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 Third Quarter 2018 Financial Results Conference Call. [Operator Instructions] The conference is being recorded. [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 statements and risk factors in its most recent MD&A and AIF for a description of these risks, uncertainties and assumptions. Although management believes that the expectations reflected in the statements are reasonable, it can give no assurance that the expectations of any forward-looking statements will prove to be correct. Element's earning release, financial statements, MD&A and 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, Chief Executive Officer. Please go ahead.
Thank you, Operator. And good morning, everyone, and welcome to our third quarter earnings conference call. Joining me this morning are Vito Culmone, our Chief Financial Officer; and Karen Martin, our Treasurer. Thanks for everyone for taking the time to listen in this morning. Vito and I are joining you from Element's offices in Eden Prairie, Minnesota, where executive team and board are holding a few days of meetings and connecting with our 400 colleagues who work out of these offices. I'm a big believer in our leadership team being very connected to the business. Our being here is part of that. Something that we're going to be doing a lot more as a leadership team, spending time with our employees and our customers across North America, including Mexico as well as Australia and New Zealand.I'd like to start our call this morning with news of some accomplishments from our transformation journey, followed by a discussion about the steady performance of the core Fleet Management business. Vito will then make additional comments on the quarter before I wrap up and we turn to questions.Since I last spoke to you on October 1, we've achieved a great deal. We're fully focused on executing our transformation program, we're well underway on this new path forward, and we're excited to deliver real and lasting profitability improvement.We have shored up the foundations of our transformation with significant accomplishments on 2 fronts. Firstly, we strengthened and derisked our balance sheet. We closed our successful equity financing, raising gross proceeds of approximately $300 million, with the expectation to receive approximately $45 million in addition -- additional proceeds with the underwriters expected to exercise their overallotment option prior to November 11.We've also reduced our dividend, redirecting our cash to where it is best invested this time into our transformation program. And we instituted a dividend reinvestment program, which will be available to our shareholders, beginning with our fourth quarter dividend. This program will further optimize our cash position, while giving our shareholders the additional opportunity to participate in our growth.Secondly, we've taken decisive action to address legacy issues. On October 19, we closed the transaction to purchase from our joint venture partner, the remainder of 19th Capital that we didn't already own. As sole owner now, we appointed a new Board of Directors and put new management in place in that 19th Capital. And this team has already begun the orderly run-off of the business, which will take up to approximately 36 months to complete.We also continue to press ahead with our plan to realize value from non-core assets such as our ECAF, aircraft leasing note. The third color of our transformation for the benefit of all of our stakeholders is the customer-centric reset of our core Fleet Management business. You'll recall our overarching mission is to make $150 million of annual pretax run rate profitability improvements to our core business by the end of 2020.To that end, I'm pleased to say that we're firmly on track to action the first $40 million of run-rate profitability improvements by the end of this year. And we're working diligently to put even more cost savings in motion all before year-end.The quick-win strategy we laid out for this calendar year is nicely taking shape. For example, we're in the midst of finalizing our new delayered organization structure. This will bring us closer to our customers and enable faster decision making. This will also result in reduced costs and higher run rate profitability.Our transformation management office is up and running, having kicked off what will eventually be 17 work streams to drive our profitability improvement. The TMO is a group of experts -- industry experts from within the Element and experts on transformations from our consulting partners. Together, they create and manage the transformation work streams, identify barriers and challenges that need to be overcome, marshall the appropriate resources and ensure that we maintain the required tempo of change.The executive team meets weekly with the TMO team for a debrief on our progress, to resolve any issues that have arisen, to make the necessary decisions to maintain momentum. And I would say that this process is working exceedingly well in its early days of being initiated.Other quick wins have come in rebate management and from stemming the leakage of trade in credits. And of course, I always like to state that all of this change is layered on the foundational strength of our core business as evidenced in our Q3 results. We're starting with an industry-leading platform that is what is so compelling about this opportunity for change. The most recent quarter clearly demonstrates the strength of our platform and the earnings power that we enjoy today.Before turning the call over to Vito, I'd like to say a few words of thanks on behalf of everyone at Element to our Chairman, Brian Tobin. As we've announced, Brian will be leaving our board as of the end of the year, as he takes on an expanded role at BMO Financial Group. Brian has played a huge part in helping Element get to where it is today. Among his many accomplishments, he's driven improvements to our governance, and he has been instrumental in building up the new management team and his support and wise counsel as we've crafted our strategy for the future has been truly invaluable. Personally, I'm grateful for the wisdom and generosity of spirit in the 5 months that we have worked together here at Element. He is smart. He is creative and a true joy to work with. We're sorry to see him go, but we understand his decision, and we wish him the very best at BMO, which is very fortunate to have him.I'll turn it over now to Vito to discuss the quarter in more detail.
