Element Fleet Management Corp
TSX:EFN
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Element Fleet Management Corp
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Welcome to the Element Fleet Management First Quarter 2018 Financial Results Conference Call. [Operator Instructions] The conference is being recorded. [Operator Instructions]I would now like to turn the conference over to Zev Korman, Senior Vice President Investor Relations. Please go ahead.
Thanks, Arielle. Good morning, everybody. Thanks for being with us this morning. Joining us today to discuss today's results are Dan Jauernig, acting Chief Executive Officer; and Samir Zabaneh, Chief Financial Officer. The news release summarizing the results was issued earlier this morning, and the financial statements and MD&A have been filed on SEDAR. This information along with the presentation we'll be referring to this morning are also available on our website at elementfleet.com. Before we begin, I want to remind our listeners that some of the information we'll share today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. And I'll refer you to the cautionary statement and risk factors of the most recent MD&A and AIF for a description of these risks, uncertainties and assumptions. Although management believes that the expectations reflected in these statements are reasonable, we can obviously give no assurance that the expectations of any forward-looking statements will prove to be correct.Our earnings release, financial statements, MD&A and today's call include references to a number of non-IFRS measures, which we believe will help 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 our MD&A. We'll begin with some formal remarks from management followed by some time for questions. [Operator Instructions]Now I'll turn the call over to Dan Jauernig.
Thank you, Zev, and thank you to everyone on the call for joining us this morning. I'll turn to our quarterly results in a moment, but before I do, I'm sure you all saw our announcement yesterday morning about our new CEO as well as a refreshment of the board. Speaking on behalf of everyone at Element, we are very excited to have a new permanent leader in Jay Forbes, whose expertise and insights can really outtake this company and the outstanding platform that we've built to the next level for the benefit of our customers, our shareholders and of all of our stakeholders.We really believe the best way to create value on all fronts is for the business to focus on execution and thereby achieve this company's full potential. Jay Forbes has a tremendous track record as an accomplished CEO who gets more out of companies. We are all looking forward to working with him to do that here at Element. And of course, all of this will take place under the oversight of a reconstituted board. As you've seen the board is adding 2 new independent directors immediately, and 2 more will stand for election at our Annual General Meeting in June. As you know, the company has been looking for new directors who can bring new perspectives to the board. Through our board's own process, they identified one nominee. And through discussions with some of Element's significant shareholders, the board has identified 3 more independent candidates, all of whom are valuable additions to the board. As part of this, Steve Hudson and Richard Venn have decided not to stand for reelection. We thank them both for their service.So we enter the next chapter of Element's development with the addition of a CEO who has a track record and the skills to take this company through the next stage in its evolution and deliver even more. And we have a board that's even better equipped to help the company navigate the challenges and opportunities in front of us.So with that, let's turn to our Q1 2018 financial results and review. As we indicated in this morning's press release, we continue to make good progress on our strategic plan, mainly enhancing the customer experience, optimizing our operations, reducing our cost structure and executing on our pipeline to position the company for earnings growth in 2019. Based on our key leading indicators, operating metrics and client customer surveys, our customer satisfaction and customer retention rates continue to improve and are rapidly returning to historical rates. Based on these improving trends, we believe our retention rates will be back to normal within the next 2 quarters.Adjusted EPS in the first quarter was $0.16, which was slightly ahead of our internal expectations. As we announced on February 5, we expected full year 2018 core fleet adjusted operating income to be down approximately 3% to 5% on a currency-neutral basis, with Q1 being down more on a year-over-year basis due to the large number of customer cancellations in late Q4 2017 than the rest of the year. Adjusted operating income before tax was down 6.8%. As expected, Q1 was down more than our full year outlook, but it was slightly better than our plan. As a result, our financial outlook for this year remains on track, and if we continue to execute on our pipeline, we currently believe we can achieve the low end or the better end of the previously communicated range. As Samir will discuss in greater detail, our effective tax rate in 2018 will be better than expected, and as a result, core adjusted operating income after tax was down only 3.3% in the quarter compared to last year. From a growth perspective, we originated close to $1.5 billion of new vehicle purchases during the quarter, up 10.4% from Q1 of 2017, which, in turn, drove a 3.8% growth in our net earning assets, both on a currency-neutral basis. We continue to execute on the strong pipeline. And later on, I'll highlight some examples of new wins that are indicative of new contracts that we're signing. Our funding platform remains the most robust in the fleet management industry and continues to provide us with significant access to capital and financial flexibility. We've recently closed a U.S. $1 billion funding in our AAA rated Chesapeake II structure, the first of several for the year. In late April, we also extended the maturity date of our $1.6 billion Canadian securitization program from November 8, 2018, to November 2019 under the same terms, pricing and conditions that we have enjoyed previously. Both fundings are a reflection of the quality of our assets, our customers and the overall strength of our business and portfolio. Together with our strong investment grade corporate credit ratings, we continue to have ample access to the capital markets to support our growth.Last quarter, we talked about several actions we took to align our cost, restructure our organization and accelerate growth. I am pleased to report that these efforts combined with ongoing process improvement initiatives are delivering results in terms of improved customer satisfaction and retention rates. Revenue attrition, due to integration challenges, peaked in Q4 of 2017, improved in Q1 and have continued to show progress so far in Q2. We are winning and renewing customers in both new and competitive wins. These are customers who trust our expertise and ability to execute and believe we have the right vision for their business. We are working to meet and exceed customer expectations. Our focus is on being faster and more efficient. We've made measurable progress in many key areas. As we achieve goals in each area, we are listening to our customers and, in many cases, setting new and higher targets. We continue to find ways to simplify the organization and to reduce