WEX Inc (WEX) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the Wright Express Corporation's second-quarter 2006 earnings results conference call. This call is being recorded; there will be an opportunity for questions and comments after the prepared remarks. (OPERATOR INSTRUCTIONS). At this time for opening remarks and introductions I would like to turn the call over to the Vice President of Investor Relations, Mr. Steve Elder. Please go ahead.

Good morning and thank you for joining us. With me today and our CEO, Mike Dubyak, and our CFO, Melissa Smith. The press release we issued after the close of market yesterday is now posted in the Investor Relations section of our website at WrightExpress.com.

First for the legalities. I'd like to remind you that we'll be discussing a non-GAAP metric, adjusted net income, during our call. Please see exhibit 1 included in yesterday's press release for an explanation and reconciliation of adjusted net income to GAAP net income. A copy of the press release has also been submitted as an exhibit to an 8-K that we filed with the SEC.

I'd also like to remind you that certain information contained in this call constitutes forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forward-looking statements as a result of various important factors including those discussed in today's press release and those factors in the Form 10-K filed by the Company on March 15, 2006 and our other filings with the SEC.

While the Company may choose to update forward-looking statements in the future, we specifically disclaim any obligation to do so even if our estimates change. You should not rely on these forward-looking statements as representing our views after today. I'll now turn the call over to our CEO, Mike Dubyak.

Good morning, everyone, and thanks for joining us. This was another quarter of steady, predictable growth for Wright Express. Our revenue and adjusted net income again came in within our guidance range and growth in overall business volume was on target with our expectations for the quarter.

Total revenue for the second quarter of 2006 increased 33% to $76.2 million from $57.3 million for the second quarter of 2005. Net income to common shareholders on a GAAP basis was $9.9 million or $0.24 per diluted share compared with $15 million or $0.37 per diluted share for Q2 last year. The Company's adjusted net income for the second quarter of 2006 was $14.1 million or $0.34 per diluted share. This non-GAAP figure excludes an unrealized mark to market loss of $7.5 million on our derivative contracts before taxes. Adjusted net income for Q2 last year was $11.2 million or $0.27 per diluted share.

Once again we're seeing sustained momentum across the business with continued growth in demand for fleet and corporate cards. If you talk to people throughout our sales organization, they're excited about the depth and quality of their pipeline. I want to address two issues we frequently get questions about -- the impact of higher fuel prices and our past experience with a slowing economy.

As far as the first question is concerned, we have never seen high fuel prices by themselves slow transaction volumes for Wright Express. And indeed, we have benefited from locking current high fuel prices well into the future. With regard to the economy, through July we have not seen any signs of a slowdown. Looking longer-term, our business model has been very resilient. During economic downturns, such as the one we saw in late 2001, our per vehicle transaction levels dropped by only a couple of percentage points.

One factor that consistently drives our growth, especially in the small fleet market, is the steady long-term transition from cash to electronic commerce. It will be a long time before the migration away from cash fully plays itself out in the fleet market. We've said before and it bears repeating, there are about 41 million commercial and government fleet vehicles operating across the country today. We estimate that only about one-third are currently purchasing their fuel on a fleet card offering like ours.

Our top operational goal is to drive organic growth for Wright Express and this is why we're generating the momentum I just mentioned. Our front end sales and marketing engine is a tremendous competitive asset and continuous improvement in our customer acquisition and retention metrics is always a high priority for us. I'm proud of how the team executed on this priority during the quarter and I'll provide more specifics later in the call. For now I'd like to turn it over to Melissa for the financial results.

Hello and good morning, everyone. Our business performed well this quarter and all of our key financial metrics came in where we expected. Our operating leverage continues to improve as the business grows. It was again encouraging to see consistency in the net payment processing rate in our fleet segment for the second consecutive quarter. Adjusted net income was up substantially and we continued to see strong cash flow. As a result we were able to pay down our financing debt in excess of our adjusted net income.

Looking forward we have good earnings visibility. When you look at the step up in the floor price of the hedge from $1.95 currently to more than $2.30 next year, you can see a significant positive impact. Our strong revenues reflect a continued growth in the number of vehicles serviced which led to an increase in the total number of transactions processed as well as the increase in fuel prices.

