Status Update

Apr 8, 2020

Good afternoon, everyone. Thank you for joining us today. My name is Jeff Kwan, and I'm the Research Analyst at RBC Capital Markets that covers Element Fleet. I will be hosting today's call to give listeners an update on how the company is positioned and is responding to the new reality in light of COVID-nineteen. On the call with me today is CEO, Jay Forbes. In a moment, I will turn the call over to Jay for some opening remarks. And after that, we'll have a fireside chat. But before I do do that, on behalf of Element and myself, we hope all of you and your families are safe and healthy during these challenging times. And with that, thank you, Jay, for doing today's call, and I'll turn it over to you. Good afternoon, Jeff, and thanks for all of all of you joining us for today's call. And let me echo Jeff's sentiments and wish you, your families and friends, nothing but good health. I'm looking forward to our discussion this afternoon and in particular, having the opportunity to outline how the strategic priorities that we've been pursuing over the last eighteen months have positioned Element Fleet Management to not only withstand the current circumstances, but indeed seize upon the opportunities that we believe will ensue. In the interest of time, perhaps, Jeff, I'll turn it back over to you so that you might lead today's conversation. Perfect. Thanks for that, Jay. So I'd like to lead off the fireside chat with this question. So in your letter to shareholders that was included in your press release last night, you wrote about the fundamental attributes of Element's business model that foster resilience and dependable operating cash flow even during tumultuous times. Can you talk about how those attributes are working in Element's favor today? Yes. So while the key attributes of our business model are valuable in any business cycle, I think that they're especially a strong source of comfort and assurance in these troubled times. It begins with our counterparty credit. We have a diversified group of largely longstanding investment grade clients. Specifically, we minimize exposure to geographic or industry concentration risk. Our clients are diverse, constituting over 700 different industry codes and are geographically dispersed across five countries. We enjoy long standing client relationships with historical norm of 98% year over year client retention. We've minimized our credit risk, catering largely to mid and enterprise level clients with about two thirds of our earning assets leased by investment grade or equivalent rated clients. The business model is further bolstered by the nature of the asset that is being leased and managed and the design of the underlying contract. A large majority of our leased assets are work vehicles. They're essential to our clients' operations. They're integral to the nature of their business. And as a consequence, this integral nature of the asset ensures continuity of payment of all obligations in normal situations. And in those few instances where clients may have to enter a restructuring process, it results in these fleet leases being reaffirmed quickly and full settling of the obligations owed to us. The client leases are also cross collateralized and are absent of force majeure clauses, which provides us with further protection. And finally, the entire lease book itself is fully match funded. So we have no interest rate, duration or FX exposure to the current lease book, nor any need for additional financing of that lease book, fully match funded through to maturity. Perfect. And then you're in the final year of your strategic plan, which included transforming the core business, strengthening Element's balance sheet and also beginning to pivot to growth in 2020. So how has COVID-nineteen impacted the plans? And when things start to return to normal, what are the key things shareholders should be thinking about regarding financial performance? Yes. So for us, quite simply, we plan to stay the course as it relates to our strategic plan. We believe we have the right strategy and our successful progression of this strategy has yielded significant benefits for all of our stakeholders. Quite simply, we wouldn't have been safe and sound today without the work that we have done to transform the business and strengthen the balance sheet, which comprised kind of that first wave of our strategic plan that we launched in the 2018. Transformation has allowed us to elevate and improve the consistency of our client experience, which has in turn returned client retention to historical norms and deepened our client relationships as evidenced by our much improved Net Promoter Scores. And so accordingly, we would confront COVID-nineteen from a very different and much improved operational position of strength and stability. Transformation has also given our people the skills and the confidence to deal with large, complex and awfully deeply nuanced business problems. And this skill set, this attitude, this capability that they have developed over the course of working to advance our strategic plan these past eighteen months has been put to good use this past quarter as we prepared for and began to react to COVID-nineteen and the ensuing disruptions. As for strengthening the balance sheet, this has materially reduced our financial risk. It has provided us with greater liquidity and has broadened our access to funding sources. Think about our robust syndication volumes that we've been able to do as we've accessed and grown that market as well as the S and P rating that we were able to secure in the fall