Just Energy Group Inc.
Q4 2017 Earnings Call Transcript

Published: 18 May 2017

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Just Energy Group Incorporated Conference Call to discuss the Fourth Quarter 2017 Results for the period ended March 31, 2017. At the end of today’s presentation there will be a formal Q&A session. [Operator Instructions] I will now turn the meeting over to your host Deb Merril, Co-Chief Executive Officer. Please go ahead.

[Deborah Merril:]

Thank you very much. Good morning, everyone, and thank you for joining us this morning for our fiscal 2017 year end earnings conference call. My name is Deb Merril, I’m the Co-CEO of Just Energy, and I have with me this morning the Executive Chair, Rebecca MacDonald; my Co-Chief Executive Officer, James Lewis; as well as Pat McCullough, our CFO. Pat and I will discuss the results of the quarter, as well as our expectations for the future. We will then open the call to questions. Before we begin, let me preface the call by telling you that our earnings release and potentially our answers to your questions will contain forward-looking financial information. This information may eventually prove to be inaccurate, so please read the disclaimer regarding such information at the bottom of our press release. Fiscal 2017 was a very important year for Just Energy from a financial, operational and strategic positioning perspective. It was a year highlighted by 4 general themes

[Patrick McCullough:]

Thank you, Deb. As Deb mentioned earlier, this is an exciting time for Just Energy as we've improved our margin performance, credit metrics and overall financial strength. As a result, we're well positioned to make investments that can have a meaningful impact on our future earnings and cash flow potential. First, I would like to cover some of the highlights of the fourth quarter and fiscal year, and then I will provide some added color in certain areas before turning to some more specific aspects of our outlook for fiscal 2018. In the fourth quarter, sales of $947 million were down 12% compared to the prior year. Gross margin for the fourth quarter was $175 million, a decrease of 14% year-over-year. The decline in both sales and gross margin is attributable to the 8% decrease in our customer base and the effects of foreign currency translation. Sales for the full year were $3.8 billion, down 8% compared to the prior year primarily because of the decrease in our customer base. For the fiscal year, our gross margin was $696 million, down 1% from the prior year, driven by unfavourable foreign exchange and partially offset by ongoing margin improvement initiatives. Gross margin for the Consumer division decreased to $513 million, down 5% from the prior year due to lower consumption. Gross margin for the Commercial division increased by 12% from the prior year to $183 million, as a result of lower balancing and capacity cost. Now I would like to spend a few minutes discussing our customer initiatives before going deeper into our financial results. For the fiscal year 2017, the combined attrition rate for Just Energy was 15%. We saw Consumer and Commercial attrition improved 2 percentage points each year-over-year. As you may recall in fiscal 2016, we were able to hold attrition levels year-over-year and this year, we're able to improve on that. This is particularly encouraging when we consider the highly competitive market that we're experiencing today. We are encouraged by the improvement in the trend of customer net additions that we are witnessing and we expect this improvement to continue as our new innovative products are gaining more appeal and presenting more value for our customers. This is allowing us to price our energy management solutions competitively without sacrificing customer satisfaction. We also saw an improvement in our renewal rate for the year of 3 percentage points up to 65% overall. We accomplished this in a very competitive market and what is even more encouraging is that we achieved a renewal rate in the Consumer division of 79%, a level that comps our recent history. We feel strongly that this achievement reflects the intended outcomes of the steps management has taken to align our customer base with compelling value-added products that will drive future growth. Administrative expenses for the fourth quarter decreased by 34% as a result of lower employee-related expenses, a decrease in legal provisions and the impact from foreign currency translation. Administrative costs were also down for the full year by 1%. Selling and marketing expenses were down 14% to $54 million for the quarter. For the full year, selling and marketing expenses were down 12%. The decline was due to lower commission expense from lower gross customer additions combined with the decrease residual commission cost. Finance cost, net of non-cash charges were down 25% during the quarter and down 4% for the year. The lower finance cost was a result of the 25% decrease in long-term debt in fiscal 2017. Moving to the bottom line, our fourth quarter EBITDA was up 11% to $75 million and our fiscal full year base EBITDA was up 8% to $224.5 million. This was within our stated guidance for the year. I will also note that the full year base EBITDA included $11.3 million of additional prepaid commission expense compared to last year. If you exclude this additional expense item, base EBITDA increased 14% year-over-year to $235.8 million. Base funds from operations for the year decreased 8% to $128 million. Although base EBITDA increased, there was a decline in base FFO due to the onetime finance cost related to the repayment of the senior unsecured notes and higher current income taxes resulting from exhaustion of non-capital loss carry-forwards in both Canada and the U.K. Dividends and distributions for the year were $77 million, an increase of 3%, reflecting the initiation of dividend payments to perpetual preferred shareholders following the new issuance in February 2017. The payout ratio on base funds from operations was 60% for the year within our target range. We generated meaningful cash flow to support our growth. Cash and short-term investments declined $44 million during the year due to several items. We made essential growth investments such as our launch into Germany and investments into ecobee. In addition, we early redeemed 320 million of the 6% convertible debentures and repaid the remaining 80 million on the senior unsecured notes. These repayments were partially offset by the issuance of $160 million in the 6 3/4% convertible debentures and $133 million in perpetual preferred shares and some utilization of the credit facility. Let me take a moment to talk a bit more about the successful execution of our balance sheet repair, which has us well positioned to aggressively pursue growth initiatives. During the year, we reduced our long-term debt by 25% to $498 million due to the early redemption of convertible debentures and the repayment of senior unsecured notes. As a result, book value net debt was 1.8x the trailing 12-month base EBITDA at year-end. This is a significant improvement from 2.6x just 1 year ago. At this point, we feel confident in our debt profile and remain committed to maintaining these relative levels moving forward in line with our capital light strategy. Before I wrap up my prepared remarks, like to review our outlook for fiscal 2018. As Deb mentioned earlier, and as you saw in our press release, fiscal 2018 is a year of investing in growth for Just Energy. We believe we will achieve net customer additions and delivered base EBITDA in the range of $210 million to $220 million. While base EBITDA reflects a decline over 2017 results, it demonstrates solid performance in our base business combined with a significant investment in the form of upfront commissions, international operations and a product and geographic growth initiatives. Again, we remain committed to maintaining our high ROIC capital-light position and we seek to make these growth investments through existing cash and the balance sheet capacity. Looking beyond 2018, we believe the business can grow earnings in fiscal '19 and beyond returning to the double-digit growth we've been able to recently achieve. This significant bottom line growth will be achieved with the successful execution of our strategic growth pursuits in new regions, products channels and energetic pursuits. With that, I'll turn the call back over to Deb for her concluding remarks. Deb?

