Q3 2021 Element Fleet Management Corp Earnings Call
Thank you for standing by this is the conference operator.
Welcome to the element fleet management third quarter, 'twenty, 'twenty, one financial and operating results conference call.
As a reminder, all participants are in listen only mode and the conference is being recorded.
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Element 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 in its year end and most recent MD&A as well as its most recent area for a description of these risks and uncertainties and 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.
Elements earnings press release financial statements and DNA supplementary information document.
The Investor presentation, and today's call include references to non I FRS measures, which management believes are helpful to present, the company and its operations in ways that are useful to investors.
A reconciliation of these non I F. R. S measure to I F. R. S.
The measures can be found in the MD&A.
Now I'd like to turn the conference over to Jay Forbes, President and Chief Executive Officer of element. Please go ahead Sir.
Thank you operator, and thanks to all of you for joining me and Frank.
This evening.
Like to use our time with you to discuss elements results for the third quarter.
Forecast as well as the progress that we've made.
Our strategic priorities.
Provide a bit of a note for the company.
As well as 2023.
Let me start by reflecting for a moment on the last three years says element.
Navigate the complexities of transformation.
The unknowns of the pandemic.
It has been this organizations ability to stay open and responsive to changing business dynamics that has served elements so well.
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And it will serve us equally well.
Wait through unexpected challenges arising from the current industry first vehicle supply shortage.
The ability of our organization to embrace an action new opportunities together with our ability to identify and mitigate.
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Element to move the needle mature over the last three years and every dimension of our business.
Allow me to provide you with a few examples.
We've grown elements global net promoter score from negative nine to a positive 26, we've.
We have achieved record high levels of client retention, including nearly 100% retention and raw, Australia, New Zealand and Mexico.
Improved employee engagement to 86%.
Expanded our operating margin from 44% to 53%, we've eliminated nearly $5 billion of debt from our balance sheet and.
And we've improved pre tax return on equity from 11, 9% to 15, 7%.
But they use and many other measures our business has never performed better nor have we been better positioned in our markets.
All of this progress in becoming a great company as evidenced in our third quarter year to date and full year forecast results for 2020 one.
Frank will take you deeper into the numbers, but at a high level. This has and continues to be another year that showcases both the resiliency of Allison's business model.
As well as the commitment of our people and forging ahead to deliver a consistent superior client experience, despite abnormal market conditions and often challenging practical circumstances in particular as a consequence of COVID-19.
While client demand for new vehicles and elements services is robust across our footprint.
OEM production delays driven by the global Microchip shortage have reduced vehicle deliveries and consequently constrained origination volumes throughout 2021, particularly in the U S, Canada, and Australia and New Zealand.
Nonetheless, our financial and operating results remained solid.
Our particularly strong service revenue growth across the business is a reflection of three fundamentals.
Strengthened and reinvigorate our commercial function.
Liberate focus on services is an important source of revenue growth.
And the return to more normalized service consumption as client activities return to pre pandemic levels.
Growing service revenue was one of the key thrusts of elements capital lighter business model.
Compared to net financing revenues services revenues have.
Much lower funding requirements all of the networking capital position, respectively, the services being procured.
This makes service revenue like syndication revenue.
<unk> accretive elements return on equity.
Service offerings are even more important to our business from a client perspective.
You've heard US talk about fleet management is a sticky business, while our ready access to cost efficient capital allows us to be competitive on financing services are the glue that creates 98% historical average client retention rates our metrics that we have proved on considerably across all.
All three regions.
Surface system and the manner in which they are experienced by our clients are also our greatest points of competitive differentiation.
We have by far the largest and broadest network of automotive service supply partners across North America.
We have the deepest datasets and the automotive industry and areas of specialty like remarketing and accident management Ernest clients said initially use element for nothing else.
As these service capabilities that underpin our compelling value proposition of materially reducing our clients' total cost of fleet operations and eliminating.
Related administrative burden.
Indeed, our trademark consistent superior client experience is at its heart.
Service experience.
Let me turn it over to Frank for a deep dive into our Q3 forecast for year 2021 results as well as an outlook on 2022 and 2023.
Thank you Jay and good evening, everyone I'm happy to be with you Tonight to talk through our resilient third quarter and year to date results as well as our forecast for this year and in our expectations for 2022 and 2023.
Let me start with a brief discussion of the quarter and year to date periods. All of the comparative results I'm going to reference are on a constant currency basis. Our outlooks on year end 2022, and 2023 are also all constant currency as we don't factor any future FX hypotheses.
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Net revenue for Q3 was four 4% higher than Q3 of last year, and 7% higher year to date versus 2020 at Q3.
We continue to demonstrate the scalability of our transformed operating platform, which magnifies net revenue growth into higher rates of adjusted operating income or AOI growth.
Italy, expanding operating margins in the process you.
Year to date NOI has grown 13, 9% from the same measure last year and operating margin has expanded 200 basis points from 51, 5% to 53, 5% for the first nine months of the year.
After tax NOI per share or adjusted EPS up 21 cents.
Q3 was flat year over year, despite a materially higher effective tax rate this year.
Q3, adjusted EPS was up one penny per share quarter over quarter.
By comparison Q3 free cash flow per share grew 17, 4%.
Or four cents per share year over year and was flat at 27 per share quarter over quarter.
Remember that the real cash tax amounts, we pay are materially less than the reported taxes line item on our income statement, which is one of the reasons why we view free cash flow per share is the most important measure of performance.
