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Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management Second 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.
Thanks, Abby. Good morning, everybody, and thank you for joining us. Here today to discuss our results are, Jay Forbes, Chief Executive Officer; Vito Culmone, Chief Financial Officer; and Karen Martin, Executive Vice President and Treasurer. The news release and MD&A were issued yesterday, and along with our financial statements, have been filed on SEDAR. This information is 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 give no assurance that the expectations of any forward-looking statements will prove to be correct. Our earnings release, financial statements, MD&A in today's call include references to 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 today from management followed by some time for questions. [Operator Instructions] And now I'll turn the call over to Jay Forbes.
Thanks, Zev, and good morning, everyone. Before commenting on the quarter, I wanted to take a moment to extend my thanks to all those who have had generously provided their time, their support and feedback since my arrival at Element in early June. As many of you will know, I spent my first 30 days doing a deep dive into our business. This included an extensive listening tour that took me across North America and gave me the opportunity to hear the candid thoughts of employees, customers, investors and our business partners. This feedback has been and will remain an essential component of our strategy go forward and will form the basis for a comprehensive strategic plan that will create meaningful value for each of our stakeholder groups. With all that I've learned, I'm even more excited by Element's prospects today, and this enthusiasm is shared by our management team, our new Board of Directors and by our employees worldwide.Turning to the quarter. We remain encouraged by the recent progress in operations, new customer acquisitions and client retention. Element delivered a solid Q2 including after-tax, adjusted EPS of $0.19 for core Fleet Management operations, up 6% on a constant currency basis. Vito will discuss these financial results in detail momentarily. In addition, we continue to enjoy strong liquidity and access to capital. Last week, we priced USD 1 billion of rated term notes through our AAA-rated Chesapeake II structure in the United States, the second such offering of the year. The transaction is expected to close on August 16. Combined with the earlier issuance in April and the creation of a dedicated funding facility in Australia in May, Element has completed securitizations of approximately $3.5 billion year-to-date. Together with our strong investment-grade corporate credit ratings, we continue to have ample access to capital markets to support our growth, including nearly $6 billion in available financing at quarter end to fund originations and growth in earning assets. Against the backdrop of these positive trends, we have launched a comprehensive strategic assessment to create a clear and compelling strategy for stakeholder value creation. We know we have the wealth of competencies and capabilities that we can use to position us for growth. But we also know we have areas of the business that needs strengthening and stabilization. Accordingly, we have assembled a team of our most knowledgeable and capable leaders across the company, supported by external consultants, to undertake a frank and realistic appraisal of our business across 3 distinct work streams.For Element Fleet, the assessment entails a thorough review of our global operations with a view to identifying opportunities for profitable revenue growth, productivity enhancement and better investment returns. The second work stream involves a strategic assessment of the 19th Capital joint venture, including its origin, evolution and current state and identifying the potential pathways forward. The final work stream encompasses a comprehensive review of our balance sheet, our capital structure and finance policies as a precursor to designing a financing strategy that will provide ready access to cost-efficient capital to support our strategic plan going forward.We're conducting this end-to-end deep dive with the goal of creating a clear pathway forward for stakeholder value creation. From previous experience with similar situations, I can comfortably state that there is no substitute for this kind of methodical, analytical and thoughtful approach to identify the opportunity at hand and then to capitalize on it. This approach builds awareness, understanding and ownership across the organization, which in turn translates into crisp execution and rapid value creation once the assessment turns into action. We're well advanced in this process and look forward to sharing our insights and the resulting strategic priorities in the early fall. On a final note, I'd like to express my further thanks to our Board of Directors for their engagement and support and to the entire Element team as we work diligently together to fulfill the incredible promise that this company holds. That concludes my remarks, and Vito will now provide an overview of our financial results for the quarter.
