Q2 2021 Element Fleet Management Corp Earnings Call
[music].
Thank.
Free standing by this is the conference operator.
Welcome to the element fleet management second quarter, 2021 of financial and operating results of conference call.
As a reminder, all participants are in listen only mode and the conference is being recorded.
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I'll, let me the wishes to remind listeners that some of the information in today's call.
Include the 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 the risk factors and if a year end and most recent M. D N a as well as at the most recent Aif for a description of these risks uncertainties and assumptions.
For analysts.
Although management believes that the expectations reflected in the statements of reasonable it can give no assurance that the expectations reflected in any forward looking statements will prove to be correct.
Elements earnings press release financial statements M. D N a supplementary information document quarterly investor presentation.
And today's call include references to non I F. R. S measures, which management believes are helpful to present, the company and its operations and of ways that are useful to investors.
A reconciliation of these non <unk> measures to Ifr S measures can be found in the MD&A.
I would now like to turn the call.
Call over to Jay Forbes.
<unk>, President and Chief Executive Officer of element. Please.
Please go ahead.
The 2 Alberto.
Thanks to all of you joining us this evening.
And I will be sharing of today's call, Jim Halliday, our chief operating officer.
The Wall Street, with our OEM partners and we'll provide an update.
Forbes.
New vehicle production delays from how we're managing the situation.
We'd like to use of our time with you to discuss all of its results for the second quarter in the first half of the year.
Progress that we made the advancing our strategic growth objectives and the <unk>.
Headwinds, we're experiencing as a consequence of those Oems.
Nitrogen delays.
Driven by the shortage of microchip supply the many Oems, including the big 3 domestic manufacturers.
Let's start by looking backwards for a moment at the.
Pam.
Impacted period for the majority of 2020.
With COVID-19.
If I can hold in our operating geographies early last year, we faced 2 significant cash.
Business model is resilient as we believed it to be.
Most of our ongoing work transforming elements of business and balance sheet.
To withstand the chalk.
Well in the past Soc.
Teen type of flying colors, our revenue and cash flow streams remained strong and steady our book of business was solid with delinquent and impaired to the receivable positions dramatically improving over the course of 2020.
The maintained really access to ample cost efficient capital for our clients, including unimpeded access to the syndicate.
<unk> reached the market.
Our liquidity actually improved under the circumstances, and we accelerated the transformation and in doing so over achieved our year end goal.
Although the element able to successfully navigate the challenges of the pandemic last year, we benefited from the experience.
We learned much about the cash flow rhythm of the business, allowing us to rightsize, our funding facilities and.
<unk> contributed substantial interest savings.
And make a very positive impact on our net financing revenue.
Reported Stephen stronger ties to our colleagues across the.
As we learned the deliberate consistent superior client experience and the very different operating environment.
The share these learnings to benefit our clients in all 3 regions.
The most rapid sharing of best practices, coupled with our ability to proactively help clients conserve resources.
Despite lapping the total cost of fleet operations and eliminating the administrative burden deepen our client relationships as evidenced by our record high net promoter scores.
Well element transformed business model proved strong and resilient throughout 2020.
The patent that mix impact is still being published on our financial performance.
In our minds is masking the true value creation capability of the.
The organization.
Service revenue weighted.
We anticipate that the the widespread availability and acceptance of vaccines with Usher in.
<unk> turn of a more normal way of life in each of our operating geographies and what's the return to historical activity and consumption patterns for many services, we provide our clients.
As it turns out this hasn't happened as quickly as we would've expected.
Continued to of sudden program.
The the precipitous decline in service usage volumes in March and April of.
2020.
The SaaS has been steady and the urban no signs whatsoever of any systemic declines from fleet sizing.
Our revenue returned to normal has been slower than anticipated.
We are only now.
From the at the end of July starting to see preventative maintenance fuel consumption and other activities that generate the service revenues on par with the pre pandemic levels.
And of course, having built the scalable operating platform to handle the planned growth in volumes for pursue.
Now the absence of these transactions is deprived us of revenue generating activities with no attendant decline in operating expenses.
This was a result of that and are continuing albeit lessening drag on first half operating income.
Virtually everything we see points to a.
And solid recovery in the service revenues through the balance of this year.
The second impact arising from the pandemic has been the unexpected delays in the OEM production arising from global Microchip shortages.
I'm talking the colleagues like Jim we've been in this industry for decades.
And it was seen ever of them.
No 1 has ever witnessed this type of abrupt disruption in the supply chain.
These unforeseen production the players have had a knock on effect for our business or supporting the delivery of vehicles and deferring the highly profitable of origination.
Decades.
Given the unprecedented nature of this occurrence, let me provide a few additional insights this evening.
First of the decline in originations is being driven by supply.
Not demand.
For the Oems are unable to produce vehicles.
Psyche of normal timelines to fulfill.
The strong order book that we have built.
Our U S. Canadian vehicle orders from the first half of 2021.50.
56% higher than in the first half of last year.
And we're ahead of the first half of 2017.
All of the volumes and on par with 2018 first half volumes domestically.
1 of 2019 at higher first half order volumes in the us reflect a year's worth of our model of orders received in that period.
N D orders also returned to pre pandemic.
In order of close in the first half growing 46% from the first half of last year.
In Mexico, we of course.
Orders for probably.
The only 2% year over year in the first half.
Currently our clients' demand for new vehicles remains robust.
However, the supply side of equation.
That make line is materially constrained.
Historically it has taken an average of 60 days for a vehicle or the replace with in the OEM in the United States to result in in the origination on our balance sheet.
The historical average in Canada is 90 days.
As of mid July.
The current average was over 125 days each country.
Well all the items were less impacted by the chip shortage of ne and see dealer inventories remain low and more vehicles are being sold into the higher margin retail channel.
So the supply of vehicles too.
The fleet management companies like element.
Mexico has been the least impacted by production delays with the major Oems in that country, having been best prepared for the market realities that we're facing.
Yeah.
The combination of robust demands from the form of borders and.
Patrick and delays in the OEM production levels has created the largest order backlogs on record in each of our 3 regions.
Now I am excluding him out of from the historical records here 1 of the law.
The distribution of their orders over the last 10 quarters.
