Hertz Global Holdings Inc (HTZ) 2017 Q2 法說會逐字稿

Welcome to the Hertz Global Holdings Second Quarter 2017 Earnings Call. (Operator Instructions)

I would now like to remind you that today's call is being recorded by the company. I would like -- now like to turn the call over to our host, Leslie Hunziker. Please go ahead.

Thank you. 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 the 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 and in the Risk Factors and Forward-looking Statements section of our 2016 Form 10-K and our second 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., a publicly-traded company. Results for the Hertz Corporation are materially the same as Hertz Global Holdings.

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

Thank you, Leslie, and good afternoon, everyone. The second quarter results reflect the continuation of the work we're doing and the investments we're making to transform the company. The weak results were in line with our expectations. There are always inefficiencies and incremental expenses in the early stages of an operational turnaround, as processes are being assessed and redesigned, products are being transitioned and investments are being seeded and expenses incurred ahead of the results. And even though inefficiencies in investments, coupled with U.S. residual pressure, have caused earnings weakness in the first half of the year, early progress on our strategic initiatives is validating the long-term plan.

After joining the company 7 months ago, the first thing I did was to flatten the organization and put together our cross-functional, collaborative team in the U.S. to redefine the strategy and develop our multi-year turnaround plan. The overarching goal is to position Hertz for consistent, long-term growth as the industry leader. You will recall that as part of this effort, we reviewed what was working and what wasn't. We prioritized initiatives, and we committed to spending the necessary amount to fix the issues and upgrade all aspects of the business.

In 2017, we've allocated gross nonvehicle CapEx of more than $200 million, targeted towards technology and facility updates to build a smart network that leverages our data and distribution assets to serve our customers more quickly and flexibly in every channel. In addition to these capital expenditures, we expect to incur approximately $300 million of expenses against adjusted corporate EBITDA this year to improve the rental experience from fleet quality and service excellence to digital e-commerce platforms and systems update. A big piece of that includes investing in our employees, equipping them to deliver enhanced service, convenience and product expertise. The end goal is to drive sustainable, broad-based customer preference for Hertz, Dollar and Thrifty. After a tough first half that focused heavily on getting the fleet right, rolling out our Ultimate Choice process, upgrading our financial and revenue management systems and assessing service opportunities, we've now made some great progress that we can build on.

Let's start with the cars. At the end of June, we achieved our goal to reduce the size of the U.S. fleet from the original plan set late last year. As I mentioned on the last call, our philosophy is to size the fleet to reflect realistic, nonaspirational demand. Being kind means that we can focus on higher-profit rental and that we'll enter shoulder periods with more manageable inventory levels. Excluding the dedicated wide handling fleet, our average core fleet was down about 3% in the second quarter year-over-year and down 5% on an absolute basis at June 30, 2017 versus June 30, 2016.

In addition to getting capacity right, we've also been successful in getting the fleet mix right by reducing the number of less popular compact cars to 16% of the total U.S. fleet from 21% a year ago and from a high of 23% in Q4 of 2015. We've also upgraded term packages to reflect customer preference and competitive standards. Having the preferred fleet that customers want to rent eventually means we'll have the preferred used cars that customers want to buy. That will drive higher residual values and lower fleet costs.

A lifetime effort in expense has been allocated towards this key initiative since the fourth quarter of 2016, and we've taken an unusually large hit to depreciation as a result. A higher-quality fleet is clearly more expensive on the front end. At the same time, the currently less desirable compact cars are more expensive on the back end. Accelerating dispositions to reduce the fleet size is also costly because it means we're selling at the steepest part of the depreciation curve. All of this on top of cyclically weaker car residuals on our existing fleet caused significant downward pressure on earnings. But there's definitely upside. Now that the fleet is fixed, the outsized residual pressure should abate somewhat. Lower new car prices are being negotiated to address the residual weakness, and we've proven we can better leverage our 80 retail car sales outlets when we profitably sell more than 70,000 used cars annually, making us the ninth largest reseller nationally.

We're also capitalizing on our large and growing dealer network. The combination of these higher-return used car channel accommodates roughly 65% of our used car sales each year. And as I said before, if you're buying the cars that customers want, that means we'll eventually be selling the cars that buyers want at higher prices.

Our focus on customer preference is all-encompassing. And the areas that are reflected in the rollout of our Ultimate Choice program, which 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 13 sites in the second quarter, added 5 more last month and have already upgraded 2 additional locations in August. As of today, Ultimate Choice is available in 37 of the top U.S. airports, on track for meeting our goal of achieving national coverage by year-end. The early feedback from some of our most valued customers continues to reinforce that we're on the right track with this initiative, which addresses both customer preference and improved utilization.

To further our goal towards service excellence, we're supporting our employees with new tools to facilitate their day-to-day work and allow them to service our customers in new ways and faster. And we brought on 4 new leaders to drive standardized site operation improvements through training, recruiting, continuous improvement miles and customer process technologies. They've been working on quick wins for the summer fleet and longer-term solutions for sustainable, best-in-class service execution. Improved processes and a seamless customer experience ultimately reduces cost and drives higher revenue. So these investments are critical.

