Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management first quarter 2022 financial and operating results conference call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the prepared remarks, there will be an opportunity for analysts to ask questions. To join or rejoin the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. 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.
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 AIF, for a description of these risks, uncertainties, and assumptions. Although management believes that the expectations reflected in the statements are reasonable, it can give no assurance that the expectations reflected in any forward-looking statements will prove to be correct. Element's earnings press release, financial statements, MD&A, supplementary information document, quarterly investor presentation, and today's call include references to non-GAAP 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-GAAP measures to IFRS measures can be found in the MD&A. I would now like to turn the call over to Jay Forbes, President and Chief Executive Officer of Element. Please go ahead.
Thank you, operator, and good morning to all of you joining us today. Frank and I will be brief with our remarks, affording us plenty of opportunity for questions and discussion. We entered this year with strong conviction that with the return to pre-pandemic client activity levels and the gradual improvement in vehicle production by the OEMs, 2022 would be a good year for Element and would in turn set the stage for a great 2023. That conviction was evident in the two-year forward guidance we provided last November, which certainly was a first for this company and indeed the first for me.
This confidence is borne out of the extensive knowledge of the business that management has acquired, strengthening every facet of our business model through the 27-month transformation journey, stress testing and adapting that business model throughout the pandemic, rebuilding our commercial capabilities as we pivoted to growth, and by devising novel approaches to supporting our clients through the global vehicle production shortages. The last four years have provided us with a whole host of challenges that have deepened our understanding of our business and, in particular, its resilience through times of great uncertainty and its ability to create sustainable value for shareholders through the generation of consistent, predictable earnings and cash flow. That said, the results of the last two years, while good, have, by virtue of a rare set of externalities, underrepresented the true potential of this business model.
For instance, we designed and built a robust operating platform that could deliver a consistent, superior client experience and scale to meet our organic growth ambitions, only to see a 20% decrease in client activity at the onset of the pandemic that obscured the power of this platform to create meaningful value. We rebuilt our commercial capabilities from the ground up to capture these organic revenue growth opportunities, only to see $10 million in revenue deferred when OEMs were unable to produce sufficient vehicles to match our sales wins. We knew that it was just a matter of time before what we, as management, saw so clearly was evident to all. With the release of these first quarter results and the upward revision of our 2022 guidance, Element's power to deliver against our strategic ambitions is now on full display.
We're growing vehicles under management, now approaching 1.5 million vehicles, by stealing share and converting self-managed fleets. We're growing service penetration using targeted campaigns to expand our share of wallet. We're increasing the utilization of these services as client activity returns to or indeed exceeds pre-pandemic levels. We're improving the profitability of these services by leveraging the scalable operating platform developed through transformation. We're advantaged by inflation as our cost-plus model benefits from increases in fuel, parts, and labor prices. This has in turn yielded first quarter performance that includes 6% net revenue growth quarter-over-quarter, 485 basis points of expansion in operating margin, and 16.6% AOI growth quarter-over-quarter, $ 0.29 of free cash flow per share, and 15.8% pre-tax return on equity.
Perhaps the only surprise for us in these results was the speed in which they arrived. Well, we knew that the overhang of the pandemic on client activity levels would fully recede, and that OEMs would gradually source sufficient semiconductor chips to restore their productive capacity and to grow our originations. We were less sure as to how these factors would play out in concert with our commercial successes and operational capabilities. Having never before enjoyed 2021 levels of commercial success, stealing other FMC's clients, penetrating the self-managed fleet market, and most of all, converting share of wallet opportunities, we underestimated the speed at which the business was capable of onboarding and activating this many new vehicles under management and this many new client service additions. Simply put, great people, supported by transformed processes and systems, converted revenue unit wins into revenue growth in record time.
