WEX Inc (WEX) 2009 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Wright Express Corporation second quarter 2009 conference call. There will be an opportunity after the prepared remarks. (Operator Instructions) Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Steve Elder, Vice President of Investor Relations. Please go ahead sir.

Good morning. With me today is our CEO, Mike Dubyak; and our CFO, Melissa Smith. The financial results press release we issued early this morning is now posted in the Investor Relations section of our website at WrightExpress.com. A copy of the release has also been included as an exhibit to an 8-K we submitted to the SEC.

We'll be discussing a non-GAAP metric, specifically adjusted net income, during our call. Adjusted net income excludes non-cash market-to-market adjustments on our fuel price related derivative instruments, the amortization of acquired intangible assets, adjustments related to the deferred tax asset and related tax receivable agreement and asset impairment charges. In addition, we've excluded the gain on the settlement of the portion of amounts due under our tax receivable agreement. Please see Exhibit 1, included in the press release, for an explanation and reconciliation of adjusted net income to GAAP net income.

I'd also like to remind you that we'll discuss 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 factors, including those discussed in our press release, most recent Form 10-K, and other SEC filings. While we may update forward-looking statements in the future, we disclaim any obligation to do so. You should not rely on these forward-looking statements after today.

With that, I'll turn the call over to our CEO, Mike Dubyak.

Hello, everyone, and thanks for joining us. Our second quarter results were clearly better than we anticipated. Revenue and adjusted net income both exceeded the high end of our guidance range, coming in at $79 million and $0.57 per share respectively. Lower bad debt was a key factor, as were higher-than-expected revenues, primarily reflecting a rise in the average fuel price.

Our strategy for managing through the recession is focused on several goals. The first is to reinvest in our business aggressively and capitalize on this advantage to gain market share.

Our second goal is to grow our new diversified businesses, to generate a larger percentage of our total revenue and create greater value for our customers. Third, we are tightly managing expenses, especially bad debt. And fourth, we are working to maximize the benefits of our healthy liquidity and cash flow as well as the insulation from fuel price volatility provided by our hedge.

Our results in Q2 demonstrate the progress we've made in each of these areas. And in many ways the parallel the results we saw last quarter.

We again delivered strong performance in the collections area with very low loss levels. For the second quarter, fleet credit loss came in at eight basis points, well below the 17 basis points we recorded in Q1 and significantly below the assumption in our Q2 guidance. Compared to many other companies that provided credit, these are outstanding results.

Looking first at our core business, fueling volume was down about 10% from Q2 of 2008 on a same-store sales basis. Including growth from front-end sales and marketing, total payment processing gallons were down just under 6%. This is essentially the same level of year-on-year erosion that we reported for the first quarter of '09.

Melissa will go into the details on credit, but it's clear that our bad debt expense has outperformed the national trend for the past two quarters. We put a number of practices in place over the past year to tighten our credit granting processes and collection tactics. And they've had a material impact primarily in our receivables aging. We've also improved our recoveries of amounts previously charged off.

A couple of other factors have contributed to our recent lower bad debt levels. First, we're not a bank that makes long-term loans and then watches the problems ripple through our extended or overextended periods of time. The credit we extend to our customers is less than 30 days, so loss is moved through our model much faster than at a bank.

Second, fleets treat their fuel bills more like a utility expense that must be paid because it's an essential part of running their businesses. The Wright Express card is not a charge card or credit card for charging out-of-pocket expenses, and the balances do not revolve.

Where the economy remains the greatest challenge for us is in its impact on fleet fueling activity. Our customer base is made up of various businesses, and they primarily drive cars, light trucks and vans, not long-haul trucks.

On our last quarter call I said that we were seeing disparities in customer behavior across certain SIC codes for the first time. This continued in Q2 with relative strength in a sector like public administration and weakness in retail. Our largest sector is construction and related trades, which was relatively unchanged in the quarter compared to the sequential first quarter.

Nationwide, business for our customers is down in all regions. Although the Southwest was significantly slower than the average, and the Northeast was somewhat stronger.

We did, however, see 5% year-on-year growth in our total average vehicle count for Q2. This reflects the ongoing addition of the new city portfolio, which was fully converted this month, as well as the GSA fleet portfolio, which we added in December. Citi is a private label portfolio that will represent an incremental 2 million small fleet transactions for 2009 and grow our base by approximately 90,000 vehicles.

As our ability to win, the GSA fleet business demonstrates we're competing for new business aggressively and continuing to gain market share. In the down economy, many of our competitors are facing pressures that have minimal effect on us because of our financial strength, liquidity, hedging program and multi-channel sales and marketing strategy. Additionally, our value proposition, which incorporates a wide range of services, continues to offer savings to businesses at a time when this is more important than ever.

We're continuing to solicit small businesses while others have pulled back or stopped altogether. We're also experimenting with different marketing strategies in various markets to accelerate growth.

In the second quarter, the average number of vehicles in our large and midsize fleet portfolio was up 8% from the same period a year ago. This largely reflects the addition of the GSA fleet.

