Wright Express Corporation Q2 2009 Earnings Call Transcript

| About: WEX Inc. (WEX)

Wright Express Corporation (WXS) Q2 2009 Earnings Call July 29, 2009 10:00 PM ET

Executives

Steve Elder - VP, Investor Relations

Mike Dubyak - CEO

Melissa Smith - CFO

Analysts

Bob Napoli - Piper Jaffrey

Tom McCrohan - Janney Montgomery Scott

Tien-Tsin Huang - JPMorgan

Greg Smith - Duncan Williams

Robert Dodd - Morgan, Keegan

Tim Willi - Wachovia Securities

Operator

Good morning everyone and welcome to the Wright Express Corporation Second Quarter 2009 Conference Call. There will be an opportunity for questions after the prepared remarks. (Operator Instructions). At this time for opening remarks and introductions, I would like to turn the call over to Steve Elder, Vice President of Investor Relations. Please go ahead, sir.

Steve Elder

Good morning. With me today is our CEO Mike Dubyak and our CFO Melissa Smith. The financial results press release we issued early this morning is now posted in the Investor Relations section of our website at ww.wrightexpress.com. A copy of the release has also been included as an exhibit to an 8-K we submitted to the SEC.

We will be discussing a non-GAAP metric, specifically adjusted net income during our call. Adjusted net income excludes non-cash, mark-to-market adjustments on our fuel-price related derivative instruments. The amortization of acquired intangible assets, adjustments related to the deferred tax asset and related tax receivable agreement and asset impairment charges.

In addition, we have excluded the gain on the settlement of the portion of amounts due under our tax receivable agreement. Please see Exhibit 1 included in the press release for an explanation and reconciliation of adjusted net income to GAAP net income.

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, most recent Form 10-K, and other SEC filings. While we may update forward-looking statements in the future, we disclaim any obligation to do so. You should not rely on these forward-looking statements after today.

With that, I will turn the call over to our CEO Mike Dubyak.

Mike Dubyak

Hello everyone and thanks for joining us. Our second quarter results were clearly better than we anticipated. Revenue and adjusted net income both exceeded the high end of our guidance range coming in at $79 million and $0.57 per share respectively. Lower bad debt was a key factor, as were higher than expected revenues primarily reflecting a rise in the average fuel price

Our strategy for managing through the recession is focused on several goals. The first is to reinvest in our business aggressively and capitalize on this advantage to gain market share. Our second goal is to grow our new diversified businesses to generate a larger percentage of our total revenue and create greater value for our customers. Third, we are tightly managing expenses especially bad debt. And fourth, we are working to maximize the benefits of our healthy liquidity and cash flow as well as the insulation from fuel price volatility provided by our hedge.

Our results in Q2 demonstrate the progress we made in each of these areas and in many ways they parallel the results we saw last quarter. We again delivered strong performance in the collections area with very low loss levels. For the second quarter, fleet credit loss came in at 8 basis points well below the 17 basis points we recorded in Q1 and significantly below the assumption in our Q2 guidance. Compared to many other companies that provided credit, these are outstanding results.

Looking first at our core business, fueling volume was down about 10% from Q2 of 2008 on a same-store sales basis. Including growth from front-end sales and marketing, total payment process in gallons were down just under 6%. This is essentially the same level of year-on-year erosion that we reported for the first quarter of '09.

Melissa will go into the details on credit, but it's clear that our bad debt expenses outperformed the national trend for the past two quarters. We put a number of practices in place over the past year to tighten up our credit-granting processes and collection tactics and they’ve had a material impact primarily in our receivables aging. We've also improved our recoveries of amounts previously charged off.

A couple of other factors have contributed to our recent lower bad debt levels. First, we're not a bank that makes long-term loans and then watches the problems ripple through our extended or over-extended periods of time. The credit we extend to our customers is less than 30 days, so losses move through our model much faster than at a bank.

Second, fleets treat their fuel bills more like a utility expense that must be paid because it's an essential part of running their businesses. The Wright Express card is not a charge card or credit card for charging out-of-pocket expenses and the balances do not revolve.

Where the economy remains the greatest challenge for us is in its impact on fleet-fuelling activity. Our customer base is made up of various businesses and they primarily drive cars, light trucks, and vans, not long haul trucks.

On our last quarter call, I said that we were seeing disparities in customer behavior across certain SIC Codes for the first time. This continued in Q2, with relative strength in a sector like public administration and weakness in retail. Our largest sector is construction and related trades, which was relatively unchanged in the quarter compared to the sequential first quarter.

Nationwide, business for our customers is down in all regions, although the Southwest was significantly slower than the average and the Northeast was somewhat stronger. We did, however see 5% year-on-year growth in our total average vehicle count for Q2. This reflects the ongoing addition of the new Citi portfolio which was fully converted this month, as well as the GSA fleet portfolio which we added in December.

Citi is a private label portfolio that will represent an incremental 2 million small fleet transactions for 2009 and grow our base by approximately 90,000 vehicles. As our ability to win the GSA fleet business demonstrates, we're competing for new business aggressively and continuing to gain market share. In the down economy, many of our competitors are facing pressures that have minimal effect on us because of our financial strength, liquidity, hedging program and multi-channel sales and marketing strategy.

Additionally our value proposition which incorporates a wide range of services continues to offer savings to businesses at a time when this is more important than ever. We are continuing to solicit small businesses while others have pulled back or stopped all together. We are also experimenting with different marketing strategies in various markets to accelerate growth.

