Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

Great. Okay. I think we are live now. All right. Welcome, everyone, to continuing here the afternoon session of the second day of our 24th Annual Credit Suisse Technology Conference, again, an event running Monday through Thursday of this week. We're very happy to be hosting Tricia Chiodo. She is the CFO of Verra Mobility. And yes, it's becoming somewhat of an old running joke at this point, but we are not related. We do share obviously a last name.

Aren't related.

But that's all.

Yes.

But -- and actually, we pronounce it a different way as well, but that's kind of neither here nor there. But Patricia has been with Verra Mobility since 2015. And she started her career at PwC, but since then has gone on to hold multiple finance and leadership positions, controller positions, et cetera, throughout the industry. And those roles ultimately led her, again, to joining Verra a few years back. So with that, I'd like to formally welcome Tricia and say thank you for being here with us today.

Well, thank you, Tim. I appreciate the opportunity to be here and tell you guys a little bit more about Verra Mobility.

All right. Great. So we clearly have a long list of questions here. But what might be more helpful in a good way to start is I know you mentioned that have a few slides that you could share with the audience. And we could take as much time as you like to walk through those slides.

Thank you. So I'm there. Can you see my screen? Can you see the slides now?

I don't.

Let's see, stand by. Here we go.

There we go.

There you go. Now can you see it?

Yes, I can. Perfect.

Perfect.

Slides are up.