In small fleets, the number of vehicles overall increased 1% from Q2 last year, a muted level of growth that reflects the underlying weakness in the economy. Small businesses were reluctant to make changes or commitments during this uncertain period, but in both sales of fleet cards and telematic units we did see some improvement in June.

In our private label channel, the number of small fleet vehicles was up 1%, which is an improvement over the 5% drop we saw in Q1. This reflects the step function growth of adding the Citi portfolio in the quarter. In the Wright Express direct channel the average vehicle count was down 1% from Q2 of '08, reflecting today's challenging environment for small businesses.

Our heavy truck private carrier fleet vehicle count was down 5% from the second quarter last year. This is consistent with the relative weakness we are seeing in the transportation sector.

Overall, our attrition rates remain low. Voluntarily attrition for the second quarter was 2.9%, compared with 1.5% for the-- for Q2 last year. As in Q1, voluntarily attrition was up over last year, but it remained below our target of 3% and at levels similar to those we experienced before the current recession.

Our second area of focus is our diversification strategy where we are growing our aggregate revenue contribution from our MasterCard, TelePoint, Pacific Pride, International and WEXSMART telematics businesses. MasterCard remains, by far, the largest of these businesses. Purchase volume on our MasterCard grew 24% from the second quarter of 2008 to $771 million, reflecting continued strength in our travel industry customer base.

Our new international business is still in the early stages and growing from a very small base. That said, Q2 was a period of important strides. We're continuing to make progress in establishing private label processing relationships with several international oil companies as we continue to build our infrastructure and our Management team. Relationships with the oils will initially focus on an ASP model of authorizing and hosting transactions using our international software program at our hosting site in Austria. This is a different approach from the full-service processing model we offer to oil companies in North America.

While we are encouraged by the response in the marketplace thus far, developing both the relationships and necessary technical assets will take time. As a result, we expect it will be several years before the international business begins generating significant revenue.

If you look at our diversification plays in total they contributed $14.7 million in revenue in the second quarter, up from $11.3 million in Q2 of '08. This represents 19% of total revenue in the quarter, up from 10% last year. Measured in terms of both revenue dollars contributed as a percentage of revenue, our diversified are growing. This growth is helping us offset the recession-driven erosion in our fleet customer base. We continue to make investments in these businesses, and we expect to see further growth in the second half of the year.

As I said earlier, one of our goals is to maximize the benefits of our cash flow and generate the highest possible return. We capitalized on an opportunity further this goal in the transaction with Realogy Corporation that we announced in June. Prepaying our tax receivable liability to Realogy used $51 million in cash. We expect it to deliver a cash payback in less than four years, while adding between $10 million and $15 million annually to our cash flow for the next 12 years. As a result of the Realogy prepayment, we concluded Q2 with a leverage ratio of 1.4 times EBITDA, compared with 1 times EBITDA going into the quarter.

Given the increased leverage and our bias towards being conservative with our cash, paying down financing debt will be our focus for the near term, with stock buybacks being our secondary priority. At the same time, we will continue to explore alliances, mergers and acquisitions that make sense for us. These could be opportunities to expand our core business within adjacent markets, to broaden the range of information products and services we can provide to our installed base of customers or to support our international strategy. We said last quarter that the current landscape seems to be relatively favorable for these opportunities, and our position has not changed.

In conclusion, we are successfully executing on our goals as we begin the second half of 2009. We're capitalizing on our model and growing our core business by both gaining share from our competitors and further penetrating the small fleet market. We're focused on tightly managing cost and containing credit losses. Our diversification strategy is working well. And we're deploying our cash effectively.

The recession and the slowdown in fleet activity remain, but the strength of our franchise positions us for our continued recovery when the economy turns around and our existing customers begin to see growth in their businesses. Until then, we will stay focused on aggressively managing what we can control and continuing to deliver solid financial results.

I'll now turn the call over to our CFO, Melissa Smith, so she can review these results. And then we'll take your questions.

Good morning, everyone. I'll review our financial results for the second quarter and conclude with our guidance for Q3 and updated outlook for the full year.

I'm pleased to report our second quarter result was $79 million of revenue and adjusted net income of $0.57. This compares to our guidance range of $66 million to $72 million and $0.38 to $0.43 of A&I.

As Mike mentioned, several factors contributed to the positive results. The most significant was lower credit losses. On the revenue side we also had higher-than-expected transaction volumes, fuel prices and late fee income.

This was another solid quarter of execution in a difficult business climate. Our sales force continues to add new business, and we have grown total vehicles over the prior year. New business this quarter helped to offset some of the erosion we've seen in our existing customer base. These customers represent transaction volume growth potential when we move into a period of economic recovery. In the meantime, we've contained our cost structure and are reaping the rewards of our sound credit and collection practices. All of these moves allow us to continue to invest for long-term growth opportunities such as international expansion and increased R&D. We're pleased with our competitive position and intend to maximize our opportunities while preparing for a period of slow economic recovery.

Looking at our financial metrics in detail, for the second quarter of 2009 total revenue decreased 29% to $78.6 million from $111.2 million for the second quarter of 2008. Net income to common shareholders on a GAAP basis was $93.2 million or $2.36 per diluted share. This compares with a net loss of $24.4 million or $0.63 per share for Q2 last year.