And we haven't talked much about orders or for that.
And singer order backlogs in past discussions given the consistently short of lapsed time between an order and cause origination.
However, with the material of the elongation of the timeframe arising from the OEM production delays the topic does warrant further elaboration.
So here's how orders relate.
Relate to originations.
Well the place orders with Oems on behalf of our clients.
Upon acceptance of element is liable to purchase that vehicle from the OEM and simultaneously.
Client becomes.
Really bound to lease that fee income from element under the terms and conditions of our agreements.
So in other words and accepted the order.
It's the equivalent of an origination.
We have a record backlog of borders which means we have the record backlog.
On the leak originations of waiting.
All of which are effectively guaranteed to occur.
The OEM production volumes normalize.
In addition, we.
C of growing need for clients to order more vehicles.
There are represented in the current backlogs because clients fleets continue.
Average.
This suggests even more pent up demand being released as the <unk>.
Wins of new vehicles do become available.
So to reiterate the fundamentals of the business remains strong and intact with the.
Client and the originations is the supply north of demand issue.
The day, we've seen orders return to pre pandemic levels as clients return to historical patterns of regular fleet renewals.
And our inability the family's orders on account of OEM production. The delays will not result in loss revenue just revenue deferred until production.
From volumes normalize.
But with the time value of money being what it is we would obviously.
To have these origination sooner than later.
That said that same factor of giving rise to the deferred originations.
Just creating incremental revenue opportunities.
Such as much higher gains on sale in Australia, and New Zealand that we would not otherwise be able to avail ourselves of.
Let me turn the call over 2 of our C. All true holiday where we.
Can provide some additional color on the importance of originations to our net revenue stream.
Across the organization as well as the 1 time or limited time net revenue that we earned in the first half and that we continue to earn today as a direct consequence of the delay of originations.
Jim.
Thank you Jay and good evening everyone.
Originations are a crucial component of element business every origination is of new vehicle for 1 of our clients and new vehicles for our clients our core drivers of net revenue for element.
I want to clarify that we don't just leased new vehicles to our clients in some cases, we order and acquire.
Vehicles on the.
Half of our clients and then turnaround and resell the vehicles directly to the clients, we call those anr or acquisition and resale transactions and they are valuable to us too even though they don't show up in origination volumes.
Think anr is an important dimension of our business to acknowledge so I wanted to mention it upfront and.
And I'll come back to it in a bit.
Originations are the precursor to leases as well as the number of pre lease and related services all of which are revenue events for element.
For example, but for a client takes delivery of their vehicle, we typically have titled licensed and registered that vehicle for them.
We're highly administrative taxes that varian nature by jurisdiction as well as by type of vehicle.
We make the complexity simple for our clients by taking care of it on their behalf in exchange for which we charge of small fee.
Another example of post origination pre lease activity we engage.
For our clients as outfit.
Approximately 55% of our clients' vehicles, our outfit in some way shape or form and in many cases element is helping design and engineer that up the package.
All of it can be anything from accustomed paint color the vehicle decals, the custom racking hydraulic suspension of our after.
The market lifting lighting systems.
It even gets as complicated as pieces of machinery that are sometimes worth more than the vehicle itself being integrated with the chassis for specialized use cases.
Vehicle outfit is a lot of work from design and planning to managing delivery and execution.
In the shops.
<unk> to provide these specialized services are often small and medium sized businesses without the infrastructure to digitize our automate the administrative parts of their operation we.
We take care of this complexity for our clients keeping their lives simple they order of the vehicles they need from element and we make sure of the vehicles get delivered to them.
Perfect condition for whatever their business use cases.
The cost of up it is typically added to the capital cost of the vehicle lease sort of an increase you would increase the reported origination value over and above the price we pay the OEM for the vehicle. This also increases our net financing revenue from that lease.
Lease and it increases the gross interest income that our syndication partners purchase if we syndicate that lease.
Another source of revenue for element between origination and activation of of vehicle lease is a combination income.
We often make of combinations for our clients to begin driving their new vehicles.
Tactically for the leases activated and.
And we invariably advanced working capital on our clients' behalf the pay the OEM and outfitter for their vehicle weeks or even months before we start collecting lease payments. So we charged small fees for these kinds of of combinations to cover the cost of our capital and activities during.
Any of that pre lease period.
Last for now, but certainly not least is our vehicle remarketing revenue.
In the U S and Canada, our clients per the residual value risk of the league of vehicles that we lease them. When it comes time to replace of vehicle in order to optimize the total cost of fleet operations that vehicle may not.
Not be at the end of its lease contract term, rather the client buying rather than the client buying out the remaining the remainder of the lease more often than not they will retain elements of a market the vehicle on their behalf.
Incredible remarketing partners like Manheim, Odessa, and retail dealers, who ensure.
Sure that our clients get the best price for the used vehicle and out of the proceeds from the remarketing of vehicle element pays off the remainder of the related lease earns a fixed fee service for Cordoning, leaving the remarketing transaction and remit any leftover proceeds of sale to the client.
The reason remarketing.
<unk> service revenue is impacted by OEM production delays is that the clients arent, giving us their existing vehicles for our market and that's because we can originate of new vehicle to replace their used vehicle width.
Those are just a few examples of the net financing and service revenue is generated in relation to our new vehicle origination.
Youll recall earlier I told you about in our vehicles, which don't get counted in the origination volume. However, all of the revenue associated with ordering up fitting titling licensing registering the delivering new vehicles is still captured on anr vehicles. It won't get capitalized as part of the lease principle and earn interest income.
Income into net financing revenue because there is no lease however, we will still ensure we cover our costs, including the cost of our working capital as part of our Anr service and were earning fees over and above that cost reimbursement those fees are being captured in the service income line on our P&L.
As Jay noted.
Even though all of this guaranteed revenue related to new vehicles has held up for now as a result of the OEM production delays. There are some 1 time and limited time opportunities for element to generate healthy net revenue from other sources, while we wait for production volumes to normalize.
The obvious example is gain on sale income in Australia, and New Zealand.
In Mexico, where the used vehicle markets are incredibly strong right now as a result of the same forces that have created record order backlogs, namely new vehicle supply constraints.