Okay. So just as a quick overview, rather than me just telling you guys about Verra Mobility, I thought I'd do a really quick overview on the concepts of how we make money, who we are and how we make money. So Verra Mobility is a global leader in smart transportation working alongside our customers basically to develop technology solutions for complex transportation challenges. We do that through 2 business segments. Commercial Services is our business segment that operates toll management, violation processing and title and registration services for large fleets, so think rental car companies, fleet management companies and just captive fleets for companies that they have. With that, they generate about 200 and -- $200 million of service revenue in the last trailing 12 months. We'll talk about their products on the next slide. We also run a Government Solutions business. That business operates the back end end-to-end solutions for photo enforcement across the country with multiple products: Red light, speeds, school bus stop arm products. They serve municipalities, counties and school districts and generate about $150 million in service revenue in the last 12 months. So back to Commercial Services. They have 3 primary products. Toll management is, by far and away, the largest product that they have, and the majority of the revenue there is generated from rental car companies. So if you've ever rented a car and opened the little box with the transponder on it and been able to use a toll gantry and go straight to the toll gantry, you've been part of our journey. We operate the tolling systems for rental -- for 95% of rental car companies across the country. So the transponder, the box is all our equipment. And so for the companies that we serve, we register 100% of their license plates with the toll authorities across the country, allowing those vehicles to use the electronic toll gantries. It eases -- it makes it easier for the traveler. And so for that convenience, the way that we get charged -- the way that we get paid is that we bill the renter an administration fee for using the product, and then we turn around and bill them the toll at the cash rate, while we pay the electronic rate and we keep the differential. We do this product end-to-end for the rental car companies. So we register all their plates with the toll authorities. We actually prepay the tolls on their behalf. We match the toll to the rental agreement and actually bill the renter for the rental car companies. So it is a fully outsourced end-to-end solution that we offer. Violations management is really a product whereby we've integrated into large authorities, so think about the New York City parking authority, where if a rental car company or one of our fleet management companies incurs a parking ticket, that goes to the registered owner of the vehicle and not the driver. That violation would be diverted directly to us, and we would either transfer the liability to the driver of the vehicle or we would bill them the parking ticket and the fee that we would split with the rental car company again. Title and registration is just a convenience that we offer to our large fleets, where we register in bulk their vehicles. You can understand that standing in line for the DMV is painful for one vehicle. It's even more painful if you've got tens of thousands of them that need to be done in any given month. So we are actually connected and integrated into DMVs in 19 states and offer that service on their behalf. Government Solutions is a little more simple to understand. We operate photo -- back-end photo enforcement systems for municipalities across the country. So these are usually cameras which are on the side of the road. Those cameras are ours. We procure them on behalf of the municipality. We install them. And then once the camera is installed, we operate a received service revenue many, many years into the future. So you can think of each of those cameras that we've installed in the ground as an annual recurring revenue stream well into the future. And we do everything for the municipalities on the back end of this, including that we transmit the picture, we identify it, we crop it, we identify the driver of the vehicle. We then send it over to the police department of the municipality who [indiscernible] cites it as a citation. Often, we print and mail the citation and sometimes collect the citation fee from our customers. This business does, like I said, about $150 million in service revenue. But it has about $56 million in product revenue. We have a few of our customers who actually want to buy their equipment rather than us have it as CapEx. So in some years, it produces a high number of product revenue. And in other years, it's relatively small. So that is sort of a lumpy side of our revenue stream. Over time, you can see where our revenues have been growing over time at a CAGR of about 10%. And we have about 86% of our service is recurring revenue, either from those photo enforcement cameras that we've installed in the ground or from the contracts that we have with our rental car companies. While we've been growing our revenue, we've been also growing our profitability. So EBITDA across the time being presented has been growing at about 15%, and we have about 54% margins. That's because -- so we're highly profitable and highly cash flow-generative. And if you look on the left-hand side of the screen, you can see that our leverage is about 3.8x. Our leverage is growing not because of our increasing debt. It's actually growing because of the impact of COVID in the current year. We do have high cash flow generation that will allow us to delever very quickly as we cross over the Q1 period, which should be at the peak in our leverage. I wanted to really quickly touch on Commercial Services and the impact that it has on COVID. This is a chart that we put in our quarterly financial results. We added one thing to it. It's that we wanted to let you see also the results of October. So from April through October, we have had 7 consecutive months of increasing revenue on a sequential basis. So you can see at the trough of this cycle, in April, we were down about 64% in the Commercial Services segment. And in the month of October, year-over-year, we're down only about 25%. So we really are seeing some growth in the recovery cycle. Some -- a lot of people ask us, "Well, how are you holding up against your underlying industries that you serve?" And I'd say, from this chart, we're holding up very, very well in relation to that. I'm sure we can talk about some of the reasons why we're holding up better than our competitors later. But I wanted to give you guys a glimpse into what we're doing today. Also wanted to let you see from our Government Solutions business, that it also is having continual consecutive growth and improving really well out of the COVID environment. On the next slide, I wanted to say that what we've told people once before about where we think we're going to be for Q4. We -- once again, we don't want to provide guidance. But we wanted to say that we did about $83 million worth of revenue in Q3, and we believe that Q4 will be very similar to that. Considering that Q3 is normally our seasonal peak, we're really excited to say that we're going to have flat quarter-over-quarter -- quarter-to-quarter revenue. We've also talked a lot about our product sales, and we did about $13 million in product sales in Q3. We anticipate that to be a lower number. We installed 180 units in Q3, that we're on the tail end of an order of 720 units. So there will be about 127 cameras in Q4. And then as we move forward, we also believe that the strength that we're seeing in Government Solutions will have its -- will have growth in the service revenue sector. And as a result, we may see a shift in our product mix because the Government Solutions business had a little lower EBITDA margins than we do in the Commercial Services segment. So that was just a really quick overview. I tried to keep it short, knowing that Tim has a ton of questions for me. So -- but I wanted to put that out there, just so you guys could see where we are. And then from there, we can talk about the business and get down into more of the details.

Tricia, that was excellent. Thank you so much. I'm sure everyone appreciates the transparency on the October update and the improving trends. So thank you very much for making that available here today during the conference.

So let's touch on a follow-up to a point that you made during the slide deck there. You were talking about the camera installations. And you mentioned 180 in Q3, an expectation for another 127 million (sic) [ 127 ] or so in Q4. I just want to take a step back and talk a little bit about that New York program in general. Maybe you could just give some investors sort of the background context, how the contract first started, what was recently re-upped? And what there could be left in terms of additional cameras that could be on the come in 2021 and beyond?

