Q2 2020 Element Fleet Management Corp Earnings Call
[music].
Thank you for standing by this is the conference operator welcome to the element Fleet management second quarter 2020, <unk> financial results Conference call.
As a reminder, all participants are in listen only mode and the conference is being recorded.
After their prepared remarks, there will be an opportunity for analysts to ask questions.
In order to afford all analysts the opportunity to ask a question.
Elements kindly request that analysts limit themselves to two questions in life dialogue with management should any analyst have additional questions. After her or it is first to have been answered. Please rejoin the question Q to rejoin or rejoined the question Q you May proceed.
More than one on your telephone keypad shooting need assistance during the conference call you may signal in the operator by pressing star and zero.
Wishes to remind listeners that some of the information in today's call includes forward looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties and the company refers you to the cautionary statements and risk factors and its year end and most recent mdna as well as.
Its most recent AOCF for a description of these risks uncertainties assumptions.
Although management believes that the expectations reflected in these statements are reasonable it can give no assurance that the expectations reflected in any forward looking statements will prove to be correct.
<unk> earnings press release financial statements Mdna supplementary information document quarterly Investor presentation, and today's call include references to non <unk> F. R. S measures.
Management believes are helpful to present, the company and its operations in ways that are useful to investors.
A reconciliation of these non <unk> I FRS measures to I FRS measures can be found in the mdna.
I would now like to turn the call over to Jay Forbes, President and Chief Executive Officer. Please go ahead.
Thank you operator, and thanks to all of you joining me in Vito to see if it to discuss elements second quarter results. The milestones reached besting our strategic priorities this quarter, even in these challenging times.
And our latest few saw the near and midterm future for.
Before I begin with her saltwater stress immense gratitude again this quarter.
Half of everyone that element fleet management to the health care professionals and so many other central workers on the front lines of the Cobot 19 pandemic.
Our first despite virtually all of our best efforts.
Much of a separate one effective.
Thank you everyone here at element to stewing, well well most aspects for business had been affected by the economic consequences called at night team.
The resilience of the business model and our people have allowed us to minimize the impacts and delivered another solid quarter operating and financial performance.
Our adjusted operating income decreased less than 10% year over year, unless a 9% quarter over quarter.
We generated 19 cents of adjusted Dps in Q2, only two cents less in Q2 last year and three cents less than our prior quarter.
We also produced 25 cents, a free cash flow per share this quarter.
Flat year over year, despite two cents decline in adjusted MPS.
[noise] Peter will walk you through the details behind these results, but overall, our diversified client base of quality credits and the fundamental attributes of our business model resulted in a quarter that predominantly met or exceeded our teams expectations.
As I shared in the past, it's terribly gratified to see employees embrace that action and ambitious change agenda like to one that is underpinned our transformative strategy for element.
It's all the more impressive when the degree of difficulty gets ratchet up by an unforeseen event like to pandemic.
Couldn't be prouder of how are people have adapted to the imposition sand and convenience a corporate 19. This brought all the while staying true to the advancement of our strategic priorities.
Sure there considerable efforts that we've been able to deliver consistent superior client experience in trying circumstances over the last five months and us through these same efforts that we've been able to overachieve I guess three strategic goals, we set back in October 2018.
First we've actually accelerate that the transformation of our business during cold with my team.
The client centric overhaul of elements operating platform hasn't slowed down a one day.
Despite being five months away from its completion.
We've redeployed the operational capacity created by somebody else and client activities vehicle title in registration for example, while many DM fees were closed during the quarter.
We use that capacity to action $20 million, a pretax annual run rate profit improvement.
This is over $6 million more than what we have been targeting for Q2.
We also delivered over $30 million of enhancements to our operating company ended the quarter, which is $6 million more than our delivery forecast from last quarter.
Having attain the sluggish performance and what the tireless energy. So if the organization focused on finishing 20 twond a strong.
We don't see Edison that would prevent us from achieving our transformation goals of delivering a consistent superior client experience and actually the full $180 million pre tax.
A run rate profit improvement before yearend.
Further we expect to deliver approximately $120 million up that enhancement to our operating income over the course of 2020.
The second goal set back in 2018.
Just to strengthen elements financial position, achieving a true investment grade balance sheet.
Have you made significant progress to date, the second quarter saw successfully execute deep crowning achievement the issuance of our inaugural 400 million U.S. dollar senior unsecured secured investment grade bonds.
The successful debut issuance represents a first step towards element, becoming a programmatic issuer in the U.S. debt capital markets diversifying or access to cost efficient capital.
Overtime, we believe U.S. investment grade debt play key roles and further lowering elements cost of capital.
Prostates up this first spartanburg were used as planned to retire $567 million a convertible debentures before the end of the corridor.
As a result, our balance sheet as at June Thirtyth showcases a nicely maturing capital structure concrete example of the benefits of our ongoing deleveraging efforts.
We continue to target tangible leverage below six times by the end of this year.
Well she looks even better.
Last week, we close the issuance of 750 million of U.S. dollar so may be s. term debt under the Chesapeake facility and use the proceeds to pay down an equal amount to variable funding notes outstanding under that same facility.
This transaction demonstrates the strength of elements access to the U.S. fleet ABS market and we were the first fleet manager to issue in that market since the last since February of this year.
And as a result relevant today has some $5.7 billion of contractually committed undrawn financial capacity to support our and our clients business objectives.