Unprecedented gain on sale premiums won't last forever for element, but we anticipate it will continue into the second half of the year.
And if we're wrong is likely because new vehicle availability has increased normalizing used vehicle market prices.
New vehicle availability means we can be originating for our clients and fulfilling demand the gain on sale of premiums that may diminish will be replaced by revenue related to new vehicles and we will.
Continue to earn gain on sale on the resale of our end of life leases in Australia, and New Zealand and Mexico.
It is just unlikely to be at the outsized amounts that we're enjoying today all else being equal revenue related to new vehicles is better for element.
In the U S and Canada constraints on origination volume.
<unk> are causing many of our clients who have placed orders for new vehicles to continue driving their existing vehicles by necessity until supply matches demand.
In some cases those vehicles are being driven beyond their optimal point of cost efficiency in other words, they're getting into the mileage bands and level of vehicle wear.
And <unk> they are likely to result in expensive maintenance and repairs having to be done we take care of coordinating that maintenance and those repairs on our clients' behalf and we ensure they are drivers of adequate alternative vehicles to use in the meantime in order to minimize downtime.
All of our work for these and making the complex simple.
For our clients and delivering consistent superior service experience is revenue generating work and it is in revenue we'd be earning if these vehicles have to be replaced in the normal course with timely originations we've.
We've also seen an uptick in service revenue from long term rentals, which we coordinate for our clients.
Who needs a standard of vehicles to continue to operate their business until the new vehicle. They are ordered at the ready for us. So I want to be clear that we are eager to return to the balance of new vehicle supply for fueling the strong demand from our clients, we'd rather meeting their regularly scheduled needs we are advocating for.
Element client needs in all of our discussions with our OEM partners and I thought I'd give you a little bit of insight into this dynamic.
First and foremost we're approaching this challenge the same way we approach everything at element make the complex simple and do the right thing for our clients that's our client centricity in a nutshell.
On the day to day basis, our teams are commencing with our counterparts at the Oems and pushing our clients' orders to get allocated production slots for also competing with our clients daily educating them about what we know and what we believe to be true.
As I know Jay and Frank of told investors before we don't have inside.
Wider access to all of them per OEM production.
<unk> or timing decisions at large for always receiving information pertaining to specific clients orders directly from our OEM partners and working with Oems to interpret the impacts the advise us of we also carefully monitor Oems public announcements and interpret how those.
That information and those announcements will impact our existing client orders with that OEM. Then we think through how that announcement might impact near term orders our clients intend to place and we are keeping our clients in the loop at all times.
Part of the reason, we're able to leverage OEM Intel to help our clients stay better informed.
Forms and make better decisions in the average OEM customer is because we have a sizable team of experts on this and of deep dataset to triangulate with for example data received from 1 OEM last week allowed us of turbine manufacturer produced over 4 times as many vehicles for element in each of June and July July to date.
As they did in April and May and they expect the more than double their production in August based on the existing production schedule.
We know every inch of our order book with that OEM. So we can now advocate for production slots it makes sense within those volumes.
We're not just calling up the other than saying hey produce more vehicles.
For our clients, we can say it looks like factory is going to have additional production slots could you allocate those to our clients' orders, which have been backlog since may of that that's the type of dialogue that we're having.
Our teams are communicating with Oems day in day out we do this even when production volumes and timing of normal.
We have deep relationships with our context at Oems and I can tell you that.
These relations are especially valuable in times like this.
The relationship value is in the fact that our context will listen to US we get the time of day, because we are constantly ordering of purchasing vehicles 365 days a year our clients are huge companies.
And brands that Oems want to serve and maintain strong relationships with the Oems know of those relationships go through element.
As a result, we're not shy about advocating for our clients, we're providing almost as much value for the Oems as we are to our clients with their advocacy Oems want to know about future order volumes.
<unk> client preferences and competitive offerings, we would all obviously never breach of clients' confidence of the Oems still learn a lot in the aggregate from the relationship with element.
The dynamic I'm, describing here the huge competitive advantage for element our clients our order volumes in our size guests to the front of the line amongst the FMC.
<unk>, that's the benefit we derived for market leadership and being approximately twice the size of the next largest FMC in North America.
Another dimension in which our size and scale matters of strategic consulting our strategic consulting team is the largest in the industry and we bring their data driven analytical skills to bear in this context.
The help clients make ordering decisions and pivot quickly from 1 of them I am to another if necessary.
We are treating this as an opportunity to shine for our clients and to showcase what we can do for them.
The philosophy of making the complex simple FERC clients really applies to the strange times just as with.
The pandemic, we believe theres an opportunity to many here to emerge from this with even deeper client relationships.
In terms of when we will emerge from this that timing is outside of element control, but as Jay noted the lower present value of deferred originations and related revenue is at least partly offset.
By the 1 time and limited time revenues, we are generating right now as <unk> result of the production delays and the revenue related to deferred originations remains guaranteed it's only a matter of time.
With that I'll hand, it back to you Jay.
Kind of package.
The additional insights on.
On this topic.
If those on the call only take 2 things away from our discussion of the OEM production delays. This evening I hope they all of the following.
Firstly, it's a supply problem the demand from our clients has returned to pre pandemic levels.
And secondly, it's a temporary problem.
1 of them, that's going to be short lived.
Based on our understanding of the latest OEM production plans with respect of returned to normal production volumes later in this half.
Crystal clear, our order backlogs and generate increased levels of originations.
And the associated impacts on revenue and cash flow and the early.
The 2022.
These would be higher than historical run rate originations.
Use of the term run rate continues to exclude our motto of originations from 2019.2020.
I do hope that we.
We've provided you with the deeper understanding of the primary challenge our business faced in the first half of the sheer I'd now.
Now going to turn the call over to Frank to discuss our financial and operating results for the period.
Thank you Jay and good evening everyone.
I'm happy to be here with you Tonight.
For our solid second quarter, and first half results and how they demonstrate our progress on the element strategic growth priorities with.
With the few exceptions I'm going to focus my comments on first half results and the comparison to the first half of last year on a constant currency basis, because the second quarter of last year was heavily impacted.
The top of bed in the first quarter of last year was 1 of element strong, yes, and not materially impacted by Covid.