Thank you, Jay, and good morning, everyone. In lieu of a slide deck to accompany this morning's commentary, please note that you will find the equivalent information in this quarter's news release, MD&A and financial statements. As Jay indicated, it was a solid quarter with positive trends continuing on the operations side, in turn leading to progress on the top and bottom lines. Consolidated net income for Q2 2018 more than doubled from the prior year to $79.1 million or $0.18 per share. The difference is largely attributable to the previous quarter's integration costs and loss on equity investment related to the 19th Capital joint venture.Looking at the core Fleet Management operations, net revenue in quarter 2 was $215.8 million, up 4% sequentially and down approximately 4% year-over-year. Segmented by its main components, service and other revenue of $129.5 million increased 0.8% from Q1 2018 but was down 9.7% from Q2 2017. On a constant currency basis, service and other revenue decreased by 0.4% and 6.8% compared to Q1 2018 and Q2 2017, respectively. The decrease from Q2 2017 was primarily due to higher remarketing revenue in that quarter and an increase in customer attrition in the second half of 2017. Customer attrition trends continue to improve and are expected to revert to their normal historical levels in the second half of 2018. Net interest and rental revenue of $86.3 million increased 6.5% from Q2 2017 and 7.9% from Q1 2018 and benefited from higher core average earning assets. On a constant currency basis, net interest and rental revenue increased by 9.9% and 6.9% compared to Q2 2017 and Q1 2018, respectively. The increase was partially due to the impact of timing of interest rate changes and pricing mechanisms in the prior quarter and a one-off contract reset in Q2 2018. Net interest margin, or NIM, was 2.73% in Q2 2018, up from the comparable period, reflecting both of these aforementioned factors. Turning to expenses. Adjusted operating expenses in Q2 2018 were $115.7 million, a decrease of 4.8% from Q2 2017 or 3.7% (sic) [ 3.8% ] on a sequential basis. The decreases reflect a combination of productivity and cost-saving initiatives, including the closure of our Ireland operations, partially offset by higher salaries and benefits as some integration resources returned to their normal operational functions.With that, adjusted operating income from core Fleet Management operations was $100.1 million, a decrease of 2.8% from Q2 2017 and an increase of 13.4% over the immediately preceding quarter. On a constant currency basis, adjusted operating income was flat compared to Q2 2017 due to the impact of the higher U.S. dollar in the comparable period and increased by 12.3% compared to Q1 2018 for the reasons noted earlier.With respect to noncore operations, these contributed $3.6 million of net revenue as compared with $23.1 million in Q2 2017. The difference relates -- reflects nonrecurring fees in Q2 of 2017, the adoption of the new IFRS 9 accounting policy and its impact on the ECAF investment and the divestiture of certain noncore assets in 2017. Noncore assets contributed $0.01 in after-tax adjusted operating income per share in the second quarter of 2018. Noncore assets amounted to $991 million at the end of Q2, substantially unchanged from $988 million at the end of Q1 and reflected the normal runoff of certain noncore assets as well as changes in foreign exchange.As you may recall, with the implementation of IFRS 9 on January 1 of this year, the company adopted a lifetime loss model with respect to our loans to the 19th Capital joint venture and recorded a reserve equivalent to $65 million. I refer you to Note 3 of the current quarter's interim financial statements for the details and mechanics of the calculation, including the high sensitivity of the results to the judgments and assumptions made.On a quarterly basis, we reconsider the facts, assumptions and judgments. In our assessment, in Q2, there's been no material change in the underlying operations or key facts. Accordingly, no change in the provision has been recorded other than the effect of foreign exchange.The balance of the receivable, net of the reserve, was USD 563.3 million or CAD 740 million as at June 30, 2018. Our conclusion relies heavily on our continued support of the joint venture's pursuit of its business plan, and we reiterate that support, pending the outcome of the strategic review.Turning briefly to the balance sheet. Element had $6 billion in available financing at quarter end to fund ongoing originations, up from the prior quarter, reflecting the increase in committed facilities and liquidity from the recently completed Australian securitization and U.S. Chesapeake term deal. We look forward to closing our current ABS funding later this week and to provide more color on our capital plans following the completion of the strategic assessment.In closing, our results through the first half of the year are consistent with prior guidance of a constant currency 3% to 5% decline in adjusted operating income. We look forward to providing updated guidance in early fall, along with the results of our strategic assessments.Thank you, everyone, for joining us in this morning's call. With that, we'll open it up to questions. Operator?