Also critical to our success is developing and introducing the latest systems and online technologies to gain maximum efficiency, leverage advanced data analytics, offer new products and facilitate customer engagement. With an enhanced rental management system now in place and the recent rollout of our new financial chart of accounts, the Hertz technology transformation is moving forward on schedule. Major deployments of our new global reservation, rental and fleet asset systems are scheduled for 2018, with some systems already completing the build phase and moving into the testing phase in the third quarter of this year.

In addition to our major frontline systems, our digital environment is getting a total overhaul. And the first deliverables will be introduced at the end of this year with our North American Hertz.com site and a new mobile application for our customers. We also have marketing campaigns launching online to increase customer engagement and raise awareness. And we've recently partnered with new agencies to refresh our brand strategy and redefine the value proposition while we rebuild our market position in the U.S., leverage our mobility initiatives globally and prepare for our 100-year anniversary next year.

Before I turn the call over to Tom, I just want to reiterate that our multi-year strategy is designed to generate sustainable growth by retaining customers who rent from us today, regaining less customers and converting casual customers to committed customers, giving each of them more reasons to rent from Hertz, Dollar and Thrifty more often. At the same time, we're assessing and developing the best experience for future customers by leveraging our advanced technology initiatives, rental car scale and fleet logistics capabilities and Donlen's corporate fleet management and telematics expertise, ensuring we're at the forefront of the transportation, mobility evolution.

We'll continue sharing our progress as we redefine both the near-term and long-term experience for our customers. With that, I'll turn it over to Tom.

Thank you, Kathy. Good afternoon, everyone, and thank you for joining the call. During my update, I'm going to provide an overview of our second quarter results, an update on our balance sheet and capital market initiatives and provide some early insight to how the third quarter is developing.

As you may remember, on our last call, we said that we expected the second quarter to be challenging as a result of continued increases in U.S. RAC vehicle costs, driven by expected declines in market residuals and our elevated sales activity, as we resize the fleet capacity and rebalance our mix of car classes. Continued pricing pressure in U.S. RAC due to the inevitable inefficiencies during the fleet transformation and continued elevated levels of spending to fix and invest in core areas of our U.S. business like fleet and service as well as in global technology and marketing initiatives, all with a focus on a commitment to delivering long-term growth and margin expansion.

Since it is our largest businesses segment and the focus of the operational turnaround, let me start by providing some insight into the operating performance and revenue trends in the U.S. rental car segment. In the second quarter, total revenue declined 4%, driven by a 3% decline in transaction days and a 2% decline in total revenue per day. The 3% reduction in transaction days was in part the result of 4% decline in off-airport volumes due to last year's high-level replacement rentals and significant customer vehicle recall activity. Airport volumes declined 2%, consistent with the first quarter's results, as the company focused on higher-quality revenue with rising vehicle costs and due in part to the impact of enforcing stricter debit card policies, which we discussed during the first quarter call.

Total revenue per day in the U.S. declined 2% year-over-year, with both airport and off-airport experiencing the same level of decline. Growth in our ride-sharing rental business contributed approximately 1 percentage point to the overall 2% decline. As you're probably aware, ride-share rentals are offered at discount rates due to a specific longer rental period and the lower fleet costs incurred by using second-life vehicles. As a result, they have favorable margin contribution.

While overall second pricing declined, April pricing was positive versus prior year, primarily driven by the Easter calendar shift from March of 2016. And although May pricing into mid-June was negative, we started to see positive pricing momentum coming out of June and into July, as our fleet tightened and seasonal demand began to pick up.

On the fleet side, in order to reduce capacity to optimal levels and get the correct vehicle mix heading into the third quarter peak season, we had to take significant losses on resale in the first half of the year. But our efforts paid off, and we met our fleet objectives, which positioned us well heading into the peak earnings season of the year.

Our average unit fleet for the quarter declined 1% versus prior year. And as Kathy mentioned, if you exclude the dedicated ride-sharing rental fleet, our average fleet for the quarter declined 3%.

Also, as Kathy mentioned, the fleet mix adjustment was completed by quarter end, with compact mix at a more appropriate 16% of its whole U.S. fleet, down 500 basis points from a year ago. While compact vehicles are still a necessary component of our fleet mix, customer preference and earned loyalty upgrades drive the need for higher mix of larger vehicles.

To achieve the fleet level, it makes it necessary to address profitable demand and customer preference, we sold 35% more risk vehicles compared to the prior year quarter on top of a 21% year-over-year increase in risk sales in the first quarter 2017. Given the elevated sales activity, the shorter length on certain models as we accelerate this position to meet our goals and the general market residual pressures, wholesale losses per unit were nearly 4x higher this quarter than what we experienced a year ago. This impact was somewhat mitigated by sales to higher return alternative channels, which represented 60% of total rent sales in the quarter, a 500 basis point improvement over last year.

