HERTZ GLOBAL HOLDINGS INC - 10-K - 20070330 - BUSINESS
PART I
ITEM 1.
BUSINESS
Our Company
We own what we believe is the
largest worldwide general use car rental brand and one of the largest equipment
rental businesses in the United States and Canada combined, both based on
revenues. Our Hertz brand name is one of the most recognized in the world,
signifying leadership in quality rental services and products. In our car
rental business segment, we and our independent licensees and associates accept
reservations for car rentals at approximately 7,600 locations in approximately
145 countries. We are the only car rental company that has an extensive network
of company-operated rental locations both in the United States and in all
major European markets. We maintain the leading airport car rental market
share, by overall reported revenues, in the United States and at the 69 major
airports in Europe where we have company-operated locations and data
regarding car rental concessionaire activity is available. We believe that we
also maintain the second largest market share, by revenues, in the off-airport
car rental market in the United States. In our equipment rental business
segment, we rent equipment through approximately 360 branches in the United
States, Canada, France and Spain, as well as through our international licensees.
We and our predecessors have been in the car rental business since 1918 and in
the equipment rental business since 1965. We have a diversified revenue base
and a highly variable cost structure and are able to dynamically manage fleet
capacity, the most significant determinant of our costs. This has helped us to
earn a pre-tax profit in each year since our incorporation in 1967. Our
revenues have grown at a compound annual growth rate of 7.7% over the last 20
years, with year-over-year growth in 18 of those 20 years.
Corporate History
Hertz Holdings was incorporated by the Sponsors in
Delaware in 2005 to serve as the top-level holding company for the consolidated
Hertz business. Hertz was incorporated in Delaware in 1967. Hertz is a
successor to corporations that have been engaged in the car and truck rental
and leasing business since 1918 and the equipment rental business since 1965.
Ford acquired an ownership interest in Hertz in 1987. Prior to this, Hertz was
a subsidiary of UAL Corporation (formerly Allegis Corporation), which acquired
Hertz’s outstanding capital stock from RCA Corporation in 1985.
On December 21,
2005, investment funds associated with or designated by the Sponsors, through
an indirect, wholly owned subsidiary of Hertz Holdings acquired all of Hertz’s
common stock from a subsidiary of Ford in the Acquisition, for aggregate
consideration of $4,379 million in cash and debt refinanced or assumed of
$10,116 million and transaction fees and expenses of $447 million. To finance
the cash consideration for the Acquisition, to refinance certain of our
existing indebtedness and to pay related transaction fees and expenses, the
Sponsors used:
·
equity
contributions totaling $2,295 million from the investment funds associated with
or designated by the Sponsors;
·
net
proceeds from a private placement by CCMG Acquisition Corporation of $1,800
million aggregate principal amount of 8.875% Senior Notes due 2014, or the “Senior
Dollar Notes,” $600 million aggregate principal amount of 10.5% Senior Subordinated
Notes due 2016, or the “Senior Subordinated Notes,” and
€
225
million aggregate principal amount of 7.875% Senior Notes due 2014, or the “Senior
Euro Notes.” In connection with the Transactions, CCMG Acquisition Corporation
merged with and into Hertz, with Hertz as the surviving corporation of the
merger. CCMG Acquisition Corporation had no operations prior to the
Acquisition. We refer to the Senior Dollar Notes and the Senior Euro Notes
together as the “Senior Notes;”
4
·
aggregate
borrowings of approximately $1,707 million by us under a new senior term
facility, or the “Senior Term Facility,” which consists of (a) a maximum
borrowing capacity of $2,000 million, which included a delayed draw facility of
$293 million and (b) a synthetic letter of credit facility in an aggregate
principal amount of $250 million;
·
aggregate
borrowings of approximately $400 million by Hertz and one of its Canadian
subsidiaries under a new senior asset-based revolving loan facility, or
the “Senior ABL Facility,” with a maximum borrowing capacity of $1,600 million
(which was increased in February 2007 to $1,800 million). We refer to the
Senior Term Facility and the Senior ABL Facility together as the “Senior Credit
Facilities;”
·
aggregate
proceeds of offerings totaling approximately $4,300 million by a special
purpose entity wholly owned by us of asset-backed securities backed by
our U.S. car rental fleet, or the “U.S. Fleet Debt,” all of which we issued
under our existing asset-backed notes program, or the “ABS Program”;
under which an additional $600 million of previously issued asset-backed
medium term notes having maturities from 2007 to 2009 remain outstanding
following the closing of the Transactions, and in connection with which
approximately $1,500 million of variable funding notes in two series were also
issued, but not funded, on the closing date of the Acquisition;
·
aggregate
borrowings of the foreign currency equivalent of approximately $1,781 million
by certain of our foreign subsidiaries under asset-based revolving loan
facilities with aggregate commitments equivalent to approximately $2,930
million (calculated in each case at December 31, 2005), subject to
borrowing bases comprised of rental vehicles, rental equipment, and related
assets of certain of our foreign subsidiaries, (substantially all of which are
organized outside of the United States) or one or more special purpose
entities, as the case may be, and, rental equipment and related assets of
certain of our subsidiaries organized outside North America or one or more
special purpose entities, as the case may be, which facilities (together with
certain capital lease obligations) are referred to collectively as the “International
Fleet Debt;” and
·
our
cash on hand in an aggregate amount of approximately $6.1 million.
In connection with the
Transactions, we also refinanced a significant portion of our existing
indebtedness, which was repaid as follows:
·
the
repurchase of approximately $3,700 million in aggregate principal amount of
existing senior notes having maturities from May 2006 to January 2028,
of which additional notes in the aggregate principal amount of approximately
$803.3 million remained outstanding following the Transactions;
·
the
repurchase of approximately
€
192.4 million (or
approximately $230.0 million, calculated as of December 31, 2005) in
aggregate principal amount of existing Euro-denominated medium term notes with
a maturity of July 2007, of which additional medium term notes in the
aggregate principal amount of approximately
€
7.6 million remained
outstanding following the Transactions;
·
the
repayment of a $1,185 million intercompany note issued by Hertz to Ford
Holdings on June 10, 2005 that would have matured in June 2010;
·
the
repayment of approximately $1,935 million under an interim credit facility that
would have matured on February 28, 2006;
·
the
repayment of commercial paper, notes payable and other bank debt of
approximately $1,212 million; and
5
·
the settlement of all
accrued interest and unamortized debt discounts relating to the above existing
indebtedness.
Our Markets
We operate in the global car
rental industry and in the equipment rental industry, primarily in the United
States.
Worldwide Car Rental
We believe that the global car rental industry exceeds
$30 billion in annual revenues. According to a 2007 report appearing in Auto
Rental News, car rental revenues in the United States totaled approximately $20
billion in 2006 and have grown at a 5.0% compound annual growth rate since
1990, including 6.2% growth in 2006. We believe car rental revenues in Western
Europe account for over $12.5 billion in annual revenues, with the airport
portion of the industry comprising approximately 40% of the total. Within
Europe, the largest markets are Germany, the United Kingdom and France. We
believe total rental revenues for the car rental industry in Europe in 2005
were approximately $10.5 billion in the nine countries—France, Germany, Italy,
the United Kingdom, Spain, the Netherlands, Switzerland, Belgium and Luxembourg—where
we have company-operated rental locations and over $2 billion in eight
other countries—Greece, Ireland, Portugal, Sweden, Norway, Denmark, Austria and
Finland—where our brand is present through our licensees.
We estimate that airport rentals account for
approximately one-half of the total market in the United States. This portion
of the market is significantly influenced by developments in the travel
industry and particularly in airline passenger traffic, or enplanements.
According to the FAA, enplanements in the United States only completed their
recovery and surpassed their pre-2001 levels in 2005. The FAA projected
in the first half of 2006 that domestic enplanements will grow at a compound
annual rate of 3.2% from 2006 to 2017, consistent with long-term historical
trends. The IATA projected in September 2006 that annual international
enplanements would grow at a compound annual rate of 4.8% from 2006 to 2010.
The off-airport part of the
industry has rental volume primarily driven by local business use, leisure
travel and the replacement of cars being repaired. Because Europe has generally
demonstrated a lower historical reliance on air travel, the European
off-airport car rental market is significantly more developed than it is in the
United States. However, we believe that in recent years, industry revenues from
off-airport car rentals in the United States have grown faster than revenues
from airport rentals.
Equipment Rental
We estimate the size of the U.S. equipment rental
industry, which is highly fragmented with few national competitors and many
regional and local operators, to be approximately $35 billion in annual
revenues, but the part of the rental industry dealing with equipment of the
type HERC rents is somewhat smaller than that. We believe that the industry
grew at a 9.7% compound annual growth rate between 1991 and 2005. Other market
data indicates that the equipment rental industries in France and Spain
generate roughly $4 billion and $2 billion in annual revenues, respectively,
although the portions of those markets in which HERC competes are smaller.
The equipment rental industry
serves a broad range of customers from small local contractors to large
industrial national accounts and encompasses a wide range of rental equipment
from small tools to heavy earthmoving equipment. The industry is undergoing a
strong recovery following the industrial recession and downturn in
non-residential construction spending between 2001 and 2003. We believe U.S.
non-residential construction spending grew at an annual rate of 14% in 2006 and
is projected to grow at an annual rate of 4% in 2007. We also believe, based on
an article in Rental Equipment
6
Register published on February 1,
2006, that rental equipment accounted for approximately 30% to 40% of all
equipment sold into the U.S. construction industry in 2005, up from
approximately 5% to 10% in 1991. In addition, we believe that the trend toward
rental instead of ownership of equipment in the U.S. construction industry will
continue and that as much as 50% of the equipment used in the industry could be
rental equipment within the next ten years.
Our Business Segments
Our business consists of two segments, car rental and
equipment rental. In addition, “corporate and other” includes general corporate
expenses, as well as other business activities, such as third-party claim
management services.
Car Rental: Our
“company-operated” rental locations are those through which we, or an
agent of ours, rent cars that we own or lease. We maintain a substantial
network of company-operated car rental locations both in the United
States and internationally, and what we believe to be the largest number of
company-operated airport car rental locations in the world, enabling us
to provide consistent quality and service worldwide. For the year ended December 31,
2006, we derived approximately 72% of our worldwide car rental revenues from
airport locations. Our licensees and associates also operate rental locations
in over 140 countries and jurisdictions, including most of the countries in
which we have company-operated rental locations.
Equipment Rental:
On the basis of revenues, we believe
HERC is the second largest equipment rental company in the United States and
Canada combined and one of the largest equipment rental companies in France and
Spain.
HERC rents a broad range
of earthmoving equipment, material handling equipment, aerial and electrical
equipment, air compressors, generators, pumps, small tools, compaction equipment
and construction-related trucks. HERC also derives revenues from the sale
of new equipment and consumables.
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Set forth below are charts
showing revenues and operating income (loss), by segment, and revenues by
geographic area, all for the year ended December 31, 2006 and revenue
earning equipment at net book value, as of December 31, 2006 (the majority
of our international operations are in Europe). See Note 10 to the
Notes to our
consolidated financial statements included in this Annual Report under the
caption “Item 8—Financial Statements and Supplementary Data.”
Revenues by Segment for
Year Ended December 31, 2006(1)
$8.1 billion
Operating Income by Segment for
Year Ended December 31, 2006(2)
$1.2 billion
Revenues by Geographic Area for
Year Ended December 31, 2006
$8.1 billion
Revenue Earning Equipment, net book value as of
December 31, 2006
$9.8 billion
(1)
Car rental segment
revenue includes fees and certain cost reimbursements from licensees. See Note
10 to the Notes to our consolidated financial statements included in this
Annual Report under the caption “Item 8—Financial Statements and Supplementary
Data.”
(2)
Operating income
represents pre-tax income before interest expense and minority interest. The
above chart excludes an operating loss of $105.8 million attributable to our
Corporate and Other activities.
For further information on our
business segments, including financial information for the years ended December 31,
2006, 2005 and 2004, see Note 10 to the Notes to our consolidated financial
statements included in this Annual Report under the caption “Item 8—Financial
Statements and Supplementary Data.”
Worldwide Car Rental
Operations
We rent a wide variety of makes and models of cars,
nearly all of which are the current or previous year’s models. We generally
accept reservations only for a class of vehicles, although we accept
8
reservations for specific makes and models of vehicles
in our Prestige Collection luxury rental program, our Fun Collection
experiential rental program, our Green Collection environmentally friendly
rental program and a limited number of models in high-volume, leisure-oriented
destinations. We rent cars on a daily, weekend, weekly, monthly or multi-month
basis, with rental charges computed on a limited or unlimited mileage rate, or
on a time rate plus a mileage charge. Our rates vary at different locations
depending on local market conditions and other competitive and cost factors.
While cars are usually returned to the locations from which they are rented, we
also allow one-way rentals from and to certain locations. In addition to car
rentals and licensee fees, we generate revenues from reimbursements by
customers of airport concession fees and vehicle licensing costs, fueling
charges, and charges for ancillary customer products and services such as
supplemental equipment (child seats and ski racks), loss or collision damage waiver,
theft protection, liability and personal accident/effects insurance coverage,
Hertz NeverLost navigation systems and satellite radio services.
We have company-operated rental locations both
in the United States and internationally. The international car rental
operations that generated the highest volumes of business from our company-operated
locations for the year ended December 31, 2006 were, in descending order
of revenues, those conducted in France, Germany, Italy, the United Kingdom,
Spain, Australia and Canada. We also have company-operated rental
locations in the Netherlands, Switzerland, Belgium, Luxembourg, New Zealand,
Puerto Rico, Brazil and the U.S. Virgin Islands.
As of December 31, 2006, we had approximately
1,700 staffed rental locations in the United States, of which approximately
one-third were airport locations and two-thirds were off-airport locations, and
we regularly rent cars from over 950 other locations that are not staffed. As
of December 31, 2006, we had approximately 1,100 staffed rental locations
internationally, of which approximately one-fifth were airport locations and
four-fifths were off-airport locations, and we regularly rent cars from
approximately 80 other locations that are not staffed. We believe that our
extensive U.S. and international network of company-operated locations
contributes to the consistency of our service, cost control, fleet utilization,
yield management, competitive pricing and ability to offer one-way rentals.
In order to operate airport rental locations, we have
obtained concessions or similar leasing, licensing or permitting agreements or
arrangements, or “concessions,” granting us the right to conduct a car rental
business at all major, and many other, airports with regularly scheduled
passenger service in each country where we have company-operated rental
locations, except for airports where our licensees operate rental locations and
Orlando International Airport in Orlando, Florida. Our concessions were
obtained from the airports’ operators, which are typically governmental bodies
or authorities, following either negotiation or bidding for the right to
operate a car rental business there. The terms of an airport concession
typically require us to pay the airport’s operator concession fees based upon a
specified percentage of the revenues we generate at the airport, subject to a
minimum annual guarantee. Under most concessions, we must also pay fixed rent
for terminal counters or other leased properties and facilities. Most
concessions are for a fixed length of time, while others create operating
rights and payment obligations that are terminable at any time.
The terms of our concessions typically do not forbid,
and in a few instances actually require, us to seek reimbursement from
customers of concession fees we pay; however, in certain jurisdictions the law
limits or forbids our doing so. Where we are required or permitted to seek such
reimbursement, it is our general practice to do so. The number of car rental
concessions available at airports varies considerably, but, except at small,
regional airports, it is rarely less than four. At Orlando International
Airport, where we do not have a car rental concession, we operate an airport
rental location at a facility located near the airport’s premises and pick up
and drop off our customers at the airport under a permit from the airport’s
operator. Certain of our concession agreements require the consent of the
airport’s operator in connection with changes in ownership of us. We sought
those consents that were required in connection with our initial public
offering of our common stock, except where not obtaining
9
them would not, in our view, have had a material
adverse effect on our consolidated financial position or results of operations.
See “Item 1A—Risk Factors—Risks Related to Our Business—We face risks related
to changes in our ownership.”
The Hertz brand is one of the most recognized brands
in the world. It has been listed in Business Week’s “100 Most Valuable Global
Brands” in 2005 and in every year that it was eligible for inclusion in the
study since the study’s inception in 2001. We understand that this study is
limited to companies with public equity and their subsidiaries, and as a
result, Hertz was not eligible for inclusion in 2006. The Hertz brand has been
the only travel company brand to appear in the study. Moreover, our customer
surveys indicate that in the United States, Hertz is the car rental brand most
associated with the highest quality service. This is consistent with numerous
published best-in class car rental awards that we have won, both in the United
States and internationally, over many years. We have sought to support our
reputation for quality and customer service in car rental through a variety of
innovative service offerings, such as our customer loyalty program (Hertz #1
Club), our global expedited rental program (Hertz #1 Club Gold), our one-way
rental program (Rent-it-Here/Leave-it-There), our national-scale luxury
rental program (Prestige Collection), our national-scale experiential
rental program (Hertz Fun Collection), our environmentally friendly rental
program (Green Collection) and our in-car navigational services (Hertz
NeverLost). We intend to maintain our position as a premier company through an
intense focus on service, quality and product innovation.