The Company's non-GAAP adjusted net income for the second quarter of 2009 was $22.4 million or $0.57 per diluted share compared with $22.4 million or $0.57 per diluted share for the second quarter last year. This quarter adjusted net income excludes an unrealized market-to-market loss on our derivative instruments on the amortization of purchased intangibles. We also excluded the gain on the prepayment of the Realogy liability of $136 million. You can see all of these items on the reconciliation we provided with our press release.

For the fleet segment, total revenue for Q2 2009 declined by 34% to $69.1 million from $104 million in Q2 last year. The average number of vehicles serviced this past quarter was approximately $4.7 million compared with $4.5 million a year earlier.

Total transactions declined 9% in Q2 2009 to $66.1 million from $72.9 million in the second quarter last year. Transaction processing transactions for the quarter declined 14% from Q2 2008 to $14.8 million-- I'm sorry, to $14.5 million in the second quarter. And payment processing transactions declined 8% to $51.6 million for the same period.

Reflecting the lower price of fuel compared to last year as well as erosion in fueling volume within our installed base of customers, payment processing revenue in our fleet segment declined 44% to $45.2 million from $80.2 million in Q2 last year. The number of payment processing transactions was down 8% from the second quarter of 2008.

When we provided guidance last quarter we expected a 10% to 15% decline in same-store sales. And net results in Q2 2009 reflect a 10% decline.

The average expenditure per payment processing transaction was down 40% from the second quarter last year to $47.37 due to the drop of fuel prices to $2.33 per gallon. Our net payment processing rate for Q2 2009 increased three basis points year on year to $1.85 percent. Although we're continuing to see positive results from our shift towards hybrid pricing arrangements compared to the first quarter of 2009, our net payment processing rate was down 9 basis points.

The increase in fuel prices during the quarter is the primary reason for the decline in the rate sequentially. As we expected, approximately 60% of our transactions in the second quarter were at merchants with hybrid contracts. Rebates as a percentage of fueling dollars paid to large fleets and leasing companies were up slightly compared to the sequential first quarter.

Our MasterCard segment continues to see strong growth. Total revenue contributed by MasterCard in the second quarter grew 32% to $9.5 million from $7.2 million in Q2 last year. Our single-use product, again, drove most of the spend increase this quarter.

Total MasterCard purchase volume was up 24% to $771 million from $623 million in Q2 last year. The net interchange rate for Q2 was 1.11%, which is up 19 basis points from the sequential first quarter. The increase is due to the new interchange rates that MasterCard implemented during the quarter. Rebates paid to our MasterCard customers as a percentage of purchase volume were down slightly due to the mix of customers.

Turning now to operating expenses, on a GAAP basis the total for Q2 declined 23% to $46.3 million from $60.3 million in the second quarter last year mainly due to lower credit loss and operating interest expense. All other operating expenses in the quarter were basically flat with the prior year, reflecting our commitment to hold the line on expenses during this uncertain period.

On a total basis, including both fleet and MasterCard, credit loss was down by $8.3 million or 76% from Q2 last year to $2.6 million. Our credit loss story in Q2 was even better than in Q1. We continue to see significant declines in our past-due balances in Q2. Going back to December of last year, we've reduced balances past due 30 or more days by $17 million, from $22 million to $5 million at the end of Q2. To put this into perspective, past-due balances as a percentage of total accounts receivable have not been this low since 2005.

The most significant factor in driving credit losses results this quarter was a trail-off in bankruptcies. We factored into guidance one significant bankruptcy each quarter, but none occurred in Q2. As you will recall we experienced a significant bankruptcy in each of the prior two quarters, so we'd expect this trend to continue.

We also saw a decline in the number and the size of small bankruptcies this quarter. The total accounts receivable balance at the end of the quarter was slightly higher than our expectations mainly due to the increasing fuel prices. Total charge-offs were in line with our expectations going into the quarter at just under $6 million, which is net of $2.3 million in recoveries. Therefore, neither of these had a significant impact on the favorability and credit loss.

All of these factors contributed to our loss rate in the fleet segment coming in at 8 basis points, significantly better than the 17 basis points we reported for Q1 in the assumptions in our guidance. The 8 basis points this quarter compares with 23 basis points in Q2 of 2008.

As we said on the last call, it's not that a single silver bullet has reduced the expense, but a series of actions combined with changes in customer behavior that have accumulated to make a significant difference. We are cautiously optimistic that our peak and losses occurred in Q4 2008.

The results this quarter were very positive, and we expect to continue to benefit from the actions we have taken. We believe that our efforts to reduce risk are appropriate actions for these uncertain times. As Mike mentioned, changes in the economy tend to move more rapidly through our portfolio since the credit we extend is short term in nature.

Looking forward, we're adjusting our guidance for full year 2009 to reflect the upside in credit we experienced in the last two quarters. We are not anticipating further improvement in our accounts receivable aging, so we expect our Q3 losses to move close to the midpoint of our historical loss range. In addition, in Q4 we expect a seasonal decline in our aging as we have seen in four of the last five years.

