WEX Inc. quarterly report, Q2 FY2017

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WEX Inc. — Q2 2017 Form 10-Q Summary

Business context and reporting period

WEX provides corporate payment solutions through Fleet Solutions, Travel and Corporate Solutions, and Health and Employee Benefit Solutions. This unaudited filing covers the quarter and six months ended June 30, 2017. Results include EFS, acquired July 1, 2016, so year-over-year comparisons reflect acquisition-related changes as well as organic performance.

Financial and operating performance

  • Revenue: Q2 revenue was $303.9 million, up 30% from $233.9 million; first-half revenue was $595.2 million, up 35% from $439.9 million.
  • Earnings: Q2 operating income was $47.6 million, down 8% year over year; net earnings attributable to shareholders were $17.1 million, or $0.40 per diluted share, versus $12.6 million, or $0.32. First-half operating income was $108.3 million, up 17%; shareholder earnings were $46.5 million, or $1.08 per diluted share, versus $35.7 million, or $0.92.
  • Margins: GAAP operating margin was approximately 15.7% in Q2, versus 22.1% a year earlier; first-half margin was 18.2%, versus 21.1%. Q2 included a $16.2 million non-cash impairment charge and higher credit-loss expense. Adjusted net income, a non-GAAP measure, was $54.2 million in Q2 and $107.1 million for the first half, compared with $42.6 million and $80.6 million, respectively.
  • Cash flow: First-half operating cash flow was negative $91.9 million, versus negative $56.8 million in 2016; investing cash outflow was $37.4 million, while financing provided $161.4 million. Cash increased $28.1 million to $219.0 million, principally supported by borrowing; higher receivables and business volumes weighed on operating cash flow. Capital additions were $37.5 million.
  • Debt and liquidity: At June 30, cash was $219.0 million. The company had $154.8 million drawn on its $470 million revolving facility, with approximately $315 million available, subject to covenants. Term loans were $1.620 billion; notes, securitized debt and other debt were $395.9 million, $104.5 million and $149.1 million, respectively. The company reported compliance with material debt covenants and said available funding sources should meet cash needs for at least 12 months. Customer deposits were $1.123 billion and are distinct from corporate borrowing.
  • Segments: Q2 Fleet Solutions revenue rose 39% to $200.3 million, while operating income fell to $19.6 million from $26.0 million. Travel and Corporate revenue increased 3% to $55.0 million; Health and Employee Benefit revenue rose 33% to $48.6 million. Travel and Corporate purchase volume grew 37% to $7.7 billion.

Material changes versus the prior comparable period

  • Fleet activity increased: vehicles serviced rose 13% to 10.9 million and total fuel transactions increased 24% to 130.0 million. Fleet payment-processing expenditure per transaction increased 23%, partly reflecting EFS’s larger over-the-road transactions and higher fuel prices.
  • Fleet credit-loss provision rose to $16.1 million in Q2 from $6.4 million companywide; management attributed the increase primarily to magnetic-stripe skimming fraud. Fleet losses equaled 20.5 basis points of fuel expenditures, versus 10.2 basis points a year earlier.
  • Q2 depreciation and amortization increased substantially, primarily due to EFS acquired intangible amortization. Higher operating costs and the impairment charge contributed to the decline in Q2 GAAP operating income.
  • Q2 financing interest expense decreased to $28.5 million from $30.4 million, mainly because prior-year acquisition-related ticking fees did not recur; this was partly offset by higher borrowings and interest rates. Foreign-currency results shifted to a $10.5 million gain from a $4.8 million loss.

Outlook, risks, contingencies and unusual items

  • No specific revenue or earnings guidance is provided in the filing. Management expects liquidity sources to be adequate for at least the next 12 months. Management anticipated fraud incidents would trend down slightly in the second half of 2017 following transaction limits and planned technology enhancements; this is an expectation, not a guarantee.
  • On July 3, 2017, after quarter-end, WEX repriced secured term loans, reducing margins by 50 basis points for tranche A and 75 basis points for tranche B at then-current borrowing levels. Approximately $3 million of fees were expected to be primarily expensed in Q3.
  • WEX was no longer hedged for fuel-price changes. Interest-rate swaps cover a portion of variable-rate borrowing; foreign-exchange movements also affect reported results. Other stated risks include acquisition integration and synergy execution, competition, credit losses, cybersecurity, regulatory changes, and increased leverage.
  • A $16.2 million non-cash charge followed a strategic decision to bring certain technology functions in-house. Restructuring charges were $2.2 million for the first half, with further costs expected under existing initiatives. The Q2 effective tax rate was 39.0%, versus 27.3%, mainly due to European tax-return adjustments and the absence of prior-year discrete tax benefits.
  • A TCPA fax-advertising class action had a settlement in principle, subject to court approval; the expected amount was described as not material. Other ordinary-course litigation was not expected by management to have a material effect.
  • Management reported a material weakness in internal control over financial reporting related to user access and program-change controls. Disclosure controls and procedures were deemed ineffective at June 30, 2017; remediation was underway, with completion targeted by the 2017 year-end filing, subject to testing and management assessment.

Important facts for investors to verify

  • How much revenue and earnings growth is organic versus attributable to EFS, and whether EFS integration delivers anticipated benefits.
  • Whether fleet fraud losses decline as management expects, and how credit-loss provisions and receivables aging develop.
  • Whether operating cash flow improves as receivables and transaction volumes grow, and how the company funds working capital.
  • Debt levels, covenant headroom, borrowing costs, and the realized savings and fees from the July 2017 repricing.
  • Progress in remediating the material weakness and whether controls are subsequently tested and judged effective.
  • The court’s approval and final cost of the TCPA settlement, and the eventual financial effects of the new revenue-recognition standard, which WEX planned to adopt using the modified retrospective method in 2018.