We continue to derive benefits from advancing our capital light business model, which enhanced pretax ROE in Q3 by 180 basis points year over year, and 40 basis points quarter over quarter to 15, 7% besting last quarters record high.
We syndicated $520 million of assets for the quarter and generated $13 9 million in revenue year.
Year to date, we are almost flat to 2020 at Q3 in terms of syndicated volume with approximately $2 1 billion and we are technically ahead on syndication revenue, but single digit basis points behind on syndication revenue yield which is indicative of how consistent the results are.
I attended the E L F pace syndication conference in San Antonio with our team a couple of weeks ago, and I have to say that the experienced confirmed my beliefs, which were that our syndication capability at element are among the most sophisticated in the vehicle leasing marketplace. We've invested.
Is it heavily and wisely and this resilient source of high quality earnings and cash flow and I'm looking forward to our expansion of the practice into Canada and Mexico in the new year.
As Jay noted growing services revenue is the other thrust advancing our capital lighter business model compared to net financing revenue service revenues has a relatively low funding requirement that been only the networking capital position have procured services.
Services revenue performance stands out in our Q3 and year to date results, particularly when you control for the $8 3 million of onetime services revenue recorded in Q3 of last year.
Absent that amount services revenue grew nine 4% year over year for the third quarter and three 8% year to date versus same period last year.
We dedicate a fair amount of space in our disclosures this quarter to discussing the importance of services revenue to our business.
I would highlight that we see a path to high single digit annual services revenue growth in 2022, as our clients return to pre pandemic vehicle activity levels, and we continue to focus on share of wallet wins across our footprint.
You can read about our early success on this front any achievements and initiatives section of our MD&A. This quarter on the first page under our clients.
Last but not least of our revenue streams net financing revenue grew $8 7 million or eight 7% year over year for Q3, Despite average net earning assets decreasing 15, 5% on the same basis.
Net financing revenue grew $41 5 million or 14, 4% for the year to date period compared to 2020 in Q3.
This strong performance was driven by gains on the sale of used vehicles in Australia, New Zealand and Mexico.
Lower cost of funding with the significant maturation of our treasury function and smaller balance sheet. Some of the benefits of our capital lighter model.
And the reduction of our balance sheet allowance for credit losses.
As we signaled last quarter adjusted operating expenses were seven 8% higher this quarter than Q3 of last year and are up two 5% year to date versus 2020 or Q3.
Due to various accruals that occur over the course of the year and the timing of same of last 12 months metric is much more indicative uptrend in progress on operating margins.
You can see 130 basis points of expansion comparing our last 12 months operating margin to that of the prior 12 months.
We recorded a onetime adjustment to the short term incentive accrual in salaries and related expenses in the quarter to reflect the outstanding performance of the business in 2021.
In the face of a first ever OEM supply shortage or people are still delivering on elements, 46% net revenue growth target and we are returning a significant amount of cash to shareholders.
The modest Opex increase on a year to date basis is mostly attributable to Q3 depreciation and amortization are several significant work in process projects came on line.
We anticipate DNA increasing over the next several years as we continue to bring it investments online that allow us to delivering consistent superior client experience, while increasing efficiencies in our operations.
Before I change gears to our outlook I want to reiterate the free cash flow per share growth that I noted earlier and speak to our return of capital strategy.
Year to date, we have grown free cash flow per share four 1% or <unk> <unk> per share from 73 cents for Q3 2020 to 76 per share this year.
The combination of free cash flow growth and our ability to manage tangible leverage through syndication enable us to return excess equity to common shareholders by way of growing dividends and share repurchases for cancellations.
Later of course enhancing elements per share performance metrics.
As of October 31. This year, we have returned approximately $568 million in cash to common shareholders.
$111 million in dividends and $457 million of buybacks under our Mci.
We announced a 19% increase the elements common dividend today from 26 cents to <unk> 31 per share annually, which is effective immediately and therefore will be reflected in the dividend to be paid in respect of Q4 2021 on January 14th 2022.
With this increase our common dividend represents approximately 30% of elements last 12 months free cash flow per share, which is the midpoint of the 25% to 35% payout range, we plan to maintain going forward.
We also announced the <unk> approval of our notice of intent to read news in and CIB, allowing us to continue returning cash to shareholders by way of buybacks well into 2022, which we intend to keep doing as we feel our common shares are undervalued as a result of the OEM production shortages and the significant.
Revenue operating income and free cash flow growth deferred in our order book.
And finally on return of capital, we intend to fully redeem elements series I preferred shares class when the opportunity presents itself in June of next year.
Moving along to our outlook on the end of 2021 and performance in 'twenty, two and 'twenty three.
Our clients demand for vehicles has surpassed pre pandemic levels. The month of October. This year was the single largest month of U S and Canadian vehicle orders in elements history, excluding our model.
The Oems ability inability to fill these waters has resulted in a massive backlog and created a significant deferral revenue operating income and cash flow.
Year end 2021, we anticipate our order backlog to be an all time high of between two five and $2 8 billion, which is approximately one five to $1 8 billion higher than our average year end backlog of approximately $1 billion.
We expect that excess backlog to represent approximately $50 million of net revenue deferred by OEM production shortages in 2021.
Unfortunately and to some extent as a result of OEM production shortages, we are trending to offset this estimated $50 million deferred net revenue growth and still achieve between four and 5% annual net revenue growth for 2020 months, so within our target, 4% to 6% constant currency range.
Certain compensating revenue drove this growth achievement.