All in, we are anticipating our full-year losses to be 18 to 23 basis points of spend. Clearly this continues to be the most volatile part of our earnings, but these results would put 2009 squarely in line with our historical norms.

Let's now move on from credit loss to other key expense lines.

Salary and other personal costs for Q2 2009 were essentially flat year on year at $18.3 million. Included in these results was an additional expense related to anticipated bonus payouts for the year.

Our average headcount for Q2 was 707, which is down 21 people from last year. In our core fleet and MasterCard operations, our headcount was down 50 people compared to last year. The overall reduction in headcount reflects our continued focus on cost control.

Continuing with operating expenses for the second quarter, service fees in occupancy and equipment costs have remained level year on year. Depreciation and amortization expense is up by $400,000. This is due to new assets placed in service as part of our product release schedule.

Operating interest expense was a positive factor in the second quarter, declining by $6 million from Q2 a year ago to $3.3 million. Our average operating debt level, including CDs and Fed funds was $394 million, compared to $706 million in Q2 last year.

For the second quarter, the interest rate on our CDs and Fed fund borrowings was 2.6%, which compared with 3.9% in Q1. Our interest rates have been declining for the past several quarters, and we expect to continue to benefit from low interest rates in the second half of 2009.

Our effective tax rate on a GAAP basis was 37.3% for the second quarter, compared with 38.1% for Q2 a year ago. Our adjusted net income tax rate this quarter was 37.8% compared with 37.5% for Q2 2008.

Let's turn now to our derivative program. During the second quarter we've recognized a real-life cash gain of $4.5 million before taxes on these instruments in an unrealized loss of $22.6 million. We concluded the second quarter with a derivative asset of $20 million.

During the quarter, we resumed purchases under our hedging program. The bottom end of the collar that we've locked in for 2009 is $0.24 higher than the bottom end we locked in for 2008. Our weighted average prices locked in for '09 are between $2.79 and $2.84. We expect to receive significant cash gains from our hedging program for the remainder of 2009.

For the portion of 2010 that we have completed hedging, which is 75% of the full year's target, our price is approximately $3.20. We've reduced our exposure to fuel price fluctuations through the use of hybrid contracts. However, based on our current volumes, a $0.10 change in fuel prices generates a change of $7.4 million in revenue for a full year.

We have received $11.6 million of realized gains from our hedging counterparties so far in 2009. We expect that hedging will continue to be important to our business model going forward, and we still intend to purchase derivatives in the future.

Moving on to the balance sheet, we have nearly three years left on our revolving credit facility, with pricing significantly better than the current market rates. We entered into a new interest rate swap last week that fixes LIBOR at a rate of $1.35 percent for the next two years on $50 million of our financing debt. This replaces swaps we had in place covering $80 million at a rate of 5.2%. We ended the quarter with a balance of $192 million.

We borrowed $55 million in Q2, primarily to fund the $51 million prepayment of Realogy. In addition, we bought back 81,000 shares of stock at a total cost of $2 million.

Concluding the review of our financial results, capital expenditures were $4.6 million for the second quarter, reflecting continued reinvestment in our core product offerings and strategic diversification. For 2009, total CapEx is expected to be between $15 million and $17 million.

I'll conclude with some key assumptions and our updated financial guidance for the third quarter and full year 2009.

Although we're planning on continued success in signing new customers, our guidance assumes a year-on-year decline in transaction volume within the existing customer base of approximately 7% to 10% for the remainder of the year due to economic conditions.

We also expect a normal seasonal decline in fleet transaction volume and MasterCard spend volume in Q4 based on fewer business days and a slowdown around the holidays. We've also assumed a slight increase in fuel prices for the remainder of the year with Q3 being $0.10 higher than Q4. At the same time we're expecting our credit loss for the full year to be in the range of 18 to 23 basis points based on the factors that I mentioned.

Let me remind you that our forecast for the third quarter and full year 2009 are valid only as of today and are made on a non-GAAP basis as Steve discussed earlier. Although our share repurchase program remains in place, we have not included any potential EPS upside from this. The fuel price assumptions are based on the applicable NYMEX futures price.

For the third quarter of 2009, we expect to report revenues in the range of $78 million to $83 million. This is based on the average retail fuel price of $2.39 per gallon. For the full year 2009, we expect revenues ranging from $300 million to $310 million based on the average retail fuel price of $2.26 per gallon.

In terms of earnings, for Q3 of 2009 we expect to report adjusted net income in the range of $21 million to $23 million or $0.54 to $0.59 per diluted share. We expect adjusted net income for the full year 2009 in the range of $77 million to $81 million or $1.94 to $2.04 per diluted share on approximately 39 million shares outstanding.

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

Thank you. (Operator Instructions) Our first question comes from Bob Napoli from Piper Jaffrey.

Thank you. Good morning. A question on the transaction outlook. You have improved the outlook from the prior quarter. Your transactions were better this quarter, several percent better than what we were modeling. And I just wondered what is driving, you know, that improvement in transactions versus your prior thoughts?