Thank you, Jay, and good morning, everyone. I'm pleased to review the financial highlights of the quarter. And I'll focus my comments primarily on, one, core adjusted after-tax earnings; two, the accounting for the 19th Capital net-of-tax charge in the amount of $360 million; three, our balance sheet and post-quarter end equity raise; and lastly, four, our transformation initiative, and what you can expect from us going forward as far as supplementary reporting.You'll also find more information in this quarter's news release, our MD&A, and, of course, our financial statements. Let's start with core adjusted after-tax earnings. As Jay indicated, it was a solid quarter with core adjusted after-tax earnings of $0.19 per share, in line with our expectation. The core fleet business generated revenue of $220.1 million, up 2% sequentially over Q2.Service and other revenue of $131.3 million, increased 1.4% from the second quarter and reflects among other things the positive trend we are seeing on customer retention.Net interest and rental revenue of $88.8 million increased nearly 3% sequentially. The factors driving this increase include one-time gains and benefits of the higher rate -- interest rate environment, partially offset by lower interim rent and higher noninterest finance charges. As a result, net interest rental revenue margin, NIM, increased to a higher than normal level of 2.8% in [ Q3 2018 ] as compared with 2.73% in [ Q 2018 ]. Notwithstanding the recent fluctuation in our reported NIM rate due to timing and other pricing-related factors, we would continue to guide to a rate closer to 2.6%.Turning to expenses. Adjusted operating expenses this quarter were at $120.7 million, an increase of $5 million over Q2 and a more modest $0.6 million over Q1 levels.Salaries, wages and benefits in the amount of $80.7 million represented 67% of the total adjusted operating expenses and were down $0.6 million versus Q2.The increase in the aggregated adjusted operating expenses relate primarily to higher IT cost, foreign exchange headwind and the benefit of some one-time credits in our Q2 cost base. We do expect our operating expense to decline meaningfully as we move through our transformation timeline.Turning now to 19th Capital. During the quarter, we recorded a previously disclosed charge of $480 million, $360 million on an after-tax basis against the 19th Capital joint venture. As Jay mentioned, the acquisition of the remaining equity, not already owned in 19th Capital, closed on October 19th, or after our quarter end.As a result, and given that we did not control joint venture as at the end of the quarter, the Q3 accounts continued to report our financial receivables from 19th Capital and accordingly, the $480 million charge is against this loan balance resulting in a residual balance of $251.7 million as at the end of Q3. This amount is slightly less than the previously disclosed CAD 260 million, primarily due to FX changes.Effective October 19, and in consideration of the amount of the loan balance, we will consolidate the assets and liabilities of 19th Capital into Element. While the accounting treatment will change, we do not expect a material change from the $252 million of value shown as at Q3. I refer you to Note 6 and Note 19 of the financial statements for additional information. In Q3, our non-core net interest income includes $12 million of interest from 19th Capital. Our consolidated IFRS loss for the quarter reflects the write-down of 19th Capital in addition to $55 million of one-time costs, of which $35 million restructuring and transformation provision relates to the completed strategic assessment, the realignment of our leadership team and the related severances as well as the start of our investment into the transformation initiative. You'll find a breakdown of these costs in Note 20 of our financial statements. A charge of $20 million was recorded in the quarter against certain equity accounted investments, bringing their values in line with fair market value or realization -- realizable value. Outside of the remaining investment into our transformation initiative in the amount of $147 million through 2020, management does not foresee further charges involved in the transformation process going forward.Turning briefly to the balance sheet. As Jay mentioned, in early October, we successfully closed our $300 million share offering and expect the overallotment option to be exercised, adding another $45 million of gross proceeds. The overwhelmingly strong demand for our equity reflects confidence in our strategic plan and our ability to execute against that plan. You will note that our balance sheet and leverage metrics as at September 30 do not take into account these proceeds, which closed after quarter end. Accordingly, please refer to Footnote 1 on Page 34 of our MD&A for helpful information illustrating the tangible leverage and financial ratios on a pro forma basis. Element has $6 billion in available financing at quarter-end to fund ongoing originations, consistent with the prior quarter. Together with strong access to capital, Element remains well-funded and positioned to meet its financial obligations and objectives and execute on its business strategy. Coming out of our strategic plan announcement, our investment grade ratings were affirmed by the rating agencies. Element has demonstrated great resilience and an ability to produce a strong operating cash flow across market cycles and time. As you know, over the last 12 to 18 months, the business has been impacted by a series of unusual charges and provisions relating to past investments and business decisions. The management team is highly focused on optimizing cash flow generation and the uses of that cash going forward.With the combination of our projected productivity improvements and the balance sheet initiatives we have announced, we are confident that Element's ability to generate strong cash flow and cash earnings will be enhanced, resulting in meaningful deleveraging and tangible equity expansion.Lastly, further to Jay's comments, let me touch on the early days of our transformation program. As Jay noted, we're off to a fast start. We have taken action on initiatives aggregating to $40 million in profitability improvements. And commencing in Q4, we will provide supplementary information outlining both the in-quarter impact of these and other actions to our P&L, as well as the detailed breakdown of our one-time investment costs.Before I turn the call back to Jay, I'd just like to take the opportunity to acknowledge and thank all the Element employees for their incredible commitment to our customers and each other. It's a absolute privilege to work alongside you. I turn it back to you, Jay.