[noise] transforming our operations of strikes the elements balance sheet were two of the three goals that we set for ourselves back in 2018.
Success as a short on both the spreads.
The circle was put too.
But the distraction of 19th capital behind element.
As you already know we've achieved that goal of the second quarter as well.
This was an important accomplishment.
Executing element from all of its non core assets and investments over the last two years, we've created the largest pure play fleet management company in the world freed from unnecessary and unproductive distractions.
Well, we were reluctant to discuss growth at the time given that could service considerable remedial work that lay ahead of us for the next quarters. The strategic goals that we sent in 28 team are always envisioned as a means to that end.
Transformed operating platform delivering a consistent superior client experience strikes a balance sheet, providing ready access to cost efficient capital at a narrowed strategic focus free of noncore distractions, we're all prerequisites for element to pursue the strong organic growth prospects that we saw across.
All five of our geographies.
[noise] originally we thought element might be ready to start that pursuit in late 2020.
However, the early success, we enjoyed all three strategic fronts encouraged us to advance that thinking.
Beginning at this time last year, we undertook in depth studies of the North America, and AMC commercial vehicle markets, the first ever market sizing and mapping of its kind to our knowledge.
The learnings from that work shaped and enhanced organic growth strategy from the.
The five planks of which are holding market share through best in class five retention.
Improving our sales force effectiveness and batting average Sean competitive bids.
[noise] better managing client profitability.
Converting self managed fleets and targeted market segments and.
Into element clients and leveraging our hard earned leadership in Mexico, and the agency markets.
We believe solid execution on the strategy can improve elements that revenue by 4% to 6% annually in normal market conditions.
We will also pursue so called Mega fleets. These opportunities for part of our growth strategy. This let's see US supported the development beep commercial vehicle capacity by one or more individual clients.
We have incomparable experience building such capacity by virtue of our ongoing strategic relationship with our motto.
I'm pleased to say that we have accelerated our pivot to growth in the first half of this year.
We appointed our chief commercial officer to be Bachoco Reconsolidated reorganized our commercial groups, we establish new compensation structures designed to accept profitable revenue growth and investors strengthening our marketing function.
Having met the necessary preconditions to go to market by virtue of our hard work in the first half elements commercial teams have begun to execute on this enhance growth strategy and purpose.
And we'll continue to the step us through the second half a 2020.
That means we are aggressively pursuing new.
Business it all of our geographies.
And all of our targeted market segments today.
Let me pause here and turn the floor over to be don't give you his insights on our second quarter performance Vito.
Thank you Jay and good evening, everyone. It's great to be with you. This evening to talk through our solid Q2 results elements first full quarter operating through co. The 19.
Overall, we're quite pleased as to how the business has performed.
Before I get into a discussion of our results I want to draw a two important points about our Q2 disclosures.
The first thing you may have noticed but our disclosures as a whole. This quarter is that there is no longer a breakout of core and non core operating segments.
And of course this stems from the sale of 19th capital on May 1st.
Taking a non core operating segment unnecessary on a go forward basis.
Our results will be presented as a single business now and importantly, comparative historical periods will reflect the same by both segments on a combined basis.
The second important point I want to make about our disclosures that we have responded with transparency to the understandably high levels of interest shown by analysts and investors how different aspects of our business had and will be impacted by the pandemic.
To this end we have added chapter due to our supplementary information document, which provides a detailed data and insights related to our working capital release.
Our client client vehicle usage.
Service transaction volumes remarketing performance.
Payment deferrals, and delinquency impaired receivables and earning asset exposures to various industries and the weighted average credit ratings up our clients and those industries.
You will hear me referred to several sections of our supplementary in my remarks here. This evening.
Before I jump into the detail of our operating results. Please let me share with you what we're seeing in respect of the all important crediting collections functions.
Simply said, we're extremely pleased with how our business is holding up in these respects.
In terms of requests for payment deferrals I refer you to section 9.1 of our supplementary for detail.
Hi, I'm requests for elements accommodations and make quoted 19 have been limited.
With just over 4% of our clients requesting payment deferral arrangement of any kind.
And over the last several weeks these requests have essentially entirely abated.
Only 1% of our clients have been granted payment deferrals to any extent and deferrals amounted to approximately $23 million, a finance receivables or just 20 basis point as a percentage of total finance receivables.
As of June Thirtyth, approximately six and a half million of the deferred receivables had been collected.
On a single departure from agreed to payment plans.
Our aggregate reported delinquencies at quarter end decreased by 12, and a half million or 26% quarter over quarter from 47.8 million to 35.3 million and we expect improvements to continue as we manage delinquencies back to pre covert 19 levels.
As we noted last quarter the delinquency values reported in our disclosure documents are elements aggregate net investments in finance receivables attributable to delinquent client accounts importantly, these are not the actual amounts that clients are delinquent on.
The actual net finance receivable amounts in respect of which clients were delinquent at June Thirtyth total just $2.9 million, which is in line with pre coal that 19 levels.
I refer you to section 9.2 of our supplementary for more information and historical context.
Now, let's look at credit.
Which remains solid for us thanks to our predominately high grade client base and our credit practices.
We are adept at picking up on early warning warning signs of credit deterioration and we proactively manage client accounts. Accordingly, so we are unlikely to find ourselves in a position of the materially surprised by client development.
To this point, while total impaired receivables were 112 million at quarter end.