[Deborah Merril:]

Thanks, Pat. As we look back on the last 20 years, we could not be more proud of what we've accomplished at the company. Just Energy has evolved dramatically over the last 3 years. Since our original Canadian IPO, the company has delivered a 16% [ph] annual returns to shareholders. We're one of the few companies who can make that claim over a 15-year period. With a proven track record, we're confident that we can continue to deliver superior results to our shareholders and customers around the globe. Now we'll open it up to any questions you might have for us.

[Operator:]

Thank you. [Operator Instructions] And I see we have our first question from Damir Gunja with TD Securities.

[Damir Gunja:]

Thank you. Good morning.

[Patrick McCullough:]

Good morning, Damir.

[Damir Gunja:]

Just wondering perhaps, Pat, if you can quantify what sort of embedded growth rate you have in the base business for 2018. Are you expecting it to be flat or low single digits? That's all of the OpEx?

[Patrick McCullough:]

So you're asking about base EBITDA, if you were to exclude those one-timers?

[Damir Gunja:]

Right.

[Patrick McCullough:]

Yes, we are seeing margin and base EBITDA improvement reflecting the expected gross additions. So if you think about that we could be doing without that overhang of one-time commissions and those new investments, we're probably be in the 5% to 10% year-over-year EBITDA range this year, if you exclude those.

[Damir Gunja:]

Okay. And can you maybe help us quantify? You mentioned the 3 buckets of commissions, international and products and geography, to the extent you're willing to get into numbers. Can you quantify sort of the onetime nature of the investment in the 3 buckets? And sort of the grand total of spend that we should be sort of adjusting for or thinking about and the way we're looking at it this year?