Let's look at our top line by segment starting with fleet where revenue grew 33% over Q2 of last year. Payment processing revenue in our fleet segment grew 40% year-over-year to $53.6 million; this was mainly driven by a 12% increase in the number of payment processing transactions to 46 million from 40.9 million a year ago as well as an increase in average fuel prices. The average expenditures per payment processing transaction was up 30% to $57.45 from $44.03 for Q2 last year. For the most part this reflected the 30% increase in the retail price of fuel from $2.20 per gallon in Q2 a year ago to $2.86 per gallon.

Overall the pricing environment was consistent with our expectations. On the merchant side every year a number of our contracts come up for renegotiation. The number of contracts does not change much from year to year and these rates have remained consistent over several years. As always, our portfolio is being affected by pricing pressure in the normal of contract renewals for our larger fleets and as we acquire new large fleet business. But we continue to be successful in offsetting some of this pressure with the value we offer in customer service and product innovation.

The changes that we did see in our net payment processing rate during the quarter were mainly related to price per gallon. Some of our agreements with merchants can take six transaction fees; with the rising fuel prices the total transaction gets larger while the rate moves in the opposite direction. For Q2 the net payment processing rate was down 3 basis points sequentially to 2.01% almost entirely for this reason.

Our total transaction processing revenue was flat with Q2 of last year at $4.3 million. The number of transactions was down 5% from last year to 15.1 million. Similar to what we saw last quarter, this was primarily due to conversions of portfolios to payment processing. Reflecting the change in mix of contracts, the average rate earned per transaction was slightly higher.

Our account servicing revenue increased 2% from Q2 last year. This reflects a 6% increase in vehicles serviced. Finally, finance fees increased 73% from a year ago to $5.2 million. This relates primarily to higher average daily accounts receivable balances subject to late fees because of higher fuel prices and an increase in payment processing transactions.

Turning to our MasterCard segment -- we saw a significant increase in purchase volume again this quarter. Our MasterCard segment contributed $4.8 million in total revenue in Q2 compared to $3.7 million a year ago. MasterCard payment processing revenue was $4.1 million, a 21% increase from $3.4 million for Q2 last year. This increase was directly attributable to growth in spend volume on our purchasing card product. The purchase volume was up 47% over last year. Just one other quick note on the MasterCard program. As part of the MasterCard IPO we received approximately $500,000 in cash which we recognized as revenue during the quarter.

Turning to operating expenses -- on a GAAP basis total operating expenses were $37.7 million compared to $31.3 million in Q2 last year. The biggest increase was $2.9 million in higher operating interest expense due to higher interest rates and debt levels. The average debt level grew due to increases in average fuel price as well as the number of payment processing transactions. Total credit expense in the quarter was $2.3 million compared to $1.9 million last year. Credit losses as a percentage of total payment processing expenditures in the fleet related business again declines this quarter from 11.4 basis points in Q2 last year to 10.9 basis points this quarter.

We're continuing to see solid gains in productivity as our business model scales. We processed 93,000 transactions per FTE this quarter compared with 89,000 in Q2 last year. This represents a productivity improvement of 4%. Our effective tax rate on a GAAP basis was 31.3% in Q2; in comparison our tax rate was 39% for the second quarter of 2005. Our GAAP tax rate is affected by the unrealized gain or loss on derivative instruments, so it may fluctuate from quarter to quarter. Our adjusted net income tax rate was 35.2% in Q2 compared with 38% last year.

Turning to adjusted net income -- once again this was up significantly year-over-year. As we bring on new customers and our business scales our expenses are growing more slowly than our revenue and that's the way our business model is designed to work. For the second quarter adjusted net income increased 27% to $14.1 million or $0.34 per diluted share, a nice step up from $11.2 million or $0.27 per diluted share last year. We are very pleased that our adjusted net income continues to grow at double-digits.

Before we move to the balance sheet and guidance, I have some comments on our fuel price related derivative instruments. We will continue our current program of purchasing these instruments quarterly to manage the Company's fuel price related earnings exposure going forward. During the second quarter of 2006 we recognized a realized loss of $13 million before taxes on our derivative instruments and an unrealized loss of $7.5 million. There was no significant difference between the additional revenue we recognized due to higher fuel prices compared to the realized loss on our derivative instruments. This was in line with our expectations.