Thanks, Vito. And operator, we're ready for questions.
[Operator Instructions] Our first question comes from Geoffrey Kwan of RBC Capital Markets.
Jay, I have a question. My first question was for you. Now that you've had some more time to kind of assess the company as well as the industry, wondering if you have some thoughts on what you think is the typical annual growth rates on both earning assets and also on the fleet services side. And do you think that maybe over the next 12 to 24 months whatever that rate is might a little bit higher just given what the company went through over the past year?
Geoff, I would say in terms of the macro aspects of the industry, still ascending the learning curve on matters like this. So receiving a lot of different inputs that we're trying to decipher to come up with an inherent organic growth rate for the market in the geographies and the lines of business that we participate in, in the larger fleet management company industry. So some interesting trends that we have noted. There is a stronger inflationary bias to the amount of up-fitting that we're seeing in the industry. So trucks and vans that are being fitted with racking systems, additional cargo capacity, increasing the average cost of the vehicle and fleet. We're seeing trends that have a stronger bias from a traditional passenger automobile to a SUV -- that is the kind of vehicle of choice for safety and productivity for sales fleets and customer care fleets. And we certainly are seeing no diminishing trend around the overall consumption of vehicles and the desire to drive significant fleet investments. So that remains equally strong in accordance with past trends. The other piece that we're watching with great interest is alternative fuel vehicles. And the interest -- early interest that fleets are showing in the adoption of these, experimentation of these and how they may fit into their overall fleet model. So there's a variety of smaller trends, if you will, that are out there, that we are analyzing to try and get a better understanding of what we might expect in terms of the evolution of our net earning asset portfolio by you as we go forward, and we'll advise you as our thinking matures around that organic growth number in due course.
Okay. And just the second question I had was, you did have some write-downs within certain of your equity investments that you've got there. Just wanted to get a sense on your philosophy on making these types of investments going forward beyond what's already been done?
We -- as you know, we inherited a portfolio of investments on -- as the organization was exploring in a number of different directions, some of those are clearly non-core. And we have signaled that with some of the write-downs that we have provided for. And others may have application to our business model and evolution of that business model as we go forward. I think for us, over the course of the next 2 years, it is really quite straightforward. We have a transformation agenda that can yield $150 million run-rate profitability improvement. And there are few things that this organization could focus on that could yield a better return at a lower risk profile than this transformation agenda. And so that will be our singular focus as we traverse 2019 and 2020.
Our next question comes from John Aiken with Barclays.
Jay, in terms of the commentary that you made in the MD&A and then in your prepared commentary. It sounds like quite rightfully that you're very internally focused at this stage in the game, trying to make sure that you get everything right, streamline the business. What can we look for in terms of the near-term opportunities for growth and average earning assets and growth in revenue? Should we be looking at kind of stability over the next little while? Or are there actually opportunities for growth on the top-line over and above what you're laying out in terms of the -- in terms of your initiatives?