[Patrick McCullough:]

Yes, we can. So if you think about the commission buckets, the first bucket, that's the big one. So the channels where we're paying upfront commissions, think door-to-door, think some of the European channels. We do make decisions with partners to optimize Just Energy's return on investment around how we structure payments. So given that between 40% and 50% of our residential channels, have upfront commission payments associated with them, you're in the land of $20 million to $30 million of overhang when we get back to significant gross additions. If you think about the international market seeding, we've shared publicly the U.K. $2 million that was done 4, 5 years ago for an organic start-up. That was only starting up the Commercial business at that point in time. As we look to expand in Germany, Ireland and Japan, we're looking at bringing book Commercial and resi sales operations in at the beginning. So you're generally going to see a few million dollars per market in terms of upfront first year OpEx that will be mostly recovered in the second year, if not turning as a slight profit. New channels, new product, that is generally contained in what we would spend on an ongoing SG&A basis. But you will see single digit millions of incremental spend as we expand to 10 total channels for the residential business consistent with our Investor Relations events that we had cut out there recently.

[Damir Gunja:]

Okay. So it sounds like you've got a high degree of confidence that this upfront commission is going to translate into growth in '19.

[Patrick McCullough:]

Yes, we saw it in the fourth quarter, Damir. If, you look at our fact sheet, you'll see we reported 7,000 net additions in the Consumer business and Deb just referred to net additions in the UK. business. So there's already signs of additive customer growth in the most profitable parts of our business. So we have a great deal of confidence that you're going to see that translate to positive total additions in fiscal '18.

[Damir Gunja:]

Okay. I’ll hope back in the queue. Thank you.

[Operator:]

Thank you. Our next question comes from Carter Driscoll with FBR.

[Carter Driscoll:]

Morning, guys.

[Patrick McCullough:]

Morning.

[Carter Driscoll:]

First question, so just if I could kind of some up. It sounds as though you're not seeing gross margin pressure. You're making a deliberate, given the low volatility in the economy and the low commodity price environment, making it difficult to acquire organically. Because the switching cost just aren't - you just don't have as much an incentive and everyone's facing that in the retail energy business you made a conscious decision to pour money into international business, new products and new channels and then obviously, you made the decision - the economic decision to prepay commissions, and that's a significant chunk of growth on the consumer side, which is a big part of your growth strategy, right. So you're kind of taking lumps now. In particular, Pat, maybe could talk about the decision to prepay the economic return versus not prepaying? And can make could be an incremental margin of say 10%, 15%? How do you think about that return metrics by choosing to invest today versus doing so through a different channel where you wouldn't have the same outlay upfront?

[Patrick McCullough:]

Sure. I'm happy to address that, and I think just to solidify your point on margin pressure, we actually did report higher margins this period on both the Consumer and the Commercial business on an actual trailing 12 months realized basis for RCE. So we reported 265 for the Consumer business, up from 264, 261, 252 in prior quarters and $89 for RCE in the Commercial business, up from $82, $80 and $76 in prior quarters this year. So this really is about the sales cost associated with the supporting the growth trajectory. Now when we make decisions about how to compensate commissions, we do think about what the market is doing first. So we do need to be as competitive as we possibly can be versus alternatives. For example, if you could make a higher upfront commissions selling for one of our competitors we may lose capable sales channels or support. The other thing that factors into the equation is what you're thinking about, which is the economic returns. So if we are in a position where we're partnering with let's say an earlier stage company who's launched a switching app or a digital presence and working capital support is important to them, then we can potentially design a superior return by negotiating a smaller upfront cash payouts on the net present value basis versus a residual model. Normally, if we're going through, for example, our new channel, which is a retail big box channel, there will be a small upfront payment to the storefront, but then there will be a residual margin sharing agreement with our partner that manages the kiosks and the mandate let's say sales platforms within those retail storefronts, so that's a bit of a high-grade. And then you get into the Commercial business, which is almost entirely residual payment business where we're cash flow day 1 at the expected margin and there won't be a step-up in margin or free cash flow a year or a few quarters later, once we get through that. We do think about this on the net present value basis. It's normally not a 15% difference on a net present value basis, you're in the land of 5% to 10% differences. But we are looking through the short-term. We do not get terribly worried if we're going to have a burden for a few years -- for a few quarters because we're looking through the contract for that 2, 3, 4, 5 year contractors for the best shareholder return. And then, I think the last comment on this is if you are pursuing growth them if you hadn't stable recurring growth, this only impacts you the first year it starts. Because if you grew, let's just say net additions 200,000 per year every year for the next 5 years, that first year, you're going to take a $20 million, $30 million burden. But then the following year, you're going to have year 2 of that first 200,000 that's dropping through without any direct sales cost. So the EBITDA impact in year 2, 3, 4 and beyond once you return to a stable growth rate is de minimis. We wouldn't see any headwinds on the earnings. It's just a fact that we're transitioning from net attrition to net additions in fiscal '18 where we have this upfront commission burden.