Yes. Great question. So New York City is our largest contract in the Government Solutions business. It's one of our largest customers -- actually is the largest customer in Q3 of the company as a whole. So New York City has what we're going to call a extremely unique photo enforcement program. And in the middle of 2019, New York City decided that it wanted to expand its school zone speed program. Those are speed cameras captured on the side of the road in school zones designed to slow down traffic and keep children safe. They decided they wanted to expand that program. At the time, they gave us an order for 300 cameras. So in the back half of '19, we started installing 300 new cameras for New York City. And then they went on to say that they wanted to expand the program by another 720 cameras in 2020. With that, they -- in order to do the 720 cameras, they actually put it on a new contract, what they called an emergency declaration, that allowed for the rapid expansion of this program. That emergency declaration contract actually allows for 1,687 cameras to be added. So when you take that 1,687 and you add it to the 300 we did in 2019, that's about 2,000 cameras overall that they could expand with the school zone speed program. In the last -- as of the end of this quarter, we will have installed all 720 for the current year. If you add that to the 300 from the prior year, that's 1,020 cameras they've already put into the program. Just to put that in context for you, the 1,020 cameras, once installed, will produce $46 million of annual recurring revenue for Verra Mobility. And so that -- I mean, it's a nonsignificant amount of revenue growth. And -- but -- and that revenue growth will go on years into the future as long as the cameras are installed and operating. And then, Tim, you asked about what's the potential. Well, the potential is about for another 1,000 cameras. Now we're kind of coy about talking about that. We don't talk about it all the time. And the reason is, is because just because we have a contract that allows for it, doesn't mean that they will actually install them. So we've sort of said, predict the product revenue will be down in the next year until we get that order in our hand. But once we get the order in the hand, I'm sure we'll be picking up the phone and calling everybody.

All right. That's great context. I want to stay here with the Government Solutions for a little bit and just talk about overall penetration. We've talked about this a little bit in the past. But some states that have been opening up lately with Virginia, Georgia, New York obviously you've been speaking about, maybe just talk about how many states might have any sort of a program at all related to cameras? How much runway there could be? And then clearly, within those states, there's runway as well. And I understand there might not be hard numbers on all of this stuff, but just any context you could provide for investors.

Yes. There's a little over 21 states that have some type of photo enforcement in them, and many states don't have multiple photo enforcement programs. So usually, legislations that enable photo enforcement are very specific. Florida, for example, only has photo enforcement for red light. You've got other areas like Georgia that has school zone speed, red light and school bus crossing arm. It's got legislation for 3 photo enforcement programs. So legislation is usually very specific. And what we're seeing is that legislation is opening up more and more for school zone speed, very purpose-built programs really identified for safety. And it's really hard to argue that you don't want to keep your children safe in a school zone. So when you think about the runway, there's a couple of things. You've got all of these states that are open. So you could expand into municipalities. You could either grow with existing customers or obtain new customers. Georgia and Virginia are the 2 that are the newest to open in school zone speed. And therefore, they're the most -- they've got the most runway as far as developing out. We believe that each of those states has a TAM of about $50 million. So there's a lot of opportunity to grow into those states. And then usually, our trajectory is, is while we're putting cameras into those states that are already open, we're looking to the next horizon of where we could go next. And where we'd really like to go to open up really meaningful legislation in school zone speed would be California.

Noted. Thank you, Tricia. Okay. Before we move to commercial here, I want to hit one last question that we get from investors from time to time. And I realize there's tons of runway in the U.S., as you just mentioned, a whole lot of it. But you have worked on taking the commercial business international. What about the possibility of taking some of the government-type services into other countries? And we fully realize that the laws are different. Municipalities are different. There could be different technology and processes, but you do have the expertise and the capabilities. And it's a question that we get from time to time.

Yes. So it's a very different marketplace. First of all, they don't sell a complete photo enforcement outsource package. They actually -- somebody sells the equipment, and somebody else may be selling software. And generally, the municipality is running that software and their program theirself. So it's less of an outsourced buy, and it's more of a manufacturing and software buy. So it's a little different market. We don't actually manufacture our photo enforcement equipment. We procure it from a supplier out of Germany, and we have the rights to the North American distribution but not into Europe. So I don't see us moving into the photo enforcement environment in internationally anytime soon. I would assume that if we were going to do something like that, we would have to acquire another company that was operating internationally.