In the United States, the Hertz brand had the highest
market share, by revenues, in 2005 and in the first ten months of 2006 at the
180 largest airports where we operated. Out of the approximately 150 major
European airports at which we have company-operated rental locations,
data regarding car rental concessionaire activity for the year ended December 31,
2005 was available at 69 of these airports. Based upon this data, we believe
that we were the largest airport car rental company, measured by aggregate
airport rental revenues during that period, at those 69 airports taken
together. In the United States, we intend to maintain or expand our market
share in the airport rental business. For a further description of our competitors,
market share and competitive position see “—Competition” below.
At our major airport rental locations, as well as at
some smaller airport and off-airport locations, customers participating in our
Hertz #1 Club Gold program are able to rent vehicles in an expedited manner. In
the United States, participants in Hertz #1 Club Gold often bypass the rental
counter entirely and proceed directly to their vehicles upon arrival at our
facility. For the year ended December 31, 2006, rentals by Hertz #1 Club
Gold members accounted for approximately 41% of our worldwide rental
transactions. We believe the Hertz #1 Club Gold program provides a significant
competitive advantage to us, particularly among frequent travelers, and we
have, through travel industry relationships, targeted such travelers for
participation in the program.
In addition to our airport locations, we operate
off-airport locations offering car rental services to a variety of customers.
Our off-airport rental customers include people wishing to rent cars closer to
home for business or leisure purposes, as well as those needing to travel to or
from airports. Our off-airport customers also include people who have been
referred by, or whose rental costs are being wholly or partially reimbursed by,
insurance companies following accidents in which their cars were damaged, those
expecting to lease cars that are not yet available from their leasing companies
and those needing cars while theirs are being repaired or are temporarily
unavailable for other reasons; we call these customers “replacement renters.”
At many of our off-airport locations we will provide pick-up and delivery
services in connection with rentals.
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When compared to our airport rental locations, an
off-airport rental location typically services more types of customers, uses
smaller rental facilities with fewer employees, conducts pick-up and delivery
services and deals with replacement renters using specialized systems and
processes. In addition, on average, off-airport locations generate fewer
transactions per period than airport locations. At the same time, though, our
airport and off-airport rental locations employ common car fleets, are
supervised by common country, regional and local area management, use many
common systems and rely on common maintenance and administrative centers.
Moreover, airport and off-airport locations, outside the area of replacement
rentals, are supported by a common commercial sales force, benefit from many
common marketing activities and have many of the same customers. As a
consequence, we regard both types of locations as aspects of a single, unitary,
car rental business.
We believe that the off-airport portion of the car
rental market offers opportunities for us on several levels. First, presence in
the off-airport market can provide customers a more convenient and
geographically extensive network of rental locations, thereby creating revenue
opportunities from replacement renters, non-airline travel renters and airline
travelers with local rental needs. Second, it can give us a more balanced
revenue mix by reducing our reliance on airport travel and therefore limiting
our risk exposure to external events that may disrupt airline travel trends.
Third, it can produce higher fleet utilization as a result of the longer
average rental periods associated with off-airport business, compared to those
of airport rentals. Fourth, replacement rental volume is far less seasonal than
that of other business and leisure rentals, which permits efficiencies in both
fleet and labor planning. Finally, cross-selling opportunities exist for
us to promote off-airport rentals among frequent airport Hertz #1 Club renters
and, conversely, to promote airport rentals to off-airport renters. In view of
those benefits, along with our belief that our market share for off-airport
rentals is generally smaller than our market share for airport rentals, we
intend to seek profitable growth in the off-airport rental market, both in the
United States and internationally.
In the three years ended December 31, 2006, we
increased the number of our off-airport rental locations in the United States
by approximately 32% to approximately 1,380 locations. In 2007 and subsequent
years, our strategy may include selected openings of new off-airport locations,
the disciplined evaluation of existing locations and pursuit of same-store
sales growth. We anticipate that same-store sales growth would be driven by our
traditional leisure and business traveler customers and by increasing
penetration of the insurance replacement market, of which we currently have a
low market share. In the United States during the year ended December 31,
2006, approximately one-third of our rental revenues at off-airport locations
were related to replacement rentals. We believe that if we successfully pursue
our strategy of profitable off-airport growth, the proportion of replacement
rental revenues will increase. As we move forward, our determination of whether
to expand our U.S. off-airport network will be based upon a combination of
factors, including the concentration of target insurance company policy
holders, car dealerships, auto body shops and other clusters of retail,
commercial activity and potential profitability. We also intend to increase the
number of our staffed off-airport rental locations internationally on the basis
of similar criteria.
In addition to renting cars, in Germany we also rent
trucks of eight tons and over, including truck tractors. This truck rental
fleet consists of approximately 3,400 vehicles, which have either been acquired
under repurchase programs similar to those under which we purchase program cars
or are under operating leases. We believe we are a market leader in heavy truck
rental in Germany. Also, we are engaged in a car leasing business in Brazil.
Our truck rental activities in Germany and our car leasing activities in Brazil
are treated as part of our international car rental business in our
consolidated financial statements.
Our worldwide car rental operations generated $6,378.0
million in revenues and $373.5 million in income before income taxes and
minority interest during the year ended December 31, 2006.
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We may also, from time to
time, pursue profitable growth within our car rental business by pursuing
opportunistic acquisitions that would expand our global car rental business.
Customers and Business Mix
We
categorize our car rental business based on two primary criteria—the purpose
for which customers rent from us (business or leisure) and the type of location
from which they rent (airport or off-airport). The table below sets forth, for
the year ended December 31, 2006, the percentages of rental revenues and
rental transactions in our U.S. and international operations derived from
business and leisure rentals and from airport and off-airport rentals.
Year ended December 31, 2006
U.S.
International
Revenues
Transactions
Revenues
Transactions
Type of
Car Rental
By Customer:
Business
47
%
51
%
48
%
52
%
Leisure
53
49
52
48
100
%
100
%
100
%
100
%
By Location:
Airport
79
%
80
%
54
%
57
%
Off-airport
21
20
46
43
100
%
100
%
100
%
100
%
Customers who rent from us for “business” purposes
include those who require cars in connection with commercial activities, the
activities of governments and other organizations or for temporary vehicle
replacement purposes. Most business customers rent cars from us on terms that
we have negotiated with their employers or other entities with which they are
associated, and those terms can differ substantially from the terms on which we
rent cars to the general public. We have negotiated arrangements relating to
car rental with many large businesses, governments and other organizations,
including most Fortune 500 companies.
Customers who rent from us for “leisure” purposes
include not only individual travelers booking vacation travel rentals with us
but also people renting to meet other personal needs. Leisure rentals, taken as
a whole, are longer in duration and generate more revenue per transaction than
do business rentals, although some types of business rentals, such as rentals
to replace temporarily unavailable cars, have a long average duration. Business
rentals and leisure rentals have different characteristics and place different
types of demands on our operations. We believe that maintaining an appropriate
balance between business and leisure rentals is important to the profitability
of our business and the consistency of our operations.
Our business and leisure customers rent from both our
airport and off-airport locations. Demand for airport rentals is correlated
with airline travel patterns, and transaction volumes generally follow
enplanement trends on a global basis. Customers often make reservations for
airport rentals when they book their flight plans, which makes our strong
relationships with travel agents, associations and other partners (e.g.,
airlines) a key competitive advantage in generating consistent and recurring
revenue streams.
Off-airport rentals typically involve people wishing
to rent cars closer to home for business or leisure purposes, as well as those
needing to travel to or from airports. This category also includes people who
have been referred by, or whose rental costs are being wholly or partially
reimbursed by, insurance companies because their cars have been damaged. In
order to attract these renters, we
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must establish agreements with the referring insurers
establishing the relevant rental terms, including the arrangements made for
billing and payment. While we estimate our share of the insurance replacement
rental market was approximately 7% of the estimated rental revenue volume for
the year ended December 31, 2006, we have identified approximately 160
insurance companies, ranging from local or regional carriers to large, national
companies, as our target insurance replacement market. Although Enterprise
Rent-A-Car Company, or “Enterprise” currently has the largest share of the
insurance replacement market, we believe that many of these companies are
receptive to our replacement rental offerings and prefer to have at least two
national rental car suppliers. Enterprise has asserted that certain systems we
use to conduct insurance replacement rentals would infringe on patent rights it
expects to obtain. See “Item 1A—Risk Factors—Risks Related to Our Business—Claims
that the software products and information systems that we rely on are
infringing on the intellectual property rights of others could increase our
expenses or inhibit us from offering certain services, which could adversely
affect our results of operations.”
We conduct active sales and marketing programs to
attract and retain customers. Our commercial and travel industry sales force
calls on companies and other organizations whose employees and associates need
to rent cars for business purposes, as well as on membership associations, tour
operators, travel companies and other groups whose members, participants and
customers rent cars for either business or leisure purposes. A specialized
sales force calls on companies with replacement rental needs, including
insurance and leasing companies and car dealers. We also advertise our car
rental offerings through a variety of traditional media, such as television and
newspapers, direct mail and the Internet. In addition to advertising, we also
conduct a variety of other forms of marketing and promotion, including travel
industry business partnerships and press and public relations activities.
In almost all cases, when we rent a car, we rent it
directly to an individual who is identified in a written rental agreement that
we prepare. Except when we are accommodating someone who cannot drive, the
individual to whom we rent a car is required to have a valid driver’s license
and meet other rental criteria (including minimum age and creditworthiness
requirements) that vary on the basis of location and type of rental. Our rental
agreements permit only the individual renting the car, people signing
additional authorized operator forms and certain defined categories of other
individuals (such as fellow employees, parking attendants and in some cases
spouses or domestic partners) to operate the car.
With rare exceptions, individuals renting cars from us
are personally obligated to pay all amounts due under their rental agreements.
They typically pay us with a charge, credit or debit card issued by a third
party, although certain customers use a Hertz charge account that we have
established for them, usually as part of an agreement between us and their
employer. For the year ended December 31, 2006, all amounts charged to
Hertz charge accounts established in the United States, and approximately 99%
of amounts charged to Hertz charge accounts established by our international
subsidiaries, are billed directly to a company or other organization or are
guaranteed by a company. The remainder of the amounts charged to Hertz charge
accounts established by our international subsidiaries are billed to individual
account holders whose obligations are not guaranteed by the holder’s employer
or any other organization associated with the account holder. We also issue
rental vouchers and certificates that may be used to pay rental charges, mostly
for prepaid and tour-related rentals. In addition, where the law requires us to
do so, we rent cars on a cash basis.
In the United States for the
year ended December 31, 2006, 86% of our car rental revenues came from
customers who paid us with third-party charge, credit or debit cards,
while 8% came from customers using Hertz charge accounts, 4% came from
customers using rental vouchers or another method of payment and 2% came from
cash transactions. In our international operations for the year ended December 31,
2006, 53% of our car rental revenues came from customers who paid us with third-party
charge, credit or debit cards, while 27% came from customers using Hertz charge
accounts, 18% came from customers using rental vouchers or another method of
payment and 2% came from cash
13
transactions. For the year
ended December 31, 2006, we had bad debt expense ratios of 0.2% of car
rental revenues for our U.S. operations and 0.4% of car rental revenues for our
international operations.
Reservations
When customers reserve cars for rental from us and our
licensees, they may seek to do so through travel agents or third-party
travel websites. In many of those cases, the travel agent or website will
utilize a third-party operated computerized reservation system, also
known as a global distribution system, or “GDS,” to contact us and make the
reservation. There are currently four principal GDSs, and we have contracts
with all of them providing that we will process reservation requests made
through the GDSs. Historically, GDSs were owned and operated by airlines and
were subject to extensive regulation along with their airline owners. In recent
years, however, airlines have greatly reduced their ownership interests in GDSs
and the level of regulation to which GDSs are subject has substantially
decreased. The owner of one of the four GDSs, Galileo, has recently entered
into an agreement to acquire another GDS, Worldspan, which would result in
further concentration in that industry.
In major countries, including the United States and
all other countries with company-operated locations, customers may also
reserve cars for rental from us and our licensees worldwide through local,
national or toll-free telephone calls to our reservations centers, directly
through our rental locations or, in the case of replacement rentals, through
proprietary automated systems serving the insurance industry. Additionally, we
accept reservations for rentals from us and our licensees worldwide through our
websites. Our websites, which also allow customers to enroll in loyalty
programs, obtain copies of bills for past transactions and obtain information
about our rental offerings, have grown significantly in importance as a
reservations channel in recent years. Third-party travel websites have
also grown in importance to us as a reservations channel.
For the year ended December 31,
2006, approximately 34% of the worldwide reservations we accepted came through
travel agents using GDSs, while 30% came through phone calls to our
reservations centers, 25% through our websites, 7% through third-party
websites and 4% through local booking sources.
Fleet
We believe we are one of the largest private sector
purchasers of new cars in the world. During the year ended December 31,
2006, we also purchased approximately 7,200 used cars that were similar to
other cars in our rental fleet. During the year ended December 31, 2006,
we operated a peak rental fleet in the United States of approximately 310,000
cars and a combined peak rental fleet in our international operations of
approximately 168,000 cars, in each case exclusive of our licensees’ fleet.
During the year ended December 31, 2006, our approximate average holding
period for a rental car was ten months in the United States and nine months in
our international operations.
Over the five years ended December 31, 2006, we
have acquired, subject to availability, over 70% of our cars pursuant to
various fleet repurchase or guaranteed depreciation programs established by
automobile manufacturers. Under these programs, the manufacturers agree to
repurchase cars at a specified price or guarantee the depreciation rate on the
cars during established repurchase or auction periods, subject to, among other
things, certain car condition, mileage and holding period requirements.
Repurchase prices under repurchase programs are based on either a predetermined
percentage of original car cost and the month in which the car is returned or
the original capitalized cost less a set daily depreciation amount. Guaranteed
depreciation programs guarantee on an aggregate basis the residual value of the
cars covered by the programs upon sale according to certain parameters which
include the holding period, mileage and condition of the cars. These
14
repurchase and guaranteed depreciation programs limit
our residual risk with respect to cars purchased under the programs and allow
us to determine depreciation expense in advance. For this reason, cars
purchased by car rental companies under repurchase and guaranteed depreciation
programs are sometimes referred to by industry participants as “program” cars.
Conversely, those cars not purchased under repurchase or guaranteed
depreciation programs for which the car rental company is exposed to residual
risk are sometimes referred to as “risk” cars. For the year ended December 31,
2006, program cars as a percentage of all cars purchased by our U.S. operations
were 61% and as a percentage of all cars purchased by our international
operations were approximately 71%, or 64% when calculated on an aggregate
worldwide basis.
We expect the percentage of our car rental fleet
subject to repurchase or guaranteed depreciation programs to decrease
substantially due primarily to changes in the terms offered by automobile
manufacturers under repurchase programs. Accordingly, we expect to bear
increased risk relating to the residual market value and the related
depreciation on our car rental fleet and to use different rotational techniques
to accommodate our seasonal peak demand for cars.
Over the five years ended December 31, 2006,
approximately 47% of the cars acquired by us for our U.S. car rental fleet, and
approximately 32% of the cars acquired by us for our international fleet, were
manufactured by Ford and its subsidiaries. During the year ended December 31,
2006, approximately 40% of the cars acquired by us domestically were
manufactured by Ford and its subsidiaries and approximately 30% of the cars
acquired by us for our international fleet were manufactured by Ford and its
subsidiaries, which represented the largest percentage of any automobile
manufacturer during that period. The percentage of the fleet which we purchase
from Ford may decline as a result of recent changes to the vehicle supply
arrangements between Ford and us. See “—Relationship with Ford” and Note 14 to
the Notes to our consolidated financial statements included in this Annual
Report under the caption “Item 8—Financial Statements and Supplementary Data.”
Historically, we have also purchased a significant percentage of our car rental
fleet from General Motors Corporation, or “General Motors.” Over the five years
ended December 31, 2006, approximately 19% of the cars acquired by us for
our U.S. car rental fleet, and approximately 15% of the cars acquired by us for
our international fleet, were manufactured by General Motors. During the year
ended December 31, 2006, approximately 17% of the cars acquired by our
U.S. car rental fleet, and approximately 13% of the cars acquired by us for our
international fleet, were manufactured by General Motors.
Purchases of cars are financed through funds provided
from operations and by active and ongoing global borrowing programs. See “Item
7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity
and Capital Resources.”
