the December quarter and this actually helped on the covenant compliant front because, correct me if I am wrong, I think you get to net LCs against the revolver size for the calculation of that leverage covenant. But per the 10-Q, the letters of credit are posted for your facilities and also for, I think, collateral for the ABS. So can you talk to us about why the amount of LCs went up for the quarter and whether that's something that we should expect to increase going forward? I don't know if vehicle value changed, et cetera, like why that went up? And should that continue to eat away at revolver capacity? Or would it go back down in the future?

Yes, Justine. Yes, that's correct. Our LC capacity increased about $190 million from year-end to first quarter. Some of that was related to, as you said, that was what our creditor issued for, insurance reserves, airports as well as, as you said, for a collateral securitizations. We did have some increase related to ensuring that we maintain, as we talked about last quarter, our AAA rating and our Moody's rating. So we put some additional capacity of collateral in the securitizations to maintain that AAA rating. We did have some additional collateral requirement for some insurance as well as just on the abundance of caution, we did increase some of our LCs in the securitization to ensure, as you said, that we did -- we can utilize that vehicle for management of our covenant. As you probably know from our financial statement, we have $1 billion of capacity LLC available in our revolver. And the credit agreement does limit it to $800 million, to be clear. So we can only, from a credit agreement management standpoint, utilize it up to $800 million for that purpose.

And your final question comes from the line of John Healy from Northcoast Research.

Kathryn, I wanted to ask kind of a philosophical question. When I hear you talk about the business, you talked about bolstering revenue growth, you've talked about how pricing is really dictated by supply industry and supply and demand, that you can't really drive demand. You kind of have to take it. But you've also said that you don't want to pursue a utilization strategy at the company. I'm trying to understand why not? Because if I look at the remarks, there's stress on the operations that you're trying to fix, there's input costs that are rising, and the company also has a little bit of stress in the liquidity metrics. So I'm trying to understand why you want to pursue a strategy where you focus on utilization, you cut the fleet and you say, "Hey, we're going to start," [you at that point experience] in pricing. Is it that you want to get back the market share that Hertz has lost over the 3 or 4 years? I'm just trying to understand why you guys won't cut the fleet, allow the pricing to rise in the industry and, as such, fix the operations when you have more cushion?

I find your question somewhat ironic, given that our -- one of our competitors consistently accuses us of over-fleeting and driving down the prices through over-fleeting. And yet now you're saying I shouldn't be doing that. And basically, that really is about, if I am driving down prices because I'm over-fleeting, it's basically I'm managing capacity. I have a ton of cars out there and I will take any business to bring some revenue against those cars. So I'll go low, I'll drive price and I'll do whatever it takes to spread the cost of those cars. And so I find it interesting that you're questioning that, but most of the analysts are accusing us of damaging the industry because we're over-fleeting. So it would be great if somebody could be consistent on what they want us to do and what they think would work.

Now we're pricing -- and I'll say it again, we are going to go after a profitable demand. If honestly, if you go too low, you guys can figure it out, you're going to lose money. You will end up losing money. There is a threshold that if you rent a car too low, you're going to lose money and you're going impact negatively your EBITDA, and we are going to avoid doing that and have been and will continue to.

And at this time, there are no further questions.

Thank you and have a great day.

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