Given the recurring nature of these leases and services, the revenue levels we achieved in the first quarter are sustainable through 2022 and beyond, prompting us to increase this year's guidance. Our bullish outlook for 2022 is further bolstered by two additional observations. Firstly, everything we've seen over the last six months has been reinforcing of our thesis of a gradual return to full OEM production by mid-2023, resulting in 10%-14% year-over-year growth in our originations on route to some 37%-47% year-over-year increase in 2023. We're holding guidance on originations constant in the $5.5-5.7 billion range, with any unforeseen downside risk arising from China lockdowns or geopolitical issues being offset by larger than expected price increases in model year 2023 vehicles. Secondly, the drivers behind our surge in service revenues have legs.
have never before managed fleets through a 24-month global pandemic, we didn't know exactly how or when the recovery in client service utilization would transpire. Today, we can safely say the recovery has arrived. Service fleet vehicles are playing catch up on lost productivity during the lowest mobility phases of the pandemic, and sales fleets are now back on the road with regularity, with a corresponding consumption of applicable services. Further, substantially longer wait times for replacement vehicles have resulted in the oldest average age of fleets in our history. This vehicle aging is driving more frequent and higher cost maintenance, as well as greater fuel consumption. With OEM production capacity showing no signs of deviating from the recovery trajectory that we're anticipating, we expect that we will have well over a year of continued older vehicle service utilization ahead.
Finally, the penetration and utilization driving service revenue growth are going to be further propelled by inflation. I addressed this as a topic in my letter to shareholders this quarter, and so I won't be overly repetitive here. Suffice it to say, I don't think many of us predicted inflation taking root this quickly and impacting costs this drastically within the first few months of 2022 alone. Element's value proposition to lower clients' total cost of fleet operations becomes even more compelling in this environment. Our cost plus business model also benefits, both of which are sustainable tailwinds. I believe Element is a rare example of a business where net revenue benefit both directly and indirectly from inflation, and to a greater extent than our operating expenses will be impacted.
This is yet another salient characteristic of the truly special business model that we enjoy here at Element. With that, I'll turn things over to you, Frank, to discuss a few particulars of the first quarter and a revised full year 2022 guidance.
Thanks, Jay, and good morning, everyone. As promised, I'll be brief and then we'll open up the line to your questions. I want to reiterate that our Q1 results were not only strong, but also demonstrate the capability and resilience of our scalable business model and the value proposition we bring to clients in these ever-changing times. First-quarter net revenue was up 4.9% year-over-year and 6.2% quarter-over-quarter. Net financing revenue contributed to that growth, itself growing 3.7% year-over-year and 7.4% quarter-over-quarter. As you saw in our supplementary, gains on sale or GAS from AMZ in Mexico continue to outperform their prior period contributions to NFR. Although we expected this to moderate in our previous outlook, it hasn't happened.
The current OEM constraints and shortages of vehicles in the regions where we take residual value risk continue to ensure a very strong secondary market. We continue to move lower than normal volume due to fewer vehicles being returned to us, but at very high prices. The return of OEM supply to normal levels will moderate these gains over time. However, with more new vehicles, we will also have more end-of-lease vehicles to work with, and we expect demand to remain healthy for the foreseeable future. I want to compliment our teams in AMZ in Mexico on the work they've done to diversify their used vehicle sales channels in each region. This diversification work alone generates better price realization. Combined with undersupply, this diversification will help keep GAS strong for full year 2022 relative to prior years, including last year.
With respect to capital light services revenue, Jay identified the buckets driving growth, which I'll reiterate as penetration, utilization, and inflation. You can see in our supplementary how each of those contributed to services revenue growth of 15.2% year-over-year and 6.6% quarter-over-quarter for Q1. The same three factors are going to keep services revenue healthy and growing for the foreseeable future, advancing our capital lighter business model and enhancing ROE. Syndication is the second thrust of that capital lighter model, and we've written and spoken a lot in the last two quarters about the incomparable contributions of syndication to our regrowth and return of capital strategies. Syndication revenue decreased materially in Q1 year-over-year, which was as planned.
We had pulled forward volume into a very strong Q1 of last year, but did not anticipate or have a repeat of that experience. We have a more balanced quarterly volume of syndication plan for this year. Briefly, on adjusted operating expenses in Q1, and this year as a whole, we saw sequential moderation in salaries, wages and benefits in the first quarter as we continue to increase efficiencies. However, as signaled in our MD&A, that line item will step up modestly next quarter as 2022 merit and pay equity driven compensation increases impact the whole quarter versus only the month of March in Q1. For 2022, adjusted operating expense will grow. We are not immune to inflation or the increased cost of returning to business as usual that include, for instance, travel and promotional spend.