handoffs so we can get customers what they need faster. We have streamlined telematics fulfillment, aligned our heavy-duty truck sales team to report directly into our commercial sales regions, consolidated and simplified our billing processes and removed layers in our fleet partnership solutions account management team.Looking ahead, we are investing in innovation to materially improve the fleet management experience. In 2018, we announced last quarter, that we will invest an additional $35 million in making our systems faster and easier to use for our customers and employees alike. Areas of focus on our product roadmap include using data from connected vehicles directly into traditional products, like fuel reporting and maintenance. This will benefit both the customer and driver experience and allow us to take greater advantage of our advanced analytic tools and data infrastructure.We are developing more capabilities into our mobile app, and are seeing strong driver satisfaction among mobile app users. And we are excited about the possibilities of a recent pilot using machine learning to automate routine maintenance approvals. Based on customer and driver feedback, we believe we have a winning product and technology roadmap. And as a result, we're in a much stronger competitive position today than ever before.On Slide 8, you will see an overview of first half releases for Xcelerate. We are continuing to deliver enhancements that optimize the customer experience and deliver on the promise of advanced analytics. In January, we released a new widget that makes it easier for our customers to manage preventive maintenance for their fleets and made it easier to communicate with customers through Xcelerate. We have also integrated CEI's systems into Xcelerate. CEI, as you recall, is our leading risk, safety and accident group that Element acquired at the end of 2016. Customers can now access CEI DriveCare (sic) [ DriverCare ] from Xcelerate through a single sign-on, and drivers get risk and safety task and communications through their Xcelerate Driver for mobile app. Our latest release has showcased Element's market-leading analytic tools, and I'm pleased to report that we just launched a new feature called Geospatial Dashboards. Geospatial Dashboards let customers view their inventory, maintenance and fuel cost on a 2D and 3D map interface. Users now have an engaging and an interactive way to analyze their data by drilling into specific areas of interest. Early feedback and prospect and customer demos have been overwhelmingly positive and has seen proof of the new kind of fleet management experience that Element can deliver. We are also testing new Xcelerate dashboards for connected fleet vehicles. Customers will be able to use Xcelerate to see telematics data and gain valuable insights in the key fleet performance and driver behavior, including idling and speeding, that impacts safety and predicts crashes. Analyzing data by breakdown or unit lets customers identify opportunities to reduce cost and impact driver behavior.On the next few slides, I'd like to highlight some examples of sales and customer retention success where our customers have allowed us to share this information with you. First of all, Primoris Service Corporation (sic) [ Primoris Services Corporation ] is a Texas-based specialty construction and infrastructure company providing services to pipeline, power, utility and civil markets. The company's fleet has grown through various acquisitions. Today, they have more than 2,600 vehicles that are both owned and managed by other fleet management companies. Primoris chose to outsource fleet management to Element to save cost and increase asset utilization and reduce vehicle downtime through Element's fleet management services. This strategy lets Primoris leverage Element's best-in-class fleet services and positions the company to effectively scale for growth.In Australia, we launched a program for Bluescope Steel, a global leader in premium coated and painted steel products to provide innovative solutions supporting their fleet management and supply chain needs. The program launched last month and is off to a really strong start. These wins, like the others in our portfolio, prove the value add of our service offering and are representative of the kinds of business we are securing from both self-managed fleets as well as from other fleet management companies. We are also proud to continue to expand our relationship with GE Appliances, a company with a 1,500 vehicle fleet. GE Appliances was acquired by Haier in 2016, a transition for both the customer, even as Element was going through its own transitions. This is why we were extremely pleased to have been named a 2018 Distinguished Supplier by GE Appliances at their 2018 Presidents' Council Summit, citing Element as a supplier who has performed with excellence across all key categories during one of our most challenging periods as we exited the integration phase in 2017.Another example of our strong customer relations can be found in Unilever, where have expanded our relationship and leveraged our strategic global alliance with [ our vow ] to secure the remaining 50% of their fleet vehicle fleet from a competitive fleet manager following a global RFP. Mexico represents Unilever's largest fleet, and we are pleased to expand our services with them in Mexico across a fleet of 1,800 vehicles, encompassing our broad of range of services, including lease, telematics and maintenance. We remain committed to delivering the best service and value to our fleet customers. During the quarter, we acquired a 15% minority stake in Amerit, the largest U.S. provider of dedicated outsourced fleet maintenance, with over 1,500 certified technicians delivering on-site, service-center and mobile vehicle maintenance. Amerit has been a strategic partner to Element and the companies -- and the 2 companies have worked together closely for the past 5 years, with Amerit serving a number of Element customers. We look forward to continuing and expanding our relationship with Amerit, which will allow for a more integrated outsourcing model for prospective and existing customers and deliver new solutions in adjacent markets, such as on-demand vehicle, ridesharing and delivery services.We completed our IFRS 9 assessment across the organization resulting in a onetime accounting adjustment to retained earnings of $65.3 million after-tax. The adjustment reflects a change in accounting methodology as required by IFRS 9 and has no material impact on our overall financial position and provides a cushion against any future losses from our non-core portfolio. The 19th Capital joint venture continues to execute on its strategic plan to improve its operations and results. While this will take time, we continue to see signs of progress. Following the write-down of all 2013 and older trucks last quarter, approximately 85% of the portfolio value is represented by trucks that are 2015 or newer. The operating team has reduced vehicle turnover times by half, from 45 days to 22 days, and are driving towards a 2-week turnaround. The joint venture produces EBITDA of USD 19 million, and with interest expense of $13.3 million, generated cash from operations of $7.7 million in the quarter. On balance, I believe we had a solid overall quarter and that we achieved many of the goals that we set out for ourselves at the beginning of the quarter. That concludes my overview of the operating performance. Samir will now provide an overview of our financial results for the quarter.
