Element Fleet Management Corp.

Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management second quarter 2023 financial and operating results conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the prepared remarks, there will be an opportunity for analysts to ask questions. To join or rejoin the question queue, you may press star, then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. Element wishes to remind listeners that some of the information in today's call includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. and the company refers you to the cautionary statements and risk factors in its near-end and most recent MD&A, as well as its most recent AIS, 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 believes are helpful to prevent the company and its operations in ways that are useful to investors. A reconciliation of these non-GAAP measures to IFRS measures can be found in the MD&A. I would now like to turn the call over to Laura Dottoria Tannazio, President and Chief Executive Officer of Element. Please go ahead.

Hello, operator. Good morning, everyone. We are pleased to be here to discuss Element's second quarter performance, which includes record results driven by commercial wins and client growth. We continue to deliver a superior client experience in all five countries we serve, and we're successfully executing all five drivers of our revenue growth strategy by retaining 99% of our existing client base, expanding our share of wallet with those clients, earning market share from our competitors, converting self-managed fleets into new clients, and securing government and mega-fleet mandates. To put this into context, this quarter, we earned market share in welcoming 23 new clients, we converted 25 self-managed fleets, and we continue to expand our share of wallet with 124 pre-existing element clients. These wins represent the potential addition of over 20% more vehicles under management than what our global commercial team accomplished during the same period in 2022. In addition, an important part of our performance was the impressive $2.5 billion of new vehicles that we were able to originate for our clients. This was a function of steadily improving OEM production capacity, which of course is great news for both our clients and our shareholders. And as we communicated last quarter, our backlog of orders continues to remain at elevated levels and is expected to carry us well into 2024 with $2.6 billion of contractually committed future origination volume. Moreover, our clients' demand for new vehicles continues to be strong as they placed $4 billion of orders, a record, in the first half of this year. Now pivoting to ESG, we published our third annual report in June containing full disclosure of our Scopes 1, 2, and upstream Scope 3 greenhouse gas emissions. And we're currently working on the establishment of science-based emission reduction targets and expect to share those with you in 2024. That said, we've already been taking action to reduce our environmental impact. We achieved a 55% reduction in Scopes 1 and 2 emissions in 2022, and that's relative to our 2019 base year. And it's thanks to our internal fleet electrification efforts and decreased energy usage at our offices. Regarding electric vehicles, We launched and guided numerous client pilots across our global footprint with the full suite of ARC by Element services. Our strategic consulting capabilities in EVs continues to garner strong interest from clients and prospective clients, particularly in the self-managed space. Now, before I hand it over to Frank, I want to thank our entire team at Element for your continued dedication and hard work. Without you, these record results would not be possible. Now looking ahead, we continue to have lots of opportunity to grow and further improve our performance with planned and paced investments in our business and with the continued execution of our strategy. This is an exciting time for Element, and we're looking forward to sharing future successes with you. Over to you, Frank.

