Element Fleet Management Corp
TSX:EFN
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Element Fleet Management Corp
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Thank you for standing by. This is the conference operator. Welcome to the Element Fleet Management's Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] 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 statement and risk factors of its 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, it can give no reassurance that the expectations of any forward-looking statements will prove to be correct. Element's earnings release, financial statements, MD&A, supplementary information document in today's call include references to non-IFRS measures, 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 conference over to Jay Forbes, President and Chief Executive Officer. Please go ahead, sir.
Thank you, operator, and good morning to all of you joining us on this call to discuss our second quarter results and the progress that we continue to make on our transformation. Since our last call in May, we've continued to make great strides on our 27-month program to transform and strengthen Element. [Indiscernible] we're seeing accelerating momentum on all fronts. In the second quarter, we delivered quarter-over-quarter and year-over-year increases in net revenue and adjusted operating income. We achieved excellent results in terms of our client retention, as well as new client wins, significantly lowered our tangible leverage, made significant progress, actioning and delivering profitability improvements through our transformation program and deepened our employees' engagement in the pursuit of our strategic objectives.As you know, our singular focus is ensuring the successful execution of our transformation plan, which in 2019, we think about as going back to basics. To that end, in Q2, we identified in actions an incremental $15 million of annual run rate pre-tax profitability improvements. Having actioned $85 million worth of such improvements to date, at the halfway point of 2019, we are fast approaching our target of $100 million of action improvements by year-end.Initiatives actioned to date will improve Element's operating income by $65 million in 2019, approximately $16 million of these improvements were delivered in Q2, slightly higher than what we had forecast last quarter. Further, we have invested $67 million in our transformation program to date, which is slightly less than expected. In other words, the improvements we're making to the business are creating great value for our bottom line. As you can see from our June year-to-date balanced scorecard were meeting or exceeding the aggressive targets we've set in advancement of our strategic objectives.Client retention is running at 102% of target. And while we still have lots of initiatives planned to further improve our systems and processes through the remainder of our transformation, our ability to significantly increase client retention speaks volumes to the meaningful progress we're making towards consistently delivering a superior client experience.Our operational effectiveness and operational efficiency indices are both running materially ahead of their ambitious year-to-date targets, signaling that we're indeed making the basics better. Our balance sheet continues to strengthen with our tangible leverage ratio at 6.9 as at June 30, down sharply from 7.4 at March 31 and nearly down a full turn since year-end.And we generated a return on equity of 11% this quarter off a core adjusted earnings per share of $0.21, so $0.42 core adjusted EPS for the first half of 2019. I can tell you, and hopefully these results show you, that our balanced scorecard and pay-for-performance systems are doing exactly what they're meant to do. They are aligning the entire focus and resources of the company to advance a few things that truly matter most. And in doing so, they have enabled us to achieve year-to-date results across every dimension of the business that are simply outstanding.Vito will drive into this more deeply in a moment, but I wanted to do my part to explain the high performance culture we're focusing on and indeed fostering here at Element. We have a strong and well-established culture within this organization, key aspects of what we want to preserve. At the same time, we, both management and the broader employee group, have determined that there are a number of cultural attributes that we will need to nurture to enjoy the full potential that this market leading organization has available to it.In particular, we want our culture to be more open and transparent, more collaborative and more performance-driven and accountable. To facilitate these cultural shifts, we've introduced a number of initiatives not the least of which is the introduction of a new performance management tool, the balanced scorecard, to measure the annual progress that we're making on the attainment of our strategic objectives, and a new annual incentive plan for all employees. And importantly, we have linked these two initiatives with our balanced scorecard performance forming the basis for determining the annual incentive for every employee including the executive. As a result, our pay-for-performance incentive plan aligns our employees in the common pursuit of our strategic priorities, and the resultant enhancement to shareholder returns. Based on our business performance year-to-date and in anticipation of continued strong performance in the second half, we increased incentive compensation accruals this quarter.This increase in incentive compensation accrual is the main reason you'll see higher quarter-over-quarter, operating expenses in the second quarter. This is one of those rare instances where one is pleased to see an unexpected increase in OpEx as it is representative of the business progressively exceeding its aggressive targets in pursuit of long-term value creation.As the core fleet management business continues to stabilize and strengthen, we're seeing encouraging signs of growth in the