Presentation
Operator
Welcome to the Element Fleet Management First Quarter 2018
Financial Results Conference Call. [Operator Instructions] The conference is
being recorded. [Operator Instructions]
I would now like to turn the conference over to Zev Korman, Senior
Vice President Investor Relations. Please go ahead.
Zev Korman
Senior Vice President of Investor Relations
Thanks, Arielle. Good morning, everybody. Thanks for being with us
this morning. Joining us today to discuss today's results are Dan Jauernig,
acting Chief Executive Officer; and Samir Zabaneh, Chief Financial Officer.
The news release summarizing the results was issued earlier this
morning, and the financial statements and MD&A have been filed on SEDAR.
This information along with the presentation we'll be referring to this morning
are also available on our website at elementfleet.com.
Before we begin, I want to remind our listeners that some of the
information we'll share today includes forward-looking statements. These
statements are based on assumptions that are subject to significant risks and
uncertainties. And I'll refer you to the cautionary statement and risk factors
of the most recent MD&A and AIF for a description of these risks,
uncertainties and assumptions. Although management believes that the
expectations reflected in these statements are reasonable, we can obviously
give no assurance that the expectations of any forward-looking statements will
prove to be correct.
Our earnings release, financial statements, MD&A and today's
call include references to a number of non-IFRS measures, which we believe will
help to present the company and its operations in ways that are useful to
investors. A reconciliation of these non-IFRS measures to IFRS measures can be
found in our MD&A. We'll begin with some formal remarks from management
followed by some time for questions. [Operator Instructions]
Now I'll turn the call over to Dan Jauernig.
Daniel A. Jauernig
Former President & COO
Thank you, Zev, and thank you to everyone on the call for joining
us this morning.
I'll turn to our quarterly results in a moment, but before I do,
I'm sure you all saw our announcement yesterday morning about our new CEO as
well as a refreshment of the board. Speaking on behalf of everyone at Element,
we are very excited to have a new permanent leader in Jay Forbes, whose
expertise and insights can really outtake this company and the outstanding
platform that we've built to the next level for the benefit of our customers,
our shareholders and of all of our stakeholders.
We really believe the best way to create value on all fronts is
for the business to focus on execution and thereby achieve this company's full
potential. Jay Forbes has a tremendous track record as an accomplished CEO who
gets more out of companies. We are all looking forward to working with him to
do that here at Element. And of course, all of this will take place under the
oversight of a reconstituted board. As you've seen the board is adding 2 new
independent directors immediately, and 2 more will stand for election at our
Annual General Meeting in June. As you know, the company has been looking for
new directors who can bring new perspectives to the board. Through our board's
own process, they identified one nominee. And through discussions with some of
Element's significant shareholders, the board has identified 3 more independent
candidates, all of whom are valuable additions to the board. As part of this,
Steve Hudson and Richard Venn have decided not to stand for reelection. We
thank them both for their service.
So we enter the next chapter of Element's development with the
addition of a CEO who has a track record and the skills to take this company
through the next stage in its evolution and deliver even more. And we have a
board that's even better equipped to help the company navigate the challenges
and opportunities in front of us.
So with that, let's turn to our Q1 2018 financial results and
review. As we indicated in this morning's press release, we continue to make
good progress on our strategic plan, mainly enhancing the customer experience,
optimizing our operations, reducing our cost structure and executing on our
pipeline to position the company for earnings growth in 2019. Based on our key
leading indicators, operating metrics and client customer surveys, our customer
satisfaction and customer retention rates continue to improve and are rapidly
returning to historical rates. Based on these improving trends, we believe our
retention rates will be back to normal within the next 2 quarters.
Adjusted EPS in the first quarter was $0.16, which was slightly
ahead of our internal expectations. As we announced on February 5, we expected
full year 2018 core fleet adjusted operating income to be down approximately 3%
to 5% on a currency-neutral basis, with Q1 being down more on a year-over-year
basis due to the large number of customer cancellations in late Q4 2017 than the
rest of the year.
Adjusted operating income before tax was down 6.8%. As expected,
Q1 was down more than our full year outlook, but it was slightly better than
our plan. As a result, our financial outlook for this year remains on track,
and if we continue to execute on our pipeline, we currently believe we can
achieve the low end or the better end of the previously communicated range.
As Samir will discuss in greater detail, our effective tax rate in
2018 will be better than expected, and as a result, core adjusted operating
income after tax was down only 3.3% in the quarter compared to last year.
From a growth perspective, we originated close to $1.5 billion of
new vehicle purchases during the quarter, up 10.4% from Q1 of 2017, which, in turn,
drove a 3.8% growth in our net earning assets, both on a currency-neutral
basis. We continue to execute on the strong pipeline. And later on, I'll
highlight some examples of new wins that are indicative of new contracts that
we're signing.
Our funding platform remains the most robust in the fleet
management industry and continues to provide us with significant access to
capital and financial flexibility. We've recently closed a U.S. $1 billion
funding in our AAA rated Chesapeake II structure, the first of several for the
year. In late April, we also extended the maturity date of our $1.6 billion
Canadian securitization program from November 8, 2018, to November 2019 under
the same terms, pricing and conditions that we have enjoyed previously. Both
fundings are a reflection of the quality of our assets, our customers and the
overall strength of our business and portfolio. Together with our strong
investment grade corporate credit ratings, we continue to have ample access to
the capital markets to support our growth.
Last quarter, we talked about several actions we took to align our
cost, restructure our organization and accelerate growth. I am pleased to
report that these efforts combined with ongoing process improvement initiatives
are delivering results in terms of improved customer satisfaction and retention
rates. Revenue attrition, due to integration challenges, peaked in Q4 of 2017,
improved in Q1 and have continued to show progress so far in Q2. We are winning
and renewing customers in both new and competitive wins. These are customers
who trust our expertise and ability to execute and believe we have the right
vision for their business. We are working to meet and exceed customer
expectations. Our focus is on being faster and more efficient. We've made
measurable progress in many key areas. As we achieve goals in each area, we are
listening to our customers and, in many cases, setting new and higher targets.