15.2 million or 16% increase from March 31 levels as we communicated last quarter, we expected three clients on our watch list to enter bankruptcy in the second quarter.
They did and they account for more than three times, the net increase in impaired receivable as quarter over quarter.
In other words, we reduced our impaired receivables materially quarter over quarter. Excluding these three clients.
Having worked closely with two of the three clients lead Neptune and throughout our ongoing restructuring proceedings, we do not expect to incur any credit losses on these accounts.
These two clients comprise 42 million up to 47 million in new impaired receivables identified in Q2.
If you refer to section 10 of our supplementary you can see that we reduced impaired receivables by 32 million over the course of the second quarter through repayments from clients and asset sales and we expect negligible credit losses in total from all of these currently impaired accounts.
As a result of the businesses performance on the credit front, we had no need to change our balance sheet allowance for credit losses from the $20 million, where it was last quarter and where it remains today.
We had no material write offs to speak up in Q2 and are expected credit loss model suggests that our position has improved overall since the end of Q1.
Given the uncertainties are the pandemic and maintaining conservative expectations.
We left the allowance at $20 million this quarter.
This is an impressive accomplishment in the midst of a global pandemic, what does that speak to it speaks to our blue chip client base and investment grade clients. It speaks to the wide distribution and diversity of that client base across geographies and hundreds of industries.
It speaks to the essential nature of our assets at our clients hands and it speaks to the effective protections against defaults and credit losses built into our processes and contracts such as cross default provisions No force majeure causes and the cross collateralization of our leases.
June Thirtyth was a point in time.
Today as a point in time.
Nothing has changed of any consequence since June thirtyth by the way, but were tremendously encouraged by this quarter's performance in these regards collections in credit and many thanks to our clients for their continued loyalty and adherence to their employer and obligations in these challenging times and of course kudos to our internal hardworking team.
Aims of these functional areas across our business.
Okay lets deep dive into a little bit of our quarterly results.
The net operating result is as Jay mentioned, a 111.1 million of adjusted operating income for Q2, which is equivalent to 19 cents at a per share basis, just two cents below Q2 of last year and three cents down from prior quarter.
Free cash flow per share was 25 cents, which is flat year over year. Despite this two cents decline in adjusted EPS on the same comparator.
Taking a closer look at originations and assets under management.
Originations are the engine a future revenues and assets under management captures the value of the vehicles, we financed minus amortization dispositions, whether those vehicles remained on our balance sheet as earning assets or have been syndicated.
We break down the quarter over quarter changes to our assets under management and section 4.5 of our supplementary information document, which is available on our website of course.
As we anticipated and forecast in our Q1 disclosures Q2 originations were lower than normal. This year, we originated 1.3 billion of assets in the quarter.
100 million less than Q2 of 2019 and over 700 million less the last quarter.
Again, this moderation was expected given that OEM production facilities and dealerships were closed for most of the quarter and many clients chose to postpone replacing their fleet vehicles, while they focused on other aspects of their business impacted by coven 19.
We provide a breakdown of originations by regions by region in our Mdna.
So the USA plus Canada, Mexico on it so and of course, Australia, New Zealand group together.
It's interesting to note that the local volumes largely correlated with Covance 19, cobot nineteens presence in our different operating geographies and we discussed this in the commentary in our Mdna.
Jay will speak shortly on our views of second half activity when it comes to vehicle orders and originations.
In terms of our assets under management, we grew 1.5 billion or 10% year over year, approximately $1.2 billion when you factor in FX.
And then a quarter over quarter basis, given the originations decrease assets under management contracted by approximately 300 million or 2% on a constant currency basis.
Net financing revenue decreased 2.9 million year over year, and increased 5.4 million quarter over quarter.
The year over year decrease actually represents a relatively strong performance for two reasons, firstly that earning assets decreased by 13% over the same period largely of course due to our syndication strategy and secondly, Q2 2019 finance in revenue included a 10.1 million cost.
Sure fusion from 19th capital.
Whereas Q2 2020 only included a 2.8 net financing revenue contribution from 19 capital.
So excluding 19th capital from the comparative results, our net financing revenue increased $4.5 million year over year.
In terms of quarter over quarter I want to point out that there is through the three more significant variances and the makeup of our net financing revenue that resulted in the 5.4 million dollar increase.
Our Q1 net financing revenue contain $5.6 billion contribution from 19th capital.
Whereas Q2 net financing revenue contained 2.8 million from 90 of capital. So excluding these contributions the quarter over quarter increase in net financing revenue was $8.2 million.
Our Q1 net financing revenue reflected a $12 million provision for credit losses in order to increase our balance sheet allowance for credit losses to 20 million as at the end of Q1 and given of course that we maintained our allowance for credit losses unchanged at 20 million as at the end of Q2, there's no comparative impact to net financing.
Revenue in the second quarter.
Partly offsetting the substantial improvement in our provision for credit losses quarter over quarter, where the expected reductions and gain on sale revenue from Anzi, a 22% decrease and originations in the corner, 36% decrease.
It's important to note that the quarter over quarter reduction and gain on sale of revenue was volume based and that volume has now returned to pre coded levels by and large.
Overall used vehicle pricing remains quite strong and we see continued strength in the secondary markets across our geographies today.
We provide additional data points and section 8.3 of our supplementary.
