Element Fleet Management Corp.

Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management fourth quarter and full year 2021 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 1 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, and the company refers you to the cautionary statements and risk factors in its year-end and most recent MD&A, as well as its most recent AIF or 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. Elements earnings press release, financial statements, MD&A, supplementary information document, quarterly investor presentation, and today's call include references to non-IFRS measures, which which management believes are helpful 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 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 thanks for all of you for joining us this morning. We're going to briefly address Elements 2021 performance and its results, as well as our outlook on this year and next year, which has not changed since we last spoke to you in November. However, the majority of our time together is going to be available for you to ask questions and we'll endeavor to provide as much color and insight as possible in our responses. Let me start by repeating what I said when we last spoke. which is that Element as a whole is performing better than ever before. And the list of proof points to this effect is three months longer now than it was in November. Allow me to step back for a moment, if you would. In October of 2020, we set out three strategic priorities for Element in 2021. The first was to grow net revenue between 4% and 6% above 2020 levels. in constant currency, demonstrating the scalability of our transformed operating platform by magnifying that growth into superior operating income growth, thereby expanding our operating margins. As you have seen in our disclosures, we succeeded on all counts. Our second strategic priority for 2021 was to advance a capital lighter business model through growing services revenue, and strategic syndication enhancing returns on equity. And we did that too. And our third strategic priority was to grow free cash flow per share and return capital to shareholders through growing our common dividend and repurchasing our common shares under an NCIB. Mission accomplished. While achieving these growth objectives is gratifying, What still amazes me is that our organization accomplished this during the first ever global vehicle production shortage in the history of this industry, which lasted the entirety of 2021 and continues to persist, albeit to a lesser extent now than before. Element's growth in 2021 against the backdrop of unprecedented supply chain disruption speaks to a few things. It speaks to the determination, the agility, the accountability of our 2,500 employees across the five countries in which we operate. My executive leadership team and I are tremendously grateful for our people and everything they accomplished for our clients in 2021. Element's growth in 2021, notwithstanding OEM production shortages, also speaks to the resilience of this business model. That resilience has been proven two years in a row now, first against the backdrop of COVID's arrival and the waves of global lockdowns in 2020, and again last year. This resilience is what gives us confidence in being able to deliver on our outlook for this year, as well as 2023. Lastly, element success in 2021 speaks to the crucial role that our services and solutions play for our clients and their businesses. While the vehicle supply side of our business was constrained in 2021, we've experienced record levels of demand for vehicles as well as elements expertise and support across the entirety of our client base. On the subject of demand for vehicles, in addition to the 2021 results we reported yesterday, our business generated between $40 and $65 million of incremental revenue, operating income, and cash flow in 2021, which has been deferred as a consequence of OEM production delays. This value is represented by the excess $1.9 billion of backlogged vehicle orders placed by Element clients as at year-end 2021. These orders are excess in that they're on top of our usual year-end global backlog of approximately $1 billion in order volume. We continue to forecast this order backlog having grown further by mid-2023 when we expect global OEM production capacity to be back at 100% and our excess backlog begins to recede. All these details are identical to the outlook we provided in our November public disclosures. If anything, our confidence in this trajectory has been bolstered by our Q4 2021 and year-to-date 2022 performance in combination with the recent public statements made by several large OEMs regarding expected production volume recoveries. Returning to my belief that Element has never performed better, allow me to offer a few proof points from our 2021 results. These are in cost of currency to eliminate FX translation noise and restrict it to our fleet management or core business performance in prior years. In other words, on an Apple to Apple's basis, Element generated more net revenue in 2021 than ever before. This was driven by more service revenue and more net financing revenue generated in 2021 than ever before. We produced more adjusted operating income than ever before, more free cash flow and more free cash flow per share than ever before. And we returned more cash to common shareholders than Element ever has before. We achieved all-time high global net promoter scores for 2021, as well as for Q4 2021 specifically. This is a truly remarkable achievement for an organization that was receiving negative net promoter scores in some geographies when I joined in 2018. A world-class loyal client base ordered more vehicles from Element in 2021 than ever before. On this count, we have to exclude Armada. However, if we include Armada, 2021 was the second best year of orders in Element's history and a mere $150 million shy of 2019. Q4 2021 on its own was the single largest quarter of vehicle orders in Element's history by a $400 million margin, regardless of whether Armada is in or out of the data set. And the list goes on. There were a dozen all-time highs reached by our commercial teams in 2021 as they carried that momentum into this year, which we anticipate will be even more successful for our clients and client prospects. The bottom line remains that Element is performing better than ever, and perhaps more importantly, we've never been better positioned to sustain and build on this success. Before I give Frank the floor, I want to conclude by spotlighting the launch of Arc by Element last week, which is our integrated end-to-end EV offerings. Arc by Element builds on our established success with EVs in all the markets we serve, with special recognition due to our colleagues at Custom Fleet in New Zealand, where their offering, called EV Plus, has been and continues to be the only end-to-end EV offering in that market for years. Element's basic value proposition, making the complex simple for our clients, is innately responsive to the challenges of fleet electrification. And as the market-leading FMC in every region we serve, Element is best positioned to support our clients and lead our industry through the gradual electrification of automobile fleets. We're excited to bring our full-service EV offering to our clients under the ARC by Element banner, ensuring consistency for our global clients in developing this offering to be seamless across all of our geographies. With that, I'll turn things over to you, Frank.