[Operator Instructions] Our first question comes from Geoff Kwan with RBC Capital Markets.
My first question was on 19th Capital. Just wondering if you are able to provide what the operating loss in the quarter was. And what the tangible net worth buffer is? I was estimating it to maybe be around $250 million.
Jay here. As we mentioned, we're in the midst of a comprehensive strategic assessment of the various lines of business, including 19th Capital. And so we have augmented our disclosure, as represented in Note 3, but won't be providing any additional details in terms of the 19th Capital operating results until that comprehensive review has been completed and the results of same have been shared with our audiences in the early fall.
Okay. And just my other question was in terms of on the customer wins and attrition. On the customer wins side, are you able to say if any of those sectors or wins that you talked about would fit into, let's call it, the large categories? So if we, say, define it as fleets bigger than 3,000 vehicles. And on the attrition side, if there's an absolute kind of number of customers that might have given notice of leaving during the quarter?
Yes, we won't be sharing that level of detail in this call, Geoff. I will say that we -- as we look at the disclosures that are offered today versus the disclosures that we think will be befitting the strategic options that we choose and bring forth in the early fall, we'll be looking to adjust and to indeed augment our current disclosures to better reflect the strategic choices that we are making and providing the line of sight that our investors would expect in terms of being able to track the progress against those strategies as we successfully execute them.
Our next question comes from Tom MacKinnon with BMO Capital.
Yes. I'm not sure if you'd be able to share us -- share with us any of the utilization rates associated with 19th Capital, you do list on your assumptions in that note and any principal repayments on the 19th Capital loan, if any. Or how much was forborne in the quarter?
In terms of the utilization rates, again, depending on where we end up in terms of our strategic options and choice of same as it relates to 19th Capital, we'll adjust our disclosures to ensure you have the information required to properly assess, both the asset value and the continuing progress of the operations of that entity in future disclosures. With regards to the loan itself and the evolution of that balance, Vito will be happy to provide a few details there.
Yes. Principal repayments in the quarter were just under CAD 2 million. So the loan balance at the end of Q2 was just under USD 618 million.
Okay. And if I could squeeze a quick one in on the net interest margin, the 2.73% sort of net yield that you had in the quarter. You're sort of helped by some timing. I think it's like timing of interest changes, pricing mechanisms, one-off contract resets. Are those sort of more of a onetime nature? How should we be looking at that number? Was it extraordinarily helped in the quarter? Or was that just the nature of the business?
Yes. I think a combination of the 2. On the onetime repricing, that was relatively a small number, $2 million. So call that less than $0.0075 EPS, or $0.005. The pricing mechanisms, obviously, we've got the timing issues there. Where is NIM going to be as we move forward? Obviously, we like the trending there. Probably a little too early, but clearly, one of the major drivers leading to the 2.73% was higher billing rates from increases in the underlying indices, so that's good momentum there and higher volume on net earning assets.
Our next question comes from Mario Mendonca with TD Securities.
I understand, Jay, that you can't get into what you're going to do with 19th Capital. But could you highlight for us what options you see on the table?
Yes. In terms of the options, they run the full gamut. We're looking at anything that could, for instance, represent us acquiring the residual 50% stake that we don't own in the asset, bringing that asset within our organization and effecting a turnaround of that, if you will. That's kind of one book end. The other book end is we exit our investment quickly and take an immediate write down in terms of any unrecognized value, unrealized value in terms of asset dispositions. So those would be the 2 bookends. And then there's a continuum in between that offers a variety of different options to the business continuing in a JV, working with our partner to effect the transition and strategy that has been previously shared with our investors. So everything is on the table in terms of being considered. The strategic assessment is progressing very well. We have been blessed with a lot of insights and perspectives as a consequence of the work that has been done. And as a consequence, we'll be moving quickly from assessment to evaluation of the full continuous strategic options available with regards, not only 19th but, obviously, Element Fleet and the solidification of our balance sheet as well.