[Carter Driscoll:]

Okay. So that's the commissions side, and maybe just kind of elaborating on what Damir just asked, so that's 1 of the 3 buckets. Maybe if not $1.00 spend, a percentage of your expected incremental OpEx on that first bucket versus the other 2, is it 50% of that incremental spend?

[Patrick McCullough:]

No, it's not. Yes, the upfront commission is about 2/3 of the total SG&A OpEx investment. The international markets and the incremental channels are smaller piece.

[Carter Driscoll:]

Okay. But it is similar in terms of both establishing the decision to go after both the Commercial and the Consumer business abroad. There's a component of that same upfront commission, right, not just building infrastructure, but part of that is having to pay up front because you see that residual being greater from an perspective and the same in the domestic market, is that fair?

[Patrick McCullough:]

Yes. If you look at Commercial, we're generally paying a residual commission. Now sometimes, we pay the first year in advance because the market does that, so to be market competitive from a cash flow, you may recognize the cash day 1, but you're going to amortize that first year over the year of sales. So from a P&L perspective, you're not going to experience an EBITDA blip on the Commercial business, which as a reminder is a little bit more than half of what we're selling right now. But remember, this is completely tied to gross additions and given Consumer, is the place where we see more opportunities to differentiate value and more profits to be made for customer, that is the focus and the main driver there.

[Carter Driscoll:]

Right. Okay, and then the last portion of the bucket is products design for the Consumer, which I think there are a couple of aspects. One is the retail stores and as you talked about again, there's some upfront portion of that, could you talk about the reception to the retail store both what you've learned so far and the rollout in fiscal '18? And then as a follow-up to that, if you think about how to say this, the product the perks program, that's and other type of upfront investments, if you talk about I know we haven't necessarily gotten the qualification that whether it has helped on the attrition side or the renewable - on the renewal rates you try to think you can quantify, qualify how the perks program has been? Thank you.

[Deborah Merril:]

Sure. I'll take that and I'll let you jump in. So our retail were on schedule and we said publicly that by in 18 months we expect to be in 700 stores and we remain on track for that. We're still about 4 different retailers we're in now and that will continue to grow - 4 different change that will continue to grow over the next 18 months. So we remain on track for that, and we're seeing the results we expected so nothing has been a big surprise there, so that felt good. And from a first perspective, this is one, I would say one of our most promising initiatives we have undertaken in the last year. Where we've seen massive improvement in attrition way higher Net Promoter Scores, longer term, better conversion and all of these metrics are things that as we started in the Midwest. We're rolling out in all of our markets, which will actually be in every single market by the end of this year, where we will have that program that will incent customers to stay longer with us and it's just anecdotally, the feedback we get from customers is incredibly positive and continue to kind of drive or drive our implementation of this program and double-digit percentage growth in percentage improvement and conversion as well as Net Promoter Scores. Right now, we have about 100,000 customers on our perks program, and we are committed to driving that over the next several quarters. Our target is to have 1 million on there, and I will look at the improvement all of that will translate into a setting better gross margin, cutting lumber customer relationships have we seen as evidence so far.

[Carter Driscoll:]

So you're expecting to have greater 50% of your customer programs is that what.

[Deborah Merril:]

In the next 12 months, that's our goal.

[Patrick McCullough:]

And one of the things, the reason for this low scaling there is we're looking at repricing our products to capture the value that we're generating through, both some LED light bulbs and the perks program, which are the editors to our contracts. So in order to do that, you really have to be looking at new contracts or renewing contracts. You're not just going to roll this out to every customer at the old economics.

[Carter Driscoll:]

Right, that makes sense. And then you talked about -- we would the organic opportunities and discuss those. How about inorganic and M&A opportunities, what you're looking at whether it's books or companies. Are you comfortable with competitive landscape that there's still some opportunities out there may be scale size or geography, anything you could qualify or quantify their because you haven't really been active in that space as you've been going through the deleveraging process?