The reduction in our allowance for credit losses, given the outstanding quality and performance of our asset portfolio will have contributed approximately 9 million to net revenue in 2021.
The elimination of fees and costs, because we recalibrated the size of our credit facilities to better meet the needs of our clients as we advance our capital light business model will have contributed approximately $15 million to net revenues in 2021.
An increased gain on sale or cost earned in ANZ in Mexico due to favorable used vehicle pricing driven by OEM production shortages in those markets will have contributed approximately $30 million to our net revenue in 2021, we.
We believe this elevated cost performance will continue until OEM production shortages subside.
These opportunities and offsets are testaments to our resilient business model through myriad market conditions, we see.
Forecast 2021, adjusted operating income of $500 million to $510 million equivalent to between 80 and 82 adjusted earnings per share.
We forecast free cash flow per share in the dollar to $1 two range for 2021, representing 3% to 4% growth in free cash flow per share over 2020.
Operating margin would have expanded year over year, and 21 to between 52 and 53%.
And pre tax return on equity will almost invariably be a record in the mid 15% range for 'twenty, one as a whole.
Moving to 2022 outlook.
Looking out to 2022, and 2023 I want to flag the reality that we do not have perfect information on the timeline or trajectory of OEM production volumes normalize.
We are trying to triangulate it from multiple sources of information, including in person meetings with our OEM partners to establish our expectations for the next two years.
We deliberately express these expectation and ranges of key financial and operating metric outcomes. We.
We will continue to report these metrics on a quarterly basis, but we won't be updating the related content in this quarter supplementary or repeating it quarterly going forward unless there's a material change to our knowledge our assumptions.
In 2022, we see a good year that will nevertheless continue to experience headwinds from OEM production shortages, we believe the year will get stronger sequentially by quarter as vehicle availability improves.
We expect demand in 2022 to be sufficient to produce 5% to 6% net revenue growth.
However, OEM production shortages will likely see approximately 30% to $35 million of this revenue deferred as order backlog, reducing the effective growth rate to between one and 3%.
We provide detailed walks and commentary on our supplementary disclosure this quarter showing how we expect each of our revenue streams service.
Net financing revenue and syndications to change from 'twenty, one to 'twenty two.
Taking a moment to drill down on syndication revenue, we expect it to moderate somewhat next year as OEM production shortages continue to delay originations and vehicle deliveries only following delivery can at least be activated which creates fleet assets for potential syndication.
As noted in the supplementary we'll be syndicating certain operating leases in 2022 and the revenue from those transactions will actually benefit the net financing revenue line because accounting requires us to treat the proceeds of these operating lease syndications as gain on sale.
Also as previously disclosed we intend to expand our syndication capabilities into Canada, and Mexico in 2022, and we expect both geographies to contribute modestly to syndication revenue.
More importantly, these are further steps being taken to advance our capital light business model, which enhances pre tax return on equity and accelerates the velocity of cash flow, allowing for reinvestment in our business and return of capital to shareholders.
Returning to our P&L at a high level I mentioned, approximately 30% to $35 million of demand driven revenue likely being deferred as order backlog the.
The remaining approximately $20 million of growth revenue next year will be partially offset by approximately $10 million of adjusted operating expense growth, resulting in year over year, adjusted operating income growth of between 1% and 3%.
We expect to hold operating margins relatively flat next year by maintaining tight opex controls in this supply constrained environment. So only depreciation and amortization is expected to grow materially as our transformation investments in infrastructure and technology.
<unk> to come on line.
We see some of the fruits of our capital return strategy in 2022, when we look at the Oi growth rate compared to that of the adjusted earnings per share.
We expect EPS to grow between six and 11% next year is a function of our continued return of capital to shareholders by way of buybacks and a free cash flow per share growth is even stronger.
We anticipate free cash flow growth of 2% to 6% in 2022, but free cash flow per share growth of 8% to 13%.
This is what's so compelling about our revolving capital lighter business model. It gives us the ability to return cash to shareholders through buybacks, which in turn magnifies free cash flow growth on a per share basis.
Looking at 2023 outlook with expectations of OEM production capacity back to 100% by the end of the first half of 2023, we can reasonably expect vehicle manufacturers to start clearing our excess order backlog in the U S and Canada shortly thereafter.
For 2023 as a whole we expect originations combined with services and syndication sufficient to grow our net revenue by 5% to 6% organically. We also expect to recover an incremental $25 million to $35 million of net revenue from our order backlog, resulting in a full year net revenue growth of 8% to 10%.
With significant additional deferred net revenue to be recovered from remaining excess order backlog in 2024.
We anticipate achieving 10% to 16% AOI growth for 'twenty three as the 8% to 10% net revenue growth is magnified into 53% to 55% operating margins atop our scalable operating platform.
Ally growth combined with our capital lighter and capital return strategies has us expecting approximately 13.
To 19% adjusted EPS growth for 2020 and.
And we expect even stronger free cash flow per share growth driven by approximately $60 million to $70 million of organic free cash flow growth in 2023, combined with the initial and only partial recovery of an additional approximately $30 million to $40 million of free cash flow from our order backlog.
Result is $20 to 27% free cash flow growth on a per share basis with significant additional deferred free cash flow to be recovered from remaining excess order backlog in 2024.
In terms of valuing the excess order backlog heading into 2024, we expect it to be sufficiently significant to bolster 2020 net 2024 net revenue growth beyond our 4% to 6% annual range in normal market conditions with a growth outlook for 2024 closer to the 8% to 10% we expect in 2023.
