WEX Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited; financial statement amounts below are in millions of dollars unless otherwise noted. WEX provides corporate payment solutions across Fleet, Travel and Corporate, and Health and Employee Benefit Solutions.
Financial performance and liquidity
- Q3 revenue: $287.8, up 27% from $226.1 a year earlier. Payment processing revenue was $146.2; account servicing $58.8; finance fees $36.1; and other revenue $46.6.
- Q3 earnings: Operating income was $54.6, down from $67.7; net income attributable to WEX shareholders was $19.7, versus $32.2; diluted EPS was $0.46, versus $0.83. Financing interest expense rose to $35.1 from $11.3. The GAAP effective tax rate fell to 24.0% from 42.4%, including a $3.2 tax benefit from reduced valuation allowances.
- Adjusted results: Adjusted net income, a non-GAAP measure, was $53.4 in Q3 versus $50.4. For the first nine months it was $134.0 versus $145.9. The filing excludes substantial items from this measure; it should not be treated as GAAP earnings or cash flow.
- Segments: Q3 revenue was $184.8 for Fleet Solutions (+29%), $63.3 for Travel and Corporate Solutions (+12%), and $39.7 for Health and Employee Benefit Solutions (+48%). Operating income was $22.3, $30.2, and $2.1, respectively. EFS and Benaissance acquisitions contributed to growth; Fleet profitability was pressured by higher expenses and financing costs.
- Cash flow: Operating cash flow was negative $80.9 for the first nine months, compared with positive $247.6 in 2015. Investing cash outflow was $1,139.6, including $1,089.3 for acquisitions. Financing cash inflow was $1,472.1. Cash ended the period at $537.2, up from $280.0 at year-end 2015. Management attributed the operating cash outflow in part to a $405.6 increase in accounts receivable.
- Balance sheet and funding: Total assets were $6,333.7 and total liabilities $4,815.5. Accounts receivable was $2,061.4; deposits were $1,286.6. Credit-facility borrowings, net, were $1,702.3; notes, net, $395.4; securitized debt $83.9; and other debt $108.1. The $470 million revolving facility had $86.4 million of net borrowings. WEX said it expected to fund cash needs for at least 12 months.
Material changes versus the prior comparable period
- WEX acquired EFS on July 1 for approximately $1.44 billion net of cash acquired, funded with approximately $1.18 billion cash and 4.012 million newly issued shares. EFS contributed to Q3 revenue, but its purchase accounting remained preliminary.
- The acquisition drove a major increase in debt and financing costs. WEX replaced its prior credit agreement with a $455 million tranche A term loan, $1.2 billion tranche B term loan, and $470 million revolving facility. Outstanding amounts under the new agreement carried a 3.8% weighted-average effective interest rate at September 30.
- Q3 revenue grew, but GAAP operating income and shareholder earnings declined. Higher depreciation and amortization, service fees, personnel costs, acquisition-related expenses, and interest expense outweighed revenue growth. The nine-month revenue increase was also supported by the acquisitions, price modernization, and growth in Health solutions.
- WEX reported no fuel-price derivatives after March 31, 2016. Q3 2015 included derivative gains; Q3 2016 did not. Foreign-currency remeasurement produced a Q3 2016 gain of $5.9 million.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific revenue or earnings guidance. Management said it believed cash resources and available funding were adequate for at least the next 12 months and expected future GAAP tax rates to be within the range of historical rates. It anticipated a slight increase in operating interest expense as it replaced deposits associated with the Higher One program, which was expected to end in Q4 2016.
- Integration and costs: WEX initiated an EFS-related restructuring program and expected additional restructuring costs of $1.3 million for that initiative, plus $3.0 million for the 2015 initiative and $0.9 million for the 2016 initiative. EFS purchase-price allocation was not final. EFS-related acquired intangibles also increased amortization; WEX recorded $5.9 million of accelerated amortization after shortening the expected life of existing over-the-road processing technology, with about $17.4 million of remaining net book value to be amortized over the following nine months.
- Debt and interest-rate risk: Much of the new credit-facility borrowing was floating-rate and secured by substantially all company assets. Credit covenants require minimum interest coverage and limit leverage, with the leverage threshold stepping down over time. WEX disclosed substantial debt-service and refinancing risks. On November 3, 2016, it entered into swaps covering $800 million of borrowings, reducing some future interest-rate variability; the swaps do not qualify for hedge accounting.
- Credit and operating risks: Approximately 93% of accounts receivable was current and 97% was less than 60 days past due. Fleet credit losses were 8.6 basis points of fuel expenditures in Q3, versus 10.6 basis points a year earlier; Travel and Corporate credit-loss expense rose, primarily due to two losses including a travel agency bankruptcy. Fuel prices, foreign exchange, customer credit, deposit funding, acquisition integration, cybersecurity, regulation, and competition remain identified risks.
- Other items: A putative TCPA class action concerning fax advertisements was disclosed; management estimated the reasonably possible loss was not material and intended to defend the case. WEX also disclosed a one-time approximately $2 million benefit from a MasterCard contract renewal in Travel and Corporate Solutions.
Important facts for investors to verify
- How EFS integration, synergies, and the final purchase-price allocation affect future earnings, amortization, and debt repayment.
- Current leverage and covenant headroom, variable-rate exposure, and the effect of the November swaps on interest expense.
- Whether operating cash flow improves as receivables and business volume grow, and whether deposit funding remains available on acceptable terms.
- How much revenue growth is organic versus acquisition-driven, and whether Fleet late-fee increases and price modernization are sustainable.
- Credit-loss trends, particularly the Travel and Corporate portfolio, and developments in the TCPA litigation.