Turning now to the balance sheet -- I will be brief since there was no significant change from our year-end financial position. In terms of our accounts receivable balance, we do not foresee a change. Our accounts receivable continued to be collected within 30 days on average. I will also point out that we paid down $15 million in principle on our financing debt this quarter. We currently have a balance of approximately $200 million in financing debt with an additional $25 million in letters of credit used to secure our derivative instruments. We paid LIBOR plus 137.5 basis points on the outstanding amounts of both the term loan and the line of credit, and 25 basis points on the unused portion of the line of credit during the quarter.

I will now turn to our guidance for the third quarter of 2006 as well as updated guidance for the full year. As you'll recall, our UPS contract ended in May 2006 and our comparisons will be affected over the next several quarters. Also keep in mind for comparison purposes that the Gulf Coast hurricanes positively impacted transactions among other things in Q3, '05. Let me remind you that our forecasts for these periods are valid only as of today and are made on a non-GAAP basis that excludes the impact of non-cash mark to market adjustments on the Company's fuel price related derivative instruments. The fuel price assumptions are based on the applicable NYMEX futures price.

For the third quarter of 2006 we expect to report revenues in the range of 75 to $80 million; this is based on an average retail fuel price of $2.88 per gallon. For the full year 2006 we expect to report revenues ranging from 290 to $300 million based on average retail fuel price of $2.70 per gallon.

As for earnings, for Q3 of 2006 we expect to report net income before unrealized gain or loss on derivative instruments in the range of 14 to $15 million or earnings per diluted share of $0.34 to $0.37. For the full year 2006 we expect to report net income before unrealized gain or loss on derivative instruments in the range of 54 to $56 million or earnings per diluted share of $1.32 to $1.38 on approximately 41 million shares outstanding.

With that I'll turn the call back over to Mike for more color on the marketplace.

Thanks, Melissa. To follow up on my initial remarks, we like what we're seeing in the sales and customer support areas of our business. Our marketing and sales group is doing a great job of growing our sales pipeline and converting the pipeline into active customers. Our customer support organization remains outstanding in responding to our customers' immediate needs and, most important, anticipating their future needs by refining, enhancing and adding to the functionality and levels of service we offer.

Our core philosophy is to meet and exceed customer requirements by understanding their business needs and working with them to provide solutions quickly and efficiently. Here's an example. Just in the past couple of weeks one of our major fleets in the St. Louis area was having problems finding fuel because of power outages in the area. Within one hour of their request we were able to post on our website a list of locations that were still operating. As a result they were able to direct their drivers to those locations and keep their fleet operating without interruption. This level of effort speaks to the depth and quality of the Wright Express customer service experience.

The key question is "How does all this translate into growth in business volume?" I'll take a minute to answer this, breaking it down in terms of fleet size and segment. The large and medium fleet market is the most penetrated so we'll start there. For the second quarter the number of vehicles we serviced in large and medium fleets was up 10% from Q2 last year. In each of the last four quarters we have shown double-digit growth over the prior year's quarter in this segment, which means we are taking marketshare from our competitors.

Our competitive wins in large and medium fleets are based on products and services, not on being the low-cost provider. Our products and services represent a combination of key competencies, among them -- site coverage, superior online tools and outstanding customer service. Large- and medium-sized fleets are super users of the features and services we provide. These fleets need nationwide coverage for fuel, their fleet managers need on-demand access to fueling data, and they also need to create customized reports and import data into their fleet management software to optimize fleet operations.

These were the functionalities that led, for example, to our renewing the state of Illinois and winning nationwide business services provider Cintas as a new customer during Q2. Our growth this quarter in the large and medium fleets also reflects the strength of our direct sales force and the breadth of our relationships with our co-brand partners. Developing strong durable co-brand relationships is a critical success factor in our business. Our co-brand portfolio includes the six largest fleet leasing and management companies in the country and our relationships with these top leasing companies average more than 10 years.

Heavy truck represents a relatively new and promising target market for us. Up to now heavy trucks have primarily been a direct sales opportunity for us and over the last year we've added significantly to the number of vehicles we service in this market. For the second quarter the number of heavy trucks we serve was up 17% from a year ago. We recently began working with some of our co-brand partners to be able to offer them our heavy truck program as well. And we see significant potential for increasing our heavy truck penetration through the co-brand channel.