We continue to find ways to simplify the organization and to reduce handoffs so
we can get customers what they need faster. We have streamlined telematics
fulfillment, aligned our heavy-duty truck sales team to report directly into
our commercial sales regions, consolidated and simplified our billing processes
and removed layers in our fleet partnership solutions account management team.
Looking ahead, we are investing in innovation to materially
improve the fleet management experience. In 2018, we announced last quarter,
that we will invest an additional $35 million in making our systems faster and
easier to use for our customers and employees alike. Areas of focus on our
product roadmap include using data from connected vehicles directly into
traditional products, like fuel reporting and maintenance. This will benefit
both the customer and driver experience and allow us to take greater advantage
of our advanced analytic tools and data infrastructure.
We are developing more capabilities into our mobile app, and are
seeing strong driver satisfaction among mobile app users. And we are excited
about the possibilities of a recent pilot using machine learning to automate
routine maintenance approvals. Based on customer and driver feedback, we
believe we have a winning product and technology roadmap. And as a result,
we're in a much stronger competitive position today than ever before.
On Slide 8, you will see an overview of first half releases for
Xcelerate. We are continuing to deliver enhancements that optimize the customer
experience and deliver on the promise of advanced analytics. In January, we
released a new widget that makes it easier for our customers to manage
preventive maintenance for their fleets and made it easier to communicate with
customers through Xcelerate. We have also integrated CEI's systems into
Xcelerate. CEI, as you recall, is our leading risk, safety and accident group
that Element acquired at the end of 2016. Customers can now access CEI
DriveCare (sic) [ DriverCare ] from Xcelerate through a single sign-on, and
drivers get risk and safety task and communications through their Xcelerate
Driver for mobile app. Our latest release has showcased Element's
market-leading analytic tools, and I'm pleased to report that we just launched
a new feature called Geospatial Dashboards. Geospatial Dashboards let customers
view their inventory, maintenance and fuel cost on a 2D and 3D map interface.
Users now have an engaging and an interactive way to analyze their data by
drilling into specific areas of interest. Early feedback and prospect and
customer demos have been overwhelmingly positive and has seen proof of the new
kind of fleet management experience that Element can deliver. We are also
testing new Xcelerate dashboards for connected fleet vehicles. Customers will
be able to use Xcelerate to see telematics data and gain valuable insights in
the key fleet performance and driver behavior, including idling and speeding,
that impacts safety and predicts crashes. Analyzing data by breakdown or unit
lets customers identify opportunities to reduce cost and impact driver behavior.
On the next few slides, I'd like to highlight some examples of
sales and customer retention success where our customers have allowed us to
share this information with you.
First of all, Primoris Service Corporation (sic) [ Primoris
Services Corporation ] is a Texas-based specialty construction and
infrastructure company providing services to pipeline, power, utility and civil
markets. The company's fleet has grown through various acquisitions. Today,
they have more than 2,600 vehicles that are both owned and managed by other
fleet management companies. Primoris chose to outsource fleet management to
Element to save cost and increase asset utilization and reduce vehicle downtime
through Element's fleet management services. This strategy lets Primoris
leverage Element's best-in-class fleet services and positions the company to
effectively scale for growth.
In Australia, we launched a program for Bluescope Steel, a global
leader in premium coated and painted steel products to provide innovative
solutions supporting their fleet management and supply chain needs. The program
launched last month and is off to a really strong start.
These wins, like the others in our portfolio, prove the value add
of our service offering and are representative of the kinds of business we are
securing from both self-managed fleets as well as from other fleet management
companies.
We are also proud to continue to expand our relationship with GE
Appliances, a company with a 1,500 vehicle fleet. GE Appliances was acquired by
Haier in 2016, a transition for both the customer, even as Element was going
through its own transitions. This is why we were extremely pleased to have been
named a 2018 Distinguished Supplier by GE Appliances at their 2018 Presidents'
Council Summit, citing Element as a supplier who has performed with excellence
across all key categories during one of our most challenging periods as we
exited the integration phase in 2017.
Another example of our strong customer relations can be found in
Unilever, where have expanded our relationship and leveraged our strategic
global alliance with [ our vow ] to secure the remaining 50% of their fleet
vehicle fleet from a competitive fleet manager following a global RFP. Mexico
represents Unilever's largest fleet, and we are pleased to expand our services
with them in Mexico across a fleet of 1,800 vehicles, encompassing our broad of
range of services, including lease, telematics and maintenance.
We remain committed to delivering the best service and value to
our fleet customers. During the quarter, we acquired a 15% minority stake in
Amerit, the largest U.S. provider of dedicated outsourced fleet maintenance,
with over 1,500 certified technicians delivering on-site, service-center and
mobile vehicle maintenance. Amerit has been a strategic partner to Element and
the companies -- and the 2 companies have worked together closely for the past
5 years, with Amerit serving a number of Element customers. We look forward to
continuing and expanding our relationship with Amerit, which will allow for a
more integrated outsourcing model for prospective and existing customers and
deliver new solutions in adjacent markets, such as on-demand vehicle,
ridesharing and delivery services.
We completed our IFRS 9 assessment across the organization
resulting in a onetime accounting adjustment to retained earnings of $65.3
million after-tax. The adjustment reflects a change in accounting methodology
as required by IFRS 9 and has no material impact on our overall financial
position and provides a cushion against any future losses from our non-core
portfolio.