Thank you, Laura. Good morning, everyone. It's great to be demonstrating Element's ability to deliver on our client value proposition and generate strong results across the business. Two things before I take you through those results. First, we disclosed this time last year we earned $8 million of non-recurring net revenue in Q2 2022. Excluding that from year-over-year comparison shows the organic growth of the business, so I'll be citing growth on that basis. And second, The growth measures I cite will also be in constant currency because strengthening of both the US dollar and Mexican peso benefited our Q2 results as reported. After normalizing for those factors, our second quarter growth was still near the high end of our long-term guidance ranges and very strong in absolute terms. We grew net revenue 8.4% year over year to 323 million for the quarter. Adjusted operating income grew 4.5% on the same basis despite increased investment in our commercial capabilities, which I'll come back to shortly. Operating margin was 55.1% for the quarter, consistent with our guidance. Adjusted earnings per share were 33 cents, which is a 10% improvement year over year. And free cash flow per share was 46 cents, which is a 22% improvement year over year. It's worth noting that Q2 free cash flow benefited somewhat from the timing of cash payments and cash inflows from originations in the first half of this year. Normalizing for those items, free cash flow per share would have been approximately 42 cents in the second quarter, and the incremental four cents would likely benefit the second half of this year equally. For certainty, we will reaffirm our guidance of $1.58 to $1.63 of free cash flow per share for the full year. Looking more closely at our second quarter net revenue growth year over year, It was driven by services revenue and net financing revenue growth. The first pillar of our capital lighter business model is services revenue. Consistently delivering superior client services is fundamental to our value proposition. These services result in our clients and their drivers developing a near daily working relationship with Element, which is the stickiness that enables us to retain almost 99% of our business annually. Services revenue was up 12% year-over-year, driven by share of wallet growth, namely increased penetration and utilization, as well as modest growth in ANZ, Mexico, and Armada services revenue streams. We've quantified the relative value of these contributions in our supplementary information document for Q2 and included further detail in the MD&A results commentaries. Net financing revenue grew 6.4% year-over-year, driven by average net earning assets growth of 6.2% and interim funded asset growth of 100%. Each of these asset categories grew as consequence of our record $2.5 billion of global originations in the quarter. Year-over-year gain-on-sale, or GOSS, growth also contributed net financing revenue growth. In Q2, Goss moderated slightly in Australia and New Zealand compared to the second quarter of last year. However, this was more than offset by Goss growth in Mexico on the same comparative basis. Now I'll turn to the second pillar of our capital lighter business model, which is syndication. We syndicated $690 million of assets in the second quarter and generated $11.4 million of revenue. That represents 1.65% yield on the assets syndicated We're 35 basis points shy of the 2% long-term average yield we continue to guide for modeling purposes. As we've said before, the continuing uncertainty around interest rates has sustained elevated spreads, which compress available syndication yields. Remember, the biggest benefits to element of our syndication program are, first, the ready access to off-balance sheet funding for growth. Second, the ability to manage our tangible leverage ratio. Third, the accelerated revenue recognition and increased velocity of cash flow, which we can redeploy for attractive returns. And fourth, the freeing up of excess equity to reinvest in the business and return to shareholders through buybacks and dividends. Our access to capital through syndication remains deep, and we are confident that we can syndicate the volumes implied by our full year guidance. Second half originations, should provide ample inventory for our syndication team to work with. Turning now to operating expenses, we knew the modest increase was coming this quarter as planned, which we signaled in May. And this increase reflects both practical and strategic choices, as well as inflation. Given our confidence in long-term higher annual organic revenue growth potential of 6% to 8%, which is up from the previous 4% to 6% run rate outlook, We need to resource our teams to lead, manage, and fulfill this potential. Resourcing properly means hiring and developing the right talent in the right roles. It means continuously improving our market-leading capabilities. And it means facilitating meaningful client interactions through travel and events as we exit the pandemic era and increase our commercial ambitions. We are also investing in our service delivery model to sustain the growth of our net promoter scores and lower our cost to serve. The health returns on these OpEx investments are already being demonstrated. For example, in our second quarter results and in the commercial success profile that Laura shared. That commercial success will have lasting impact on our performance over the next several years, such as the nature of our incremental recurring revenue growth model. I want to briefly discuss sustaining capital investments, which we disclosed in our calculation of elements free cash flow in the supplementary. We expect to make between 75 and 80 million of sustaining capital investments this year, which is more than we have in recent years. This is partly a function of inflation on the 50 to 55 million in annual sustaining CapEx range we first set out several years ago. However, that range was predominantly focused on IT spec. As Laura mentioned, we've been electrifying elements internal globally, which will impact our sustaining capital investment totals both this year and next year. We will also be optimizing certain of our real estate footprints over the next two to three years, the cost of which will be partially comprised of incremental sustaining CapEx. These and other non-IT sustaining capital investments are forecast to be approximately $18 million in 2023. Turning now to our funding, as you know, Element maintains ready access to diversified sources of on-balance sheet funding from a roster of high-quality lenders and investors across all of our markets. And this is evidenced by our activity in the first half of the year. In April, we issued $750 million of asset-backed term notes, which was greeted by strong investor demand, allowing us to upsize the offering from $500 million while improving pricing. In June, we upsized our credit facilities, as well as issuing a $750 million U.S. dollar senior unsecured note at 200 basis points over the relevant treasury. We're very pleased with this pricing for our third-ever U.S. bond deal and given the market at the time. With a strong outlook for originations over the next several quarters, we continue to evaluate funding options to optimize both our on and off balance sheet mix and, of course, lower our cost of capital. This is an exciting time to be looking ahead at elements prospects because there's so much positive momentum in our business. Our record profitability continues to validate our strategy and the organization's cohesive approach to delivering that consistent superior client experience. Over time, this growing profitability, combined with recent and contemplated global tax legislation, is likely to drive increasing cash tax expenses. That said, we expect cash taxes to remain below the accounting provision for tax that is a function of our effective tax rate. Before we take your questions, let me officially reaffirm the full year 2023 results guidance we've provided the market in May, which remains unchanged. We commit to revisiting this guidance since November as part of our Q3 earnings release. We also expect to be in a position to provide you with full year 2024 results guidance at that time. For now, I'll turn this call over to the operator for your questions.