The fundamental premise of our scalable operating platform is that net revenue can and will outgrow OpEx, expanding operating margins over time. I would also flag the reality that we are operating with a cost base supporting materially more business volume than we are seeing hit the top line due to the OEM production delays and the deferral of significant revenue, operating income, and free cash flow into future quarters and years. Lastly, considering the sustainable trends in our Q1 results, as you'll have seen in our disclosures, we've revised our guidance for full year 2022. We anticipate growing annual net revenue 4%-6% and our scalable operating platform magnifying that into 4.5%-7.5% adjusted operating income growth, implying a 52.5%-53.5% operating margin.
We anticipate 9%-14% adjusted EPS growth in 2022 at an effective tax rate of 25.5%-26.5%, and weighted average common share count for the year of between $390 and $400 million shares. Similarly, we expect free cash flow per share to grow 10%-15% to $ 16- 21 per common share for the year. All of our guidance is in constant currency. We have not revised our 2023 guidance. We will do this later this year and share with you. However, we believe our strong Q1 results and increased 2022 guidance materially de-risk that existing 2023 guidance, in particular, because the broad-based strength we are seeing in Q1 was not envisioned or factored into the 2023 guidance put forward last year.
We will be reviewing that 2023 guidance as we move forward and will provide an update later in the year. With that, operator, let's please open the line for questions.
Thank you. We will now begin the analyst question and answer session. In order to afford all analysts the opportunity to ask questions, Element kindly requests that analysts limit themselves to two questions and live dialogue with management. Should an analyst have additional questions, please rejoin the queue. To join or rejoin the queue, you may press Star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press Star then two. The first question comes from Geoff Kwan with RBC Capital Markets, please go ahead.
Hi. Good morning.
Good morning.
My first question was, Jay, since you reported the Q4 2021 results, you know, what would be the incremental data points you've gotten in terms of the return to normalized OEM production levels? What have you heard that gives you know, maybe a bit more optimism and conversely anything that gives you a little bit more concern around that trajectory? I know you talked about the overall trajectory I think is staying the same as what you're seeing, but just wondering if there's incremental data points on both sides.
Yeah. I think there are a number of incremental data points since announcing our guidance for 2022 and 2023 last November. You know, we finished the Q4 stronger than we anticipated at higher production levels and thus higher origination levels than what we had anticipated. While Q4 was indeed a trough for OEM production, it wasn't as deep a trough as we had originally envisioned. Secondly, our thesis had Q1 being a material step up from Q4 in terms of quarter-over-quarter
Increases in production volumes and continuity of productions by each of the major OEMs, and that played out very well in terms of Q1 and our origination results. As we just wrapped up April, another month of data points that were encouraging and reinforcing of our thesis. As we think about that original hypothesis and how it was gonna play out, everything that we have seen to date is consistent with that thesis. Thus we expect a full recovery of productive capacity by the OEMs by mid-2023, and as a consequence that their ability to start to draw down this very large order backlog that we have built.
You know, we have not seen anything in terms of the European conflict or the shutdowns in China manifest themselves in any decrease in either year-to-date production or production outlook. You know, obviously those are factors that are wild cards and no one can fully understand their implications. The comfort that we derive as an offset to that is we are expecting price increases in model year 2023 vehicles that will be in excess of what we would have projected as part of our planning for 2022 and 2023. To the extent that that holds and there is any headwinds coming out of the macroeconomic or geopolitical situation, then again, we believe that there are sufficient opportunities in terms of price increases that would offset that.
Feeling very bullish in terms of that $5.5 -5.7 billion of originations for calendar year 2022.
Perfect. Thanks. Just my second question was, you know, with the increased 2022 guidance, but keeping it the 2023 unchanged, so I guess the way to think about this is if you continue to execute on your growth strategy, is it more likely that there would be upside as opposed to downside to your 2023 guidance?
Very much so. You know, the revenue growth drivers that we're seeing in the model, and in particular on the services side, you know, these are services that are both new services taken up by our clients and higher utilization of those services. And then when you mix in the inflation component that we expect to see throughout 2022, you know, again, we're building a base of service revenue that should exit 2022 at a level in excess of what our expectations would be. We will enter 2023 with a you know, higher jump off point than what was originally anticipated when we offered up 2023 guidance back in November of 2021.
Okay, great. Thank you.
Thank you.
The next question comes from John Aiken with Barclays. Please go ahead.
Good morning, Jay. In terms of taking a look at the order backlog, now I know remaining flight is far from a reason to panic. Are we expecting on a go-forward basis as the OEMs ramp up production the backlog to drop off a little faster than had previously been anticipated? As well, can you talk about, I guess the shadow backlog in terms of the orders that are out there that can't be placed with the OEMs? How is that looking since the fourth quarter?