Before I turn it back to Jay a couple of housekeeping items first as we have matured our business and in particular, our balance sheet and cost of funds, we have the opportunity to modestly increase our leverage levels from a target of six times tangible leverage to one of six five times, thereby further optimizing our cost.
A capital while staying safely within our credit rating parameters.
We look at this on an FX normalized basis and as a result, we would remain below the six five times level with the current strength of the Canadian dollar.
Second I want to acknowledge the significant volume of proposed tax legislation being floated right. Now you will note that we assumed a modestly higher effective tax rate on our adjusted operating income in 2022, and 2023 and our supplementary table on forward looking adjusted EPS as part of our outlook.
It is early going we do not know with proposed legislation will be enacted.
The ultimate impact on our ETR will be as models.
Recall that real cash taxes amounts element pays are materially less than the reported tax line item on our income statement.
For that reason, we continue to believe that free cash flow per share, it's a better metric than after tax eni per share when it comes to evaluating the underlying performance of our business.
With that I'll turn it back to Jay.
Thanks Frank.
Having had the benefit of studying those 2022 and 2023 of us for the last several weeks as we pressure tested our forecasts and challenged and debated the assumptions underlying same come to think of our business having a good year ahead in 2022.
And a great year in store for 2023.
Unquestionably, we have the right strategic priorities in place and these priorities are well understood and warmly embraced by our 2500 employees such as everyone. That's driving on the same track in the same direction.
Our momentum in growing the business is accelerating you will see ample evidence of that throughout our disclosures this quarter.
While OEM production shortages will defer the financial impacts of much of that growth until 2023. The keyword here is differ none of the benefits of our growth efforts are loss.
What's more as you rollout bread in my letter to our shareholders. Today, there are silver linings to the current circumstances, which continue to evidence.
A remarkable Brazilian sub this business model and its capacity to generate free cash flow through a myriad of market conditions.
And while we will continue to.
Strategically reinvest a small amount of that free cash flow back into the development.
Maturation of our operations and capabilities, we will be returning the lion's share of that free cash flow to our shareholders by way of growing common dividends and ongoing share buybacks.
I'm now well into my fourth year with element and never have I been more confident regarding the future success of this company.
Our commercial teams are hitting their full stride in all three regions for the very first time.
Operations has never been more efficient nor more effective in their service of our clients.
Finance has given us unbridled access to cost effective capital that allows us to compete with anyone in our markets.
And our people more experienced and capable from on overcoming the challenges of the last few years.
Our engaged they are collaborative.
Quickly disseminating best practices across our global footprint to deliver a consistent superior client experience every single day.
We provided you with a great deal to chew on this quarter. So we're going to keep our prepared remarks to this.
And allow more time to hear from you and to take and answer your questions. So let's open the floor to those now.
Later.
Certainly.
We will now begin the analyst question and answer session.
It gets to afford all analysts the opportunity to ask questions element kindly request.
Limit themselves to two questions and live dialogue with management.
Several analysts have additional question please rejoin the queue.
To join or rejoin the question queue. You May Press Star then one on your telephone keypad, you'll hear a tone acknowledging your request if you're using a speakerphone. Please pick up your handset before pressing any clue.
To withdraw your question. Please press Star then two.
Our first question is from Geoff Kwan with RBC capital markets. Please go ahead.
Hi, good evening.
My first question was on the OEM kind of normalization guidance you've given.
Is there a specific data point or points that changed in the past couple of months to have the meaningful change in expected time today protection to normalize and how would you describe the level of your comfort with this new timeline.
Yes, good evening Jeff.
As we.
We talked through in the second quarter. There was a dearth of information both sources the quantity of information that was available to us and we were.
Much like the larger investor public.
Trying to aggregate the publicly disclosed information and refine that based on our.
Our own knowledge of the industry just come up with some type of informed view go forward.
That was proved to be very unsatisfactory and over the course of the summary.
We undertook a series of actions to goldfarb deeper in terms of our understanding of the root causes and they're cascading effects to the Oems and into our industry. So firstly.
We took the conversation.
If you will from the trenches to the executive suites of the Oems are engaged with their executive teams.
To better understand.
Their views as to what was unfolding and in turn share our needs in terms of they are having a greater visibility in terms of their production schedule.
Secondly, we took the input from those meetings and very clear guidance in terms of production.
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Volumes as it related to the models of greatest interest to ourselves and our clients and we undertook our own analysis based on.
Our best estimates of productive capacity coming back online.
To full capacity.
Over the ensuing months match that up against our understanding of our portfolio and the maturation of that portfolio too.
To develop a very.
Concise and more precise indication as to how this might all unfold.
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Origination volumes in the.
Next six to eight quarters, and then lastly, we undertook independent research.
And again, what's the root cause.
Semiconductor chip shortage.
Why.
We ended up in this situation in terms of the cascading effects to the Oems and.
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Achieved a better understanding in terms of both the enablers.
Blockades.
The Oems, we're likely to encounter as the.
Positioning themselves to be a bigger taper.
Semiconductor chips or the next year or two.
So if you will.
Those three.
Three pronged.
A deep dive.
We undertook allowed us to have a more informed view as to the root causes.
There are effects on the Oems and in turn the most likely effects. So that would have on our originations.
And.
The output has been shared with the investors.
Investors as part of our disclosures here this evening.
Okay. Thanks for that and then my second question was in your 2022 and 2023.