Thanks, Jay, and good morning, everyone. I want to make several comments regarding our 2021 results and another few about our outlook for Element this year. After that, we'll jump into Q&A. The last time we spoke in November, we gave you some guidance ranges on how we expected Q4 to play out and therefore how 2021 would look as a whole. The business ended up outperforming many of those guidance ranges. We are pleased with the outcome, and I will provide some insights on the strong performance. For the month of October 2021, the top five OEMs we do business with in the U.S. and Canada posted their lowest vehicle production numbers that we have record of. They were struggling with supply chain issues, and the near-term outlook was dubious, with the consumer holiday season approaching and presumptive routing of microchips to higher margin in-demand consumer electronics. This changed very quickly in November. OEM scheduling and production capacity accelerated materially. Supply chain raw materials, including microchips, ended up being able to support multiple shifts at our OEMs, and a number of plants worked throughout the U.S. Thanksgiving holiday and later into December than is customary to maximize vehicle production before the end of the year. With historic order backlogs, the OEMs were able to be selective about which vehicles they produced, So they focused on higher margin and less microchip intensive models to maximize results in total production numbers. Many of our clients' vehicles fall into the higher margin but less microchip intensive category. As a result, our originations were above initial expectations in Q4. Additionally, and this is independent of originations, we were able to implement and start generating revenue on a number of commercial wins that we had assumed would come online in 2022. Essentially, our Q4 outperformance benefited from this timing of originations and implementation of client wins. But it is also a testament to the performance of our employees who were able to process this volume of unexpected originations and onboard new client wins. As we have told you before, originations are very revenue and cash accretive events in our business, especially when you include the knock-on effects to services like titling and registering the new vehicle, and remarketing the vehicle being replaced. The outperformance was not 100% driven by incremental originations, but there were significant contributors, as was the anticipated January revenue being earned in December. Indication revenues for the year were healthy, $64.4 million, with a full year yield of 2.4%. Cue force indications were 14.5 million, while achieving a healthy 2.9% revenue yield during the quarter. Notwithstanding the strong syndication revenue yields in both Q4 and Q3 2021, we continue to recommend modeling syndication revenue yields closer to 2% going forward, and we will let you know if this outlook changes. The other metric that varied modestly from our Q4 guidance was adjusted operating expenses. You may recall that Q3 adjusted op-ex included a year-to-date catch-up accrual for short-term incentive costs, reflecting strong business performance relative to our balanced scorecards. Q4 business performance exceeded expectations on the same basis, and Q4 salaries, wages, and benefits increased incredibly. Nonetheless, we delivered on our adjusted operating margin guidance for 2021, and adjusted operating income growth continues to outpace net revenue growth, exemplifying our scalable operating platform. As you update your model for 2022 based on yesterday's results, a couple of items that should help. We remain committed to 2% net revenue growth in constant currency in 2022, despite higher than anticipated net revenue in 2021. We expect our adjusted effective tax rate to be somewhere between 25 and 27% in 2022. Many external factors impact this on the margin, including currency and dispersion of earnings by geography, amongst other variables. We will let you know as we progress through the year if our ETR expectations change. That being said, as you know, effective tax rate is an accounting construct and our actual cash tax obligations remain materially lower. We expect cash taxes to be in the 50 to $55 million range for 2022. We expect to keep our operating margin in line with 2021, despite slower growth. And we expect sustaining capital investments to be in the 50 to $55 million range. Recall that we've already signaled our intention to redeem our Series I preferred shares in June this year, which will have a positive impact on our free cash flow per share. And we are committed to continuing to repurchase shares under our NCIB. In addition, our focus on an asset lighter model is enabling the return of cash to shareholders via the NCIB and our recently increased dividends. These ongoing returns of capital remain a critical component of our value proposition. 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 in live dialogue with management. Should an analyst have additional questions, please rejoin the queue. To join or rejoin the question queue, you may press star then one on your telephone keypad. You will hear it so in 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 Joc Juan of RBC Capital Markets. Please go ahead.

