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Edited Transcript of ECN.TO earnings conference call or presentation 26-Feb-20 10:30pm GMT

Q4 2019 ECN Capital Corp Earnings Call

TORONTO Mar 12, 2020 (Thomson StreetEvents) -- Edited Transcript of ECN Capital Corp earnings conference call or presentation Wednesday, February 26, 2020 at 10:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John B. Wimsatt

ECN Capital Corp. - Head of Corporate Development & IR

* Michael Lepore

ECN Capital Corp. - CFO

* Steven K. Hudson

ECN Capital Corp. - CEO & Director

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Conference Call Participants

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* Jaeme Gloyn

National Bank Financial, Inc., Research Division - Analyst

* Tom MacKinnon

BMO Capital Markets Equity Research - MD & Analyst

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Presentation

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Operator [1]

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Welcome to the ECN Capital Fourth Quarter 2019 Results Conference Call. (Operator Instructions) The conference is being recorded. (Operator Instructions) I would now like to turn the meeting over to Mr. John Wimsatt. Please go ahead, Mr. Wimsatt.

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John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [2]

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Thanks, operator, good afternoon, everyone. Thank you for participating in our conference call to discuss ECN Capital's fourth quarter 2019 results announced earlier today. Joining us are Steven Hudson, Chief Executive Officer; and Michael Lepore, Chief Financial Officer.

A news release summarizing these results was issued this afternoon and the financial statements and MD&A for the 3-month period ended December 31, 2019, have been filed with SEDAR. These documents are available on our website at www.ecncapitalcorp.com. Presentation slides to be referenced during the call are accessible in the webcast as well as in the PDF format under the Presentation section of the company's website.

Before we begin, I want to remind our listeners that some of the information we are sharing with you today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. I'll refer to you -- I will refer you to the cautionary statement section of the MD&A for a description of such risks, uncertainties and assumptions. Although management believes that the expectations reflected in these statements are reasonable, we can obviously give no assurance that the expectations of any forward-looking statements will prove to be correct.

You should note that the company's earnings release, financial statements, MD&A and today's call include references to a number of non-IFRS measures, which we believe help to present the company and its operations in ways that are useful to investors. A reconciliation of these non-IFRS measures to IFRS measures can be found in our MD&A. You should also note that as of January 1, 2018, the company changed its presentation and functional currency from Canadian dollars to U.S. dollars. In addition, readers should note that legacy operations were discontinued and classified as held-for-sale as of the fourth quarter 2018. All figures are presented in U.S. dollars unless explicitly noted.

With these introductory remarks complete, I'll now turn the call over to Steven Hudson, Chief Executive Officer.

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [3]

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Thank you, John. And good afternoon. Let's turn to Slide 7. These are the 3 key takeaways from our recent Investor Day. I just want to revisit those briefly with you.

First and foremost, we have a resilient business model with proven take and make share working. We also have proven growth pipeline. You see that manifest itself in monetizing our existing business funnel, coupled with adding complementary products. Secondarily, we've -- we are prudent managers of capital, with dividend and share repurchase and appropriate liquidity reserves, all this while -- well, all this while executing on our organic growth initiatives. And finally, we are deepening our relationships with both existing and new financial institution partners. These 3 takeaways drive our significant -- our confidence in our 2020 EPS guidance of $0.36 to $0.41 a share, representing 42% growth over the midpoint.

Turning to Slide 8. We've accomplished some management transition at Triad. Don Glisson approached me a year ago asking to be elevated to the role of Chairman. We've completed this transition -- this natural evolution transition in the last 2 weeks. Don is now Chairman. Mike Tolbert, many of you met Mike at our Investor Day, he's been promoted to President. The management team has been enhanced with Matt Heidelberg joining. Matt has been tasked with adding new products and expand the funding, we'll revisit that in a second. And all of this has been accomplished by keeping a senior management team with over 200 years of industry experience. Transition also allows Triad to reduce annual compensation by more than $1 million and eliminating $6 million of incentive comp through 2022. I think it's a good deal for members of management and for Don as well as for Triad and for ECN. We're happy that it's been completed.