business, with more client wins across every geography. Fleet assets under management as at the end of the quarter showed increases across all geographies on a constant currency basis. In the US and Canada, we're seeing growth from a larger group of clients, including the one large rapidly growing client we first made mention of last quarter.At the same time, we're focused on laying the groundwork for our mid-market strategy to generate growth beyond the enterprise segment. In Australia and New Zealand, despite the challenge of both competitive and economic headwinds, we remain pleased with the performance of our customed fleet business. We continue to win new clients and market share, while prioritizing earnings over volume in the current business environment. Element Mexico also turned in another quarter of solid growth in earning assets as our team there leverages our international platform to offer clients competitive economics and unmatched services.And our efforts to generate overall growth in the core fleet business are being supported by an increasingly strong balance sheet. Having recently concluded the redemption of $345 million of convertible debentures, our balance sheet is now materially strengthened and derisked from where it sat 12 or even six months ago. That said, we continue to consider ways to deleverage our balance sheet, and lower our cost of funding. Thinking about 2020, we're focused on obtaining an additional US credit rating, which will in turn enable us to access to US and secure the bond market.This would allow Element to lower its cost of capital further bolstering our already strong financial position. To this end and in alignment with our efforts to manage client concentration risk and accelerate deleveraging, you will recall that last quarter we announced broadening our use of syndication as a source of funding. Syndication continues to generate new material recurring revenue on our income statement. In the second quarter, we syndicated approximately $750 million of assets based on strong demand and supply. In doing so, we decreased tangible leverage by half a turn and generated $21.7 million of revenue that will flow towards our bottom line.Finally, regarding our non-core assets, as previously reported, our interest in the ECAF note was successfully sold in the quarter, for proceeds equal to its carrying value of approximately $97 million. And a quick update on 19th Capital. We received approximately $20 million of cash from the business in Q2, bringing the total cash generated by 19th Capital to approximately $50 million, which is in line with expectations. Regarding the prospects for cash generation from asset sales in the second half, we've seen some softening of demand and thus pricing over the last couple of months on account of the impact of tariffs and trade spats, harsh winter, as well as a loss of truck production by OEMs.We're monitoring the market, but not seeing anything that impacts our plans for the business as we look to realize the maximum value through an organized wind down.With that, I'll turn it over to Vito to provide greater detail on our financial results.
Thank you, Jay, and good morning everyone. It's great to be with you this morning to talk through our Q2 '19 results, which continue to show great momentum as we execute against our transformation strategy. As you will have seen within our disclosures, our Q2 '19 core fleet adjusted operating income was $126.7 million or $0.21 EPS, up 26.5% versus prior year and 3.8% versus prior quarter.On a year-to-date basis, our core fleet adjusted operating income of $248.7 million is up 32% versus the comparative 2018 period. The strong performance has been driven by a number of factors. Let me start with a view of the movement in net earning assets in the quarter. I refer you to Schedule 3.2 in our supplementary information, which walks you from an ending Q1 '19 position of $12.7 billion in core end of period earnings assets to $12.3 billion as at the end of Q2. The point to note here is that notwithstanding syndicated volumes of $0.8 billion in the quarter, core earning assets reduced by only $0.4 billion due to strongactivations of $1.9 billion, offset by amortization of $0.9 billion, dispositions of $0.4 billion and changes in FX of$0.2 billion.This reflects a strong quarter of organic growth across all of our geographies. Furthermore, originations in Q2 totaled $1.8 billion, representing a 5.4% increase over prior year and 2.7% increase on a constant currency basis. On a year-to-date basis, originations totaled $3.5 billion, a 10.5% increase over prior year and 6.8% on a constant currency basis.The strong performance is reflective of the continued success of our customer attrition efforts and the underlying growth in all of our geographies. As we continue with our syndication strategy, assets under management becomes an increasingly important metric for us to focus on and Section 3.4 and 3.5 of our supplementary provides the details and how this has progressed by quarter.Our core assets under management at the end of Q2 2019 was $15.5 billion, a $200 million increase over the Q1 '19 levels on a constant currency basis.Let me now turn to some of the P&L highlights for the quarter. Our core net revenue in Q2 was $248.4 million, a 4.5% increase versus prior quarter and a 15.1% increase versus prior year.As you know, the components of our core revenue are financing, service and syndication. Let me touch on each of these. Our net core financing revenue was $102.5 million for the quarter consistent with the prior quarter and slightly up on last year. Given the reduction in earning assets resulting from our syndication strategy, a flat quarter-over-quarter absolute financing revenue is an impressive result. The factors contributing to this rate improvement include in large part, the benefits of the revenue assurance work described in Section 1.0 of the supplementary and the higher quarter-over-quarter activations.Turning to syndication, Q2 volumes aggregated to $752 million, bringing our year-to-date total to $1.24 