Yes. Well, I think we had given kind of a range of 10 to 15 basis points before we came in at the low end of that, at 10-- I shouldn't say basis points-- 10% down on existing customer usage. And we also know that last year starting in the third quarter if you remember, and then continuing into the fourth quarter, we had a significant drop-off in existing customer usage. So it's somewhat also then reflecting that in those numbers, looking at what the trend has been so far in the first half that got us to the 7% to 10% for the last two quarters.

Is there anything within there, within your base of customers that is, you know, that improved versus your expectation? It was not a-- what is-- does that-- what's-- is it just across the board?

Yes. I'd like to say there was, but we haven't seen it yet. I mean, we've looked at it geographically. We talked in our prepared remarks about retail being down. That was the same as we saw in the first quarter. We've talked about transportation being down, public administration being up. But the other is still kind of riding in the middle, and there was not much change. So, you know, we saw basically a 10% decline in the first quarter, and the same thing in the second quarter. I think there's macroeconomic news that's starting to improve, but we haven't seen it yet in those existing customers in their usage.

Thanks. On the Citibank, was there anything in the second quarter for Citi?

Yes, there was some because we had actually converted over the cards. It wasn't mandatory for them to switch over. They didn't switch over till early July, so there were some transactions in the month of June. But then basically starting in July we got the full impact.

Okay. And then the pipeline for new business-- last question and I'll get out of the queue here. But I mean, are you guys-- where are you seeing opportunities that that pipeline has improved from last quarter, is it stable from last quarter? And where, generally, are you seeing opportunities? What kinds of businesses?

Well, I think we're continuing to see strong pipelines. No change in kind to the sales cycles in the midrange and the large marketplace, so we feel good about that. We saw in the first quarter and continuing into the second quarter kind of a slowdown in the sales cycles on small businesses.

The good news for us, we started to see that improve in June, and it's continued on July. So we feel that small businesses that I think took the real brunt of the economy impact were just not making decisions. We saw that on WEXSMART as well. So they weren't making buying decisions on telematics. They weren't making changes on their fleet cards.

So we started to see a little bit of, I said, an uptick there. Clearly on the MasterCard side we feel very good about what we're seeing on MasterCard, not just in what it's producing now and its revenue, but also on the pipeline. And we've got some large accounts that are kicking in and some new large accounts that we've signed.

Great. Thank you.

Thank you. Our next question is coming from Tom McCrohan from Janney Montgomery Scott.

Hi. Thanks for taking the question. And congratulations. Very strong quarter.

Had a question on organic transaction growth, same-store sales organic transaction growth, Mike, how did that kind of track? That 10% number, how did that track throughout the quarter, and how is that tracking in the month of July?

Pretty much consistent throughout the quarter. You know, there wasn't a lot of change. There was really no uptick. It just continued to stay down. You know, we're probably just dragging along the bottom. And we really haven't seen any uptick or any change in July, so it's kind of staying at that same level.

Okay. And when you said you were seeing relative strength in public administration and a couple-- well, just taking the public administration, how big is that, SIC codes in the context of all your transactions?

It's not huge, but I mean, it's still significant enough. It's in single digits in terms of percentage of our customer base. But, you know, we do have 17 states. We do have thousands of municipalities, and we have the General Services Administration, the GSA. So we've been aggressive, making sure we're working with the states, working with the municipalities within those states to make sure we're there and supplying their fueling needs as they expand, and there has been some expansion.

Great. And just a question on the funding side. Given the funding advantage associated with CDs and the ability to kind of lock-in cheap term funding, why borrow under the Fed fund lines, as we saw this quarter, about a $48 million increase in that activity?

We typically are borrowing off Fed funds just from a timing perspective. So when we have peaks in funding needs we'll borrow through the Fed fund lines, but it's not something that we keep long term typically. Or in this case we were waiting for some CD orders to get filled, so it's just temporary.

And so the-- kind of the average blended-- the way I calculated it looks like you had a pretty nice drop-off in the funding costs this quarter down to about 3%. Is that a pretty fair number to use?

Yes. Yes.

And gross recoveries for the quarter, can you provide that for us?

Yes. Recoveries were-- yes, $2.3 million.

$2.3 million. And how did the charge-off activity kind of trend through the months of the quarter? Was it front-end loaded? Did you see kind of charge-offs really drop off in June?

There was little bit of a drop-off but not significantly.

But then in terms of kind of reserve levels, Melissa, like if you just annualize, you know, the $6.2 million of the net charge-offs for the quarter and compare that to kind of reserve levels, it seems like reserves are a little light. But I guess what you're saying is you don't think charge-offs are going to run at $6 million a quarter, I guess. So just kind of talk to that.

Yes. Actually, part of that is the impact of fuel prices, you know, still coming through. You know, if you compare what's getting charged off with what fuel prices they were at to current rates. So that's impacting it to a certain extent as well as just in general. When we look at our reserve we're looking typically at six months of charge-offs, not a full year.

So when gas prices go up the charge-offs kind of go up in lockstep?

I'm sorry. Say that again.