Net interest and rental revenue margin or NIM improved 29 basis points year over year, and 26 basis points quarter over quarter.
This improvement is driven by optimization of elements balance sheet, which results in decreased that cost instances of improved client profitability across our portfolio, an incremental changes and the geographic mix of our net earning assets.
Let's move on to servicing income now which of course has been a major area of focus and understandably. So in this environment.
Our revenue from services was resilient in Q2, it decreased 8% year over year and 9% quarter over quarter.
US a Canadian servicing income decreased 10%.
Year over year, and 6% quarter over quarter, whereas both NZ and Mexico's servicing income where effectively flat on both accounts.
The majority of our servicing income is driven by clients vehicle usage and we discuss four major reasons for its Q2 durability beginning on page 13 of the Mdna.
It's encouraging to see gradual reversion.
Towards 2019 levels across most of our servicing income drivers and that began as early as halfway through Q2, depending on the geography section 8.2 of our supplementary provides data points.
Notwithstanding the encouraging data and Jay will say more about the shortly we're still carefully managing the business one week at a time.
Trends are in the right direction that wall summer steep.
Others are less so.
Our third and final revenue stream is of course from syndication.
We syndicated 759 million of assets in Q2, including 73 million two new investors, which means we sold $143 million of syndicated assets to new investors in the first half of 2020.
But the strong Q2 volume generated only 10.3 million of revenue.
And that quarter over quarter decrease in syndication revenue is a function of.
On the 9% decrease in volume of asset syndicated to the significant tightening of pricing on our assets through the quarter notwithstanding the persistent demand. This was true for all leases, including those with high grade credit Counterparties, such as our motto, whose assets of course, we need to syndicate.
Thirdly onetime costs incurred to support the re amortization of a large clients previously syndicated assets, partially offset by the resulting benefits to net financing revenue.
Lastly, the particular mix of assets syndicated in the quarter.
We've invested in our syndication capabilities as discussed in our disclosures and were successfully growing demand in the market for our product which is already robust.
Having new conversations every week with investors that are interested in high grade commercial fleet paper syndication is a strategic driver for us it's a value driver. It's in the management tool and for all these reasons remake we remain committed to the market.
Jay will say more in his closing remarks shortly regarding syndication.
In terms of impact our Q2 syndications help deleveraged, our balance sheet from seven point Fourx tangible leverage at the end of March to 6.8 X at the end of June and they would have been 6.49 ex excluding the Armada nonrecourse facility.
Our adjusted operating expenses in Q2 were down $9.2 million year over year, and 3.6 million dollar quarter over quarter and this is primarily driven by our transformation efforts.
I also want to point out the working capital release, we experienced in the quarter from lower service volumes. This isn't a nate defensive mechanism built into our business model when client demand slows. So does our use of cash and you can see this in detail in section seven of our supplementary.
Finally, Jay spoken briefly to our financing progress in Q2 in Q3 with our inaugural US bond offering that drew a lot of interest and investor support in June and most and more recently of course are ABS term note issuance last week, which was 11 times oversubscribed and allocated to 129% more unique investors in our last.
Yes term note last year.
I will also mentioned our renewed 1 billion dollar Australian dollar securitization facility, ensuring customer fleet has continued ready access to cost efficient capital in support of our growth strategy in that region.
These successful debt financings are very important measure of our strength.
These otherwise difficult times speaking to the resilience of our business model and debt investors' understanding and appreciation of our ability to generate consistent free cash flow.
We have 5.7 billion of contractually committed undrawn liquidity available to us today, and where you're here for our clients both existing clients and prospective clients.
With that I will turn the call back to Jay.
Thanks Pete.
Before we open the call to Q in a this evening, let me offer a few thoughts regarding the near and midterm prospects for element.
The mid term is comparatively easy beginning in 2021 to talk by fully transformed operating platform with our investment grade balance sheet and ready access to ability to dollar so capital.
Element will shift focus and resources to the pursues organic profitable revenue growth.
Over the last two years, you've seen the exponential outcomes. This organization can achieve by focusing the entirety of its resources on the few things to address.
In 2021.
The single thing that will matter most to element this growth.
While the 2021 that we are heading towards is far less certain than any of us with wish for we believe the economic consequences of Copel 19 make elements value proposition, even more compelling to both existing and prospective clients.
There is ample evidence of this likelihood in the second quarter as we shared with two and a written disclosures. This evening element around new clients and deepen existing client relationships in all of our geographies in Q2.
This includes conversion of self managed fleets television clients in each of our markets a sale leaseback transaction the retention and renewals some of our largest accounts the increase of elements services provided to existing clients, including the largest hospice care provider in the us and with gratitude to our colleagues.
A custom fleet and AMC, winning the business of two of the largest supermarket chains in Australia New Zealand.
It's not hard to imagine why all of these clients chose element ready access to cost efficient capital, which diversifies our sources of financing.
The ability to reduce fleet ownership and operating cost by approximately 20%.
And the ability to further reduce those audit ownership and operating costs over time as evidenced by the billion dollars of fleet cost saving opportunities our strategic consultants have identified for our clients in the first six months of 2020.
As I mentioned envisioning the opportunities for element to create meaningful value in 2021 and beyond is easy part.
Understanding how cdnineteen will shape or world in the short term is less obvious.
Here's what we can share at this juncture regarding the second half.