billion. Syndication revenue in the quarter totaled $21.7 million, a $4.5 million increase or 26% over Q1 total of $17.2 million. We continue to be pleased with the economics we are realizing, recognizing that the yield on these syndicated assets will vary from quarter-to-quarter based on a number of factors, including client and asset mix, lease term, etc.Continuing through to the last component of our revenue and that is net servicing revenue in Q2, it amounted to $124.2 million, up 5% versus Q1, '19 and 11% against prior year. Again, another impressive result and the factors that contributed to the quarter-over-quarter increases in service revenue, included higher maintenance billings of commission rates, higher fuel revenue from higher gas prices, improvement in our Accident and Safety Management division and overall benefits being driven through transformation. So overall, I must say that although much work remains across Element -- all elements of our transformation, we are pleased with the early indication and results across all of our revenue lines.Let's now turn to our core fleet expenses, and I'll direct you to Section 2.1 in our supplementary. Core adjusted operating expenses in Q2 aggregated to $121.7 million for the quarter, an increase of $6 million from both Q1 2019 in Q2 2018. As Jay has noted, the majority of this increase was driven by an adjustment in the amount of $4.2 billion to our year-to-date accrual related to our anticipated year-end pay-for-performance compensation.In addition, the other item impacting our quarter-over-quarter increase in reported operating expenses is the timing of professional fees, which increased by $3.1 million. These increases in costs were partly offset by the continued improvements in our transformation program, which drove $8.5 million of operating expense reductions in the quarter, up $2.1 million from the Q1 2019 levels.Turning to the balance sheet quickly, Jay spoke to the impact that both syndication and improved earnings are driving to our tangible leverage. Section 4.0 of our supplementary tracks the quarterly movement in our tangible leverage. We ended Q2 at 6.92x and we're targeting less than 6.0x at the end of calendar year 2020. It is important to note that we do expect the path to our year-end 2020 target to be non-linear and fluctuate based on anticipated originations for one large, rapidly growing client in particular.Before I hand the call back to Jay, I do want to mention a couple of other very important metrics. Our consolidated return on equity was 11% for Q2 2019, this is in line with our expectations for the quarter and continues to put us on track to achieve our target range of between 13% 13.5% exiting 2020. And secondly, consolidated free cash flow in Q2, as depicted in Section 5 of our supplementary information, amounted to $108.2 million, an increase of $27.6 million or 35% year-on-year. And lastly, I remind you that there is no change in our 2020 EPS outlook, we expect to generate after-tax adjusted operating income per share in the range of $1.00 to $1.05.With that, Jay, I'll hand it back to you.
Thanks, Vito. I couldn't be more pleased with the progress of our business and the efforts of our employees on all fronts. Across Element, there is evidence of undeniable momentum that is steadily translating into results. But even as we celebrate our accomplishments to-date, we must acknowledge that our work is far from done. Our focus for the remainder of 2019 is, as it must be, on ensuring this transformation and this year's cumulative $100 million profitability improvement is actioned, delivered and sustained. When the time comes to begin to pivot to growth in 2020, we will be doing so from the strongest possible position, one, of market leadership underpinned by a strong, stable operating platform offering a consistent and compelling client experience, a lower risk, lower-cost capital structure and an engaged employee group that has been energized and strengthened in a successful pursuit of a truly transformed Element. We look forward to sharing with you our thoughts on our growth strategy as part of next quarter's disclosure.In closing, I'd like to recognize Karen Martin, who will be retiring later this year to pursue Board work.Karen, who many of you will know, is our Treasurer at Element. She has been an important part of our success over the years and in particular, a great colleague to me over this past year. I want to thank Karen for all she has done and express the collective gratitude of everyone at Element for her selfless and tireless leadership.Now it's my pleasure to open the floor to your questions, operator?
Certainly. We will now begin the analyst question-and-answer session. [Operator Instructions] Our first question comes Geoff Kwan with RBC Capital Markets.
Hi, good morning. Just had a question on the higher compensation with relation to the performance and just want to understand, was that expected and kind of implicit in your guidance or would it not necessarily have been reflective in the guidance trajectory? So in other words, paying this higher compensation could suggest guidance could be exceeded in 2020.
Yes, so good morning, Geoff. The 2020 guidance assumed a normal course, if you will, in terms of variable compensation as it related to bonus plans and by virtue of the great start that we have been able to give off on in terms of this first half, obviously, we performed at levels far in excess of what we had planned and that is translating into a higher accrual around what we would anticipate as 2019 annual incentive program. So we budget and would have set guidance for 2020 based on paying annual incentive plan at target and in 2019, we are certainly in the first half trending well beyond that.
Okay. And then my second question was on the client wins that you're getting, are these you're taking them from competitors, are they ones that were being done in-house that they are now outsourcing, is this partly your push into the kind of the mid-sized space in the industry? Just any color would be helpful.