Okay. Thank you for that context. And again, just a question we got from time to time. So wanted to tick that one off quickly. Didn't need to spend too much time there. Let's move on to commercial. And one of the key topics we often discuss here with investors is around the moat here in terms of how long it took to build this business out, the integrations that were required, both with the RACs, the tolling authorities, et cetera. Maybe you could just give us some context and bring it to life in terms of just how difficult that is to replicate and how many years it took to build out.

Things -- it took a long time. There were 2 competitors in this space. We ended up acquiring our competitor, HTA, in 2018. It, respectively, took each of those companies close to 10 years to build out the integrations with the toll authorities. If you can imagine, toll authorities aren't necessarily motivated to integrate with us. So we have to -- it's not a 50-50 meet in the middle. It's very much, you walk 100% to them because you're also looking for something to them. You're looking to take a product that they have, which is tolling for passenger cars, and really converting it into something for large fleets. So it takes a system where their system is built to enroll one car at a time, and we need to enroll hundreds of thousands of cars every single day. So it was a long haul to get there. And that is one of our biggest moats is that we're integrated with the toll authorities. One of the other moats that we have is that all the matching process that matches the individual toll to the rental agreement is ours. And it's fairly customized for each of the customers that we serve. So we've really got a unique edge in that we're doing 100% of the work behind the scenes. But our customers, the rental car companies, are still creating revenue that flows to the bottom line for them.

Excellent. Okay. Thank you. Before we move on to broader revenue algorithm questions, I wanted to just touch briefly on -- specifically to commercial and not even necessarily with numbers, but the various drivers of growth in this segment. If we look at it on an ex COVID basis, one of those is the sort of the rental car industry growth or the rental days or rental nights, if you will. The cash-to-cashless conversion is another driver and then, of course, to the extent that there are neutral toll roads created through legislation. Maybe you could just add some color to each of those drivers and perhaps add others, maybe pricing or others that maybe I didn't list.

Yes. So those are the drivers for the growth in this industry. And usually, you talk about the underlying growth of our rental car companies. Pre-COVID, we would have said that we normally don't bank on growth of the underlying rental car companies in order to get the uptake of our product. This -- 2021 is going to be a little bit different in that the bounce back from the travel industry will definitely impact us as we move back to sort of the 2019 more normalized levels. But the real drivers of the uptake in our product is centered around cashless tolling. So if you think about it, if you're -- you have a rental car in a tolling region, there's only 2 ways to avoid using our product. You can avoid the toll road altogether or you can get cash. So as they move to more and more toll ways that could allow you to stop and pay cash, you will opt in for the convenience of the traffic flow of the toll road, and then you move over into the fast lanes in order to opt into our product. And once you've used the product you're opted in, whether you want -- whether that -- you knew that or not was part of the package. So once you've used the tollway, we will bill you for the toll and the administrative fee associated with it. So that is a big driver in our overall growth. If you look historically, the -- this Commercial Services segment has been growing from 14% to 18% in the last 4 years. Now that was a big push because of the conversion of the cashless tolling. We don't expect that it will continue to grow at that rate. We think it will probably normalize more at 6% to 8%. The other drivers, as Tim mentioned, are that there are more and more toll roads. We do believe that the COVID impact will accelerate the number of toll roads. We think it will also impact the number of toll roads with cash -- no-cash options. So those are the drivers as well. But you mentioned price. Price really isn't a driver for us probably because we have fairly long contracts with our rental car companies. And they control the price to the end consumer. So it's really their customer that we're billing. So we don't have much control over the price to the consumer.

Perfect. Let's move to the revenue algorithm in general for the overall company. On a pre-COVID basis, it was often discussed as something in the range of, call it, 6% to 8% total company organic revenue growth. The components of that included something in the mid-single-digit range for government or approaching mid-single-digit and then perhaps slightly higher, mid- to high single-digit for commercial. And then there were some call options, which were essentially potential new wins within government, new states opening up, some of the topics we mentioned earlier and then also the European business, which is very nascent and early days. As we've gone out of COVID, should we think about that same algorithm? Or is there anything to change?