Hi, good morning. When looking at the new client wins and the cross-selling, that seems to have been accelerating in the past six quarters. The momentum seems to be broad-based, but there were two things that stood out to me for the Q4 results. When I looked on the trailing 12-month basis, the revenue units in the U.S. and Canada were up almost 100% year-over-year, and the share of wallet was up 460% year-over-year on the market share wins. So just You know, wondering how you explain, you know, some of the positive momentum, you know, how much of this is not kind of included in the 2022-2023 guidance because of the chip shortage and how does the pipeline look?

Good morning, Jeff. Listen, I'm really excited with the revitalization of our commercial efforts as a consequence of our decision to pivot to growth in early 2021. You might remember that we began the wholesale overhaul of our commercial function in the U.S. and Canada mid-2020 in anticipation of going hard on this growth agenda in 2021. And as you have called out, the results reflect the success that David Madrigal has had as our Chief Commercial Officer in revitalizing this commercial function. I would say there are a lot of secrets to the success. It has come as a consequence of a reorganization, an upgrading of the talent, the skills of our commercial force, the revamping of their compensation, and a distinct bias introduced to the sales group in terms of the pursuit of services, revenue growth, on a much more aggressive basis than perhaps what has been the case in the past. And that ability to increase share of wallet through both penetration of our service offerings to the entirety of our client base as well as increasing the usage of those services across that client base has been a key part of the success that we see in terms of service revenue growth certainly revenue unit growth in 2021, which in turn we expect to translate into very attractive service revenue growth in 2022 as those sales or transactions are implemented and those services are spooled up with those respective clients. So, yeah, this has all been very much about the concerted energies and focus that we brought to the revitalization of our commercial groups across all five countries, but in particular, the U.S. and Canada and the success that they've enjoyed in shared wallet gains with our existing client base, as well as stealing share and converting self-managed fleets, and in doing so, the provision of services to those new units that we've taken under management.

And then can you give a progress update on the North American self-managed opportunity? And are you seeing any early opportunities for market share wins relating to the Donlon wheels and ALD lease plans transactions?

Yes. So, you know, I would say to you that, you know, the ready opportunities that have been afforded to us in terms of this focus on shared wallet, have taken a lot of the focus, a lot of the energies of our sales team and devoted them to that. And I would say further that the OEM production shortages have, coupled with the continuing restrictions associated with operating in a pandemic world, have tempered our efforts around self-managed fleets. All the opportunity is there, just our ability to access it has been somewhat constrained by our inability to have the face-to-face meetings with the C-suite personnel that we believe are the right points of contact to converting the self-managed fleets into FMC clients, coupled with the ready success that we've had enjoyed in terms of increasing share of wallet. So that opportunity for us continues to be real. We're actively pursuing it and enjoying great success, as you see disclosed in the supplementary. And it will be the backbone of our revenue growth strategy go forward. But for 2021, it was a bit tempered, given, again, the restrictions imposed by the pandemic. coupled with the phenomenal success that the team was enjoying in terms of both stealing share as well as share of wallet. And on the stealing share, the consolidation and the shifts that we've seen in ownership of certain of our market competitors have given rise to their clients seeking alternative FMC representation, recognizing that, the perils and trials of integration can and might be disruptive to the client experience that they might enjoy. So us having come out of that and offering a first-rate industry-leading client experience coupled with the concern that the experience that they're enjoying with their current service provider might degrade as a consequence of the integration has certainly given us opportunities to steal share. And again, you see it in the numbers. The team has taken full advantage of that.

And if I can just maybe sneak in one last one. On Amazon, or sorry, I mean Armada, they've talked about their desire to electrify their delivery van fleet as evidenced by their order with Rivian and more recently Stellantis. I just wanted to understand Armada's ability to procure electric delivery vans given the chip shortage and that there's a limited number of OEMs that are producing these electric delivery vans. Are you able to talk about whether Armada is facing these same procurement issues for getting these electric vans and has Element been involved in helping Armada with this?