Thank you, Dan, and good morning, everyone. Starting on Page 17. Adjusted earnings per share for the core fleet management operations was $0.16, which was slightly better than what we had planned for, reflecting solid progress and stabilizing customer retention, signing new customers, optimizing our cost structure and a lower sustainable tax rate following the enactment of the U.S. tax reforms. Non-core assets contributed $0.01 in the quarter.Page 18 is for your information purposes and sets out how the consolidated results are separated between core fleet management and non-core assets.On Page 19. Core fleet management net revenue was $208 million, which was a decline of 6% and 2% sequentially and compared to the first quarter of 2017, respectively. On a constant currency basis, revenue increased by 2% compared to the same period in the prior year. The sequential decline in services revenue reflected the attrition experienced at the -- at year-end as well as seasonally strong Q4 for syndication and remarketing revenues. The impact of the attrition we experienced in Q4 will continue into the second quarter of the year as customers migrate their services but will increasingly be offset by new vehicle origination and activation as the year progresses. Retention rates in the U.S. for Q1 2018 was up significantly, indicating solid improvement in customer experience. Compared to the prior year, services revenue increased by 3%, constant currency, driven by various service lines in various jurisdictions, of which accident management and telematics are 2 examples. Normalizing for the unusual attrition in Q4 2017, services revenue would have grown within the range of what we expect this line item to grow at under normal circumstances. Net interest and rental revenue was $80 million for the quarter, relatively flat on a constant currency basis compared to previous periods.Page 20. Net interest margin for the quarter was 2.6%, relatively flat on a sequential basis with -- and consistent with expectations. The decline from the 2.7% in the previous year was a result of onetime items that were booked as interest income in the prior year and which were not repeated in the current quarter. In addition, the higher customer incentive compensation, or IDC, that was incurred in 2017, and which is amortized as a contra-revenue and overall spread reduction on the customer side contributed to the reduction in the revenue yield. This was partially offset by lower relative overall cost of funds given the various term notes issued in our Chesapeake ABS platform.Next page. Adjusted operating expenses were $121 million for the quarter, a decrease of 5% on a sequential basis and an increase of 5% compared to the prior year. As we indicated previously, operating expenses peaked in the fourth quarter of 2017 given various factors, mainly related to the IT migration earlier in the year. We also indicated that such expenses would decline over the course of 2018. As Dan mentioned, we have executed on an operational efficiency plan, and which has resulted in the cost savings during the quarter. We expect the remainder of the quarters during this year to remain relatively in line with the current quarter, and which will result in the nearly $20 million to $25 million of saving, constant currency, from the Q4 2017 annualized level. As a percentage of revenue, operating expenses increased to 57% as a result of the near-term reduction in revenue related to both core and non-core assets but is expected to decline over time reflecting our active cost reduction measures and the expected resumption of core fleet revenue growth.Turning to non-core operations. Overall, revenue was $2.9 million for the quarter. Services revenue remained relatively flat sequentially, and the decline in net interest and rental revenue was primarily due to the adoption of IFRS 9 and the related impact on ECAF, which will be discussed later. Compared to the prior year, services revenue declined due to the nature of such revenue in the past, and which we -- as we had indicated would not be repeated. NIM declined due to the sale of various non-core assets, mainly the Rail Notes and over half of the heavy-duty truck portfolio, the depletion of other assets, including the equipment financed in New Zealand and the adoption of IFRS 9 and related impact on ECAF revenue. On Page 23, we provide an update on the non-core portfolio. During the quarter, we received $1.3 million in principal repayment related to the senior term loans to 19th Capital. The higher balance shown in the page reflected currency exchange impact between December 31, 2017, and the end of Q1 2018. This principal repayment is lower than what we had expected. However, we do expect the principal repayment will increase during the remainder of this year as utilization rates increase, maintenance expenses decline and the disposal of unutilized vehicles ramps up. We indicated previously that Element expected that principal delays may reach up to $60 million at any one time. We currently expect that the aggregate amount of delayed principal repayment to be at or near this level.Operating losses in the joint venture brought the equity balance to 0. The carrying amount for ECAF declined as a result of IFRS 9 adoption. And finally, the New Zealand equipment finance portfolio and the heavy-duty truck portfolio depleted as planned. As noted in our year-end financial statements, Element purchased a heavy-duty truck portfolio during Q1 from 19th Capital, and which was added to this portfolio and hence the balance increased compared to year-end.Next page. At quarter-end, Element had $4.2 billion in available financing to fund ongoing originations. Our adjusted cash flow from operations continues to be strong and was $106 million for the quarter or an annualized level of $424 million. We believe our strong cash flow and liquidity available on our balance sheet will be sufficient to fund future growth and