of last year, which opens us up to a U. S. Unsecured bond market when that market settles down. So accordingly, transformation, achieving that consistent superior client experiencing experience as we action $180,000,000 in run rate profitability improvement will remain our first priority through 2020. Strengthening the balance sheet will also be a top priority as we pursue our sub-6x tangible leverage ratio. And again, the syndication market remains open to us. Buyer appetite is robust, and we're actually seeing some new names come into that market, which bodes well in terms of that deleveraging effort. And interestingly, just by virtue of the nature of the model, any temporary headwinds that we might experience in terms of originations and or service revenue will actually assist us in our deleveraging efforts. And so if that is two of the three pillars of growth that we've talked about in the past being transforming the core business and strengthen the balance sheet. The last that we talked about in the fall of last year was this pivot to growth. And taking that transformed and strengthened operating platform, taking that solid balance sheet and putting that to use in the pursuit of growth through the six point growth strategy that we outlined several months back. We think that actually the current environment might actually be an accelerant for this pivot to growth, especially on two planks of the strategy. Firstly, from a self managed fleets, including our government self managed fleets, there may be a greater propensity to outsource as they look to diversify funding sources, put some cash in the till, recognize some inherent value in the fleet assets and lower their operating costs profile go forward. So that self managed fleet marketplace that constitutes somewhere between 50% of Canada and The U. S. Fleet population to threefour of the fleet population in Australia and New Zealand, we see that as probably having an even greater demand for our type of service offering than what is true even today. The second plank that could see an increase in interest and appetite is mega fleets. We see these as viable candidates for growth, perhaps even sooner than what we'd anticipated as they recognize the attractiveness of having their own delivery capabilities to respond to online shopping, to provide home delivery as work from home social distancing works its way into the norms of our society. So self managed fleets, mega fleets, as attractive as they were as candidates for growth for this organization as we look to the future, the current environment may be a stimulant for those becoming more plausible candidates for growth even sooner. Perfect. And then switching over to kind of the operational side, your letter to shareholders stressed the importance of first focusing on elements people, which is obviously the right thing to do. Now with 95% of people working from home, can you give maybe some other examples of what Element has had to change to balance the health and safety of its employees on one hand, but also delivering results for your stakeholders? Yes. We feel very strongly about this point, Jeff, in terms of our employees' welfare and well-being. And so our we began as this started to emerge kind of late twenty nineteen, early twenty twenty, something that had the potential to significantly impact our communities, let alone our workplaces. We rolled out our business continuity planning as related to a pandemic and quickly put provisions in place to protect our people. And as you'd note, some 95% of our people are now working safely and productively from home. Interestingly, while the individual transition has its own unique challenges with it, with cohabitating the space in many cases with other family members. It has not been a particular challenge in terms of the organization's ability to support its people. Our technology, our processes and all the work that we've been doing over the last eighteen months put us in good standing in terms of our ability to provide the requisite capabilities and guidelines and enablers for our people to work productively in servicing the needs of our clients. So from that point of view, it has worked very well. Further, we have five ways of working, if you will, that include agility, accountability, connection, transparency. And these ways of working have transitioned beyond the corridors of our offices to the workplaces at home. And it is really the kind of the fabric of our culture that keeps us connected, that keeps us highly engaged with one another through active transparent communication. And the spirit of accountability and taking responsibility, again, is an evidence in everything that we're seeing as our people not only look after our clients, but look after one another as everyone adapts to this new way of working. Over and above that, for those 5% of our employees that are still in the workplace, they are still needed close to the operations, close to the systems of the business. Obviously, we have eliminated all travel, instituted practices, distributed them across a variety of different physical facilities to give them, again, better isolation from other groups in the organization, antiviral cleaning, the whole work. So again, I couldn't be prouder of how this organization has promptly and completely responded to the needs of our employees and situated them for success in terms of having meaningful productive experience working remotely for the 95% are working on our premises for the remaining five. The feedback from our clients has been fabulous. They have taken great effort to communicate