The 19th Capital joint venture continues to execute on its
strategic plan to improve its operations and results. While this will take
time, we continue to see signs of progress. Following the write-down of all
2013 and older trucks last quarter, approximately 85% of the portfolio value is
represented by trucks that are 2015 or newer. The operating team has reduced
vehicle turnover times by half, from 45 days to 22 days, and are driving
towards a 2-week turnaround. The joint venture produces EBITDA of USD 19
million, and with interest expense of $13.3 million, generated cash from
operations of $7.7 million in the quarter.
On balance, I believe we had a solid overall quarter and that we
achieved many of the goals that we set out for ourselves at the beginning of
the quarter.
That concludes my overview of the operating performance. Samir
will now provide an overview of our financial results for the quarter.
Samir Michael Zabaneh
Former Chief Financial Officer
Thank you, Dan, and good morning, everyone.
Starting on Page 17. Adjusted earnings per share for the core
fleet management operations was $0.16, which was slightly better than what we
had planned for, reflecting solid progress and stabilizing customer retention,
signing new customers, optimizing our cost structure and a lower sustainable
tax rate following the enactment of the U.S. tax reforms. Non-core assets
contributed $0.01 in the quarter.
Page 18 is for your information purposes and sets out how the
consolidated results are separated between core fleet management and non-core
assets.
On Page 19. Core fleet management net revenue was $208 million,
which was a decline of 6% and 2% sequentially and compared to the first quarter
of 2017, respectively. On a constant currency basis, revenue increased by 2%
compared to the same period in the prior year. The sequential decline in
services revenue reflected the attrition experienced at the -- at year-end as
well as seasonally strong Q4 for syndication and remarketing revenues. The
impact of the attrition we experienced in Q4 will continue into the second
quarter of the year as customers migrate their services but will increasingly
be offset by new vehicle origination and activation as the year progresses.
Retention rates in the U.S. for Q1 2018 was up significantly, indicating solid
improvement in customer experience. Compared to the prior year, services
revenue increased by 3%, constant currency, driven by various service lines in
various jurisdictions, of which accident management and telematics are 2
examples. Normalizing for the unusual attrition in Q4 2017, services revenue
would have grown within the range of what we expect this line item to grow at
under normal circumstances. Net interest and rental revenue was $80 million for
the quarter, relatively flat on a constant currency basis compared to previous
periods.
Page 20. Net interest margin for the quarter was 2.6%, relatively
flat on a sequential basis with -- and consistent with expectations. The
decline from the 2.7% in the previous year was a result of onetime items that
were booked as interest income in the prior year and which were not repeated in
the current quarter. In addition, the higher customer incentive compensation,
or IDC, that was incurred in 2017, and which is amortized as a contra-revenue
and overall spread reduction on the customer side contributed to the reduction
in the revenue yield. This was partially offset by lower relative overall cost
of funds given the various term notes issued in our Chesapeake ABS platform.
Next page. Adjusted operating expenses were $121 million for the
quarter, a decrease of 5% on a sequential basis and an increase of 5% compared
to the prior year. As we indicated previously, operating expenses peaked in the
fourth quarter of 2017 given various factors, mainly related to the IT
migration earlier in the year. We also indicated that such expenses would
decline over the course of 2018. As Dan mentioned, we have executed on an
operational efficiency plan, and which has resulted in the cost savings during
the quarter. We expect the remainder of the quarters during this year to remain
relatively in line with the current quarter, and which will result in the
nearly $20 million to $25 million of saving, constant currency, from the Q4
2017 annualized level. As a percentage of revenue, operating expenses increased
to 57% as a result of the near-term reduction in revenue related to both core
and non-core assets but is expected to decline over time reflecting our active
cost reduction measures and the expected resumption of core fleet revenue
growth.
Turning to non-core operations. Overall, revenue was $2.9 million
for the quarter. Services revenue remained relatively flat sequentially, and
the decline in net interest and rental revenue was primarily due to the
adoption of IFRS 9 and the related impact on ECAF, which will be discussed
later. Compared to the prior year, services revenue declined due to the nature
of such revenue in the past, and which we -- as we had indicated would not be
repeated. NIM declined due to the sale of various non-core assets, mainly the
Rail Notes and over half of the heavy-duty truck portfolio, the depletion of
other assets, including the equipment financed in New Zealand and the adoption
of IFRS 9 and related impact on ECAF revenue.
On Page 23, we provide an update on the non-core portfolio. During
the quarter, we received $1.3 million in principal repayment related to the
senior term loans to 19th Capital. The higher balance shown in the page
reflected currency exchange impact between December 31, 2017, and the end of Q1
2018. This principal repayment is lower than what we had expected. However, we
do expect the principal repayment will increase during the remainder of this
year as utilization rates increase, maintenance expenses decline and the
disposal of unutilized vehicles ramps up. We indicated previously that Element
expected that principal delays may reach up to $60 million at any one time. We
currently expect that the aggregate amount of delayed principal repayment to be
at or near this level.
Operating losses in the joint venture brought the equity balance
to 0. The carrying amount for ECAF declined as a result of IFRS 9 adoption. And
finally, the New Zealand equipment finance portfolio and the heavy-duty truck
portfolio depleted as planned. As noted in our year-end financial statements,
Element purchased a heavy-duty truck portfolio during Q1 from 19th Capital, and
which was added to this portfolio and hence the balance increased compared to
year-end.
Next page. At quarter-end, Element had $4.2 billion in available
financing to fund ongoing originations. Our adjusted cash flow from operations
continues to be strong and was $106 million for the quarter or an annualized
level of $424 million. We believe our strong cash flow and liquidity available
on our balance sheet will be sufficient to fund future growth and deliver
capital to our shareholders.