Strategically we expect to complete our transformation by year end actually about $180 million, a pretax annual run rate profitability improvements and delivering approximately $120 million up in your profit improvement.
We also expect to achieve that sub six times tangible leverage ratio and successfully pivot to growth in the US, Canada, Australia and New Zealand.
As you May recall, we're already very much in gross mode in Mexico.
Operationally with a rival of covered 19 in the U.S and Canada in mid March we experienced as immediate and in certain areas significant falloff client activities. All times that quickly found its floor and since then we've seen gradual recovery begin at varying paces, depending on what were met.
Shrink and were measured again.
Fortunately the trajectory is almost universally in the right direction.
The month to make was better for element of the month of April.
June was better than May June July looks like it will be even better than June.
While we're pleased to see this positive progression and our confidence in the fundamental resilience of our business is very high rate now what we know about the future Big Copas 19 is outweighed by what we don't know.
With this as a backdrop, let a share our current views for the second half on several key aspects of the business.
Firstly orders originations.
And assets under management.
Vehicle orders to come lease originations and origination sustain and grow elements assets under management.
Many vehicle orders placed for Q2 origination or delayed by OEM facility closures.
With the resumption of production and the reopening of dealerships. We would expect these originations to take place in Q3.
Further many vehicle orders that would normally have been placed in Q2.
Were postponed by our clients due to a number of factors, including OEM facility closures.
Decrease in miles driven the shelter in place directives that decrease the utilization of certain of our fleets would have delayed the need to order replacement vehicles for those clients, who renew their fleet based on mileage.
Then lastly, a lack of business confidence understandably some of our clients are still working through the current economic downturn and what that means for that business and while they do so renewing fleet vehicles is often simply de prioritize.
We view these orders post fault for matter time without knowing the duration.
Fortunately other than isolated instances in specific industries, we're not seeing any meaningful de fleeting.
Upper client base, we're carefully tracking all the leading indicators not the least which is a regular direct dialogue with our clients.
We believe these variables could amount to as much as 20% fewer originations in 2020.
In 2019.
However, again, we view the vast majority of this volume postponed rather than loss. So the originations would instead occur in 2021.
Also for the sake of clarity all new client with set result in originations in 2020, which served to offset this potential headwinds.
Secondly, our net financing revenue.
In simple terms net financing revenue continues to be arrived so long as our clients our leasing element vehicles.
However, newly leased vehicles generate more net financing revenue for our business than vehicles towards the end of that lease term.
As a result, a deferral of origination volumes can change the average age of at least book in effect net financing revenue.
This change is quite gradual as you can imagine even if we originated zero new leases in the quarter the lease but with all the age three months and in fact less than that because every quarter certain volume of older vehicles come off lease entirely taking them out of the equation.
But keeping a simple ticket.
Origination headwinds potentially pushing some new lease volume from this year out into 2020 watt, thereby aging or at least book incrementally and having a small potential impact on net flat finance revenue in the second half.
The other salient input Tonight net financing revenue in any given quarter. This gain on sale contribution from AMC and to a lesser extent Mexico.
Well gains on sale were soft in Q2 used vehicle market pricing has shown a V shape recovery at AMC and has remained strong in Mexico. Accordingly, we would expect to realize much of this delay gains in the second half.
Thirdly servicing income the majority of which as you know, it's a function of transaction volumes and miles driven.
Do you have nearly as much information as we do regarded this income stream since March based on our detailed disclosures in the Mdna and supplementary this quarter, we don't anticipate any major surprises one way or the other than the second half pertaining to servicing income we continued to see transaction volumes and value.
Trending upwards towards historical norms week over week month over month.
Fourth and finally, our outlook for syndication revenue remained strong, though tempered by the elevated returns required by investors in these unprecedented times.
Regarding second half demands, we expect that the syndication market will continue to be both robust and growing.
We've been able to onboard and transact with new syndication investors in the first half and that was an advance or syndication team build out which is just nearing completion now.
Regarding yields the percentage, we achieved as a function of the assets, we syndicate, which in turn as a function of the client credit.
Contract terms age of fleet et cetera.
These hasn't materially changed over the last 18 months of syndication and we expect to remain status quo in the second half.
It's also a function of hurdle rates.
That are investors have which in turn have for some increased materially to.
To the extent of these thresholds continue to remain high in the second half, we think that they can be partially offset by transacting with new investors with lower return expectations.
And thirdly.
Syndication revenue was affected by one time adjustments in the second quarter. These arose from the re amortizations and other client initiatives that we undertook that ultimately increase net financing revenue.
Bought their nonetheless, a drag on syndication revenue and yields.
We are likely to see some more of these in the second half so not to the same extent as the second quarter.
We remain fully committed to a significant presence in the syndication market given the strategic merits of the practice, it's fundamental basis for value creation, which extends beyond the integral role of de leveraging and de risking our balance sheet.
Let me step back and we look at weekly metrics since mid March across our geographies and their economies and throughout our diversified client base we're optimistic.
Many positive trends, we're seeing will continue.
Some cases like remarketing, the changes will be rapid and very likely absolute.
Others progress will be more gradual.
Importantly, we've noticed encountered a single data point less suggests the absence of a full and complete recovery in due course.
Looking at the next two quarters from a narrative perspective elements story.
It's going to be in transition.
We're moving from a state of especially rapid frequent internal change to one of a more predictable pace and focus.
Again.
That immediate focus will be on our organic profitable revenue growth.