Just a quick follow-up on that. Why did you refer to the words, "We're looking at the origins of 19th Capital?" Why would the origins of this joint venture matter to your strategic outlook?
Yes. Coming from the East Coast, we have an expression, Mario, that you don't pull down a fence until you understood why it was put up in the first place. And understanding the history, understanding the origins, understanding the evolution of the relationships and the resulting strategies and issues around the execution of those strategies, I think, is hugely important as one considers a range of options as broad as we are considering for this particular asset. In some ways, you have to be almost a bit of a historian, a bit of an anthropologist here as you, again, take stock as to what has transpired, why it has transpired and how it might have manifested itself in the current situation that the organization is experiencing. And with that context, I think you're in a position to make a better, more informed decision as to the future of that investment, the future of that operation.
Our next question comes from Paul Holden with CIBC.
So first question's related to fee income on the core fleet business. This is down 7% year-over-year on a constant currency basis. It's a little bit more than we would have expected based on communication from prior management. So prior customer losses would suggest that it should be down something like 3%, 4% year-over-year. Is that kind of a good baseline assumption going forward? Maybe there was some unusual items this quarter?
In terms of guidance go forward, we'll let the current guidance stand, Paul. There's no material change in our view of the business. And on the, for all intents and purpose, on the eve of sharing a strategic assessment with you in the early fall, yes, we will withhold any additional guidance at this point in time.
Okay. Fair enough. And then I want to ask you again on the core fleet business. You have some impairments on one particular customer bankruptcy. And I think it's an interesting example, because you don't expect any losses on that bankruptcy. So maybe you can you just kind of talk us through why no losses are expected. Is that due to asset recoveries? Or do you expect the customer to work through its bankruptcy and continue to operate and make good on its lease payments?
Yes. So I'm sure we'll have a few thoughts on this as well. It's actually quite amazing as I've kind of continued to ascend the learning curve and as I've gained a keener appreciation of some of the underlying dynamics of the business, its resiliency in terms of delinquencies and credit losses has been something that has been really quite amazing, quite admirable. And it goes anywhere from the quality of customers we actively pursue and secure to the active management of credit facilities and exposures to those customers. And one of the dynamics, Paul, that we're constantly looking at is, regardless of the credit quality of those organizations, we also look to assess just how integral the fleet assets are to the core business and, thus, how they might fare in the case of a bankruptcy or receivership. And what we have found is that these assets are some of the first to be released in those types of proceedings, given just how integral they are to the fundamental operations of our customers' businesses. The other attribute that I have come to appreciate is that our team has done a very good job in terms of understanding the possibilities of these exposures, however remote as they might be, and making sure that we have good equity positions in the assets, such that those assets are -- when they're not turned back over to the customer in terms of those types of proceedings and are liquidated, that our positions are well accounted for and well secured in terms of the net realization of proceeds on disposition. So from time to time, we will see a customer enter into these types of arrangements. And more often than not, we see the assets supporting those loans freed up very quickly. And in those rare situations that we don't, again, by the time those assets are disposed of, we find ourselves in a net equity position such that we do just fine in terms of our credit experience.
Our next question comes from Brenna Phelan with Raymond James.
I wanted to ask about funding. So the issuance details of your latest ABS issuance indicates spreads are looking really good. But there's a larger component of floating paper in the issuance. Is this driven up by institutional demand? And does this, in turn, impact what you're passing along to customers? Will more of your leases be floating?
A few points -- it's Karen speaking, by the way. A few points to that. With our senior notes within our term note issuance, we have always sized to demand. So typically, on the, like, if you look at last year and 2016, there was a higher demand for fixed-rate notes. So that was just how it flowed out. Since we hedge everything, we are actually indifferent to whether or not the noteholder wants fixed or floating rate, because we hedge our entire book, both the asset side and the debt side, so that we're -- we lock in a NIM on our -- in our funding. In terms of the spreads, we had very good execution on this deal, and I say it was average with 2017. And the markets remain quite robust. Did I cover them all, Brenna?