In the second quarter, the average number of vehicles in our large and mid-size fleet portfolio was up 8% from the same period a year ago. This largely reflects the addition of the GSA fleet. In small fleets, the number of vehicles overall increased 1% from Q2 last year, a muted level of growth that reflects the underlying weakness in the economy.

Small businesses were reluctant to make changes or commitments during this uncertain period, but in both sales of Fleet cards and telematic units, we did see some improvement in June. In our private label channel, the number of small fleet vehicles was up 1% which is an improvement over the 5% drop we saw in Q1. This reflects the step function growth of adding the Citi portfolio in the quarter.

In the Wright Express direct channel, the average vehicle comp was down 1% from Q2 of '08 reflecting today's challenging environment for small businesses.

Our heavy truck private carrier fleet vehicle comp was down 5% from the second quarter last year. This is consistent with the relative weakness we are seeing in the transportation sector.

Overall our attrition rates remain low. Voluntary attrition for the second quarter was 2.9% compared with 1.5% for Q2 last year. As in Q1, voluntary attrition was up over last year, but it remained below our target of 3% and it leveled similar to those we experienced before the current recession.

Our second area of focus is our diversification strategy where we are growing our aggregate revenue contribution from our MasterCard, TelaPoint, Pacific Pride, International, WEXSmart telematics businesses.

MasterCard remains by far the largest of these businesses. Purchase volume on our MasterCard grew 24% from the second quarter of 2008 to $771 million, reflecting continued strength in our travel industry customer base. Our new International business is still in the early stages and growing from a very small base. That said Q2 was a period of important strives. We are continuing to make progress in establishing private label processing relationships with several international oil companies as we continue to build our infrastructure and our management team.

Relationships with the oils will initially focus on an ASP model of authorizing and hosting transactions using our international software platform and our hosting site in Austria. This is a different approach from the full-service processing model we offer to oil companies in North America. While we are encouraged by the response in the marketplace thus far, developing both the relationships and necessary technical assets will take time.

As a result, we expect it will be several years before the International business begins generating significant revenue. If you look at our diversification plays in total, they contributed $14.7 million in revenue in the second quarter, up from 11.3 million in Q2 of '08. This represents 19% of total revenue in the quarter, up from 10% last year, measured in terms of both revenue dollars contributed and as a percentage of revenue, our diversified businesses are growing. This growth is helping us offset the recession-driven erosion in our fleet customer base. We continue to make investments in these businesses and we expect to see further growth in the second half of the year.

As I said earlier, one of our goals is to maximize the benefits of our cash flow and generate the highest possible return. We capitalized on an opportunity to further this goal in the transaction with Realogy Corporation that we announced in June.

Prepaying our tax receivable liability to Realogy used $51 million in cash. We expect it to deliver a cash payback in less than four years, while adding between $10 million and $15 million annually to our cash flow for the next 12 years. As a result of the Realogy prepayment, we concluded Q2 with a leverage ratio of 1.4 times EBITDA compared with 1 times EBITDA going into the quarter.

Given the increased leverage and our bias towards being conservative with our cash, paying down financing debt will be our focus for the near term, with stock buybacks being a secondary priority. At the same time, we will continue to explore alliances, mergers and acquisitions that makes sense for us. These could be opportunities to expand our core business within adjacent markets, to broaden the range of information products and services we can provide to our installed base of customers or to support our international strategy.

We said last quarter that the current landscape seems to be relatively favorable for these opportunities, and our position has not changed.

In conclusion, we are successfully executing on our goals as we begin the second half of 2009. We're capitalizing on our model and growing our core business by both gaining share from our competitors and further penetrating the small fleet market. We're focused on tightly managing cost and containing credit losses.

Our diversification strategy is working well and we're deploying our cash effectively. The recession and the slowdown in fleet activity remain, but the strength our franchise positions us for a continued recovery when the economy turns around and our existing customers begin to see growth in their businesses. Until then, we will stay focused on aggressively managing what we can't control and continuing to deliver solid financial results.

I'll now turn the call over to our CFO, Melissa Smith, so she can review these results. And then, we'll take your questions.

Melissa Smith

Good morning everyone. I'll review our financial results for the second quarter and conclude with our guidance for Q3 and updated outlook for the full year.

I am pleased to report our second quarter results with $79 million of revenue and adjusted net income of $0.57. This compares to our guidance range of 66 to 72 million and $0.38 to $0.43 of [A&I]. As Mike mentioned, several factors contributed to the positive result. The most significant was lower credit losses. On the revenue side, we also had higher than expected transaction volumes, fuel prices and late fee income.

This was another solid quarter of execution in a difficult business climate. Our sales force continues to add new business and we have grown total vehicles over the prior year. New business this quarter helped to offset some of the erosion we've seen in our existing customer base. These customers represent transaction volume growth potential, when we moved in to a period of economic recovery.

In the mean time, we've contained our cost structure and are reaping the rewards of our sound credit and collection practices. All of this news allow us to continue to invest for long-term growth opportunities, such as international expansion and increased R&D. We're pleased with our competitive position and intend to maximize our opportunities while preparing for a period of slow economic recovery.

Looking at our financial metrics in detail. So, the second quarter of 2009 total revenue decreased 29% to $78.6 million from $111.2 million for the second quarter of 2008. Net income to common shareholders on a GAAP basis was $93.2 million or $2.36 per diluted share. This compares with the net loss of 24.4 million or $0.63 per share for Q2 of last year.