By using the first half results, we get a better picture of last year's Q1, and Q2 balance each other out a bit for comparison purposes.
In addition, our stated target growth rates are annual so comparing.
By coated day this year to year to date last year is more indicative of our progress against these goals.
I will also focus many of my comments on constant currency, which is a true measure of our progress given the translation of noise and restating our U S revenues earnings and cash flows our largest geographic contributor.
Herring you Canadian dollars.
To put the magnitude of this translation noise into perspective, the Canadian dollar appreciated by nearly 10% from U S. Dollar 73 last year. The U S. Dollars 80, this year trading of non economic drag on our financial performance.
In starting briefly with Q2 results our adjusted operating income for the quarter was $126.5 million or <unk> 20 per common share on an after tax basis, which is in line with consensus the provision for taxes applicable to elements. Adjusted operating income is based on 25, 8% effective rate.
For the second quarter up from 23, 4%.
Last quarter.
As I mentioned on our last call, we recommend modeling elements adjusted EPS based on the 23% to 25% of effective tax rate for 2021.
I would suggest earning towards the higher end of that range.
Remember.
The real cash tax amounts that element pays for a lot less than the reported tax line item on our income statement for that reason, we continue to believe free cash flow is a better metric than the after tax of L Y on a per share basis. When it comes to evaluating the underlying performance of our business.
In the first half of 2021 element generated.
That's on the 84 million of net revenue, which is 38 million or 8.4% growth from first half of 2020 net revenue up $446 million on a constant currency basis.
This growth was primarily driven by net financing revenue improvements of $32.9 million or 17, 6% helped along.
By $2.3 million and $2.4 million of improvements of first half over first half servicing income and syndication revenue growth respectively again, all on a constant currency basis.
Adjusted operating expenses in constant currency were flat in the first half of this year compared to last year with salaries.
For hundreds is up modestly offset by lower G&A expenses.
Growing net revenue, while keeping opex flat is the hallmark of the scalable operating platform the.
The first half operating margin expanded by 390 basis points and year over year, and still 360 basis points after the impact of changes in the.
And wait exchange.
As we indicated in our disclosure today, we expect operating margins to moderate slightly in the second half because first half adjusted operating expense benefited somewhat from a collection of discrete nonrecurring items and net revenue also benefited from approximately $5 million up for Covid.
For for credit loss releases in the first half, which are likely to be the largest releases from our allowance for credit losses. This year.
Nevertheless, we will continue to enjoy strong operating leverage throughout 2021.
That 8.4% first half net revenue growth was magnified by our scalable platform.
Vision for most to fold into 16, 7% adjusted operating income growth year over year before the impact of FX.
Adjusted EPS for the half year over half the year grew 10, 9% in constant currency.
Spike of 730 basis point increase in the applicable effective.
Oh tax rate.
Changing gears now to our strategic priority of advancing of capital lighter business model I want to offer my perspective on the role of syndication and elements of growth strategy since.
Syndication advances all 3 of our current strategic priorities.
We're not relying on syndication of grow net revenue for the 6%.
Effective however, with low related operating expenses syndication revenue contribute materially to our operating margin by landing heavily on the adjusted operating income line.
Syndication leads are charged 2 of capital lighter business model by reducing liabilities on our balance sheet, freeing up equity, while maintaining our target tangible leverage.
T O.
Additionally, syndication provides the means to generate capital that can be returned to shareholders via a repurchase of common shares for cancellation under our NCI day for.
We're also driving return on equity and accelerating growth on a per share basis.
So the strong performance.
Rates and reducing the equity capital invested in the business. We grew our pre tax return on common equity 100 basis points of alone in Q2 on a quarter over quarter basis.
It is important to remember that each leases entered into under terms, we're willing to keep on our balance sheet.
We only syndicate leases from the.
The formality of the transaction is economically superior to holding the lease on our balance sheet.
So syndication is always a net win for element.
In the first half of this year, we syndicated $1.6 billion in assets for $36 million of net revenue largely on par with the roughly $1.5 billion syndicated.
For the first half last year that generated $33.3 million of revenue on a constant currency basis.
The other driver of our capital of lighter business model then enhance the return on equity is servicing income, which grew 1.3 per cent in the first half over last year, and 1.4% as measured quarter over quarter.
The case in both cases before foreign exchange.
Service revenue requires all the working capital to support its growth and therefore represents high quality high return revenue.
Service revenue is being led by maintenance volume uptick in the U S and Canada as well as the accident services revenue.
And we're also seeing the organic growth of service revenue streams from Australia, New Zealand, and Mexico, where we continue to increase our share of wallet with existing clients. In addition to new client wins.
As you heard Jay say and we have communicated in our Britain disclosures. This quarter, we believe that servicing income has now.
The corner and we anticipate continued growth in the second half of this year on a constant currency basis with clients vehicle usage, returning towards pre pandemic levels of this month.
Each Q3, and Q4 servicing income should be successfully better than Q2, this year, even without adjusting for potential.
Ill turn the FX headwinds.
Our third strategic priority alongside profitable revenue growth and advancing our capital of lighter business model is the annual free cash flow growth before FX.
In 2021.
And the return of excess equity to common shareholders.
Free cash.
All of share for the first half was essentially flat year over year with Q1 of last year being the free cash flow high point for the last 3 years, and thus making for a tough comparison.
Year over year for the second quarter free cash flow was up 13, 8% and 16, 3% on a per share basis, each before FX.
Flow price.
Quarter over quarter Q2, free cash flow grew 16, 3% and 18, 2% on a per share basis again before foreign exchange.
The per share metrics for aided by <unk> and CIB activity element repurchase over $13.5.
<unk> common shares in the second quarter and has repurchased over 22 million common shares or 5% of our float for cancellation since the inception of the program last November.
Combined with common dividends, we returned $189.4 million of cash to shareholders in Q2 and have returned.
Millions of $360 million since the NCI V began.
Before I hand things back to Jay I would like to walk you through the impacts of the OEM production delays and deferred originations on a net revenue and cash flow.
The key message here regarding the OEM production delays is that the financial benefits of affected of Virginia.
<unk> patients are not <unk>.