Yeah, truthfully, all of the above. And we have held our own in terms of no major client losses in 2019, a great reversal of fortunes that reflects the organization's myopic focus on delivering a more consistent, superior client experience. And then in terms of wins, they have been a combination of taking clients from the competition, bringing clients on board that are new to FMCs and have also been -- well, there's been perhaps an overweighting to enterprise. There has been good bit market penetration as well. So truly all of the above have contributed to the organic growth that we're seeing.
Okay. And then if I can sneak in one very last question. wondering if you can kind of comment the large client that's growing really fast with you and partly why you're syndicating? Do you see this kind of relationship seeing vehicle growth in 2020 but also too is, do you think that there is an opportunity to work with that client to expand internationally with where they they operate outside of the US?
Yeah, we had a Slide 18 to the investor presentation deck just to give everyone a comprehensive understanding of the flow from receipt of order to the financing of vehicle given the predominance of syndication in 2019 and on a go-forward basis. And I think one of the dynamics that will be more apparent as we enter into third quarter is that dynamic of moving from order receipt to being drafted by the OEMs and actually have an origination. And so the impact of this new large fast growing client on the business will probably have greater visibility as we move from that order receipt to the origination, through up fast and onto activation.And so as you can appreciate as you ramp up with the new client, the receipt of the order is an important initiation, if you will, in terms of the relationship with that client. And at the same time, it really doesn't manifest itself in tangible results for the organization in a meaningful way until you move through that origination up first, and into the actual lease activation. And so Q3 will allow you an opportunity for greater visibility in terms of dynamics of that new relationship, and how that might play out, not only in 2019 but in 2020 as well. And like all of our clients, we love to do business internationally. So in those domains in which we operate, we're happy to leverage the relationship that we enjoy in one country, to make introductions to demonstrate our capabilities and to win their trust and lustre [ business in other domains and we've been successful in establishing initial relationships in Canada, the US and taking those into Australia, New Zealand, Mexico. Very recently, we had a very good relationship in Mexico, that allowed us to move into a client position in the United States, and so we absolutely look for those opportunities to work across our five countries with those clients operating international mandates.And where we don't operate, we're delighted to engage with [indiscernible]. We have a very tight go-to-market strategy with them, so that we can offer our clients with far-reaching geographical needs, proper coverage in those markets in which we may not have operations.
Our next question is from Paul Holden with CIBC. Please go ahead.
Hi, good morning. So I have a few questions for you related to the operating expenses in the quarter. First one is with respect to the professional fees paid, what projects would those be associated with?
Hi. Paul, good morning, it's Vito. A series of, I call them, ordinary course-related initiatives within the organization and that's why they are above the line. Clearly having said that, there's been a tremendous amount of activity across all of our corporate services as the new leadership team has taken steps that we believe are necessary to, obviously, continue to evolve our practices and support our initiatives. So nothing unusual that I would call out. I would say the timing of them are, you got some timing issues. So as I look at Q1 versus Q2, both with the timing of some of these professional fees and with the bonus accrual that we referred to, if were normalizing Q1 and Q2 and, obviously, hypersensitivity and hyper-focused on our cost as there should be both internally and externally.And I must say with each passing quarter, I get increasingly confident that we will be at and achieve our, obviously, our targets from a cost basis, you really get to a plus or minus, I call it, 118 base, if you will, on a normalized basis, plus or minus $1 million.
Okay, that's helpful. And I guess part of what I was getting to as well as the [indiscernible] any of these professional fees or other costs related to maybe any ongoing IT development, whether that's sort of, let's call it, back end work or front-end work. Could you remind us where you are at in terms of project spend and any further development on technology capabilities?
No, again, Paul, Jay here, good morning. Now these are all legal tax costs of that ilk, in terms of IT development we have set aside a goodly amount of the transformation budget, the $150 million of one-time investment, that we are making to cover the costs of both application and hardware upgrades as a consequence of the transformation effort and will also draw on our annual capital investment budget to fund those over the transformation period. So think about IT as kind of reaching into one or two envelopes, part of the $150 million one-time cost or the annual capital investment budget for the organization. Professional fees in this organization are again slightly more towards lawyers and accountants.
All right. That's helpful. One final question, if I can, you had or Vito had really indicated before that this syndication yield would bounce around a bit quarter-over-quarter, 60 basis point change on 350 last quarter. It's a pretty big move. So maybe, you can help us think about how we can model this on an average run rate basis going forward?
Yeah. Thank you. As we did mention, the mix of the assets being syndicated, coupled with market dynamics, are going to create some variability in the field from quarter-to-quarter. Think about credit quality, think about the interest terms, the remaining asset lives as three factors, that will create a degree of variability this year, in terms of that net fee calculation. And so again, two quarters in and with the mix shifting, so I'll come back to, we are moving from a big order intake to bigger originations and up-fitting in onto activations with the new strategic relationship and as we do, that's also going to change the mix in terms of syndication. But let's watch this play out for a couple more quarters and I think it will be readily apparent, as we do, how this will kind of settle in in terms of a tighter range on what you can base your models on.