Although we've been focusing on penetrating private carrier heavy trucks, we're also looking at adding some new product functionalities aimed at establishing a presence for Wright Express in portions of the long haul segment. For example, during Q2 we launched a product that provides long haul truck drivers access to cash at ATMs and our goal is to continue to add incremental functionality over time.

Let's turn to the small fleet market. This is where we see the greatest potential for growth in transaction volume. It's also where Wright Express stands apart from its peers in terms of our ability to identify, attract and acquire new customers as well as understand the needs of this market.

Our differentiators in the small fleet market include our front end sales and marketing capabilities as well as success in developing products that meet the requirements of small fleets. A small fleet is typically managed by a business owner whose needs are much different from the fleet manager of a large company. Our product is tailored to help small fleets save time, control spending and easily get access to information on their vehicles. We've done in-depth research and analysis on the needs of small fleets and our upcoming product releases have been designed to deliver even greater value to this kind of customer. These products will ultimately be offered through all of our channels.

Our direct channel is especially important in the small fleet market because, as compared with the private label side, we can control the resources and activity on the front end. Last year our inside sales organization set a new record for the number of vehicles added to our program and they're on tract to set another record in 2006. The result is that Q2 was another quarter of solid growth in the small fleet market with the Wright Express universal product posting a growth rate of 20% year-over-year. Overall, however, the number of small fleet vehicles we serviced through all of our channels was comparable to last year.

We're working to develop additional channel opportunities to capture small fleet business. One example is a new product that enables distributors who are servicing local fleets to be more aggressive in their marketing and we're seeing good growth from that and other distributor products today.

Q2 was an excellent quarter for our MasterCard business. Total purchase volume was up 47% year-over-year. We're winning new business away from competitors and finding unpenetrated opportunities. Having started our MasterCard program only seven years ago, we're now the seventh largest purchasing card issuer in the United States according to the July issue of the Nielsen report. The online travel services firm, PriceLine.com, has contributed to this growth and I'm happy to report that during the second quarter we renewed PriceLine for an additional five years.

What truly sets us apart from the other competitors in the purchasing card and T&E space is the service we give small and mid size companies. In fact, we provide our customers with online tools that are typically offered only to major corporations through large card issuers. These tools allow customers to tailor the MasterCard program to their needs. We also give them a named account manager to help meet program goals. Not only do we provide a level of service typically only offered to major corporations, but our customer service team is in-house which allows us to react more quickly to customer needs.

Before we take your questions I wanted to comment quickly on our M&A strategy. As we've said in the past, we're looking at the marketplace for opportunities that can accelerate our long-term growth and/or enhance our strategic position by leveraging our core competencies. At the same time we are focused on expanding our core business. Over the past several years we've generated significant organic revenue growth excluding the impact of fuel prices. The potential for future growth is there and with creative thinking and steady execution we'll continue to see strong increases in business volume going forward.

With that we'll be happy to take your questions. Operator, you can proceed with the Q&A now.

(OPERATOR INSTRUCTIONS). Tien-Tsin Huang, JPMorgan Chase.

It's actually Reggie filling in for Tien-Tsin. A question -- I was wondering, was there any impact from wider fuel spreads this quarter?

No, actually if you looked at the quarter we had less than a half a cent of impact between the realized loss for the third party counterpart and the additional revenue we received from the higher price of gas.

Okay, got you. Real quick, where could you guys hedge out the next round of hedges if you were to do it today?

We'd be able to hedge at this point at or higher than our last purchase.

Okay. And then my final question -- I noticed a 4 point sequential I guess decline in payment processing volume. Was anything going on there or anything we should be thinking about?

Can you clarify on payment processing volume; do you mean the net discount rate?

No, no, no. Transaction volume -- sorry.

So you're looking at the growth number from quarter to quarter.

Yes.

I think we're talking primarily there -- I think if you would add back in the loss of UPS you'd add back in like another 0.5% or so on top of that. But that was probably the change that impacted us on the payment processing side.

Okay. And what was the impact you said you guys received the benefit when that other client moved from transaction processing to payment processing? Didn't you talk about that a few quarters ago?