Put simply deferred are.
Our clients need these vehicles to operate their businesses and fulfill the needs of their customers.
As Jay plane and order placed with an OEM creates a binding obligation on our client to lease when the order of vehicle is produced by the OEM, thereby turning it into.
Originate in Asia.
Net origination occurs we begin to obtain both the P&L and cash flow benefits associated with that new vehicle.
At the end of Q2, we had just under $1.5 billion of would be originations in the form of backlog of orders.
Put that into perspective its a.
And the rich backlog when you exclude backlog their motto order volumes from prior periods.
It's over $170 million larger than the order backlog at the end of last quarter, meaning the end of Q1.2021.
It's over 425 million larger than the order backlog at the end of Q2 of last year.
Record and its over 500 million larger than the order backlog at the end of Q2.2019 again, excluding our model.
These deltas are all based on global volumes in constant currency, but the Q2.2021 global record backlog is comprised of record backlogs in each of our geographies.
Please.
So how does the OEM production delays impact net revenue.
The OEM production delays negatively impact net finance revenue in the near term because of the deferred originations keep the financial benefits from hitting the books in the current period.
However, the orders of firm and the financial benefits.
From the books when the OEM is ultimately able to deliver the vehicle and trigger an origination.
The net financing revenue from originating in leasing that vehicle is not lost but simply deferred to subsequent quarters and it will be incremental net financing revenue on top of the net financing revenue linked to normal arena.
The OEM production delays impact the number of vehicles to which element provides services shortly after origination.
Such as title and registration and the other services that Jim talked us through including the remarketing of the vehicle being replaced.
Again, the related service revenues would be absent from the period affected by the deferral of.
Do cognitive 2 of future period in which the origination of occurs.
The deferral of originations also leaves us with a lower number of new leases, we can syndicate.
Depending on the proportion of originations we plan the syndicate in any period lower originations could lead to lower syndication revenue.
Like net financing revenue and servicing.
The city of income be syndication revenues from not lost but rather only deferred until origination occurs and we of the asset on book to syndicate.
We will realize the related deferred syndication revenues for the 6 months generally 4 to 6 months after the origination.
This revenue would be incremental of the normal syndication revenue.
Of the being generated in the period.
Remember our business has proven solid and that includes the financial performance. We believe we will offset much but not all of the revenue and cash flow headwinds from OEM production delays through countervailing revenue streams inherent in our business model such as gain.
Revenue for sale as well as other opportunities we have identified some of which Jim spoke to earlier.
We remain on target to achieve between 4 and 6% net revenue growth for full year 2021 over last year on a constant currency basis.
Right now the OEM production delays.
The answer was trending towards the lower end of that for years to 6 per cent range, but the situation is very fluid as you've heard.
To give you a directional sense of the size of the positive impact that deferred originations can have on our business when the OEM production capacity normalizes I offer the following the hypothetical.
If element is effectively accumulated.
<unk> had 1 billion of deferred originations by the time OEM production capacity normalizes, we would expect the ensuing 12 to 18 months to benefit from those originations occurring.
We would expect the net revenue growth rate during that 12 to 18 month period to increase by 100 to 300 basis points, meaning that.
Emulate it if we were otherwise going to grow 5% of annually over that period, we would expect the growth rates of increase to between 6 and 8%.
And we would expect free cash flow.
From the same 12 to 18 months to benefit incrementally by approximately $40 million to $50 million in total.
Finally.
I would add that the incremental growth will ultimately be driven by the timing of how quickly Oems can meet our backlog and new orders, which are likely to be spread out as they ramp up to meet not only our pent up demand, but the markets in general.
With that I'll hand, it back to Jay.
Thanks Frank.
Just a few more thoughts.
I mean before we open the floor to your questions first of all in I think about the challenge our business the spacing in the form of the OEM production delays.
For Q2, and first half results for all the more impressive.
Remain on track to grow net revenue of 4% to 6% year over year of before FX as.
We said reward.
Alright.
The product supply shortage.
We're materially enhancing of our.
On the equity despite of the type of service revenue recovery and on plan syndication activity.
We are growing free cash flow year over year, and returning excess equity to shareholders.
Exactly as we said the board.
This is once again showcasing the resilience of elements business model, which we proved last year of 2 of the depths of the pandemic.
Again, we're growing element business in spite of unforeseen and unprecedented circumstances.
My.
My second line of thinking is inspired by being back on the East Coast of Canada right now.
Where I grew up.
<unk> market, leading growing resilient the fleet management business.
The stunning cost of the stuff.
Which has often been shrouded the ACOG, thereby obscuring the view.
Back in 2018, we had the heavy fog cover of 19th capital an over leveraged balance sheet and of struggling core fleet business.
Transformation started cutting through that fog.
The early 2020 offering the first visibility of what this company really well.
Looks like.
When the fog of the Pentagon Macworld in.
No sooner does that fog start to dissipate.
And we became shroud within the US another backup volume caused by these OEM production delays.
However, like close to weather systems the curve.
The cloud won't last long, we can tell that.
From the weather report showing the strength of our order book the recovery of our service revenue and our healthy financing and syndication positions.
You can imagine element looking like.
Is the clear light of day.
It's highly scalable.
<unk> operating platform, 1 that insurers net revenue growth falls almost straight through to operating income.
Yes.
Our view or our transform processes systems and procedures, which we continue the automated and improve meaning that we can handle high transaction.
<unk> and the interaction volumes without a commensurate increase in the operating costs and more importantly, we can do that without risk of degradation and the consistent superior experience that our people deliver to our clients.
And our world class and uninterrupted funding and syndication.
<unk> capabilities to continue to show the value advancing our capital light business model that is already materially enhanced our Roe.
It provides the opportunity to return capital to shareholders.
Imagine what the results will look like when the new clients.
Share of wallet wins.
Wins and the accompanying revenue unit secured by our commercial teams in the first half had been onboard it implemented generating net revenue operating income and cash flow.
And imagine the service revenue potential in a post COVID-19 V shaped economic recovery with our clients' fleets.
<unk> now back at pre pandemic levels of activity.
Jim Frank and I have the privilege of seeing element of close every day.
The obscured by any fog.