Yeah. Good morning, John Aiken. You know, when we think about order backlog and the continuity of that balance, as you've rightly identified two critical factors, supply and demand, maybe I'll speak to demand first. Demand continues to be robust. As we've gone out to our clients, guided them in terms of the order banks being opened by the OEMs this month, and continuing through June and July, helping them understand their vehicle needs, get their orders in the queue, so that they get first call on the productive capacity that is gonna be opening up with model year 2023. That's been kind of a full court press here over the last couple of months.
I will tell you, even in the face of potential, meaningful price increases in the vehicles, there's been no hesitation whatsoever in terms of our client base in putting forth orders. They're in desperate need of replacement vehicles. Those that are in service are long in the tooth, consuming, again, excessive amounts of maintenance and, gas and, risking downtime, a very, costly aspect of fleet operations. As a consequence of all those factors, we're seeing demand very strong. No relenting in demand from the client base whatsoever from what we would've expected back in November. We saw that in terms of a basically flat, quarter-over-quarter, order backlog of $2.9 billion, even despite, you know, originations that were stronger than perhaps we had expected.
On the supply side, in referencing the answer that I provided Geoff, again, all the data points that we are seeing are upholding the thesis of, yep, this will be a $5.5-5.7 billion year originations. And again, while we don't see much in the way of risk to that at this point in time, some potential upside comes, you know, with the model year 2023 price increases that we're now being guided to. Feeling very good about the order backlog. And again, it will vacillate. It wouldn't surprise us in Q2 to maybe have a slight pull down on that as the order banks open up later in the quarter and originations are strong through the quarter.
That said, if the OEMs are open up those order banks a little earlier, we might, you know, be able to see sustained order backlog or maybe an increase. It just really depends, the pivotal factor here is really the timing of those order banks being opened by the OEMs. Demand remains strong and fleet production is increasing.
Great. Thanks, Jay. For my second question, Frank, thank you very much for the vehicles under management disclosures. It's gonna be helpful. I understand that this is a moving forward metric, but can you give us a sense, because when we look at the dollars per vehicle under management in terms of both revenue and operating income, obviously we can see the leverage that is there. But the leverage that we saw on the operating income per vehicle this quarter, was this unusual or is this a trend that you've been seeing over the last little while?
Again, it is a new metric for us, and we're growing it, growing into our skin on this as well as you, and taking the learnings that we're finding from this new metric, as is. I don't believe it is a surprise that as you look at your vehicles under management, and we see the type of share of wallet gains that we have benefited from, by definition of share of wallet is gonna increase your revenues per at least that existing base of vehicles that are there, as we move forward here. It will depend on how quickly we onboard new clients and new vehicles and what the level of services are on coming into that from a proportional basis, as we move forward.
I think it gives us a great opportunity to measure those share of wallet penetrations, and anticipate seeing that statistic being a metric that we can help the analyst community and the investor community really measure the growth and the profitability of the business.
Frank, if I could build on that, the other piece of this is utilization. When we think about that VUM and revenue per VUM certainly got a big boost in terms of service revenue as we, you know, had increased penetration, increased utilization, increased inflation. You know, I referenced this in my CEO letter to investors this quarter that, you know, as we reflected on the Q1 results and reflected on the journey of transformation, I mean, it was, you know, predicated on building this scalable operating platform.
We were halfway through that transformation journey, and we had 20% of our transaction volumes basically evaporate overnight, with a shelter-in-place, stay-at-home, mandate adopted throughout our five geographies. It has been you know, a patient, journey that we've been on these last two years as we waited for a return to normal levels of consumption and activity within our client base. That's what you're seeing in part in terms of this big increase in revenue per vehicle under management is that restoration of normal utilization.
as Frank has pointed out, you know, this has always been about creating a scalable operating platform that will be able to ingest that 4%-6% annual revenue growth without a commensurate increase in costs, and its ability to do so will be reflected in that adjusted operating income per vehicle under management as we go forward.
Great. Thanks, guys. I'll requeue.
The next question comes from Jaeme Gloyn with National Bank Financial. Please go ahead.