[Patrick McCullough:]

Yes, this is Pat again. So we're looking at 3 areas for inorganic growth. The first one is North American retail so if you think about books that are probably smaller than us that looks similar to us in terms of approach, that's the first bucket that we're looking at and I'll come back to describing that a little bit in just a second. The second bucket we're looking at, our international retailers. So can we, let's say, accelerate our international growth or geographic footprint through inorganic means? That is challenging one because we see higher multiples in Europe then we see in North America, higher multiples and our own multiple. So we'll be disruptive to shareholders if we were to buy a large, mature profitable company in Europe right now. However, there are opportunities like we did in Germany where we have an earlier stage pre-profit entity where you're not paying that multiple on a basis of a larger scale transaction. The third bucket we're looking at our strategic accelerants and that fancy term essentially means anything that can deliver a broader customer experience through product for let's say new offerings. So if you think about the Commercial business, can we find CapEx light ways to further engage with the Commercial accounts and maybe create more value for them. Obviously, if we're looking in this bucket and we see heavy CapEx, then we would not be interested in acquisition. We will be interested in pursuing a partnership model with the CapEx intensive players. The first bucket though, the North American retail, it's probably where the opportunities are for us. We generally have a multiple advantage over most of the North American market. We are generally buying at larger scale. So there should be cost of goods sold synergy. We're generally making more profit than average retailers and selling a much broader suite of products so we think there's longer term Commercial synergies. But obviously, within this bucket, if you could find a book that didn't have regulatory issues, that didn't have a lot of variable products, that didn't have, let's say, a declining customer base. So we had confidence that there was, let's say, sustainable growth that could be endured, those are the type of North American retailers that are interesting to us. Now I did not describe the majority of the available books or the majority of the companies that exists. I just described very, very small subset of chain so that's what we'll be looking for. We'll be looking for high quality companies that we can roll it into the fold and will not be looking to lever up to do that.

[Carter Driscoll:]

Okay. And may be last question before I get back in the queue. Can you talk about the regulatory environment, any changes, surprises, any states or territories we should be concerned obviously New York is still an ongoing issue overall, any comments there? Thank you.

[James Lewis:]

Carter, what we think the positive conversations in the western part of the U.S. are really conversations in Arizona, Nevada and California there. So we are all happy there and see those conversations happening. And like I said on the flip side, in New York, I think we're positive in the sense that they're having conversations, they're having discussions and [indiscernible] how do they make that market better and work one of those discussions at our other industry players out there. But that would be the current landscape. And I think lastly, talk about the UK. There are some conversations in the UK going on come on price cut there, but we are aware of and we're in discussions there as well.

[Carter Driscoll:]

Perfect. I’ll get back in queue. I appreciate it answering all my questions. Thank you.

[Operator:]

Thank you. Our next question comes from Nelson Ng with RBC Capital Markets.

[Nelson Ng:]

Great, thanks. So just in terms of geographic expansion, can give a bit more color on the timing, location and strategy? So you did a small acquisition in Germany in December last year and I was just wondering whether it's up and running. And then for Ireland, you mentioned that you have a business license. So I was just thinking are you kind of starting from scratch in terms of that having any partners? And then I guess lastly on Japan, just talk about the strategy there? Thanks.

[Deborah Merril:]

Sure. So Germany, as we release before, we actually entered the market in December, and we are active in the market today. So yes, we're selling customers and kind of billing that business from - it was a very early stage start-up so it wasn't - we just have a little bit of work to do to get our products out there. But one of the things we believe and especially in Germany, there is a lot of product differentiation going on there, so we have to - we believe that bringing our product and services in some of the ways we look at you know, driven value to customers like our first programs, our flat bill, all of that will yield better customer switching and higher-margin in Germany. So that is groundwork being laid today. We’re currently operating in the market, but we're also laying groundwork for kind of the launch of all of our products that will happen in late Q2, early Q3. In Ireland, we received our license. We are in the testing phase of everything. So we're going through those regulatory testing process and all of our systems and billing systems, and all the communications that go back and forth in the market. We expect to be able to launch some time in September this year in Ireland. In Japan, we also - that one might be a little bit later this year, where that one is a bit more early stage for us, but working hard on getting all of the things in place for us to be able to launch on that, but that will also be an organic play as well.

[Nelson Ng:]

So for Ireland, it's purely organic? Is it simply just getting your UK platform and expanding that into Ireland?

[Deborah Merril:]

Yes. So we're leveraging our UK capabilities since it's so close and yes, so we're not --it's purely organic in UK.

[Nelson Ng:]

Okay. And then Japan you said, it's purely organic as well or are you kind of looking around for partners?

[James Lewis:]

Yes, Japan is organic now from a partnership perspective, from sales channels. We expect to leverage our retail platform we've been talking about over there as well. But it will be organic with the some partnerships as we move forward, but not looking at numbers to acquire an entity.

