WEX

Business Context and Reporting Period

Company: Wright Express Corporation (WEX Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: A leading provider of payment processing and information management services to the vehicle fleet industry, operating through a wholly-owned bank subsidiary. The company manages transactions via a closed network of oil companies and fuel retailers.

Key Financial Metrics

Note: Total Debt includes Deposits ($381,335), Borrowed Federal Funds ($22,376), Revolving Line-of-Credit ($51,000), and Term Loan ($140,560) as of Sep 30, 2006.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 18% quarter-over-quarter and 25% year-over-year (nine months). This was driven by a 12% increase in average fuel prices ($2.87/gallon vs. $2.57) and a 6% increase in payment processing transactions.
• Profitability Turnaround: The company reported a net income of $34.4 million for the quarter, compared to a net loss of $6.2 million in the same period in 2005. The nine-month period showed a net income of $55.7 million versus a loss of $9.7 million in 2005.
• Derivative Impact: A significant driver of the income improvement was a net realized and unrealized gain of $18.1 million on derivative instruments in Q3 2006, compared to a loss of $38.5 million in Q3 2005. This volatility is due to fuel price hedging strategies.
• Interest Expense: Operating interest expense increased 67% quarter-over-quarter ($6.9 million vs. $4.1 million) due to higher interest rates (average 5.1% vs. 3.5%) and increased debt balances to fund receivables.
• Credit Losses: Provision for credit losses increased to $5.0 million in Q3 2006 from $2.3 million in Q3 2005, largely due to a specific $2.2 million reserve increase for one customer.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects transaction volume growth of 7% to 9% excluding the impact of the terminated UPS contract and hurricane recovery effects from the prior year. They anticipate these negative factors to continue into Q4 2006.
• Unusual Items:
  • Derivatives: The company uses fuel price derivatives (put/call options) that do not qualify for hedge accounting, causing significant volatility in reported earnings. Unrealized gains of $31.1 million were recognized in Q3 2006.
  • MasterCard Sale: In October 2006 (subsequent event), the company sold all remaining MasterCard Class B stock for a pre-tax gain of $1.7 million.
  • Accounting Correction: The 2005 cash flow statement was restated to reclassify changes in deposits and borrowed federal funds from operating to financing activities.
• Risks:
  • Fuel Price Volatility: Revenues are highly dependent on fuel prices.
  • Internal Controls: Management concluded that disclosure controls and procedures were not effective as of September 30, 2006, due to a material weakness in accounting for goodwill and related deferred income taxes.
  • Credit Risk: Increased bad debt expense could result from failure to assess customer credit risks adequately.

Investor Verification Checklist

• Derivative Valuation: Verify the sustainability of earnings given the heavy reliance on unrealized gains from fuel price derivatives ($31M gain in Q3).
• Internal Control Remediation: Monitor the progress of remediation for the material weakness regarding goodwill and deferred tax accounting.
• Customer Concentration: Assess the impact of the specific $2.2 million credit reserve on one customer and the status of repayment negotiations.
• Interest Rate Sensitivity: Evaluate the impact of rising interest rates on operating margins, as average debt rates increased from 3.5% to 5.1%.
• Cash Flow Quality: Note that while net income was positive, operating cash flow was negative ($23.9M used) due to significant increases in accounts receivable driven by higher fuel prices.