John, yes, I would agree with you 100% with a twist. So absolutely, internally focused in terms of the transformation agenda with the caveat that the transformation agenda starts and ends with the customer. And so the customer centricity, the engagement with the customer is the overarching theme here. And it is amply displayed in terms of the active engagement of this executive team with that customer group. And the increased interaction the larger organization is enjoying with the customer as a result of some proactivity and data-driven customer attrition work that we have been doing as part of this transformation agenda. We do believe that that will lead to stability. So as we have talked in the past, customer attrition rose as a consequence of the integration issues of 2017. We believe that that has indeed peaked and that we're on the downside of that attrition returning to a more normalized situation. And as one returns to that more normal situation, the inherent revenue erosion that comes with customer loss gets eliminated. And as a consequence, you should be enjoying the full organic growth opportunities of the industry. And as Jeff has asked and I have attempted to answer, we're trying to get our arms around that, recognizing that we operate in 5 different countries, with a variety of different business models and a variety of different fleet needs. We want to provide you with a little bit more insight in terms of that organic growth profile. But as we all know, the easiest way to grow is to stop losing customers in the first place. That's the order of business #1. And as we do indeed create that superior customer experience and the ability to deliver consistently, that is a meaningful point of differentiation in terms of our competitive stance in the marketplace, which should allow us not only to retain the customers that have entrusted their fleet needs to us, but indeed to capture additional customers as we go forward.
Great. And then one quick follow on, if I may. In terms -- I get Vito's point in terms of the leverage ratios not including the equity issuance, and thank you for the footnote. I didn't notice it and it actually did verify my own calculations. But how comfortable is your own lending syndicate with your plans to delever and plans to pay down at least the first tranche that converts? Can you give us some sense of how those conversations went?
Exceptionally well. Karen and her team have developed an excellent working relationship with the lending syndicate. We worked and -- we have worked and continue to work in a very collaborative, transparent fashion. And that combined with the discussions that were held with the rating agencies made for a very smooth and positive acceptance of the strategic plan that we shared with you on October 1. Again, the -- we have been through a lot with that syndicate. They know us well. Know the sturdiness of the underlying business model and have great confidence in the treasury team and hopefully, the broader executive team as we go forward.
And just one other point. Actually effective today, we have extended the senior line by 1 year. So it will be effective on Friday, but so we'll have a full 3 years. So the lending group has given us unanimous consent to extend the maturity date from 2 years out to 3 years out. So it's just another indication of their support.
Our next question comes from Paul Holden of CIBC.
First question I want to ask is related to operating expenses on the core business. So there's an uptick Q-over-Q on IT spend. So wondering if that's going to be an ongoing spend. And how we should think about that relative to the $150 million of planned profit improvement?
Good morning, Paul. It's Vito. Yes, you're absolutely right. As I referenced in my commentary, our Q3 costs were up $5 million over Q2. IT was about half of it. We also did have some FX headwind as we went from Q2 to Q3 and some one-time credits in our Q2 costs. A bit of a -- relatively small with the aggregate to that $5 million. Paul, we expect our operating costs to decline as we move into Q4 and into, obviously, our 2019 new transformation. IT and the related costs there -- IT is a critical component of our levers obviously as we move forward on strategic initiatives, and we'll continue to spend as we see fit. But it will be focused, it will be strategic and will be enabling the productivity improvement. But I've looked at operating costs on an aggregated bucket basis and as they indicated, we're highly confident that we'll see reductions to that aggregated spend as we move forward.
Maybe just to a bit more color on that too. We have a $40 million of run- rate profitability improvement that we are planning to exit 2018 with as we signaled early -- earlier 80:20 split between productivity enhancements and revenue assurance and retention. And so as Vito has noted, upon exiting 2018, a goodly amount of that $40 million will be productivity improvements and thus will have contributed immediately to an improved operating expense profile as we enter 2019. The other piece of that too, Paul, is that, as part of our Q4 disclosures and as we have previously committed, we want to provide the analyst community with a clear indication of the expense reduction profile for 2019. As we've indicated in the past, these -- the $40 million, $100 million at the end of 2019 leading to the $150 million of run-rate profitability improvements exiting 2019 are all actioned items. And we want to give you a clear idea as to how those actioned items translate into actual expense savings and revenue enhancements in quarter. And so we'll provide that profile as part of our year-end disclosures.
Got it. And then just a follow-up on that in terms of thinking about Q4 operating expenses. You've already executed on $30 million of cost savings to exit the year with $40 million. So I should expect somewhere around $7.5 million to $10 million of cost savings net to Q4 and even including the additional IT spend? Is that the right way to think about it?
Paul, no. I think it's important from a definitional perspective. When we say actioned, it doesn't -- it's not effectively delivery of those items. So I'd guide you away from extrapolating that. And again, we'll provide definitions as we move into 2019. I think you can expect lower operating costs into Q4, but we'll stop just short of dimensionalizing what that may look like.