Let me start by saying that we continue to deepen our relationship with Armada, which is our largest client, as we provide more services to its ever-growing fleet. And further, much of the services that we provide to Armada are drivetrain agnostic. So whether they're Rivian or Stellantis, Bright Drop, Ford... We will service those vehicles much like we do their ICE vehicles as we work closely with this organization to achieve their last mile ambitions as they gradually electrify their growing fleet. They, like every other client, would be constrained by these chip shortages. Clearly, at their scale, they attract a disproportionate amount of interest and attention by the OEMs. But the simple math has it that every one of our clients is being constrained in terms of their ability to secure the necessary vehicles in volume to meet their demand.

Thank you.

Thank you.

The next question comes from John Eichen of Barclays. Please go ahead.

Good morning. Frank, I wanted to talk about syndication. I think in the MD&A you talked about a difference, like there was three, what you classified as portfolio transactions. And if I understand correctly, these were done to a single buyer. Can you talk about these transactions first? Were these three transactions all to the same buyer or were these to three different buyers? What type of concentration risk does this pose from the other syndications? And also, I think the MD&A mentioned that this actually resulted in higher yields. I'm assuming that this is from, you know, less costs associated with a simpler process, but is there anything else involved in the higher yields derived from this?

Yeah, thank you. Thank you. So, the quick answers are these are deals where we may have smaller portfolios of assets that in and amongst themselves, the effort, the cost, and the scale could negatively impact the yield associated with these smaller portfolios. So by putting together a number of these smaller portfolios, smaller deals programs into one portfolio, we attract a broader range of buyers for those portfolios because it's worth their while to look at significantly larger portfolios than to look at very small deals as we look at that. And so that has two effects. One is because you attract more buyers because of the scale of the portfolio, there's more competition for those assets. And as a result, you get better yields and better auction dynamics in regards to those portfolios. And then secondly, just the ease of doing internally one deal versus doing 12 or 15 obviously has its benefits too, just from a bandwidth perspective with our syndication partners. So that's really what's going on here with those portfolio deals as we put them together.

And Frank, is this a response to the fact that the originations from the OEMs have been slower? And if that's the case, do you expect to carry this practice on going forward, given the fact that you've got higher yields?

We expect to carry the practice going forward. And this has always been part of the maturation strategy of the syndication portfolio. So it also allows us to take some of the smaller non-investment grade names and combine those with some of the investment grade names and get better economics there. So really, I would say it's more part of our ongoing strategy. It's always been on the radar screen. And as we've continued to mature this market and broaden the buyer universe, this made sense to come to market with these deals, especially given the yield profiles we were able to access by doing that. I would expect that you would continue to see portfolio deals in the future, just as we've continued to broaden our syndication strategies over the last several years. I'd also add that this week we were able to do our first Canadian syndications. And so, again, another step in the maturation process of our syndication platform.

That's quite clear. Thanks, Frank. And, Jay, if I may, in terms of the return capital to shareholders, you've been very aggressive on the buyback. You've increased the dividend. But is there any set – timing for a review of the dividend by the board or when the management would suggest to the board. It looks like you've done it in the third quarter for the last couple of times, but given the fact that we've seen free cash flow very strong this quarter and presumably growing forward, are we going to need to wait a couple more quarters for the next dividend increase, or would this be something that the board or the management team would suggest sooner than that?

Yeah, John, I think, you know, to your point, we've settled into a comfortable groove here as, you know, coincident with the release of our Q3 results. We have announced a dividend increase for two years in a row. I wouldn't expect that to change materially for 2021 given, you know, or excuse me, for 2022 given the that we're working our way through the resumption of full productive capacity by the OEMs and we'll have a much better view of 2023 as we enter the second half. And thereafter, I think it will be at the Board's discretion as to the frequency and the timing of those dividend announcements based on the return to more normalized levels of origination and indeed excess originations as we claw back some of that backlog that has built as a consequence of these vehicle shortages.

Great.

Thanks, Jay. I'll recoup. Thanks, John.

The next question comes from Jamie Gloin of National Bank Financial. Please go ahead.

Thank you. Good morning.