And we can tell you it looks even better from here and it does from a prior.
The best that's still yet to reveal itself.
With that let's open the floor to your questions off.
Operator.
We will now begin the analyst question and answer session.
In order to go for it all analysts from the opportunity to ask the question element kindly request from the analyst.
Limit themselves to 2 questions and lifestyle of with management.
At the analyst have additional questions. Please rejoin the queue.
The join our rejoin the question queue. You May Press Star then 1 on your telephone keypad.
You will hear of tone acknowledging your request.
You were using a speaker phone.
Please pickup your handset before pressing any teeth.
You withdraw your question. Please press Star then 2.
The first question comes from the Geoff Kwan with RBC capital markets.
Please go ahead.
Hi, good evening.
My first question.
<unk> was just.
On sort of the new client wins in the existing clients doing more business with you I mean, the Q2 results.
You showed yet another good quarter of new client wins and again.
Existing clients of more business, you talked about shortening the sales cycle of improving the pipeline quality.
It's hard to generalize, but are there additional.
Additional insights that you can share.
It's about what you what you're doing and why clients are switching.
Causing your hit rate to increase.
And then any additional insights on on trying to get the self managed as well as U S Mega fleet targets.
Yeah, Good evening, Jeff J here.
We continue to ramp up.
The win rates across all 3.
The 3 regions and I think it's a combination of the number of factors Firstly sales force effectiveness. So we have invested heavily in a much more disciplined.
The approach to our commercial.
Leppard from what has been the case from the past leveraging some of the IP that we have developed in the Mexican market refined in the ANZ market, then and brought into the U S Canadian market.
And.
And the final form of 3 well and then with that team.
Embracing it putting it.
Into.
Houston and productive use here in Canada, and the U S. They.
They have expanded on that IP and in turn have share of their learnings with our colleagues in both Mexico and ANZ for the betterment of their sales force effectiveness. So a concerted effort in developing.
Hey.
The go to market process complete with.
Marketing capabilities complete with that.
Better.
<unk> funnel management.
We're in the quality of.
Of the prospects in that funnel the.
Speed by which we're able to move from prospect to.
Proposal 2 contract to sign the agreement.
That is all helped accelerate the.
The pace of growth that you're seeing so I think that's 1.
The key factor second factor is indeed, the best practice sharing across 3 regions, where there is active sharing of learnings.
So in terms of what's working what isn't.
And.
I would also point to the.
The the reputation and the the.
Return of the.
The reputation that we enjoyed prior to.
The all the amalgamation of these organizations into the entities that became known as.
All of them, but.
The operated as market leaders had a great.
Our reputation in the marketplace for the.
Consistent.
The client experience that they offered and.
And the return to that stature we're in.
We are seeing.
Seem to be the market leader not only in size.
But indeed, the consistency and superiority of that.
Client experience has opened up more doors for us both with our existing client base. So as we look to increase the share of wallet.
And the services that we provide our existing clients, who have a deeper level of trust and respect.
For us, but it was also open the door to prospects and in particular in the sport as a surprise to us in particular the <unk>.
Clients of our competitors, who aren't satisfied with the offerings.
And the experience up there, but we're having with our competitors.
And.
They have come for knocking on our door asking us to.
Entertain doing business with them in and you can see that in the numbers, we've skewed heavily towards share of work wallet and market share.
In terms of beds in the first half largely as a result of again.
Going within the existing client base and.
Selling into the white space of opportunities there.
But secondly.
<unk>.
Being more responsive to the rfps that come forward.
As a prospective clients of locked into the market.
Market has seen a viable alternative to the incumbent and approached us to consider doing business both of them.
And sorry, just on self managed and in U S Mega fleet targets.
Yeah, and self manage I would say.
2 of the.
For any available.
The bulk of highly qualified.
<unk> targets in the.
Stealing market share and.
And share of wallet.
Reis has helped build out some of our effort that we would've put it into self managed to be honest with you.
It does not in any way shape or form reflect in the.
Diminished perspective or diminished interest quite the contrary, what we're seeing.
Our early forays into the self managed fleet.
Have been encouraging.
They constitute the a goodly amount of the.
Pipeline in terms of prospects.
And we have been modifying.
Applying our go to market approach for self managed fleets based on those.
For those early forays into the U S and Canadian market in particular and to some extent ANZ again, leveraging a lot of the knowledge.
But the.
We cultivated.
As we built a very successful.
Self manage strategy for Mexico.
And then the Mega nothing.
Probably of of substance. The report there are again long sales cycles.
And complex client.
Client needs very bespoke.
Offerings and so we continue to have a number of opportunities that we're pursuing the interest then and again.
I would say that the the.
The credentials that come with.
Supplying our model with.
Like the service solutions.
It has served us very well of in terms of.
Providing us an entre for.
The discussions with these larger potential Mega fleet opportunities.
Okay and just my second question was on.
And you know the Q1 and Q2.
You were very subdued amount there I think last quarter, you still suggested that the quote normal here.
We may see that still in 2021, but given we haven't had much so far in Q1 and Q2 do you still kind of think that's.
That's achievable or are we going to see something less than a typical.
For them in terms.
Originations this year.
I, probably would have to fall back to our our blanket statement around the OEM production volumes in the resumption of the same later in the in the second half.
It really is quite.
Dependent on how quickly the.
<unk> are going to be able to rebuild.
The production capability.
As for Microchip shortage starts to wane and that becomes less of the constraint. So.
Yeah, well have to fall back on that just as the catch all.
Unfortunately, and so it will totally depend on the.
The rate of of sent the Oems in terms of return to normal production levels.
Okay. Thank you.
Thank you.
The next question comes from Paul Holden.
With CIBC.
Please go ahead.
Thank you good evening.
First question is with respect to servicing income. So you provided some helpful context around where you're at in utilization end of July like back to pre pandemic.
The.
Better understand that'd be helpful to understand where you were in Q2 relative to sort of pre pandemic run rates.
Yeah.
[laughter] nearly normal [laughter] you know it has been.
Just a very.
Constant a sense back to normal in terms of transaction levels, and where transaction levels could be anywhere from the occurrence of a routine preventative of maintenance the consumption of fuel are the <unk>.