Let me now turn our attention to the IFRS 9 impact. As mentioned
previously, Element adopted IFRS 9 beginning January 1, 2018. This slide shows
the 3 main categories of the new accounting standard and the components of our
business where such changes apply. You will note that the aggregate pretax
impact of this adoption was $86 million, with a provision against the loans to
19th Capital accounting for $65 million of the change followed by the impact on
ECAF, which accounted for $17.5 million and $0.6 million for the New Zealand
runoff equipment business. The remaining $3 million was related to the core
fleet management business. On an after-tax basis, the impact was $65 million,
which was booked against the beginning balance sheet in returned earnings. It
is important to note that the impact of this adoption, together with a onetime
restructuring charge of $40 million, is well within the capacity and our
financial covenants with plenty of headroom. And such room is only expected to
grow with the growing net income level we expect to have going forward.
Let me provide you an update on our tax rate. You will notice that
we expect ongoing effective tax rate to be approximately 18%, a reduction
compared to the 20% to 21% historical level. Since the beginning of this year,
we reviewed our tax strategies and took into account the recent tax reform in
the U.S. And as you can see from the page, the impact of other jurisdiction on
top of the Canadian statutory rate declined meaningfully, partially offset by
various adjustment to statutory rates.
Overall, let me summarize the quarter with the following remarks.
Performance in the core business was in line to slightly better than what we
had expected. The retention rates are back to nearly historical levels, and the
customer pipeline has never been stronger. We implemented operational
efficiencies quickly, without a negative impact on the core business. We will
continue to look for ways to optimize the business throughout this year and
into 2019. We have efficient funding platforms, evident by the 2 recent term
deals in Canada and the U.S. Our liquidity is strong with significant capacity
to fund earning assets and core business growth. Financial covenants are in
compliance, even taking into account the impact of IFRS 9 and the $40 million
restructuring charge, with plenty of capacity to spare. Finally, we are pleased
with the solid rating all 3 of our rating agencies confirmed earlier this year.
We do look forward to continue this momentum into this year and beyond.
With that, I'll turn the call back to Dan for his closing remarks.
Daniel A. Jauernig
Former President & COO
Great. Thank you, Samir. In summary, as Samir has stated, we
believe the business is off to a solid start in 2018. As I stated in our last
call, our focuses here remains on improving the customer experience, one
customer at a time, and returning to growth by executing on our pipeline and
continuing to add services that make our customers' fleet safer, more efficient
and less costly to operate.
As Samir indicated, our core financial position is strong. We have
solid access to capital. We are rightsizing expenses. And as we execute on our
pipeline, we expect results to improve over the course of the year. From a
macro perspective, commercial fleet sales were up nearly 11% in the first 4
months of 2018, providing a very healthy backdrop for growth. Based on our
first quarter results and our future expectations, we remain comfortable that
core fleet adjusted operating income before tax for 2018 should be within the
previously provided range of being down 3% to 5% compared to 2017. As discussed
previously, if we continue to execute on our pipeline, and present trends
continue, we will end up towards the better end of that range.
With that, operator, I will pass the call back to you to open up the lines for
questions.
Question and Answer
Operator
[Operator Instructions] Our first question comes from Geoff Kwan
from RBC Capital Markets.
Geoffrey Kwan
RBC Capital Markets, Research Division
My first question was on the Amerit investment. You've also,
obviously, done the CEI acquisition. Just trying to understand -- is this
Element looking to further vertically integrate with in the industry? And also
in that context, is, maybe, part of the strategy to -- being able to reach out
to potential new fleet leasing customers that you're not currently dealing with
through making these investments?
Daniel A. Jauernig
Former President & COO
Jeff, it's Dan. Yes, I mean if you look at our investments and
some of the ones that we have announced historically, what we try to do is
focus on providers that -- and some of these are strategic supplier providers
that are good fit for us and our customers and provide the types of products
and services that our customers want, in particular, on-demand maintenance to
reduce the downtime of their vehicles, so you don't have to waste the driver's
time or the vehicle's time taking it into a maintenance location. Amerit can actually
come out to the client's location and do the work after hours. So while it
might cost a little bit more, it saves the client a lot of money because there
is a lot less downtime. The reason we want to do some of these investments
strategically is because when we pick certain suppliers, we can work with them
more closely. We can integrate their data with our data offerings and really
get a good connection with the supplier to really get a steady stream of data.
And that makes the service more valuable to our customers. So that's our
strategy. That's our approach. And I think we're going to continue it
strategically where it makes sense going forward.
Geoffrey Kwan
RBC Capital Markets, Research Division
Okay. Just another question I had was in the notes of financial
statement, you mentioned in Q1 at the JV, there was a -- albeit very small a
$10 million portfolio acquisition from the JV, and then indicated with that
there was third-party funding that matured. Just wanted to get some color, I
guess, what was the third-party funding. And just color around it, like: Are
you going to have to do more of this going forward?
Daniel A. Jauernig
Former President & COO
Yes, I mean, that was a one-off. The joint venture does have some
third-party funding. This one particularly had a bullet maturity. Not something
that we want to do going forward, but we thought it made sense in this
particular case. We bought these vehicles or trucks at fair market value. And
19th Capital was able to use the proceeds to pay up that bullet maturity. So in
this particular case, it made sense. But certainly not something that we're
going to do going forward or need to do going forward.
Samir Michael Zabaneh
Former Chief Financial Officer
Okay and maybe, Geoff, I will add one point. The quality of that
portfolio is actually high. They tend to be -- and the utilization within the
truck portfolio is also relatively high. So that's the one that we added to the
heavy-duty truck portfolio, and so far, it's been performing as expected.
Geoffrey Kwan
RBC Capital Markets, Research Division
Okay. And if I can maybe sneak in one last question. In terms of,
let's call it, inning of the Ball Game as to where you stand on Xcelerate and
then the retention challenges that you've had, what inning would you say you
are at? Say, in terms if -- ninth as you've completely done everything? Where
would you put yourself today? And where would you've been when we were last
talking in February?
Daniel A. Jauernig
Former President & COO
Yes, from -- I mean 2 different questions, because I'll focus on
retention, and I'll talk about the systems. With respect to retentions, I
firmly believe we're in the late seventh quarter -- inning or early eighth
inning. And we feel really good about where we're headed and everything that
we're doing to improve the processes and make the experience better for our
customers. So that's moving along very well.
