WEX Inc. (WEX) Earnings Call Transcript & Summary

Good morning, and welcome to Citi FinTech 11. My name is Pete Christiansen. I'm on the U.S. IT Services, Payments and Processors team. And this morning, I'm pleased to be hosting WEX with Melissa Smith, WEX' CEO. Before we get started, I'd like to remind you that during today's discussion, Melissa may make forward-looking statements. Actual results may vary materially from today's statements. Information concerning risks, uncertainties and other factors that could cause results to differ from these forward-looking statements is included in WEX' SEC filings and is available on WEX' Investor Relations website. Our discussion today will include references to non-GAAP financial measures. A reconciliation of non-GAAP financial measures is included in the company's most recent SEC filings. And with that, I'd like to welcome Melissa to our discussion today. Thank you for joining us. Great to have you. And perhaps, Melissa, I think maybe it would be great if you could start off with some opening remarks.

Sure. Thanks, Pete. It's great to be here today. Before we actually get into the questions, I thought I'd quickly point out to the audience that we provided additional disclosure today around our Travel and Corporate Payments interchange rate, which can be found on our Investor Relations website. We're going to go through one of those pages today. But I just want to address the misperception that we have around the interchange rate from Travel and Corporate Payments that the rate changes sequentially are being driven by competition. And if you can see, I think the chart is up now. What we're showing is purchase volume here from 2019 to current quarter, and we've split it between our Travel and our Corporate Payments volume, and we provided rate split between Travel and Corporate Payments so you can see sequentially. And across this graph, the blue line represents Travel. The yellow line at the top represents Corporate Payments. And the green line represents the blended rate pro forma for the change that we have been accounting with a contract rate -- contracting that we just announced. And you can see by looking at the graph that really the sequential changes, as we have said, 15 out of 16 basis points of the net rate change sequentially was driven based on mix. We've had a nice rebound in travel volume. And as we've had that rebound, those customers are operating at a lower rate and they really go into this category of some of the offerings that we have, which we call embedded payments where what we're doing for services is built off of our infrastructure still highly profitable, but at a lower net interchange rate than some of our other offerings that are bundled into our Corporate Payment business, which include like our direct business which operates at a higher rate and has more complexity associated with that part of the business. And so, again, just out of desire to make sure that we were being transparent, we put this additional closure out there. And we continue to win in a very highly competitive marketplace, and we've done that because we have real class technology, our cloud-first offerings are resonating in the market. We've got a unique platform, and we have unique set of services that we've built over many years. We're able to go into the marketplace with these industry-leading solutions using a digital marketing, cloud-based engine. And we've seen some tremendous results on our ability to actually bring customers into our business in a way that we haven't seen in the past. Some of the competitive wins that we announced in Q3 include a U.S.-based multinational corporations and specializing in package delivery. We've also had wins in transportation, e-commerce, business services all on the fleet side, we had a large health care -- health education institution in our health care part of the business. We talked about Stampli, who's the member of the FinTech 250, who's got over $200 billion worth of accounts payable under management in the Travel and Business -- Travel and Corporate Payments segment. So one of the things that I feel incredibly bullish about is our continued ability to offer compelling markets into -- compelling products into the marketplace, bring in new customers as a result and doing that through the technology that we've really built out over a number of years. We continue to invest heavily in our technology. We've been talking about the fact we've moved our business to Cloud First a number of years ago. I've gone through a cloud migration with the business that wasn't originally built in the cloud and have been able to create some really compelling offerings in the marketplace in a highly reliable manner. And with that, Pete, I'm going to turn it back over to you.

Thank you so much, Melissa, and thank you again for the added transparency here. I think this is clearly going to help investors model the business a bit more accuracy on, I think, understanding. But just help us on this chart itself, I just have 2 areas that I just want to dig into a little bit. First of all, you do have some business where some accounts where there is going to be an accounting change, I guess, on a go-forward basis. So where should -- now that's not going to impact profitability, at least, $1 or cents, maybe margins, I'm not sure. But how should we think about the Corporate Payments line generally, how -- so that should dip, I guess, has this just on this accounting change on the next quarter or 2?

Yes. And actually, we showed this pro forma on the blended rate. So the green line that's on this chart is pro forma for that accounting change, just again to make sure that it was simple to follow as you go into the next quarter. The other 2 lines are not pro forma, just again to show you on a like-for-like basis, what they look like.

