WEX Inc. (NYSE:WEX) Q4 2022 Earnings Call Transcript

WEX Inc. (NYSE:WEX) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Good morning. My name is David, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the WEX Q4 2022 Earnings Call. Todays conference is being recrded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Steve Elder, Senior Vice President, Global Investor Relations, you may begin your conference.

Steve Elder: Thank you, operator, and good morning, everyone. With me today is Melissa Smith, our Chair and CEO and President; and Jagtar Narula, our CFO. The press release we issued earlier this morning and a slide deck to walk through our prepared remarks have been posted to the Investor Relations section of our website at wexinc.com. A copy of the release have also been included in an 8-K we submitted to the SEC earlier this morning. As a reminder, we will be discussing non-GAAP metrics, specifically, adjusted net income attributable to shareholders, which we refer to as adjusted net income, or ANI, and adjusted operating income and related margins and adjusted free cash flow during our call. Please see Exhibit 1 of our most recent earnings press release, and it’s on deck available on our Investor Relations website for an explanation and reconciliation of adjusted net income attributable to shareholders to GAAP net income attributable to shareholders, an explanation and reconciliation of adjusted operating income to GAAP operating income and a reconciliation of adjusted free cash flow to GAAP operating cash flow.

The company provides revenue guidance on a GAAP basis and earnings guidance on a non-GAAP basis. The non-GAAP guidance cannot be reconciled without unreasonable efforts due to the uncertainty and the indeterminate amount of certain elements that are included in reported GAAP earnings. We have most recent earnings release and slide deck for more detail about the Company’s non-GAAP measure. I would also like to remind you that we will 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 and the risk factors identified in our most recent annual report on Form 10-K and subsequent SEC filings.

While we may update forward-looking statements in the future, we disclaim any obligations to do so. You should not place undue reliance on these forward-looking statements, all of which speak only as of today. With that, I’ll turn the call over to Melissa.

Melissa Smith: Thank you, Steve. And good morning, everyone. We appreciate you joining us today. WEX finished 2022 in a strong position with another impressive quarter, beating our guidance for revenue and adjusted net income per share and increasing revenue for the 10th straight quarter. But let me start with a very quick overview of the full year numbers. Revenue increased 27% over 2021 to a record revenue for WEX of $2.4 billion. This is driven by full year total volume process of $212 billion, which was up 45% compared to 2021. Full year adjusted net income per share grew 48%. Our success through market cycles is enabled through our reoccurring revenue model, our diverse earnings engine and our reliable cash flow model. As previously shared more than 80% of WEX’s revenue is reoccurring in nature.

Over 20% of our revenue now comes from our health segments, in this year exceeding $1.5 in revenue for the first time. This provides a fast growing profitable and predictable revenue and earnings stream. Our health business further strengthens the stability of WEX, but its revenue from custodian assets, acting as a natural hedge for interest expense. WEX remains well positioned to invest for growth, while opportunistically returning capital to shareholders, as valuations and market conditions warrant. Our combination of growth, scale and cash generation puts us in the enviable position of both returning capital to shareholders, while also investing for the long term future as a business. Now I’d like to give a quick recap of our quarterly financial results released this morning, which Jagtar will provide more detail on later, before diving into our priorities for 2023.

I’m pleased to share that revenue in the quarter was $690 million a year-over-year increase of 24%. This growth is primarily driven by volume growth across the business. Normalization of late fees, increased revenue from custodial assets and the benefit of higher fuel prices. On an organic basis, which excludes the impact of fluctuations in fuel prices and foreign exchange rates, revenue in the quarter grew 19% compared to the prior year period. This continues the spring of quarters where we’ve exceeded our long term growth targets of 10% to 15%. Strong quarterly revenue, paired with the scalability of our business model and a superior funding model resulted in adjusted net income per diluted share of $3.44, an increase of 33% compared to the same quarter last year.

Total volume process across the organization in the fourth quarter grew 31% year-over-year to $53 billion, driven by strong performance in each of our segments and reflecting the power of our model. Now I’d like to turn to a recap of our business highlights in 2022. We’ve had several exciting new product launches and customer wins throughout the year that helped drive our outstanding results. In addition to our large enterprise level wins, we’ve added more than 100,000 new customers in 2022, the majority of which were small businesses. This speaks the strength of our sales and marketing engine year in and year out. We close the year posting a 73% increase in travel and corporate payment purchase volume adding 1.7 million new vehicles inside our total health SaaS accounts grow 14%.