Guidance, what sort of assumption is there around new revenue unit wins or additions.
We are very bullish as you can see by the continued success that we're having in terms of stealing share share of wallet and self managed fleets in all three regions.
We're very bullish in terms of the underlying fundamentals of the business.
Our issue is not making a sale.
Not converting that sale into an order seven net orders being fulfilled.
With the delivery of the vehicle and the origination which we have described for many years as being the most lucrative.
Part of the cycle in terms of our business. So we continue to remain very bullish in terms of our outlook for sales very bullish in terms of orders as Frank spoke to in his remarks.
Kober.
Is just absolutely outstanding months in terms of Brexit or order taking.
In November is off to an equally bullish start.
Again.
For us this is translating into an order backlog.
For which we have very good a very high level of confidence in terms of line of sight around the amount of deferred net revenue.
Deferred operating income and free cash flow.
But it is deferred to.
Subsequent periods.
Thank you.
Our next question is from John Aiken with Barclays. Please go ahead.
Good evening first of all you guys. Thank you very much for the detail in the deal, but that said that's fantastic and I really appreciate it Jay I'm not going to argue with your outlook for what the OEM production is going to be you're going to say it is obviously way better mine is going to be but.
My question to you is just if there is risk of additional push out I know you've gone to great pains to explain to us that.
The orders right now are walked in their contracts, but is there at some point.
Yeah.
There were that actually doesn't break down and when does the contract ever break down if you through the OEM cannot actually produce a vehicle is there some timeframe, where there's actually dissipates and secondarily is there any risk on the vehicle purchased in terms of inflation. So if the vehicle delivery is 12 to 18 months out.
And presumably the cost of cars are going to be bought higher at that stage of the adult stage is there any risk on that on your income statement.
Yeah.
Good evening, John So.
So firstly when.
When we think about the change.
Chain of obligation here with a quiet places an order with element element in term placement side order with an OEM upon acceptance of that order by the OEM, we effectively traded a shade of obligation we are legally obligated to.
Execute that order pay for the.
Vehicle upon its delivery to us and in turn.
Coincident too that the client is obligated legally obligated to pay for that vehicle.
Upon.
So we have a again a legal obligation that.
It takes effect upon acceptance of these orders by the Oems Secondly, we have a very practical consideration the Oems swap the sale they want to produce this vehicle fulfill the order to deliver that via a poll and record the sale at the same time the client needs that vehicle.
It's either replacing a vehicle that is long in the tooth well before well beyond the best before date or is it need to facilitate the growth objectives. So for instance.
While the clients I was talking to you in the last two weeks these 500 new Malibu.
Or an expansion of their.
Our sales force.
And those are additive vehicles.
The orders will be placed and they will be anxiously awaiting the arrival. So legally there is an obligation that sees this fulfilled regardless of the timeline it takes to fill that and practically the longer this goes.
More eager.
The client has to have that vehicle because either they are.
Paying.
Higher operating costs to utilize their existing vehicle or they're paying even higher costs in the form of long term rental from us to provide their workforce. So they're able to visit their clients are salespeople are serviced appliance as a service personnel. So.
That is the legal and practical.
Ties that bind.
Chain of obligations together, if you will.
And it looks through the time line.
And remember.
While this is not exactly.
First in first out.
There is a precedent so the earlier orders are getting fulfilled generally speaking.
Earlier than the later orders and so on.
Even though we're looking out to 2023 before the backhaul.
<unk> is a.
<unk> begins to be cleared.
Yeah.
Q1's backlog is being cleared as we speak.
Q2s will be clear and as we speak and into the next quarter et cetera. So the timeline for this isn't 18 or 24 months from date of order to date of receipt of a vehicle and then lastly in terms of the inflationary piece of this again.
We are protected from that.
The B b.
Client.
Understand the pricing understands the ability for that price to shift and assumes obligation in terms of that price.
We are seeing increases in model year pricing.
22 model year in general has gone up 2% with select bottles in the high single digit levels of inflation and for US you know as we've talked before inflation as our friends. It's additive in terms of net finance revenue its additive in terms of syndication revenue.
Over time, it's quite additive from a service revenue point of view as well.
That's great great. Thank you very much I'll requeue.
Thank you.
Our next question is from Paul Holden with CIBC. Please go ahead.
Hi, Thank you. Good evening. So first question for you is related to your 2021 guidance and again I would echo depreciation for the all the additional details you've given us in the guidance, but the.
2021 guidance of 80 to 82 cents of EPS compares to 63 year to date and so implies.
<unk> 19 cents for Q4, and just wondering whats kind of driving the.
The expectation for a sequential decline in Q4 earnings.
Sure. This is Frank so when.
When we look at it I think back to the summer in the summer when most of the Oems had production.
The weakest production that <unk> seen in a long time with many many of the facilities closed for the chip shortages and the like.
Those vehicles that would have been manufactured in the summer would likely be the vehicles that would be originated in Q4, and so as a result, Q4 originations will likely be lighter than we've seen in the first three quarters and hence the flow through of those.
Our originations will will impact the quarter.
Service revenues other revenues should be in line, but the order rate origination component of that is likely to drive a weaker quarter than the.
On a sequential basis.
Understood Okay.
Clearly a surprising answer but my gosh well thank you for that.
Another question I guess with respect to the quarter and also how incorporates into into forward guidance. As this increase in the short term incentive payments. So just wondering specifically what performance metrics.
Drove the incentive payments this quarter.
And what is the risk that similar incentive payments.