The incidents around accidents and collection.
Patients are you know.
We never really saw anything but kind of a straight line of.
You know a sense in terms of the return to normal it just playing out a little lower than what we had anticipated.
<unk> talked a little longer.
The moat, we have planned for and again I think it is much of a function of.
The general the environment and the issues that we have seen around vaccines vaccination and the.
Returned to normal.
In terms of supply.
The cycle.
The reaction so.
The light it too as we.
Sadly continued.
Of sent the through the second quarter delighted too.
Subsequent to Q2 to see us actually hit normal pre pandemic levels of consumption.
From especially around fuel consumption and manage maintenance so feels like were there.
And obviously based on the growth that you're seeing in terms of the new client wins the share of wallet the.
The new prospects that we convert it to 2 of clients.
Clients.
Then.
Uh huh.
Encouraged by the profile of our.
For service revenue growth go forward.
Thank you Okay second question is.
Well it helped me better understand.
The risks either upside or downside to sort of your origination.
But for the next.
Few quarters right stretching into 2022 and I guess the question is what what changed between the Q1 update with respect to the expect the delay of roughly 200 million from Q2 to Q3 and what actually.
I'll occurred in does that again does that mean anything in terms of potential risks either negative or positive in terms of your forward outlook today.
Yeah, and maybe it was given.
Jim is that the coal faced here of Alaskan too to speak to.
To that Paul.
Yeah, Paul Thanks for the question I think you know the the main driver of that obviously is the you know the OEM production cycles continue to rise in Q2.
As Jay sort of alluded at the beginning of the call. There normally you know 60 days in the U S of 90 in Canada, and they're now up to 130 and Theres still lot of moving north.
So that's really the you know the driver.
Kind of the the fluidity in the Oems.
The forecast as much as as much as ours is changing is that dynamic happens.
So sorry, I don't I don't I guess I don't fully understand the the answer.
And so just in terms of.
Again, I think the original expectations, roughly 200 million of worth of religion origination of being delayed.
The reason it for it but yeah. The reason the originations proved out in quarter 2 was because of the oem's ability to deliver those vehicles to us moved out.
I understand.
So in the U S policy.
We actually ended up the twice.
The.
The normal time to convert an order to an originated unit.
And.
And the increase from 2 months.
On average.
Just pushed.
Those originations into future periods of them and again as Jim has indicated right now the.
Cycle time, it continues to increase and so we as we look to.
To the second half they are difficult to have any type of line of sight.
With any degree of exactitude as to when that cycle time will start to compress and we'll get back to the normal 60 day cycle time from order to origination.
It's not that you know that.
Was the big factors just the.
The elongation of the.
The cycle time from order to origination far beyond what anyone.
Of the anticipated.
And if I read through the answer correctly and based on my understanding of light.
Vehicle sales in the U S. Then at that but that's kind of such.
Suggesting that the Oems are prioritizing the restocking of dealer inventories, though for fleet sales of that as that of correct interpretation.
No no.
No I mean, I can take that 1 day, if you wanted to.
Yeah, Yeah. So the body in the in the U S. The way that the Oems of work in Canada is the same as there is an allocation.
That's for the fleet customers.
And so the so they're not de prioritizing our business. It just in the retail is facing the same challenges if you drive by.
The dealer lot today, you'll see I was just incredible.
The lack of vehicle inventory, particularly from our core 3 Oems.
And that's both on the retail and fleet.
It's not the different but.
So where we get updates from them every every every day and.
Certainly the or perspective is.
But they're making progress towards.
Securing more chips in that they expect the return to normal production volumes.
Late in the kind of the second half of the year.
Okay.
Yes.
I.
I think back I think is important.
Think of an important just to step back again as you as you think about this.
Recognize that as we think about the business globally, we're absolutely in the U S and Canada.
Missing out on net financing revenue.
Syndication revenue and service revenue.
For more importantly to us we're missing out on significant amounts of cash flow by virtue of having these originations differed.
Okay.
They will take place.
But they are being.
The deferred right now.
But globally the <unk>.
Same factor that is given the <unk>.
Rise to the OEM production shortages has given rise to.
Hey.
Ridiculous I'll used vehicle market in the ANZ into all of it.
The lessor.
Or extend the Mexico, which in turn has given rise to significant increments.
Increments in gain on sale and so when we look at the business globally.
There's almost day.
The hedging here that has taken place at the end of higher level.
What were actually.
Seeing.
Per than the U S and Canada.
It will be realized because of revenue in the subsequent period for actually in receipt of 1 time revenue that significantly offsets.
And so the real exposure for US is more along the service revenue and the stimulus.
The pointed out remarketing, so if we're not replacing a vehicle we can't sell the end of life vehicle off and earn the associated of fees associated with doing so which again is a very lucrative part of our business nor.
Are we able to through the origination generate the.
Upfront cash flow is that usually come as part of of origination transaction that.
Those of the 2 per parts of the business that are are still exposed.
By virtue of this OEM production.
Production delay and that exposure.
<unk> again is temporary in nature.
Short term in nature and the mirrored the for all of the revenue that will be earned in the subsequent period.
Subsequent period being a totally conditional upon the ability of the Oems to quickly ramp up of.
Given the influx of.
Chips, but the.
Becoming available to them now.
Understand understand thank you.
Okay.
Okay.
The next question comes from Mario Mendonca with TD Securities.
Please go ahead.
Good evening Jay.
Sort of along the same line you've offered that.
The cycle time in the U S is up by 2 months and 1 month in Canada.
That would imply then that with the orders being as strong as they are that we should see a real spike in originations next quarter.
I mean, if we're really just talking about a month or 2.
The delay.
What's causing you to think 2022 is it simply that the cycle time is not a constant it continues to expand or is there something else zone.
Okay.
Couple of factors.
To say cross the 1 yes absolutely.
We're at 100.
2500, 30 day cycle time, right now and it's rising.
And so when do we crashed.
And when do we actually start to see.
The reduction in that cycle time, and an expansion of capacity and the ability to draw down the.
The order book and so what we're seeing is the the pipeline for all intents and purposes has been constrained and yes, we will have the originations in Q3 and Q4 absolutely.
The are going to be.