The company's non-GAAP adjusted net income for the second quarter of 2009 was $22.4 million or $0.57 per diluted share, compared with $22.4 million or $0.57 per diluted share for the second quarter of last year. This quarter adjusted net income excludes an unrealized mark-to-market loss on our derivative instruments and the amortization of purchased intangibles. We also excluded the gain on the prepayment of the Realogy liability of 136 million. You can see all of these items on the reconciliation we provided with our press release.

For the fleet segment total revenue for Q2 2009 declined by 34% to $69.1 million from 104 million in Q2 last year. The average number of vehicle service this past quarter was approximately 4.7 million, compared with 4.5 million a year earlier. Total transactions declined 9% in Q2 2009 to 66.1 million from 72.9 million in the second quarter last year. Transaction processing transactions for the quarter declined 14% from Q2 2008 to 14.5 million in the second quarter and payment processing transactions declined 8% to 51.6 million for the same period.

Reflecting the lower price of fuel compared to last year, as well as erosion in fueling volume within our installed base of customers, payment processing revenue in our fleet segment declined 44% to $45.2 million from 80.2 million in Q2 last year. The number of payment processing transactions was down 8% from the second quarter of 2008.

When we provided guidance last quarter, we expected a 10 to 15% decline in same-store sales and our results in Q2 2009 reflect a 10% decline. The average expenditure for payment processing transaction was down 40% from the second quarter last year to $47.37, due to the drop of fuel prices to $2.33 per gallon.

Our net payment processing rate for Q2 2009 increased 3 basis points year-on-year to 1.85%. Although, we're continuing to see positive results from our shift towards hybrid pricing arrangements compared to the first quarter of 2009, our net payment processing rate was down 9 basis points. The increase in fuel prices during the quarter is a primary reason for the decline in the rate sequentially.

As we expected, approximately 60% of our transactions in the second quarter were at merchants with hybrid contracts. Rebates as a percentage of fuelling dollars paid to large fleets and leasing companies were up slightly, compared to the sequential first quarter.

Our MasterCard segment continues to see strong growth. Total revenue contributed by MasterCard in the second quarter grew 32% to $9.5 from 7.2 million in Q2 last year. Our single use product again drove most of the spend increase this quarter. Total MasterCard purchase volume was up 24% to 771 million from 623 million in Q2 last year.

The net interchange rate for Q2 was 1.11% which is up 19 basis points from the sequential first quarter. The increase is due to the new interchange rates that MasterCard implemented during the quarter. Rebates paid to our MasterCard customers as a percentage of purchase volume were down slightly due to the mix of customers.

Turning now to operating expenses. On a GAAP basis, the total for Q2 declined 23% to $46.3 million from $60.3 million in the second quarter of last year mainly due to lower credit loss and operating interest expense.

All other operating expenses in the quarter were basically flat with the prior year reflecting our commitment to hold the line on expenses during this uncertain period. On a total basis, including both Fleet and MasterCard credit loss was down by $8.3 million or 76% from Q2 last year to $2.6 million.

Our credit loss story in Q2 was even better than in Q1. We continue to see significant declines in our past two balances in Q2. Going back to December of last year, we reduced balance past due 30 or more days by $17 million from $22 million to $5 million at the end of Q2. To put this into perspective, past due balances as a percentage of total accounts receivable have not been this low since 2005.

The most significant factor in driving positive credit losses results this quarter was the trail off in bankruptcies. We factored into guidance one significant bankruptcy each quarter but none occurred in Q2. As you will recall, we experienced a significant bankruptcy in each of the prior two quarters, so we had expected this trend to continue.

We also saw decline in the number and the size of small bankruptcies this quarter. The total accounts receivable balance at the end of the quarter was slightly higher than our expectations mainly due to the increase in fuel prices. Total charge-offs were in line with our expectations going into the quarter at just under $6 million which is net of $2.3 million in recoveries. Therefore neither of these had a significant impact on the favorability in credit loss.

All of these factors contributed to our loss rate in the fleet segment coming in at 8 basis points; significantly better than the 17 basis points we reported for Q1 and the assumptions in our guidance. The 8 basis points this quarter compares with 23 basis points in Q2 of 2008.

As we said on the last call, it's not that a single silver bullet has reduced the expense, but a series of actions combined with changes in customer behavior that have accumulated to make a significant difference. We are cautiously optimistic that our peaking losses occurred in Q4 2008. The results for this quarter were very positive and we expect to continue to benefit from the actions we have taken. We believe that our efforts to reduce risk are appropriate actions for these uncertain times.

As Mike mentioned, changes in the economy tend to move more rapidly through our portfolio since the credit we extend is short term in nature. Looking forward, we are adjusting our guidance for full year 2009 to reflect the upside in credit we experienced in the last two quarters. We are not anticipating further improvement in our accounts receivable aging, so we expect our Q3 losses to move close to the midpoint of our historical loss range.

In addition, in Q4 we expect a seasonal decline in our aging as we have seen in four of the last five years. All in, we are anticipating our full year losses to be 18 to 23 basis points of spend. Clearly, this continues to be the most volatile part of our earnings, but these results would put 2009 squarely in line with our historical norms.