Yes. And several quarters ago we had a couple of our strategic relationships switch from transaction processing relationships to payment processing relationships.

Exactly. What was that impact that you gave back then?

It's about 700,000 per quarter impact moving from one to the other.

Okay. All right, thank you.

Paul Bartolai, Credit Suisse.

Thanks, good morning. Just a follow-up on one of the last questions on the transaction growth sequentially. If UPS is only 0.5%, is there anything else that was going on to cause that sequential slowdown? I know it was a little bit of a tougher comp, but just curious if there's any other detail there?

I think that's the biggest one to comment on. As you know, we came in at around 8% overall on transactions and UPS would have added that other 0.5% that would help push it up closer at least to the 9%.

And just to clarify, we're talking about total transactions.

So UPS was 0.5% on total transactions?

Yes, on total transactions.

So was it maybe closer to 2% on the payment side? Well, that's all right, we can back into that. Mike, just to follow-up on your comments on the vehicles serviced on the small side. You mentioned the strength on the universal card, but flat overall. Can you give us any more color on what caused the non-universal card part to I guess be down then?

Yes, and it almost gets to our overall card growth of 6% for the quarter. If you add in the fact that we talked about UPS moving away after May, we also had two private labels that cleaned up inactive card that weren't fueling. And one of these cleaned up a lot of cards. This was a good story for us. We had taken them over from a competitor, brought them on to basically the software that they had that was put onto our system but we eventually wanted to transfer it over to our software.

When we did that there was a cleanup of an excess of 50,000 cards. So if you factor all that in the private label would have grown and overall the small fleet would have been up in the range of 4 to 5%. But you had these inactive cards on the small side basically being deleted off the books for two of our private labels during the quarter.

Okay, great. And then Melissa, it looked like the gallons per transaction was actually down a little bit from the past quarter. Can you give us anymore color on what impacted that?

Yes. And actually looking at it more on a year-over-year basis we saw a little bit of growth. So you're going to see it move slightly from quarter to quarter just based on the mix of vehicles that are fueling.

But we still expect that to keep trending up just given the success on the heavy truck side?

Yes, we do.

Okay. Then just last question, it looked like the credit losses improved a bit. Anything structurally there or what your expectations are for the rest of the year?

The methodology that we've used is highly mechanical. We're actually going through a calculation that looks at charge-offs and roll rates over the last six months. So we've seen strong performance within the portfolio in most recent periods and we're very pleased with that. As we've said before, it's probably the biggest place you'll see fluctuation in our income statement from period to period.

And if you look for it in the future -- we're very pleased with where we are. We are not seeing any trends that should affect it negatively, but it can correct pretty quickly.

Okay, thanks.

Greg Smith, Merrill Lynch.

Good morning. The first question, Melissa, just want to make sure that the sensitivity analysis you've been using with your hedges, the $0.10 higher fuel equals $6.5 million of operating income, is that fully in tact?

It is.

Okay, great. And then is there any additional opportunity within your overall fleet card portfolio to move any clients going forward from transaction to payment processing?

Yes. We are constantly -- and there are a couple that we're working with today. I can't make any promises, but we try to work with them and they look at their cost of money versus what we can do on our cost of money. But there are opportunities, Greg, without getting into specifics.

Okay. And then, are you seeing any difference in overall behavior? I mean, I know you said you're not really seeing any sensitivity to the economy in your fueling transactions -- but any difference in behavior among large and small fleets that you could highlight?

As far as their fueling patterns?

Exactly.

No, we have actually seen no change in behavior right up to this call.

Okay. And then there's been some stuff in the press about you maybe looking at some acquisitions and there's been a little concern I think among investors about you potentially doing a dilutive acquisition. What is your policy on acquisitions from a dilutive versus accretive standpoint? Do you have any hard and fast rules or how should we think about that?

We're still working through those metrics with our Board. And obviously it's something that we would consider whether it was cash dilutive or not is one of the criteria. But I wouldn't say that there is necessarily a hard and fast fuel.

Okay. And then one quick one. Can we get an update on the service network, how that's progressing?

Yes. As you know, we keep talking about that being more of a future opportunity. But on the network side and the merchant acceptance side we've recently got Pep Boys on board in terms of getting them signed up and we'll be rolling them out later in the year. So we keep seeing the merchant side grow. We have in place plans to have both the private label and some of our co-brands start to have transactions on the service network later this year.