On operating results, turning to Slide 10, on Service Finance. Q4 results in line with management expectations and guidance. Adjusted operating income before tax of $17 million -- $17.3 million. I would note that, that includes $100,000 of PACE wind-down costs in the quarter, $500,000 for the full year. Also, I'd note in Q4 of '18 includes some lumpiness as that's the quarter which includes solar loans originated throughout the year, which were sold in that quarter with a revenue of approximately $4 million realized in the fourth quarter of 2018. Origination growth, excluding PACE, of 30% year-over-year is healthy as well as the 42% growth in the managed portfolio.

On Page 11, the Lennox volume has fully recovered from the impact of the 2008 (sic) [2018] tornado and business interruption. We've seen 22% growth in fourth quarter origination, solid growth continuing in 2020. In particular, Lennox volumes were up almost 20% in January and up almost 30% in February. I think we can tick the scorecard as this has now been completed.

As well, I'd like to mention to you that Service Finance has prudently raised FICO scores, we mentioned this in previous calls, and pricing on solar loans. This has been done to protect our bank partners by enhancing the credit quality of the portfolios that originate and manage on their behalf. And even though Solar will continue to decline as a percentage of overall originations, we are very confident in our full year origination guidance for 2020 of $1.9 billion to $2.1 billion.

Turning to Slide 12, assets held-for-trading. You'll see that since fourth quarter '18 to the fourth quarter '19, they're down approximately $200 million. I think we have proven the ability to create new assets within our expertise of credit and to create homes for those with our institutional investors. We also expect that there will be additional asset sales in March of 2020. And existing partners will prefer to buy these in bulk purchases for administrative ease. I think we are on -- I don't think. We are on track to flowing these loans through our balance sheet. And I think the success has been proven over the last 5 quarters.

I won't comment on Slide 13. I'll just say that our origination growth, as I mentioned in 2 previous slides, is significant and continuing in the first quarter of 2020.

Turning to Kessler Group. The fourth quarter results, Slide 14, are in line with expectations. EBITDA margin of 54% reflects Scott's operating efficiencies and better revenue performance. We also announced in this quarter that we've acquired a card management business, which was a third-party provider. This part -- this card business will allow us to partner with additional institutional investors to originate and syndicate on credit portfolios. Again, I want to emphasize, as we did in our Investor Day, our intention is to limit future ECN capital investments but to further build on our card management and performance fee base.

15. An important strategic shift, which we discussed at Investor Day is shifting away from onetime revenue, so-called transaction service revenue, to more recurring revenue in the form of partnership, services and marketing services. I would give you 3 points to reference on Slide 15. At the date of transaction, approximately 2/3 was recurring, 1/3 was transaction. At the end of '19, that was 74%, 26%. And our forecast of 85%, 15% is well in hand based upon the first quarter -- first part of Q1. We think this shift to recurring revenue improves the quality of the earnings from Kessler and allows more transparency into the future forecast of Kessler.

Turning to Slide 16. We are raising the -- on Triad, we are raising the guidance for this business from $30 million to $34 million to $31 million to $35 million, reflecting the results of the compensation savings from the management transition I just referred to. The fourth quarter results were ahead of expectations. Originations came in at approximately 7%. Managed portfolios at 12% growth and EBITDA growth of approximately 30%. Assets held-for-trading were up modestly, but we've now completed a process to acquiring assets and on selling those to institutional investors, who prefer to buy them in minimum blocks, minimum size as opposed to a flow basis but that's been done. I think an important update for you is that Matt Heidelberg and the other team, Mike and Matt, announced the Bronze initiative at the Investor Day. We're happy to announce that there's already $25 million approved in that program in January and February. That's a new initiative. An incremental loan, if you will, and a new institutional investor. That should bode well for Triad in 2020.

Turning to Floorplan on Page 17. I'm happy to see the first bullet is that the active dealers have been decreased from 218 from 236. That culling, if you will, as we've gone through the team at Triad, Lee and the members up there have gone through and removed Floorplan dealers who weren't providing loan product to us. And that's part of running a very efficient, low-risk portfolio. As you know, people who use Floorplanning, their origination growth is 3x that of someone who doesn't use Floorplanning. Floorplanning is a strategically important initiative, albeit modest in size, that drives the origination volume for Triad. It's still a very attractive asset with a realized yield of 8%.

Again, on 18, originations are strong and continuing at Triad.

I think Michael, I'll pass it over to you.

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Michael Lepore, ECN Capital Corp. - CFO [4]

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Thank you, Steve, and good afternoon, everyone.