We feel very positive about the progress for the five year 10% to 15% revenue growth plan, we outlined at our Investor day last March. In 2022, we posted an impressive 14% from existing customers, 4% from net new customers, 2% from new products, and 1% from M&A. I am incredibly proud of our performance in 2022 and grateful to our team members who helped us achieve such spectacular financial results. When I look back on the year, it was a year characterized by significant economic and geopolitical events. Overall, WEX remain resilient and well-structured company. Thanks to our diverse earnings engine, and $782 million generated n adjusted free cash flow, setting us up for a strong 2023. I’ll conclude my remarks this morning by outlining our strategy as we head into 2023.

As we talked about in our investor day last spring, our strategy continues to focus on deepening share of wallet, maintaining our market leading positions by driving customer focused innovation through our strong sales engine and further building out the scalability of our platform that hosts our specialized vertical services. We’re doing this by thoughtfully allocating capital across the business to manage through a dynamic economic environment with a balance between reinvestment in the business and shareholder return. The growth scale and cash generation of WEX uniquely situated us to capitalize on our momentum. Our business is characterized by large total addressable markets with structural tailwinds that provide significant opportunities for continued growth.

Let me translate this to the segments we operate in and highlight a few priorities for the enterprise. First, let’s look at our Travel and Corporate Payments solution segments. We’re unique in the space as we couple wholly owned market leading technology with a global issuing and funding capability. The combination of these two gives us the ability to scale quickly, be more agile responding to customer needs, and leads to strong margins in the segments. In the Travel portion of our portfolio, we are the clear market leader. We’re pleased with the rebound in travel and are excited about growth as travel volumes continue to normalize around the globe. As part of travel, we increase investment in sales and marketing, yielding positive results in 2022 and will give us momentum through 2023.

Next in health and benefits solutions. Employers are looking for tools to simultaneously manage rising healthcare costs, and provide benefits to attract and retain employees, which create a secular resilient tailwind. Our market leading products allow employers to have a simplified security experience utilizing our payments platform, which also offers their employees an integrated benefit experience, whether they’re choosing an HSA account, paired with a high deductible plan, an FSA, traditional PPO plan, taking advantage of lifestyle benefits, or utilizing products like Medicare Advantage or COBRA. As we look to 2023 in the health and employee benefits segment, we’ll continue to benefit from our large diverse distribution network, an industry experience and expect to deliver another year of strong account growth.

Our ability to distribute broadly, both direct to employer and wholesale partners enhances our ability to penetrate the market. Additionally, our revenue from custodial assets is becoming an increasingly important driver of growth. WEX became an HSA custodian fewer than two years ago, and is now the sixth largest custodian according to Devenir, mid-year update. Finally, our global fleet business, organizations need to control costs. And as a result, there are ongoing opportunities to further increased penetration with our proven sales engine. Growing market share with our leading fleet solution and capturing Greenfield customers represents a significant opportunity. We’re also making good progress with our fleet solutions, simplifying the transition to a mix fleet environment with the addition of electric vehicles.

While the timing of the transition is uncertain, we believe it is becoming increasingly apparent that we will compete in the mixed fleet world more than the next decade. The transition to EV, introduces a new TAM, that we believe will be valued at $1.5 billion to $2 billion in revenue, and continues to grow recurring revenue for the company through subscription based revenue streams. We’ve made great strides in EV in 2022. Launching products allowing for the payment of charging at public locations in both the U.S. and Europe, in our building functionality to allow for home charging reimbursement, and energy management at deeper locations, all designed to be integrated into mix fleet offering with our industry leading mobility products. Looking across the enterprise, we have multiple levers to drive growth.

And importantly, in this macroeconomic environment scale. From a growth standpoint, we’ll continue to enhance our global commerce platform by adding new offerings for mixed fleet and electric vehicles, further integrate platforms, streamline and add efficiencies through our contact centers and enable speed in our business through the enhanced use of data and analytics across the company. We’re also focused on deepening our share of wallet and believe the compelling value of our solutions allows for increased cross-selling, which will take on an even more prominent role in 2023. We have some early success signing up customers for additional services throughout 2022 by adding nearly 100 customers in the second half of the year. We’re working with the sales team to apply these learnings to other customers in each segment.