No, that's super helpful. And then I guess if we think about the Travel vertical itself, I think, obviously, with the pandemic, can you discuss, has there been any level of concessions that you've been offering to some of your key customers? And do you expect that -- if there are, do you expect those levels of concessions to persist for a certain period of time? And just to help investors frame part of that dynamic.

Yes. It's -- if you look at that graph, you can see in the first quarter of 2021, we saw a step down in rate. And we talked about this in the first quarter. We did see, as we were recontracting some of our customers and during the pandemic period of time that we did see some impact to rate. And it also was affected in the first quarter as we blended in eNett and Optal into our business. The page before this, which isn't up right now, is Page 11 in the deck, on the bottom right side of that shows what's happened to operating margins within this segment sequentially. And I think that's really important as well because even though the blended rate, again, because you have got the skewing to travel, has skewed it down, our operating margin has improved sequentially each quarter. And that's a combination of the scalability of the model. So as we're bringing in revenue, having that, again, we -- a lot of the infrastructure was set up in order to make sure that we had a highly scalable model, and we've seen the benefit of that going as travel volumes rebound. And in addition to that, we've been doing the work that we had intended to with synergy capture with Optal and eNett. We're now at $30 million of run rate synergies associated with those 2 transactions, and we have line of sight for another $10 million as we do the platform consolidation work. And so -- you're getting the benefit of us, continuing to work on the cost structure with the addition of volume coming up, and you can see that reflected as margins are improving sequentially.

Got you. That's certainly helpful. Might as well jump to this question then again, back to the eNett and Optal synergies, which you've driven in 3/4 of them so far. Could you perhaps break down what were some of the areas on the cost side that you've been able to achieve so far? What's left? And then how should investors potentially think about -- I mean, obviously, there's a recovery that still -- we'll have to go on the consumer travel side. But how should we think about revenue synergies longer term as you build scale? Does this enable you to expand services with existing clients? Do you see any potential cross-sell, upsell opportunities? Just trying to get a sense of how you think about the potential long-term revenue synergies of this business as you scale?

Sure. So with a combination of eNett and Optal, when we actually closed on that transaction, we had a model that showed a range of possibilities of what could happen because there's a little bit more uncertainty in that period of time, what's going to happen with pandemic. And we're tracking really well to that. So what we feel good about is, originally, we had identified $25 million of synergies. As we've gotten more involved, we've seen more kind of like-for-like overlap where we've been able to make adjustments. Initially, it was consolidation of like-for-like resources across the enterprise and that took a little bit of time because they had to go through work council approval in a number of the regions. Some of that we're licensing, where we had duplication of licensing in certain regions is going through the process of eliminating where you had redundancies. And then on top of that, again, this kind of the last part, which is pulling together the 2 platforms. And we believe not only that allow us to really make sure that we're focused on continuing to have product differentiation in the marketplace by focusing on 1 platform, but it also allows us to create some further synergy capture. From a revenue perspective, it gives us expertise in some of the international markets. So I'd say it's more that it gives us the ability to build out on the infrastructure, the compliance structure that we pick up in other parts of the world and than resources that have that level of expertise more than it is an inherent cross-selling capability.

No, that makes tons of sense. And how do you think about the Travel business competitive positioning perhaps? Now you're the largest scale player in this area. There are some new entrants that are looking to get into this area and then more so just in virtual cards just generally. But how do you think about the competitive position of this now unified platform and what you bring to the table versus some of your peers?

Yes. We've had the advantage of being in this space for a long time, which has allowed us to create quite a bit of customization for our customers in this space. It's also a high level of integration within their businesses. And you kind of look at what you do in travel a couple of other places which are really pretty complicated, the compliance structure because you're operating globally and moving money across -- really across the world in 200 different countries and it's really a global offering. And so there's a lot of structure that sits behind that. But in the way that Optal and eNett had set up that money movement is something that we find it to be quite compelling. It allows the customers to have more ready access to their cash but does it in a way that's secure from a risk perspective to us. And so we believe that there's a model that they've created on more of a prepaid basis, which is an advantage to us to use in other industries, not just Travel. And so we do believe this is -- it's a model that was created with a very specific purpose, but has been built out over time with a lot of customization, a lot of integration with the end users. And from a competitive perspective, the compliance structure that level of currency movement and the chargeback activity are all really actually quite complex, which is why we play more heavily in the cross-border part of this business, which is really the most complicated part.