Let's now move on from credit loss to other key expense lines. Salary and other personnel costs for Q2 2009 were essentially flat year-on-year at $18.3 million. Included in these results was an additional expense related to anticipated bonus sales for the year.

Our average headcount for Q2 is 707, which is down 21 people from last year. In our core fleet MasterCard operations, our headcount was down 50 people compared to last year. The overall reduction in headcount reflects our continued focus on cost control.

Continuing with operating expenses for the second quarter, service fees and occupancy and equipment costs have remained level year-on-year. Depreciation and amortization expense is up by $400,000. This is due to new assets placed in service as part of our product release schedule.

Operating interest expense was a positive factor in the second quarter, declining by $6 million from Q2 a year ago to $3.3 million. Our average operating debt level including CDs and Fed funds was $394 million compared to $706 million in Q2 last year.

For the second quarter, the interest rate on our CDs and Fed fund borrowings was 2.6%, which compared with 3.9% in Q1. Our interest rates have been declining for the past several quarters and we expect to continue to benefit from low interest rates in the second half of 2009.

Our effective tax rate on the GAAP basis was 37.2% for the second quarter compared with 38.1% for Q2 a year ago. Our adjusted net income tax rate this quarter was 37.8% compared with 37.5% for Q2 2008.

Let's turn now to our derivatives program. During the second quarter, we recognized a realized cash gain of $4.5 million before taxes on these instruments and an unrealized loss of 22.6 million. We concluded the second quarter with the derivative assets of $20 million. During the quarter we resume purchases under our hedging program.

Bottom end of the collar that we've locked in for 2009 is $0.24 higher than the bottom end we locked in for 2008. Our weighted average prices locked in for '09 are between $2.79 and $2.84. We expect to receive significant cash gains from our hedging program from the remainder of 2009. For the portion of 2010, we have completed hedging which is 75% of the full year's target. Our price is approximately $3.20.

We've reduced our exposure to fuel price fluctuations through the use of hybrid contracts. However, based on our current volumes a $0.10 change in fuel prices, generates a change of $7.4 million in revenue for full year. We have received 11.6 million of realized gains from our hedging counter parties so far in 2009. We expect that hedging will continue to be important to our business model going forward and we still intend to purchase derivatives in the future.

Moving on to the balance sheet. We have nearly three years left on the revolving credit facility with pricing significantly better than the current market rates. We entered in to a new interest rate swap last week that fixes LIBOR at a rate of 1.35% for the next two years on $50 million of our financing debt.

This replaces swaps we had in place covering $80 million at a rate of 5.2%. We ended the quarter with a balance of 192 million. We borrowed $55 million in Q2 primarily to fund the 51 million prepayment of Realogy. In addition, we've bought back 81,000 shares of stock at a total cost of 2 million.

Concluding the [review] of our financial results. Capital expenditures were $4.6 million for the second quarter, reflecting continued reinvestment in our core product offerings and strategic diversification. For 2009 total CapEx is expected to be between $15 million and $17 million.

I'll conclude with some key assumptions and our updated financial guidance for the third quarter and full year 2009. Although, we are planning on continued success in signing new customers, our guidance assumes the year-on-year decline in transaction volume within their existing customer base of approximately 7% to 10% for the remainder of the year due to economic conditions.

We also expect a normal seasonal decline in fleet transaction volume and MasterCard spend volume in Q4, based on fewer business days and a slow down around the holidays. We've also assumed a slight increase in fuel prices for the remainder of the year, with Q3 being $0.10 higher than Q4. At the same time, we are expecting our credit loss for the full year to be in the range of 18 to 23 basis points based on the factors that I mentioned.

Let me remind you that our forecast for the third quarter and full year 2009 are valid only as of today and are made on a non-GAAP basis as Steve discussed earlier. Although, our share repurchase program remains in place we have not included any potential EPS upside from this. The fuel price assumptions are based on the applicable NYMEX futures price.

For the third quarter of 2009, we expect to report revenues in the range of $78 million to $83 million. This is based on the average retail fuel price of $2.39 per gallon. For the full year 2009, we expect revenues ranging from 300 to $310 million based on the average retail fuel price of $2.26 per gallon.

In terms of earnings, for Q3 of 2009 we expect to report adjusted net income in the range of 21 to $23 million or $0.54 to $0.59 per diluted share. We expect adjusted net income for the full year 2009 in the range of 77 to $81 million or $1.94 to $2.04 per diluted share on approximately 39 million shares outstanding.

With that, we'll be happy to take your questions. Shay, you can proceed with Q&A now.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Bob Napoli from Piper Jaffrey.

Bob Napoli - Piper Jaffrey

Thank you. Good morning. A question on the transaction outlook you have improved the outlook from the prior quarter, your transactions were better this quarter, several percent better than what we were modeling. And I just wondered what is driving that improvement in transactions versus your prior thoughts?

Mike Dubyak

Yes. Well, I think we had given kind of a range of 10 to 15 basis points before. We came in at the low end of that at 10. I shouldn't say basis points, 10% down existing customer usage.

And we also know that last year starting in the third quarter if you remember and then continuing into the fourth quarter, we had a significant drop off in existing customer usage. So it's somewhat also then reflecting that in those numbers, looking what the trend has been so far in the first half that got us to the 7% to 10% for the last two quarters.

Bob Napoli - Piper Jaffrey

Is there anything within there, within your base of customers that is that improved versus your expectations, is it just across the board?