We maintain automobile maintenance centers at certain
airports and in certain urban and off-airport areas, providing maintenance
facilities for our car rental fleet. Many of these facilities, which include
sophisticated car diagnostic and repair equipment, are accepted by automobile
manufacturers as eligible to perform and receive reimbursement for warranty
work. Collision damage and major repairs are generally performed by independent
contractors.
We dispose of risk cars, as
well as program cars that have for any reason become ineligible for
manufacturer repurchase or guaranteed depreciation programs, through a variety
of disposition channels, including auctions, brokered sales, sales to
wholesalers and, to a lesser extent and primarily in the United States, sales
at retail through a network of seven company-operated car sales locations
dedicated exclusively to the sale of used cars from our rental fleet. During
the year ended December 31, 2006, of the cars that were not repurchased by
manufacturers, we sold approximately 85% at auction or on a wholesale basis,
while 8% were sold at retail and 7% through other channels. We closed 24 retail
car sales locations in the United States in the year ended December 31,
2006. These closures did not have a significant impact on our results of
operations for the year ended December 31, 2006.
15
Licensees
We believe that our extensive worldwide ownership of
car rental operations contributes to the consistency of our high-quality service,
cost control, fleet utilization, yield management, competitive pricing and our
ability to offer one-way rentals. However, in certain predominantly smaller
U.S. and international markets, we have found it more efficient to utilize
independent licensees, which rent cars that they own. Our licensees operate
locations in over 140 countries, including most of the countries where we have
company-operated locations. As of December 31, 2006, we owned 96% of
all the cars in the combined company-owned and licensee-owned
fleets in the United States.
We believe that our licensee arrangements are
important to our business because they enable us to offer expanded national and
international service and a broader one-way rental program. Licenses are issued
principally by our wholly owned subsidiaries, Hertz System, Inc., or “System,”
and Hertz International, Ltd., or “HIL,” under franchise arrangements to
independent licensees and affiliates who are engaged in the car rental business
in the United States and in many foreign countries.
Licensees generally pay fees based on a percentage of
their revenues or the number of cars they operate. The operations of all
licensees, including the purchase and ownership of vehicles, are financed
independently by the licensees, and we do not have any investment interest in
the licensees or their fleets. System licensees share in the cost of our U.S.
advertising program, reservations system, sales force and certain other
services. Our European and other international licensees also share in the cost
of our reservations system, sales force and certain other services. In return,
licensees are provided the use of the Hertz brand name, management and
administrative assistance and training, reservations through our reservations
channels, the Hertz #1 Club and #1 Club Gold programs, our one-way rental
program and other services. In addition to car rental, certain licensees
outside the United States engage in car leasing, chauffeur-driven rentals
and renting camper vans under the Hertz name.
System licensees ordinarily
are limited as to transferability without our consent and are terminable by us
only for cause or after a fixed term. Licensees in the United States may
generally terminate for any reason on 90 days’ notice. In Europe and certain
other international jurisdictions, licensees typically do not have early
termination rights. Initial license fees or the price for the sale to a
licensee of a company-owned location may be payable over a term of
several years. We continue to issue new licenses and, from time to time,
purchase licensee businesses.
Competition
In the United States, our principal car rental
industry competitors are Avis Budget Group, Inc., or “ABG,” which
currently operates the Avis and Budget brands, Vanguard Car Rental USA Group,
or “Vanguard,” which operates the National Car Rental and Alamo brands, Dollar
Thrifty Automotive Group, Inc., or “DTG,” which operates the Dollar and
Thrifty brands, and Enterprise, which operates the Enterprise brand.
16
The
following table lists our estimated market share, and the estimated market
shares of our principal competitors and their licensees, at the 180 largest
U.S. airports at which we have company-operated locations, determined on
the basis of revenues reported to the airports’ operators on which concession
or off-airport permit fees are determined for the indicated periods. Complete
market share data is not available for any date later than for the ten months
ended October 31, 2006.
Ten
Months
Ended
October 31,
Years ended December 31,
2006
2005
2004
2003
2002
2001
Brand
Name
Hertz
28.4
%
29.2
%
29.6
%
29.0
%
29.2
%
29.5
%
Avis
19.9
20.2
20.2
21.2
22.3
21.6
Budget
10.4
10.5
10.2
10.4
10.8
11.8
ABG Brands(1)
30.3
30.7
30.4
31.6
33.1
33.4
National/Alamo (Vanguard Brands)(2)
19.7
19.4
19.8
20.8
21.8
25.4
Dollar
7.2
7.1
7.7
7.4
7.2
7.1
Thrifty
4.4
4.3
4.5
4.4
3.2
1.8
DTG Brands
11.6
11.4
12.2
11.8
10.4
8.9
Enterprise
7.6
7.0
6.0
5.0
3.9
2.0
Other
2.4
2.3
2.0
1.8
1.6
0.8
Total
100.0
%
100.0
%
100.0
%
100.0
%
100.0
%
100.0
%
(1)
ABG acquired all of
the outstanding shares of Avis Group Holdings, Inc. on March 1, 2001
and acquired substantially all of the domestic assets of the vehicle rental
business of Budget Group, Inc. on November 22, 2002.
(2)
National and Alamo
have been owned by Vanguard since October 2003.
The U.S. off-airport rental market has historically
been dominated by Enterprise. We now have a significant presence in the
off-airport market, and ABG’s brands also are present. Many smaller companies
also operate in the airport and off-airport rental markets.
In Europe, in addition to us, the principal
pan-European participants in the car rental industry are Avis Europe plc (which
is not an affiliate of ABG but is operating under a license from ABG), which
operates the Avis and Budget brands, and Europcar, which was acquired from
Volkswagen AG by Eurazeo in 2006. In certain European countries, there are also
other companies and brands with substantial market shares, including Sixt AG
(operating the Sixt brand), Vanguard (operating both the National Car Rental
and Alamo brands) in the United Kingdom and Germany, and through franchises in
Spain, Italy and France, and Enterprise (operating the Enterprise brand) in the
United Kingdom, Ireland and Germany. Europcar has acquired Vanguard’s European
business and has entered into an agreement relating to a trans-Atlantic
alliance with Vanguard. In every European country, there are also national,
regional or other, smaller companies operating in the airport and off-airport
rentals markets. Apart from Enterprise-branded operations, all of which
Enterprise owns, the other major car rental brands are present in European car
rental markets through a combination of company-operated and franchisee-
or licensee-operated locations.
17
Competition among car rental industry participants is
intense and frequently takes the form of price competition. For the year ended December 31,
2006, based on publicly available information, we believe some U.S. car rental
companies experienced transaction day growth and pricing increases compared to
comparable prior periods. For the year ended December 31, 2006, we
experienced a less than one percentage point volume decline versus the prior
period in the United States, while pricing was up over three percentage points.
The volume decline was the result of a reduction in fleet volume given
significant fleet cost increases, higher leisure pricing for the period from March
through May 2006 and the difficult comparison in the quarter ending December 31,
2006 due to the extraordinarily high volumes of post-hurricane rentals in the
Gulf Coast and Florida areas in 2005. During the year ended December 31,
2006, we experienced low to mid single digit transaction day growth in our
European operations and our car rental pricing was above the level of our
pricing during the year ended December 31, 2005.
Our competitors, some of which
may have access to substantial capital or which may benefit from lower
operating costs, may seek to compete aggressively on the basis of pricing. To
the extent that we match downward competitor pricing without reducing our
operating costs, it could have an adverse impact on our results of operations.
To the extent that we are not willing to match or remain within a reasonable competitive
margin of our competitors’ pricing, it could also have an adverse impact on our
results of operations, as we may lose market share. As a result of increased
use of the Internet as a travel distribution channel, pricing transparency has
increased. See “Item 1A—Risk Factors—Risks Related to Our Business—We face
intense competition that may lead to downward pricing, or an inability to
increase prices, which could have a material adverse impact on our results of
operations.” We believe, however, that the prominence and service reputation of
the Hertz brand and our extensive worldwide ownership of car rental operations
provide us with a competitive advantage.
Equipment Rental
Operations
We, through HERC, operate an
equipment rental business in the United States, Canada, France and Spain.
On
the basis of revenues, we believe HERC is the second largest equipment rental
company in the United States and Canada combined and one of the largest general
equipment rental companies in France and Spain.
HERC has operated in the United States since 1965.
HERC’s principal business is the rental of equipment.
HERC offers a broad range of equipment for rental; major categories include
earthmoving equipment, material handling equipment, aerial and electrical
equipment, air compressors, pumps, generators, small tools, compaction
equipment and construction-related trucks.
HERC’s comprehensive line of equipment enables it to
supply equipment to a wide variety of customers from local contractors to large
industrial plants. The fact that many larger companies, particularly those with
industrial plant operations, now require single source vendors, not only for
equipment rental, but also for management of their total equipment needs fits
well with HERC’s core competencies. Arrangements with such companies may
include maintenance of the tools and equipment they own, supplies and rental
tools for their labor force and custom management reports. HERC supports this
through its dedicated in-plant operations, tool trailers and plant management
systems.
As of December 31, 2006, HERC operated 362
equipment rental branches, of which 242 were in 40 states within the
United States, 33 were in Canada, 79 were in France and 8 were in Spain. HERC
generated same-store, year-over-year revenue growth for each of the last
thirteen quarters. HERC’s rental locations generally are situated in industrial
or commercial zones. A growing number of locations have highway or major
thoroughfare visibility. The typical location is approximately three acres in
size, though smaller in Europe, and includes a customer service center, an
equipment service
18
area and storage facilities for equipment. The
branches are built or conform to the specifications of the HERC prototype
branch, which stresses efficiency, safety and environmental compliance. Most
branches have stand-alone maintenance and fueling facilities and
showrooms.
HERC slightly contracted its network of equipment
rental locations during the 2001 to 2003 downturn in construction activities.
HERC added five new locations in the United States during 2004 and six during
2005. During the year ended December 31, 2006, HERC added ten U.S.
locations and two new Canadian locations. We expect HERC to add approximately
15 to 20 additional locations in the United States and approximately three
additional locations in Canada in 2007. In connection with its U.S. expansion,
we expect HERC will incur non-fleet start-up costs of approximately $0.6
million per location and additional fleet acquisition costs over an initial twelve-month
period of approximately $5.4 million per location.
Starting in 2004, HERC began to broaden its equipment
line in the United States and Canada to include more equipment with an
acquisition cost of under $10,000 per unit, ranging from air compressors and
generators to small tools and accessories, in order to supply customers who are
local contractors with a greater proportion of their overall equipment rental
needs. As of December 31, 2006, these activities, referred to as “general
rental activities,” were conducted at approximately 42% of HERC’s U.S. and
Canadian rental locations. Before it begins to conduct general rental
activities at a location, HERC typically renovates the location to make it more
appealing to walk-in customers and adds staff and equipment in anticipation of
subsequent demand.
HERC’s operations generated
$1,672.6 million in revenues and $269.5 million in income before income taxes
and minority interest during the year ended December 31, 2006.
Customers
HERC’s customers consist predominantly of commercial
accounts and represent a wide variety of industries, such as construction,
petrochemical, automobile manufacturing, railroad, power generation and
shipbuilding. Serving a number of different industries enables HERC to reduce
its dependence on a single or limited number of customers in the same business
and somewhat reduces the seasonality of HERC’s revenues and its dependence on
construction cycles. HERC primarily targets customers in medium to large
metropolitan markets. For the year ended December 31, 2006, no customer of
HERC accounted for more than 1.0% of HERC’s rental revenues. Of HERC’s combined
U.S. and Canadian rental revenues for the year ended December 31, 2006,
roughly half were derived from customers operating in the construction industry
(the majority of which was in the nonresidential sector), while the remaining
revenues were derived from rentals to industrial, governmental and other types
of customers.
Unlike in our car rental
business, where we enter into rental agreements with the people who will
operate the cars being rented, HERC ordinarily enters into a rental agreement
with the legal entity—typically a company, governmental body or other
organization—seeking to rent HERC’s equipment. Moreover, unlike in our car
rental business, where our cars are normally picked up and dropped off by
customers at our rental locations, HERC delivers much of its rental equipment
to its customers’ job sites and retrieves the equipment from the job sites when
the rentals conclude. Finally, unlike in our car rental business, HERC extends
credit terms to many of its customers to pay for rentals. Thus, for the year
ended December 31, 2006, 95% of HERC’s revenues came from customers who
were invoiced by HERC for rental charges, while 4% came from customers paying
with third-party charge, credit or debit cards and 1% came from customers
who paid with cash or used another method of payment. For the year ended December 31,
2006, HERC had a bad debt expense ratio of 0.3% of its revenues.
19
Fleet
HERC acquires its equipment from a variety of
manufacturers. The equipment is typically new at the time of acquisition and is
not subject to any repurchase program. The per-unit acquisition cost of units
of rental equipment in HERC’s fleet vary from over $200,000 to under $100. As
of December 31, 2006, the average per-unit acquisition cost (excluding
small equipment purchased for less than $5,000 per unit) for HERC’s fleet in
the United States was approximately $35,000. As of December 31, 2006, the
average age of HERC’s rental fleet in the United States was 26 months. We
believe that this fleet is one of the youngest fleets in the industry. Having a
younger fleet reduces maintenance expenses, which generally escalate as
equipment ages. As of December 31, 2006, the average age of HERC’s
international rental fleet was 31 months in Canada and 33 months in France and
Spain, which we believe is roughly comparable to or younger than the average
ages of the fleets of HERC’s principal competitors in those countries.
HERC disposes of its used
equipment through a variety of channels, including private sales to customers
and other third parties, sales to wholesalers, brokered sales and auctions.
Ancillary to its rental business, HERC is also a dealer of certain brands of
new equipment in the United States and Canada, and sells consumables such as
gloves and hardhats at many of its rental locations.
Licensees
HERC licenses the Hertz name
to equipment rental businesses in eight countries in Europe and the Middle
East. The terms of those licenses are broadly similar to those we grant to our
international car rental licensees.
Competition
HERC’s competitors in the equipment rental industry
range from other large national companies to small regional and local
businesses. In each of the four countries where HERC operates, the equipment
rental industry is highly fragmented, with large numbers of companies operating
on a regional or local scale. The number of industry participants operating on
a national scale is, however, much smaller. HERC is one of the principal
national-scale industry participants in each of the four countries where
it operates. HERC’s operations in the United States represented approximately
76% of our worldwide equipment rental revenues during the year ended December 31,
2006. In the United States and Canada, the other top five national-scale
industry participants are United Rentals, Inc., or “URI,” RSC Equipment
Rental, Sunbelt Rentals, Home Depot Rentals and NES Rentals. A number of
individual Caterpillar dealers also participate in the equipment rental market
in the United States, Canada, France and Spain. In France, the other principal
national-scale industry participants are Loxam, Kiloutou and Laho, while
in Spain, the other principal national-scale industry participants are
GAM and Euroloc.
Competition in the equipment
rental industry is intense, and it often takes the form of price competition.
HERC’s competitors, some of which may have access to substantial capital, may
seek to compete aggressively on the basis of pricing. To the extent that HERC
matches downward competitor pricing, it could have an adverse impact on our
results of operations. To the extent that HERC is not willing to match
competitor pricing, it could also have an adverse impact on our results of
operations due to lower rental volume. From 2001 to 2003, the equipment rental
industry experienced downward pricing, measured by the rental rates charged by
rental companies.
For the
years ended December 31, 2004, 2005 and 2006, we believe industry pricing,
measured in the same way, improved in the United States and Canada and only
started to improve towards the end of 2005 in France and Spain. HERC also
experienced higher equipment rental volumes worldwide for the years ended December 31,
2005 and 2006. We believe that HERC’s competitive success has been
primarily the product of its 40 years of experience in the equipment rental
industry, its systems and procedures
20
for monitoring, controlling
and developing its branch network, its capacity to maintain a comprehensive
rental fleet, the quality of its sales force and its established national
accounts program.
Other Operations
Our wholly owned subsidiary,
Hertz Claim Management Corporation, or “HCM,” provides claim administration
services to us and, to a lesser extent, to third parties. These services
include investigating, evaluating, negotiating and disposing of a wide variety
of claims, including third-party, first-party, bodily injury,
property damage, general liability and product liability, but not the
underwriting of risks. HCM conducts business at nine regional offices in the
United States. Separate subsidiaries of ours conduct similar operations in nine
countries in Europe.