Yes. And can you tell us how much was securitized in Australia? And at what spreads there?
So the spreads were a bit wider, and that's a function of the market. I think we did better than the average market. The facility itself is AUD 1 billion, and we drew down AUD 855 million.
Great. And last one for me. In Q1, you commented in regards to customer retention and acquisition, that your percentage of new wins for new business versus the competition had ticked up. Can you comment on how that trended in the quarter? And how you see it trending for the rest of the year?
Yes. Just the continued positive momentum on the trend. And as we said in our release, expect continued steadiness of the business moving forward.
[Operator Instructions] Our next question comes from Jaeme Gloyn with National Bank Financial.
First question is related to the operating expenses or adjusted operating expenses in the core fleet business. You talked about expense savings initiatives driving the deep decrease, partially offset by some integration resources returning to their normal operational functions. Can you give us a sense as to the breakdown of that? How much of the -- how much did the expense cost-save initiatives drive it lower? And then how much was brought back because people are moving into their old roles?
It's Vito here. Maybe I won't get into those specifics per se. The biggest driver was a number of things. Obviously, the productivity initiatives, and we'll have much more to say about this as we move into our strategic review. Obviously, the Ireland -- Irish -- Ireland office closure was also a significant contributor. So there might be a bit of a time lag as we move forward into the U.S. business picking up some of those expenses. But obviously, we expect to be net down on a net basis. So I'll sum it up by saying, encouraged by and are very appreciative for the hard work across the organization and continued pursuit of productivity gains. And will obviously be a very key focus as we move forward here over the next 12 to 18 months.
Okay. Next question is related to the transaction actually that occurred in Q1, where you acquired a performing portfolio from the 19th Capital joint venture. The portfolio was acquired at its fair market value of $9.6 million. I'm just curious, what was the book value of that acquisition? I guess, asked differently, what was the discount applied to that portfolio when you purchased it last quarter?
Brad Rowse is whispering in my ear that the book value was slightly higher, approximately $11 million.
Okay. And last one for me. Just wanted to get a sense in regards to the disclosures on Page 21. Some of it is talking about the types of vehicles; the brand of vehicle; the unusual wear and tear on the equipment; technological, economic obsolescence has risks around, not only just the core fleet, but also to the noncore assets. Are there any vehicles you've identified -- or types of vehicle that you've identified in the noncore assets that you think present a larger risk on that front? And what percentage of the portfolio that might -- that represent?
No, no. Simple answer is that, Jaeme, is no we haven't.
Our next question comes from Mario Mendonca with TD Securities.
Just quickly. The JV, the 19th Capital, I understand at this time, it's -- you don't want to get into what the operating loss was. But if there is an operating loss, is it included in the $4.6 million JV losses? Or where is that recorded on your income statement?
Yes, Mario, we don't have any -- as you know, we wrote down the equity down to 0. So any further losses from that JV are not reflected in our P&L.
So where did it -- they have to go somewhere. Someone lost money, so that's to be recorded somewhere. Does it go directly through retained earnings or....
Yes. It's just trapped in the JV. We create a notional account so that if there's any future gains, we grind down the future -- grind down the losses, accumulated losses before we can get into an equity pickup. But it does not flow through our P&L.
Okay. That's JV accounting, and not something I remember. So you just -- you don't actually record it anywhere until there are potential gains going forward. I'm not -- I think I understand. I wasn't aware of that. And just one final thing, the capital in Australia, can you just size that for us, the capital support in the Australian business?
Karen, you want to get that one or...
Yes. Directly our equity position is AUD 380 million.
This concludes the question-and-answer session. I would like to turn the conference back over to Zev Korman for any closing remarks.
Great. Thanks, Abby. Thank you all for joining us this morning. We hope you have a great rest of the summer, and we look forward to reconnecting with you in the fall. Have a great day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.