Turning to Page 20. As for the Q4 consolidated highlights, total originations for Service Finance and Triad Financial Services of $542 million in Q4 2019 were up 17% compared to Q4 2018. Q4 adjusted EBITDA was relatively flat year-over-year primarily due to the impact of the held-for-trading fair value adjustment of Service Finance that Steve spoke to previously, and elevated transaction revenue at KG in Q4 2018.

As previously highlighted at Investor Day, we recorded an after-tax provision of approximately $14 million related to our legacy aviation business. We recorded an after-tax provision of approximately $2 million related to the leadership transition of Triad, which again, Steve just spoke to previously. As a result of the cost savings from this charge, we expect to get a payback in about 2 years.

Finally, we also incurred about $2 million in nonrecurring M&A-related expenses in Q4, including just over $1 million in costs attributable to a transaction that we did not ultimately pursue. And closing it out, we purchased the remaining 4% noncontrolling interest in KG for approximately 3 million shares of ECN. These shares will be issued in March, and no gain or losses realized on this transaction. As a result of this transaction, we no longer have any noncontrolling interests in any of our operating subsidiaries.

Turning to Page 21. Just a few presentation changes to highlight. First, we reclassified certain aviation assets from held-for-sale to inventory to give us more flexibility to realize on our capital. Second, the asset related to Triad's reserve deposits is now presented gross with the matching liability as required by IFRS. There was no impact on the retained reserve interest, which is what Tried expects to recover from the reserve deposits, and what we have previously reported. This was simply a presentation change. Finally, we have broken out marketing services revenue earned by KG as a separate line item on our consolidated income statement.

Turning to the next page. No significant changes in the balance sheet compared to Q3. Total assets and total debt were both down by about $20 million. As a result of the acquisition of the card investment management platform, managed and advisory assets are now approximately $34 billion as of the end of Q4 2019.

Turning to the next page. Q4 adjusted EPS of $0.08 per share was at the high end of our guidance range and up 60% compared to Q4 2018. For the year, adjusted EPS was $0.27 per share, up from $0.11 in the prior year. The year-over-year growth in adjusted EPS reflects the strong performance of all 3 of our operating businesses. And finally, just to note, our effective tax rate and adjusted net income was 21% in 2019 and 19% in the fourth quarter, in line with our annual guidance range of 20% to 22%. Operating expenses were down slightly compared to Q4 2018, prior due to lower expenses at KG and lower corporate operating expenses, partially offset by higher operating expenses at Service Finance.

And finally, I'll turn to the next page. On discontinued operations, there are no significant changes in our rail and C&V assets from -- and C&V legacy assets from Q3. Aviation assets are down to $97 million in the held-for-sale category and another $25 million in inventory. We were at total legacy assets of approximately $330 million at the end of 2018, $170 million at the end of 2019, and expect to be at or below $50 million by the end of 2020. We will continue to expedite the exit from the remaining assets as quickly and efficiently as possible with a view to maximizing value.

And with that, I will pass it back to John.

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John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [5]

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Thanks, Michael.

Steve asked me to speak to a couple of slides that we presented at Investor Day, starting on Page 27. While we intend to remain an asset-light business services company, ECN's liquidity and balance sheet have been huge competitive advantages. We're able to use our balance sheet to develop foundation products, which are designed to drive core originations for our bank and financial services partners. Our operating companies enjoy the benefits of ECN's investment-grade rating, making many programs possible. Even so, to the extent that we are using the balance sheet, we'll either be actively selling through bulk sales or stick to lower-duration product before we turn into flow.

Because we turn over the balances rapidly, the average age of the assets on the balance sheet of only 4 months represents very low-risk, newly originated production. Our 3 largest programs to date have been Solar and Complementary Flow at Service Finance and our Floorplan business at Triad. Collectively, through December 2019, we have originated more than $1.1 billion worth of paper under these programs but had only $150 million on balance sheet at year-end. These are effectively balance sheet-light programs.

On Page 28, we are attempting to show the many programs that we've actively helped our operating partners launch, some of the technology enhancements we have spearheaded and other areas where ECN has helped to grow our partners' businesses. In some cases, partners have used our balance sheet like the Solar and Floorplan initiatives that we discussed previously. In other cases, our deep knowledge and experience in commercial finance has moved a new growth program forward, like Commercial MH or Commercial HVAC. We announced several new programs at Investor Day in January that we are very excited about, and we definitely look forward to updating you on our progress later in 2020.