Mike Dubyak

Yes, I'd like to say there was, but we haven't seen it yet. I mean we've looked at it geographically, we talked in our prepared remarks about retail being down, that was the same as we saw in the fourth quarter. We've talked about transportation being down, public administration being up, but the other is still kind of riding in the middle and there was not much change. So, we saw basically a 10% decline in the first quarter, the same thing in the second quarter. I think there is macroeconomic news that's starting to improve, but we haven't seen it yet in those existing customers in their usage.

Bob Napoli - Piper Jaffrey

Thanks. On the Citi Bank, was there anything in the second quarter for Citi?

Mike Dubyak

Yes, there was some because we had actually converted over the cards, it wasn't mandatory for them to switch over. They didn't switch over till early July, so there were some transactions in the month of June, but then basically starting in July we got the full impact.

Bob Napoli - Piper Jaffrey

Okay. And then the pipeline for new business, last question I'll get out of the queue here but, where are you seeing opportunities in that pipeline? Has it improved from last quarter? Is it stable from last quarter? And where generally are you seeing opportunities, hat kinds of businesses?

Mike Dubyak

Well, I think we are continuing to see strong pipelines, no change in kind of the sales cycles in the mid range in the large market place. So, we feel good about that. We saw in the fourth quarter and continuing into the second quarter, kind of a slowdown in the sales cycles on small businesses.We started to see that improve in June and it's continued in July.

So we feel that small businesses that I think took the real brunt of the economy impact. We are just not making decisions, we saw that on WEXSmart as well. So they weren’t making buying decisions on telematics, they weren’t making changes on their fleet cards. So, we started to see a little bit of an up-tick there.

Clearly, on the MasterCard side, we feel very good about what we are seeing on MasterCard, not just in what it is producing now in its revenue, but also on the pipeline and we've got some large accounts that are kicking in and some new large accounts that we've signed.

Bob Napoli - Piper Jaffrey

All right. Thank you.

Operator

Thank you. Our next question is coming from Tom McCrohan from Janney Montgomery Scott.

Tom McCrohan - Janney Montgomery Scott

Hi, thanks for taking the question and congratulations on a very strong quarter. The question on organic transaction growth, the same-store sales, organic transaction growth, Mike how did that kind of track the 10% number? How did the track throughout the quarter and how is that tracking in the month of July?

Mike Dubyak

Pretty much consistent throughout the quarter. There wasn’t a lot of change, there was really no up-tick. It just continued to stay down. We are probably just dragging along the bottom and we really haven’t seen any uptick or any change in July. So it's kind of staying at that same level.

Tom McCrohan - Janney Montgomery Scott

Okay. And when you said you were seeing relative strength in public administration and just taking the public administration, how big is that SIC Code in the context of all your transactions?

Mike Dubyak

It's not huge, but it's still significant enough. It's in single digits, in terms of percentage of our customer base, but we do have 17 states, we do have thousands of municipalities and we have the general services administration the GSA. So, we've been aggressive, making sure we are working with the states, working with the municipalities within those states to make sure we are there and supplying their fueling needs as they expand and there has been some expansion.

Tom McCrohan - Janney Montgomery Scott

Great. And this question on the funding side. Given the funding advantage associated with CDs and the ability to lock in cheap term funding, why borrow under the Fed fund lines as you saw this quarter about $48 million increase in that activity?

Melissa Smith

We typically are borrowing off hedge funds just from a timing perspective. So when we have peaks and funding needs, we'll borrow through the Fed fund lines, but it's not something that we keep for long term. Typically or in this case, we were waiting for some CD orders to get filled, so, it's just temporary.

Tom McCrohan - Janney Montgomery Scott

And so the kind of the average blend is, the way I calculate, it looks like you had a pretty nice drop-off in funding cost this quarter, down to about under 3%, is that it a pretty [good] number to use?

Melissa Smith

Yes. Yes.

Tom McCrohan - Janney Montgomery Scott

And gross recoveries for the quarter, can you provide that for us?

Melissa Smith

Yes, recoveries were $2.3 million.

Tom McCrohan - Janney Montgomery Scott

2.3. And how did the charge-off activity trend through the months of the quarter? Was it front-end loaded? Did you see charge-offs really drop off in June?

Melissa Smith

There was little bit of a drop off, but not significantly.

Tom McCrohan - Janney Montgomery Scott

But then in terms of reserve levels, Melissa, like if you just annualize the $6.2 million of net charge offs for the quarter and compare that to reserve levels, it seems like reserves are little wide, but I guess what you're saying is you don’t think charge-offs are going to run at $6 million a quarter, I guess. So, it was kind clocked to that --

Melissa Smith

Yes. Actually, part of that is the impact of fuel prices still coming through. If you compare what's getting charged off, what fuel prices they are at current rate, that's impacting it to a certain extent, as well as just in general. When we look at our reserve, we are looking typically at six months of charge offs, not a full year.

Tom McCrohan - Janney Montgomery Scott

When gas prices go up, charge-offs kind of go up and marks that?

Melissa Smith

I am sorry, say that again.

Tom McCrohan - Janney Montgomery Scott

When gas prices trend higher charge-offs generally trend higher as well?

Melissa Smith

When gas prices go up in the six months later you are going to see that higher price of fuel charge off.

Tom McCrohan - Janney Montgomery Scott

Right.

Melissa Smith

And so, the period that's getting charged off, we have to look at what the fuel prices were about six months prior.