Seasonality
Car rental and equipment
rental are seasonal businesses, with decreased levels of business in the winter
months and heightened activity during the spring and summer. To accommodate
increased demand, we increase our available fleet and staff during the second
and third quarters. As business demand declines, fleet and staff are decreased
accordingly. However, certain operating expenses, including minimum concession
fees, rent, insurance and administrative overhead, remain fixed and cannot be
adjusted for seasonal demand. See “Item 1A—Risk Factors—Risks Related to Our
Business—Our business is highly seasonal, and a disruption in rental activity
during our peak season could materially adversely affect our results of
operations.” The following tables set forth this seasonaleffect by providing
quarterly revenues and operating income for each of the quarters in the year
ended December 31, 2006.
Revenues
Operating Income
In Millions of Dollars
In Millions of Dollars
Employees
As of December 31, 2006, we employed
approximately 31,500 persons, consisting of 22,200 persons in our U.S.
operations and 9,300 persons in our international operations. Employee benefits
in effect include group life insurance, hospitalization and surgical insurance,
pension plans and a defined contribution plan. International employees are
covered by a wide variety of union contracts and governmental regulations
affecting, among other things, compensation, job retention rights and
21
pensions. Labor contracts covering the terms of
employment of approximately 7,400 employees in the United States (including
those in U.S. territories) are presently in effect under 140 active contracts
with local unions, affiliated primarily with the International Brotherhood of
Teamsters and the International Association of Machinists. Labor contracts
covering approximately 2,300 of these employees will expire during 2007. We
have had no material work stoppage as a result of labor problems during
the last ten years, and we believe our labor relations to be good. Nonetheless,
we may be unable to negotiate new labor contracts on terms advantageous to us,
or without labor interruptions.
In addition to the employees referred to above, we
employ a substantial number of temporary workers, and engage outside services,
as is customary in the industry, principally for the non-revenue movement of
rental cars and equipment between rental locations and the movement of rental
equipment to and from customers’ job sites.
As part of our effort to implement our strategy of
reducing operating costs, we are evaluating our workforce and operations and
making adjustments, including headcount reductions and process improvements to
optimize work flow at rental locations and maintenance facilities as well as
streamlining our back-office operations, that we believe are necessary and appropriate.
On January 5, 2007 and February 28,
2007, we announced job reductions affecting a total of approximately 1,550
employees primarily in our U.S. car rental operations, with much smaller
reductions occurring in U.S. equipment rental operations, the corporate
headquarters in Park Ridge, New Jersey, and the U.S. service center in Oklahoma
City, as well as in Canada, Puerto Rico, Brazil, Australia and New Zealand.
Risk Management
Three types of
generally insurable risks arise in our operations:
·
legal liability arising from the operation of
our cars and on-road equipment (vehicle liability);
·
legal liability to members of the public and
employees from other causes (general liability/workers’ compensation); and
·
risk of property damage and/or business interruption
and/or increased cost of working as a consequence of property damage.
In addition, we offer optional liability insurance and
other products providing insurance coverage, which create additional risk
exposures for us. Our risk of property damage is also increased when we waive
the provisions in our rental contracts that hold a renter responsible for
damage or loss under an optional loss or damage waiver that we offer. We bear
these and other risks, except to the extent the risks are transferred through
insurance or contracts.
In many cases we self-insure
our risks or reinsure risks through wholly owned insurance subsidiaries. We
mitigate our exposure to large liability losses by maintaining excess insurance
coverage, subject to deductibles and caps, through unaffiliated carriers with
respect to our domestic operations and our car rental operations in Europe. For
our international operations outside Europe and for HERC’s operations in
Europe, we maintain some liability insurance coverage with unaffiliated
carriers. We also maintain property insurance through our captive insurer,
Probus Insurance Company Europe Limited, or “Probus” (with the risk reinsured
with unaffiliated insurance carriers) domestically and in Europe, subject to
deductibles.
22
Third-Party
Liability
In our domestic operations, we
are required by applicable financial responsibility laws to maintain insurance
against legal liability for bodily injury (including death) or property damage
to third parties arising from the operation of our cars and on-road equipment,
sometimes called “vehicle liability,” in stipulated amounts. In most places, we
satisfy those requirements by qualifying as a self-insurer, a process that
typically involves governmental filings and demonstration of financial
responsibility, which sometimes requires the posting of a bond or other
security. In the remaining places, we obtain an insurance policy from an
unaffiliated insurance carrier and indemnify the carrier for any amounts paid
under the policy. As a result of such arrangements, we bear economic
responsibility for domestic vehicle liability, except to the extent we
successfully transfer such liability to others through insurance or contractual
arrangements.
For our car rental operations
in Europe, we have established two wholly owned insurance subsidiaries, Probus,
a direct writer of insurance domiciled in Ireland, and Hertz International RE
Limited, or “HIRE,” a reinsurer organized in Ireland. In European countries
with company-operated locations, we purchase from Probus the vehicle
liability insurance required by law, and Probus reinsures the risks under such
insurance with HIRE. Effective January 1, 2007 reinsurance is provided by
another subsidiary of ours. Thus, as with our domestic operations, we bear economic
responsibility for vehicle liability in our European car rental operations,
except to the extent that we transfer such liability to others through
insurance or contractual arrangements. For our international operations outside
Europe and for HERC’s operations in Europe, we maintain some form of vehicle
liability insurance coverage. The nature of such coverage, and our economic
responsibility for covered losses, varies considerably. In all cases, though,
we believe the amounts and nature of the coverage we obtain is adequate in
light of the respective potential hazards.
Both domestically and in our
international operations, from time to time in the course of our business we
become legally responsible to members of the public for bodily injury (including
death) or property damage arising from causes other than the operation of our
cars and on-road equipment, sometimes known as “general liability.” As with
vehicle liability, we bear economic responsibility for general liability
losses, except to the extent we transfer such losses to others through
insurance or contractual arrangements.
To mitigate our exposure to
large vehicle and general liability losses domestically and in our car rental
operations in Europe, we maintain excess insurance coverage with unaffiliated
insurance carriers against such losses to the extent they exceed $10 million
per occurrence (for occurrences in Europe before December 15, 2003, to the
extent such losses exceeded $5 million per occurrence). The coverage provided
under such excess insurance policies is limited to $100 million for the current
policy year, which began on December 21, 2006 and ends on December 21,
2007 (for occurrences between December 15, 2005 and December 20,
2005, the limit is $235 million; between December 15, 2004 and December 14,
2005, $185 million; between December 15, 2003 and December 14, 2004,
$150 million; and between December 15, 2002 and December 14, 2003,
$675 million). For our international operations outside Europe and for HERC’s
operations in Europe, we also maintain liability insurance coverage with
unaffiliated carriers in such amounts as we deem adequate in light of the
respective potential hazards, where such insurance is obtainable on
commercially reasonable terms.
Our domestic rental contracts, both for car rental and
for equipment rental, typically provide that the renter will indemnify us for
liability arising from the operation of the rented vehicle or equipment (for
car rentals in certain places, though, only to the extent such liability exceeds
the amount stipulated in the applicable financial responsibility law). In
addition, many of HERC’s domestic rental contracts require the renter to
maintain liability insurance under which HERC is entitled to coverage. While
such provisions are sometimes effective to transfer liability to renters, their
value to us, particularly in cases of large losses, may be limited. The rental
contracts used in our international operations sometimes
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contain provisions relating to insurance or indemnity,
but they are typically more limited than those employed in our domestic
operations.
In our domestic car rental operations, we offer an
optional liability insurance product, Liability Insurance Supplement, or “LIS,”
that provides vehicle liability insurance coverage substantially higher than
state minimum levels to the renter and other authorized operators of a rented
vehicle. LIS coverage is provided under excess liability insurance policies
issued by an unaffiliated insurance carrier, the risks under which are reinsured
with a subsidiary of ours. As a consequence of those reinsurance arrangements,
rental customers’ purchases of LIS do not reduce our economic exposure to
vehicle liability. Instead, our exposure to vehicle liability is potentially
increased when LIS is purchased, because insured renters and other operators
may have vehicle liability imposed on them in circumstances and in amounts
where the applicable rental agreement or applicable law would not, absent the
arrangements just described, impose vehicle liability on us.
In both our domestic car rental operations and our
company-operated international car rental operations in many countries,
we offer an optional product or products providing insurance coverage, or “PAI/PEC”
coverage, to the renter and the renter’s immediate family members traveling
with the renter for accidental death or accidental medical expenses arising
during the rental period or for damage or loss of their property during the
rental period. PAI/PEC coverage is provided under insurance policies issued by
unaffiliated carriers or, in some parts of Europe, by Probus, and the risks
under such policies either are reinsured with HIRE or another subsidiary of
ours or are the subject of indemnification arrangements between us and the
carriers. Rental customers’ purchases of PAI/PEC coverage create additional
risk exposures for us, since we would not typically be liable for the risks
insured by PAI/PEC coverage if that coverage had not been purchased.
Our offering of LIS and PAI/PEC coverage in our domestic
car rental operations is conducted pursuant to limited licenses or exemptions
under state laws governing the licensing of insurance producers. In our
international car rental operations, our offering of PAI/PEC coverage
historically has not been regulated; however, in the countries of the European
Union, the regulatory environment for insurance intermediaries is rapidly
evolving, and we cannot assure you either that we will be able to continue
offering PAI/PEC coverage without substantial changes in its offering process
or in the terms of the coverage or that such changes, if required, would not
render uneconomic our continued offering of the coverage. Due to a change in
law in Australia, we have discontinued the sales of insurance products there.
Provisions on our books for
self-insured vehicle liability losses are made by charges to expense based upon
evaluations of estimated ultimate liabilities on reported and unreported
claims. As of December 31, 2006, this liability was estimated at $327.0
million for our combined domestic and international operations.
Damage to Our Property
We bear the risk of damage to our property, unless
such risk is transferred through insurance or contractual arrangements.
To mitigate our risk of large, single-site property damage
losses domestically and in Europe, we maintain property insurance through our
captive insurer, Probus (with the risk reinsured with unaffiliated insurance
carriers), generally with a per-occurrence deductible of $3.0 million ($10
million effective April 30, 2006 in the United States) and $2.5 million in
respect of vehicle damage, and $50,000 in respect of all other losses, in
Europe. For our international operations outside Europe, we also maintain
property insurance coverage with unaffiliated carriers in such amounts as we
deem adequate in light of the respective hazards, where such insurance is
available on commercially reasonable terms.
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Our rental contracts typically
provide that the renter is responsible for damage to or loss (including loss
through theft) of rented vehicles or equipment. We generally offer an optional
rental product, known in various countries as “loss damage waiver,” “collision
damage waiver,” “theft protection” or “accident excess reduction,” under which
we waive or limit our right to make a claim for such damage or loss. This
product is not regulated as insurance, but it is subject to specific laws in
roughly half of the U.S. jurisdictions where we operate.
Collision damage costs and the
costs of stolen or unaccounted-for vehicles and equipment, along with other
damage to our property, are charged to expense as incurred.
Other Risks
To manage other risks
associated with our businesses, or to comply with applicable law, we purchase
other types of insurance carried by business organizations, such as worker’s
compensation and employer’s liability (for which we, through contracts with
insurers domestically, bear the risk of the first $5 million of loss from any
occurrence), commercial crime and fidelity, performance bonds and directors’
and officers’ liability insurance, from unaffiliated insurance companies in
amounts deemed by us to be adequate in light of the respective hazards, where
such coverage is obtainable on commercially reasonable terms.
Governmental Regulation and Environmental Matters
Throughout the world, we are
subject to numerous types of governmental controls, including those relating to
prices and advertising, privacy and data protection, currency controls, labor
matters, charge card operations, insurance, environmental protection, used car
sales and licensing.
Environmental
The environmental requirements
applicable to our operations generally pertain to (i) the operation and
maintenance of cars, trucks and other vehicles, such as heavy equipment, buses
and vans; (ii) the ownership and operation of tanks for the storage of
petroleum products, including gasoline, diesel fuel and oil; and (iii) the
generation, storage, transportation and disposal of waste materials, including
oil, vehicle wash sludge and waste water. We have made, and will continue to
make, expenditures to comply with applicable environmental laws and
regulations.
The use of cars and other
vehicles is subject to various governmental requirements designed to limit
environmental damage, including those caused by emissions and noise. Generally,
these requirements are met by the manufacturer, except in the case of
occasional equipment failure requiring repair by us. Measures are taken at
certain locations in states that require the installation of Stage II Vapor Recovery
equipment to reduce the loss of vapor during the fueling process.
We utilize tanks worldwide,
approximately 490 of which are underground and 1,840 of which are aboveground,
to store petroleum products, and we believe our tanks are maintained in material
compliance with environmental regulations, including federal and state
financial responsibility requirements for corrective action and third-party
claims due to releases. Our compliance program for our tanks is intended to
ensure that (i) the tanks are properly registered with the state or other
jurisdiction in which the tanks are located and (ii) the tanks have been
either replaced or upgraded to meet applicable leak detection and spill,
overfill and corrosion protection requirements.
We are also incurring and
providing for expenses for the investigation and cleanup of contamination from
the discharge of petroleum substances at, or emanating from, currently and
formerly owned and leased properties, as well as contamination at other
locations at which our wastes have reportedly been identified. The amount of
any such expenses or related natural resource damages for which we may be held
responsible could be substantial. The probable losses that we expect to incur
for such matters have been accrued, and those losses are reflected in our
consolidated financial statements.
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As of December 31, 2006
and December 31, 2005, the aggregate amounts accrued for environmental
liabilities reflected in our consolidated balance sheet in “Other accrued
liabilities” were $3.7 million and $3.9 million, respectively. The accrual
generally represents the estimated cost to study potential environmental issues
at sites deemed to require investigation or clean-up activities, and the
estimated cost to implement remediation actions, including ongoing maintenance,
as required. Cost estimates are developed by site. Initial cost estimates are
based on historical experience at similar sites and are refined over time on
the basis of in-depth studies of the site. For many sites, the remediation
costs and other damages for which we ultimately may be responsible cannot be
reasonably estimated because of uncertainties with respect to factors such as
our connection to the site, the nature of the contamination, the involvement of
other potentially responsible parties, the application of laws and other
standards or regulations, site conditions, and the nature and scope of
investigations, studies, and remediation to be undertaken (including the
technologies to be required and the extent, duration, and success of
remediation).
With respect to cleanup
expenditures for the discharge of petroleum substances at, or emanating from,
currently and formerly owned or leased properties, we have received
reimbursement, in whole or in part, from certain U.S. states that maintain
underground storage tank petroleum cleanup reimbursement funds. Such funds have
been established to assist tank owners in the payment of cleanup costs
associated with releases from registered tanks. With respect to off-site U.S.
locations at which our wastes have reportedly been identified, we have been and
continue to be required to contribute to cleanup costs due to strict joint and
several cleanup liability imposed by the federal Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 and comparable state
superfund statutes.
Environmental legislation and
regulations and related administrative policies have changed rapidly in recent
years, both in the United States and in other countries. There is a risk that
governmental environmental requirements, or enforcement thereof, may become
more stringent in the future and that we may be subject to legal proceedings
brought by government agencies or private parties with respect to environmental
matters. In addition, with respect to cleanup of contamination, additional
locations at which wastes generated by us or substances used by us may have
been released or disposed, and of which we are currently unaware, may in the
future become the subject of cleanup for which we may be liable, in whole or
part. Further, at airport-leased properties, we may be subject to
environmental requirements imposed by airports that are more restrictive than
those obligations imposed by environmental regulatory agencies. Accordingly,
while we believe that we are in substantial compliance with applicable
requirements of environmental laws, we cannot offer assurance that our future
environmental liabilities will not be material to our consolidated financial
position, results of operations or cash flows.
Dealings with Renters
In the United States, car and equipment rental
transactions are generally subject to Article 2A of the Uniform Commercial
Code, which governs “leases” of tangible personal property. Car rental is also
specifically regulated in more than half of the states of the United States.
The subjects of state regulation include the methods by which we advertise,
quote and charge prices, the consequences of failing to honor reservations, the
terms on which we deal with vehicle loss or damage (including the protections
we provide to renters purchasing loss or damage waivers) and the terms and
method of sale of the optional insurance coverage that we offer. Some states
(including California, New York, Nevada and Illinois) regulate the price at which
we may sell loss or damage waivers, and many state insurance regulators have
authority over the prices and terms of the optional insurance coverage we
offer. See “—Risk Management” above for further discussion regarding the loss
or damage waivers and optional insurance coverages that we offer renters.
Internationally, regulatory regimes vary greatly by jurisdiction, but they do
not generally prevent us from dealing with customers in a manner similar to
that employed in the United States.
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Both in the United States and
internationally, we are subject to increasing regulation relating to customer
privacy and data protection. In general, we are limited in the uses to which we
may put data that we collect about renters, including the circumstances in
which we may communicate with them. In addition, we are generally obligated to
take reasonable steps to protect customer data while it is in our possession.
Our failure to do so could subject us to substantial legal liability or
seriously damage our reputation.