Finally, on Page 29 -- I'm sorry, skipped a page there. There you go. Sorry about that. Finally, on Page 29, we have successfully helped each of our businesses expand operating margins. While obvious at Triad and KG from the chart, if we adjust SFC's, or Service Finance's, very high absolute margins in Q4 2018 for the bulk sale held-for-trading assets, it is also upward sloping. We expect continued improvement for each of these businesses in 2020. ECN spends an enormous amount of time and resources doing deeper views on the businesses to identify areas for efficiency growth and other improvement. Each of our businesses have an experienced business analyst responsible for analytics and issue identification. In effect, we have married exceptional entrepreneurial businesses with experienced corporate culture to drive improved performance, and we are thrilled with the results.

With that, I'll turn it back over to Steve.

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [6]

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Thanks.

On Slide 30, a few quick closing comments before we open the call. Happy to report $0.08, in line with guidance of $0.07 to $0.08. Full year of $0.27 compares favorably to our increased guidance of $0.25 to $0.28, which was updated from the original $0.23 to $0.25. We are highly confident as a management team in our $0.36 to $0.41 of guidance for 2020. In terms of capital management, quarterly dividend remains $0.025, which, as you know, was raised in the third quarter of '19. Our 2019/'20 NCIB is authorized, and our senior credit facility has been extended to 2023.

With that, operator, I'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Tom MacKinnon with BMO Capital Markets.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [2]

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Just a couple of questions here. With respect to the M&A-related expenses and the leadership transition expenses, were those all part of the $18.5 million adjusted net income for continuing operations? Were any of those put below the line?

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Michael Lepore, ECN Capital Corp. - CFO [3]

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Tom, it's Michael. Yes, those -- we put those charges below the one.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [4]

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Both of those charges were below the line?

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Michael Lepore, ECN Capital Corp. - CFO [5]

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There's a -- yes, you can -- yes.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [6]

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Okay. And then the -- it -- what -- why was the Service Finance -- it looked like the general and admin expenses seem to be running quite a bit higher than their normal run rate in the fourth quarter. Is there any kind of seasonality? Or how should we be looking at those? On the flip side, the corporate seemed to be a little bit lower. I'm not sure how you may have treated the M&A-related expenses in corporate in the past as well, so maybe some color with respect to those.

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [7]

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Yes. I think, Tom, on Service Finance, you're probably -- well, let's confirm it post the call, but I expect you're seeing is the -- is a build-out cost related to the multi-lender platform being expensed and not capitalized. I think -- I'm sure that's the majority of it. But let me -- we'll confirm that after the call.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [8]

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Okay. And then interest expense, if I look at that, seems to be $5.2 million. I mean this thing's been jumping all over the place but it's been the lowest what it's been for the last 3 quarters. I'm just not sure how we should be thinking about that given the use of your balance sheet going forward for 2020.

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Michael Lepore, ECN Capital Corp. - CFO [9]

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Well, I think as we said at Investor Day, I think we anticipate debt levels to stabilize around where they are now given the organic growth opportunities in front of the business. So I think at Q4 -- the Q4 run rate of interest expense is probably a reasonable way to look at it for 2020. You see, it did come down -- it came down from Q1, it was $600 million in the end of Q1 to approximately 4 -- around the $430 million to $450 million range, and we anticipate that for debt levels over -- for -- through 2020. And then the all-in cost from that, including the amortization to financing cost, is approximately 5%.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [10]

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Yes, I'm looking at Page 23, the $5.183 million interest expense, that's what I'm referring to. It seems to be quite a bit lower than previous quarters. And you're telling us that, that probably should be the run rate for that?

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Michael Lepore, ECN Capital Corp. - CFO [11]

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Yes.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [12]

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Yes. Okay. And then just a couple of quick ones here. The guidance for cash flow hasn't changed, but now that you -- should we assume somehow that now it's -- wouldn't it be 4% higher as a result of the buy?

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Michael Lepore, ECN Capital Corp. - CFO [13]

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We anticipated the buyout of the noncontrolling interest when we did our guidance, so there's no change there.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [14]

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Okay. So the guidance did have -- at the Investor Day did have the 100%?