Good morning. I wanted to just dig into some of the yield generated on the rental portfolio. So looking back into 2019, 2020, it was kind of running around a 5% revenue yield on rental revenue. And now we're stepping up close to 8%. Could you Could you break down some of the drivers of that? I would assume that Mexico is a big driver, but could you break down and give us a little bit more color as to the contributing factors and the sustainability of those factors?

Sure.

So what I would tell you is there's a couple of things that are driving that. Obviously, geographic growth. is a big positive for that as we see it going forward. Additionally, scarcity of assets is also a driver for that. So more competition for scarce assets in regards to that is another driver of it. So in the near term, we'd expect it to be relatively consistent, but we'll keep an eye on that and make sure we update you as the market dynamics change.

Did we lose Jamie? I think so.

Pardon me, Jamie. Pardon me, Jamie. Your line is open. Please go ahead.

It looks like we lost Mr. Glenn.

We'll go ahead to the next question, sir.

The next question is from Tom McKinnon from BMO Capital. Please go ahead.

Yeah, good morning and thanks for taking my question. Just looking at the operating expenses, up 3% or 3.5% quarter over quarter, 7% year over year. If I look at the November guidance where you lay out revenue and pre-tax operating income, you can sort of back into what you see as being an OPEX growth there. And that would imply about a 2% CAGR in terms of operating expense growth. So for 2022 and 2023. So I guess the question is, you know, how comfortable are you maintaining operating expenses at, you know, a 2% growth rate here going forward when they went up 7% year over year in 2021 when you had some pretty good production and they went up 3.5% quarter over quarter. So maybe some color on that, please. Thanks. Sure.

I'll take a crack at that. So when we look at the OpEx growth this year, it really falls into two categories. One is, and impacted in the third and fourth quarter, salaries and wages. So the outperformance in our business created more short-term incentive compensation as we beat balanced scorecard, met and beat balanced scorecard metrics throughout the third and fourth quarter, and so adjusted that. Offset modestly by less long-term incentives compensation adjustments. If you remember, fourth quarter of last year, we had a material adjustment up in the long-term incentive plan accruals. This year, not so much. Offset by lower G&A. And then a big driver has been the depreciation and amortization, as a lot of our new projects have come online in regards to pre- 2019 2020 investments that came online in 2021 around mid-year and many of them coming on at the same point in regards to the outlook of two percent growth this is one of the number one focuses of the management team cost control of the salary and wages line and the gna line as we move forward here and so This is an ongoing discussion identified and taking pass to drive to those operating expense numbers consistent with the growth in those forecasts. So I would tell you that implies target growth and therefore target incentive comp should we significantly outperform the growth then you might see slightly higher salary and wages, but you'll see an increase in your margins because of that outperformance. So it would effectively more than pay for itself should that occur. But with our guidance, we feel very strongly that this is a critical area of focus and that we are focused on delivering those OpEx numbers for the company.

Frank, if I could, I just want to build on that and maybe take it to a slightly strategic level. As Thomas, we shared with you, our long-term ambition for this organization is to grow revenue at 4% to 6% and to translate that revenue growth into a higher level of operating income growth. We do expect our operating expenses to grow in keeping with a growing business. But we expect to be able to expand our operating margin like we did in 2021 by 66 basis points to some 52.6% as we go forward. The other piece that I want to draw your attention to is in 2021, our operating expenses were in support of that you know, 5.5% revenue growth that we achieved, plus in support of the revenue growth that has been deferred. So we had $45 to $55 million of additional revenue that we earned that had to be analyzed, sold, ordered by our teams. So we had to have the necessary resources in place to earn revenue that revenue. Rough, rough, rough, the business grew 10% last year. Unfortunately, 45 to 55 million or 4% of that growth ended up getting deferred into future years. That's the other piece that isn't necessarily obvious on the disclosures is we needed to have the infrastructure in place and the associated costs of providing for closer to 10% growth than the stated 5.5% growth that we achieved in year. Plus, as you can appreciate, with those vehicles not being available, we had to expend a great deal of effort on behalf of our clients to help them manage through this industry-first phenomenon that, again, was a large call on resources. So coming back for us, this is profitable revenue growth and expansion of operating margin over time. And so we would expect our operating expenses to increase. As Frank says, we will manage them judiciously in 2022 as we continue to work through a constrained vehicle environment. However, our eye is always on that operating margin as our means of assessing just how well we are evolving the ability of our operating platform.