Yeah, good morning. Wanted to stay on the vehicles under management disclosure and looking at the breakdown, serviced only vehicles showing pretty rapid growth over the last couple of quarters, but serviced and financed fairly flat. I wonder if you could give us a little bit more color as to what's driving that, I guess, dislocation between the two lines.
Yeah. Good morning, Jaeme. In terms of vehicles under management and you know, this initial disclosure that we provided, you know, I will note that, you know, there is a goodly amount of service only vehicles under management there. Think about that maybe as two segments. The first being, you know, a little under half of that would be represented by clients that only consume services for their vehicles, but these are clients that we actually do finance other vehicles with.
You know, this is not a typical, for instance, in our Mexico business unit, where we'll get a toehold in terms of the financing business, but they'll provide us with full mandates in terms of services for the entirety of the fleet, and we'll earn our way into the other aspect of the financing business. The other, slightly more than half, would represent, you know, basically service-only clients. These would be large clients that have their own ready access to cost-effective financing, decided to keep those assets on book, and rely on us only for managed maintenance, managed fuel, managed accidents, title registration, and other services of that nature. Armada would be a perfect example of that.
If we step back and say, "Okay, you know, as you look at that services versus services and financing versus financing only," you know, you come back to the second core tenet of our strategy, that being a capital-lighter business model, and the desire to go deeper in terms of of services as a growing and a greater representation of our revenue as we go forward. We you know services recognized and the low capital intensity associated with it is something that you know we have a strong bias in terms of our pursuit, and it's evidenced in terms of the results you're seeing in the vehicles under management.
Okay, great. Thanks for that color. Second question was on the order backlog. I would have expected a dip this quarter with most of the books closed. The fact that it remained flat, is that an indication of your clients shifting their orders from one OEM perhaps to another, and trying to just, like, prime their pump that way? With that comment, I understand that some books are open already for the 2023 model year. Can you give us any color as to what level of price increases have been pushed through on those books that have opened?
We would've shared the kind of the same view going into Q1. We would have thought with ±85% of the order banks closed, that our shadow order backlog would have been building, but we would have been unable to place those orders. As it turns out, the mix of orders that we needed to place actually meshed well with kind of the 15% of order banks that were open. A few order banks that were supposedly closed miraculously opened. As a consequence, we were able to place more orders than what we'd anticipated. Secondly, we do also work with a few large clients that are very acquisitive in nature, and they have bought companies recently.
As they buy those companies, and they immediately turn over the fleets to us, and we will do a sale-leaseback on those, and that will be a source of originations for us. That also helped bolster Q1 originations. Absolutely, in terms of shifting demand, if someone has a need for a light-duty pickup, and a Ford order bank is closed, GM is open, then absolutely, we will shift that demand from one OEM to another to ensure that that vehicle is manufactured and delivered on a timely basis. You know, a lot of different things coming into play, but in the end, demand was incredibly robust. Very pleased with what we're seeing in the shadow order backlog.
Eagerly awaiting the opening of the production order banks at the end of the month. We have a couple of very important ones, including GM's Silverado and Sierra pickup, which is a mainstay in our fleet. That opens later this month, and we've been building demand to place those orders in the order bank as that opens up.
Sorry, are you able to help us think through what level of price increases are coming through on these 2023 model years that have opened up?
Again, at this point in time, one, we believe that it will vary and perhaps materially by model. Two, it will impact not only MSRP, but also the purchase discounts that we've been able to secure for individual clients. We would expect higher on the former, lower on the latter. It will, as I say, vary from model to model. You know, we're hearing anything that is, you know, in the range of 5%-10% increase in vehicle pricing for model year 2023. We'll give you some additional color on that when it becomes obvious to us.
To say the least, we're eagerly looking forward to some of these order banks opening up and to see what's in store in terms of these price increases.
Thank you very much.
Thank you.
The next question comes from Paul Holden with CIBC. Please go ahead.
Yeah, thank you. Good morning. You provide a geographic segmentation of revenue growth, and that shows that all of your year-over-year revenue growth was generated by Mexico and ANZ. Curious on the North American piece in terms of when we should expect revenue growth to resume and what are the key drivers to get that revenue growth positive again?