deliver capital to our shareholders.Let me now turn our attention to the IFRS 9 impact. As mentioned previously, Element adopted IFRS 9 beginning January 1, 2018. This slide shows the 3 main categories of the new accounting standard and the components of our business where such changes apply. You will note that the aggregate pretax impact of this adoption was $86 million, with a provision against the loans to 19th Capital accounting for $65 million of the change followed by the impact on ECAF, which accounted for $17.5 million and $0.6 million for the New Zealand runoff equipment business. The remaining $3 million was related to the core fleet management business. On an after-tax basis, the impact was $65 million, which was booked against the beginning balance sheet in returned earnings. It is important to note that the impact of this adoption, together with a onetime restructuring charge of $40 million, is well within the capacity and our financial covenants with plenty of headroom. And such room is only expected to grow with the growing net income level we expect to have going forward. Let me provide you an update on our tax rate. You will notice that we expect ongoing effective tax rate to be approximately 18%, a reduction compared to the 20% to 21% historical level. Since the beginning of this year, we reviewed our tax strategies and took into account the recent tax reform in the U.S. And as you can see from the page, the impact of other jurisdiction on top of the Canadian statutory rate declined meaningfully, partially offset by various adjustment to statutory rates.Overall, let me summarize the quarter with the following remarks. Performance in the core business was in line to slightly better than what we had expected. The retention rates are back to nearly historical levels, and the customer pipeline has never been stronger. We implemented operational efficiencies quickly, without a negative impact on the core business. We will continue to look for ways to optimize the business throughout this year and into 2019. We have efficient funding platforms, evident by the 2 recent term deals in Canada and the U.S. Our liquidity is strong with significant capacity to fund earning assets and core business growth. Financial covenants are in compliance, even taking into account the impact of IFRS 9 and the $40 million restructuring charge, with plenty of capacity to spare. Finally, we are pleased with the solid rating all 3 of our rating agencies confirmed earlier this year. We do look forward to continue this momentum into this year and beyond.With that, I'll turn the call back to Dan for his closing remarks.
Great. Thank you, Samir. In summary, as Samir has stated, we believe the business is off to a solid start in 2018. As I stated in our last call, our focuses here remains on improving the customer experience, one customer at a time, and returning to growth by executing on our pipeline and continuing to add services that make our customers' fleet safer, more efficient and less costly to operate.As Samir indicated, our core financial position is strong. We have solid access to capital. We are rightsizing expenses. And as we execute on our pipeline, we expect results to improve over the course of the year. From a macro perspective, commercial fleet sales were up nearly 11% in the first 4 months of 2018, providing a very healthy backdrop for growth. Based on our first quarter results and our future expectations, we remain comfortable that core fleet adjusted operating income before tax for 2018 should be within the previously provided range of being down 3% to 5% compared to 2017. As discussed previously, if we continue to execute on our pipeline, and present trends continue, we will end up towards the better end of that range.With that, operator, I will pass the call back to you to open up the lines for questions.
[Operator Instructions] Our first question comes from Geoff Kwan from RBC Capital Markets.
My first question was on the Amerit investment. You've also, obviously, done the CEI acquisition. Just trying to understand -- is this Element looking to further vertically integrate with in the industry? And also in that context, is, maybe, part of the strategy to -- being able to reach out to potential new fleet leasing customers that you're not currently dealing with through making these investments?
Jeff, it's Dan. Yes, I mean if you look at our investments and some of the ones that we have announced historically, what we try to do is focus on providers that -- and some of these are strategic supplier providers that are good fit for us and our customers and provide the types of products and services that our customers want, in particular, on-demand maintenance to reduce the downtime of their vehicles, so you don't have to waste the driver's time or the vehicle's time taking it into a maintenance location. Amerit can actually come out to the client's location and do the work after hours. So while it might cost a little bit more, it saves the client a lot of money because there is a lot less downtime. The reason we want to do some of these investments strategically is because when we pick certain suppliers, we can work with them more closely. We can integrate their data with our data offerings and really get a good connection with the supplier to really get a steady stream of data. And that makes the service more valuable to our customers. So that's our strategy. That's our approach. And I think we're going to continue it strategically where it makes sense going forward.
Okay. Just another question I had was in the notes of financial statement, you mentioned in Q1 at the JV, there was a -- albeit very small a $10 million portfolio acquisition from the JV, and then indicated with that there was third-party funding that matured. Just wanted to get some color, I guess, what was the third-party funding. And just color around it, like: Are you going to have to do more of this going forward?