When gas prices trend higher, charge-offs generally trend higher as well?

When gas prices go up into six months later you're going to see that higher price of fuel charge-off.

Right.

And so the period that's getting charged off, you have to look at what the fuel prices were about six months prior.

Okay. And the last question I have is on the regulatory side. I had talked about this proposal out there that would eventually eliminate the current non-bank/bank designations. So if you just-- how would you advise shareholders and investors to kind of handicap the possibility that Wright Express would need to convert to a bank holding company given the current proposals that are out there. And that's all I have. Thanks.

Yes. I-- we know that what's out there so far is a white paper, and it was a small piece of the white paper, but it did mention ILCs. There's a lot of uncertainty, so you can read a lot of different opinions on what's going to happen. I think it's somewhere off in the future before we'll know for sure what is going to happen, if there's going to be changes, or if there's not going to be changes.

We believe the facts are in our favor, that the ILCs have been well run, well managed, well audited and scrutinized by different agencies. They do what they should be doing for businesses, providing, as in our case, a strategic piece of our deliver strategy. I think that we also know that if there had to be a change we know in the past we have done business without having the ILC. We know our competitors do business, and they compete with us without an ILC.

So we don't know all that's going to happen. We just know some of the things that could happen, and we're preparing ourselves and looking at things. And also out there making sure our voice is heard because we do like the ILC. It keeps our business today in a place where it's helped us during a very tough economic climate. But we also know there are other options, and we feel comfortable that we can look at those options once we understand the playing field.

Great. Thanks for taking my questions, and congratulations on a strong quarter.

Thank you.

Thank you. Our next question is coming from Tien-Tsin Huang JPMorgan.

Great. Thanks. Just a few follow-ups actually. Just the sources of growth in new business or new vehicles, like you said, is up 5. I know you-- Mike, I know you gave some details there, but just can you go into a little bit more detail? Where are you taking customers exactly and through what channel? Just trying to better understand the strength there and the sustainability.

Yes. We're-- well, we know where some of the vehicle increase was because of the GSA, so that's clearly a large fleet, government related. We are winning market share both through our co-brand channel and our WEX channel in the midsize and large fleet marketplace.

When you get down to the small fleet marketplace there's so much open space. It's not necessarily against competition. It's mostly cash customers and other forms of payment. And that's where we've been a little bit of a slowdown, as I've said, because of small businesses, I think, just being reluctant to make any changes.

But where we are taking market share is in that midsize and large fleet space through those two channels that primarily represent us in that space, co-brand and WEX.

Good. Have you seen any change in the competitiveness from some of the other brands?

Yes, we've seen some. I think the economic environment cause people to back away in some cases from the small fleet market. We've seen people change their payment terms to the small fleet, shortening those payment terms from 30 days to something less. So I think that's been a big change.

I think because of the economic climate we have a few competitors that are under private equity, so I think they're looking at different markets and being more rationale in how they're going about going after those markets. So I think those are some of the things that we watch and try to just measure our strengths against their strengths and where we should be aggressive. And we are being aggressive in a number of different areas to take market share and continue to take market share.

Excellent. Excellent. That's good to know. A couple housekeeping questions then. The-- I guess, Melissa, the-- another question was on loss reserves earlier. Is there a good rule of thumb that we should consider? I know there's a lot of dynamics around changes in fuel price, but, you know, loss reserves, obviously the percentage of receivables, is there a rule of thumb that we can use?

I think if you look back in our history you'd say that it's gone all over the place.

Yes.

When we're looking at the reserve we're looking at what we think we're going to have for charge-offs over the next six months as well as recoveries and what we think is going to happen to the roll rates within the portfolio, which is affected by the aging. So a lot of different measures are included in that. I don't think you can just take a standard percentage.

Yes. Okay. I guess it's not unreasonable to think that obviously that will step up from the (inaudible) or so that we saw in the second quarter.

Yes. Particularly we're saying in the fourth quarter. If you go back the last six years on average between our Q2 aging to our Q4 aging, it's deteriorated about 30% on average. That doesn't even look at just what happened last year. So when we're estimating our allowance we think, you know, Q3 will look more kind of like a standard number, and then Q4 will look worse than what you've seen the last few quarters.

Okay. And then just the same old question, if we were to hedge today where are we at in terms of hedge level or price? And also has there been any shift in the wholesale retail spread?

There hasn't been a significant shift between wholesale and resale. The current prices, if you get out there, are hovering around $2.70.

Two dot seven zero?

Yes.

Great. Thanks a lot. Well done.

Thanks.

Thank you. Our next question is coming from Greg Smith from Duncan-Williams.

Yes. Hi, guys. Melissa, you gave that new sensitivity on fuel prices to revenues, but any chance you can work that down to EPS?

Historically, our costs have been about 15% of the revenue number. That's obviously going to change depending on what the estimate is of credit loss and what's happening with their funding cost rates. But those are the two things that are variable.

Yes, okay. But if we just use 15%.

That's just kind of a rule of thumb.

Yes, and then tax it, right, to an EPS number.

Yes. Yes.