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Michael Lepore, ECN Capital Corp. - CFO [15]

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Yes. It was at 100% basis, yes.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [16]

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And the reason for the lift in the Triad, was that success of the Bronze? Was -- and then that $25 million that Steve spoke of at the Bronze program at Triad, is that origination? And is that included in the -- sort of the $680 million to $720 million originations that we -- that you guided to?

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [17]

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Two messages there, Tom, the reference on Bronze was just to give you a sense of how the new programs -- we launched a number of new programs at Investor Day. And that's $25 million of approvals, which over half of those will fund into originations. It was just to give color on that. The reason for the guidance increase in Triad was we are -- with the transition complete, we are now eliminating management compensation expenses. So we -- having invested capital in the transition, we wanted to show you there was an appropriate buyback.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [18]

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Okay. And sorry for taking a lot of time here. The last one, in terms of the -- how much in terms of the Service Finance originations was Complementary Flow? And how should we be thinking about that going forward?

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John B. Wimsatt, ECN Capital Corp. - Head of Corporate Development & IR [19]

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Yes. Complementary Flows was probably 10% to 15% of originations in the quarter.

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Tom MacKinnon, BMO Capital Markets Equity Research - MD & Analyst [20]

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And is that -- in the guidance for 2020, is that kind of what we should be thinking for that?

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [21]

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It is, Tom. That flow, as you know, is being originated on behalf of 4 to 5 bank partners. We originated them to a minimum portfolio size and sell it through. Has the same yield and same -- same yield and same credit characteristics as "the core business."

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Operator [22]

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(Operator Instructions) The next question comes from Jaeme Gloyn with National Bank Financial.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [23]

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First question is just related to the lift out of the credit card team. Can you just walk us through the -- what you're getting out of this business? Where did the team come from? Just want to get a little bit of understanding as to what this team represents, and maybe talk about the purchase price of about $10 million for this team of individuals.

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [24]

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Yes. Thanks, Jaeme. The team was -- we -- it was an external firm that have worked with us in all of the 4 credit card transactions that we have closed. And my thought was, that we -- at some point, once we had done enough work with them, we would internalize that team. That team had management fees associated as part of their platform on these assets that we acquired. So we did purchase prices, leave the present value of those management fees. So it's a fair -- it's a good price for us -- a fair deal for them, but a good price for us because we're PV-ing the management fees they receive on those 4 portfolios. The other benefit for us is that the senior executives' deep history in credit cards are now carrying the full Kessler, the full KG menu, if you will.

So they're now out marketing in addition to sourcing credit card opportunities for institutional investors, they're also marketing things like risk-based management and other products, so that part isn't in the forecast. So it was kind of a wait and see on my part to see how these first transactions went. We were happy with how they went. We were able to cut a deal, which is the PV of the fees, which I think is a conservative valuation for us, a good valuation, and we're happy to have them on board. And I think there will be a lot of success from this team over and above identifying credit cards for institutional investors. The purchase price was $10 million, which is the PV of the fees.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [25]

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Okay. And are the expenses tied to this team, are they included in the existing guidance for Kessler Group as well?

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Michael Lepore, ECN Capital Corp. - CFO [26]

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Yes, they are.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [27]

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Great. Second question is then around capital deployment. And just thinking about buybacks versus dividend increases. How does the -- I guess write-downs of the legacy assets and maybe deferral of some of those asset sales in future years, does that impact how you're viewing share buybacks and dividends going forward?

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Steven K. Hudson, ECN Capital Corp. - CEO & Director [28]

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Yes. I think, Jaeme, the increased valuation was -- allowed us to more flexibility on -- to increase the -- to accelerate the timetable of return on capital. Don't think that we're giving that back to the people that we're dealing with. It was to give us more flexibility. So our intention is to still recover the capital here and have a positive variance, i.e., more than what we need in the valuation. But that capital, as you point out, a lot of it isn't leveraged. We're showing this portfolio going down somewhere between $0 to $25 million -- sorry, $50 million by year-end.

Our target is to be out of this business by the end of 2020, you might have a little piece left. But you can -- rest assured that every dollar we get back here is going to go back into the redeployment of capital. And as you pointed out in the past, that has been a function of -- principally, it's been used for our tender offer. As you -- and while we were active in our NCIB in the fourth quarter before we went into blackout and if you look at the current valuation, we still believe it to be very attractive, i.e., undervalued.

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Operator [29]

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There are no questions registered at this time. This concludes today's conference call. You may disconnect your lines. Thank you for participating. And have a great day.