Yes, I mean, that was a one-off. The joint venture does have some third-party funding. This one particularly had a bullet maturity. Not something that we want to do going forward, but we thought it made sense in this particular case. We bought these vehicles or trucks at fair market value. And 19th Capital was able to use the proceeds to pay up that bullet maturity. So in this particular case, it made sense. But certainly not something that we're going to do going forward or need to do going forward.
Okay and maybe, Geoff, I will add one point. The quality of that portfolio is actually high. They tend to be -- and the utilization within the truck portfolio is also relatively high. So that's the one that we added to the heavy-duty truck portfolio, and so far, it's been performing as expected.
Okay. And if I can maybe sneak in one last question. In terms of, let's call it, inning of the Ball Game as to where you stand on Xcelerate and then the retention challenges that you've had, what inning would you say you are at? Say, in terms if -- ninth as you've completely done everything? Where would you put yourself today? And where would you've been when we were last talking in February?
Yes, from -- I mean 2 different questions, because I'll focus on retention, and I'll talk about the systems. With respect to retentions, I firmly believe we're in the late seventh quarter -- inning or early eighth inning. And we feel really good about where we're headed and everything that we're doing to improve the processes and make the experience better for our customers. So that's moving along very well. With respect to systems' investments, that's a hard one to judge. We have a -- we feel pretty good about the state of our system and where it is relative to the competition. But in terms of where the system could go in the future and the opportunities that we have to shape the fleet management industry, there's a lot of opportunities. So it's really hard to identify where we are in terms of all the opportunities that are in front of us. Having said that, I believe that those opportunities, to a large extent, can self-fund themselves. Obviously, we won't make a major investment in our systems unless we believe we're going to get a financial return for it. So that one I feel pretty good about where we are, but there's still plenty of opportunities going forward as well.
Our next question comes from Tom MacKinnon of BMO Capital Markets.
Two questions. First has to do with the $35 million investment in 2018 that you're making. Just to be clear, I think that's -- it doesn't include the Amerit purchase. I assume that's correct, right? This is over and above the Amerit purchase.
Yes, so when I talked about the $35 million, that's CapEx, not acquisition. That's exactly right.
And how much of this -- how does this impact OpEx going forward? Is this sort of capitalized, amortized? What or how should we be thinking about this $35 million then from that prospective?
Yes, good question. I'll give you my perspective, and then maybe Samir can jump in with greater details. When you look at our OpEx, we break it down between 3 lines: SG&A and depreciation and amortization. So when we talk about the cost management that we've been doing for the last quarter or 4 months and where we expect that to go, we're really focused on the first 2 lines, SG&A. And that's where we're measuring ourselves against the run rate from Q4 2017 and some of the cost savings that Samir talked about before. Depreciation and amortization, we do expect that number to go up. Right now, I could see us easily spending $35 million per year going forward. Some of these investments in technology and product enhancements and product improvements and new product releases have long-life-cycle returns. So I think we amortize them in over anywhere between 9 and 12 years depending upon what the technology is for. So you will see that number growing steadily through the next several quarters.
Okay. And then a question on the comment you made about the service revenues. I think you said that x attrition, the service revenues would have been in line with expectations. So how should we be looking at some of these new wins that you're getting? And how long would it take for those new wins to sort of replace the -- what you lost in terms of the attrition losses in service revenue?
Sure. So the services revenue, as I indicated before, I mean, under normal circumstance, you should expect services revenue to grow in the mid-single digit, call it 4% to 6%. And during this quarter, when you compare it to the last quarter, we would -- and excluding the impact of the spark of attrition, we would have grown nearly at that level. So that's to us is a very positive sign, even after the year of 2017, that we're able to start with this momentum, normalizing for an usual attrition that we truly believe right now has ended. In terms of the new signings and the net earning assets. I mean that should continue to provide us with momentum throughout the year. As I mentioned in my remarks, there is a little bit of a headwind in Q2 on the services side as customers that attrited at the end of Q4 will continue to leave into Q2. But certainly, the new winnings and the signings that we have will offset that. And at the end of the year, we should be, in some ways, back to where we started, hopefully slightly higher.
Okay. And finally, is there -- what's the seasonality in this business, again, if you can remind us with respect to originations?
Originations would be -- when you look at origination, it's really going to be dependent on the timing when customers sign as well as -- also at sometimes it is impacted by the size of the customers that are renewing with us because that gets into the numbers origination. So there is a seasonality. I mean, maybe, Q3 would be usually strong. I think that's our strongest one and as well as Q2. But you will see some fluctuation. If we have a really large customer that renewed with us, that also gets accounted into origination. We will do our best to begin to break that down sometimes between new customers and existing customers. Our existing customers sometimes expand as well. So that gets added into it. Another metric to look at, Tom, and I am sure you do, is the net earning assets. The growth in net earning asset is a pure, new revenue.
Our next question comes from Vincent Caintic of Stephens.
Want to ask the broad question about the -- all the changes that are happening at the top here to the extent Dan or anyone on the board could chat about it. So we have the new CEO as well as the board changes. There was also a mention on the press release yesterday about the 3 investors, and I'm just kind of wondering if there is a coordinated view, maybe, be able, the path, that we'll be taking that's different from the past. And kind of just the overarching view what's the plan for shareholder value in the near term and the long term with the changes that have been made?