Okay. Perfect. And then I don't believe you talked about losses on the MasterCard side. What's happening with charge-offs there?

Charge-offs were low on MasterCard. There was nothing really of note that happened. And actually if you look at that segment, it performed particularly well financially in large part because of the lack of losses.

Okay. And then haven't heard much talk about the service network. Is that a business that's progressing as expected or is it-- kind of what's going on in that side of the business?

Yes, it plays a strategic role. I can't say that there's, you know, a lot of growth. There is growth in the service sector, but it's not anything that would be material enough to, I think, talk about. We do use it in different aspects of our business. It's also a big piece of what we do with the GSA. I mean, that was a big piece of their business. Not just the fueling side but also the service side.

That's interesting. Good. Okay.

So that's probably where the biggest growth has been.

Yes. Thank you.

Thank you. Our next question is coming from Robert Dodd from Morgan Keegan.

Hey, guys. I got off a few-- the first one I'm obviously missing something here. You talked about-- on the credit, first couple on credit, you talked about significant decline in balances past due in the quarter, but at the same time one of the revenue, sources of revenue upside was higher late fees. Can you explain to me what happened there?

Yes. We changed the way that we assess late fees late last year as part of the measures that we were taking in order to make sure that we were protecting the portfolio. And so we reduced the grace period or eliminated the grace period, I guess I should say, that we had given out historically and changed the calculation. So that's why you're seeing two different things happen at the same time.

Okay. Got it. On the credit side obviously, you know, spectacularly good. Can you give us some-- an idea on where you think your current credit policies will go in better economic times? Do you think your current relative tightness in terms of monitoring, aging, et cetera, is appropriate just for this point in the cycle, or do you think you're going to maintain that kind of discipline in a better economic period, or would you loosen up a little?

I think that it's probably a little bit of each. You know, if you think of the way that we're managing high-risk accounts I think that that's going to be true regardless of what type of economic environment you're in. And I think just in general we've invested more in credit tools that allow us to be more precise than we have been historically, particularly in the changing economic times.

So I think all those things will change. Where you might get a little bit more lenient is with the amount of credit that you're extending to some of the less risky customers. I think those are--

And another I'd say, we went into this, Robert, saying, you know, we're still a business that prides itself on driving high metrics and customer satisfaction. And that was one of the things that we wanted to look at very closely.

And we have not seen, as we really evaluate attrition, that this has really caused any high level of attrition or something seeping through that's saying to us we're losing customers because of what we've done. I think we're being smart about it. I think we had to do it because of what we saw in the fourth quarter and some of the fears we had when the economy was just dropping and no one knew where it was going.

But always with looking at this saying how do we also keep a high level of customer satisfaction. And so far we feel very good about where those metrics are and seeing the improvements in bad debts and write-offs.

Okay. That sounds very, very fine. I mean, can I-- at the risk of you just saying no, can I ask you to speculate on where you think your credit losses could go? Historically, 11 to 22 basis points, obviously, a little elevated but not very in this point of the cycle. I mean, longer term do you think this with, you know, keeping happy customers is going to lead it down to, you know, mid teens, low teens? I mean, any visibility there would be hugely helpful.

Yes. I think that's awfully hard to answer that right now. I mean, if you look back at our results, if you go back to 2005 we had 16 basis points of credit loss. You know, that 11 was kind of an unusual year for us, so I think right now we're just pleased that we think that we're going to come in within a normal range this year.

Okay. Got it. Thank you. Moving it on to kind of the small segment where you say you've seen a little bit of a slowdown because the merchants are-- or the businesses, rather, aren't wanting to make changes right now. But you also mentioned, you know, some new sales initiatives. I'm not sure if that was necessarily in the small segment. But can you give us a bit of color what you're doing in terms of new ways of targeting that small business market?

Yes. I don't to want to get too specific. I think some of the things we've put in place are some opportunities to look at testing different ways to be more aggressive in those marketplaces. I really wouldn't want to say from a strategic standpoint exactly what those are, but we are trying to find ways as well, you know, to bundle products and make it more attractive on the value proposition. But that's probably as far as I'd want to go in knowing we probably would give away too much to our competition.

Okay. Got it. One more if I can. Going by the bank holding company, it looks to me like you're in compliance with the tangible equity rules for that anyway, so after the gain. Any-- do you have any opinion on what proportion of your business would count as sort of non-financial, if anything, if that law were to come to pass, which obviously is still speculation at this point?

Yes. Well, I think it's some of-- it's a very small amount. It's part of some of the diversification strategies that we've gotten ourselves locked in with our customers and our partners like WEXSMART Telematics. I mean, that's kind of a commercial product that's not necessarily a financial-related product.

So that would be one. But these are important strategies to us. But it's a very small piece of our business overall.

Thank you. Our next question is coming from Paul Bartolai from PB Investment Research.

Thanks, guys. Good morning. First question, I just wanted to clarify on the transaction growth assumptions for the rest of the year. The 7% to 10% that is just for the second half. That's not comparable to the 10% to 15% you guys have been talking about for the year, right?

You're right. It's the second half.