Tom McCrohan - Janney Montgomery Scott

Okay. And the last question I have is on the regulatory side, we -- I had talked about this proposal out there, that would eventually eliminate the current non-bank -- bank designation. So can you just -- how would you advice shareholders and investors to kind of handicap the possibility that Wright Express would need to convert to a bank holding company given the comp proposals that are out there? And that's all I have thanks.

Mike Dubyak

We know that what's out there is so far as a white paper. And it was a small piece of the white paper, but it mention ILCs. There is a lot of uncertainty. So you can read a lot of different opinions on what's going to happened. I think it's somewhere off in the future before we'll no for sure, what is going to happen, if there is going to be changes or if there is not going to be changes.

We believe the facts are in our favor that the ILCs have been well run, well managed, well audited and scrutinized by different agencies. They do what they should be doing for businesses, providing as in our case a strategic piece of our delivery strategy. I think that we also now that if there had to be a change we know in the past we have done business without having the ILC. We know our competitors do business and they compete with us without an ILC.

So, we don't know what all is going to happen. We just know some of the things that could happen. And we are preparing ourselves and looking at things and also out there making sure our voice is heard because, we do like the ILC. It keeps our business today in a place where it's helped us during a very tough economic climate. But, we also know there are other options and we feel comfortable that we can look at those options once we understand the playing field.

Tom McCrohan - Janney Montgomery Scott

Great. Thanks for taking my questions and congratulations on a strong quarter.

Mike Dubyak

Thank you.

Operator

Thank you. Our next question is coming from Tien-Tsin Huang from JPMorgan.

Tien-Tsin Huang - JPMorgan

Great, thanks. Just a few follow-ups actually. Just the sources of growth in new business or new vehicles, I think it is up [5]. Mike, I know you can give us some detail there. But just can you go into a little bit more detail where are you taking customers exactly and through what channels? Just trying to better understand the strength there and the sustainability?

Mike Dubyak

Yeah. We know where some of the vehicle increase was because of the GSA, so that's clearly a large fleet government related. We are winning market share both through our co-brand channel and our WEX channel in the mid-size and large fleet marketplace. When you get down to the small fleet marketplace there is so much open space.

It's not necessarily against competition. It's mostly cash customers and other forms of payment. And that's where we are seeing a little bit of a slowdown as I said because of small businesses I think just being reluctant to make any changes. But, where we are taking market share is in that mid-size and large fleet space, through those two channels that primarily represent us in that space, co-brand and WEX.

Tien-Tsin Huang - JPMorgan

Good. Have you seen any change in the competitiveness from some of the other brands?

Mike Dubyak

Yeah, we've seen some. I think the economic environment cause people to back away in some cases from the small fleet market. We've seen people change their payment terms for the small fleets, shortening those payments terms from 30 days to something less. So, I think that's been a big change and I think because of the economic climate we have a few competitors that are under private equity.

So, I think they are looking at different markets and being more rational, how they are going after those markets. So I think those are some of the things that we watch and try to just measure our strengths against their strengths and where we should be aggressive. And we are being aggressive in a number of different areas to take market share and continue to take market share.

Tien-Tsin Huang - JPMorgan

Excellent, excellent, it's good to know. Couple of housekeeping questions and then I guess most of the questions was on large reserves earlier. Is there a good rule of thumb that we should consider? I know there's a lot of dynamics around changes in fuel price. But large reserves, obviously the percentage of receivables, is there [real from there] we can use?

Melissa Smith

If we can do it back in our history you'd say it's gone all over the place. When we're looking at the reserve we're looking at what we think we're going to have for charge off over the next six months, as well as recoveries. And what we think are going to happen to the real rates within the portfolio, which is affected by the aging. So the lot of different measures included in that, so I don't think you can just take a standard percentage.

Tien-Tsin Huang - JPMorgan

Okay. But I guess it's not an unusual thing. But, obviously, that will step up from the 70 bits or so that we saw in the second quarter?

Melissa Smith

Yes, particular staying in the fourth quarter. If you go back then the last six years on average, between our Q2 aging to our Q4 aging, it's deteriorated about 30% on average and doesn't even look at just what happened last year. So, when we're estimating our allowance, we think in Q3 will look more like a standard number and then Q4 will look we'll assume, what you've seen in the last few quarters.

Tien-Tsin Huang - JPMorgan

Okay. And then just the same old question, If we were to hedge today where are we at in terms of hedge level or price? And also has there been any shift in the wholesale retail spread?

Melissa Smith

There hasn't been a significant shift between wholesale and retail. Their current prices if you go out there are hovering around $2.70.

Tien-Tsin Huang - JPMorgan

2.70.

Melissa Smith

Yes.

Tien-Tsin Huang - JPMorgan

Great. Thanks a lot. Well done.

Mike Dubyak

Thanks.

Operator

Thank you. Our next question is coming from Greg Smith from Duncan Williams.

Greg Smith - Duncan Williams

Yes, hi guys. Melissa, you give that new sensitivity on fuel prices to revenues, but any chance you can work that down to EPS.

Melissa Smith

Historically, our costs have been about 15% of the revenue number. That obviously is going to change depending on what the estimate is of credit loss and what's happening with our funding cost raise. So those are the two things that are variable.

Greg Smith - Duncan Williams

Yes, okay. But if we just use 15%?

Melissa Smith

That's just kind of a rule of thumb.