With respect to systems' investments, that's a hard one to judge.
We have a -- we feel pretty good about the state of our system and where it is
relative to the competition. But in terms of where the system could go in the
future and the opportunities that we have to shape the fleet management
industry, there's a lot of opportunities. So it's really hard to identify where
we are in terms of all the opportunities that are in front of us. Having said
that, I believe that those opportunities, to a large extent, can self-fund
themselves. Obviously, we won't make a major investment in our systems unless
we believe we're going to get a financial return for it. So that one I feel
pretty good about where we are, but there's still plenty of opportunities going
forward as well.
Operator
Our next question comes from Tom MacKinnon of BMO Capital Markets.
Tom MacKinnon
BMO Capital Markets Equity Research
Two questions. First has to do with the $35 million investment in
2018 that you're making. Just to be clear, I think that's -- it doesn't include
the Amerit purchase. I assume that's correct, right? This is over and above the
Amerit purchase.
Daniel A. Jauernig
Former President & COO
Yes, so when I talked about the $35 million, that's CapEx, not
acquisition. That's exactly right.
Tom MacKinnon
BMO Capital Markets Equity Research
And how much of this -- how does this impact OpEx going forward?
Is this sort of capitalized, amortized? What or how should we be thinking about
this $35 million then from that prospective?
Daniel A. Jauernig
Former President & COO
Yes, good question. I'll give you my perspective, and then maybe
Samir can jump in with greater details. When you look at our OpEx, we break it
down between 3 lines: SG&A and depreciation and amortization. So when we
talk about the cost management that we've been doing for the last quarter or 4
months and where we expect that to go, we're really focused on the first 2
lines, SG&A. And that's where we're measuring ourselves against the run
rate from Q4 2017 and some of the cost savings that Samir talked about before.
Depreciation and amortization, we do expect that number to go up. Right now, I
could see us easily spending $35 million per year going forward. Some of these
investments in technology and product enhancements and product improvements and
new product releases have long-life-cycle returns. So I think we amortize them
in over anywhere between 9 and 12 years depending upon what the technology is
for. So you will see that number growing steadily through the next several
quarters.
Tom MacKinnon
BMO Capital Markets Equity Research
Okay. And then a question on the comment you made about the
service revenues. I think you said that x attrition, the service revenues would
have been in line with expectations. So how should we be looking at some of these
new wins that you're getting? And how long would it take for those new wins to
sort of replace the -- what you lost in terms of the attrition losses in
service revenue?
Samir Michael Zabaneh
Former Chief Financial Officer
Sure. So the services revenue, as I indicated before, I mean,
under normal circumstance, you should expect services revenue to grow in the
mid-single digit, call it 4% to 6%. And during this quarter, when you compare
it to the last quarter, we would -- and excluding the impact of the spark of
attrition, we would have grown nearly at that level. So that's to us is a very
positive sign, even after the year of 2017, that we're able to start with this
momentum, normalizing for an usual attrition that we truly believe right now
has ended. In terms of the new signings and the net earning assets. I mean that
should continue to provide us with momentum throughout the year. As I mentioned
in my remarks, there is a little bit of a headwind in Q2 on the services side
as customers that attrited at the end of Q4 will continue to leave into Q2. But
certainly, the new winnings and the signings that we have will offset that. And
at the end of the year, we should be, in some ways, back to where we started,
hopefully slightly higher.
Tom MacKinnon
BMO Capital Markets Equity Research
Okay. And finally, is there -- what's the seasonality in this
business, again, if you can remind us with respect to originations?
Samir Michael Zabaneh
Former Chief Financial Officer
Originations would be -- when you look at origination, it's really
going to be dependent on the timing when customers sign as well as -- also at
sometimes it is impacted by the size of the customers that are renewing with us
because that gets into the numbers origination. So there is a seasonality. I
mean, maybe, Q3 would be usually strong. I think that's our strongest one and
as well as Q2. But you will see some fluctuation. If we have a really large
customer that renewed with us, that also gets accounted into origination. We
will do our best to begin to break that down sometimes between new customers
and existing customers. Our existing customers sometimes expand as well. So
that gets added into it. Another metric to look at, Tom, and I am sure you do,
is the net earning assets. The growth in net earning asset is a pure, new
revenue.
Operator
Our next question comes from Vincent Caintic of Stephens.
Vincent Albert Caintic
Stephens Inc., Research Division
Want to ask the broad question about the -- all the changes that
are happening at the top here to the extent Dan or anyone on the board could
chat about it. So we have the new CEO as well as the board changes. There was
also a mention on the press release yesterday about the 3 investors, and I'm
just kind of wondering if there is a coordinated view, maybe, be able, the
path, that we'll be taking that's different from the past. And kind of just the
overarching view what's the plan for shareholder value in the near term and the
long term with the changes that have been made?
Daniel A. Jauernig
Former President & COO
Yes, Vincent. I mean you're right. There were a number of changes
announced yesterday. I think they're good for the company overall. I think it
provides stability, and I'm excited about where the business is headed based
upon our Q1 results and some of the things that we've got going on in the
pipeline. I can't speak for Jay. I expect you'll hear more from him on his plan
in due course once he's officially in the role, which he is going to start on
June 1. And at the same time, I can't speak for the board. What I can say is
that we are all excited about Jay and the new directors joining and look
forward to working with them and the refreshed board, as we work with them in
greater detail on our strategic plan and what adjustments they may want to make
or not to that plan going forward.