Okay, great. And then just on the payment rates, that was down 9, 10 basis points sequentially. Given the change in fuel prices I was a little bit surprised it was down so much. Was there anything unusual in that number? And I guess also any-- you know, how does it look as far as big customer renegotiations coming up in the next couple quarters?

Well, there's continuous customer renegotiations. We-- Melissa mentioned in the rate it was primarily the price of gas, the impact on the hybrids moving up I think over $0.30 during the quarter. But there are, you know, continuous or weak-type market shares. We renegotiate some contracts. There was some slight increases on rebates to our co-brands and some of (inaudible) but nothing material. And that will probably continue as we move forward. It just depends on the price of gas though.

Right. But with the hybrids I would have thought that that discount rate would have been a little bit less sensitive to changes in the gas prices. Is it more sensitive now?

Well, because of the fixed component, you know, we've gone from 30% being hybrid to say, as Melissa said, 60% being hybrid. And there's a fixed component, so as the price of gas goes up that fixed component as a percentage just goes down. And that's what really impacted us as we saw the price of gas go up from the first quarter to the second quarter.

Okay. And then any comments on, you know, kind of the outlook for the payment rate going forward? I mean, does that just kind of continue to trend down as you renegotiate with some of your big customers?

Well, again, I think it's going to mostly be impacted by the price of gas. And then we'll have, as I said, continuous rebates that will be going to some of our customers. Sometimes there's volume rebates, but that's usually the small piece of it. It's really primarily going to be driven by the price of gas having an impact because of the hybrids.

Okay, great. And then just following up on some of the regulatory and legislative issues going on. I mean, do you see any impact to your business as far as-- I mean, there's some talk of late fees being impacted and how those fees are charged? Anything you see there that could impact how you guys do business?

Most of what we see on that side of the house is for consumers. We're business to business. We're not a revolver. We're not a credit card. We're a charge card. So when we hear of those restrictions, you know, at this point we don't think it affects us. It's mostly talking about how they're going to impact consumers. And primarily I think when their revolve their charges.

Okay. Great. Thanks. Good job.

Thank you. Our next question is coming from Tim Willi from Wachovia Securities.

Thank you. Good morning. Just two questions. First, if you'd talk a little bit about just what you're seeing around the M&A environment and the cash flow you have relative to-- I think your comments were debt pay-down, buyback. Does that indicate that there's not an active market or that you just really are focused on bringing the debt to EBITDA back down towards the one level before you get more active in the M&A market?

No. I'd say that we've been consistently saying we're looking at that. We want to be prepared for that. I think some of that is making sure it's the right transaction. Sometimes you make the right decision when you don't pull the trigger to do something. But also waiting for maybe more rational opportunities in the marketplace.

But, you know, we're inquisitive. We're looking at things. We talked about how can we expand our diversification strategy. Can we move into some adjacent markets? Could it help us in the international arena? So all of those are being looked at.

I think we're in a good position. You know, if they're small we clearly have a debt structure that can absorb that. If they're large I think we have opportunities there as well, and you know, we'll look at both, but I think it just has to be the right conditions. And we're still be cautious. We still think there'll be more rational opportunities as we move forward.

Okay. And then on the diversification strategy in general and maybe international, more so within that context, do you see within the next 12 to 18 months any likelihood that there may be an accelerated investment cycle that may coincide with, obviously, an improvement in the domestic economy to try to accelerate that diversification strategy? Or do you feel like the rate of investment you currently have in place is more than adequate to evolve that business commensurate with market opportunities?

Well, I'm not sure I'm going to answer it exactly as you're asking, but we are making investments. We do believe because of the 285,000 customers we have that we should continue to look at ways to diversify. We keep making investments in our MasterCard program.

This single-use (inaudible) product continues to get great market penetration with new customers. As I mentioned earlier, we've signed some new ones. Some ones we signed recently are getting more aggressive with that product. We're expanding that product, working with some of our other channels to use that product in some of their fleet marketplaces.

We're investing in our distributor program. That would include Pac Pride and even some of the other distributor programs we have in place with some of our oil companies today. So we are making those investments. We think the distributor market has great opportunity for more penetration because that's the small fleet marketplace.

You know, TelePoint's one where it's a diversification strategy that helped us provide more services to merchants. We're making an investment there because they've never wandered in to fleets that had underground storage tanks. We know we have customers that have underground storage tanks, so we're trying to build a fuel desk and allow them to use our card for their retail purchases and use our Reappoint product to manage their inventories with that supply chain management product.

So we are investing. We're actually investing more in international than we expected because we see good traction. We see good opportunities. By announcing the Vienna operation I think that's telling people that we're pretty comfortable. We're going to start to see some business in that marketplace. But I want to be fair. I mean, a lot of it means you've got to build it. You've got to get a lot of things converted over, and I don't think it'll be material for a couple of years. But still, it's worth the investment because we see the opportunities.

Great. Thanks so much.

Thank you. We do not have time for any further questions. I'd like to turn the call back over to the speakers for any closing comments.

Well, thank you. We thank everyone for listening again this quarter, and we look forward to talking to you again next quarter. Goodbye.