From a scale standpoint, we continue to make good progress in capturing $100 million in operating efficiencies by the end of 2024. As I wrap up my comments, we’re confident in our ability to deliver on our financial targets, including our long-term revenue CAGR of 10% to 15% and adjusted net income EPS growth of 15% to 20%, as we outlined at our last Investor Day. Regardless of the economic environment, WEX is positioned to benefit from the flexibility and diversity of our business as well as our reoccurring revenue model. We continue to monitor the macroeconomic environment and are staying close to our customers to understand the impact of a potential downturn on their businesses. We will nimbly respond to challenges or capture opportunities for our fan as they materialize.

While some companies may struggle with the impact of rising interest rates or limited capital availability in the current macro environment, WEX will take advantage of its low leverage, strong cash flow and superior funding model to invest for the future. I continue to be confident in our path forward in the future of WEX as we remain focused on managing the business through a dynamic economic environment. With that, I’m pleased to turn things over to our CFO, Jagtar Narula, to walk you through WEX’ financial performance this quarter. Jagtar?

Jagtar Narula: Thank you, Melissa, and good morning, everyone. As you just heard, we again delivered strong financial results while continuing to make progress on our strategic objectives. As with prior quarters, this quarter showed the strength of our global commerce platform, the competitiveness of our offerings and the power of our business model. Now let’s start with the quarter results. For the fourth quarter, total revenue exceeded the midpoint of our guidance by $44 million, primarily due to a combination of earnings of custodial assets, fuel price impacts and the normalization of rate fees. Total revenue came in at $618.6 million, a 24.3% increase over Q4 2021 with more than 80% of revenue for the quarter recurring in nature.

As a reminder, we define recurring revenue as payment processing and account servicing revenue, revenue from our factoring business, transaction processing fees and other smaller items. In total, adjusted operating income margin for the company was 38.2%, which is up from 37.1% last year. From an earnings perspective, on a GAAP basis, we had a net income attributable to shareholders of $88.7 million in Q4. Non-GAAP adjusted net income was $152.8 million or $3.44 per diluted share. This represents a 33% increase over the prior year. Now let’s move to segment results, starting with fleet. Fleet revenue for the quarter was $367.2 million, a 20% increase over prior year, powered by volume growth, higher fuel prices and an increase in finance fee revenue, including the contribution of the new ExxonMobil portfolio on-boarded at the end of Q3.

Payment processing transactions were up 5% year-over-year. The growth was led by local U.S. fleets while we saw an expected slowdown in over-the-road trucking fleets due to a recessionary environment in the freight business. As you see in our metrics, the net late fee rate continued to mobilize to pre pandemic rates. Overall, finance fee revenue was up 32% due to increases in volume, steel prices and the number of late fee instances. All of these include the impact of the new ExxonMobil portfolio, which is primarily revolving balance portfolio. The domestic fuel price in Q4 2022 was $4.34 versus $3.42 in Q4 2021. We estimate the year-over-year impact of higher fuel prices increase fleet revenue by approximately $34 million, including a benefit of approximately $6 million for European fuel price spreads.

The net interchange rate in the fleet segment was 1.11%, which is down 5 basis points from the prior year. The higher fuel prices compared to last year is the primary reason for the decline in the net rate. The segment adjusted operating income margin for the quarter was 45.2%, down from 50.9% in 2021, primarily due to elevated credit and fraud losses, which I will speak about next. Fleet credit losses were above our expectations at 33 basis points of spend volume, including approximately 6 basis points of fraud losses. Let me first discuss credit losses. While loss rates improved each month through the quarter, they were above expected levels. As I’ve stated in previous calls, we have a healthy portfolio overall but we have continued to experience increased delinquencies, predominantly in our smaller over-the-road trucking customers.

As I mentioned earlier, the freight business has experienced a recessionary downturn, and this has had a more pronounced impact with our smaller customers. We continue to focus on actively managing the portfolio, including adjusting our credit models to tight underwriting standards, reducing credit lines where appropriate and reducing payment terms. Next on to fraud losses. We have seen both our application fraud rates and transactional fraud rates improved sequentially. The actions we have taken to date have slowed the rate of fraudulent activity by more than 50%. We are launching product enhancements and further improving monitoring tools to help us combat scheming activity. We are also in ongoing conversations with our merchant partners to address the sources of fraud and, in some cases, shift the financial responsibility.