[noise] result than you know.
Lower maybe lower EPS EPS guidance than what you've embedded in your forward outlook.
Sure. So in regards to the incentives given the lack of visibility on the OEM production shortages through the first half of the year, we were accruing or.
Bonus incentives at target for that as we continue to focus on both the financial metrics and the other meaningful components in our balanced scorecard, which drives our short term incentive plans, we have seen outperformance and as we got through Q3, it was clear to us that that outperformed.
Thats whats going to manifest itself in more than a higher than target payout in regards to that short term incentive payments.
From that perspective, and think about you know.
The lack of clarity around the market as the OEM production shortfalls were playing out and the fact that in the face of that from a financial perspective, we are generating 4% to 6% net revenue growth. We are scaling the platform and many of the things that we talk about our strategic priorities clients.
<unk> faction net promoter scores and the wife all of those have been performing well for the year and that's what caused that increase.
In Q4, I would not anticipate a another.
Material change to that up or down.
So I think that you know.
That would not be something that concerns me in regards to volatility around the earnings profile for the fourth quarter.
Got it okay. Thank you.
Okay.
Our next question is from Jamie <unk> with National Bank Financial. Please go ahead.
Yeah. Thanks, good evening.
My question is looking at the compensating non.
Nonrecurring items in 2021.
Clearly beneficial for this year.
I would think that as we go through a normalization process this versus in future years, but I don't see that in the in the walk throughs on any of the guidance. So I'm just wondering if that is embedded somewhere else that that we can't see.
And how youre thinking about those revenue drivers in those future years, yes.
Yeah, So think about the gain on sale component, which is the largest component of those drivers right and if we continue to see OEM production shortfalls through the first half of 2023, and then still not eating through the full backlog in 2023.
We remain bullish on the outlook for gain on sale in used vehicle prices.
As that moves forward.
A major up that both 2021 and the forecast period. So you don't see it because it's in the base similar to many of the.
<unk>.
Financing benefits that we got as far as the reduction in the balance sheet.
The.
Optimization of our capital structure again stays in the base so because it's in the base and we're not looking at a material change.
Those numbers just kind of carryforward.
That base for base piece through that forecast period.
Okay, great. Thank you.
Our next question is from Tom Mackinnon with BMO capital. Please go ahead.
Yeah, Thanks, very much for taking my question.
Just with respect to your.
The investigation in terms of the OEM.
OEM delays.
From what I understand when you order it.
Really the time between ordering and vehicles and getting the vehicle produced by the OEM. That's the biggest delay that youre seeing right now correct and that's caused most of this push.
Push out in terms of earnings.
What have you seen in terms of.
At the time it takes really before you pay between when you pay in OEM and then you actually get the lease activated.
Is that can take some time, there's vehicle delivery time, theres a vehicle upsetting time.
What are you seeing with respect to that trend and is that any change in that trend been reflected in your push out of your guidance.
Yeah, Good evening Todd.
This is essentially all attributable to the.
The delay in order to origination.
Cycle time with the Oems.
We're not seeing any material elongation of the cycle times in terms of delivery outfitting.
And ultimately at least activation.
There's all kinds of capacity in the pipeline.
Given the inability for the Oems to produce that volume, but now this is all attributable to the elongation of the cycle time between order and origination with the Oems.
So no issues in terms of labor or updating or any kind of parts needed for upsetting or a non upfront.
<unk> issues.
No issues in terms of labor or materials in terms of fitting.
Inflationary pressures it is costing more than.
The price points.
612 months ago.
But no there's no bottlenecking in terms of.
Constraints on either labor or materials.
Okay. Thanks, and just as a quick follow up can you talk about the backlog now.
How does the backlog look versus what you may have traditionally been getting in terms of orders that it just is it more is there anything in terms of the self managed market. That's in this backlog or the AR is the backlog have any kind of additional services that are.
Customers might be taking that where they weren't taking in the past.
Yeah. So this order backlog.
It would be.
Just to dimension. It for you at $2 billion growing two anticipated $2 five to $2 $8 billion by year end, we would anticipate that this would be.
$1 billion 5 billion eight.
Above our normal backlog.
At year end, so we all.
We have a a.
Orders that we've taken placed on behalf of our clients with the Oems that are awaiting.
Production and delivery, we always have some backlog, but we're running at multiples of historic backlog.
And again at year end, we anticipate that to be roughly a $1 billion 5 billion in the age of order backlog that backlog would be for vehicles.
Vehicles.
In Canada, the U S to a lesser extent, ANZ and Mexico and.
Would be across the full continuum of our client base. So we're not seeing any particular concentration in one industry, but instead across the entirety of our client base and further obviously with the.
The viewpoint that we had into each and every clients fleet.
No we're not seeing any order stuffing the channel if you will the orders that are being in place.
Vehicles that are needed to either replace a vehicle that is coming off lease replace a vehicle that has been.
Damaged and taken off road by virtue of an accident or vehicle that is in need.
To fulfill the growth mandate of their clients. So these are bonafide orders.
Quarters that are anxiously.
Being anticipated.
Our clients and well distributed across the full continuum of our clients.
And.
Are there any of those orders associated with the self managed markets.
There are more than you would've seen in the past or is it just that constant. The makeup of that is just generally the same as what you've seen in the past.
So clients yeah.
We've had some success with our self managed fleets in terms of Ah <unk>.
Sale leasebacks, so to the extent that we have.
Purchasers of those assets and brought them on book.
Obviously.