Changes in Regulation
Changes in government
regulation of our business have the potential to alter our business practices,
or our profitability, materially. Depending on the jurisdiction, those changes
may come about through new legislation, the issuance of new regulations or
changes in the interpretation of existing laws and regulations by a court,
regulatory body or governmental official. Sometimes those changes may have not
just prospective but also retroactive effect; this is particularly true when a
change is made through reinterpretation of laws or regulations that have been
in effect for some time. Moreover, changes in regulation that may seem neutral
on their face may have either more or less impact on us than on our
competitors, depending on the circumstances. Recent or potential changes in law
or regulation that affect us relate to insurance intermediaries, customer
privacy and data security and rate regulation, each as described under “Item 1A—Risk
Factors—Risks Related to Our Business—Changes in the U.S. and foreign legal and
regulatory environment that impact our operations, including laws and
regulations relating to the insurance products we sell, customer privacy, data
security, insurance rates and expenses we pass through to customers by means of
separate charges, could disrupt our business, increase our expenses or
otherwise could have a material adverse effect on our results of operations.”
In addition, our operations,
as well as those of our competitors, also could be affected by any limitation in
the fuel supply or by any imposition of mandatory allocation or rationing
regulations. We are not aware of any current proposal to impose such a regime
in the United States or internationally. Such a regime could, however, be
quickly imposed if there were a serious disruption in supply for any reason,
including an act of war, terrorist incident or other problem affecting
petroleum supply, refining, distribution or pricing.
Relationship with Ford
Prior to the Acquisition,
Ford, through its wholly owned subsidiary Ford Holdings, was Hertz’s only
stockholder. As a result of the Acquisition, Hertz Holdings indirectly owns all
of Hertz’s outstanding common stock. As a result of our initial public
offering, investment funds associated with or designated by the Sponsors
currently own approximately 72% of Hertz Holdings’ outstanding common stock.
Set forth below are
descriptions of certain agreements, relationships and transactions between
Hertz and Ford that survived the completion of the Acquisition.
Supply and Advertising
Arrangements
On July 5, 2005, Hertz,
one of its wholly owned subsidiaries and Ford signed a Master Supply and
Advertising Agreement, effective July 5, 2005 and expiring August 31,
2010, that covers the 2005 through 2010 vehicle model years.
The terms of the Master Supply
and Advertising Agreement only apply to our fleet requirements and advertising
in the United States and to Ford, Lincoln or Mercury brand vehicles, or “Ford
Vehicles.” Under the Master Supply and Advertising Agreement, Ford has agreed
to supply to us and we have agreed to purchase from Ford, during each of the
2005 through 2010 vehicle model years, a specific number of Ford Vehicles. Ford
has also agreed in the Master Supply and Advertising Agreement to pay us a
contribution toward the cost of our advertising of Ford Vehicles equal to
one-half of our total expenditure on such advertising, up to a specified
maximum amount. To be eligible for advertising
27
cost contribution under the
Master Supply and Advertising Agreement, the advertising must meet certain
conditions, including the condition that we feature Ford Vehicles in a manner
and with a prominence that is reasonably satisfactory to Ford. It further
provides that the amounts Ford will be obligated to pay to us for our advertising
costs will be increased or reduced according to the number of Ford Vehicles
acquired by us in any model year, provided Ford will not be required to pay any
amount for our advertising costs for any year if the number of Ford Vehicles
acquired by us in the corresponding model year is less than a specified minimum
except to the extent that our failure to acquire the specified minimum number
of Ford Vehicles is attributable to the availability of Ford Vehicles or Ford
vehicle production is disrupted for reasons beyond the control of Ford. To the
extent we acquire less than a specified minimum number of Ford Vehicles in any
model year, we have agreed to pay Ford a specified amount per vehicle below the
minimum.
The advertising contributions
paid by Ford for the 2006 vehicle model year were slightly higher than the
advertising contributions we received from Ford for the 2005 model year due to
an increase in the number of Ford Vehicles acquired and an increase in the per
car contribution. We expect that contributions in future years will be below
levels for the 2006 model year based upon anticipated reductions in the number
of Ford Vehicles to be acquired. We do not expect that the reductions in Ford’s
advertising contributions will have a material adverse effect on our results of
operations.
Under the terms of the Master
Supply and Advertising Agreement, we are able to enter into vehicle advertising
and supply agreements with other automobile manufacturers in the United States
and in other countries, and we intend to explore those opportunities. However,
we cannot offer assurance that we will be able to obtain advertising
contributions from other automobile manufacturers that will mitigate reductions
in Ford’s advertising contributions.
Ford subsidiaries and affiliates
also supply other brands of cars, including Jaguar, Volvo, Mazda and Land Rover
cars, to us in the United States under arrangements separate from the Master
Supply and Advertising Agreement. In addition, Ford and its subsidiaries and
affiliates are significant suppliers of cars to our international operations.
Other Relationships and
Transactions
We and Ford also engage in
other transactions in the ordinary course of our respective businesses. These
transactions include HERC’s providing equipment rental services to Ford, our
providing insurance and insurance claim management services to Ford and our
providing car rental services to Ford. In addition, Ford subsidiaries are our
car rental licensees in Scandinavia and Finland.
We may be exposed to liabilities
for regulatory or tax contingencies of Ford arising from the period during
which we were a consolidated subsidiary of Ford. While Ford has agreed to
indemnify us for certain liabilities pursuant to the arrangements relating to
our separation from Ford, we cannot offer assurance that any payments in
respect of these indemnification arrangements will be made available.
Available Information
We file annual and quarterly reports and other
information with the United States Securities and Exchange Commission, or the “SEC.”
You may read and copy any documents that we file at the SEC’s public reference
room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330
for further information about the public reference room. In addition, the SEC
maintains an Internet website (www.sec.gov) that contains reports and other
information about issuers that file electronically with the SEC, including
Hertz Holdings. You may also access, free of charge, our reports filed with the
SEC (for example, our Annual Report on Form 10-K, our Quarterly
Reports on Form 10-Q and our Current Reports on Form 8-K
and any amendments to those forms) indirectly through our Internet website
(www.hertz.com). Reports filed with or furnished to the SEC will be available as
soon as reasonably practicable after they are filed with or furnished to the
SEC. The information found on our website is not part of this or any other
report filed with or furnished to the SEC.
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ITEM 1A. RISK FACTORS
Our business is subject to a number of important risks
and uncertainties, some of which are described below. The risks described
below, however, are not the only risks that we face. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial may also impair our business operations. Any of these risks may have
a material adverse effect on our business, financial condition, results of
operations and cash flows.
Risks Related to Our Business
An economic
downturn could result in a decline in business and leisure travel and
non-residential capital investment, which could harm our business.
Our results of operations are
affected by many economic factors, including the level of economic activity in
the markets in which we operate. A decline in economic activity either in the
United States or in international markets may have a material adverse effect on
our business. In the car rental business, a decline in economic activity
typically results in a decline in both business and leisure travel and,
accordingly, a decline in the volume of car rental transactions. In the
equipment rental business, a decline in economic activity typically results in
a decline in activity in non-residential construction and other businesses in
which our equipment rental customers operate and, therefore, results in a
decline in the volume of equipment rental transactions. In the case of a
decline in car or equipment rental activity, we may reduce rental rates to meet
competitive pressures, which could have a material adverse effect on our
results of operations. A decline in economic activity also may have a material
adverse effect on residual values realized on the disposition of our revenue
earning cars and/or equipment.
We face
intense competition that may lead to downward pricing, or an inability to
increase prices, which could have a material adverse impact on our results of
operations.
The markets in which we
operate are highly competitive. See “Item 1—Business—Worldwide Car Rental—Competition”
and “Item 1—Business—Equipment Rental—Competition.” We believe that price is
one of the primary competitive factors in the car and equipment rental markets.
Our competitors, some of whom may have access to substantial capital, may seek
to compete aggressively on the basis of pricing. To the extent that we match
competitors’ downward pricing, it could have a material adverse impact on our
results of operations. To the extent that we do not match or remain within a
reasonable competitive distance from our competitors’ pricing, it could also
have a material adverse impact on our results of operations, as we may lose
rental volume. The Internet has increased pricing transparency among car rental
companies by enabling cost-conscious customers, including business travelers,
to more easily obtain the lowest rates available from car rental companies for
any given trip. This transparency may increase the prevalence and intensity of
price competition in the future.
Our car
rental business is dependent on the air travel industry, and disruptions in air
travel patterns could harm our business.
We estimate that approximately
72% of our worldwide car rental revenues during the year ended December 31,
2006 were generated at our airport rental locations. Significant capacity
reductions or airfare increases (e.g., due to an increase in fuel costs) could
result in reduced air travel and have a material adverse effect on our results
of operations. In addition, any event that disrupts or reduces business or leisure
air travel could have a material adverse effect on our results of operations.
In particular, many U.S. airlines have experienced economic distress in recent
years. Any further deterioration in the economic condition of U.S. and
international airlines could exacerbate reductions in air travel. Other events
that impact air travel could include work stoppages, military conflicts,
terrorist incidents, natural disasters, epidemic diseases, or the response of
governments to any of
29
these events. For example,
shortly before the September 11, 2001 terrorist attacks, we estimated that
we would earn a pre-tax profit of approximately $250 million in 2001; by
contrast, our actual pre-tax profit for 2001 was only approximately $3 million,
and we continued to feel the adverse effects of the attacks well into the
following year. On a smaller scale, the 2003 outbreak of Severe Acute
Respiratory Syndrome, or “SARS,” in the Toronto, Canada area and parts of Asia,
significantly reduced our 2003 results of operations in Canada.
Our business is highly
seasonal, and a disruption in rental activity during our peak season could
materially adversely affect our results of operations.
Certain significant components
of our expenses, including real estate taxes, rent, utilities, maintenance and
other facility-related expenses, the costs of operating our information
systems and minimum staffing costs, are fixed in the short-run. Seasonal
changes in our revenues do not alter those fixed expenses, typically resulting
in higher profitability in periods when our revenues are higher and lower
profitability in periods when our revenues are lower. The second and third
quarters of the year have historically been our strongest quarters due to their
increased levels of leisure travel and construction activity. In 2006, the
second and third quarters accounted for approximately 25% and 28% of total
revenues and 29% and 82% of income before income taxes and minority interest,
respectively. Any occurrence that disrupts rental activity during the second or
third quarters could have a disproportionately material adverse effect on our
liquidity and/or results of operations. See “Item 7—Management’s Discussion and
Analysis of Financial Condition and Results of Operations—Liquidity and Capital
Resources.”
We may
not be successful in our business strategy to expand into the off-airport
rental market, including marketing to replacement renters and insurance
companies that reimburse or pay for such rentals.
We have been increasing our
presence in the off-airport car rental market in the United States. We
currently intend to pursue profitable growth opportunities in the off-airport
market. We may do this through a combination of selected new location openings,
a disciplined evaluation of existing locations and the pursuit of same-store
sales growth. In order to increase revenues at our existing and any new
off-airport locations, we will need to successfully market to insurance
companies and other companies that provide rental referrals to those needing
cars while their vehicles are being repaired or are temporarily unavailable for
other reasons, as well as to the renters themselves. This could involve a
significant number of additional off-airport locations or strategic changes
with respect to our existing locations. We incur minimal non-fleet costs in
opening our new off-airport locations, but new off-airport locations, once
opened, take time to generate their full potential revenues. As a result,
revenues at new locations do not initially cover their start-up costs and often
do not, for some time, cover the costs of their ongoing operation. See “Item 1—Business—Worldwide
Car Rental—Operations.” The results of this strategy and the success of our
implementation of this strategy will not be known for a number of years. If we
are unable to grow profitably in our off-airport network, properly react to
changes in market conditions or successfully market to replacement renters and
the insurance companies covering the cost of their rentals, our financial
condition, results of operations and cash flows could be materially adversely
affected.
We face
risks of increased costs of cars and of decreased profitability, including as a
result of limited supplies of competitively priced cars.
We believe we are one of the largest private sector
purchasers of new cars in the world for our rental fleet, and during the year
ended December 31, 2006, our approximate average holding period for a
rental car was ten months in the United States and nine months in our
international car rental operations. In recent years, the average cost of new
cars has increased. In the United States, increases of approximately 17% in
monthly per-car depreciation costs for 2006 model year program
30
cars began to adversely affect our results of
operations in the fourth quarter of 2005, as those cars began to enter our
fleet. On a comparable basis, we expect 2007 model year program vehicle
depreciation costs to rise approximately 20% and per-car depreciation costs for
2007 model year U.S. risk cars to decline slightly. As a consequence of those
changes in per-car costs, as well as the larger proportion of our U.S. fleet we
expect to purchase as risk cars and other actions we expect to take to mitigate
program car cost increases, we expect our net per-car depreciation costs for
2007 model year cars in the United States will increase by approximately 5%
from our net per-car depreciation costs for 2006 model year U.S. cars. We began
to experience the impact of those cost changes and mitigation actions in the
fourth quarter of 2006, as substantial numbers of 2007 model year cars began to
enter our U.S. rental fleet. We may not be able to offset these car cost
increases to a degree sufficient to maintain our profitability.
Historically, we have purchased more of the cars we rent
from Ford than from any other automobile manufacturer. Over the five years
ended December 31, 2006, approximately 47% of the cars acquired by us for
our U.S. car rental fleet, and approximately 32% of the cars acquired by us for
our international fleet, were manufactured by Ford and its subsidiaries. During
the year ended December 31, 2006, approximately 40% of the cars acquired
by us domestically were manufactured by Ford and its subsidiaries and
approximately 30% of the cars acquired by us for our international fleet were
manufactured by Ford and its subsidiaries, which represented the largest
percentage of any automobile manufacturer during that period. Under our Master
Supply and Advertising Agreement with Ford, Ford has agreed to develop fleet offerings
in the United States that are generally competitive with terms and conditions
of similar offerings by other automobile manufacturers. The Master Supply and
Advertising Agreement expires in 2010. See “Item 1—Business—Relationship with
Ford—Supply and Advertising Arrangements.” We cannot assure you that we will be
able to extend the Master Supply and Advertising Agreement beyond its current
term or enter into similar agreements at reasonable terms. In the future, we
expect to buy a smaller proportion of our car rental fleet from Ford than we
have in the past. If Ford does not offer us competitive terms and conditions,
and we are not able to purchase sufficient quantities of cars from other
automobile manufacturers on competitive terms and conditions, then we may be
forced to purchase cars at higher prices, or on terms less competitive, than
for cars purchased by our competitors. Historically, we have also purchased a
significant percentage of our car rental fleet from General Motors. Over the
five years ended December 31, 2006, approximately 19% of the cars acquired
by us for our U.S. car rental fleet, and approximately 15% of the cars acquired
by us for our international fleet, were manufactured by General Motors. During
the year ended December 31, 2006, approximately 17% of the cars acquired
by our U.S. car rental fleet, and approximately 13% of the cars acquired by us
for our international fleet, were manufactured by General Motors.
To date we have not entered
into any long-term car supply arrangements with manufacturers other than Ford.
In addition, certain car manufacturers, including Ford, have adopted strategies
to de-emphasize sales to the car rental industry which they view as less
profitable due to historical sales incentive and other discount programs that
tended to lower the average cost of cars for fleet purchasers such as us.
Reduced or limited supplies of equipment together with increased prices are
risks that we also face in our equipment rental business. We cannot offer
assurance that we will be able to pass on increased costs of cars or equipment
to our rental customers. Failure to pass on significant cost increases to our
customers would have a material adverse impact on our results of operations and
financial condition.
We face risks related
to decreased acquisition or disposition of cars through repurchase and
guaranteed depreciation programs.
For the year ended December 31, 2006,
approximately 64% of the cars purchased in our combined U.S. and international
car rental fleet were subject to repurchase by car manufacturers under
31
contractual repurchase or guaranteed depreciation
programs. Under these programs, car manufacturers agree to repurchase cars at a
specified price or guarantee the depreciation rate on the cars during a
specified time period, typically subject to certain car condition and mileage
requirements. These repurchase and guaranteed depreciation programs limit the
risk to us that the market value of a car at the time of its disposition will
be less than its estimated residual value at such time. We refer to this risk
as “residual risk.” For this reason, cars purchased by car rental companies
under repurchase and guaranteed depreciation programs are sometimes referred to
by industry participants as “program” cars. Conversely, those cars not
purchased under repurchase or guaranteed depreciation programs for which the
car rental company is exposed to residual risk are sometimes referred to as “risk”
cars.