Okay. And one follow-up then on that if I can, which is then based on your three criteria, you would have had a pretty good idea, of how Q2 would have looked. Was there something in Q2, particularly that suggests it was a lower net yield quarter based on those characteristics than what you would normally expect?
No.
Our next question is from Mario Mendonca with TD Securities. Please go ahead.
Good morning. It sounds Jay and Vito from some of your comments that things are going to look a little different in Q3, 2019. And so what would be helpful to understand is, and I appreciate that you can't give us numbers on how important this new client is, but can you let us know if in Q2, any of that $752 million in syndications, did any portion of that include the new client or was that all the existing business?
Good morning, Mario. And just in Q2, the syndication revenue did include some contribution from this new strategic relationship.
Okay. And so would it be fair to say that as this new strategic relationship ramps up in Q3, that we should be prepared for the syndication yield to continue to trend down. Would that be a fair assumption?
And so we put a number of stakes in the ground in terms of guidance. The 2020 EPS guidance can be an idea as to where we're targeting leverage and the transformation agenda. So we have a number of stakes out there that I think give you a very good appreciation for the value creation opportunity inherent in the model, and then, obviously, providing you with these updates to give you tangible proof points of how we're advancing with them, so we wouldn't want to get into specific quarterly guidance in terms of syndication revenues and such.Again back to Paul's point. this is about the second quarter of syndication. And as we explained, we're going to be drawing historical assets as well as new originations into the flow, you can expect that that mix will change. And as we have -- the program ramps up and the flow of originations build, we'll be drawing more from new flow as opposed to all the originations, that's going to impact in terms of the fleet. So again, back to credit quality, interest terms, remaining asset lives are kind of the three factors that one thinks about shifting that mix and as the quarters progress, I think it will be more obvious whether the shoulders of the road are here in terms of the variability of those fees.
And maybe just asked a slightly different way. Would this be the first quarter where the new strategic relationship appeared in syndications and appeared in originations. Is this sort of the -- may be the beginning of that where we just start to see the effect of the new relationship?
No.
So it was around in Q1 as well as is what you're suggesting?
That is correct.
Okay. And then my final question. You referred to pivoting to growth in 2020. This is more philosophical. You say pivoting to growth, I mean, the growth is great right now. So what do you mean, are you referring to just being more aggressive on acquisitions, maybe new products, client acquisitions? What do you mean by pivoting to growth because the growth is fine now?
Yes, so one of the things that has been a bit of a source of frustration for the leadership team is the lack of a clear visibility in terms of market dynamics and whether that -- there's a lot of factoids that floats around the industry, but we want to have an in-depth understanding of the market, the market segmentation, the needs of each one of those segments, the competitive dynamics within each one of those segments and how the needs of those particular market segments mesh with our current capabilities and what they will do to inform the capabilities that we will need to have in order for us to have a compelling value proposition to offer to those segments.And so that's an exercise that we have recently launched as an organization, an in-depth exploration of the Canadian and US marketplace to understand those segments, the needs within those segments and to originate clear go-to-market strategies for both enterprise and mid-market and so when we think about pivoting to growth, the transformation for all intents and purposes has been designed to stabilize and strengthen the platforms and deliver that consistent superior experience.With that well underway and clear plans to take that through to the end of 2020, we want to make sure that we're going to leverage this platform and direct its capabilities to those market segments in which again we can offer differentiated compelling value proposition.So that's the pivot to growth is the deeper understanding of the market, the market dynamics and how we can compete, the shift in our go-to-market strategy to accommodate the learnings that will come out of that and then the readying of the organization, the directing of the organization towards those market opportunities and so rough, rough, rough timing, we would expect to be in Q3 in a position to share with you our learnings from this exercise. our plans in terms of go-to-market. So that, that in turn would be able to allow our investors to understand the mid to long-term growth prospects of this industry and this organization within the industry.
Our next question is from Jaeme Gloyn with National Bank Financial. Please go ahead.
Yeah, hi. First question is just on the syndication part of the business. I'm curious to learn if the $750 million done today, is that -- does that indicate at all that you're tapping into perhaps that expanded market outside of the $20 billion that you identified as being core to the fleet lease asset segment. Is there any indication that that is occurring at this point?
And I would say the market that we have identified for you is absolutely the markets that we're drawing on. That said, we think that our offering is additive to that market. So as you know, we have been a bit [ player in that in the past, we believe that we will be a sizable player, maybe the largest player on that segment as we go forward and it is our aspiration to greatly enlarge that marketplace by virtue of the introduction of these high-quality assets and high-quality counter-party credits.So it is the one and the same, but we do expect at the same time that that market will be enlarged by the quality of and size of the program that we have envisioned here.