Okay. Fair enough. And then Jay, you've made a number of comments regarding the stability of the business and normalization of customer attrition. And I just want to ask 1 follow-up question on that. Just because year-end tends to be when customers leave if they're going to leave. So just want to get a gauge of how confident you are that we're not going to see any significant customer attrition end of 2018?
Yes. No, we are definitely on the downtrend. Again, as we have noted the 80 to 100 initiatives that we've envisioned tackling over this 2-year transformation journey are all about creating that superior customer experience that is readily repeatable by this organization. And so for us, we've already set up the TMO. The first initiative the TMO has launched is actually customer attrition. And we have finalized a definition of churn. We have gone back to understand the churn profile and the organization and have actually begun to introduce processes and shift mindsets around a much more data-driven and a much more proactive approach to churn management in the organization. So given that we were trending down and back to normal before and given that we have now shifted this to be a first priority and resourced it accordingly for the organization, our full expectation is that churn will continue to decrease, and the rate of decrease is expected to actually improve as a consequence of the actions that we're taking -- that initial priority of our transformation agenda.
Our next question comes from Jaeme Gloyn of National Bank Financial.
My first question is on that $40 million of quick wins. You did talk about executing on that $30 million as of October 1. And from what I understand today, you've executed on $40 million now. So is it fair to say or fair to characterize that, that 2018 $40 million is a done deal? It's locked in and we should see that run through 2019? And if you can just give us maybe a little bit of color as to any of those 50-plus small projects that were specifically better than expected and any that were worse than expected?
I'll start with the second and push it over to Vito for the first question. And -- so generally speaking, in kind of a -- let's call it 6 weeks given that we got a little bit of a head start in advance of the October 1 announcement -- with kind of 6, maybe 7 weeks under our belt in terms of the transformation, I would say that the vast majority of the initiatives that we have put into action have delivered at or above expectations. So very pleased with the early progress, the validation of our early identification of these opportunities and the sheer amazement of how quickly the organization has embraced this change initiative and is actioned again. So very encouraged. I would say that as we look to the next tranche of initiatives that we are pursuing to realize that $40 million and to get us off to a good start in 2019 towards the next $60 million to build to the $100 million. Yes, everything continues to look like it's operating in a tight band, either slightly better or slightly less than what we've anticipated. But as we look at the sum total, very much in line with the expectations and very much capable of being realized in accordance with the timelines that we have set forth. And in terms of color, again, this runs the full gamut. So the delayering and span of control exercise that brings management closer to the customer and the front-line employees that serve them has yielded strong results for us in terms of the transformation agenda arguably better than what we had anticipated. We've had some early success in indirect spend and procurement -- strategic procurement and the renegotiation of supplier contracts. And we've also enjoyed good success in terms of expense management servicing a number of opportunities or run-rate cost reduction on the operating side of the house. So as Vito has indicated, this is -- these are actions that have been identified and actions by us. And so there is a firm commitment in place. We have dialed in the saving and then depending on -- so you can, for instance, as you look at procurement, when you negotiate a, let's say, an increased purchase discount, that is going to take place on all your purchases go forward. But you're not going to see that full run rate impact until you're through your 12th month of purchasing, if you will, in terms of its annual impact on your numbers. So again, Vito will talk little bit more about the $40 million, in particular, but, yes, popping back up to 10,000 feet, very pleased with the early results we're seeing in terms of the realizability of the benefits that we had identified and articulated.
Jay, very well said. I mean, I'll just add a little bit more there. We originally thought we'd come out of 2018 with $30 million in actioned. We're off to a faster start with that $40 million. As we move into the Q4, obviously, we have got another $60 million or $70 million or so to identify, $60 million -- our commitment is identify $100 million of action as we move through 2019. And what we'll do with our supplementary information here in Q4 is start to give some ranges and color as to where we -- when we expect those dollars to fall into the Q4 bottom line on a quarterly basis, if you will. I think that's the line of questioning here. And happy to do that as we get a bit more visibility and turn those actions into delivery of dollars effectively.
Okay. That's a great color there. Second question for me is just around the allocation of the convertible debentures. I'm just wondering if you could give me a little bit of color around the impact that that had, I guess, more allocated to non-core assets? So the impact that that had on core fleet net interest margins? And how does the reallocation of the convertible debt, I guess, back up to core fleet? Is that factored into the guidance that you gave previously around 2.6% NIM guidance going forward? And then just a little bit further on the redemption of the convert, how does that affect your NIM guidance post-Q2 2019?