Longer and arriving to us the neighborhood.
It would normally be which means that.
The orders that we might have for quite a stand.
Q1 Q2.
The reduced in Q3.
And so.
It wouldn't be unrealistic to see the order book continues.
To build.
The order backlog continues to build on depending on how quickly the Oems were ready to.
The ramp back up production to normal levels from reduce the cycle time. So it is just could scripted.
Supply.
It is prevent anything else from.
Of originating these vehicles.
And there are clear, but it will be cleared.
At a pace that resembles the Oems of building too.
Produce volume.
The related.
Question, then I think you told us at the correct me, if I'm wrong, but I think he told us that the backlog of about 1 point of 5 billion of alright.
Uh huh.
Yeah I understand.
So maybe you.
You've also been good enough the explained that our motto hasn't made a meaningful.
The contribution to originations in Q1 end of Q2.
As our motto made a meaningful contribution to that order of backlog in 2021.
The the comparisons at the.
We have off for that have tried to bring our model out of this just so because.
We could have like for like an end if you will every 1 butler of motto or the.
Our core business.
And the reason why.
Our model of head so few originations.
In Q1, Q2 was a function of.
Better.
Better matching.
Hum.
Supply to their needs.
Vehicles of arriving in Q1.
Our non ferrous valuable to them those vehicles that are arriving in Q3.
So did have the have.
Given the orders to F N as I'm out of off.
Given order of CSN in 2021.
Yes, the half.
Thank you.
Yes, absolutely.
[laughter].
The next question comes from Tom Mackinnon with BMO capital. Please go ahead.
Yeah.
Yeah, Thanks, very much and good evening.
We certainly than the certainly made it clear of that of demand is robust and you know.
Seems to be an issue here in terms of Oems.
Able to are you now.
They'll fill of what it's been a very strong order book, but I was curious by the comments.
Comments you put in the press release, where you said element believes there is additional near term client demand for vehicles in the U S and Canada that is not reflected in the first half 'twenty 1 order volumes as some clients have remained cautious in the first half of the year just the lingering uncertainty regarding the downtick.
And the economic recovery.
Maybe you can maybe you can tell us what made you.
You've talked about demand being robust, but at the same time, you're saying that clients have remained cautious and maybe you can talk about what you were seeing there and why you are saying that and how that cautiousness with respect to clients of <unk>.
Has trended through the first half of the year. Thanks.
Yeah, and maybe I'll start and ask Jim to the a little bit more color.
So if you will ton.
Segment of the population of clients.
In 2 of the Bulls and the bears.
So loans.
Whose business model has been.
Less impact of less affected by the pandemic.
And in the very bullish outlook for the future prospects of the organization.
Of the orders in.
There are.
Aggressively moving towards the.
The continued revitalization of the bank.
Past practices at the same time.
Would have.
Some of the clients I wouldn't it be taking a more cautious.
The view.
How the pandemic.
Unfolds and the impacts of it may have on the Oregon, it organizations and the organizational needs and.
And then you stare into that and Gosh, you know, even if I put an order in.
Given the chip shortages and the resulting OEM production delays.
Even going to.
To be able to get the coke.
Why bother.
So you know if you stratify the the client base into.
Those 2 groups.
What you see in terms of a record.
Order backlogs in each of the 3 of them.
The regions reflects.
Thanks, Matt.
Conviction.
Those clients with the bullish attitude when it does.
Does it reflect.
As all of those that are sitting on the sideline.
By virtue of either.
For a cautious view as to how it was the.
The economy might unfold.
What's the how the business may be impacted and door.
A a bit of of reluctance to place an order knowing.
I was just gonna be queued up for.
Considerable periods of time awaiting OEM production and Jim's conversations the beams conversations.
Chris there's others leaders conversations with those clients.
Would suggest that yeah, you know what the.
We've been cautious for a while.
And we can no longer.
Either we have become more bullish in terms of the economic sentiments or just more pragmatic.
In terms of our approach our fleet is aging.
Its becoming more expensive to run we're incurring greater down.
Time than what we should be and it's just time to place those orders.
So that would represent that second group and what we're hearing in terms of additional pent up demand.
That's.
And our mindset is how the 2 <unk>.
Segments can coexist both of them.
The place the orders and contributed to record order.
Backlogs, coupled with those that to this point have been a bit more cautious, but more wait and see and attitude, but the clock is running.
<unk> got some in terms of managing an efficient fleet and and and.
They need to make some decisions.
Okay. Thanks for that and the and the second question is with respect to the buyback the.
The 5.6 leverage are you bought back a lot in accord with the 5.6 leverage kind of stayed the same quarter over quarter.
Your line halfway through and it's at 10% in CIB and there's some maybe of them.
A little over 4 months left on it so.
Related to that like is your intention to just sort of continue on this pace.
And you utilize the entire ntis, especially given that you're at an attractive 5.6.
The leverage in that.
This increase in the OEM cycle time have any impact on that.
Thanks.
Yeah the.
With regards to the latter point and met with the OEM cycle time wouldn't have any material weighting in terms of the consideration around the <unk>.
Iberia or capital allocation process, so that wouldn't be a factor per se.
And.
We're pleased with the pace of the program.
For.
The set up to buy as much of 10% of the shares of expenditures the.
The organization and as we've stated before 1 of the governing factors for US 1 of the more important government factors for us is tangible leverage and trying to keep our tangible leverage.
In that sweet spot of plus or -6 times tangible leverage.
<unk> recognized.
And that's where we want to be on the efficient.
Frontier, So you know that.
That will continue to be a bit of a beacon of bit of a guiding light for us in terms of the pace of sizing of the share buy back program as the go forward.
Okay. Thanks.
Thank you.
Once again, if you ask the question. Please press Star then 1.
There are currently no more questions from the phone lines and this concludes the question and answer session.
I would.
Like to turn the call back over to Mr. Forbes for any closing remarks.
Thank you operator.
And more importantly, thanks to all of you for joining US this evening port.
Discussion of our Q2 results mushroom I appreciate your time and your continued support.
All of them stay well.
This concludes today's conference call you may disconnect. Your lines. Thank you for participating and have a pleasant evening.
Okay.
[noise].