Repurchase and guaranteed depreciation programs enable
us to determine our depreciation expense in advance. This predictability is
useful to us, since depreciation is a significant cost factor in our
operations. Repurchase and guaranteed depreciation programs are also useful in
managing our seasonal peak demand for fleet, because some of them permit us to
acquire cars and dispose of them after relatively short periods of time. A
trade-off we face when we purchase program cars is that we typically pay
the manufacturer of a program car more than we would pay to buy the same car as
a risk car. Program cars thus involve a larger initial investment than their
risk counterparts. If a program car is damaged or otherwise becomes ineligible
for return or sale under the relevant program, our loss upon the disposition of
the car will be larger than if the car had been a risk car, because our initial
investment in the car was larger.
We expect the percentage of our car rental fleet
subject to repurchase or guaranteed depreciation programs to decrease
substantially due primarily to changes in the terms offered by automobile
manufacturers under repurchase programs. Accordingly, we expect to bear
increased risk relating to the residual market value and the related
depreciation on our car rental fleet and to use different rotational techniques
to accommodate our seasonal peak demand for cars.
Repurchase and guaranteed depreciation programs
generally provide us with flexibility to reduce the size of our fleet by
returning cars sooner than originally expected without risk of loss in the
event of an economic downturn or to respond to changes in rental demand. This
flexibility will be reduced as the percentage of program cars in our car rental
fleet decreases materially. See “Item 1—Business—Worldwide Car Rental—Fleet”
and “Item 7—Management’s Discussion and Analysis of Financial Condition and
Results of Operations—Overview.”
In the future, car
manufacturers could modify or eliminate their repurchase or guaranteed
depreciation programs or change their return policies (which include condition,
mileage and holding period requirements for returned cars) from one program
year to another to make it disadvantageous to acquire certain cars. Any such
modification or elimination would increase our exposure to the risks described
in the preceding paragraphs. In addition, because we obtain a substantial
portion of our financing in reliance on repurchase and guaranteed depreciation
programs, the modification or elimination of those programs, or the associated
return policies, by manufacturers or significant adverse changes in the
financial condition of manufacturers could make needed vehicle-related
debt financing significantly more difficult to obtain on reasonable terms. See “—Our
reliance on asset-backed financing to purchase cars subjects us to a
number of risks, many of which are beyond our control.”
We could be harmed by a
decline in the results of operations or financial condition of the
manufacturers of our cars, particularly if they are unable, or reject their
obligations, to repurchase program cars from us or to guarantee the
depreciation of program cars.
In 2005 and 2006, Ford and General Motors, which are
the principal suppliers of cars to us on both a program and risk basis, have
experienced deterioration in their operating results and significant
32
declines in their credit ratings. A severe or
persistent decline in the results of operations or financial condition of a
manufacturer of cars that we own could reduce the cars’ residual values,
particularly to the extent that the manufacturer unexpectedly announced the eventual
elimination of its models or nameplates or ceased manufacturing them
altogether. Such a reduction could cause us to sustain a loss on the ultimate
sale of risk cars, on which we bear the risk of such declines in residual
value, or require us to depreciate those cars on a more rapid basis while we
own them.
In addition, if a decline in results or conditions
were so severe as to cause a manufacturer to default on an obligation to
repurchase or guarantee the depreciation of program cars we own, or to cause a
manufacturer to commence bankruptcy reorganization proceedings, and reject its
repurchase or guaranteed depreciation obligations, we would have to dispose of
those program cars without the benefits of the associated programs. This could
significantly increase our expenses. In addition, disposing of program cars
following a manufacturer default or rejection of the program in bankruptcy
could result in losses similar to those associated with the disposition of cars
that have become ineligible for return or sale under the applicable program.
Such losses could be material if a large number of program cars were affected.
For example, we estimate that if Ford Motor Company, but not its subsidiaries,
were to file for bankruptcy reorganization and reject all its commitments to
repurchase program cars from us, we would sustain material losses, which could
be as high as over one hundred million dollars, upon disposition of those cars.
A reduction in the number of program cars that we buy would reduce the magnitude
of this exposure, but it would simultaneously increase our exposure to residual
value risk. See “—We face risks related to decreased acquisition or disposition
of cars through repurchase and guaranteed depreciation programs.”
Any default or reorganization
of a manufacturer that has sold us program cars might also leave us with a
substantial unpaid claim against the manufacturer with respect to program cars
that were sold and returned to the car manufacturer but not paid for, or that
were sold for less than their agreed repurchase price or guaranteed value. For
the year ended December 31, 2006, outstanding month-end receivables for
cars sold to manufacturers were as much as $805 million, with the highest
amount for a single manufacturer being $204 million owed by Ford. A decline in
the economic and business prospects of car manufacturers, including any
economic distress impacting the suppliers of car components to manufacturers,
could also cause manufacturers to raise the prices we pay for cars or reduce their
supply to us. In addition, events negatively affecting the car manufacturers
could affect how much we may borrow under our asset-backed financing. See
“—Our reliance on asset-backed financing to purchase cars subjects us to
a number of risks, many of which are beyond our control.”
We may not be
successful in implementing our strategy of reducing operating costs and our
cost reduction initiatives may have other adverse consequences.
We are implementing
initiatives to reduce our operating expenses. These initiatives include
headcount reductions, as well as other expense controls. We cannot assure you
that we will be able to implement our cost reduction initiatives successfully,
or at all. Even if we are successful in our cost reduction initiatives, we may
face other risks associated with our plans, including declines in employee
morale or the level of customer service we provide. Any of these risks could
materialize and therefore may have a material adverse impact on our results of
operations, financial condition and cash flows.
Our reliance on asset-backed
financing to purchase cars subjects us to a number of risks, many of which are
beyond our control.
We rely significantly
on asset-backed financing to purchase cars for our domestic and
international car rental fleets. In connection with the Acquisition, a
bankruptcy-remote special purpose entity wholly owned by us issued
approximately $4,300 million of new debt (plus an additional $1,500 million in
the form of variable funding notes issued but not funded at the closing of the
Acquisition) backed by our U.S. car rental fleet under our U.S. asset-backed
securities program, or our “ABS Program.” In
33
addition, we issued
$600 million of medium term notes backed by our U.S. car rental fleet prior to
the Acquisition, or the “pre-Acquisition ABS Notes,” all of which remain
outstanding. As part of the Acquisition, various of our non-U.S. subsidiaries
and certain special purpose entities issued approximately $1,781 million of
debt under loan facilities secured by rental vehicles and related assets of
certain of our subsidiaries (all of which are organized outside the United
States) or by rental equipment and related assets of certain of our
subsidiaries organized outside North America, as well as (subject to certain limited
exceptions) substantially all our other assets outside North America. The asset-backed
debt issued in connection with the Transactions has expected final payment
dates ranging from 2008 to 2010 and the pre-Acquisition ABS Notes have expected
final payment dates ranging from 2007 to 2009. Based upon these repayment
dates, this debt will need to be refinanced within five years from the date of
the closing of the Transactions. Consequently, if our access to asset-backed
financing were reduced or were to become significantly more expensive for any
reason, we cannot assure you that we would be able to refinance or replace our
existing asset-backed financing or continue to finance new car
acquisitions through asset-backed financing on favorable terms, or at all.
Our asset-backed financing capacity could be decreased, or financing
costs and interest rates could be increased, as a result of risks and
contingencies, many of which are beyond our control, including, without
limitation:
·
rating
agencies that provide credit ratings for our asset-backed indebtedness,
third-party credit enhancers that insure our asset-backed
indebtedness or other third parties requiring changes in the terms and
structure of our asset-backed financing, including increased credit
enhancement (i) in connection with the incurrence of additional or
refinancing of existing asset-backed debt, (ii) upon the occurrence
of external events, such as changes in general economic and market conditions
or further deterioration in the credit ratings of our principal car
manufacturers, including Ford and General Motors, or (iii) or otherwise;
·
the
terms and availability of third-party credit enhancement at the time of
the incurrence of additional or refinancing of existing asset-backed
debt;
·
the
insolvency or deterioration of the financial condition of one or more of the
third-party credit enhancers that insure our asset-backed
indebtedness;
·
the
occurrence of certain events that, under the agreements governing our asset-backed
financing, could result, among other things, in (i) an amortization event
pursuant to which payments of principal and interest on the affected series of
asset-backed notes may be accelerated, or (ii) a liquidation event
of default pursuant to which the trustee or holders of asset-backed notes
would be permitted to require the sale of fleet vehicles or equipment that
collateralize the asset-backed financing; or
·
changes
in law that negatively impact our asset-backed financing structure.
Any disruption in our ability to refinance or replace
our existing asset-backed financing or to continue to finance new car
acquisitions through asset-backed financing, or any negative development
in the terms of the asset-backed financing available to us, could cause
our cost of financing to increase significantly and have a material adverse
effect on our financial condition and results of operations. The assets that
collateralize our asset-backed financing will not be available to satisfy
the claims of our general creditors. The terms of our senior credit facilities
permit us to finance or refinance new car acquisitions through other means,
including secured financing that is not limited to the assets of special
purpose entity subsidiaries. We may seek in the future to finance or refinance
new car acquisitions, including cars excluded from the ABS Program, through
such other means. No assurances can be given, however, as to whether such
financing will be available, or as to whether the terms of such financing will
be comparable to the debt issued under the ABS Program.
34
Most of our asset-backed debt
outside the United States was issued under an interim facility which provided
for increased margins if the debt was not refinanced by March 21, 2007. We
are in the process of negotiating new financing facilities to enable us to
refinance this debt. However, we cannot assure you that these efforts will be
successful or, if they are successful, that the new facilities will enable us
to finance our operations at rates which are as favorable to us as those of the
existing facility. On March 21, 2007, the existing facility was amended
and restated to, among other things, modify the provisions which provide for
increased margins. The effect of these changes will be to reduce or eliminate
the adverse consequences of these provisions to us for an interim period that
will end on December 21, 2007 in order to give us additional time to
refinance the interim facility. As a result of the changes, there was no
increase in margins on March 21, 2007. The extent of the relief that we
will receive during the remainder of the interim period will depend upon our
ability to achieve certain interim goals during that period. We cannot assure
you that we will be successful in achieving these interim goals.
Fluctuations in fuel
costs or reduced supplies could harm our business.
We could be adversely affected
by limitations on fuel supplies, the imposition of mandatory allocations or
rationing of fuel or significant increases in fuel prices. A severe or protracted
disruption of fuel supplies or significant increases in fuel prices could have
a material adverse effect on our financial condition and results of operations,
either by directly interfering with our normal activities or by disrupting the
air travel on which a significant portion of our car rental business relies.
See “—Our car rental business is dependent on the air travel industry, and
disruptions in air travel patterns could harm our business.”
Manufacturer
safety recalls could create risks to our business.
Our cars may be subject to
safety recalls by their manufacturers. Under certain circumstances, the recalls
may cause us to attempt to retrieve cars from renters or to decline to re-rent
returned cars until we can arrange for the steps described in the recalls to be
taken. If a large number of cars are the subject of simultaneous recalls, or if
needed replacement parts are not in adequate supply, we may not be able to
re-rent recalled cars for a significant period of time. We could also face liability
claims if recalls affect cars that we have already sold. Depending on the
severity of the recall, it could materially adversely affect our revenues,
create customer service problems, reduce the residual value of the cars
involved and harm our general reputation.
We face
risks arising from our heavy reliance on communications networks and
centralized information systems.
We rely heavily on information
systems to accept reservations, process rental and sales transactions, manage
our fleets of cars and equipment, account for our activities and otherwise
conduct our business. We have centralized our information systems in two
redundant facilities in Oklahoma City, Oklahoma, and we rely on communications
service providers to link our systems with the business locations these systems
serve. A simultaneous loss of both facilities, or a major disruption of
communications between the systems and the locations they serve, could cause a
loss of reservations, interfere with our ability to manage our fleet, slow rental
and sales processes and otherwise materially adversely affect our ability to
manage our business effectively. Our systems back-up plans, business continuity
plans and insurance programs are designed to mitigate such a risk, not to
eliminate it. In addition, because our systems contain information about
millions of individuals and businesses, our failure to maintain the security of
the data we hold, whether the result of our own error or the malfeasance or
errors of others, could harm our reputation or give rise to legal liabilities
leading to lower revenues, increased costs and other material adverse effects
on our results of operations.
35
The
concentration of our reservations, accounting and information technology
functions at a limited number of facilities in Oklahoma, Alabama and Ireland
creates risks for us.
We have concentrated our
reservations functions for the United States in two facilities, one in Oklahoma
City, Oklahoma, and one in Saraland (Mobile County), Alabama, and we have
concentrated our accounting functions for the United States in two facilities
in Oklahoma City. Similarly, we have concentrated reservations and accounting functions
for our European operations in a single facility near Dublin, Ireland. In
addition, our major information systems are centralized in two of our
facilities in Oklahoma City. A disruption of normal business at any of our
principal facilities in Oklahoma City, Saraland or Dublin, whether as the
result of localized conditions (such as a fire or explosion) or as the result
of events or circumstances of broader geographic impact (such as an earthquake,
storm, flood, epidemic, strike, act of war, civil unrest or terrorist act),
could materially adversely affect our business by disrupting normal
reservations, customer service, accounting and systems activities. Our systems
designs, business continuity plans and insurance programs are designed to
mitigate those risks, not to eliminate them, and this is particularly true with
respect to events of broad geographic impact.
Claims
that the software products and information systems that we rely on are
infringing on the intellectual property rights of others could increase our
expenses or inhibit us from offering certain services, which could adversely
affect our results of operations.
A number of entities, including some of our
competitors, have sought, or may in the future obtain, patents and other
intellectual property rights that cover or affect software products and other
components of information systems that we rely on to operate our business. For
example, Enterprise has asserted that certain systems we use to conduct
insurance replacement rentals would infringe on patent rights it would obtain
if it were granted certain patents for which it has applied. One of the patent
applications has received a notice of allowance and we expect that Enterprise
will be issued a patent pursuant to that application in the near future.
Litigation may be necessary to determine the validity
and scope of third-party rights or to defend against claims of
infringement. If a court determines that one or more of the software products
or other components of information systems we use infringe on intellectual
property owned by others or we agree to settle such a dispute, we may be liable
for money damages. In addition, we may be required to cease using those
products and components unless we obtain licenses from the owners of the intellectual
property, redesign those products and components in such a way as to avoid
infringement or cease altogether the use of those products and components. Each
of these alternatives could increase our expenses materially or impact the
marketability of our services. Any litigation, regardless of the outcome, could
result in substantial costs and diversion of resources and could have a
material adverse effect on our business. In addition, a third-party
intellectual property owner might not allow us to use its intellectual property
at any price, or on terms acceptable to us, which could materially affect our
competitive position and our results of operations.
For example, if Enterprise
obtains the patent referred to above and after that were to pursue and prevail
on claims of infringement similar to those it has previously asserted, it could
have a material adverse effect on our insurance replacement business and, in
turn, our off-airport business. We have already commenced litigation against
Enterprise with respect to claims it has made to third parties regarding the
patent rights referred to above. See “Item 3—Legal Proceedings” for more
information regarding that litigation.
36
If we acquire any
businesses in the future, they could prove difficult to integrate, disrupt our
business, or have an adverse effect on our results of operations.
We intend
to pursue growth primarily through internal growth, but from time to time we
may consider opportunistic acquisitions which may be significant. Any future
acquisition would involve numerous risks including, without limitation:
·
potential
disruption of our ongoing business and distraction of management;
·
difficulty
integrating the acquired business; and
·
exposure
to unknown liabilities, including litigation against the companies we may
acquire.
If we make acquisitions in the
future, acquisition-related accounting charges may affect our balance
sheet and results of operations. In addition, the financing of any significant
acquisition may result in changes in our capital structure, including the
incurrence of additional indebtedness. We may not be successful in addressing
these risks or any other problems encountered in connection with any
acquisitions.
We face risks related
to changes in our ownership.
A substantial number of our
airport concession agreements, as well as certain of our other agreements with
third parties, require the consent of the airports’ operators or other parties
in connection with any change in ownership of us. Changes in ownership of us
could also require the approval of other governmental authorities (including
insurance regulators, regulators of our retail used car sales activities and
antitrust regulators), and we cannot offer assurance that those approvals would
be obtained on terms acceptable to us. If our owners were to proceed to change
their ownership of us without obtaining necessary approvals, or if significant
conditions on our operations were imposed in connection with obtaining such
approvals, our ability to conduct our business could be impaired, resulting in
a material adverse effect on our results of operations and financial condition.
We face risks related
to liabilities and insurance.