Fleet utilization in the U.S. declined 130 basis points year-over-year. We estimate the incremental sales activity contributing approximately 110 basis points to the decline, as vehicles are in various stages of remarketing channels, given the elevated level of sales activity during the quarter. Average monthly depreciation in the U.S. was about $353 per unit in the second quarter, similar to the $348 per unit we reported in the first quarter, reflecting a 27% or $75 per unit increase versus the prior year quarter. When we translate it against an average fleet of 495,000 units, the cost increase of the fleet equated to over -- at over $100 million negative impact to our total company adjusted property EBITDA versus the prior year quarter.

The wholesale losses on risk sales, when combined with other impacts of resizing our fleet and mix, contributed approximately $38 per unit to the $75 per unit increase. Investments in higher quality and mix of our fleet represented a $13 per unit increase. We estimate that the core residual decline contributed approximately $32 per unit of the increase, all partially offset by an $8 per unit decrease due to lower capital cost and model year 2017 vehicles and other items.

Now let me turn to the International segment. Total revenues increased 1% to $542 million versus the prior year quarter. Excluding an $18 million unfavorable currency impact, international RAC revenue increased 4%. Transaction days grew 6%, driven by a strong Easter holiday, and we continued to experience favorable growth in leisure volumes, both local and inbound. Leisure volumes were particularly strong in the U.K., France, Italy and Spain.

International pricing decreased 1% on a constant currency basis versus prior year quarter, largely due to the growth in the lower RPD value brands. Net depreciation per unit increased 2% in part due to a lower residual value in certain jurisdictions such as U.K. and Germany and due to a richer mix of fleet. Vehicle utilization increased 120 basis points as a result of the growth in leisure volumes and improvement in fleet management procedures.

In total, International segment reported adjusted corporate EBITDA of $63 million, an increase of $21 million, reflecting lower insurance costs year-over-year as we took permanent actions to reduce our risk profile.

Now I'd like to provide an update on our recent financing activities, free cash flow and corporate liquidity. As I'm sure you are well aware, we closed on a $1.25 billion second lien bond in early June and used a portion of the proceeds to retire the $250 million senior notes due in 2018 and reduce our senior revolver commitment by $150 million at the end of the second quarter, which freed up a like amount of second-lien proceeds to unrestricted cash.

Our intention remains to deploy the remaining second-lien bond proceeds of $834 million, net of fees, to retire corporate indebtedness. The remaining proceeds are classified as restricted cash on our balance sheet and will remain as such until we redeploy the funds for that purpose.

Our determination is that the conditions precedent to the reduction of the 2019 note had not been satisfied, was a result of our continued evaluation of the transactions related to the second-lien notes, including our evaluation of the appropriate corporate indebtedness to retire such proceeds.

The third quarter is the key quarter for the rental car industry and for Hertz where we've earned 50% to 60% of our annual adjusted corporate EBITDA. We believe knowing actual July-August results will allow us to best determine how to optimize repayment of corporate debt across our capital structure.

We also anticipate we'll facilitate our ability to execute extension of our revolving fleet facilities with our bank group. As I'll share in a moment, the early signs are encouraging that the third quarter will be a significant improvement from the first half of the year results.

Our intention is to make these determinations regarding the deployment of the second-lien bond proceeds, by or before the end of the third quarter, and to probably take the appropriate actions to implement those initiatives. To be clear, the redemption of the $450 million in outstanding 2019 notes is still being considered, together with our other refinancing options, and we do not intend to have the current need to use the proceeds from the second-lien bond offering for our ABS structure. Rather, we intend to use the proceeds as originally planned for the refinancing of our corporate debt maturities.

Now turning to cash flow. Adjusted free cash flow for the 6 months ended June 30 was negative $566 million, mainly reflecting the negative $428 million of operating cash flow, excluding digital depreciation, related primarily to higher fleet costs and lower RPD in the U.S. In addition, net nonvehicle CapEx of $92 million, largely reflecting the ramp-up of investments we are making and $46 million of fleet growth were incremental use of cash -- were the incremental use of cash in the period. This 6 months of fleet growth usage reflects an intentional increase in letters of credit of $158 million.

We ended the second quarter with $1.15 billion in corporate liquidity. We expect to generate positive cash flow in the second half of the year, increasing liquidity from its current seasonal low point, essentially, all of our liquidity in the form of unrestricted corporate cash on our balance sheet. We will revisit the amount of cash we expect to carry on our balance sheet as we move through the third quarter.

From a financial covenant perspective, we ended the quarter at 2.56x on our first-lien leverage ratio calculation relative to the covenant threshold of 3.25x. Our trailing 12-month corporate EBITDA cushion relative to the 3.25x threshold was $79 million and $55 million using the year-end 3.0x threshold. We will continue to evaluate the third quarter operating results and are confident through improving performance and our decisions around deploying the remaining second-lien bond proceeds that we'll have the sufficient headroom against our first-lien maintenance covenant.

Finally, open-market acquisitions of the company's common stock by third-party investors recently resulted in a technical change in control for U.S. federal tax purposes.

Such a change in control limits how certain tax attributes, including net operating losses, can be used in future periods. However, due to the large built-in gains in the company's fleet resulting from our like-kind exchange program, the tax ownership change has no effect on the company's U.S. tax liabilities or its future NOL usage.