[Nelson Ng:]

I see. And then for like in terms of expansion, it will mainly impact or will it mainly impact the G&A line item? And so do you see fiscal 2018 G&A have a material increase year-over-year?

[Patrick McCullough:]

Yes, for - we see both G&A and selling cost. If you think about the fixed overheads within building sales offices or channel support, if we’re going at it organically from a sales perspective versus partnering with another company, you could see some selling as well. But we're generally thinking a few million dollars per market is budgeted for year 1, so you're probably around $10 million in total.

[Nelson Ng:]

Okay, perfect. And then just a few more questions. In Q4, the gross margins declined by about 14%. You mentioned the weakness on the gas side. I'm just wondering whether you have like big picture number in terms of whether some of that weakness is due to the mild winter. I mean, what proportion of the decline that contributed to?

[James Lewis:]

Yes, I think the winter sales were pretty good there hedge wise, so I think the mild winter didn't have a material impact on us it's a smaller gap customer base part of the issue there is that fourth quarter gas side, total margin.

[Nelson Ng:]

I see, so it's more about having a smaller gas the base, which resulted in a decline in margins?

[James Lewis:]

Your total margin, yes.

[Nelson Ng:]

Okay, got it.

[James Lewis:]

Offset some of that higher operating performance there. So on a per unit basis, we had higher margins, but with smaller base.

[Nelson Ng:]

Okay. And then Pat, I have a question for you. In terms of cash taxes, do you have any guidance in terms of where that will be in fiscal '18? I'm just wondering whether it will increase again next year or given that EBITDA will be flat to little lower? And also like investing in international growth, will that help reduce taxes in any way?

[Patrick McCullough:]

Yes. So the short answer on tax is we are a full cash taxpayer right now in Canada and the UK and we did see almost an entire year of exhausted net operating losses in those 2 markets. So what we're seeing right now is what we believe we'll probably happen over the next couple of years. As we go into well, let me tell you what the US first. We still have a net operating loss in the US, which we expect to last us another 2 to 3 years. Obviously, if tax reform in the US happens, that may extend beyond that length of time. But we feel like the cash tax payments that we're seeing today will be a good surrogate for '18 and '19, if you want a good 2 years forward. As we invest in new markets, we're obviously creating a loss that will be applied to the future. So in markets like Japan, Germany, Ireland, they may take 2 or 3 years to get to a cumulative profit position where you'd start thinking about tax. Obviously, with the significant presence that we're building in Europe, we'll be able to structure efficiently from a tax perspective how we manage those businesses from a profitability perspective, but it won't impact the '18 or '19.

[Nelson Ng:]

Okay, thanks. And then just a quick question on the legal provisions. I think the notes indicate that there was a $10.6 million of provisions of that were used or reversed during the year. Like how much of the legal provisions were reversed in the last quarter?

[Patrick McCullough:]

So first of all, let's talk about what happened there. So the class action suits that we had taken legal provisions for over the prior 2 periods, the surveys and involvement in this class action suits has been completed and there was a much lower percentage participation then we had expected and accrued for. So upon learning definitively that those participation levels were going to be a fraction of what we planned, we're able to purposely reverse those accruals. So we did take a significant, let's say earnings good guy in the year, we've got $5 million net reduction in legal reserves and accruals.

[Nelson Ng:]

Okay, got it. And then just one last question. In terms of solar rooftops, like have you - like are you still moving forward with that or have you kind of ended the initiative after the pilot program?

[Patrick McCullough:]

Yes, so let me talk about this a little bit in prior periods. And if we're just really honest about solar, we have taken a different approach for Solar. We're much more bearish on the solar space. The good news with our business model is we're not risking CapEx. So if we see an opportunity and we attempt to address it and then we realize it's not there, there's no big way off coming or no big some cost other than the OpEx and the selling cost that we had deployed. Our view on the residential rooftop solar is honestly, the only people that have made money in that business to date are the banks, and if you look at energy pulling out [indiscernible] longevity going bankrupt, you have 3 of the top 6 players that have elected to leave or haven't been able to succeed financially. The folks that are into solar business today that could be white label partners with us are also struggling and we fear with tax reform that whether that tax credit continues to exist, it's going to be a lot less valuable as people need less tax credits with lower tax burdens in the United States. Hopefully border tax doesn’t happen, but if border tax happens, you'll obviously have a big – the same stress on the pressure around the profit pool that the residential rooftop value chain enjoys. So we're looking at it, saying well, people aren't making money in total today. There's going to be more pressure on profit. We're finding our no CapEx partnership idea harder to do because of those stresses, and we are not going to be investing significant OpEx dollars in solar. However, there will be green certification that we continue to bring the customers and as customers inquire about solar, we'll make sure that we can at least generate the lead for their solar experience.