Good morning, Paul. In a nutshell, OEM production ramping back up. That is the only thing holding back North America. On the services front, David Madrigal and the commercial team have just been throttling it, in terms of share wallet wins, within our existing client base. They've been aggressively stealing share, converting self-managed fleets, and all the while, maintaining, you know, or bettering industry average in terms of retention. You know, in terms of the levers for revenue growth, they're all in place, they're all being pulled. The piece that is missing here is we can't deliver against the NFR opportunity given, the shortage of vehicles that are being constrained by OEM production delays.
As the OEMs ramp up that production and we're able to fulfill the orders that have been taken, earned in 2021 and Q1 2022, you can expect to see both the revenue cash flow profile of Canada, U.S., reflect the underlying revenue generation efforts that have taken place. Unlike ANZ, where they've endured great vehicle shortages, obviously we take no residual value risk in North America. We do in ANZ. That has been to our advantage with this unique circumstance as that shortage of vehicles that have constrained NFR for them has been offset in ANZ by the gain on sales. We just don't have that same opportunity in Canada and U.S. In Mexico, again, very different marketplace, and vehicles were much more readily available.
They were slower to come. They saw their cycle time expand from order to origination, but nowhere near what we saw in the U.S. and Canada. As a consequence, they were able to basically fuel the engine of growth that they had put in place with deliveries in keeping with historical norms. It is really that simple. The services side of it, we couldn't be more pleased with the penetration utilization, the inflation that we're seeing driving the U.S. and Canadian service revenue. Honestly couldn't be more pleased in terms of the sales wins. They're just not translating to revenue because they're being deferred.
Got it. Thank you.
Jay, I'd just add two quick points to that. When you look back at Q1 2021, and I've just referenced in my commentary earlier in the call, we pulled forward significant syndication volume in Q1 of last year because there's a strong market differential of $9.3 million. We also had a release of the provision for credit loss of $3.7 million. If you were to normalize that Q1 2021 number for those two items, you would actually see some material growth in the US market.
That's helpful. Thank you. Second question, I guess, going back to credit provisioning. There's a very broad concern in the marketplace over the potential for recession. Let's just call that a 2023 recession for argument's sake. We haven't really seen Element as a public company go through what I'd call a regular recession. Pandemic was unique in nature. It'd be very helpful, I think, to get your thoughts around how your 2023 guidance might be impacted if we go into sort of a traditional recession next year. You know, not necessarily putting exact numbers behind it, but to what extent might it toggle the EPS?
Not materially. I would argue that the pandemic is actually a great example of an early and a vicious onset of a recessionary period. You know, come March of 2020, I mean, everything came to an abrupt halt. Capital markets seized up. If you could get financing, it was at, you know, ridiculously high pricing. Yet, we maintained ready access to multiple funding sources, including securitization, syndication in the U.S. bond market and at reasonable pricing. Ready access to capital. Secondly, what we discovered with the model is in times of recession, debt, economic downturns, we actually increase the velocity of our free cash flow as our working capital position monetizes.
We actually have cash accretion in a recessionary period as opposed to cash utilization. From a balance sheet point of view, no issue. We stress test the portfolio, going into the pandemic. Again, that shock, you saw, you know, minuscule in terms of basis points of credit losses through that period. The portfolio was performed and had performed beautifully. From a balance sheet point of view, ready access to capital, stress test the assets and everything held up, you know, wonderfully. As we think about the income statement and revenue, you know, again, our proposition is we've reduced the total cost of operations of our clients' fleets by using our scale.
As these organizations would enter, we'll say under your hypothesis of a 2023 recession, they'll be looking for cost out opportunities. Our ability to use our scale to help them be more productive in terms of the management and operation of their fleets, I think offers a very good value proposition. Further, you know, we have 5,500 clients across 700 industries, so we're not overly exposed to any one industry or segment.
If you think about the nature of the underlying services, and the ability to reduce that total cost of ownership through managed maintenance, managed fuel, managed accident, again, each of them has, you know, strong value as organizations look to reduce their costs and maintain an optimal cost structure going into a recessionary environment. We feel very good about the business model, both on the balance sheet and the income statement in terms of its ability to continue to perform very well, even with the onset of a recessionary environment.
Sorry, I gotta ask a follow-up. If I think about those impacts, then do you think it's fair to characterize that guidance range that maybe if we get a recession, maybe be more at the lower end of the range but still within the range? Would that be a relatively fair characterization?