throughout the leadership team just how informed our people are keeping them in terms of industry developments, how attentive our people are to their needs, how empathetic they are to situations our clients are facing. So again, our frontline people are just doing a fabulous job through the eyes of our clients. And just as an interesting aside, it is so interesting to watch how people respond to these types of situations in the face of great uncertainty, with a strong customer ethic. We had a group that took a product from concept delivery being kind of a certified clean product that allows our clients to share vehicles amongst multiple employees, but to make sure that it is cleaned on a commercial grade level between shifts. They're working with our supplier network, took this from concept to reality in a matter of days and made it available for a number of our essential services that key to supporting our communities in this time of crisis. So you hear stories like that, and it's just a reminder of the deep ethic that our people have for the client and the ingenuity that they bring to their role regardless of where they're working. That's a really good example. Well, we'll talk about your clients in a moment here. But first, as an aggregator of services for your clients, there's obviously only so much that you can control. What about everything that's outside your control, the OEMs, the DMVs, the upfitters and the service supply chain? Like what are you hearing from that network? And how it is it how it's impacting your business? Yes. I hadn't had a full appreciation before I came into the industry as to just how extensive our web of relationships are with our suppliers and how we integrate the turn are in terms of us being able to do what we do so well on behalf of our clients. So if we look at some of those component parts to that supplier network, obviously, the OEMs have shut down production. They continue to accept orders. And so when the plants resume service, resume production, you can be sure that element orders are going to rise to the top. They have visibility in terms of our demand, know that, that demand can be placed in clients' hands quickly. And the commercial clients that we have will spool up more quickly than the retail environment that the OEMs have through their dealer network. And so we would expect similar to cases that we have viewed in the past that, again, companies such as ours are going to have a very good place in the production pecking order, and we'll be able to have our orders produced and those leases originated with the resumption of OEM production. Upfitters, a number of our upfitters have closed. And so the pipeline that's available to us to take those vehicles that have been produced, upfit them and then ultimately deliver them to the client, that pipeline has narrowed, but it's still open, and we're continuing to process orders through the upfitters. Even the distribution network that we use to deliver those vehicles, again, has narrowed in terms of its capacity, but there's still sufficient capacity for us to pump through the last of the OEM production units that made it out of the factory. As we look further downstream in terms of operations, the most of the places that we would be referencing our clients to in terms of maintenance and repairs, including body shops and parts suppliers are open. They have been deemed essential services. We've been working with governments at various levels to ensure that they remain identified as essential services so that those fleets can be properly maintained throughout this period. Further downstream, remarketing, a lot of the auction house capacity has actually shut down, which is slowing the remarketing of vehicles, the resale of vehicles into the dealer network. And so most of the vehicles being sold today are being done via online auction. And again, a fairly significant crimp in volume, which means potentially a longer hold period of those assets by our clients. So DMV is another key part of the value chain. We continue to see closures of Department of Motor Vehicles across states and provinces. Some remain open, particularly for commercial clients like ours that qualify as essential services. For those that are closed, the governments have generally extended re registration deadlines by three to six months. So it's not a matter of whether this will be done, it's more a matter of when this will be done. So again, a tremendous ecosystem here that supports over 1,000,000 vehicles under management. And we're working with each one of those different parts of that system to ensure the continuity of service to our clients during this period of time and planning for the resumption of some degree of normalcy on the other side of the matter. Perfect. Client centricity has been your mantra since you took the helmet element. One of the common questions I get from investors is what are you hearing from your clients? How are they faring? Elements vehicles are essential for your clients to generate revenue, but do they have the ability to generate revenue right now? Yes. So the again, I'll take it back to kind of some of the core attributes of the business model. So again, we have a heavy concentration in enterprise and mid market clients, two thirds of the portfolio investment grade. The nature of the vehicles, 80% plus or minus of the vehicles are work vehicles. These are essential to fairing workers and parts to workplace locations. And so we have seen a great deal of continuity in the businesses of our clients through these early days of the pandemic. There has been some softening