And second question is on the servicing income during the quarter, bit of a bump there on an absolute basis, but also as a percentage of assets under management. I'm just wondering if there's any sort of seasonality related to that rate of revenue as a percentage of earning assets, or if there's -- not earning assets, fleet assets under management or if there's anything else going on in the quarter that would suggest that's more permanent or will change in future quarters?
Yeah, there is -- as we look at it, and as Vito has articulated, kind of two big drivers here, maintenance and fuel. The maintenance piece, unlike Q1, where we had seen a little bit of seasonality, that's not impacting the maintenance revenues in Q2. That said, the fuel revenues are being driven by higher US gas prices quarter-over-quarter. So under the broad definition of seasonality, there may be a bit of a positive lift in terms of just market dynamics as we see higher US gas prices.
Okay. So we should expect to see that, that rate of servicing revenue as a percentage of AUM sort of tick up in Q2 and Q3 perhaps. And then sort of fade back in Q4, similar to I guess like driving miles driven during the year. Is that a fair way to look at it or are there other things in other parts of the servicing offering that is out there that is going to create volatility?
Yeah. So that certainly is one way to look at it. And let's just say that we would anticipate consistent performance from our service product portfolio for the remainder of the year.
Our next question is from Brenna Phelan with Raymond James. Please go ahead.
So I wanted to follow-up on the servicing income question, should we be so helpful guiding or commentary that think of it as consistent for the remainder of the year. But as you think about the goal of the transformation project, are you looking to ultimately increase the penetration of services on your asset base?
Yeah, so as part of the go-to-market refinement that we plan to do in the second half, certainly as we look at quick wins, one of the areas that will be certainly a pronounced area of focus for us is penetration and looking at the array of service offerings that we have today and how well penetrated they are with our client base. And suffice it to say, that work has already begun, to understand those dynamics and to provide that information to our sales team, so that they can advance some of these more obvious opportunities.
And then you referenced in your commentary regarding Australia and New Zealand that you are focusing on profitable growth, is it fair to assume that the competition in those markets is being more aggressive on pricing. And can you tell us, what you're seeing across various geographies when you're going to market and are competitors being aggressive on price and how are you thinking about
Yeah, so in ANZ, we are blessed with a first-rate team, Aaron Baxter has put together just a fantastic group of individuals that constitute the executive employee ranks of that organization, that organization has been in business for more than 40 years, they're well steeped in terms of market dynamics and as a consequence, the first signs of a slowdown in the economy there made some decisions to position themselves to be one at the forefront of clients' minds as they went out for business and to again manage the bottom line ahead of the top-line growth. That said, with the disarray that have been introduced into the market through the failed merger of two large competitors, that has created opportunities and we have taken advantage of those opportunities to the benefit of client additions.And the other dynamic that is offered up around ANZ, obviously that's a region in where we have residual value risk, the team again well steeped in terms of managing that risk and the dynamics that we have talked about in the past are actually playing out there consistent with those conversations, i.e. as the economy softens, consumers end up instead of buying a new car looking at a used car, and as a consequence used car values are not only holding and actually appreciating, which is allowing us to continue to produce solid gains on sales and avoid any type of downside in terms of residual risk.So again, very well experienced team doing a great job for us in that marketplace and not seeing prices as a contributor to any type of slowdown in revenue, instead kind of more of the general economic downturn. In Mexico, again to be magical, and the team there are just shooting the lights out, I mean, just unbelievable growth. I had spent some time recently with the team in the field visiting with clients, the respect that they have been able to establish with those clients through the delivery of a very strong offering in that marketplace, a deep understanding of their business and a willingness to invest alongside them has served the Mexico Element team very well in terms of outperforming that market and, again, we haven't seen anything that would indicate that pricing is coming under any type of pressure there. Pricing in Canada and the US, it has been and continues to be competitive, which means that you need to have a comprehensive value proposition to put in front of that client. Part of that is that superior client experience. Part of it is delivering in a very consistent fashion and part of it is being able to deliver the deep insights that are afforded to a company like us that has better, larger data sets that can provide the information to these fleets to lower their total cost of ownership.And so you'll note on one of our balanced scorecard metrics, the magnitude of cost savings that we've been able to identify and share with our clients is one of our measures of success, recognizing that as we think about differentiating ourselves -- again, our scale affords us great insight and being able to harvest those insights from our systems and provide those in a way in which they can be actioned by our clients, is a true meaningful differentiator in the marketplace. So, yeah, price has been and will continue to be prominent in terms of the sales routine, and yet being able to demonstrate value, so the provision of high quality superior offerings is really the name of the game.