Yeah. We won't get into 2023 guidance for this call. We gave you an update in terms of 2022. You know, we'll bring forward guidance for 2023 later this year. You know, at that point in time, you know, we'll factor in the very positive momentum that is built here in Q1 that has underpinned our outlook for an even better 2022. You know, we'll offer up some thoughts in terms of our view as to 2023, the likelihood of a recession in the markets that we're dealing with and how that might impact the outlook for 2023.
That's great. Okay. Thank you.
Thank you, Paul.
The next question comes from Tom MacKinnon with BMO Capital. Please go ahead.
Yeah, good morning, and thanks for taking my questions. The first is with respect to the merit and pay equity increases that came into effect in March 1st, 2022. Just for modeling purposes, you mentioned there's a step up, you know, in OpEx in the second quarter as a result of this. Just for our modeling purposes, how should we be looking at those pay increases, and how do they compare with inflation?
Yeah. What I would tell you is the best way to do that is that, first of all, in comparison to inflation, I think they're relatively in line, merit plus pay equity, etc. , relatively in line with inflation. We pay our people fairly, and we've got great people on board. In regards to modeling, the best thing that I can point you to is look at the operating margins we've put out in our revised guidance and look at the revenue growth that you have there, and then you can discern what total OpEx is. We've given some guidance before about depreciation, how that steps up year-over-year, as we'll start to navigate that component of it.
That margin will allow you to dial in, based on your perspective, where within that margin our operating expenses will fall. That's the 52.5%-53.5% adjusted operating margin.
Okay, that's great. Oh, and just can you quickly remind us about the depreciation step up year-over-year? That's gonna run faster than the rest of OpEx, is that correct?
It's gonna run faster because if you remember, it didn't step up till Q3 of last year. We'll get the full impact of that plus a bit more. Call it, you know, in the $ 8 million range.
Great. The second question is with respect to the gain on sale we see in Mexico and I guess Australia and New Zealand in particular. If I look in Australia and New Zealand, do you think it was a little bit higher than anticipated? I mean, we had, there's some seasonality there. There's some you know, extreme weather events. How would you characterize the first quarter for gain on sale, particularly in that region? Would we anticipate something even higher than that in the second or third and fourth quarter? My guess is this one is probably a little bit outsized, at least in terms of Australia and New Zealand, the first quarter numbers in terms of gain on sale, that is.
We continue to see that strengthening despite the fact that, as we said earlier, our outlook for this year when we put our guidance in place was for a bit of a moderation on that ANZ gain on sale component of it. We believe that the gain on sale has some legs for two reasons. One is obviously the demand remains high, and some of the weather events that destroyed roughly 25,000 vehicles over there have increased the demand for the used vehicles there, and then compounded with the lack of OEM new product coming in.
Two things that I think will give our ANZ and our overall GOS legs here, and I'm not gonna say higher or lower but strong, are, one, that demand that we see, which will continue in the lack of supply. Two is as the new model years come out, the price increases that we will see on those model years will obviously underpin higher used vehicle prices. Then thirdly, eventually, when those OEM originations begin to show up in greater quantity, we will have more vehicles to sell into the used vehicle market. We will see first a shifting of price, but an increase in volume, which should help protect that gain on sale for some period of time.
Okay, thanks.
The next question comes from Shalabh Garg with Veritas Investment Research. Please go ahead.
Thank you, and good morning. I want to pivot back to utilization rates. Seems like aging fleets drove majority of the growth and utilization rate. Do you think is there any further talk from utilization now?
Utilization was a big contributor to this. I don't wanna underplay penetration, and inflation played a role as well, but utilization was an important part of this, and it was really kind of twofold. One was that final return to normal consumption levels by both service and sales fleets to pre-pandemic levels. Then it was the utilization that came as a consequence of, one, the growth in the vehicles under management throughout 2021, and the increased consumption of maintenance in particular, but also accident services, long-term rentals and other services that we provide that have even more value as a fleet becomes more aged.
As we think about that dynamic throughout the remainder of this year and into 2023, you know, to the extent that we continue to have vehicle shortages and aren't able to originate normal levels of vehicles, deliveries, then yes, we're going to have increasing utilization of these types of services by these older vehicles until they ultimately get replaced.
Once we have passed the backlogs and, like once the OEM productions are normalized, majority of the growth in utilization would come from higher vehicles under management, right? Am I getting that right?