in the consumption of fuel and maintenance services during this period. But there's been, nonetheless, kind of a core level of activity that would suggest that indeed these attributes are holding true even in these times of unique circumstances. We are in regular contact with our clients on a day to day basis in terms of operation, but our commercial group has also begun a program of outreach to help them better understand what we can be doing to assist them today. So here's how we can help you in these times of great uncertainty, lower your total cost of ownership or better manage your balance sheet position. Further, we use those opportunities of engagement with our clients to solicit their views as to how they're seeing things unfold in their own businesses and their concerns and issues. So to date, we have reached out to approximately three fifty clients, which represent about half of the revenue of the business. And I would offer up that supply chain management and the disruption of supply chain is probably the highest reported concern with more than half of our clients reporting a challenge in terms of dealing with their own supply chains and disruptions therein. A little bit more than half of our clients are challenged by sales declines. They too are seeing some softness in the demand for their products and services, particularly in the oil and gas segments or the brick and mortar retail. And a little more than a quarter of our clients are citing cash or liquidity concerns as they look at the tightening credit markets and their access to capital. And again, as you can appreciate, each and every one of these concerns that they're voicing to us play to our strengths. We have a solid balance sheet. We have ready access to capital. And just last year alone, we generated over $1,000,000,000 on a proactive basis of productivity savings and communicated the same to our clients. So we have a treasure trove of ideas available to help them lower their total cost of operations in these difficult times. Perfect. And you touched about that in terms of some clients that are seeing some revenue headwinds. What about those clients that aren't getting the generating revenue right now? What percentage of clients require payment deferrals effectively due to an inability to pay or challenging ability to pay? And at what point do delinquencies add up to a material risk for Element? And how do you satisfy your ABS and syndicated lease obligations in that scenario? Yes. So as part of our business continuity planning and as we reflected on the learnings from the Great Recession, We instituted a global cash management office to assess and then proactively manage the liquidity position of the organization to make sure that we had a strong control over our cash flow and early indications of any sensitivities in terms of that cash flow being maintained. So that was kind of a first step that we put in place. And one of the learnings that came out of that for me was the natural ability of the business to actually delever in these uncertain times. So we actually have fund a large working capital position for kind of two main purposes in our business model. The first is, as you know, even though we report $1,000,000,000 of net revenue, we actually generate about $12,000,000,000 of gross revenue, have $11,000,000,000 of cost of goods sold. That nets down to that $1,000,000,000 of revenue that appears on our income statement. And so for us, we procure all the fuel and all the maintenance services for our clients, bill our clients and receive those funds at some point in time. Meanwhile, we're paying for that fuel. The fuel consumed today, we pay for tomorrow. And the maintenance, we pay thirty days out. So we fund a very large working capital position on behalf of our clients. And interestingly, as we look at that, any softness in spend as it relates to fuel or maintenance actually delivers the balance sheet. It actually creates cash flow for the business. The second source of working capital relief in a softer market is originations. So as clients look to defer the purchase of the vehicle today and to originate a new lease, and instead continue with the existing vehicle for a few months longer, that decline in orderoriginations results in, again, a freeing up working capital. So we're actively managing our liquidity position of the organization to ensure that we continue to have the same generous positive free cash flow position that has been evidenced in our disclosures over the last eighteen months. As it relates to credit and collections, as I've commented in the past, we have a very rigorous credit management program that starts with the attributes that I spoke of earlier, being industry discretion, size discretion, credit discretion. And there's active management of the existing portfolio such that the organization hasn't posted a double digit basis point of credit loss in its history. So, you know, would say to you, those processes, those practices will need to be sharp as we go through this. The abrupt nature of this economic slowdown is unlike anything we've ever seen before. And so we do expect that we will see some requests for credit accommodations coming from our clients. We're prepared for those. We will address those under the protocols that we have established. And for those that warrant consideration in terms of an accommodation, we have both the liquidity and depth of balance sheet backing that we won't be able to readily fund those with the current facilities that we have. And lastly, there's while one would never want to rely on this, I think it is