[Nelson Ng:]

Okay. So obviously it's a lot of focus, but it's probably one of the smaller, one of the many products you might offer if consumers ask for it? Is that a fair comment?

[Patrick McCullough:]

That's right.

[Nelson Ng:]

Okay. Thanks a lot. Those are all my questions for now.

[Operator:]

Thank you. Our next question comes from Sophie Karp with Guggenheim.

[Sophie Karp:]

Hi. Good morning, guys. Thank you for taking my question. I have a more of an introspective question about long-term plan here. So we get the story that next year you’re going to be investing in growth and economic value to pay an upfront commission. But is that really a truly one-time thing or comes 2019 you'll see more growth opportunities and maybe like you have to invest in growth again? So what I'm try to get to, what is the level of investment that we should think about as ongoing to sustain the growth rate that you are targeting?

[Patrick McCullough:]

Yes, and I think like I've said before, this year is the year where gross additions will increase significantly. So there will be a spike in '18 versus '17, about $20 million to $30 million by our estimation. And that will be incurred in '18, but it will not have the massive or the larger gross additions from '17 and '16 to offset it and carry the data to bottom line in '18. So as we grow at a higher level, let's assume in '18, '19 and '20, it's the first year where that upfront earnings hit has taken. As you get into the second and the third quarter, you have the compounding effect of the earlier year’s gross margin with no direct commissions to cover because it's entirely paid up front. So as you get into '19 and 20, right you are able to drop through a higher rate of profit to the bottom line. So we see that as a 1 year phenomenon as we get back to growth and if you think about the company's transformation here, we’ve been taking 100% of our free cash flow to delivering in the past, now, we have 75 plus million dollars per annum to be able to invest in accelerating organic growth and look at inorganic opportunities, and that's why this is happening in '18 because we're pivoting from the delivery with internal repair to a let's get aggressive about growth.

[Sophie Karp:]

Got it. And then as far as the trajectory of the gross margin per RCE, is that something that you see expanding in '18, I think maybe it's a different way of asking the question that's already been asked, but just clarify?

[Patrick McCullough:]

Yes, we hope so. I think you've noticed that the actual realized margin increase is starting to stabilize in the last 3 quarters. So we don't think there's tremendous upside, but as Deb mentioned earlier, perks is not fully penetrated across our customer base. That should be a nice profit uplift, small profit uplift for us. We do have plans to enhance value propositions and hopefully capture some premium pricing. However, market competitiveness is always up a little bit of a unknown issue going into a new year. So we don't see pressure to the downside, we hope to see some opportunity to the upside.

[Sophie Karp:]

Got it. Thank you. I’ll jump back into the queue.

[Operator:]

Thank you. Our next question comes from Sameer Joshi with Rodman & Renshaw.

[Sameer Joshi:]

Good morning. This is Sameer. So most of the questions have been answered, but looking at the long-term, as you expand into international markets and the customer or rather margin profiles of each countries are likely to be different. Are you going to provide some different kind of metrics going forward like in sort of RCE's there's some other metric that better represents kind of customers in Ireland versus Japan versus Canada versus US?

[Deborah Merril:]

Yes, Sameer we've been talking for several quarters about the RCE metric as efficiently as we bring in different products becomes a little less - we'd say representative of what is actually going on in our business. So we're definitely going to move maybe towards having RCE reported as well as something a customer - actually customer number or products per customer. We're kind of in the process of cleaning that this year and I think that based on a kind of bringing it down to a more customer base level, that will help us really show what kind of things we're doing with perks and sprinkler systems and things like that, we'll show up better and tend to have more complete story about what we're doing.

[Sameer Joshi:]

Okay. Great. And that's a good segue. You mentioned the sprinkler systems. How is that going? And are there any other smartphone [ph] initiatives or products that are in the pipeline that you expect to drive growth, as well as add margins?