There hasn't been a cycle of replacement for both.
Indeed, there are.
The.
The population of clients constituting that order backlog will indeed.
Include new.
Recent.
Self managed fleet wins in all three.
<unk>.
Okay. Thank you thank.
Thank you.
Our next question is from Mario Mendonca with TD Securities. Please go ahead.
Good evening can we just start with the originations outlook for 2023.
It's a big it's a big improvement and I understand the underlying assumptions.
That would drive.
It looks like about a 40% increase in 2023 relative to 2022.
What surprised us a little bit is with the origination growth.
It seems to me that I that we wouldn't see a little bit more on the revenue on the revenue side that your revenue outlook.
Well, its certainly better seems a bit light relative to the origination growth you're assuming are you sort of building in a little conservatism into your revenue outlook.
Particularly in the context of this origination growth Youre speaking up.
Yeah Mario what.
What I'd say is.
When you think about 2023 remember, we said that it doesn't start to recover the order backlog until the second half of the year. So you've got a much heavier weighting in the second half of the year. So youre not getting the full run rate on that normalized production plus the backlog eating through.
And so that's probably why you're you're seeing when you look at it doesn't look as big as it should be because it's not annual it's neither annualized nor beginning at the beginning of the year, it's that recoveries.
Heavier in the second half.
Okay, I think that that does go a long way to water kind of explaining to me one other quick question here on the origination outlook.
Could you help us think through what activations could be like relative to the originations.
I don't want to pin you down too much on this but would it be appropriate to assume that on a quarterly basis Activations might run a couple of hundred million dollars light of where originations are.
Yeah, there are definitely be a.
Time delay so so if we step back for a second and just.
L level set everyone in terms of fleet. So of our portfolio 80, 20 service sales vehicles up to 80% service rough rough rough.
60% of those are up fit us.
So to the extent that you are taking a origination dill.
Deliver vehicles from the Oems and then getting it up fitted before it's delivered to the client yes, there will be a delay between the origination.
And the activation of the beliefs in terms of that.
Fully upset at vehicle and.
In terms of quantification.
Think about it.
As opposed to maybe on a monetary basis think about it on a timeline basis 30 to 60 days.
Okay now when Theyre also be a difference in originations and activations related specifically to our motto orders is that still a dynamic you would highlight for us.
Yes.
Okay.
And then finally.
You may have addressed this when Paul asked the question but.
You'll recall that last year Q4 'twenty.
There was a fairly meaningful amount of share based comp.
Should we assume that a similar trip could happen this quarter or was that more specific to last year.
We're not we're not expecting that to happen that was more specific to a significant outperformance of.
The 2019 plan.
And right now we don't expect that type of outperformance in any of the other plants.
Okay, and just one final one while I've got you there Jay the company went through an important transformation in the last the first few years.
Your tenure do you see any need going into 2022.
With these OEM delays for maybe another maybe right sizing of the organization of our restructuring or do you really see that there's still fleeting pardon the pun, but it's still bleeding that they're really it would be too drastic to make any changes transfer make transformational or already kind of restructuring of the organs.
Yeah.
But remember one of the great legacies of the transformation has just been a mindset and a capability that we introduced into the organization of continuous improvement.
Constantly challenging.
Why we do things why we do it that way.
And in turn how we might be able to improve the effectiveness and our efficiency.
Different business processes that support the client experience and and suffice it to say that you know.
We have this kind of.
Competing.
Set of priorities.
We want to stay the course strategically so when we think about the organic growth to top of scalable platform on the abilities.
Operating income gains into free cash flow for distribution to our shareholders that strategy is proving out on every dimension of our balanced scorecard. So we want to hold.
To that strategy.
And stayed true to it through 2022, even though we are going to be constrained by vehicle deliveries from the Oems at the same time, you want to deliver a fair rate of return to the shareholders should want to continue to test.
The model and the resiliency of the model and that's the that's that that is the.
Yeah.
Bit of stress if you will that we've introduced into our three year planning process and particularly in respect of 2022, we want to strategically stay the course, but short term we want to continue to evolve.
Our means of doing business to make sure that they are you know.
The most efficient the most effective and are you seeing that in our commitment to hold too in 2022 and operating margin.
Did a 53% and.
Even against a modest top line growth and the attendant benefits that flow through to both EPS and free cash flow growth is less attention that we introduced into the business as we embarked upon our three year planning how do we stay true.
To what we do and they are proving is the right strategy for the organization long term.
While we continue to deliver.
An acceptable level of performance short term.
For our investors.
So does that mean.
Likely that would be another restructuring or transformation.
No no instead this will be.
Yeah, it's another year of continuous improvement.
We're again, we examine the underlying processes and systems that support the business and look for additional areas for efficiency. So that we have transformed the business the business again.
Be it.
Promoter score.
Employee engagement operational effectiveness.
The team is just shooting the lights out operationally it really is quite incredible to see all of the time and the investment of the last three years take hold in terms of concrete improvements.
Improvements in the operational performance of the business. So we know we have something very special here and so it's about <unk>.
Continuing to evolve it and refine it.
To ensure that again.
Yields the necessary efficiencies that will allow us to meet the objectives that we've set in terms of the financial guidance for 2022.
Very much appreciate it thank you.
Our next question is from Geoff Kwan with RBC capital markets. Please go ahead.
I just had a follow up.
<unk> tons questions earlier.
And the discussions you've had with the Oems when you fast forward to 2023, it's their plan on production going.