Now before I turn the call over to the operator for questions, I want to provide some commentary on what we're seeing early in the third quarter. During the first half of 2017, we were keenly focused on positioning the company to optimally participate in the peak earnings season through the efforts on getting the fleet levels and mix corrected, implementing operational improvements, including continuing to deploy Ultimate Choice products and delivering our operating revenue management system. These efforts, in addition to the ongoing operating capital expenditures we are making to fix and invest in the business, have clearly negatively impacted the first half of the year results. Nonetheless, the early signs of these efforts are encouraging. With our U.S. RAC fleet level and mix at desired levels, we expect our level of fleet sales will decline significantly in the third quarter as compared to the second quarter, which will reduce the pressure in fleet costs we experienced in the fleet changes in the first half of the year. Further, we will have a greater proportion of fleet comprised of model year 2017 vehicles, which are less expensive on a like-for-like basis and miles year 2016 vehicles. All factors should favorably impact depreciation costs sequentially related to the second quarter results.

Preliminary U.S. RAC revenue statistics are also encouraging. Preliminary July U.S. RAC revenue of $613 million is an approximately 1% decline versus prior year, driven by a 4% decline in transaction date as result of our efforts to improve revenue quality. And preliminary U.S. RAC total revenue per transaction day increased approximately 3%, which is a significant improvement from the second quarter results on a year-over-year basis.

It also should be noted that like second quarter, the growth in our ride-share business has a lower average daily rate and, therefore, has an approximate 1-point negative impact on total reported RPD relative to prior year.

While it is too soon to predict the ultimate outcome of August and September, our bookings for August are consistent with our July experience, with approximately 55% of the month of August booked now. And while September is traditionally a shoulder month, we intend to work aggressively to maintain disciplined fleet levels and pricing more relative to the fleet costs.

International RAC bookings are also looking positive, including in the U.S. and Asia, despite the recent terror events abroad. In summary, while our first half year results were disappointing, we took the actions necessary in fleet, operations, sales and marketing and technology to position the company for the third quarter and to continue to invest in the long term for margin expansion and growth.

With that, I'll turn the call over to the operator for questions. Operator?

(Operator Instructions)

And we do have a question from Chris Agnew with MKM Partners.

Tom, thanks for all the detail on fleet cost, depreciation. So as we think about the second half of the year, is it fair to take the sort of second quarter run rate? And then if we eliminate what you identified as the wholesale rebalancing figure, I think it was about $38, does that give us the kind of run rate we should be thinking about for the second half?

Chris, clearly, our objective in calling out the unit cost is to give you and the investors a perspective of what we believe to be more transitory versus what should be ongoing impact on fleet costs. The ongoing impact on fleet costs will be the mix investments we're making because we're going to continue to be at that level. We have not changed our view, but we'll continue to have the impact of that view, the residual decline in operating (inaudible) although recent data would indicate maybe that's starting to abate somewhat. There's been some positive news in our recent -- our own performance in July on our wholesale sales and our retail sales, or we're not posting losses anywhere close to where in the first half of the year, which, again, is a good leading indicator, that when we do our rate beginning in September, we should be in line. So we did call out in the first quarter and the second quarter what we believe to be the impact of the elevated sales, the losses on those sales. And as a result, we believe that it's transitory in nature. So we're not giving guidance, but I think it's a good way to look at how you would disaggregate our fleet costs and try to get to what is a run rate impact versus what is really kind of transitory in nature.

Good. And then just a follow-up. The ride-hailing impact you identified in the second quarter, I think you said it was a 1% headwind on second quarter pricing. Would that be fair to assume that, that's the same through the rest of the year? And then in July, that would imply that pricing is actually stronger without that headwind, about 4%?

Yes. I mean, I think this is the first quarter, I think, we've been more transparent because it's starting to become more significant. And it's important for us to clarify kind of what the core year-over-year impact is on rate relative to what might be a new business model that's growing and it's at a lower RPD. So yes, it's fair to say, in the second quarter, that had about a 1-point impact on the pricing. So ex that, the pricing would have been 1% better. The July results are consistent. We're not giving kind of forward guide. The riding business does start to grow a little bit in the fourth quarter, but the impact for the second -- for the third quarter, the relative impact is around another 1-point headwind on the reported external pricing. But again, from our perspective, if you think about the July results, preliminary results being up 3 is really on the core business, it's up 4.

And we have a question from the line of David Tamberrino with Goldman Sachs.

Great. Maybe just following up on that. The size of your ride-hailing fleet, can you just dive into how big that is? It didn't seem like it was that large to begin with, but you're calling out impacts to fleet size, I think utilization as well and pricing. So how big of a fleet is that at least today?

Yes, David. So again, we said that the fleet decline, I think it's around 2 points difference between reported and the core. So it's about 2 points. If you think about our average fleet, that's about the size of the fleet that's dedicated to ride-hailing. We had essentially very little last year, so from a year-over-year standpoint, it is fairly significant and it's been growing. During the third quarter, it's not growing as much because as we experienced second quarter, as the bulk is just going to be on the core business that's during the peak earnings season. But we expect it to then start to grow again after we get past the peak earnings season.

Got it. And then the higher pricing that you're able to get so far through July, is that enough to offset the incremental vehicle depreciation expense from the premium vehicles that you're buying?