Yes, Vincent. I mean you're right. There were a number of changes announced yesterday. I think they're good for the company overall. I think it provides stability, and I'm excited about where the business is headed based upon our Q1 results and some of the things that we've got going on in the pipeline. I can't speak for Jay. I expect you'll hear more from him on his plan in due course once he's officially in the role, which he is going to start on June 1. And at the same time, I can't speak for the board. What I can say is that we are all excited about Jay and the new directors joining and look forward to working with them and the refreshed board, as we work with them in greater detail on our strategic plan and what adjustments they may want to make or not to that plan going forward.
Okay, got it. And I appreciate your enthusiasm, Dan. So maybe just a separate question on the business. So high confidence in the retention rate and high confidence in the pipeline that should grow, or should improve earnings in the second half of the year. I'm just kind of wondering from what you're seeing now -- your confidence in the second half of the year, is that -- is the pipeline already signed now where you already have that kind of visibility or even maybe you have a 3 or 6 months' window on account of -- if you could describe how that seasons when the loans come on board and the customers come on board?
Yes, so what I do feel good about is we do break down our pipeline between deals that we've won, the deals that have been awarded to us and deals that are still in the negotiation phase, et cetera. We have to execute on the pipeline. The biggest challenge that we have is we move at the speed and pleasure of our customers notwithstanding how quickly we want to move. But having said that, again, I feel pretty good about what see in the pipeline. It just comes down now to execution and getting those orders on the books.
Okay. Got it. And maybe just quick -- one last, quick follow-up. Any kind of sense of the competition versus you? And where you're improving of that where you're strengthening your hand up against the pipeline?
Yes, that's another area where we feel better. In particular, Kristi Webb has spent quite a bit of time with our customers and at industry events. And increasingly, we're getting more and more people speaking up about the benefits that Element can provide and our technology roadmap. And I think there is a certain buzz and -- in terms of our ability to provide compared to our competition. So I'm feeling optimistic in terms of where we stand versus our competition. And again I think that's making our sales team feel more confident, and -- with respect to what they're seeing in their pipeline and in their ability to win deals that are out on RFP.
Maybe I could add one comment on that. If you look at the stats of percentage wins we have so far this year compared to the percentage wins against the competition, we have, last year -- while we still have one, one quarter of data, but you could notice that our wins are actually beginning to become higher. So that is a good sign of actual wins that we're starting to have. And that will give us a good tailwind as we go through the rest of the year.
Our next question comes from Mario Mendonca of TD Securities.
Could we go to the $65 million hit against -- or the write-off, the opening equity write-off, on the joint venture? I think you can probably make an argument that, that's a little lower than what the street was expecting and although it's hard to get a handle on what that was. But could you talk about the nature of the assumptions that go to $65 million? And I'm certainly not asking for detailed breakdown of assumptions. But what would 19th Capital have to start delivering from an earning -- an operating earnings perspective? And over what time period would we have to see it turn profitable to be consistent with that $65 million hit? You sort of see -- Samir, do you see where I'm going with this?
Yes, I do. So I'm going to give you the fulsome answer, Mario. I hope it's a fulsome. So on the $65 million, we took the methodology that has been probably followed by most companies. We looked at what would a rating for this loan look like. And we started that on the -- on the sort of our base case. And ascribed a rating on it and determined, based on Moody's and S&P's, what would be the 1-year and the 5-year percentage losses if you were to rate this loan this way. And -- so this is one item. That's not the only conclusion we have. And then we ran a number of scenarios from there, downside scenarios. We ascribed probabilities for every scenario. And we estimated the loss on active assets as well as ideal assets that we would have in every case. On a probability weightage, we came -- actually if you look at the scenario, we came at slightly below the $65 million. We moved it up to the $65 million because this is sort of our first adoption of it. And obviously, that number will be adjusted on a go-forward basis. So that's the base methodology that we actually have. We have to take into account the timing of the operational improvement that 19th Capital is going through. And we have to take into account what we expect the cash flow to come and how long would it be for us to get the principal back. And this is the point that you're going through, Mario. This joint venture had to go through in 2017. And as Dan -- as you could see from Dan's slides, there is operational improvements going on here. I think the management team has begun to improve the overall quality of the owner operators from a credit perspective and have begun to put a lot more assets into the corporate fleet, which means higher sustainable revenue eventually, lower recovery cost, lower maintenance cost, overall, it will be a better business. That takes some time, as Dan has actually mentioned. But we do see enough KPI improvements where we need to give it more time, and we truly believe that the utilization where they are right now, any incremental of the utilization will be substantially to the benefit of paying back our principal. There is a number of idle trucks that form the security of our loan, and those are unlikely to be utilized, and those will be sold for the remainder of this year. So -- and I said in my remarks that we do expect principal payments to ramp up for the remainder of this year. That is what we expect to happen. As we get to a higher utilization with better quality owner operators as well as fleet -- as well as corporate fleet, we expect the cash flow from then on will be sustainable, and there will be a lower maintenance, lower recovery cost and obviously, much lower delinquencies which has already declined. So we take all of these factors into account starting with the base-case assumption. That's how we feel the $65 million, where we are today, is a sufficient number to report.