Turning now to Travel and Corporate Solutions. Total segment revenue for the quarter increased 36% to $110.7 million. Purchase volume issued by WEX was $17.1 billion, which is an increase of 57% versus the prior year. The net interchange rate in this segment was up 9 basis points sequentially, predominantly due to favorable customer and product mix as well as a year-end true-up for incentives based on full year performance. Breaking the segment down further, travel-related customer volume represented approximately 68% of the total spend and grew 69% compared to last year. Revenues from travel-related customers was up 75% versus Q4 2021. This reflects continued strength in consumer travel demand in the U.S. and Europe. We believe that there is more room for recovery as pent-up demand appears strong, and Asia begins to open up its borders.

Corporate payments customer volume grew 36% versus last year and revenue was up 12%. This growth was led by continued strength in the partner channel. The segment delivered an adjusted operating income margin of 47.9%, up from 38.8% in Q4 last year. There has been significant improvement in these margins during the year as volume accelerated. We have designed the cost base to be relatively fixed, allowing for a high drop-through of new revenue to margins. Finally, let’s take a look at the health segment. We continue to drive strong growth in Q4 with revenue of $140.7 million. This represents a 29% increase over the prior year. Approximately half of the growth is due to earnings from custodial assets and the remainder is from the increases in the account base and purchase volume.

SaaS account growth was 14% in Q4 versus the prior year. Health segment purchase volume increased 20%, leading to a 20% increase in payment processing revenue. We had a significant amount of success in 2022 with Medicare Advantage accounts sold through large health plans, which contributed to the volume growth. Custodial assets, which generated interest income over use for working capital were $3.5 billion on average in Q4 versus $2.5 billion last year, representing an increase of 41%. Of the $3.5 billion total, approximately $1.4 billion was held at third-party banks with the remainder held at WEX Bank. We realized approximately $25.6 million in revenue in total from these deposits in Q4 versus $8.1 million last year. This represents a blended yield of 3.4% on the funds that were invested during Q4 this year.

The health segment adjusted operating income margin was 28.1% compared to 19.2% in 2021. The high flow-through on the revenue from the invested HSA deposits is the primary driver of the increase in margins. Shifting gears now, I will provide an update on the balance sheet and our liquidity position. We remain in a healthy financial position and ended the quarter with $922 million in cash. We have $899 million of available borrowing capacity on the revolver and corporate cash of $171 million as defined under the company’s credit agreement at quarter end. As you expect, we saw a sizable $555 million decrease in our accounts receivable versus last quarter as fuel cost moderated and travel volumes declined seasonally. At the end of the quarter, the total outstanding balance on our revolving line of credit, term loans and convertible notes was $2.6 billion.

The leverage ratio as defined in the credit agreement stood at 2.5 times, which is the bottom end of our long-term target of 2.5 times to 3.5 times and down from the end of 2021 due primarily to strong earnings. Next, I would like to turn to cash flow. WEX generates a significant amount of cash. Using our definition, adjusted free cash flow is $782 million for 2022. Note that due to the rapid decline in fuel prices at the end of the year compared to the end of Q3, our deposit balances and as a result, our reported adjusted free cash flow was about $150 million to $175 million more than we would normally expect. This excess will likely reverse during 2023. As Melissa mentioned earlier, we are committed to driving strong cash generation and deploying it by both opportunistically repurchasing our own shares and investing in our business with an overall goal of growing as well as continuing to build further resiliency into the business model.

We purchased 1.9 million shares at a total cost of $291 million last year and an additional 103,500 shares so far in 2023. We still have nearly $500 million remaining in our authorization. Finally, let’s move to 2023 revenue and earnings guidance for the first quarter and the full year. Starting with the first quarter, we expect to report revenue in the range of $600 million to $610 million. We expect adjusted net income EPS to be between $3.15 and $3.25 per diluted share. For the full year, we expect to report revenue in the range of $2.43 billion to $2.47 billion. We expect adjusted net income EPS to be between $13.55 and $14.05 per diluted share. Let me spend a couple of minutes going through the larger assumptions in our guidance. First, a couple of high-level macro assumptions.