Our businesses expose us to
claims for personal injury, death and property damage resulting from the use of
the cars and equipment rented or sold by us and for workers’ compensation
claims and other employment-related claims by our employees. Currently,
we generally self-insure up to $10 million per occurrence in the United States
and Europe for vehicle and general liability exposures and maintain insurance
with unaffiliated carriers in excess of such levels up to $100 million per
occurrence, or in the case of equipment rental in Europe and international
operations outside of Europe, in such lower amounts as we deem adequate given
the risks. We cannot assure you that we will not be exposed to uninsured
liability at levels in excess of our historical levels resulting from multiple
payouts or otherwise, that liabilities in respect of existing or future claims will
not exceed the level of our insurance, that we will have sufficient capital
available to pay any uninsured claims or that insurance with unaffiliated
carriers will continue to be available to us on economically reasonable terms
or at all. See “Item 1—Business—Risk Management” and “Item 3—Legal Proceedings.”
We could face
significant withdrawal liability if we withdraw from participation in one or
more multiemployer pension plans in which we participate.
We participate in various “multiemployer”
pension plans administered by labor unions representing some of our employees.
We make periodic contributions to these plans to allow them to meet their
pension benefit obligations to their participants. In the event that we
withdrew from participation in one or more of these plans, then applicable law
could require us to make an additional lump-sum contribution to those plans,
and we would have to reflect that on our balance sheet and statement of
operations. Our withdrawal liability for any multiemployer plan would depend on
the extent of the plan’s funding of vested benefits. We currently do not expect
to incur any withdrawal liability in the
37
near future. However, in the
ordinary course of our renegotiation of collective bargaining agreements with
labor unions that maintain these plans, we could decide to discontinue
participation in a plan, and in that event, we could face a withdrawal
liability. Some multiemployer plans, including ones in which we participate,
are reported to have significantly underfunded liabilities. Such underfunding
could increase the size of our potential withdrawal liability.
We have
received an informal request from the SEC to provide information about car
rental services that we provide to our independent registered public accounting
firm in the ordinary course of business.
In July 2005, the Division of Enforcement of the
SEC informed us that it was conducting an informal inquiry and asked Hertz to
voluntarily provide documents and information related to car rental services
that we provide to our independent registered public accounting firm
PricewaterhouseCoopers LLP, or “PwC.” The SEC noted in its letter that the
inquiry should not be construed as an indication by the SEC or its staff that
any violations of law have occurred, or as a reflection upon any person, entity
or security. We cooperated with the SEC by providing it with certain requested
information in July and September 2005. Since then, we have received
no further requests from the SEC with respect to this informal inquiry, but neither
have we been advised that it has been closed.
After learning of this
informal inquiry, our audit committee and representatives of PwC discussed PwC’s
independence with respect to us. PwC reconfirmed that it has been and remains
independent with respect to us. In making this determination, PwC considered,
among other things, its belief that PwC’s arrangements with us represent arm’s-length
transactions that were negotiated in the normal course of business, and,
therefore, that the commercial relationship does not impair PwC’s independence
with respect to us. If the SEC were to take a different view and it were
ultimately determined that PwC was not independent with respect to us for
certain periods, our filings with the SEC which contain our consolidated
financial statements for such periods would be non-compliant with applicable
securities laws. A determination that PwC was not independent with respect to
us could, among other things, cause us to be in violation of, or in default
under, the instruments governing our indebtedness and airport concession
agreements, limit our access to capital markets and result in regulatory
sanctions. Also, in the event of such a determination, we may be required to
have independent audits conducted on our previously audited financial
statements by another independent registered public accounting firm for the
affected periods. The time involved to conduct such independent audits may make
it more difficult to obtain capital on favorable terms, or at all, pending the
completion of such audits. Any of the foregoing could have a material adverse
effect on our results of operations, liquidity and financial condition, the
trading prices of our securities and the continued eligibility for listing of
our common stock on The New York Stock Exchange, or “NYSE.”
Environmental
laws and regulations and the costs of complying with them, or any liability or
obligation imposed under them, could adversely affect our financial position,
results of operations or cash flows.
We are regulated by federal, state, local and foreign
environmental laws and regulations in connection with our operations,
including, among other things, with respect to the ownership and operation of
tanks for the storage of petroleum products, such as gasoline, diesel fuel and
motor and waste oils. We have established a compliance program for our tanks
that is intended to ensure that the tanks are properly registered with the
state or other jurisdiction in which the tanks are located and have been either
replaced or upgraded to meet applicable leak detection and spill, overfill and
corrosion protection requirements. However, we cannot assure you that these
tank systems will at all times remain free from undetected leaks or that the
use of these tanks will not result in significant spills.
We have made, and will
continue to make, expenditures to comply with environmental laws and
regulations, including, among others, expenditures for the cleanup of
contamination at or emanating
38
from, currently and formerly
owned and leased properties, as well as contamination at other locations at
which our wastes have reportedly been identified. We cannot assure you that
compliance with existing or future environmental legislation and regulations
will not require material expenditures by us or otherwise have a material
adverse effect on our consolidated financial position, results of operations or
cash flows. See “Item 1—Business—Governmental Regulation and Environmental
Matters” and “Item 3—Legal Proceedings.”
Changes
in the U.S. and foreign legal and regulatory environment that impact our
operations, including laws and regulations relating to the insurance products
we sell, customer privacy, data security, insurance rates and expenses we pass
through to customers by means of separate charges, could disrupt our business,
increase our expenses or otherwise could have a material adverse effect on our
results of operations.
We are subject to a wide variety of laws and
regulations in the United States and the other countries and jurisdictions in which
we operate, and changes in the level of government regulation of our business
have the potential to materially alter our business practices or our
profitability. Depending on the jurisdiction, those changes may come about
through new legislation, the issuance of new laws and regulations or changes in
the interpretation of existing laws and regulations by a court, regulatory body
or governmental official. Sometimes those changes may have not just prospective
but also retroactive effect, which is particularly true when a change is made
through reinterpretation of laws or regulations that have been in effect for
some time. Moreover, changes in regulation that may seem neutral on their face
may have either more or less impact on us than on our competitors, depending on
the circumstances.
The optional liability insurance policies and products
providing insurance coverage in our domestic car rental operations are
conducted pursuant to limited licenses or exemptions under state laws governing
the licensing of insurance producers. In our international car rental
operations, our offering of optional products providing insurance coverage
historically has not been regulated. Any changes in the law in the United
States or internationally that change our operating requirements with respect
to insurance could increase our costs of compliance or make it uneconomical to
offer such products, which would lead to a reduction in revenues. For instance,
in the countries of the European Union, the regulatory environment for insurance
intermediaries is rapidly evolving, and we cannot assure you either that we
will be able to continue offering such coverage without substantial changes in
our offering process or in the terms of the coverage or that such changes, if
required, would not render uneconomic our continued offering of the coverage.
Due to a change in law in Australia, we have discontinued sales of insurance
products there. See “Item 1—Business—Risk Management” for further discussion
regarding how changes in the regulation of insurance intermediaries may affect
us internationally.
Laws in many countries and jurisdictions limit the
types of information we may collect about individuals with whom we deal or
propose to deal, as well as how we collect, retain and use the information that
we are permitted to collect. In addition, the centralized nature of our
information systems requires the routine flow of information about customers
and potential customers across national borders, particularly into the United
States. If this flow of information were to become illegal, or subject to
onerous restrictions, our ability to serve our customers could be seriously
impaired for an extended period of time. Other changes in the regulation of
customer privacy and data security could likewise have a material adverse
effect on our business. Privacy and data security are rapidly evolving areas of
regulation, and additional regulation in those areas, some of it potentially
difficult for us to accommodate, is frequently proposed and occasionally adopted.
Thus, changes in the worldwide legal and regulatory environment in the areas of
customer privacy, data security and cross-border data flows could have a
material adverse effect on our business, primarily through the impairment of
our marketing and transaction processing activities.
39
Further, the substantive regulation of the rates we
charge car renters, either through direct price regulation or a requirement
that we disregard a customer’s source market (location or place of residence)
for rate purposes, could reduce our revenues or increase our expenses. We set
rates based on a variety of factors including the sources of rental
reservations geographically and the means through which the reservations were
made, all of which are in response to various market factors and costs. The
European Commission is considering a directive that could restrict our ability
to take into account the country of residence of European Union residents for
rate purposes, and bills have been introduced into the New York State legislature
that would seek to prohibit us from charging higher rates to renters residing
in certain boroughs of New York City. The adoption of any such measures could
have a material adverse impact on our revenues and results of operations.
In most places where we
operate, we pass through various expenses, including the recovery of vehicle
licensing costs and airport concession fees, to our rental customers as
separate charges. The Attorneys General of Massachusetts, Virginia, Montana and
Alaska have in the past two years taken positions that car rental companies may
not pass through to customers, by means of separate charges, certain of their
expenses, such as vehicle licensing costs and airport concession fees, or that
car rental companies’ ability to pass through such expenses is limited. In
addition, we are currently a defendant in an action challenging the propriety
of certain expense pass-through charges in Nevada. We believe our expense
pass-through charges, where imposed, are lawful, and expense pass-throughs
have, when challenged, been upheld in courts of other states. The position of
the Attorney General of Virginia was reversed by subsequent legislation, while
the concerns of the Attorney General of Montana, which related primarily to our
licensees’ passing through of vehicle licensing costs, were resolved by
assurances of voluntary compliance by our licensees (which permitted passing
through of such costs subject to certain limitations of small operational
significance). Nonetheless, we cannot offer assurance that the Attorney General
of Massachusetts or Alaska, or of another state, will not take enforcement
action against us with respect to our car rental expense pass-throughs. If such
action were taken and an Attorney General were to prevail, it could have a
material adverse impact on our revenues and results of operations. In the
United States, our revenues from car rental expense pass-throughs for the year
ended December 31, 2006, were approximately $311.5 million.
The
misuse or theft of information we possess could harm our reputation or
competitive position, adversely affect the trading price of our common stock or
give rise to material liabilities.
We possess non-public
information with respect to millions of individuals, including our customers
and our current and former employees, and thousands of businesses, as well as
non-public information with respect to our own affairs. The misuse or
theft of that information by either our employees or third parties could result
in material damage to our brand, reputation or competitive position or
materially affect the price at which shares of our common stock trade. In
addition, depending on the type of information involved, the nature of our
relationship with the person or entity to which the information relates, the
cause and the jurisdiction whose laws are applicable, such misuse or theft of
information could result in governmental investigations or material civil or
criminal liability. The laws that would be applicable to such a failure are rapidly
evolving and becoming more burdensome. See “—Changes in the U.S. and foreign
legal and regulatory environment that impact our operations, including laws and
regulations relating to the insurance products we sell, customer privacy, data
security, insurance rates and expenses we pass through to customers by means of
separate charges, could disrupt our business, increase our expenses or
otherwise could have a material adverse effect on our results of operations.”
40
The Sponsors control us
and may have conflicts of interest with us in the future.
Clayton, Dubilier &
Rice Fund VII, L.P. and related funds, Carlyle Partners IV, L.P. and related
funds and ML Global Private Equity Fund, L.P. and related funds currently
beneficially own approximately 24.2%, 23.9% and 23.5%, respectively, of the
outstanding shares of the common stock of Hertz Holdings. These funds and Hertz
Holdings are parties to a Stockholders Agreement, pursuant to which the funds
have agreed to vote in favor of nominees to our board of directors nominated by
the other funds. As a result, the Sponsors will continue to exercise control
over matters requiring stockholder approval and our policy and affairs, for
example, by being able to direct the use of proceeds received from future
securities offerings. See “Item 13—Certain Relationships and Related
Transactions, and Director Independence.”
Additionally, the Sponsors are
in the business of making investments in companies and may from time to time
acquire and hold interests in businesses that compete directly or indirectly
with us. One or more of the Sponsors may also pursue acquisition opportunities
that may be complementary to our business and, as a result, those acquisition
opportunities may not be available to us. So long as investment funds associated
with or designated by the Sponsors continue to indirectly own a significant
amount of the outstanding shares of our common stock, even if such amount is
less than 50%, the Sponsors will continue to be able to strongly influence or
effectively control our decisions. While we have adopted a code of ethics and
business conduct that applies to all our directors, it does not preclude the
Sponsors from becoming engaged in businesses that compete with us or preclude
our directors from taking advantage of business opportunities other than those
made available to them through the use of their position as directors or the
use of our property.
Risks Relating to Our Substantial Indebtedness
We have substantial
debt and may incur substantial additional debt, which could adversely affect
our financial condition, our ability to obtain financing in the future and our
ability to react to changes in our business.
As of December 31, 2006,
we had an aggregate principal amount of debt outstanding of $12,359.4 million
and a debt to equity ratio, calculated using the total amount of our
outstanding debt net of unamortized discounts of 4.9 to 1.
Our
substantial debt could have important consequences to you. For example, it
could:
·
make
it more difficult for us to satisfy our obligations to the holders of our
outstanding debt securities and to the lenders under our senior credit
facilities and the U.S. and international fleet debt financings entered into as
part of the Transactions, resulting in possible defaults on and acceleration of
such indebtedness;
·
require
us to dedicate a substantial portion of our cash flows from operations to make
payments on our debt, which would reduce the availability of our cash flows
from operations to fund working capital, capital expenditures or other general
corporate purposes;
·
increase
our vulnerability to general adverse economic and industry conditions,
including interest rate fluctuations, because a portion of our borrowings,
including under the agreements governing our U.S. and international fleet debt
financings entered into as part of the Transactions and our senior credit
facilities, is at variable rates of interest;
·
place
us at a competitive disadvantage to our competitors with proportionately less
debt or comparable debt at more favorable interest rates;
·
limit
our ability to refinance our existing indebtedness or borrow additional funds
in the future;
·
limit
our flexibility in planning for, or reacting to, changing conditions in our
business and industry; and
41
·
limit
our ability to react to competitive pressures, or make it difficult for us to
carry out capital spending that is necessary or important to our growth
strategy and our efforts to improve operating margins.
Any of the foregoing impacts
of our substantial indebtedness could have a material adverse effect on our
business, financial condition and results of operations.
Despite our current
indebtedness levels, we and our subsidiaries may be able to incur substantially
more debt. This could further exacerbate the risks associated with our
substantial indebtedness.
We and our subsidiaries may be
able to incur substantial additional indebtedness in the future. The terms of
the instruments governing our indebtedness do not prohibit us or fully prohibit
our subsidiaries from doing so. As of December 31, 2006, our senior credit
facilities provided us commitments for additional aggregate borrowings (subject
to borrowing base limitations) of approximately $1,611.1 million, and permitted
additional borrowings beyond those commitments under certain circumstances. As
of December 31, 2006, our U.S. fleet debt facilities, international fleet
debt facilities and our fleet financing facility for our fleet in Hawaii,
Kansas, Puerto Rico and St. Thomas, the U.S. Virgin Islands provided us commitments
for additional aggregate borrowings of approximately $1,500.0 million, the
foreign currency equivalent of $1,236.4 million and $107.0 million,
respectively, subject to borrowing base limitations. If new debt is added to
our current debt levels, the related risks that we now face would increase. In
addition, the instruments governing our indebtedness do not prevent us or our
subsidiaries from incurring obligations that do not constitute indebtedness. On
June 30, 2006, Hertz Holdings entered into a $1.0 billion loan facility in
order to finance the payment of a special cash dividend of $4.32 per share on June 30,
2006. Although this facility was repaid in full with the proceeds from our
initial public offering, we cannot assure you that Hertz Holdings will not
enter into similar transactions in the future.
We may not be able to
generate sufficient cash to service all of our debt, and may be forced to take
other actions to satisfy our obligations under such indebtedness, which may not
be successful.
Our ability to make scheduled
payments on our indebtedness, or to refinance our obligations under our debt
agreements, will depend on the financial and operating performance of us and
our subsidiaries, which, in turn, will be subject to prevailing economic and competitive
conditions and to the financial and business risk factors, many of which may be
beyond our control, as described under “—Risks Related to Our Business” above.
We cannot assure you that we
will maintain a level of cash flows from operating activities sufficient to
permit us to pay the principal, premium, if any, and interest on our
indebtedness.
If our cash flows and capital
resources are insufficient to fund our debt service obligations, we may be
forced to reduce or delay capital expenditures, sell assets, seek to obtain
additional equity capital or restructure our indebtedness. In the future, our
cash flows and capital resources may not be sufficient for payments of interest
on and principal of our debt, and such alternative measures may not be successful
and may not permit us to meet scheduled debt service obligations. We also
cannot assure you that we will be able to refinance any of our indebtedness or
obtain additional financing, particularly because of our high levels of debt
and the debt incurrence restrictions imposed by the agreements governing our
debt, as well as prevailing market conditions. In the absence of such operating
results and resources, we could face substantial liquidity problems and might
be required to dispose of material assets or operations to meet our debt
service and other obligations. The instruments governing our indebtedness
restrict our ability to dispose of assets and restrict the use of proceeds from
any such dispositions. We cannot assure you we will be able to consummate those
sales, or, if we do, what the timing of the sales will be or whether the
proceeds that we realize will be adequate to meet debt service obligations when
due.