another attribute of the Element Fleet Management model that bears consideration. Technically, all elements credit risk fall to the ABS investors and syndication buyers, not the organization. So these are, you know, with ABS facility, we're bankruptcy remote with syndication. There's a non recourse basis. Again, it's our full intention recognizing the importance of continually accessing both securitization and syndication markets to keep those investors whole. But ultimately, the liability falls to them, not to the organization. Perfect. Moving on to liquidity. Your letter to shareholders cites well over $5,000,000,000 in contractually committed funding. What does that include? What does it exclude? And are there any limits on what you can use that for? Yes. So it there are some slight limitations depending on the vehicle. It is if you think about that $5,500,000,000 stack, it starts with our ABS facilities. So we have asset backed securitization facilities in The U. S, Canada and Australia. And we have unused capacity in those facilities that is ready for us to tap. And obviously, we would look to securitize our traditional book of fleet leases through those ABS facilities. We also have a significant component of the nonrecourse line that we set up for Armada that is available to fund additional interim funding of Armada originations prior to those being syndicated. We have, on top of that, our senior line. So we have a senior line that we use to fund the operations of Mexico, the working capital needs of the organization and any assets that we may not choose to securitize at this point in time. It also provides a bridging facility for the non Armada assets that we ultimately syndicate. And then on top of the $5,500,000,000 of committed contractually committed funding, we obviously have the syndication market that we have been growing and developing that continues to be open and fully accepting of the orders. Perfect. Moving over to the balance sheet. That committed forward funding is undrawn capacity. In other words, not on your balance sheet right now. What about your balance sheet today? You've been strengthening and deleveraging as part of the strategic plan. Is it where you want it to be or at least where you need it to be today? Yes. I would say to you, it is quickly maturing to where we want it to be. It is more than adequate for what we need today, but it's there is still work to be done. So when we started this journey in October 2018, we had a tangible leverage ratio of 9.11, and we've been able to significantly reduce that coming in at 7.11 here at the 2019. And had we not had to take the additional write down on nineteenth Capital, we would have been deep into 6x tangible leverage. So we are absolutely progressing towards that 6x, sub 6x tangible leverage target. We remain on track to achieve that by the end of this year through all of the deleveraging efforts that have taken place. And again, with recent affirmations of our ratings by the rating agencies, we have an investment grade balance sheet that has all the capacity that we need, not only to meet the existing needs of the organization, but to fund our growth ambitions as well. Perfect. Just a couple more questions. Next is just on the income statement. Can you quantify any of the following kind of three things for us? And these are kind of questions that I get asked fairly often by investors. So first one is in terms of the service revenue headwinds, in your letter to the shareholders, you noted that fleet services revenue may be softer in part due to lower mileage impacting fuel, maintenance, accident services. Does this imply fleet services revenue growth could still be positive in 2020 on a year over year basis, albeit to a lesser extent than if COVID-nineteen hadn't happened? Or could Service revenues be lower this year on a year over year basis? Secondly, on anticipated syndication volume, does your guidance of $2,500,000,000 in 2020 still hold? In your letter, you did note that syndication, the market remains open, buyers have appetite and the company has even added and transacted with new syndication partners in the 2020. And then the third part was around operating expenses. It was a little under $470,000,019. Based on what you know right now and factoring in the transformation plan and pivoting to growth, how should we be thinking about OpEx in 2020? So in terms of service revenue headwinds, the sensitivity analysis that we have been modeling has been on two kind of two key variables being severity and duration. And so we have looked at multiple scenarios in terms of how long are we likely to be in this economic trough created by this pandemic And how might the business be impacted by virtue of severity of fall off? And what does that resulting resumption of full service consumption will look like in terms of how it might evolve. So we've modeled we've built a variety of different scenarios on those two dimensions. And I would say to you in direct answer to the service revenue headwinds and whether or not this might impinge upon growth in service revenues in 2020, just too early to tell. It is quite amazing to see the difference as you start to play with those two variables. How deep could this go and how long might this be? And so probably need to refrain from offering much in the way of insight, again, just not knowing how this pandemic will take hold across those five geographies and thus impact the consumption of those service revenues. In terms of the syndication volume, yes, plus or minus the $2,500,000,000 was kind of the thumb up in the air that we provided as