Yes, maybe I'll leave the second one for Karen. The first one, you saw us disclose the methodology of the allocation of the interest expense to core and non-core. Obviously, as the non-core becomes a smaller component of our business, we're going have to reevaluate what that looks like. And again, I expect for us to come back in Q4 and give you some color to that as we're working through -- we're currently in the process of working through 19th Capital and what that looks like from both a P&L obviously and a balance sheet perspective as we move into the consolidation aspects of that. So the -- in relation to Q3, the impact from an allocation perspective was relatively minor. I think we called it out at $1.3 million in the quarter. So it didn't have a significant impact from a NIM perspective in the quarter, but obviously something as we that we'll reallocate and look at collectively from an interest expense perspective. Karen, any color on as we think about the refinancing of our converts?
Sure. So just a few points to note. When we look at our convertible plan, we're going to be redeeming the converts, the 2019 converts with a combination of our own resources and the issuance of new subordinated debt. So we'll be -- we'll have a benefit from the fact that we're issuing only, say, our target is $150 million and redeeming $345 million. When you look at also the interest rate, even though we're in a rising rate interest environment. When you look at it -- when you look at the 5 years ago, the size and ratings of the company, it was much different. So we expect better spreads on what we'll be able to issue in the market. And again, always that it is dependent upon market conditions and the liquidity in the market when we actually go, which we expect to be sometime in -- early in the new year.
Our next question comes from Tom MacKinnon of BMO Capital Markets.
2 questions, Vito. I think you talked about the one-time gains you got in terms of NIMs in the second quarter. They're around $2 million. I wonder if you could elaborate on what they were in the third quarter. And then, I have a follow-up on any kind of seasonality with respect to your earning assets?
Yes. The one-time gains in Q3 on the NIM side were roughly $5 million to $6 million. The majority related to a one-time gain on the termination of interest rate swaps due to the repayment of Chesapeake III facility. It was $165 million, Karen, was that one? So that was the big driver there in Q3 from a one-time perspective.
Is was that a -- is that a pre-tax?
That is pre-tax.
And in terms of the seasonality of assets. Average earning assets for the fleet were up 5% year-over-year on a constant currency basis. That's similar to the 5% increase you got in the second quarter as well on a year-over-year basis. But the -- they were down slightly quarter-over-quarter, and the ending assets were down as well quarter-over-quarter. I noticed the same trend in the third quarter of last year. I'm wondering if there's any kind of seasonality here. Or is there higher principal payments in the third quarter? Or -- and also maybe is -- to what extent would seasonality play in any of your originations in the quarter -- in the third quarter as well?
Tom, this is Jay. As a newcomer, I had the same question myself when I saw the change. And was afforded some insights from the veterans of the industry in terms of the natural cyclicality of our business. If you can envision this as orders translating into origination. So we take receipts of customer orders, they tend to peak. The Q4 continues to be kind of a new model year introduction time frame. So customer orders typically ramp up in Q4 and continue into Q1, which drives strong originations in Q2, which fall off in Q3. And if you go back to 2015, '16, '17, you'll see this exemplified in terms of the charts. Q3 is typically a down month in terms of originations and thus net earning assets on exit from the quarter. So there is indeed a natural cyclicality to the industry.
And is there any -- there is -- does this interim funding pickup in the third quarter? Or are there higher principal payments in the third quarter as well? Or is it just the originations that drive that?
Largely, the originations. I too kind of bore down on our -- a couple of those assets that kind of showed quarter-over-quarter increases. And again, more a function of a customer and where they are in terms of their own ordering cycle in our delivery. And so for instance, you may have vehicles -- if one of your customers was a having a large amount of their fleet, new orders up for this, that period between when we receive the asset from the OEM and we actually originated it and assign it to the customer, that gives rise to that interim funding obligation and receivable on our balance sheet. So that is driven more as a function of customer profile and where they are in their ordering cycle and how many of those vehicles may be in that nether land of -- in between OEM and an ultimate assignment to the customer.
You're right. And I get that customer profile isn't always -- it's not always just constant throughout the calendar year then? Is there...
No. No. It is interesting, Tom, like, so if it's a pharmacy fleet, there's -- typically, that's sales people and passenger vehicles or small SUVs with no upfitting. And so you wouldn't find much in the need of interim financing requirements for that type of fleet. You would basically take receipt from the OEM and assign it to the customer creating the origination with very little time gap. The flip side is, if you're out working with an oil and gas support company, a services company, wow, they could have a large number of light-duty pickups that all needed to be outfitted with racking and pop goes your interim funding requirement.