No. I think that's right as far as the growth opportunities for us. Clearly, the New York City expansion is a huge opportunity for us to grow, and it creates a step function for Government Solutions. So you were talking about that 2% to 4% growth. Really, what you're going to see is this stairstep as we install cameras in New York. Once we get to this higher plateau, we're going to grow probably at that 2% to 4% range but at a much higher level. And European expansion into tolling for us is one of the biggest opportunities we have as far as growing the Commercial Services business. Now I like this opportunity, but I think it's going to take us a long time to get there. We're starting our rollout. We're starting our pilot programs just now, but we have to go from rental car company to rental car company from country to country. It will take us a little while to build up to the meaningful revenue that we want it to be. And then when you really think about our growth opportunities, where they're going to come from is that both of the businesses that we operate today are highly cash flow-generative. And as they are, as they continue to build up their cash flow, we want to use that and the health of our balance sheet to really acquire into our next growth opportunity. That would give us sort of -- think of it as like the third leg of the stool: if we've got 2 business units, it's adding a third.

Okay. Great. Thank you. I do want to touch on that if we have time here. But in the few minutes we have left, real quick, if -- could we touch briefly just on competition within the government segment? The names that most often come up in investor discussions are Conduent and Redflex. Maybe you can just put some context around how the offerings differ, you versus your competitors, and relative levels of share and how that helps as you go into RFP processes.

Yes. So I think there's a couple of things that help us. Government Solutions isn't one of these things that you can really compete on. You can a little bit on price, but price wasn't pretty well-known out in the marketplace. So we really compete on the efficacy of our program. We believe that our program has a better capture rate of violations and a better throughput yield, that more of the violations that our cameras capture actually get turned into citizen citations over time. If you couple that with the fact that we have the size and the scale to run very large programs, we're running the largest program in the country right now, we also have the strongest financial health of any of these organizations. Meaning that we can outlay the capital to install large programs very easily, while others may have to borrow to do so. So it's a lot -- it's about the overall performance of our camera systems, the overall performance of our software package or ease of use of that and then our ability to get the community what they need, which is to improve their safety by issuing the right amount of citations.

Okay. Excellent. Thank you. We only have a few minutes left. Why don't we end on a topic that you brought up in terms of M&A and capital allocation? And maybe for investors, you could recap sort of the favorable covenants or the covenant-light, as we've described it, situation that you have in terms of your balance sheet. And then in terms of M&A, surely, you look at potential acquisitions often. Maybe if you could just describe what the environment looks like? Are there -- is there a lot of competition for assets? Is the pricing looking fair? Are there assets that are coming available due to COVID? Maybe just how things may have changed or maybe not changed at all over the last 4 or 5 months.

Okay. So let me address the capital structure first. And as you mentioned, we've got a really nice position in that we have about $130 million of cash on the balance sheet. We have a $75 million line of credit, and we have a first lien facility that is really covenant-light. It has no testable covenants at the current time frame. The only thing that it has is at the end of the year, there is a prepayment based on a cash flow sweep calculation. The nice thing about that is that in a year where you have less cash flow, you have less payments. So it's a very friendly calculation for us. We don't get into any triggering covenants until we exceed 5.2x leverage, which we're a long way off from that at our current 3.8. So we're in a really nice position that it is -- even it has an accordion feature that would allow us to expand the first lien, if we needed to do that. And then you talked about M&A. So now that we've got the cash and even in this year, in a pandemic year tied to travel, in the first 9 months of the year, we've produced $44 million of cash flow from operating activities, so still a nice result for us. But we really want to put that money to work, and M&A is where we would do that. But with that, we'd end up with -- you asked how are people thinking about opportunities. And I think you'll find this with a lot of your companies that you're talking to, is that nobody wants to believe -- nobody wants to sell their company based on their COVID EBITDA. Everybody wants to sell their company based on their future EBITDA. So it's really about finding the right asset at the right price that gives our shareholders the best value, and we are continually looking at that. We've got a large pipeline out there. We've got a very excellent executive leader of M&A in Mike McMillin. So it's something we're working on all the time.

Excellent. I think we made it in under time. Tricia, thank you so much for not only the time today, but the preparation of the slides, which were, I'm sure, very helpful, the October update and again the time you spent with us today. Hope you had a good day of meetings.

I had a great day. Thank you for having me, Tim.

Thanks a lot. We'll talk soon.

Thanks.