Element Fleet Management Corp.

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 1 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and 0. 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 MDNA, 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. Elements, 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 beliefs 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 MDNA. 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 discussions. 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, had 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 tens of millions of dollars 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. And we're advantaged by inflation as our cost plus model benefits from increases in fuel, parts and labor prices. This is 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, 29 cents 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. While we knew that the overhang of the pandemic on client activity levels would fully recede and that OEMs would gradually source efficient 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 in 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. And 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 to 14% year-over-year growth in our originations en route to some 37 to 47% year-over-year increase in 2023. We're holding guidance on originations constant in the $5.5 to $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 23 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 recovering 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 the 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. And 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. And 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 percent quarter over quarter. As you saw in our supplementary, gains on sale, or GAS, from ANZ and 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 ANZ 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 planned for this year. 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 MDA, 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% to 6%, and our scalable operating platform magnifying that into 4.5 to 7.5 adjusted operating income growth, implying a 52.5 to 53.5% operating margin. We anticipate 9 to 14% adjusted EPS growth in 2022, and an effective tax rate of 25.5 to 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 to 15% to $1.16 to $1.21 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-risked 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 we'll provide an update later in the year. With that, operator, let's please open the line for questions.