Well, every 1-point increase in pricing annually is worth $55 million as a sensitivity, and we said in prior quarters, our investment in mix is around a $78 million investment on the mix. This year, it's $70 million to $80 million. So from an investment, from a mix investment relative to pricing, the pricing we're getting would be more than what's required. But you have the mix investment and the residual environment, and what we're working towards is a number of drivers to try to continue to mitigate the residual impact and that is continue to grow the disposition channel to retail and alternative, which are higher profitability and then working to -- with our OEM partners to negotiate pricing that's reflective of the market environment as what the residuals are. So those are factors that, I think, the people need to think about. The fleet costs are cyclical in nature, and there are factors that help over time to abate that increase. We, I think, have been disproportionately impacted in the first half of the year on our fleet costs because of specific issues related to Hertz on driving out excess fleet and significantly taking elevated sales and elevated sales and losses. And that will abate in the second half of the year as well.

And we now have a call from the line of Yilma Abebe with JPMorgan.

My first question is, if I look at the restricted cash balance of $879 million, is the proceeds that were expected to be used for '18 redemptions, is any of that in there? Or has that been pulled out?

So the restricted cash on the balance sheet at quarter end is primarily made up of the second-lien bond proceeds that are going to be used, as I said in my opening remarks, to be used by the end or before the end of third quarter on the redemption of corporate debt.

Okay. So the redemption of the '18 that have happened already, that's fully reflected in the closing balance sheet?

Correct. The redemption '18 was an event that occurred prior to the end of the close. The remaining proceeds, and then we did cap the $150 million of the revolver and then there were $16 million of expenses. And so the remaining proceeds of around [$134 million] are what primarily comprised of restricted cash on the balance sheet at the end of second quarter.

And we do have a question from Chris Woronka with Deutsche.

I think, Kathy mentioned a number of about $300 million investment and not really the CapEx, just kind of operational initiatives flowing through this year. Is there a way to kind of think about how much of that is onetime in nature versus how much will stick around?

Yes. I mean, I think, the preliminary item there that is more run rate would be the fleet. There's a portion of that investment, which is really the fleet mix that we said is $70 million, $80 million. We'll obviously continue to iterate that and optimize around that, but Chris, that is one that will continue largely. There are some sales and marketing that will determine at what's the right level of sales and market that might continue. But largely, there's a lot of IT investment that's even -- there's CapEx IT, below [line] IT. But there's EBITDA impacting IT that is going to be transitory in nature, meaning we're going to have elevated levels of IT this year and some of it next year. But ultimately, that's going to, obviously, stop as we modernize our systems, and that's not going to continue. So I would characterize, we haven't determined our 2018, 2019 plans yet, but there's a portion of that we'll continue that we'll be reiterating around what the optimal kind of run rate is on step-up in sales and marketing and then the fleet mix.

Okay, great. And the follow-up is, I know you guys have significantly refreshed the fleet and kind of a little bit off-cycle this year. But I assume you'll still be buying some model '18s at some point. Do you guys have a preliminary view on what that might look like in terms of pricing cost?

Yes. I mean, we have -- we were purposeful in what our commitments are in model year '18. We have committed to probably around 50% of our buy, what we expect to buy. We'll always leave a proportion of what we ultimately believe we need uncommitted to create flexibility or offer flexibility of spot deals as well as just making sure we have clarity where the market is headed, overall demand market is headed from a transaction standpoint. So that will continue. We're achieving -- as I said, we're working with our OEM partners who have been great to work with, who have been helping, I think, the company evaluate what the residual market is and where it's headed and negotiating pricing that we believe is reflective of the reality that there's residual risk in the out years. And so that's what we've been negotiating from a pricing standpoint on that fleet.

I think we've also looked at what the fleet -- the fleet mix, what's in the fleet and how to buy smarter and better. And we're not phasing into the same kind of challenges for the year going out, either for the '17 buys or the '18 buys. And the OEMs, we have great relationships with them. And even on some of the '17 buys, we've been able to change some of the mix and what goes into the cars to come up with a better mix of cars that our customers are looking for as well as will sell at a better price when we go to sell them out into the future. So overall, I think, prior to me joining and since then, we have a continuing, improving relationship with the OEMs to create a win-win situation. If we're buying vehicles that are more desirable, that's going to help the residual market as well.

We have a question from Michael Millman with Millman Research.

So from -- I think, from what you said, it sounds like you will be paying less for model '18s than you pay for model '17s. Can you also tell us what you expect the size of fleet to look like June 30 of '18 compared with the current size?

I mean, Michael, we haven't finished all our -- we have assumptions kind of what kind of a relative growth is. I think GDP is historically a good indicator privy. But obviously, as you noticed from our first and second quarter results on fleet and our third quarter early to July kind of dates being down, fleets down as well in July not equal to the dates being down, but it is down a couple points in July. We're going to be targeting to be somewhat conservative on a fleet level standpoint relative to maybe how the company perhaps is living in the past. And the strategy is going to be the fleet to flex up when the demand materializes and hold cars and/or get more cars in as opposed to, I think, when we were kind of trapped in the past as having a little bit too early optimistic recovery curve, which was resulting in levels of fleet that requires to flex down, which, as you know, is much harder to do having followed the industry as long as you have. It's much harder, particularly with less program content in your fleet mix. So we'll be conservative in our approach. We'll be having a strategy of more flexing up and flexing down. And I think we'll be disciplined than, perhaps, we have been in the past.