And then last one from me, on the tax rate, looked a little bit elevated in the quarter, was there any noise there to be aware of?
Thank you for raising the tax rate. Yeah. Effective tax rate of 19.5 in the quarter versus 17.5 for Q1, so that did create a bit of headwind, approximately $0.05 to EPS through our Q2 results. I'd say a couple of things, in Q1, we had some one-timers primarily out of the Mexico group that provided a bit of a one-time benefit and I'd guide you to a 19 -- call it 19 to 19.5 for the balance of the year in effective tax rate.
Our next question is from John Aiken with Barclays. Please go ahead.
Good morning. Just wanted to circle back on the formation of the annual incentive plan again. Vito, just to make sure that I'm crystal clear on this, the $4.2 million increase in the quarter, did any of that relate to Q1 because this was -- the plan was implemented this quarter or had this plan been in place and we just got a bump on the accrual in the second quarter?
The plan was in place from the beginning of the year. However, the adjustment reflects a 6-month adjustment so to -- I think you're asking the question is, how much of that co-relates to Q1 and Q2. It related to a year-to-date adjustment. So it's reflective our view of a 6-month incremental cost related to where we project to be vis-a-vis our original base.
That's great. Thank you. And so, Vito, the plan then will, I guess, introduce a little more volatility on the compensation expense line to try to get -- help me map this out, if we were to progress on the object towards the objectives like we've seen to date. What impact would that have in terms of the accrual for bonus plan? And I'm not looking to the $1 million, but if we were to progress going forward with this flat line, with this increase with the decrease just to get a little bit of sensitivity around this, if you wouldn't mind.
Yes, I mean, I think we're going to stop just short of telling you what we have accrued to vis-a-vis our original targets from our overall performance perspective, I'll just take you back to the balanced scorecard. I would guide you to, as the CFO to some [ (55:33) relation. I am absolutely delighted that we're accruing more bonus because that's the gift that keeps giving as far as sustainable value creation going forward. So I'll stay away from the quarter-to-quarter guidance on EPS -- on bonus accrual. This is a very good thing for the organization.
And just one last question, when you are analyzing the financial performance of Element, do you look at any metrics like inefficiency ratio or operating leverage when going through -- is that important? Or is that at this stage in the game just not really within the metrics.
Yes, John. Jay here. It really isn't within the metrics and again it's back to this comparator set and the absence of any type of tangible comparator set. As we are rather unique out there in the marketplace, any real comparator or private entities and this type of information that would allow us to establish a benchmark and report against that just doesn't exist. So again, our decision early on was let's be readily transparent, let's create the supplemental, let's establish the targets and then provide full and complete visibility of our progress towards those established targets. And so there isn't a benchmark that we're working towards, but as said, there is a series of targets that we've set for the organization that we think are the most appropriate to drive the right behaviors, the right outcomes and in the end, the right shareholder value creation.As we go through the growth strategy and develop our go-to-market plans, we'll get an important input to our thinking around the comparator set and who might constitute valid comparisons as we better understand the market, the market dynamics and how we might envision our gross organic growth profile in the years to come.So with that piece of information coupled with what we've learned about the business thus far, I think we're going to be in a better position to start to point to other organizations that would serve as valid comparators and in doing so then be in a position to say, and this metric, that metric, and our third metric would be appropriate for you to use as you assess our performance vis-a-vis these other comparators.
Our next question is from Tom MacKinnon with BMO Capital Markets. Please go ahead.
Just following on the core OpEx. Vito, there is -- another segment in that waterfall chart on 2.1 is professional fees and other. We never did see that item in the waterfall chart for the first quarter. So this one is kind of new for us. How should we be thinking about that going forward? Is this going to be $3.1 million each quarter going forward? And sort of was that all baked into your 2020 guidance as well?
Yes. Totally, I mean, it, again, really bring us back to the 2020 guidance and we feel absolutely 100% comfortable with that. We're getting fairly micro and we're talking about quarter-to-quarter movements. So what you see us doing is being very, very, obviously, transparent, but detail oriented to give the external community as much color as we can.I just bring you back. Tom, this is a quarter-over-quarter variance. And I would say, Q1 was probably abnormally low on prof fees. Q2 is probably abnormally high on the prof fees. So as I think about the smoothing over the course of the calendar year, I think there is probably nothing noteworthy you're talking about when it comes to professional fees going forward.
Okay, thanks. Now the interest in -- net interest income and rental revenue is flat quarter-over-quarter, but the average earning assets were down about 3%. I think Jay had talked about competitive pricing environment. But that sounds like your growth yields were up. So maybe you can just -- is there anything unusual in the second quarter versus the first quarter there?