Yes. Once we are back to normal levels and we have replaced, you know, these fleets and we're kind of back to our average 41 months of average amortization, then yes, we would expect that preventative maintenance and continuing maintenance would step back down to normal levels. Obviously at higher price points, given the inflation that we anticipate will happen. At the same time, remember, as those service revenues return to normal, those service revenues that are being held back will also return to normal. Think, for instance, remarketing. Right now, by virtue of fewer vehicles being originated, we have fewer vehicles being sold, and we're not able to earn the remarketing fees on those vehicles for our clients.
Expect, as utilization returns to normal for some of our services, utilization will also return to normal for other of our services that are underutilized given the production shortages, and that will counterbalance any degradation in service revenue.
Okay, that's helpful. I just wanted to get a sense on the outlook on NCIB activity, given the redemption of the preferred shares series that's expected in this quarter. Do you expect to, like based on the guidance, it's like, $390-400 million shares outstanding by the end of the year, which is approximately 2.5% of the outstanding shares. Do you expect to fulfill that? Or is there anything that can hold you back from hitting those targets or the lower end of that range?
No, we expect to be able to fulfill that. Obviously, you know, redeeming the preferred share in the next month, I guess, $ 150 million preferred share has been kind of something that we've held out as something we wanted to target in terms of reducing our overall cost of capital. We'll divert monies that we would have otherwise used to buy back common shares to retire those preferred shares and otherwise, you know, are holding to that $390-400 million share count for the year.
Okay. Thank you. That's helpful. Jay, I would just point out that's an average share count for the year. Obviously to hit $ 3.90 we would be below, you know, materially below the $ 3.90, etc .
Yeah.
Okay. That's actually helpful. Thank you.
The next question comes from Mario Mendonca with TD Securities. Please go ahead.
Good morning. Jay, it sounds like things are functioning really well, maybe a little bit ahead of plan. It strikes me that as OEM production increases and originations increase, the need for funding will obviously increase. Are you seeing anything on the funding side? Or what can you tell us about funding right now? Number one, markets appear to be really strong and open, but we are seeing LIBOR start to increase fairly meaningfully. What do you feel about funding right now and EFN's capacity to pass on the higher cost of funding, particularly when funding demands really start to ramp up later this year?
Um, so-
Jay, I'll take that if you'd like.
Yeah, go ahead, Frank. Yeah.
Mario, what I would tell you is, remember our business model is effectively interest rate agnostic. That means that when we originate a new lease vehicle, that origination pricing is underpinned by the current market rates that are in effect at the time. As we fund those simultaneously to those originations or roughly simultaneous to, we then have that matched funding that we talk about, you know, in all of our disclosures as we move forward here. The one thing I would say is we do see ample funding capacity in the market for us, through all of the vehicles that we have explored and currently utilize.
Additionally, we continue to see a strong syndication market, which again, not only allows us to deliver, but it is a funding source as we cycle that cash back through the business, to then go do future originations.
Is it your view then that the environment is such that EFN can pass on all of the increased cost of funding? There's no need to absorb. 'Cause there have been scenarios in the past where companies have had to absorb some of the increase in funding costs. It seems like your view is there's more than sufficient capacity to pass those costs on.
That is correct.
Yeah.
No issue there whatsoever. You know, in conversations with our clients as we queue up the 2023 model year, and socialize what we expect to be meaningful MSRP increases and associated interest rate increases, again, the clients understand that, and there's been no diminished interest in placing those orders. Demand remains very strong. We, you know, again, the model is designed that we, as Frank said, are agnostic in terms of interest rates up or down. For us, this matched funding philosophy has served us very well, something that we manage to religiously.
Okay, one quick follow-up. More of a modeling question. I understand that gain on sale was strong this quarter and that you see it continuing somewhat. Were there any other sort of unusual fee or NII, net financing revenue or other sort of revenue items that came through that were sort of lumpy or unusual this quarter? I'm asking because these moves are meaningful, and I wanna make sure I'm modeling this out appropriately.
Yeah. No, nothing that I would say is materially unusual in the quarter that isn't underpinned by the overall strength we're seeing and utilization we're seeing in the marketplace, and the delay in certain OEM deliveries.
Okay, thank you. Appreciate it.
Once again, analysts who have a question may press Star then one. This concludes the question and answer session. I would like to turn the call over to Mr. Forbes for any closing remarks.
Just to say thank you. Appreciate you joining us today and look forward to our follow-up discussions.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.