kind of a target, probably a little heavier skewed to Armada as opposed to non ARMADA syndication, just recognizing the receipt of orders, the build out of the orders and the delivery of those orders that we received in 2019 carrying over into 2020 and in anticipation of yet another fulsome year of activity with Armada. So the $2,500,000,000 feels good. And again, it's all offered up under the cabinet, but the syndication market continues to be open for business. Again, delighted with the receptivity that we have been receiving, have actually been able to do what we thought we might be able to do, is expand the number of buyers, number of investors in the syndication market. And so again, demand is strong. Pricing is tight, but demand is strong. And so if the market remains over that opened throughout the 2020 period, then by all means, that $2,500,000,000 feels like a good number. And then operating expenses were a little under $470,000,000 When we think about OpEx for 2020, again, we start with an underlying commitment to our people. And so we believe that this pandemic represents an event and an event that is not going to fundamentally alter the business model or business prospects for Element Fleet Management. So we want to work our way through this event, trying to keep our organization intact in terms of the capabilities and the unique knowledge base that our people have, recognizing that our value proposition, we believe, is even going to be more compelling coming up the other side of this pandemic. And so we don't expect any material reductions in OpEx were arising from COVID-nineteen. Again, we're still trying to understand the dimension of this and the duration and severity and the resulting impact on our business. So perhaps we should leave it at that and offer not much more in the way of commentary. Okay. And my final question is that it seemed like there's a hopeful tone in your letter to shareholders yesterday in terms of seizing opportunities that this pandemic may create. I know you I think you might have alluded to some of this earlier, but could you maybe be a little bit more specific around these opportunities? Jeff, I just look at this and again, first priority has been our people. Second is to make sure that this business is going to be able to withstand any and all threats that come as a consequence of this pandemic and the resulting economic downturn. And so we have been nonstop in stressing every assumption, every belief that we have in terms of the business model to ensure that we've thought of everything, provided for everything and that the resiliency that we believe exists in this business model will indeed hold under any and all assumptions that we can envision. And so with that peace of mind and comfort that indeed we will have a business business model that will be able to continue with great strength and stability for all of our stakeholders, not the least of which our clients and our investors, then one's mind goes to the other side. How do we reengage our people in the business? How do we reengage with existing and prospective clients? And again, when we come back to our core value proposition and that ability to provide ready access to cost effective capital to organisations whose funding sources are heck of a lot more expensive than they were before 2020 came about. And if they have the same degree of access, we'll find our Ready Access to Capital point of attraction. That ability to for prospective customers to receive a cash infusion through a sale leaseback transaction will have great value. That opportunity to materially reduce the ongoing operating burden associated with fleets and to dissolve them of the administrative responsibility of the fleet will have more appeal. So we think that, again, not only are we well prepared to handle whatever comes our way by way of this economic downturn, we actually think that there is a real opportunity for us to take our market leading position and all the attributes that we've been talking about here over the last bit of time and apply them to selectively grow the business with investment grade clients that have a true appreciation for the value proposition that we have. Perfect. Thanks for that, Jay. Those were all the questions that I had. Were there any remaining thoughts you wanted to leave with investors? Jeff, just that, again, thank you. Thanks for the confidence in this organization, its management team and its people. I think you would be very proud of how well your people are attending to their responsibilities, say this unparalleled work from home where 95% of our people are now actively engaged and supporting our clients out of their home workspace has gone amazingly well. The feedback from our clients has been incredibly gratifying. And again, our first priority is to make sure that there is the continuity of the business. The business not only survives, but indeed thrives in this time of uncertainty. And I think we have the not only the right plans, but the necessary preparations for that to happen. And then thereafter, it's about having established a fortified position to withstand anything that might come at us. We want to be prepared to selectively go after those opportunities that are going to be a very important part of our future as we execute that pivot to growth. So again, appreciate the understanding, much appreciate the support, we'll continue on the journey together. Great. Well, that concludes today's call. I would like to thank Jay and all the listeners for taking time out of their busy schedules to be with us today. Thank you. Thank you, Jeff.