That's great. And as a follow-up, you have mentioned, I believe, in the release that client vehicle activity is now back or approximating pre-pandemic levels. So just in terms of the usage-based services that you get revenue on, You know, looking at things like fuel and tolls and accidents and maintenance, I guess, tires, things like that. Are those all back to relatively pre-pandemic levels as well? Maybe you can highlight which kind of your services are sort of all back to pre-pandemic levels.

Yeah, the vast majority of our services are back to pre-pandemic levels. And to cite a couple of the examples that you offered up, you know, fuel consumption, managed maintenance, accidents, incidents, tolls and violation. So they are at or approximating the volumes of activity that we would have seen pre-pandemic. A major area of service revenue for us that isn't is remarketing. So that inability to have a new vehicle delivered to our clients such that we can take possession and remarket their vehicle in Canada and the U.S. and generate the associated revenue from that, that is obviously still significantly depressed given the OEM production shortages. We will expect remarketing revenue to grow from its base of 2021, given our increased expectations around originations in 2022. However, there will be aspects of the service revenue, like remarketing, that are still held back by virtue of our inability to secure sufficient vehicles in quantity.

Okay, thanks for that.

Not at all, thank you.

The next question comes from Jamie Glowing of National Bank Financial. Please go ahead.

Yeah, thanks for letting me back in here. So second question was just going to be on the order backlog. And in your conversations with your customers, obviously an impressive order backlog building to date. But in those conversations, do you have any sense or any indication how much they've potentially pulled forward orders from, let's say, 23 or 24 or even beyond to just really prime the pump to get ahead of OEM production delays. Do you have a sense as to how much that is driving activity and building of order backlogs today?

Yeah, actually, we have a good sense of that, Jamie, and very little of the order backlog that we have built as of December 31st, 2021. would be pulling forward future orders. I think in the early days of the vehicle shortage, say Q2, there probably was a subsequent quarter worth of pre-ordering that might have been pulled back by certain of our clients. As this has unfolded, that has settled down substantially. in large measure due to a couple of factors. So one, 80% of the order banks for our major OEMs are closed. So we can't actually place future orders for future model years with the OEMs, which is giving rise to what we reference as shadow order backlog. So in addition to these contractual backlogs, orders that we have taken and reported to. We're actually monitoring, based on our knowledge of our clients' fleets, their vehicle usage, and the optimum point for retiring that vehicle, remarketing that vehicle, and having that vehicle replaced by a new vehicle. And that shadow order backlog is building substantially. Again, we can't place those orders with the OEMs until the order queues open back up, which we expect would happen kind of late spring, early summer for some of the models that would be of interest to our client. So again, as we look at that $2.9 billion of order backlog that is built as at December 31st, 2021, Roughly $1.9 billion is really excess. In any given year, we'd exit the year with $1 billion worth of order backlog. So there's nearly $2 billion of order backlog. And all of that is vehicles that are required today by our clients to satiate their growth needs or to manage down the total cost of ownership of their fleets. And as you can appreciate with the more inflationary environment that we're seeing out there, there is a real interest, a real need to have those vehicles delivered ASAP.

Thank you.

The next question comes from Paul Holden of CIBC.

Please go ahead.

Thank you. Good morning. I'm going to go back to the discussion around operating expenses. I guess I would have a particular concern around the expense potential passport of expenses given wage inflation we're seeing, and particularly in the U.S., and just wondering what you've accounted for in terms of wage inflation and, I guess, thoughts around employee retention in that context as well.

Yeah. So, perhaps, Frank, let me start and invite you to offer up any additional comments around this. So your question is timely, Paul. We have just gone through our annual performance reviews and compensation discussions with our employee base. We operate within a performance-based compensation structure for the entirety of the organization. So every employee participates in an annual short-term incentive program that's based on our balanced scorecard results and One of the reasons why we saw an increase in our operating expenses in Q3 and Q4 last year was as a result of that increased performance that we were seeing regarding the attainment of those balanced scorecard objectives. And as I itemized in my opening comments, you know, record high NPS, you know, record-setting operational effectiveness, efficiency, top quartile employee engagement scores, and returns to our shareholders' cash flow income in keeping with the plan all led to a rather exceptional payout on behalf of our entire employee group. That was shared with our employees earlier this month, And in addition, so were the merit increases for 2022, all of which were very well received by our employees as fair recognition of their performance and appreciation for saying. So I would say to you, the inflationary impacts associated with those wage increases have been factored in. to our 2022 and 2023 guidance that we have provided you and the reaction from the employee base regarding both the merit increases and the performance payments associated with the short-term incentive programs were very well received.