Vincent Albert Caintic
Stephens Inc., Research Division
Okay, got it. And I appreciate your enthusiasm, Dan. So maybe just
a separate question on the business. So high confidence in the retention rate
and high confidence in the pipeline that should grow, or should improve
earnings in the second half of the year. I'm just kind of wondering from what
you're seeing now -- your confidence in the second half of the year, is that --
is the pipeline already signed now where you already have that kind of
visibility or even maybe you have a 3 or 6 months' window on account of -- if
you could describe how that seasons when the loans come on board and the
customers come on board?
Daniel A. Jauernig
Former President & COO
Yes, so what I do feel good about is we do break down our pipeline
between deals that we've won, the deals that have been awarded to us and deals
that are still in the negotiation phase, et cetera. We have to execute on the
pipeline. The biggest challenge that we have is we move at the speed and
pleasure of our customers notwithstanding how quickly we want to move. But
having said that, again, I feel pretty good about what see in the pipeline. It
just comes down now to execution and getting those orders on the books.
Vincent Albert Caintic
Stephens Inc., Research Division
Okay. Got it. And maybe just quick -- one last, quick follow-up.
Any kind of sense of the competition versus you? And where you're improving of
that where you're strengthening your hand up against the pipeline?
Daniel A. Jauernig
Former President & COO
Yes, that's another area where we feel better. In particular,
Kristi Webb has spent quite a bit of time with our customers and at industry
events. And increasingly, we're getting more and more people speaking up about
the benefits that Element can provide and our technology roadmap. And I think
there is a certain buzz and -- in terms of our ability to provide compared to
our competition. So I'm feeling optimistic in terms of where we stand versus
our competition. And again I think that's making our sales team feel more
confident, and -- with respect to what they're seeing in their pipeline and in
their ability to win deals that are out on RFP.
Samir Michael Zabaneh
Former Chief Financial Officer
Maybe I could add one comment on that. If you look at the stats of
percentage wins we have so far this year compared to the percentage wins
against the competition, we have, last year -- while we still have one, one
quarter of data, but you could notice that our wins are actually beginning to
become higher. So that is a good sign of actual wins that we're starting to
have. And that will give us a good tailwind as we go through the rest of the
year.
Operator
Our next question comes from Mario Mendonca of TD Securities.
Mario Mendonca
TD Securities Equity Research
Could we go to the $65 million hit against -- or the write-off,
the opening equity write-off, on the joint venture? I think you can probably
make an argument that, that's a little lower than what the street was expecting
and although it's hard to get a handle on what that was. But could you talk
about the nature of the assumptions that go to $65 million? And I'm certainly
not asking for detailed breakdown of assumptions. But what would 19th Capital
have to start delivering from an earning -- an operating earnings perspective?
And over what time period would we have to see it turn profitable to be
consistent with that $65 million hit? You sort of see -- Samir, do you see
where I'm going with this?
Samir Michael Zabaneh
Former Chief Financial Officer
Yes, I do. So I'm going to give you the fulsome answer, Mario. I
hope it's a fulsome. So on the $65 million, we took the methodology that has
been probably followed by most companies. We looked at what would a rating for
this loan look like. And we started that on the -- on the sort of our base
case. And ascribed a rating on it and determined, based on Moody's and
S&P's, what would be the 1-year and the 5-year percentage losses if you
were to rate this loan this way. And -- so this is one item. That's not the
only conclusion we have. And then we ran a number of scenarios from there,
downside scenarios. We ascribed probabilities for every scenario. And we
estimated the loss on active assets as well as ideal assets that we would have
in every case. On a probability weightage, we came -- actually if you look at
the scenario, we came at slightly below the $65 million. We moved it up to the
$65 million because this is sort of our first adoption of it. And obviously,
that number will be adjusted on a go-forward basis. So that's the base
methodology that we actually have. We have to take into account the timing of
the operational improvement that 19th Capital is going through. And we have to
take into account what we expect the cash flow to come and how long would it be
for us to get the principal back. And this is the point that you're going
through, Mario. This joint venture had to go through in 2017. And as Dan -- as
you could see from Dan's slides, there is operational improvements going on
here. I think the management team has begun to improve the overall quality of
the owner operators from a credit perspective and have begun to put a lot more
assets into the corporate fleet, which means higher sustainable revenue
eventually, lower recovery cost, lower maintenance cost, overall, it will be a
better business. That takes some time, as Dan has actually mentioned. But we do
see enough KPI improvements where we need to give it more time, and we truly
believe that the utilization where they are right now, any incremental of the
utilization will be substantially to the benefit of paying back our principal.
There is a number of idle trucks that form the security of our loan, and those
are unlikely to be utilized, and those will be sold for the remainder of this
year. So -- and I said in my remarks that we do expect principal payments to
ramp up for the remainder of this year. That is what we expect to happen. As we
get to a higher utilization with better quality owner operators as well as
fleet -- as well as corporate fleet, we expect the cash flow from then on will
be sustainable, and there will be a lower maintenance, lower recovery cost and
obviously, much lower delinquencies which has already declined. So we take all
of these factors into account starting with the base-case assumption. That's
how we feel the $65 million, where we are today, is a sufficient number to
report.
Mario Mendonca
TD Securities Equity Research
Okay. That's a lot of good information. And because we're looking
at this from the outside looking in, we need some way to sort of measure the
$65 million. So the way I'm asking the question is this: With the $65 million
being consistent with the JV breaking even in, say, Q4 of this year -- the
reason I'm asking the question is we need something to sort of monitor and
measure the success of this. So if the JV was still losing, say, $10 million a
quarter in -- by Q4 '18, would that then cause you and cause us to question the
sufficiency of the $65 million?