Greg Smith - Duncan Williams

Yes and then tax right?

Melissa Smith

Yes, yes.

Greg Smith - Duncan Williams

So an EPS number. Okay perfect. And then I don't believe you talked about losses on the MasterCard side, what's happening with charge-offs there.

Melissa Smith

Yes, the charge-offs were low on MasterCard. There was nothing really of note that happened and actually if you look at that, segment performed particularly well financially in large part because of the lack of losses.

Greg Smith - Duncan Williams

Okay. And then haven't heard much talk about the service network, is that a business that's progressing as expected or is it, kind of what's going on that side of the business.

Mike Dubyak

Yes, it plays a strategic role. I can't say there is a lot of growth. There is growth in the service sector, but it's not anything that would be material enough to talk about. We do use it in different aspects of our business. It's also a big piece of what we do with the GSA. I mean that was a big piece of their business, not just the fueling side, but also the service side.

Greg Smith - Duncan Williams

Interesting, good.

Mike Dubyak

So, that's probably where the biggest growth has been.

Greg Smith - Duncan Williams

Yes, thank you.

Operator

Thank you. Our next question is coming from Robert Dodd from Morgan Keegan.

Robert Dodd - Morgan Keegan

Hi guys. I got a few. First couple on credit. You talked about a significant decline in balances past due in the quarter, but at the same time one of the sources of revenue upside was higher late fees. Can you explain to me what happened there?

Melissa Smith

Yes, we changed the way that we assessed late fees late last year as part of the measures that we were taking in order to make sure that we were protecting the portfolio and so we reduced the grace period or eliminated the grace period. I guess I should say that we've had given out historically and change the calculation. So, that’s why you are seeing those two different things happen at the same time.

Robert Dodd - Morgan Keegan

Okay, got it. On the credit side obviously, it's spectacularly good; can you give us an idea on where you think your current credit policies all go in better economic times? Do you think your current relative tightness in terms of monitoring, aging, et cetera is appropriate just for this point in the cycle or do you think you can maintain that kind of discipline in a better economic period or would you loosen up a little bit?

Melissa Smith

I think it's probably a little bit of each and if you think of the way that we are managing high risk accounts, I think that that’s going to be true regardless what types of economic environment you are in and I think just in general, we've invested more in credit tools that allow us to be more precise than we have been historically particularly in the changing economic times.

So, I think all those things will change, where you might get a little bit more lenient with the amount of credit that you are extending to some of those less risky customers.

Mike Dubyak

And the other thing I'd say we went into this Robert saying, we are still a business that prides itself on driving high metrics in customer satisfaction and that was one of the things we want to look at very closely. And we have not seen as we really evaluate attrition that this has really caused any high level of attrition or something seeping through that’s saying to us, we're losing customers because of what we've done.

I think we're being smart about it, I think we had to do it because of what we saw in the fourth quarter and some of the fears we had when the economy was just dropping and no one knew where it was going, but always with looking at this, saying how do we also keep a high level of customer satisfaction? And so far we feel very good about where those metrics are, and seeing the improvement in bad debts and write-offs.

Robert Dodd - Morgan Keegan

Okay, that's sounds very, very solid. At the risk of you just saying no, can I ask you to speculate on where you think your credit losses could go? Historically 11 to 22 basis points? Obviously, a little elevated, but not very in this point of the cycle, longer term you think this with keeping happy customers is going to lead it down to mid-teens, low-teens, I mean any visibility there would be hugely helpful.

Melissa Smith

I think it's awfully hard to answer that right now. If you look back at our results, if you go back to 2005, we had 16 basis points of credit loss. 11 was an unusual year for us. So, I think right now we're just pleased that we think we are going to come in within a normal range this year.

Robert Dodd - Morgan Keegan

Okay. Got it. Thank you. Moving on to the small segment where you say you’ve seen a little bit of slowdown because the merchants aren't or the businesses rather aren't wanting to make changes right now. I think you also mentioned some new sales initiatives, I'm not sure if that was necessarily in the small segment, but could you give us a bit of color on what you're doing in terms of new ways of targeting that small business model?

Mike Dubyak

Yes. I don't want to get too specific. I think some of the things we put in place are some opportunities to look at testing different ways to be more aggressive in those market places. I really wouldn't want to say from a strategic standpoint exactly what those are. But we are trying to find ways as well to bundle products and make it more attractive on the value proposition. But that's probably as far as I'd want to go in knowing we probably would give away too much to our competition.

Robert Dodd - Morgan Keegan

One more if I can, going by the bank holding company, it looks to me like income plans for the tangible equity rule for that anyway. So after the gain, any -- would you have any opinion or on what proportion to your business would count as, as sort of non-financial if anything, if that rule were to come [the past] which obviously is still speculation at this point?

Mike Dubyak

Yeah, right. I think its some of, it's a very small amount its part of some of the diversification strategies that we've gotten ourselves, locked in with our customers and our partners like WEXSMART telematics I mean that's kind of a commercial product its not necessarily a financial related product. So that would be one. But these are important strategies to us, but it's a very small piece of our business overall.

Operator

Thank you. Our next question is coming from Paul [Bartolia] from PB Investment Research.

Unidentified Analyst

Thanks guys. Good morning. First question just want to clarify on the transaction growth assumptions for rest of the year. The 7 to 10% that is just for the second half that's not, comparable to the 10 to 15% you guys are talking about for the full year, right?