Okay. That's a lot of good information. And because we're looking at this from the outside looking in, we need some way to sort of measure the $65 million. So the way I'm asking the question is this: With the $65 million being consistent with the JV breaking even in, say, Q4 of this year -- the reason I'm asking the question is we need something to sort of monitor and measure the success of this. So if the JV was still losing, say, $10 million a quarter in -- by Q4 '18, would that then cause you and cause us to question the sufficiency of the $65 million?
We expect the JV to become near profitability by the end of this year or early in the following year. And you have to look at the profitability as one metric, and yes, that will -- we will take all of these factors. It's not just that profitability from a GAAP net income, Mario. We'll have to look at the cash flow that we're receiving. So we'll look at a number of factors, and the $65 million is our beginning number. We still believe when you look at -- we still believe that based on the business plan, the recoverability of the debt is going to be there. This is our provision against this -- under the new accounting rules, and of course, that number will be adjusted as we learn more about the business and monitor the performance. In terms of from the outside looking in, we will continue to provide you with, obviously, update every single quarter. We will begin to share some of the metrics that Dan has actually talked about to kind of help you track the operational improvement that you see here. We've always talked about utilization, and of course, you will see at every year-end statement, the summary -- income statement of the joint venture.
Okay. Then finally, the -- Samir, the only reason why this all matters at all was if it causes you to breach any covenants that really matter. And you made the point that you feel that there's a lot of headroom.
Yes.
Can you offer us more information on the bank covenant? Is it still -- is 6.5 still the upper limit? And are you're at around 6 6.1 now? And then also some information on the tangible net worth covenant, what can you provide us to make us confident that you really do have that headroom?
Okay. I -- so let me maybe start by giving some information. So Element is a solid investment grade. Our ratings have been confirmed. And we feel very pleased with that. The bank covenants themselves, we have significant room there. We've taken these charges in. And we are -- I mean without getting into actual details of what the range is, but we can take multiple of this charge and still be within the covenants. So the -- I know when I say ample headroom, that's a little bit subjective. But sitting in my seat here, I'm really comfortable with the capacity that we have. And this is -- the bank covenant is one area that I'm -- as far as this charge is concerned, that I'm not worried about.
Why won't you then -- if you're confident, why wouldn't you provide us the details, like is it 6.5? Are you at 6.1? What's the net worth? Like confidence would suggest to me that you'd be pleased to tell us. Why is it that you can't?
Mario, the covenants is -- the overall senior line agreement is a private document between the banks and Element. And I think that -- we decided that's not going to be disclosed at this time. And maybe that's a common practice. But I could tell you -- I mean -- all what I will provide you right now is we are -- we have a significant room here. And while I know, after the last call, there was a big worry that will breach our covenants, and -- but I could assure you we are very, very far away from that.
Our next question comes from Paul Holden of CIBC.
So continuing with the topic of the debt outstanding to 19th Capital, maybe you can just explain to us, outside of the loan that you purchased this quarter, why the principal is not decreasing q-over-q given the asset sales and improvement in utilization, et cetera?
Sure. Paul, before I start the answer, I must say I did enjoy the headings you have in your note this morning of -- saying, A Crisis Averted. We looked at each other here, and what crisis? Anyways, we have -- so on the loan itself, we -- as I mentioned in my remark, we -- the repayment of the loan was actually lower than what we thought would happen based on the business plan. Maintenance expense increased at 19th Capital, higher than planned. And that maintenance was mainly to provide sufficient alternatives for corporate fleet and owner operators in terms of the type of trucks that they needed to have. And that will enable to bring trucks on the road a lot faster than it has happened in the past. There wasn't a lot of truck sales during the -- a quarter. There was the anticipation that it would actually happen, but it wasn't to the level that we had seen. As I mentioned, there are -- all of the 2013 vintage year and earlier are being evaluated as we speak and will be evaluated based on the potential for lease and at what price and to the extent, obviously, they form part of our security, which for the most part they do, they will be sold. And during that time, utilization will increase. And then hopefully we'll get to a level of sustainable cash flow coming from the joint venture. Maybe I'll make just one more remark. In this joint venture, when I look back right now, it's almost given the quality of the owner operators that, that JV had at the beginning of 2017, management of the JV had to go back before moving forward and needed to reclaim a lot of trucks, and back -- due to delinquency, and all of that cost money. So there was a period of time, and we are still through it where we basically reset the business plan and improve the overall quality of the owner operators. And hopefully this will be the business plan that will be sustainable and that will get us to full recovery of our debt.
All right. Sorry, I've heard you mention utilization rate a number of times now, but I missed what the actual number is. What is that?
So if you look at the -- I mean, the utilization rate, you have to -- when we talk about it, we need to remind ourselves to let you know if that includes the trucks that are going to be held for sale or not. If you look at the overall portfolio, it's nearly the 50%. But that includes the trucks that are unlikely to be utilized. So we are at around 62%.
Okay. And then last question. Samir, you mentioned something called IDC, the incentives you provide to customers, and you gave us some sense, on an accrual basis, how that's impacting NIM. Can you give us a sense on a cash basis how the IDC compares year-over-year?