So today the only people able to access the service network are basically Wright Express direct customers and we're now working to get those private labels access to that network as well as some of our co-brands. So on both the merchant side and the card vehicles side we see opportunities in the future.

Okay. Thanks a lot. Keep up the good work.

Tien-Tsin Huang, JPMorgan Chase.

A quick follow-up question, I was wondering if the charge-offs -- if there was an allowance adjustment in there this quarter. Any onetime items?

No, when we go through the methodology we'll look overall to see if there's any specific reserves that are required and there was nothing unusual in that process this quarter.

All right, thank you.

(OPERATOR INSTRUCTIONS). Abhi Gami, Banc of America.

Also a question on the charge-off reserve. Is there any component of that calculation that does include some level of management input or is it purely a mechanical calculation?

It's mostly mechanical. As I just said, we actually do go through an analysis to determine if there's anything that we know of that's occurring within the portfolio outside of what the calculation comes up with the result. And so we'll layer in any specific reserves if necessary, but that's a very small part of the reserve analysis.

Okay. It's primarily designed to layer in additional reserve if necessary, not necessarily pull back on reserves?

Correct.

Okay, great. How much visibility do you have on that number? So you have a one quarter, two quarter visibility on where (sic) that number would look like?

We have visibility -- obviously the shorter term period we have greater visibility into, but what we're doing is modeling out what the charge-off model would look like going forward into the future and you're placing a month of historical experience with a month of projected experience. And so to the extent you're getting out six months there's less perfectibility into that.

Okay, great. And one more question. You mentioned earlier you saw less than half a cent from the wider spread between wholesale and retail during the quarter. Just from observed data the spread was relatively high throughout the quarter. So has anything changed in the way you're hedging or maybe our understanding is missing here. Can you please reeducate us on how those hedges work and how the spread can influence your ultimate results?

Sure. We hedged approximately 15 million gallons within the quarter and we're settling with our third party counterpart monthly based on the daily average closing price of the front month contract. That is what creates the actual -- in this case it was a realized loss. On the revenue side we're receiving revenue that's coming in that's based on our settlement agreements with our merchants off the retail price of gas which is affected a little bit to the extent it's going to mix between gasoline and diesel. And all those factors are what we evaluate when we're comparing how much additional revenue we've received net the third party counterpart payment.

Okay, great.

And there's been no change in that methodology.

Okay, great. Thank you.

Michael Weisberg, ING.

Good morning. Just to understand a point you made that you had two private label customers with 50,000 cards that were basically inactive. That has an effect on the number of small vehicles served and the number of total vehicles served, but no impact on revenues?

That's right, unless there would be some card fees or things like that, but they're not large on these private labels. And actually the 50,000 was just for one of them that we had converted over from a competitor program. There was a second one, so it was actually greater than 50,000, actually greater than 60,000 in terms of the private label impact to the card numbers, both in the small fleet and the total.

So I think you said the small fleet number would have been, in terms of number of vehicles served, would have been up 4 to 5% but for this factor?

That's right.

Okay. And I'm just trying to gauge the impact on the total number of vehicles served, what's the total number there?

I think all we said was between the UPS loss and these two private labels it would have added 3 percentage points, if you will, onto the 6% getting us closer to 9%.

I see. That's great. The UPS and this is 3%. That's great. Any guidance in terms of future debt paydowns?

As we've looked in the future, we're using our adjusted net income as a barometer of free cash flow and the paydown of debt has been -- or the place that we've been placing that cash historically.

So we should factor just net income paying down your debt balances?

Our adjusted net income is generally what we've used historically to pay down debt. We're now at below our target leverage ratio. We just dipped below 2.

Okay. And is there any possible adjustment in how much you're paying over LIBOR with your banks or has that been completed already?

It's already been completed.

Great. Thanks a lot.

Thank you.

At this time there are no questions in the queue. I will now turn the conference back over to Mr. Mike Dubyak for any closing or additional remarks.

Thank you, Mark, and thanks, everyone, for listening. We look forward to speaking with you again next quarter. This concludes our call. Have a great day.

That does conclude today's conference call. Thank you for joining us.