Okay. And changing the subject a little bit. Can you talk about where you think you stand on general technology AI kind of things with Avis and where you think you stand compared to that with RAC? And you might also add in terms of where you think you are in terms of conversions.

Well, yes, I would say, we've been somewhat quiet on this in general, but we are working with 3 different AI groups. And we've found, particularly on the revenue management side as well as the fleet management side, we've been getting some pretty solid insights that have helped us, and we started to feel some of the impact around bookings and pricing. We also will be using this from a fleet buy and demand perspective to better match where our cars are needed and where the demand is. But at the same time, we're getting some real insights into our customers, our customers' needs and also around the sales process. We're very fortunate that we have a terrific sales network for being best-in-class around buying and selling cars. And as we apply some of these AI capabilities in that area, we think we can do better at picking all the right cars as well as knowing where to sell and when to sell them to maximize our value out of those cars over their lifetime with us.

And we now have a question from the line of Dan Levy with Barclays.

Could you provide some broad strokes on the weak free cash flow in the quarter? I think it was a $530 million use of cash. And does this relate to why your revolver was fully drawn? Was there a true-up of the ABS trust in the quarter?

Yes, Dan. So the big-picture change in kind of corporate liquidity from a core (inaudible) about $570 million change in corporate liquidity. And these are approximately through your free cash flow, so they're approximately equal. Operational performance, obviously, has been disappointing, driven by the relation between pricing and fleet cost, particularly in the U.S. -- in the U.S. That is approximately a $240 million drag on liquidity from quarter-end to quarter-end. As we said earlier, we are in a very elevated period of nonvehicle investments. So year-to-date, I think we're up to $90 million and in the quarter alone, it was 45 and 90 year-to-date, so nonvehicle CapEx is up. And then fleet was around $250 million. But to be clear, about $170 million of that is for -- of course, for Europe. As Europe is even more seasonal pronounced and that we're in need of cash there. We did not receive the facility in place this year like we had last year, so we used more corporate cash of European facility. There wasn't a large true-up per se in the ABS -- U.S. ABS. We do have mark-to-market and we're constantly making a month of lease payment. There is ebbs and flows of that requirement. But yes, generally, we did -- we drew the revolver for some of that seasonal facility. That's with the revolvers therefore. It's to fund the seasonal needs, particularly this year when Europe just had its separate seasonal facility, we did rewind and revolve that. As we said, we wanted to make sure in my remarks, we had the liquidity on the balance sheet at the end of the quarter, and we'll determine the third quarter, along with our determination by or before the end of the quarter, the use of the restrictive proceeds of paying down debt, corporate debt. We'll also determine what's the right amount of unrestricted cash and undrawn revolver to have at the end of the third quarter.

Yes. Got it. And just as a follow-up. If I had to break apart some of the price declines we've seen in the recent years, I know, in the past, you've talked to the negative mix shift that we've seen due to the loss of share around large contracted customers. So I'm just wondering, what have the share trends been in large commercial? I mean, have those share decline ceased? Are you finally starting -- is there a path to seeing improved share and thus improve the mix? How long does it take to yield the benefits of that better service offering around that?

We are already seeing some of the benefits. We did just bring on a fairly large international client that we moved 99% or 98% of their business over, and it's actually run very successful. We're also seeing the stabilization of our corporate share as well as the percent of share that we have in accounts that we call splitter accounts. So we have a really solid team from a sales and relationship perspective. And they have been going out and raising more attention to the Ultimate Choice rollout, the significant improvement in the mix of cars, the service improvements that they're seeing and some of the promotions that we've been running as well. So again, we are starting to see some of the benefits of the hard work and the upgrades, generally speaking, as we've made the revenue management and system improvements, along with improved service, Ultimate Choice and better cars, we are slowly and surely starting to see the impact.

We have a question from the line of John Healy with Northcoast.

Kathy, I wanted to get your thoughts, just generally speaking. I know you're not giving guidance or anything like that, but I have to say that this is probably one of the more optimistic calls I've heard from Hertz in a while. And I'm beginning to wonder if we're at a kind of inflection point. You guys have talked to positive pricing trends. You've talked about fixing the fleet issues. I got to imagine you're starting to get some benefit from some of the initiatives in place. You've kind of changed the team running. Are we at a point where it's reasonable for investors, do you think, to start expecting EBITDA growth on a year-over-year basis? I know, last year, you guys had a tough third quarter and, I think, around $330 million. But I just want to try to see if it's reasonable for us to start benchmarking dollar improvements more so than just kind of the discussion points?