No, that makes a lot of sense. So it's certainly not as easy to replicate as some may think or just the standard virtual card business that we have tonight. No, that's helpful. Okay. Great. I'm glad we hit that head on. Now, let's talk about some of the more of the broader issues impacting the company today. Just wondering if you -- obviously, we've recovered off of the pandemic closed quite well, and you seem to be accelerating in that trajectory. But qualitatively, maybe can you think of -- can you -- can we run through maybe some of the major categories and certainly there are subcategories within them. Where are you seeing things really starting to begin to turn around? Where are some of the areas that investors should think about in terms of perhaps a longer pathway towards normalization?

Sure. I'll start with Travel. We saw a pretty nice rebound in the third quarter, but they still have not returned to pre-pandemic levels. So you had travel-related volume increased 85%, even just sequentially and then up 6x from what we had in the third quarter the year prior. So again, a lot of a nice rebound, but not back where it was to kind of dig into that customer segment, you're seeing more travel in the kind of the more established Europe -- Western Europe, in the United States. We had still a lot of latent demand that's still left in Asia. And so that was lagging as were -- you kind of segment it, you start looking at it based on vaccination rates, you can see that the higher vaccinated countries had more correlation to travel, at least, within our customer base. And so I think that people have had more of a risk-based bias towards where they're traveling and certainly, it's also impacted based on what the local regulations are and ease of getting it to different countries. So we believe that there's still a lot of pent-up demand in that part of the business. From our fleet business on the mobility side, we have continued to see this steady increase, the mobility. I was just on the phone last night with our MD in Australia, as they've come out of lockdown that's been a benefit. And so if you're seeing little incremental improvements back here in the United States, some of the areas you see incremental improvement is offices start to open up or salespeople start to get out, those are kind of the last components that are still pent up. And those tend to be geared towards some of the larger employers that are still working remotely, where some of our smaller customers really continue to move through the pandemic after that first quarter. And so we'd say there's a little bit of pent-up demand there. And then on the health care side of the business, we've had really pent-up demand where people aren't spending money on elective types of health care costs like they have historically. And so we view that as something that will change as well as was some deferral around decisions during the period of time of the -- kind of the worst, the pandemic again because I think people didn't want to layer it any more complexity. And so we think that all of those areas that are ripe to see some incremental growth.

That's helpful. Earlier, you talked about WEX' about move to Cloud First native development there. And last quarter, you talked about a new marketing tech stack that you're bringing to the platform. But generally, how should we think about WEX' digital transformation in the past 2 or 3 years? I know what was it 2 years ago, you started bringing volumes onto this cloud system. And what maybe in baseball terms, how do you think about the overall business and its digital transformation and cloud development?

Yes. I feel really good because again, we've started this path a number of years ago. When our CTO came in, we moved everything new wherever possibly being built in micro services and cloud based. We migrated our systems into the cloud. We actually just completed one of the very important migrations we had within our Corporate Payments system. And so a lot of the foundational work is behind us, which opens up more opportunity for us as we continue to progress forward. One of the things that I've talked about is the Marketing Cloud. And I think what I'm excited about that as a growth company, it just creates so much opportunity. You have -- and think of this as where we tested this in our North American fleet business, have over 400,000 customers that are small, that is sitting within that business. We're representing over 24 brands in the marketplace. And so to be able to go into the marketplace digitally then be able to actively test and learn where you're getting a lead has been incredibly rewarding. So our marketing costs have been flat, and we're up 94% on customers in that category year-over-year. And so it's just -- and again, this is relatively new for us. And so we're learning and have gotten some really great results to the point that half of our customers are coming through without being touched by a salesperson. And so it's got just amazing lift for us. We've tested this in North American fleet. We believe that there's opportunity we're going to move that into the European marketplace. And so nearly across the business, that is using AI. We've got AI that's going into other areas of business. And as we have introduced new technology off the data that we've accumulated across our business, it's creating some great results.

I'm sorry. So marketing has been just flat, but in the SMB category on the fleet side, you increased your bookings 94% year-over-year just using a digital approach?

Yes.

So granted lots of success there. So I guess, I mean, WEX has always kind of been known as having the big accounts or the larger entities, I assume, few bigs versus many smalls in that context. But now with these new capabilities, do you think that dynamic will shift over time, be more relevant to, I guess, SMBs into smaller fleets?