We expect to generate excess free cash flow from that gross and we expect to be able to share more with you in the second half of this year, but our board's thinking on allocating that capital.
We don't for updating you on that front than others for now my pleasure to open the floor to your questions.
Operator.
Thank you we will now begin the analyst question and answer session. As a reminder, in order to afford all analysts the opportunity to ask questions element kindly request that analysts limit themselves to two questions in line dialogue with management should.
And analysts have additional questions after her or his first to have been answered. Please rejoin the question Q.
To join or rejoining the question Q you May Press Star then one on your telephone keypad.
We'll hear tone acknowledging your request.
If you are using a speakerphone please pick up your handset before pricing any team.
Draw. Your question. Please press Star then too.
The first question comes from Jeff Kwan with RBC capital markets. Please go ahead.
Hi, good evening.
Can you give some great insight as some of the new client wins I was just wondering.
If there's anything they can kind of give in terms of insights in terms of the progress on some of the governments that you're targeting.
Anything on the Mega fleets, recognizing obviously to sales cycles can take longer than the clients.
Good evening, Jeff.
In terms of new client wins as we mentioned we are fast pivoting to gross in all five of our country operations and have posted some nice early successes as those teams complete their restructuring the introduction of the new incentive plans and and target.
More of the self managed market, which includes government I would say to you. The early reception from government has been warm.
We're finding governments out the municipal county provincial and even federal level.
Very receptive to our advances and and have a particular interest in sales leaseback type of transaction as a means of obtaining.
That initial cash infusion.
And with that.
Kind of introductory conversation, we hope to lever that into a more fulsome discussion of how we might be able to reduce the administrative burden and their associated costs.
Servicing those compartment fleets so.
Very early days and as we've mentioned.
As you can all appreciate.
Their focus wasn't much on fleets, but instead, the healthcare and the wellbeing of.
Of their citizens.
As as things have.
Come under a degree of control here in recent weeks Weve found those partners to be much more available much more interested in having this conversation remains early days in terms of Mega fleets, we continue to do well with Armada in terms of advancing their needs and and continuing to power.
Forward other aggressive growth aspirations that in turn is giving us great IP that we hope to big available to other organizations that are contemplating a similar type of investment.
Okay.
On the syndication range you talked about the various drivers that explains the decline quarter over quarter.
Can you talk but I guess, just kind of the rough ballpark in terms of.
How much came from each of those those buckets and also specifically on that re amortization that transaction.
Why that happened kind of what exactly happened with that.
Yes so.
Again, I'm delightfully and you might remember when we began this conversation as it goes Q1 2019 and the expansion of the syndication program.
While we were comfortable with the profitability of dynamics of moving these assets off our books and onto the books to others.
Question, we had to us how might this market stress.
Through a business cycle in delightful here at a stressed incredibly well for us.
Through.
One of the tougher cycles, we could ever imagined.
And we've been actually able to attract additional investors and transact with those additional investors to expand the syndication market for lease fleet assets. So.
Remain rather bullish in terms of our local outlook for demand that says the market that has developed.
Thanks.
Our first comprised of regional banks on life coasts.
Have a high degree of sensitivity.
Around interest rates for rates of return and preservation of capital and so.
What we saw in second quarter and this week, we hit adapt in part of our Q1 disclosures was a.
Increase in the hurdle raising the decrease in the yields that we received.
As we look at the quarter over quarter decline and let's call it roughly $16 million.
Thank you both to this three buckets maybe.
Third of that would have been the result.
A decline in quarter over quarter volume.
Plus a softening of yield on the core assets that we syndicate the non our motto assets that we syndicate.
A third would have been armada.
And would have cockpit costs due to buy both rate and mix how much our model, we did vis-a-vis Q1, and as well as the rate that we were offered in the marketplace for those assets and lastly, a third would have been the result of these onetimers the largest being this re amortization.
So in this particular situation we had a tire.
A portion of our Theyre holding wassa indicated.
We worked with them to re amortize the entire portfolio of assets and that part that was indicated we have to make have a onetime make whole payment.
To the investor as it related to that.
Reorganization, we benefit from that in terms of net.
Financing revenue gained over time as well as smallish transaction fees, but the counter point of that as a onetime immediate hit in terms of syndication revenue.
As it relates to.
The second quarter or excuse me the second half we would expect.
The expansion of the market and the introduction of investors with different thresholds to give us some relief in terms of the overall yield on both core and our motto assets, we expect less than the way of onetime adjustments.
And and we should be back to a more typical mix in terms of our modern core so again feeling very good both the demand in the marketplace.
But this is a segment of the of.
Of our business that it too is been exposed to CB team that way.
More.
Greater conservation of investment capital at a higher expectation of return when that is made available to us.
If I could just one really quick last question, the 4% to 6% revenue guidance during normal times, how do you think of Opex gross.
Like in that environments.
Yes.
We think that we have built by virtue of the transformation investment that we've made a very scalable platform certain aspects of the services that we provide don't scale actually they are they require.
You know more human intervention.
Since the ordering platform that we have put in place.
Scalable beyond any growth aspiration that we would have and thus.
Each of the additional vehicle that we would administer through that system results at no incremental costs. So we would expect a disproportionate amount of the rates of growth to translate into or.
Hey.
A meaningful growth of.
Operating income for the business.
Okay. Thank you.
The next question comes from Paul.