Going back to full production as it kind of in a normal economic conditions are they looking to do.
Higher levels of protections for example, adding extra shifts and I'm just wondering if there's implications for.
Any sort of capacity issues from the transportation logistics network as long as the upstairs.
Yes, very much the latter Jeff L. S. They step back and again you can appreciate the.
FMC marketplace is near and Dear to their heart when you think about the the volumes that we transact with them. When you think about the predictability of the order volumes.
The fact that in the U S. The vast majority of the vehicles. We originate are ordered with the factory and so they can plan their production of wellness bet. We're a very attractive segment for them and the vehicles that our clients use are very attractive vehicles in terms of both price.
<unk> and.
Profitability and so.
They will be.
They will have a strong bias.
To ramp up production of these types of vehicles for these types of clients.
Fast and where possible add additional capacity.
So that they can.
Be producing well beyond the 100% and just start chewing through this backlog recognizing.
Recognizing the.
Teach nature of it for their own revenue and profitability.
Then as you kind of then look at how that might in turn translate into pressures along the the.
<unk> not fitting I'll just point you back to our model.
So in 2019, we took our board on this new client that place the single largest quarter in the history.
Of FMC industry.
And.
We worked with our supply chain to ensure that each and every one of those vehicles property up fitted.
And delivered on time to that client so they.
<unk>.
Again 55000 service you.
Dealers.
7000 auto body shops countless transportation.
Facilities hundreds up vendors, we have a very very extensive network that will allow us to.
Move.
That pig through the Python with a relative degree of bees.
Okay, great. Thank you.
Once again any analyst who ask a question press Star then one.
Our next question is from Jeremy <unk> with National Bank Financial. Please go ahead.
Okay.
Yes. Thanks, just wanted to follow up on the service services revenue walk for 'twenty, one to 2022.
Looking at maintenance registration towards violation SKU on other services as being the largest step up.
First how much as a how much of the current fuel price environment. It is baked into that forecast and then the second piece is.
In the Mexico market, which is the second largest part of that work yeah. How much of that is driven by a return to normal activity versus clients that had been added at the end of 2021 and through 2022.
Yeah, Jamie happy to step through it I'm looking at.
Page 12 of the supplementary information document.
We do indeed provide the walk from 'twenty to 'twenty, one forecast to 2022.
Expected.
As Frank has highlighted in his comments.
As we think about year over year.
We delivered nine 4% on a kind of normalized constant currency basis in terms of service revenue. So you're already beginning to see a lot of the drivers that are represented here in this work and the results in Q3.
As we look at this remarketing with.
An expectation that we're going to see somewhere in the neighborhood of 14% to 18% growth in originations that will in turn give rise to remarketing opportunities the opportunity to take that vehicle that is being replaced and solid on behalf of their clients generating the associated fees. So that will be the kind of our first meaningful.
Step up in terms of year over year service revenue.
We are seeing a lot of demand for accidents long term rental and telematics and in part because of these shortages.
Our clients can ill afford to have a vehicle written off and taken out of service because there is no vehicle to replace them.
In the event that that happens or.
A client needs to add personnel than they are.
I worked with us.
For us to in turn secure long term rental program.
Our short term rentals, thank days to weeks.
Long term rentals, thank weeks to months and these are vehicles that we.
Procure on their behalf with rental agencies that kind of front of the line discounted pricing too.
To provide them with short term capacity.
And again, given the vehicle shortages that we're seeing continuing to see that will be a source of revenue growth and lastly, telematics and and again better understanding of the deployment of the fleets.
Given the limitations.
Adding to that fleet by virtue of the shortages.
The maintenance registration tolls violations fuel and other services yep their inherent in that is an inflationary component for sure.
The bigger driver is the full years returned to normal consumption levels pre pandemic consumption levels that that's.
But really if you will fueling.
That aspect of the revenue walk and then lastly in ANZ in Mexico remember.
Both of those operations were effectively carve outs GE financial and as a consequence, both of those business units had a very financial orientation.
As we have reinvigorated the commercial function.
We have shared best practices both of those entities have just done a fantastic job of introducing more and more services maintenance fuel registration etcetera into their respective marketplaces and our growing <unk>.
Services had double if not triple.
Percentage rates year over year, and so we would expect.
Increased share of wallet growth in both Australia, and New Zealand as well as Mexico as the other contributor to the work that we're seeing here. So we're very bullish on service revenue.
In turn.
The service and syndication.
Big drivers behind that capital light business model and so with the success that we would anticipate with service revenue growth and term comes a progression in terms of a return on equity of progression in terms of our our free cash flow per share.
Okay got it good color and then that just like with a Super quick answer as part of the debt that 'twenty one to 'twenty three outlook I presume that leverage will remain at six times or under yes.
As Frank has.
Indicated we've made a great progress in reducing the operational financial and credit risk of the business through.
The transformation program and as such we've actually been able to move the organization in terms of the efficient frontier and you know our target leverage in terms of maximizing our WAC. So we're six times was appropriate for the profile of the organization. When we started that journey back in.
Late 2018.
Again, the maturation of our risk management programs a decrease in leverage the operational sophistication.
At cetera has.
And I should say the poor performance of the portfolio through a very stressed.
Stressful period.
It allowed us to take that tangible leverage target to six five times and again, that's on the basis of $1 three one FX rates.
Great. Thank you very much thank you.
As there are no further questions registered this concludes today's conference call. You may disconnect. Your lines. Thank you for participating and have a pleasant day.
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