Well, I'll go back to something I said as I first joined the company, which is, there is absolutely nothing structural that exists in this company or the marketplace that Hertz can't return back to the margins we've seen in the past. And most of the issues have been self-inflicted. But at the same time, we are really playing catch-up for multiple years of not investing in the company. So it's not like I am trying to fix something that just went wrong for a year or 2. There were multiple years where the investments were made in the technology, in the service, in the fleet that we're having to call back on now. And so I think the positive that I feel is, when we come out at the end of 2018 with the technology updates in place, with the better fleet in place for now well over a year as well as we're doing a lot of hard work on just getting the right process in place out of our different sites, ensuring that as we have these better cars, that we're running utilization rates, that the cars are clean, that they're well-maintained and things that sounds easy, but getting everybody through the exit gate and making sure everybody's in the right car even when it's touchless where they can just walk in and get into one of the Ultimate Choice cars, there's a lot that goes into it. So I'm not going to be too aggressive on when we'll start to see us back up at those margins. But one would hope we will slowly and surely see improvement in our revenue, improvement in the pricing to better match the quality in the cars, the service as well as the cost of those cars and then start to see the goodness that comes out of doing the right service or the right process at the right time in the service. But I think, as everybody knows in this industry, it's how well you buy and sell the cars, and it's how well you match the bookings, the supply and the demand with price as well. And so I think, with a lot of the work we've done around the earlier question around AI, the lion of the work we're doing with AI and machine learning and understanding supply and demand and where the cars need to be, it's a learning process. But I think, as time progresses, we've got the right initiatives in place to really start seeing the benefits. So I don't know that I really answered your question. It maybe boils down to, it's going to be probably another solid 6 quarters of hard work and fairly hefty investments. But then structurally, we should start to see some real strong goodness coming out of it.

Okay. Fair enough. And just one follow-up question. I apologize, I was going through security when Tom mentioned at the airport. But could you touch on the change of control item? I wasn't too familiar with everything you guys were saying there. What was the threshold that was kind of touched? And is there any sort of impact to the tax-free status of the kind the spin associated with the threshold that was breached?

No. There's -- John, there's no impact to the tax-free status of the spin. It's not related. It's a technical IRS regulation that there's a trailing 3 months monitoring of shareholders, buyers integrator and how that changes over time. And if you essentially have a turnover in that, that exceeds 50% ownership, that you then trigger a potential limitation of NOL usage. That is the traditional way to look at in a car rental company like ours that has a large built-in gain as a result of like-kind exchange program. You can essentially mitigate any limitations on NOL usage because you've built-in gain and you can amortize that. Built-in gain is an offset, so you essentially don't have any limitations on your NOLs.

From the line of Anj Singh with Crédit Suisse.

I was hoping you can discuss your pricing improvement commentary for July and early Q3. Would it be possible for you to discuss how much of that is being driven by mix versus, let's say, ancillary versus -- I'm trying to get a sense of what is apples-to-apples, just pure pricing from better environment versus things like mix or your ability to yield pricing through systems upgrades. And then, I guess, related to that question, can you give us a sense of where the new modules are starting to have the most tangible effect? Which KPI do you expect to show improvement here in the early days?

Well, where we've seen some very strong improvements, and I think it is tied to a better fleet, Ultimate Choice, better operations and clearly, our revenue management system, is in the Hertz brand. We're really seeing some goodness there from a retail and overall perspective. We're doing a lot better in matching supply and demand there. At the same time, we're also seeing pricing move up in our other brands, our value brands. What we have seen not as much strength in is the ancillary product in revenue there. So again, as we look at, we do have -- we brought in 2 new agencies around branding and positioning in our products to work with us on how to better position our different ancillary products to match the needs of our customers. So they are more attractive, and we are able to get better pricing on this. At the same time, though, we've seen a much better match between understanding where the supply and demand is coming from, from the AI work that we've done and the revenue management system that we have in place. And we're still working as above. It's not 100% there. But we're already seeing significant strength for both July, August and even going into September from our efforts there.

Okay, got it. And then for a follow-up question. Would you be able to share your fleet mix outside of compact cars? Is it -- like right now, perhaps, which segment are you most skewed to now that you fix this compact car exposure?

Well, generally speaking, we are down to 16% on compact. And then what we've done is we do have -- we still have a pretty big market for midsize and full-size, but then we've also moved a lot of that percent of what was down in the compact into the SUVs. And the good news on the SUVs is they sell for a really -- they hold the residual values very nicely. And in some cases, we even sell -- we were able to sell at a gain. So we're seeing pretty good goodness there. So basically, we have about 50% of the mix in midsize and full-size about, I would say, another 35% up in SUV, specialty and premium and then 15%, 16% in compact. And I think, the other thing to note is we've been really smart in negotiating with the OEMs to trim and just basically what's inside of the car. And so the features and just smart things like -- things like cars that are easy to clean and maintain overall. So we've done a lot of good work with the OEMs to make sure that the cars -- what's in the car is what our customers need and want as well.

From the line of Hamzah Mazari with Macquarie Capital.

The first question is just on pricing. Was hoping if you could give us a sense of what commercial pricing is doing in July. How much of your commercial business is currently contracted in your view on whether commercial follows leisure?