Samir Michael Zabaneh
Former Chief Financial Officer
We expect the JV to become near profitability by the end of this
year or early in the following year. And you have to look at the profitability
as one metric, and yes, that will -- we will take all of these factors. It's
not just that profitability from a GAAP net income, Mario. We'll have to look
at the cash flow that we're receiving. So we'll look at a number of factors,
and the $65 million is our beginning number. We still believe when you look at
-- we still believe that based on the business plan, the recoverability of the
debt is going to be there. This is our provision against this -- under the new
accounting rules, and of course, that number will be adjusted as we learn more
about the business and monitor the performance. In terms of from the outside
looking in, we will continue to provide you with, obviously, update every single
quarter. We will begin to share some of the metrics that Dan has actually
talked about to kind of help you track the operational improvement that you see
here. We've always talked about utilization, and of course, you will see at
every year-end statement, the summary -- income statement of the joint venture.
Mario Mendonca
TD Securities Equity Research
Okay. Then finally, the -- Samir, the only reason why this all
matters at all was if it causes you to breach any covenants that really matter.
And you made the point that you feel that there's a lot of headroom.
Samir Michael Zabaneh
Former Chief Financial Officer
Yes.
Mario Mendonca
TD Securities Equity Research
Can you offer us more information on the bank covenant? Is it still
-- is 6.5 still the upper limit? And are you're at around 6 6.1 now? And then
also some information on the tangible net worth covenant, what can you provide
us to make us confident that you really do have that headroom?
Samir Michael Zabaneh
Former Chief Financial Officer
Okay. I -- so let me maybe start by giving some information. So
Element is a solid investment grade. Our ratings have been confirmed. And we
feel very pleased with that. The bank covenants themselves, we have significant
room there. We've taken these charges in. And we are -- I mean without getting
into actual details of what the range is, but we can take multiple of this
charge and still be within the covenants. So the -- I know when I say ample
headroom, that's a little bit subjective. But sitting in my seat here, I'm
really comfortable with the capacity that we have. And this is -- the bank
covenant is one area that I'm -- as far as this charge is concerned, that I'm
not worried about.
Mario Mendonca
TD Securities Equity Research
Why won't you then -- if you're confident, why wouldn't you
provide us the details, like is it 6.5? Are you at 6.1? What's the net worth?
Like confidence would suggest to me that you'd be pleased to tell us. Why is it
that you can't?
Samir Michael Zabaneh
Former Chief Financial Officer
Mario, the covenants is -- the overall senior line agreement is a
private document between the banks and Element. And I think that -- we decided
that's not going to be disclosed at this time. And maybe that's a common
practice. But I could tell you -- I mean -- all what I will provide you right
now is we are -- we have a significant room here. And while I know, after the
last call, there was a big worry that will breach our covenants, and -- but I
could assure you we are very, very far away from that.
Operator
Our next question comes from Paul Holden of CIBC.
Paul David Holden
CIBC Capital Markets, Research Division
So continuing with the topic of the debt outstanding to 19th
Capital, maybe you can just explain to us, outside of the loan that you
purchased this quarter, why the principal is not decreasing q-over-q given the
asset sales and improvement in utilization, et cetera?
Samir Michael Zabaneh
Former Chief Financial Officer
Sure. Paul, before I start the answer, I must say I did enjoy the
headings you have in your note this morning of -- saying, A Crisis Averted. We
looked at each other here, and what crisis? Anyways, we have -- so on the loan
itself, we -- as I mentioned in my remark, we -- the repayment of the loan was
actually lower than what we thought would happen based on the business plan.
Maintenance expense increased at 19th Capital, higher than planned. And that
maintenance was mainly to provide sufficient alternatives for corporate fleet
and owner operators in terms of the type of trucks that they needed to have.
And that will enable to bring trucks on the road a lot faster than it has
happened in the past. There wasn't a lot of truck sales during the -- a
quarter. There was the anticipation that it would actually happen, but it
wasn't to the level that we had seen. As I mentioned, there are -- all of the
2013 vintage year and earlier are being evaluated as we speak and will be
evaluated based on the potential for lease and at what price and to the extent,
obviously, they form part of our security, which for the most part they do,
they will be sold. And during that time, utilization will increase. And then
hopefully we'll get to a level of sustainable cash flow coming from the joint
venture. Maybe I'll make just one more remark. In this joint venture, when I
look back right now, it's almost given the quality of the owner operators that,
that JV had at the beginning of 2017, management of the JV had to go back
before moving forward and needed to reclaim a lot of trucks, and back -- due to
delinquency, and all of that cost money. So there was a period of time, and we
are still through it where we basically reset the business plan and improve the
overall quality of the owner operators. And hopefully this will be the business
plan that will be sustainable and that will get us to full recovery of our
debt.
Paul David Holden
CIBC Capital Markets, Research Division
All right. Sorry, I've heard you mention utilization rate a number
of times now, but I missed what the actual number is. What is that?
Samir Michael Zabaneh
Former Chief Financial Officer
So if you look at the -- I mean, the utilization rate, you have to
-- when we talk about it, we need to remind ourselves to let you know if that
includes the trucks that are going to be held for sale or not. If you look at
the overall portfolio, it's nearly the 50%. But that includes the trucks that
are unlikely to be utilized. So we are at around 62%.
Paul David Holden
CIBC Capital Markets, Research Division
Okay. And then last question. Samir, you mentioned something
called IDC, the incentives you provide to customers, and you gave us some
sense, on an accrual basis, how that's impacting NIM. Can you give us a sense
on a cash basis how the IDC compares year-over-year?
Samir Michael Zabaneh
Former Chief Financial Officer
So the IDC, based on our plan, right now, we expect to spend
similar amount of cash as we did in 2017. We hope this is a conservative
number. It's still early in the year to give an indication where we're going to
be. But clearly, last year was substantially higher than 2016. And Element felt
compelled to do it given the challenges our customers went through as we
completed the IT migration. Going forward, we are planning that this number
will be the same, but as I mentioned, we hope that it will be lower. And also,
Paul, just one more point going back to your first question. You mentioned that
the principal balance did not decline on 19th Capital. It actually did decline
by $1.3 million. I know it's a small amount, but just want to make sure we have
the right facts.
Operator
Our next question comes from Brenna Phelan of Raymond James.