And, Jay, I would just add that, you know, obviously we have invested in technology. So we do see the wage increases that Jay has discussed. We also see considerable opportunity to find and discover and enact efficiencies around our business. In part, as we start to see attrition, as most companies are these days, we are looking to better drive efficiencies through every component of our organization, leveraging both task practice, but also technology investments we've made into the business.

Okay, that is helpful. Thank you. And then my second question is related to EVs. Obviously, you've announced a number of initiatives in that regard recently. And if I think about the underlying driving trends towards EV, it would seem like a particularly important initiative for government-sponsored fleets, which tend to be mostly self-managed, I believe. Do you think that over time, the transition to EVs and your capabilities within that can help you penetrate that very large government self-managed market?

Very much so, Paul. I think your observation is spot on. As governments look to lead on the ESG agenda, and in particular around sustainability, I think they recognize that they want and need to walk the talk, and in doing so, will want to consider the electrification of their own fleets. And that is readily apparent to us in New Zealand. They've been at the forefront. of policy design and adoption around a much more sustainable environment. And as they cascaded, those ambitions through their government departments have sought to lead by example in terms of having at least 30% of their fleet electrified. And our custom fleet group in New Zealand has been at the forefront of that. now sits on a number of government panels as an advisor to governments in terms of helping them assess and plan for this evolution. So yes, I think they will be the flag bearer of fleet electrification go forward. And as they do, and as they start to appreciate the complexities of evolving from ICE to EV, I think organizations like us will be in a very good position to provide them counsel, provide them services, and ultimately provide them financing for those fleets.

That's great. Thank you. I'll leave it there.

Thanks, Paul. The next question comes from Shalab Garg from Veritas Investment Research. Please go ahead.

Good morning, and thank you for taking my questions. So first thing I want to touch on provisions for credit losses. I see that after Q2 F20, this is the first time Element took a chart. So any color over there and any outlook on how it can shape up in the coming months or quarters?

Yeah, so we were on the path to reduce the provision for credit loss as we move forward, and then Omnicron came. And so we've got two components to Omnicron. our credit loss, one is our statistical piece of this, and then some management overlays that we put in place at the beginning of COVID, if you remember, in 2020. And we've been peeling those off. We have some of those left. We were preparing to take them off, and we tapped the brakes because Omicron happened in December and wanted to keep an eye on how that could potentially impact some of the business. I would say that... Coming through Omicron, we feel very good about our position here and would continue to take our trajectory of relieving ourselves of those management overlays as we progress, all things being held equal as of today.

Okay, thank you. My next question is on the direct cost of fixed-trade service contracts line items. I see that it has increased like almost 10% year-over-year, not taking into account consideration effects. So just one, I understand that this is related more to the ANZ subscription program. So how's the pricing or the repricing capability over there? Like if it's inflation driven, is it possible for anyone to quickly reprice the subscriptions? Like how does that work?

Yeah, the contracts in ANZ have been designed such that it offers us a great deal of discretion and flexibility. in terms of the pricing arrangements, and thus we're less exposed to inflationary increases on the associated parts and labor that we procure as part of that managed maintenance program.

Okay, thank you. Those answers my questions.

Thank you very much.

The next question comes from Jiaquan from RBC Capital Markets. Please go ahead.

Just a couple of follow-up questions. One was just given the Russia-Ukraine situation. Has there been any insights you've gotten from your discussions with people in the industry, whether there might be any impact on chip production, just given the neon production that comes out of Ukraine?

Yeah. Well, obviously we're monitoring the situation closely and have not yet identified any immediate issues for our business. Our current understanding is that the primary impact will be on European OEMs manufacturing in Europe that rely on Russia and Ukraine for certain key ingredients to the automotive supply chain. not the least of which would be palladium, the neon gas that you've referenced as well as nickel and aluminum. So, you know, I would say to you that the chip shortage of 2021 took most global OEMs to a very different place in terms of their understanding of their own supply chains. And with that increased understanding, you know, plans in place to minimize disruptions along that supply chain for 2022, 2023 as they look to bring back their full productive capacity.