Please go ahead.
Morning.
So again very much appreciate all the additional details.
This quarter.
For.
One I wanted to focus on a little bit for second is.
8.3, the remarketing.
Performance.
For the quarter to talk about the ends that business and Mexico business and the gain on sale, there and I think I understand that but.
Want to better understand if that if those remarketing trends in any way and hi.
Servicing income or otherwise.
Core U.S. and Canadian businesses like are there some.
Associated with the volume of remarketing transactions that got done.
Yes.
Good evening, Paul Yes serious.
So to your point remarkably we we largely talked about remarketing the context, the gain on sale them in AMC and to a lesser extent, Mexico, but to your point the remarketing activity. So value added service that we provided our clients in Canada use for fee and in fact, we have developed a.
And expertise and a reputation that were actually remarket on behalf of a variety of other institutions as well and saw the closure of these auction facilities and.
The.
Pull back in demands that we saw in Q2.
No not only impact as the gain on sale realization in AMC in Mexico, but is actually for stalled our ability to transact on behalf of our clients and on behalf of those institutions that we serve so service income would have been impacted.
The second quarter as a consequence of the closure of those auction facilities.
So you obviously did update drill down on.
The way your company or element.
ER and servicing income during the quarter and maybe better understanding of the profile of your customers as well I can provide a nice but between.
Sales oriented versus servicing was there anything.
Got you discover Jay during that process that was.
A surprise.
Do you like what were the or what were the one or two things that really stood out to you that you learned about your business going through that process.
Yep.
There.
As a relative newby to the industry.
I'm still stumbling over things from time to time as new learnings for me to that or old hat for for some of my colleagues one of the highest for me.
Was the disproportionate consumption.
Of maintenance fuel accident et cetera bye.
The service versus sales fleets.
They.
The the size of.
The differential there was a surprise to me the and the fact that we skew 80% to service versus sales.
Yes speaks to my predecessors until the wisdom that they have to identify these opportunities that generate far more revenue generating opportunities for our business that if we had skewed to.
Sales things, that's probably one of the.
Biggest learnings on the second was.
Again, I think our commercial and credit teams have worked hand in glove with one another very effectively over the years to ensure that even in some of the categories that we have highlighted here theres a few that frankly I talked in eyebrow at when I looked at the category.
Korean if that changes we have exposure to that and then as you.
Delve into.
Who we have as a client in in that particular area.
Quickly gain a great deal satisfaction by virtue of more often than not split leader in that segment more often than the not it has a superior credit rating more often than not.
It is someone that we have transacted with for decades and ever long established relationship with so the.
Even when you look at some of the hot spots in the portfolio. Those industries that are perhaps more susceptible to the impact of coated 19.
Wes reassuring that the team has done a great job in identifying those clients is though segments that were truly be the crumbs of upfront.
Thank you.
The next question comes from Mario Mendonca with TD Securities. Please go ahead.
Good afternoon can you guys give me okay.
We can't Hawaii Merrill.
Good. Thanks, Thanks for asking if we could go back to the re amortization for a moment.
I was always under the impression that syndication was an actual fail.
With limited or no recourse to the seller being Ben.
So when when the assets were taken back.
Why was that was that something that yet then was legally required to do.
Yeah, Ben do that more to be like I did a good corporate citizen and I ask it that way because.
We saw something like this many many years ago in the banking sector in the asset backed commercial paper market, where the banks reimbursement out legally required as they get back where they thought it was the right thing to do so can you help me think through what happened in this case was that are legal requirement or just the right thing to do.
Oh.
Neither.
Because I I believe there's a.
Misconception here, we did not take these assets back.
So think about this as a a large client relationships that we've had for many many years.
Great credits.
Long history.
Great to build it pay and demonstrated willingness to pay.
They came to up I think we actually came to them and proposed to re amortization of their fleet.
Recognized in the quality of the counterparty to call these assets.
Some of that fleece is on our books some of that fleet has been sold.
Through the syndication process, but the.
The client wants to reduce by extending the amortization period up that.
That agreement.
Hopefully so for those assets on our books easy for those assets that are in the hands of a third party we have to enter into an agreement with them because were altering that contract that we sold two of them through the syndication process. So these assets do not come back on our books for all intents.
Purposes, we could have said to the client no actually we're only going to re amortize that which still is on our our.
On our books as part of our portfolio, but as you can appreciate if if we did that than it's a lesser benefit to the client and.
Hi, set up a degree of resistance to syndicating their assets in the future. So.
Economically marrow think about this as we have the.
The true up that we need to make.
With our syndicated investor, but that is going to be offset.
Absolutely.
By the net.
Finance revenue gains that we'll get through this re amortization. So we'll see that trickle through as net financing revenue over the course at least in terms of the the uptick that we got.
We have to take the onetime pit.
In terms of the two syndication revenue in the quarter.
Does that.
I want to make sure that were not.
I have missed them one another in terms of this there was no buyback of those assets to your point once we sell them, they're sold on a non recourse basis.
That does clarified a lot for me so.
It does sound to me like this isn't unusual situation, where a client would come to you inciting wanted to extend the amortization, but you said that you felt this could continue to be an issue.
In subsequent quarters, you can see more of this why what is the underlying trend or seen that makes you believe we could see more of this because it does sound really unusual all the way you what you've described southwest something we should not see regularly for me.
Yeah, I think and again.