I think people -- they think of us in that large in the marketplace because we have products that are built for complexity. And -- but the unique part of how we go into the marketplace is -- and I'd say this across any of our channels, we do business with the biggest, most complicated companies in the world, literally in the world. And then we can pivot and sell that functionality in a more contained way to a small business. So if you look across our fleet portfolio, the average size vehicle is like 15 vehicle fleet. It's actually really pretty small. And we might be selling that directly or we might be selling that with any of the amazing brands that we represent in the marketplace that have outsourced on a co-branded basis, their sales and marketing as well as their processing to us. And so I think it just adds more power to that as opposed to creating something new. Every time we introduce something like that will allows us to get just a little bit smaller customer, too, into the mix in a cost-effective way.

No, that makes sense. I think maybe some of that perception is, especially when you won Chevron, right, that's a huge account. But really, you're doing the sales and marketing there as well. So you're really representing that brand in that case. So that's certainly -- that helps with some perspective. Maybe let's stay on fleet a little bit more. Are we thinking -- you've managed credit really well during this period. But I guess as we're coming out of this pandemic, things are starting to open up. Obviously, there's still supply chain issues and other things that need to be ironed out. But how are you thinking about the extension of credit? And how much of that competitive differentiator in the marketplace? I mean, is this something that clients are really looking to expand upon? Do you see this as a tool to grow your bookings in the Fleet Solutions business?

Yes. So I think credit is a little -- it actually shows up as a really important feature in certain periods of time and it becomes less important. I think it depends on what's happening from a credit cycle. But when we're doing business with small businesses, they're always going to care about having access to credit. So the fact that we own a bank, they were able to fund in a very low-cost manner. In fact, we use -- we're using some of the deposits that we get on the health care side of the business and now it's part of the mechanism in the bag. And so, again, I think credit is part of the equation. Generally, what we hear from our customers, though, that it's small in the marketplace, really the #1 thing that they want is to know that they can lock down spending into a very defined sliver. And so that may be fuel only, it may be that they want to do fuel and where we're going -- we have an ability with our products to be very targeted about how people spend their money. And that's typically the first thing they care about and the second thing often is credit, although not always. And as with our customer base, what we're hearing more at the moment with those smaller customers is credit being a limited to their ability to grow. And so it's something we're cognizant of, and we want to make sure that we're providing services in a way that's helpful to our customers, but at the same time, we're minimizing the risk that we have. And so we -- if anything, I'd say, move towards shortening payment terms as opposed to extending them based on their primary need.

So it's really vertical specific. It really depends upon the -- I got you. I got you. But on an overall basis, that mix shift, you are seeing some contraction in payment terms?

So generally, again, it does -- there's a little bit -- what you just said about mix is very true. But generally, with our smaller fleet customers, we have, if anything, tightened terms as opposed to extending them over the years. Although not much, I mean, let's say, on the fringe.

Right. Okay. No, that's certainly helpful. You got to address this topic on electric vehicles, and we were talking to your friends in Atlanta about this yesterday. And one of the observations I think I've gathered from listening to you and your competitor is that it seems like there's more stuff to be done on the EV side in terms of -- there's a wider range of services that you could offer a mixed fleet or even, let's say, 1 day a pure EV fleet. Now granted the unit economics are -- were ways away from sorting that out. But how should investors think about that? I mean you have employee reimbursement. There's a whole lot of other data that can be captured in within this whole transaction a lot more controls. How should investors think about the value profit WEX could add to a mixed fleet or even a pure EV fleet over time?

Yes. As I've been closer to this, as we've actually evolved into really spending time with our customers listening to what do they want now, what are their concerns, we're in this unique position. We have 16 million commercial vehicles that we do business with and a very small number, we're estimating only about 1,000 actually using EVs. And so we are very eager to make sure that as this trend, from a macro perspective, whether it happens in a year or it happens over 10 years, where -- there are our customers and help supporting through this trend. And it also, we believe, gives us an opportunity to change how we monetize that customer experience because we're adding a different level of value. They're very interested in having an ability to have an integrated bill through that phase in time where they've got a mixed fleet that's going to increase the level of complexity because they need to be able to understand the cost of their gas powered vehicle along with their EV. They really want to understand the total cost of ownership. If they're a public company, they want to understand their carbon footprint and what they're doing to affect that. And so there's just a lot more data feeds along with the need to have an integrated payment offering that reconciles and consolidate all the information together, and we feel like we are in this privileged position to actually play in that space. And so I would agree. I think that this is -- this creates an opportunity for us over whatever period of time this transition happens. And there's going to be this initial phase of product that we're working on right now. But there will be other products that come behind that as we looks in it and hear more from our customers about what you're expecting in the market.