I wouldn't -- I guess, I don't necessarily see commercial following leisure. I think there has been consistent pressure on the commercial pricing, and that's due to the competition around that space. So we didn't -- I think a lot of the goodness we saw in pricing was more around the leisure retail area. We didn't see significant downturns in commercial pricing, but I don't think that's an area that we're going to be able to see much movement upwards then due to the competition level.

Got it. And just a follow-up. You mentioned sort of 6 quarters of heavy lifting. You threw out a $180 million incremental spend number. We talked about $80 million on the fleet side. Is the investment spend going to come down in 2019? Is that the way we should view this and that most of this is a catch-up in order to effectively turn around the business?

Yes. I would say that we will see it come down in 2018. Not hugely dramatic, but it will be, I think, significant and noticeable. And then '19, even more so. We -- it is a -- candidly, this is just a phenomenal amount of investment spending that we are bringing in very close and in a time frame that normally you'd spread over 5 to 7 years. But the reality is the Board and the management team think we can't wait any longer, and we have to move on, beat the challenges that we have in building these improvements. If you look into the future of autonomous driving, right, which I do think is 8 to 10 years out. I'm not one of these people who thinks it's just tomorrow. And I have a pretty deep involvement with OEMs, and in this market for quite a while around this space. No matter what, you have to be really great at managing a fleet, and you have to have the assets that make you really great at managing a fleet. And the good news for us is the better we are around doing that and the more time and money we spend into investing that, not only do we create enormous goodness within our current business, but it really does position you for winning down in the future. And so as companies get into this autonomous space, and they -- there's nobody out there that has, I would say, the assets we have in this regard, and that we have both Donlen, which actually -- we're in our Donlen building right now in Chicago. So we have a large, very significant corporate fleet management company that manages large corporate fleets and all the capabilities around that. And then we also have this consumer base, large rental car company that we're focusing on being the best at managing fleets and getting the best service and profitability out of that by the investments we're making right now. So in my view, and I think our team and our Board's view is to prepare for the future, it's about making this company operate at a very high level around how it manages fleet and then combining that with a great corporate fleet management company, we'll be very well positioned in the future. So the good news is, we just have to focus at business at hand, and it's the best preparation for the future.

From the line of Doug Karson with Bank of America.

I wanted to just dig a little deeper on the revolver draw. I understand that it's used for this purpose, but $1.1 billion of cash from the balance sheet seems to be a little bit in excess of what you may need to run the business. And if cash flow is going to be positive in the second half of the year, was this a prudent action? Better safe than sorry? Or is this cash you may need in the third quarter? Just seems like it's a lot.

Yes. I mean, Doug, as I said in my script and in my remarks, and I think I can answer that question, we disagree. I think we were being prudent going to the peak earnings season. Clearly, we have a hell of a lot of investment, but we also wanted to see the visibility in July and August, as we're now seeing, and to ensure that as we expected -- as we did expect internally that we start to see improvements in pricing, improvement in the performance of the business that, that would give us the better clarity and transparency for ourselves to determine then what's the right amount of cash to have in the balance sheet, in fact, half year versus revolver paid out. We acknowledge there's negative carry. It's not normally what we do, but we wanted to. With the elevated sales of fleet activity in the second quarter and, really, the first half, we wanted to see the residual market's near-term performance, wanted to see our sales on our wholesale in July and August, we want to see pricing and everything else. And it clearly is a seasonal period, too, where, as you know, we -- our fleet's up, International fleet's up even more significantly in the second quarter and even U.S. And we did have a seasonal facility in place this year in Europe. So we expect the second half of the year to be free cash flow positive. The earnings, the early indications are it's even better than our internal expectations. And so we'll revisit as we enter the third quarter, the optimal level of cash and undrawn revolver, along with the deployment of the second-lien remaining proceeds on the refinancing of the corporate debt, all kind of as part of kind of a comprehensive conclusion of kind of our work on our balance sheet initiatives.

That's very helpful answer. I just have 1 or 2 other follow-ups, so kind of squeeze in. You may have already answered this question. I know investors are kind of interested about the decision around the '19s and the $830-some-odd million of cash you have restricted for that purpose. Would you entertain buying back longer-dated debt that has a lower dollar price in the kind of the context of that restricted cash? And also, can that restricted cash be used to pay the revolver back?

Yes. We can have -- for the revolver, we have to reduce commitments. We could do that, and then that would free up equal amount of the second-lien proceeds from restricted or unrestricted cash. Basically, you can do that to reduce commitments. As far as which components of our corporate debt complex we intend to refinance, we're looking at all the different options, including continuing the 2019s. We do need to address the 2019s because it does become a current maturity in the first part of next year. So it's something we need to address relative to all the other options that would be available to us, and that's what we're still evaluating. And then we'll actually just make the right economic decision for the company. Really the objective of all this is to create the runway for us to continue to allow Kathy to invest and fix the business, to drive longer-term margin and growth perspective or earnings, but with the near-term balancing kind of the near-term maturity and kind of what the optimal level of the debt complex is. So we're all -- we're going to be working on that and as I said in my script, come to a decision by or before the end of the third quarter.

And there are no further calls in queue.

Okay. Thank you, everyone. We appreciate your listening in this evening. Have a great night. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect. Thank you.