Our next question comes from Brenna Phelan of Raymond James.
So just a follow-up on that seasonality question. It also looked like syndications were high in the quarter. Is this also as expected in Q3? Or was there one large exposure that needed to be syndicated in the quarter?
Kind of as expected. No large syndicate, no large exposure that we needed to address.
Okay. And next question. In the MD&A, there's a note stating that subsequent to the strategic review available vehicle management asset-backed commitments were reduced. Can you tell us -- reduced by $450 million. Is that just given the equity you raised you no longer need that commitment?
No. It's in the management of the overall program. Typically, we would have looked at our funding commitments within -- forward funding commitments within the Chesapeake program. And when we had issued a $1 billion in term debt in that program, we would have reassessed our forward funding commitments at that time. But we held off on doing that in Q2 to go through the full strategic assessment and look at our business in totality. So when we went through that process, we agreed that indeed we could reduce the amount of the commitment. And we took action at the end of September and it was effective on October 1st.
Okay. And then, just on the non-core investments given the write-down taken on ECAF in the quarter. Does that increase the visibility on when you could look to divest that asset?
Yes. I think in the end, we have deemed ECAF to be non-core nonstrategic. We recognized that the buyer universe is fairly narrow for that asset. And as we looked at the nature and timing of the next strategy for that, thought it prudent to take it to a value that we believed was readily realizable in the marketplace. And we'll seek the right time and right buyer to maximize proceeds on disposition.
Okay. And then, what about Splend? Is that -- are you still involved with that entity? Is this still -- can you remind us of your equity investment and the nature of the relationship and your expectations for ongoing involvement in the future, if any?
Yes. Splend offers an interesting business model. Obviously, this was an investment that had been made by the previous leadership team as they explored different avenues and looked for opportunities to gain insights on the evolution of parallel industries and the potential impact on the Fleet Management company industry. For us, we have a continuing relationship -- operational relationship with Splend. But had decided that -- again, as we look to ensure that we have a balance sheet that reflects the innate value of our holdings and as we think about future obligations, while we are supported by it at the operating level, we would not have a desire to invest further in that business.
Okay. So they are still a customer?
Yes, and an operating partner. That's correct.
Our next question comes from [Steven Bullin] of [Incore Financial].
Just one question on the $0.90 to $0.95 guidance that you've talked over the past month. And I just want to make sure that that's -- entering 2020, your expectation is that beyond, I guess, the adjustment within that number, there really should be no more restructuring or transformation charges? Is that the way to look at that number, just want to make sure you're clear on that?
Yes. That number is core adjusted pretax number obviously. Though -- but I think you're absolutely right as far as how you defined it and described it.
Our next question comes from Mario Mendonca of TD Securities.
Could we go to the MD&A for a moment? You referred to extensive benchmarking. What would be helpful to understand is did you find support in your benchmarking for the sort of efficiency gains and efficiency ratio that your guidance would suggest? What I'm getting at specifically here is, what sort of efficiency ratio do you anticipate this company delivering? By efficiency ratio I am just referring to your operating expenses relative to your revenue. What sort of efficiency ratio are you thinking about and did you find any benchmarking to support it?
Mario, the extensive benchmarking, as you know, trying to find like-for-like comparators and access readily available information at a financial and/or operational level is very difficult. Perhaps, as difficult as I've ever encountered in the variety of industries that I've worked in. So what we had done in the absence of being able to gain that type of insight was to look at like-for-like processes. And so we broke down the different functionalities, work streams, products and services and how they originated and supported into continuums. And did like-for-like comparisons with other organizations offering a similar type of functionality, service or offering and benchmarked against them in terms of productivity gains. So the natural default as you think about a transformation of an organization, your first benchmark ideally is always your industry peers. And once you get on par or top quartile amongst industry peers, then you go outside your industry and redefine your peer group in terms of best of class for that function, for that offering. In the absence of being able to access the comparators for that first tier of benchmarking, we went straight to best-in-class world for like-to-like processes and offerings. So it's a little larger step for us. But as we indicated earlier, as we talked about early observations, that which we have been able to identify as the 80 to 100 different initiatives and that which we have already put into reviews, scrutiny and subsequent reaction have all yielded at or above the expectations that we have set. So nice early validation of the benchmarking exercise that we have done.
I think I understand a little better. I too couldn't find good benchmarks.
No. No. And again, it's a bit frustrating, but to be honest with you, it imposes a higher standard on the organization going immediately to best-in-class industry -- best-in-class regardless of the industry. And again, it is the natural progression as one looks to fine-tune. And in the absence of the readily available industry competitors, we went directly there.