[Deborah Merril:]

Yes. So we just - we launched our Skydrop in various markets in kind of a pilot level, so we're thinking how that practice that together and with the real value proposition for the customer is and which channel do you want to sell it in. So it will translate into some of our direct sales channels and maybe some of our retail channels. So we’re in the process of launching those. And as we look at the smart thermostat, as we view it as you know, energy is a big part of what smart and connected home is. And so if you think about the thermostat, that connected to your home security system and connected to your phone, it becomes interesting for us as we look at a smartphone and the things around I would say utility, gas, power, water and how we can pull those together. So we actually have a team in our strategy group that does nothing, but look at those things and look for partnerships and products that we can pull forward. So we've got a couple of things in the hopper, but we've rolled out that, we're in the process of really try to execute upon just the produce we have so far and getting those going and pulling more in it make sense.

[Sameer Joshi:]

Great. Thanks. I’ll take my questions offline. Thanks.

[Rebecca MacDonald:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Kevin Chiang with CIBC.

[Kevin Chiang:]

Thanks for taking my question here and good morning. I was wondering maybe looking at the sales and marketing lift you're expecting in fiscal 2018, maybe looking at it another way. If I look at the total additions you had this year and the amount you spent, it looks like it's about $20 to $29 per RCE of sales and marketing expense. As you pivot towards growth year, I'm wondering are using the intensity per RCE for that line item declining? So you're seeing some level of efficiency or that increasing because of some of the initiatives you're taking, just wondering how you see that line item on a per customer basis.

[Patrick McCullough:]

It will definitely go down and go lower. The recent has been driven up recently is the lower absolute scale of gross adds that we've had for the channels that have been built. So you'll definitely see a movement down on a per RCE basis as we raise the amount of gross additions that we put through the design channels.

[Kevin Chiang:]

And when I think of some of the initiatives you've spoken about over the longer term here, it seems like a lot of is create a sticker customer. When you think out longer term and you have lower attrition, higher renewals, , how does that - how do you see that line item playing out presumably it should decline because you don't have to incentivize more customers to fight that turn you're seeing today, or am I wrong in thinking about that?

[Patrick McCullough:]

No, you're right. We – we’re thinking about this on a customer let's say life cycle basis. And as we see that consumer renewal rates spiking up to 79%, we don't know how much more headroom we have to improve that, that's a very big number. We're very pleased with that. But we definitely think will continue to address attrition with things like loyalty, with things like differentiated superior products with more value that allow conservation if you think about energy efficiency or water conservation. So it really is about attracting a customer way over the hearts and minds and keeping them for longer periods of time.

[Kevin Chiang:]

And just how that roles into how you think about embedded gross margin, you make some assumptions there on renewal, on attrition maybe on a product line, that was a lot less diverse. Just does that metric make sense moving forward…

[Patrick McCullough:]

It makes a lot less sense. Yes, it makes a lot less sense. The assumptions that are in the embedded margin calculation we're really designed for our suppliers who offer us credits. As we think about the subject that we're talking about here, we really do want to understand what is the value of customer contract on a forward basis. You will see us working with our audit partner on potentially valuing that and maybe even bringing it into the financial statements in the future, but I think the valuation for customer contracts and for our cash flows will look a lot different than the embedded gross margin calculation.

[Kevin Chiang:]

That’s very helpful. Thank you. That’s it from me.

[Deborah Merril:]

I would just like to add one thing, not just for yourself, but to everyone else, this management team with our first CEOs in the past has delivered on every single promise they made in the last 3 years. We share a very deep and long discussion, as this coming year we are coming into and with all the growth strategies that are replaced, you might say that we are taking a very conservative approach around our EBITDA and our outlook, but that's what we want to do. This management team delivered for the shareholders, delivered the returns and they intend to deliver in the future. We all say that I already thought, under promise and over deliver and I think that we are coming under a conservative approach to our outlook, but we are very, very bullish on our 2020 plan and everything is wrapped around 2020 plan, particularly this coming year on the execution. And whatever you saw from this management in the last 3 years, you're going to be seeing in the future. And I'm incredibly proud to have them around this business.

[Operator:]

It seems we have no further questions at this time. I will turn the call back over to Deb Merrill for closing remarks.

[Deborah Merril:]

All right, thank you very much. Well, we appreciate everybody joining us today. I wanted to take a quick second to again thank our employees who have really helped us to deliver on a great year this past year, and a lot of the employees who have been with us for long time. As we mentioned before, we're celebrating our 20th anniversary this year, it's a huge milestone for us and we wouldn't be here without the dedication and the work, the intelligence, from all of our employees, and all the countries we operate in. So I want to make sure we take a few minutes and thank them and we will look forward to seeing you again in August. Thank you.

[Operator:]

And thank you. Ladies and gentlemen, this concludes today's meeting. We thank you for participating. You may now disconnect.