So the IDC, based on our plan, right now, we expect to spend similar amount of cash as we did in 2017. We hope this is a conservative number. It's still early in the year to give an indication where we're going to be. But clearly, last year was substantially higher than 2016. And Element felt compelled to do it given the challenges our customers went through as we completed the IT migration. Going forward, we are planning that this number will be the same, but as I mentioned, we hope that it will be lower. And also, Paul, just one more point going back to your first question. You mentioned that the principal balance did not decline on 19th Capital. It actually did decline by $1.3 million. I know it's a small amount, but just want to make sure we have the right facts.
Our next question comes from Brenna Phelan of Raymond James.
So I just wanted to ask about the Amerit acquisition. Do they do business with Class A trucks? Is there the opportunity to leverage their service centers and maintenance services for the fleet within 19th Capital?
Yes, the short answer is, yes. I mean, Amerit specializes in a number of categories from light-duty trucks to medium-duty trucks and heavy-duty trucks. And we have commenced conversations with their management team and 19th Capital to see if there's an opportunity to use them in certain locations to help reduce the maintenance cost of 19th Capital. Absolutely.
Okay. And any update on the securitization facility to fund the Australia and New Zealand business?
Yes, we feel good -- very good about where that's progressing. We expect that to be done in this quarter and be able to announce it shortly.
Our next question comes from Jaeme Gloyn of National Bank Financial.
First question is just related to the convertible debt maturities upcoming in 2019 and 2020. If I look at the sort of cash flow forecast and our estimates, it's -- it appears as if there is -- there should be sufficient cash to fund that maturity in 2019. What would be the impact on the covenant ratios of redeeming that maturity in 2019? And then similar question for 2020. How do your cash flow projections look for funding that maturity? And then the impact on the covenants in 2020?
Jaeme, so we -- you're absolutely correct. When you look at the overall convertibles, we do expect that internal resources of cash as well as debt securities that we know will be available for us, the combination of both will be sufficient to -- for us to redeem the 2 tranches of the convertible debt. And when we talk next quarter, you -- we will hopefully be able to provide you with more detail on the plan, but for the time being, this will be what we would actually expect from our abilities to actually do that.
The only thing I would add is that, might -- I just want to remind everyone that the convertible debentures were already included as debt when the rating agencies looked at our debt to tangible equity ratios. Obviously, the bank covenants were put in place when we had a different capital structure under Element Financial and would need to be adjusted going forward, where we want to have a funding structure that doesn't include convertible securities going forward because, again, the credit ratings that we have already assumes that, that's 100% debt with no equity treatment.
Okay. And I guess that's kind of what I was getting at is the bank covenant does treat it as equity at some percentage. So when you talk about using cash and debt facilities, that's basically tapping the credit facility to fund the maturity. But what impact does that have on the covenant? Is there a potential that maturing -- redeeming both of these converts breaches the covenant ratio as it stands today? And is this something that you need to renegotiate?
So let me add some color. As Dan mentioned, from the rating agencies, the convertible debt is already included. And if we finance all of the convertible debt with additional -- with another debt, then there should be no impact on our covenants. To the extent we use cash to actually redeem them, then we'll have to be speaking with our senior line banks and work through the adjustment to the covenants that we need to make through to reflect the new capital structure.
Okay. And on that note, then I noticed in the -- sort of one of the slides that you extended the maturity of the $1.6 billion Canadian funding facility. Were there any changes to the covenants of that Canadian funding facility as part of that extension?
No. A good question. I thought I covered that off in my opening remarks, but there were no changes in terms of pricing, terms or conditions. It was exactly the same as it was before.
Okay, great. Shifting gears then just around the 19th Capital. I just wanted to follow up on the comments. You mentioned that utilization rates on a -- excluding the trucks that are held for sale, is about 62%. I believe some of the discussions a few quarters back suggested that utilization was north of 80% and trending higher. I'm just wondering what changed from, I'd say, a few quarters ago to today that would have driven that significant decline given that trucks have been sold?
Why don't I take that. The 85%, I think, that was suggested before. That was -- there was -- that was a bigger component of the assets that were to be for sale. And as I mentioned, this -- when you look at the utilization, you have to always provide color on what trucks are they actually included, whether they were held for sale or not.
Yes, and I think I just wanted to add. This is part of the ongoing strategy of 19th Capital to shift trucks from owner operators to small corporate fleets. You might have had a higher utilization rate with owner operators. But those owner operators, if they weren't driving sufficient miles, they weren't paying anywhere close to their monthly lease payments. So you've got to look at the combination of collection rates and utilization rates. So at the time that utilization rate was high, but it was high with a high percentage of owner operators that just weren't driving enough miles to meet their monthly lease obligations. Hence the entire shift in strategy throughout 2017.So with that, operator, I think we're going to take one more question and then wrap up the call. Oh, I'm sorry, we're done for now. So I just wanted to provide some concluding remarks. First of all, I want to thank everyone for joining us today. And before we go, I just wanted to welcome Jay to the organization. We look forward to working with him as we move forward to execute on our strategic plan and return to growth. I also wanted to thank all of our employees for all of their hard work and support over the last 3 months. We had a solid first quarter, and I look forward to working with each of you to make the necessary investments that we need to make to position the company for future growth. With that, I would like to thank everyone for joining us today and conclude the call. Thank you.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.