I'm going to give you.
Our shoes, and and hand grenade type of representations here, but I think I can only remember one of these of sizes in 2018 in the second half.
And.
One or two maybe last year.
And I say maybe.
And I would expect.
No more than half a dozen this show what this does.
This is working with our client to create value we had a great counterparty credit you have accrual rate asset base that we know well.
We have great cross collateralization and and an acceptable collateral DAP, if we don't even have a surplus.
And so hey, why wouldn't we help provide the client with immediate relief in terms of the cash flow obligations that they would have.
In terms of very sizable lease fleet. So to your point these are rare.
They are value add that are a tremendous amount of work all my gosh, there's a lot of work and hence the few numbers that we ultimately do bought for.
Our special clients that we can help boat.
We do and as you can appreciate the economics of doing so our are very favorable to us.
Okay. Thank you and thank you for all the enhanced disclosure this quarter.
No not at all.
The next question comes from Jamie Lane with National Bank Financial. Please go ahead.
Hi, Jay Thanks.
I'm good thank you.
Okay.
Oh you okay perfect. Thank you.
The next question comes from Tom Mackinnon with BMO. Please go ahead.
Okay.
Thanks, Good afternoon.
Oh.
Well, you mentioned a bunch of wins.
I think later on you talked about how you get orders and then how you get a goods moves.
It seems like orders come in when they fall within the work their way into the originations on.
There were all these wins that you mentioned here they are been origination quarter would some of them being.
Orders and expected to be originations in the second quarter.
Were they all.
This is where we get where you put them on your own books or on your balance sheet as well on.
Doug how does that work its way into this your comment about originations in 2020 expected to be 20%, although 2019.
So Tom I think we.
We'd have a.
Quite a few different outcomes slash impacts as a result of these wins so when we do a sale leaseback absolutely that's an immediate.
Increased the assets under management net earning assets of the the business and so any type of sales leaseback transaction. We do that's an immediate accretion if you will.
Of.
Volume.
When we transact with a self manage fleets that typically would result in a sale lease backs, we buy out the existing fleet in some situations. They may decide just to continue owning that and instead.
Initiate new orders with us that will result in originations.
In future months.
And.
And then.
Obviously in terms of the retain book Weve continued to work with that segment of our client base.
Facilitate their ongoing.
Replacement strategy for their particular fleets so.
Again, it depends and and even when they client comes on and you know it depends on where they are the ordering cycle. They may have just ordered.
For the year. They may have a large pending order that may be on a two year cycle. So it is.
Quite unique and I'd love to give you some rules of thumb, but it truly is quite unique as it relates to the vehicles lease part of it terms of services.
When we acquire new client services are usually ported on within a quarter and certainly within two quarters and sold the ramp up on services happens very very quickly.
Okay on them.
As a follow up.
Yeah.
Hertz and self managed.
More and more self managed fleet than expected.
Element clients and that.
Moving along nicely.
You know that has an impact on leverage.
The movement to the six times leverage was helped by a move more to syndication but.
Do more conversion of self norms fleets and bring them on balance sheet.
You may not hit six times leverage by the end of year, but certainly any good position with free cash flow. So how should we be thinking about 2021 way or you know that transition to a.
You know to giving investors some of that free cash flow on how does that memory into this six times tangible leverage.
Argued that you have for the end year, how does that all say David.
On balance sheet more of these are more and more fleet from less three syndication.
Yes, well and and I think you said the word that is the swing factors here in that syndication. So when you think about taking on a fleet, Dan and yes, let's call. It Dave Yes, 150 million dollar.
Book of assets that they would have.
You know depending on their credit rating.
And given their new this as a plant.
We may only be able to take on that exposure by virtue of being able to syndicate apart or indeed entire parts of that portfolio and so syndication is.
One of the reasons why we augmented the are modest syndication.
As to create that vehicle for de leveraging but also we knew in time as we've picked as it grows we would have a ready market that would allow us to fund.
These new clients that we're bringing on and not take a and overly aggressive stance in terms of credit risk. So syndication is.
A very important funding vehicle, especially in the context of self managed fleets sale leaseback opportunities that we see.
And as a consequence of that coupled with a operating income that won't be burdened with onetime costs in 2021 and beyond.
Combination of those two factors, we think is going to continue to sense in terms of tangible leverage creates that excess capital position.
We will need to opine on in terms of a than the share buyback strategy for investors.
So it seems like syndication it's.
Really begin or pardon.
Are you still standing by 2.4 billion I think was the previous guidance for syndication volume for.
2020.
That was split 50, 50, with Armada and non Armada Where's that looking like it could be higher.
Okay.
We're not refreshing our guidance, but to your point, we had we had.
Councils that the 2.4 felt like a good number four.
2020.
And and again I think we'll be in a position as part of our Q3 disclosures just offer little bit more insight around that.
Okay. Thanks very much.
Thank you Tom.
At this time element would like to invite any analysts that hasn't already had the opportunity to pose the question to come in the Q.
Once again, if you have a question. Please press Star then one.
There are no questioners in Q.
This concludes the question and answer session I would like to turn the call back over to Mr. form for any closing remarks.
Thank you operator, and just want to close by saying, Thank you for making the time.
Good afternoon and to wish everyone there.
Good health as you go forward.
Thanks again.
This concludes today's conference call you may disconnect. Your lines. Thank you for participating and have a pleasant evening.
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