One quick follow-up question there. When you think about measuring efficiency internally, do you look at ratios like the operating expenses to your revenue, the same sort of thing that would happen outside of the fleet business because -- it was an interesting point you made to look outside of the fleet business to look at best-in-class world. So do you look at things like an efficiency ratio that a typical bank might report, like what is the efficiency ratio you would use?
Yes. And for us, we will evolve to that. At this point in time, I'd like you to think about it more from a perspective of that -- that is a refinement in terms of where we will ultimately get to. But today the things that need to be done are so obvious, the opportunity at hand is so great that the focal point really is on the 80 to 100 initiatives that create that superior customer experience, that create the consistency in that customer experience that our customers are longing for which drive these benefits. So for us, once we have matured into that -- to that place, where we have completed the transformation, we are steady state. Then I think the natural evolution is exactly what you have articulated. And looking at other benchmarks and how do we -- how do we refine where we are to where we might be. But at this point in time what needs to be done is so obvious, so compelling that that's a degree of refinement that probably just doesn't have a whole lot of value at first. So philosophically yes, totally aligned, but we're probably thinking about that as we're going through 2020, line of sight to exiting 2020 fully completed on the transformation agenda and fully matured in terms of the steady stabilized state that we have articulated that we are envisioning at the end of 2020.
Just one quick follow-up maybe for Vito. The $30 million in assurance -- revenue assurance gains let's call it, does that emerge in 2019? Or is that more of a 2020 story?
We'll see some of it come through in 2019 as well.
Our next question comes from Nigel D'Souza of Veritas Investment Research.
So I just wanted--my first question was related to the $150 million business investment that you've outlined. I just wanted to understand how we should think about that flowing through the P&L? Is that something we should expect to flow through as a restructuring transformation cost over the coming quarter? And is the $35 million incurred in Q3, is that net of that, how should we think about it?
Yes. The $150 million, Nigel, it's Vito here, you'll see us reporting that through our P&L as restructuring charge moving forward. I indicated $3 million of the $35 million effectively. We started spending into the $150 million. The $35 million effectively related to cost bringing us up to the transformation project, but there was a small amount there in the $35 million, call it $3 million and you heard me reference the remaining balance of $147 million, substantially all of it as we move forward here in Q4 2018 through to 2020. So over the next 9 quarters you'll see us reporting that. And obviously our supplementary information again will, in addition to the financial statement representation, will provide much more granularity and detail as to what that looks like, the components of it and what we're projecting looking forward.
Last quick question for me. Forgive me if I missed this in your comments or MD&A. Could you provide any update on whether you expect your overallotment issuance to be exercised or not?
Yes. We do expect it to be exercised. The expiry date there is November 11th, I think, correct, and we do expect full exercise of the allotment.
Our next question is a follow-up from Jaeme Gloyn of National Bank Financial.
Just a quick follow-up on a couple of questions. One related to the other industries. Are you able to provide any sort of color or description of some of those other best-in-class, best-in-world industries that you were looking at specifically?
Yes. To be honest with you, it ran the full gamut depending on the functionality or the product offering that we were looking at. And yes, probably wouldn't want to say much more beyond that. But yes, we basically for each and every aspect of the business that we broke down into its subcomponent, went out to either benchmark industry or individual organizations that had exemplified themselves in terms of their service and/or productivity around that functionality or offering and use those as our relevant benchmarks. So we were agnostic in terms of industry -- comparability of the industry in the end for instance, to talk about something that is terribly minute, if we look at call center response time. We went best-in-class /world in terms of that, there's readily available industries that we could tap into, compare and understand the gap and the gap closure opportunities for the organization.
And last one just in terms of the commentary around the sub-debt and expected issue in 2019, I guess. What's the rationale for tapping the sub-debt market this early I guess, in the program I would've thought maybe it would have been something for the 2020 maturity. What's the thinking there rather than using line of credit or cash flow at this point?
It's just managing our leverage on our leverage position. And looking at it and if we're continuing to a rising rate environment it's probably better to issue in 2019 than wait to 2020. So that's part of the consideration that we'll be making when we decide to go-to-market and the timing of go-to- market.
We have more options perhaps we have had in the past so we are obviously working our way through it.
Okay. And would you be thinking just sort of U.S. sub-debt issue or cross-border?
Again, all of those decisions haven't been finalized, but they are certainly under consideration.
This concludes the question-and-answer session. And this concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.