Tom this is Jay. I'll turn it over to Vito in a second. The piece that we need to remember is, as we think about the transformation agenda, well it has a deep bias to cost productivity. We also have revenue enhancements there and one of the areas that we've talked about in the past is revenue assurance and identifying and stopping revenue leakage in the business and that has been one area we had talked maybe two quarters ago, about the different areas of the business in the yield that we're seeing from the investment of time and resource. And revenue assurance has been one that is over produced for us in terms of identifying areas in which we weren't billing to the extent that we could, should, our clients for the delivery of the services that we're providing to them. And as we think about the revenue picture for the second quarter, some of the lift, some of the improvement in the effect of NIM rate is indeed associated with that revenue leakage, and addressing that revenue leakage.
Yeah, and nothing much more to add, Jay. I just would take you to 1.2 in our supplementary, Tom, where you see us based on the actioned items of $85 million to-date are articularly [ where we believe the resulting delivery of that $85 million is hitting the revenue lines -- hitting our P&L lines and just to Jay's point, that falls right to the bottom line.
And then finally, with respect to the servicing income, I assume we should be looking at that as a percentage of the total AUM as opposed to just the earning assets in a sense. And if this company became significantly more in terms of syndicated assets, in particular, because of on-boarding this strategic and fast growing clients, would we anticipate any difference in terms of what the service revenue would be on the syndicated portion versus the earning assets portion or how should we be looking at that?
Yes, so the service revenue is agnostic, it doesn't matter whether the asset has been securitized or syndicated, we generate the same service revenue from those assets. And so, yeah, the two kind of are separate and distinct in terms of the choice of funding vehicle versus the generation of service revenue.
So the package is offered to whether you syndicate or whether you lease?
Yeah, the choice to syndicate is ours, and so we will enter into the financing agreement with the client and then independent of that, we will decide whether or not we want to put that into our Chesapeake facility and securitize it or whether we want to syndicate that.
Our next question is from Jeff Fenwick with Cormark Securities, please go ahead.
Just to follow up on some of the questions on syndication. Just a quick one here. When we spoke earlier in the year, you had suggested an annual range on that securitization activity of about -- I think $2.4 billion was the number you gave us on an annual basis. So given the big uptick we saw in the quarter here, should we be expecting that number to be larger than over the course of 2019?
Good morning, Jeff. No. Yeah, we had guided you to roughly $2.5 billion, $750 million[ph[ reflects kind of the maturation of the program and its ramp-up and brings us to the $1.2 billion year-to-date, which is kind of halfway through the $2.4 billion that we got in Q2. So [indiscernible] the $2.4 billion feels good for 2019.
And then maybe just big picture on OpEx, when I look back over the last couple of years, the core OpEx is run sort of in a range of about $115 million to $125 million on a quarterly basis. I think Vito, you mentioned a normalized rate maybe being something around $118 million. And just thinking when you've removed the many layers of management and looked for a lot of efficiencies in the business, I would be expecting to see that absolute spend on expenses begin to dip a little more meaningfully. So how should we be thinking about that in terms of those efforts you've been putting in. I guess some reinvestment into other areas of the business like compensation and incenting people and where that level of expense should dip and when do we start to see that occur over the next, say, four to six quarters.
Yeah. So maybe for clarity and alignment, Vito's comment on the 118 was in reference to Q1 and Q2 being kind of if you were to normalize for a couple of the factors that have been the discussion points of the morning. And so I think, again, just wanted to align and be consistent on that. The 115 last year was what we would call an abnormally low mark in terms of our run rate, and then broadly as you step back and think about the productivity of the business and -- of the $65 million of transformation benefit that will impact the bottom line in 2019 alone, we reference you back to the $1.00 to $1.05 EPS guidance for 2020, which reflects again us being able to not only achieve the $100 million of actioned, the $65 million of delivered, but continue that transformative agenda and just continue to identify and deliver meaningful improvements in 2020.
And I guess that's the goal for me is to try and square what's happening here on the OpEx line with that EPS guidance and to get there. When I look at it, if you're having modest revenue growth and it looks like that OpEx number needs to fall fairly reasonably significantly to get you down the path towards hitting that EPS number in 2020, is that fair to say?
Yes. And again, a good progression on that and I always kind of like referencing and one of the reasons we put it into the supplementary our consolidated free cash flow if you look at Page 15, you will see a year-over-year increase in free cash flow of 35%. That's kind of the acid test as to whether or not the stuff is "real" and a 35% increase in the free cash flow, I think it kind of demonstrates just how tangible these improvements are.
This concludes the question-and-answer session. I would like to turn the call back over to Mr. Forbes, for any closing remarks.
Thanks everyone for joining us this morning. Much appreciate your participation and wish you the very best for the remainder of the summer.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.