And just my second question was just going back to your comments on Armada. It seemed to me to suggest you have comfort with line of sight on revenues with them or at least the relationships. I just want to understand what's driving that. Is it because you perhaps renewed your contract with them? Is it specific discussions you've had with them about how they view their relationship with Element or something else? I'm just trying to get some insights of being a long-term partner for Armada.

As we've shared in the past, we did renew our contract late. 2020 with Armada for the continued provision of services and indeed the expansion of services that we provide to this fast-growing fleet that they operate. I would say that under the leadership of Chris Giddens, we have made just phenomenal inroads in terms of the relationship that we enjoy with this client. We have always had the lofty ambition of being a thought leader in the fleet management space for this organization, and if you spoke with them, I think they would be very forthright in saying that is exactly the role that we fulfill for them. We work in very close partnership to understand their evolving needs, and they are evolving and fast evolving, and then to help design and implement timely solutions to enable their strategic pursuit of same-day delivery. Now, the relationship, again, continues to deepen. It has never been better. It has never been more constructive. And we work in an enviable fashion in terms of the openness, the transparency, and the spirit of collaboration to affect meaningful solutions on a time-to-basis for this client.

Thank you.

The next question comes from Stephen Bowen from Raymond James. Please go ahead.

Thanks. Good morning, everyone. I just want to talk about the backlog again. Jay, I think last, going into Q4, you provided some guidance of where the backlog would be at Q4, which... came in, I think, a little bit above your guidance. But maybe you could just talk about – you're talking about the backlog growing until, I guess, until the first half of 23. So do you have some sort of range where you think the backlog will be at that point? And then how long does it take to clear to get back to that $800 million, $900 million normalized amount? Yeah.

As we think about the order backlog, again, these are contractual commitments that we've made to an OEM to have a vehicle produced, which in turn results in a contract we have with our client to accept that vehicle on production. And having built to $2.9 billion in orders, that meant that we needed to place and the OEMs needed to accept these orders that our client have in turn provided us. We will, in Q1, we have the possibility of being flat or maybe even being slightly down in terms of the order backlog. In that, we expect the originations, OEM production, to increase in Q1 and as a consequence draw down some of the order backlog that has built. At the same time, as I mentioned earlier, some 80% of the order banks have been shut by the OEMs. They're not accepting any more orders for model year 22 and won't be opening model year 23 order banks until April, May, June, depending on some of the models, or perhaps even a little later, again, depending on the models. So we're going to have this dynamic where we enter Q1 with $2.9 billion of order backlog. It will be drawn down, which is a great thing in terms of originations, and some of that will be replenished by new orders that we've been able to place with the OEMs. And that, for us, is just a bit of a black box to... just how many orders we will be able to place. And to the extent that we're not able to place those orders, it is giving rise to this increasing shadow order backlog. We started with originations, we went to orders, we went to order backlogs, and now we have to evolve this to a discussion around shadow order backlog, just to give you an idea as to just how complex this topic has become. And, again, as you can appreciate, there's no one who has a better understanding of the need for replacement of our client vehicles than we do. And so we have a clear idea as to when that vehicle is in need of replacement and when our client would typically signal an order. And what we're seeing is that shadow order backlog is increasing substantially. as a consequence of the order banks being closed and us not being able to place the order with the OEM and create that contractual chain between us, the OEM, and the client. So yes, we would expect the order backlog in Q1 could be flattish, could be down a little bit, could be up a little bit. We would expect as the order banks open in Q2, and again, depending on how quickly the OEMs continue to ramp up production, there's an opportunity to increase the order backlog through Q2, Q3, and obviously Q4, we would expect a fairly significant increase. In 2023, so if we expect our... the OEMs to continue to ramp up. By the end of the first half of 2023, we expect the OEMs to be back to 100% productive capacity, which means they will be able to handle the fullness of our current order volume. And at that point, we'll be in a position to add additional shifts to start to chew through the order backlog. And we expect a goodly amount of of that order backlog to be addressed in the second half of 2023, and then an equally goodly amount to be addressed in the first half of 2024 before we get to a more normalized level of originations, call it the second half of 2024. So, again, we're not seeing anything To this point, that would cause us to be a little bit concerned about the guidance that we provided in November regarding OEM productive capacity. Indeed, if anything, what we've seen from the OEMs to date, what we're experiencing in the business in the first couple of months of 2022 has been very much in keeping with the thesis that we shared with you.

Okay, that's very helpful. Thanks, Jim.

Given the hour, this concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.