42
A
significant portion of our outstanding indebtedness is secured by substantially
all of our consolidated assets. As a result of these security interests, such
assets would only be available to satisfy claims of our general creditors or to
holders of our equity securities if we were to become insolvent to the extent
the value of such assets exceeded the amount of our indebtedness and other
obligations. In addition, the existence of these security interests may
adversely affect our financial flexibility.
Indebtedness under our senior
credit facilities is secured by a lien on substantially all our assets (other
than assets of foreign subsidiaries), including pledges of all or a portion of
the capital stock of certain of our subsidiaries. Our senior notes and senior
subordinated notes are unsecured and therefore do not have the benefit of such
collateral. Accordingly, if an event of default were to occur under our senior
credit facilities, the senior secured lenders under such facilities would have
a prior right to our assets, to the exclusion of our general creditors,
including the holders of our senior notes and senior subordinated notes. In
that event, our assets would first be used to repay in full all indebtedness
and other obligations secured by them (including all amounts outstanding under
our senior credit facilities), resulting in all or a portion of our assets
being unavailable to satisfy the claims of our unsecured indebtedness.
Furthermore, many of the subsidiaries that hold our U.S. and international car
rental fleets in connection with our asset-backed financing programs are
intended to be bankruptcy remote and the assets held by them may not be
available to our general creditors in a bankruptcy unless and until they are
transferred to a non-bankruptcy remote entity. As of December 31, 2006,
substantially all of our consolidated assets, including our car and equipment
rental fleets, have been pledged for the benefit of the lenders under our
senior credit facilities or are subject to securitization facilities in
connection with our U.S. and international fleet debt facilities. As a result,
the lenders under these facilities would have a prior claim on such assets in
the event of our bankruptcy, insolvency, liquidation or reorganization, and we
may not have sufficient funds to pay all of our creditors and holders of our
unsecured indebtedness may receive less, ratably, than the holders of our
senior debt, and may not be fully paid, or may not be paid at all, even when
other creditors receive full payment for their claims. In that event, holders
of our equity securities would not be entitled to receive any of our assets or
the proceeds therefrom. As discussed below, the pledge of these assets and
other restrictions may limit our flexibility in raising capital for other
purposes. Because substantially all of our assets are pledged under these
financing arrangements, our ability to incur additional secured indebtedness or
to sell or dispose of assets to raise capital may be impaired, which could have
an adverse effect on our financial flexibility.
Restrictive
covenants in certain of the agreements and instruments governing our
indebtedness may adversely affect our financial flexibility.
Our senior credit
facilities and the indentures governing our senior notes and senior
subordinated notes contain covenants that, among other things, restrict Hertz’s
and its subsidiaries’ ability to:
·
dispose
of assets;
·
incur
additional indebtedness;
·
incur
guarantee obligations;
·
prepay
other indebtedness or amend other debt instruments;
·
pay
dividends;
·
create
liens on assets;
·
enter
into sale and leaseback transactions;
·
make
investments, loans or advances;
43
·
make
acquisitions;
·
engage
in mergers or consolidations;
·
change
the business conducted by us; and
·
engage
in certain transactions with affiliates.
In addition, under our Senior Credit Facilities, we
are required to comply with financial covenants. If we fail to maintain a
specified minimum level of borrowing capacity under our Senior ABL Facility, we
will then be subject to financial covenants under that facility, including
covenants that will obligate us to maintain a specified debt to Corporate
EBITDA leverage ratio and a specified Corporate EBITDA to fixed charges
coverage ratio. The financial covenants in our Senior Term Facility include
obligations to maintain a specified debt to Corporate EBITDA leverage ratio and
a specified Corporate EBITDA to interest expense coverage ratio for specified
periods. Both our Senior ABL Facility and our Senior Term Facility also impose
limitations on the amount of our capital expenditures. Our ability to comply
with these covenants in future periods will depend on our ongoing financial and
operating performance, which in turn will be subject to economic conditions and
to financial, market and competitive factors, many of which are beyond our
control. Our ability to comply with these covenants in future periods will also
depend substantially on the pricing of our products and services, our success
at implementing cost reduction initiatives and our ability to successfully
implement our overall business strategy. Our ability to comply with the
covenants and restrictions contained in our senior credit facilities and the
indentures for our senior notes and senior subordinated notes may be affected
by economic, financial and industry conditions beyond our control. The breach
of any of these covenants or restrictions could result in a default under
either our senior credit facilities or the indentures that would permit the
applicable lenders or holders of the senior notes and senior subordinated
notes, as the case may be, to declare all amounts outstanding thereunder to be
due and payable, together with accrued and unpaid interest. In any such case,
we may be unable to make borrowings under the senior credit facilities and may
not be able to repay the amounts due under the senior credit facilities and the
senior notes and senior subordinated notes. This could have serious
consequences to our financial condition and results of operations and could
cause us to become bankrupt or insolvent.
We are also subject to operational limitations under
the terms of our ABS Program. For example, there are contractual limitations
with respect to the cars that secure our ABS Program. These limitations are
based on the identity or credit ratings of the cars’ manufacturers, the
existence of satisfactory repurchase or guaranteed depreciation arrangements
for the cars or the physical characteristics of the cars. As a result, we may
be required to limit the percentage of cars from any one manufacturer or
increase the credit enhancement related to the program and may not be able to
take advantage of certain cost savings that might otherwise be available
through manufacturers. If these limitations prevented us from purchasing, or
retaining in our fleet, cars on terms that we would otherwise find
advantageous, our results of operations could be adversely affected.
Further, the facilities relating to our international
fleet financing contain a number of covenants, including a covenant that
restricts the ability of Hertz International, Ltd., a subsidiary of ours that
is the direct or indirect holding company of substantially all of our non-U.S.
operating subsidiaries, to make dividends and other restricted payments (which
may include payments of intercompany indebtedness), in an amount greater than
€
100
million plus a specified excess cash flow amount, calculated by reference to
excess cash flow in earlier periods. Subject to certain exceptions, until the
later of one year from the Closing Date and such time as 50% of the commitments
under the facilities on the Closing Date have been replaced by permanent
take-out international asset-based facilities, the specified excess cash
flow amount will be zero. Thereafter, this specified excess cash flow amount
will be between 50% and 100% of excess cash flow based on the percentage of
facilities relating to
44
our international fleet debt at the closing of the
Acquisition that have been replaced by permanent take-out international asset-based
facilities. These restrictions will limit the availability of funds from Hertz
International, Ltd. and its subsidiaries to help us make payments on our
indebtedness. Certain of these permanent take-out international asset-based
facilities are expected to be novel and complicated structures. We cannot
assure you that we will be able to complete such permanent take-out financings
on terms acceptable to us or on a timely basis, if at all; if we are unable to
do so, our liquidity and interest costs may be adversely affected. See “—Our
reliance on asset-backed financing to purchase cars subjects us to a number of
risks, many of which are beyond our control.”
Certain of our Canadian
subsidiaries are parties to our Senior ABL Facility and are not subject to
these International Fleet Debt restrictions. Our non-U.S. subsidiaries, including
the operations of these Canadian subsidiaries, accounted for approximately 30%
of our total revenues and 24% of our Corporate EBITDA for the year ended December 31,
2006. See Note 10 to the Notes to our consolidated financial statements
included in this Annual Report under the caption “Item 8—Financial Statements
and Supplementary Data.”
An
increase in interest rates would increase the cost of servicing our debt and
could reduce our profitability.
A significant portion of our
outstanding debt, including borrowings under our Senior Credit Facilities,
International Fleet Debt and certain of our other outstanding debt securities,
bear interest at variable rates. As a result, an increase in interest rates,
whether because of an increase in market interest rates or an increase in our
own cost of borrowing, would increase the cost of servicing our debt and could
materially reduce our profitability, including, in the case of the U.S. Fleet
Debt and the International Fleet Debt, our Corporate EBITDA. The impact of such
an increase would be more significant than it would be for some other companies
because of our substantial debt. For a discussion of how we manage our exposure
to changes in interest rates through the use of interest rate swap agreements
on certain portions of our outstanding debt, see “Item 7—Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Market
Risks—Interest Rate Risk.”
The
instruments governing our debt contain cross default or cross acceleration
provisions that may cause all of the debt issued under such instruments to
become immediately due and payable as a result of a default under an unrelated
debt instrument.
The indentures governing our
senior notes and senior subordinated notes and the agreements governing our
senior credit facilities contain numerous covenants and require us to meet
certain financial ratios and tests which utilize Corporate EBITDA. Our failure
to comply with the obligations contained in these agreements or other
instruments governing our indebtedness could result in an event of default
under the applicable instrument, which could result in the related debt and the
debt issued under other instruments becoming immediately due and payable. In
such event, we would need to raise funds from alternative sources, which funds
may not be available to us on favorable terms, on a timely basis or at all.
Alternatively, such a default could require us to sell our assets and otherwise
curtail our operations in order to pay our creditors. Such alternative measures
could have a material adverse effect on our business, financial condition and
results of operations.
Risks Relating to Our
Common Stock
We may
have a contingent liability arising out of electronic communications sent to
institutional accounts by a previously named underwriter that did not
participate as an underwriter in the initial public offering of our common
stock.
We understand that, during the week of October 23,
2006, several e-mails authored by an employee of a previously named underwriter
for the initial public offering of our common stock were ultimately
45
forwarded by employees of that underwriter to
approximately 175 institutional accounts. We were not involved in any way in
the preparation or distribution of the e-mail messages by the employees of this
previously named underwriter, and we had no knowledge of them until after they
were sent. We requested that the previously named underwriter notify the
institutional accounts who received these e-mail messages from its employees
that the e-mail messages were distributed in error and should be disregarded.
In addition, this previously named underwriter did not participate as an
underwriter in the initial public offering of our common stock.
The e-mail messages may constitute a prospectus or
prospectuses not meeting the requirements of the Securities Act of 1933, as
amended, or the “Securities Act.” We, the Sponsors and the other underwriters
that participated in the initial public offering of our common stock disclaim
all responsibility for the contents of these e-mail messages.
We do not believe that the
e-mail messages constitute a violation by us of the Securities Act. However, if
any or all of these communications were to be held by a court to be a violation
by us of the Securities Act, the recipients of the e-mails, if any, who
purchased shares of our common stock in the initial public offering might have
the right, under certain circumstances, to require us to repurchase those
shares. Consequently, we could have a contingent liability arising out of these
possible violations of the Securities Act. The magnitude of this liability, if
any, is presently impossible to quantify, and would depend, in part, upon the
number of shares purchased by the recipients of the e-mails and the trading price
of our common stock. If any liability is asserted, we intend to contest the
matter vigorously.
Hertz
Holdings is a holding company with no operations of its own that depends on its
subsidiaries for cash.
The operations of Hertz
Holdings are conducted almost entirely through its subsidiaries and its ability
to generate cash to meet its debt service obligations, if any, or to pay
dividends is highly dependent on the earnings and the receipt of funds from its
subsidiaries via dividends or intercompany loans. However, none of the
subsidiaries of Hertz Holdings are obligated to make funds available to Hertz
Holdings for the payment of dividends. In addition, payments of dividends and
interest among the companies in our group may be subject to withholding taxes.
Further, the terms of the indentures governing Hertz’s senior notes and senior
subordinated notes and the agreements governing Hertz’s senior credit
facilities and Hertz’s fleet debt facilities significantly restrict the ability
of the subsidiaries of Hertz to pay dividends or otherwise transfer assets to
Hertz Holdings. Furthermore, the subsidiaries of Hertz are permitted under the
terms of Hertz’s senior credit facilities and other indebtedness to incur
additional indebtedness that may severely restrict or prohibit the making of
distributions, the payment of dividends or the making of loans by such
subsidiaries to Hertz Holdings. See “—Restrictive covenants in certain of the
agreements governing our indebtedness may adversely affect our financial
flexibility.” In addition, Delaware law may impose requirements that may
restrict our ability to pay dividends to holders of our common stock.
If the
ownership of our common stock continues to be highly concentrated, it will
prevent other stockholders from influencing significant corporate decisions.
The concentrated holdings of
the funds associated with the Sponsors, certain provisions of the Stockholders
Agreement among the funds and Hertz Holdings and the presence of these funds’
nominees on our board of directors of Hertz Holdings may result in a delay or
the deterrence of possible changes in control of Hertz Holdings, which may
reduce the market price of our common stock. The interests of the Sponsors may
conflict with the interests of our other stockholders. See “Item 1A—Risk
Factors—The Sponsors control us and
may have conflicts of interest with us in the future.” Our board of
directors has adopted corporate governance guidelines that will, among other
things, address potential conflicts between a director’s interests and our
interests. In addition, we
46
have adopted a code of
business conduct that, among other things, requires our employees to avoid
actions or relationships that might conflict or appear to conflict with their
job responsibilities or the interests of Hertz Holdings, and to disclose their
outside activities, financial interests or relationships that may present a
possible conflict of interest or the appearance of a conflict to management or
corporate counsel. These corporate governance guidelines and code of business
ethics will not, by themselves, prohibit transactions with our principal
stockholders.
Our share
price may decline due to the large number of shares eligible for future sale.
Sales of substantial amounts of our common stock, or
the possibility of such sales, may adversely affect the price of our common
stock and impede our ability to raise capital through the issuance of equity
securities.
There were 320,618,692 shares of our common stock
outstanding as of December 31, 2006. Of these shares, the shares of common
stock sold in the initial public offering are freely transferable without
restriction or further registration under the Securities Act, unless purchased
by our “affiliates” as that term is defined in Rule 144 under the
Securities Act. The remaining 232,383,692 shares of common stock outstanding
will be restricted securities within the meaning of Rule 144 under the
Securities Act, but will be eligible for resale subject to applicable volume,
manner of sale, holding period and other limitations of Rule 144 or
pursuant to an exemption from registration under Rule 701 under the
Securities Act. In November 2006, we filed a registration statement under
the Securities Act to register the shares of common stock to be issued under
our stock incentive plans and, as a result, all shares of common stock acquired
upon exercise of stock options and other equity-based awards granted under
these plans will also be freely tradable under the Securities Act unless
purchased by our affiliates. A total of 28.5 million shares of common stock are
reserved for issuance under our stock incentive plans.
We, each of the funds
associated with or designated by the Sponsors that currently own shares of our
common stock, our executive officers and directors have agreed to a “lock-up,”
meaning that, subject to certain exceptions, neither we nor they will sell any
shares without the prior consent of the representatives of the underwriters
before May 14, 2007. Following the expiration of this 180-day
lock-up period, 229,500,000 of these shares of our common stock will be
eligible for future sale, subject to the applicable volume, manner of sale,
holding period and other limitations of Rule 144. In addition, our
existing stockholders have the right under certain circumstances to require
that we register their shares for resale. As of December 31, 2006, these
registration rights apply to the 229,500,000 shares of our outstanding common
stock owned by the investment funds affiliated with or designated by the
Sponsors.
Our certificate
of incorporation, by-laws and Delaware law may discourage takeovers and
business combinations that our stockholders might consider in their best
interests.
A number of provisions
in our certificate of incorporation and by-laws, as well as anti-takeover
provisions of Delaware law, may have the effect of delaying, deterring,
preventing or rendering more difficult a change in control of Hertz Holdings
that our stockholders might consider in their best interests. These provisions
include:
·
establishment
of a classified board of directors, with staggered terms;
·
granting
to the board of directors sole power to set the number of directors and to fill
any vacancy on the board of directors, whether such vacancy occurs as a result
of an increase in the number of directors or otherwise;
·
limitations
on the ability of stockholders to remove directors;
47
·
the
ability of our board of directors to designate and issue one or more series of
preferred stock without stockholder approval, the terms of which may be
determined at the sole discretion of the board of directors;
·
prohibition
on stockholders from calling special meetings of stockholders;
·
establishment
of advance notice requirements for stockholder proposals and nominations for
election to the board of directors at stockholder meetings; and
·
prohibiting
our stockholders from acting by written consent if investment funds affiliated
with or designated by the Sponsors cease to collectively hold a majority of our
outstanding common stock.
These provisions may prevent our stockholders from
receiving the benefit from any premium to the market price of our common stock
offered by a bidder in a takeover context. Even in the absence of a takeover
attempt, the existence of these provisions may adversely affect the prevailing
market price of our common stock if they are viewed as discouraging takeover
attempts in the future.
Our certificate of incorporation and by-laws may also
make it difficult for stockholders to replace or remove our management. These
provisions may facilitate management entrenchment that may delay, deter, render
more difficult or prevent a change in our control, which may not be in the best
interests of our stockholders.
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