We are basing our guidance on a slow growth environment in the U.S. Market surveys suggest a slowing economy and consensus U.S. GDP growth of around 0.5% for the year, which we have taken into account in our growth expectations. We are expecting continued interest rate increases early this year adding another 25 to 50 basis points to the current Fed funds rate target. As a rule of thumb, a 100 basis point increase in interest rates presents a modest $10 million headwind to adjusted net income for this year. Excluding the impact of fuel prices, fleet segment revenue growth is expected to be towards the lower end of our long-term growth target, which is 4% to 8% because of the expected slow economic growth in the U.S. We are assuming an average fuel price of $3.83 for the year, which compares to $4.46 last year.

This change is expected to reduce revenue by approximately $95 million. The Travel and Corporate Payments segment is expected to grow between 7% and 11%. Similar to 2022, we continue to expect the net interchange rate for travel customers to remain fairly steady and for corporate payment customers to continue to turn down slightly due to customer mix. We see significant pent-up demand and continued strength in the demand for travel despite indications of a potentially slowing economy. Finally, the health and employee benefit solutions segment is expected to have another strong year with growth of 25% to 30%. We have completed a successful open enrollment season and expect benefits from a significant increase in the custodial balances invested as well as higher interest rates.

We are on track to remove $100 million of operating costs on a run rate basis by the end of 2024 as we outlined last quarter. We expect adjusted operating income margins to trend up through the year as we get the benefit of these cost savings measures and reduced credit losses. All of this leads to EPS growth in the range of 0% to 4% due to the significant drop in fuel prices expected. Excluding out fuel price degradation and FX, we would expect adjusted EPS growth to be in the range of 11% to 15%. As I complete my prepared remarks, I would like to emphasize again how pleased we are with our Q4 results. Finally, we have great confidence in our ability to win new customers, expand with existing customers and bring new products to market, leading to the long-term growth targets of the company.

With that, operator, please open the line for questions.

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Q&A Session

Operator: We’ll take our first question from Mihir Bhatia with Bank of America. Your line is open.

Mihir Bhatia: Good morning. And thank you for taking my question. I want to do it he just stocked with the healthcare segment. You had a nice step up and saxophones and revenue growth comes in the fourth quarter. And it sounds like you expect that to continue into 2023. Can you just talk about some of the drivers of that? And just remind us the enrollment the current enrollment season numbers, those are not showing up in Q4, right? So we should see that benefit in Q1, is that right? And then just also relatedly, I wanted to ask about just the Benefits Express acquisition. I think this is the first enrollment season where you were going to see some of the benefits. Just an update on that, how that went? Was it in line with expectations, better or worse? And what we can expect from here?

Melissa Smith: A lot in there to unpack on health care. And so, if I take — I’m going to parse that out in pieces. The account growth that we saw we added 2.3 million SaaS accounts in 2022. So had a really strong growth year. In addition to that, when we went into the enrollment season, we saw more strength than we had anticipated, which is what you’re seeing reflected in the fourth quarter and part of what we’re picking up in our guidance for next year. So some of the enrollment season numbers, some of our customers who are already started through that enrollment. So that growth that you’re seeing in the fourth quarter is really what’s going to drive through into 2023. So we feel really good. It gives us a lot of visibility into the numbers for 2023.

And then on top of that, we’ve been able to supplement the account growth, which is about 3/4 of the revenue stream with custodian asset revenue with the investments that we have. And so, we’ve been able to really maximize the revenue opportunities that we have with the combination of those two things. You also asked about the benefit administration components. We are continuing to sell that into the marketplace. We sell it both on a stand-alone basis and we sell it integrated into the offerings that we have. We’ve had success also — I talked a little bit about cross-selling and we’ve had success with the ability to sell that into some of our existing customer bases within our fleet business. So kind of across the board, I’d say really strong momentum.

One of the things that distinguishes us in the marketplace is that we’re selling directly. We’re also selling through a bunch of different partner channels, which is what we do across the business. But within the health and benefit segment, it’s a little bit more unique to what you’re seeing competitively happen in the marketplace. And we think that model really works well because we can go through our broker channel directly into the marketplace and meet the needs of that customer segment, but also offer the technology to our partners where they can use that to supplement their offering into the marketplace. And all of those things combined really bringing some really great revenue numbers.

Operator: Next, we’ll go to Nik Cremo with Credit Suisse. Your line is open.

Nik Cremo: Good morning. Thank you for taking my question. First, I just wanted to touch on the cost savings program. Thanks for the update. I was just curious what’s embedded in the 2023 outlook? I know that previously, it was said that you thought you could exit the year at, like $65 million, $50 million revenue run rate.