Brenna Phelan
Raymond James Ltd., Research Division
So I just wanted to ask about the Amerit acquisition. Do they do
business with Class A trucks? Is there the opportunity to leverage their
service centers and maintenance services for the fleet within 19th Capital?
Daniel A. Jauernig
Former President & COO
Yes, the short answer is, yes. I mean, Amerit specializes in a
number of categories from light-duty trucks to medium-duty trucks and
heavy-duty trucks. And we have commenced conversations with their management
team and 19th Capital to see if there's an opportunity to use them in certain
locations to help reduce the maintenance cost of 19th Capital. Absolutely.
Brenna Phelan
Raymond James Ltd., Research Division
Okay. And any update on the securitization facility to fund the
Australia and New Zealand business?
Daniel A. Jauernig
Former President & COO
Yes, we feel good -- very good about where that's progressing. We
expect that to be done in this quarter and be able to announce it shortly.
Operator
Our next question comes from Jaeme Gloyn of National Bank
Financial.
Jaeme Gloyn
National Bank Financial, Inc., Research Division
First question is just related to the convertible debt maturities
upcoming in 2019 and 2020. If I look at the sort of cash flow forecast and our
estimates, it's -- it appears as if there is -- there should be sufficient cash
to fund that maturity in 2019. What would be the impact on the covenant ratios
of redeeming that maturity in 2019? And then similar question for 2020. How do
your cash flow projections look for funding that maturity? And then the impact
on the covenants in 2020?
Samir Michael Zabaneh
Former Chief Financial Officer
Jaeme, so we -- you're absolutely correct. When you look at the
overall convertibles, we do expect that internal resources of cash as well as
debt securities that we know will be available for us, the combination of both
will be sufficient to -- for us to redeem the 2 tranches of the convertible
debt. And when we talk next quarter, you -- we will hopefully be able to
provide you with more detail on the plan, but for the time being, this will be
what we would actually expect from our abilities to actually do that.
Daniel A. Jauernig
Former President & COO
The only thing I would add is that, might -- I just want to remind
everyone that the convertible debentures were already included as debt when the
rating agencies looked at our debt to tangible equity ratios. Obviously, the
bank covenants were put in place when we had a different capital structure
under Element Financial and would need to be adjusted going forward, where we
want to have a funding structure that doesn't include convertible securities
going forward because, again, the credit ratings that we have already assumes
that, that's 100% debt with no equity treatment.
Jaeme Gloyn
National Bank Financial, Inc., Research Division
Okay. And I guess that's kind of what I was getting at is the bank
covenant does treat it as equity at some percentage. So when you talk about using
cash and debt facilities, that's basically tapping the credit facility to fund
the maturity. But what impact does that have on the covenant? Is there a
potential that maturing -- redeeming both of these converts breaches the
covenant ratio as it stands today? And is this something that you need to
renegotiate?
Samir Michael Zabaneh
Former Chief Financial Officer
So let me add some color. As Dan mentioned, from the rating
agencies, the convertible debt is already included. And if we finance all of
the convertible debt with additional -- with another debt, then there should be
no impact on our covenants. To the extent we use cash to actually redeem them,
then we'll have to be speaking with our senior line banks and work through the
adjustment to the covenants that we need to make through to reflect the new
capital structure.
Jaeme Gloyn
National Bank Financial, Inc., Research Division
Okay. And on that note, then I noticed in the -- sort of one of
the slides that you extended the maturity of the $1.6 billion Canadian funding
facility. Were there any changes to the covenants of that Canadian funding
facility as part of that extension?
Daniel A. Jauernig
Former President & COO
No. A good question. I thought I covered that off in my opening
remarks, but there were no changes in terms of pricing, terms or conditions. It
was exactly the same as it was before.
Jaeme Gloyn
National Bank Financial, Inc., Research Division
Okay, great. Shifting gears then just around the 19th Capital. I
just wanted to follow up on the comments. You mentioned that utilization rates
on a -- excluding the trucks that are held for sale, is about 62%. I believe
some of the discussions a few quarters back suggested that utilization was
north of 80% and trending higher. I'm just wondering what changed from, I'd
say, a few quarters ago to today that would have driven that significant
decline given that trucks have been sold?
Samir Michael Zabaneh
Former Chief Financial Officer
Why don't I take that. The 85%, I think, that was suggested
before. That was -- there was -- that was a bigger component of the assets that
were to be for sale. And as I mentioned, this -- when you look at the
utilization, you have to always provide color on what trucks are they actually
included, whether they were held for sale or not.
Daniel A. Jauernig
Former President & COO
Yes, and I think I just wanted to add. This is part of the ongoing
strategy of 19th Capital to shift trucks from owner operators to small corporate
fleets. You might have had a higher utilization rate with owner operators. But
those owner operators, if they weren't driving sufficient miles, they weren't
paying anywhere close to their monthly lease payments. So you've got to look at
the combination of collection rates and utilization rates. So at the time that
utilization rate was high, but it was high with a high percentage of owner
operators that just weren't driving enough miles to meet their monthly lease
obligations. Hence the entire shift in strategy throughout 2017.
So with that, operator, I think we're going to take one more
question and then wrap up the call. Oh, I'm sorry, we're done for now.
So I just wanted to provide some concluding remarks. First of all,
I want to thank everyone for joining us today. And before we go, I just wanted
to welcome Jay to the organization. We look forward to working with him as we
move forward to execute on our strategic plan and return to growth. I also
wanted to thank all of our employees for all of their hard work and support
over the last 3 months. We had a solid first quarter, and I look forward to
working with each of you to make the necessary investments that we need to make
to position the company for future growth.
With that, I would like to thank everyone for joining us today and
conclude the call. Thank you.
OperatorThis concludes today's
conference call. You may disconnect your lines. Thank you for participating,
and have a pleasant day.