To bring this solution to market and scale it, I guess, over time, does WEX need to have relationships with the charging infrastructure providers or even the OEMs? How do you think those relationships will form, I guess, over the coming years? And to what degree do you leverage a partnership with those players?

Yes. So we have a relationship with ChargePoint. We're already operating a space with some of our customers now. And we announced recently the fact that we've got this extended relationship with ChargePoint, where we're going to work together in this space. And we're working together to create offerings. We talked about the fact that jointly, we're going to serve elements needs in this marketplace. And so all these different players that are involved, our leasing partners are interested in their role in this as well as people like ChargePoint, the oil companies. A number of them are playing in this space as well. And so maybe you'll find that we're going to continue to build these partnerships the way that we have historically in order to leverage the assets in a way that our customers need.

No, that's helpful. Before I wrap up, I realize I just forgot one question. I want to go back to the to the Corporate Payment side of the business. Now I guess the way I think about it is a big portion of that business is partnership driven. You deal with some FIs, but now you have firms like Avid coming on. How do you think about those partnerships as potential like leaping pads to further engage with other firms? What is that potential synergy, I guess, the client win synergy of expanding your network effect? How should investors think about that? And Corporate Payments, do you see that becoming more and more of a partnership-driven sale model or maybe more direct? How should we think about that mix?

Yes. If you look across the business, we always have ended up with a multichannel approach, but we start with the partner channel, and that's what we did with Corporate Payments. We started with a partner channel. That's been the most predominant part of our channels so far. But we've had success selling into the marketplace directly. We just have not scaled it. We're now at the point where we're starting to scale that capability. And so we see opportunity kind of across. We see the opportunity on more of the infrastructure plays with what you see with embedded payments, which is about moving a lot of volume through. Again, this kind of fixed infrastructure that we've created. And then on top of that, having more value-added sales in the marketplace, which sometimes or directly sometimes those will also go through partner channels. The Corporate Payments avenue is something that we see as an asset that you really can leverage across everything that we do at WEX because at the end, what we're trying to do is simply business. And we're doing that in unique use cases with fleet and with travel, but it all sits on the backbone and it helps the payments platform. And so this idea of being able to actually distribute and sell more into that customer is important, I think, in this next wave of growth for WEX.

Embedded finance, embedded payments, super hot topic that we're digging into. And just to remind investors that we're doing a full session on Thursday at noon talking about embedded finance and payments there. So please be sure to follow up with that. But a super hot area right now and a bunch of companies have been bringing that up at WEX in that area. I want to finish off with a quick question about capital allocation. I think you were a bit more vocal last call on how you think you see WEX deploying its capital. And one of the things I want to tackle is the leverage ratio, which I think you've shown some really consistent -- real consistency in being able to draw that down over time. I recall with EFS, it was up temporarily and you were able to reduce that to your range within, I don't know, a 1 year or 2 fairly quickly because you're such a good free cash flow generator. But how should we think about this deleveraging cycle that you've talked about? Because I remember with EFS, it was really more about expanding EBITDA and that's helping the ratio. Do you think debt paydown is a bigger component of this time around? And how should we think about that in the context of your financial model, 10% top line grower, mid-teens, upper teens EPS grower? Does deleveraging add on top of that?

Yes, sure. So our leverage goals for a long time, leverage target, 2.5 to 3.5x. And so as you just said, we are willing to go up beyond that, but then we will go into a period of time where we're delevering to look back historically and see that we've had that pattern. We have a bias towards moving our cash towards acquisitions that we've had a good track record of creating shareholder value and growth associated with that. So we have a bias towards that. But we are willing to buy back stock opportunistically. We do have a share buyback program in place and are certainly willing to do that. And so it's, again, first biased, but then second -- our second avenue on share back -- buyback is more opportunistic. In terms of how we think about the difference between a revenue number and our earnings target. This comes from the leverage that we have created across the platform, our G&A costs and so we think that as we bring in new sources of revenue or just grow the business, it is coming at a high incremental drop-through rate. And so that's really the primary driver of how we're thinking about EPS expansion. What's happening to our financing cost is going to depend on where we are in that cycle. It's less of how we're planning that into the equation.

No, that's super helpful. Melissa, thank you so much for joining us. Thank you for the added disclosure today. It's super helpful and great to have you at Citi FinTech 11. Thank you.

Thanks, Pete. Appreciate it.