Melissa Smith

You're right, it's second half.

Unidentified Analyst

Okay, great. And then just on the payment rate that was down 9, 10 basis points sequentially. Given the change in fuel prices I was a little bit surprised that was down so much. Was there anything unusual on that number? And I guess also any, how does it look as far as big customer rate renegotiations coming up in the next couple of quarters?

Mike Dubyak

Well there is continues customer renegotiations. Melissa mentioned in the rate it was primary the price of gas the impact on the hybrids. Moving up I think of $0.30 during the quarter, but there are continuous, if we take market share, as we renegotiate some contracts, there was some slight increases on rebates to our co-brands in some of our [companies]. But nothing material and that will probably continue as we move forward. It just depends on the price of gas though.

Unidentified Analyst

Right. But with the hybrids I would have thought that discount rate would have been a little bit less sensitive, which changes in the gas prices, is it more sensitive now?

Mike Dubyak

Well because of the fixed component, we've gone from 30% being hybrid to say as Melissa said 60% being hybrid and there is a fixed component. So, if the price of gas goes up that fixed component as a percentage just goes down and that's what really impacted us as we saw the price of gas go up from the first quarter to the second quarter.

Unidentified Analyst

Okay. And then any comments on kind of the outlook for the payment really going forward, I mean that's just kind of continue to trend down as you renegotiate with some of your big customers?

Mike Dubyak

Well again, I think it's going to mostly be impacted by the price of gas and then we'll have as I said continuous rebates that will be going to some of our customers, sometimes as volumes rebates. But that's usually a small piece of it. It's really primarily going to be driven by the price of gas having an impact because of the hybrids.

Unidentified Analyst

Okay, great and then just following up on some of the regulatory and legislative issues going on. I mean do you see any impact your business as far as, I mean there's some type of late fees being impacted and how those fees are charged? Anything you see there that could impact how you guys do business?

Mike Dubyak

Most of what we see on that side of the house is for consumers. We are business-to-business. We are not a revolver. We are not a credit card, we are charge card. So when we hear those restrictions, at this point we don't think it affects us. It's mostly talking about how they are going to impact consumers and primarily I think when they revolve their charges.

Unidentified Analyst

Okay, great. Thanks, good job.

Operator

Thank you. Our next question is coming from Tim Willi from Wachovia Securities.

Tim Willi - Wachovia Securities

Thank you, good morning. Just two questions, first if you talk a little bit about just what you are seeing around the M&A environment and the cash flow you have relative to I think your comments were debt pay down buyback. Does that indicate that there's not an active market or that you just really are focused on bringing the debt to EBITDA back down towards the one level before you get more active in the M&A market?

Mike Dubyak

No, I'd say that we have been consistently saying, we're looking at that, we want to be prepared for that. I think some of that is making sure, it's the right transaction. Sometimes you make the right decision, when you don't pull the trigger to do something. But, also waiting for maybe more rational opportunities in the marketplace, but we're inquisitive, we're looking at things. And we talked about how can we expand our diversification strategy.

Can we move into some adjacent markets, could it help us in the international arena, so all of those are being looked at, I think we're in a good position. If they're small, we clearly have a debt structure that can absorb that. If they're large, I think we have opportunities there as well. And we'll look at both. But I think it just have to be the right conditions. And we're still being cautious. We still think there'll be more rational opportunities as we move forward.

Tim Willi - Wachovia Securities

Okay and then, on diversification strategy in general and maybe international, more so within that context. Do you see within the next 12 to 18 months any likelihood that there may be an accelerated investment cycle that may coincide with obviously an improvement in the domestic economy to try to accelerate that diversification strategy or do you feel like the rate of investment you currently have in place it is more than adequate to evolve that business commensurate with market opportunities?

Mike Dubyak

I'm not sure I'm going to answer it exactly as you're asking, but we are making investments. We do believe because of the 285,000 customers we have, that we should continue looking at ways to diversify. We keep making investments in our MasterCard program, the single use goes to comp product continues to get, great market penetration with new customers as I mentioned earlier.

We've signed some new ones, some ones we signed recently are getting more aggressive with that product. We are expanding that product working with some of our other channels to use that product in some of their fleet market places.

We are investing in our distributor program that would include Pac Pride and even some of the other distributor programs we have in place with some of our oil companies today. So, we are making those investments, we think the distributor market has great opportunity for more penetration because that's the small fleet market place.

TelaPoint is one where it's a diversification strategy that helped us provide more services to merchants. We are making an investment there because they never wandered into fleets that had underground storage tanks. We know we have customers that have underground storage tanks, so we are trying to build a fuel desk that will allow them to use our card for their retail purchases and use our TelaPoint product to manage their inventories with that supply chain management product.

So, we are investing, we are actually investing more into international than we expected because we see good traction, we see good opportunities by announcing the Vienna operation. I think that's telling people that we are pretty comfortable, we are going to start to see some business in that marketplace. But I want to be fair, a lot of it means you got to build it, you got to get a lot of things converted over. And I don't think it will be material for a couple of years, but still it's worthy investment because we see the opportunities.

Tim Willi - Wachovia Securities

Great. Thanks so much.

Operator

Thank you. We do not have time for any further questions. I would like to turn the call back over to the speakers for any closing comments.

Mike Dubyak

Well thank you. We thank everyone for listening again this quarter. And we look forward to talk to you again next quarter. Good bye.

Operator

Thank you. This does concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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