Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

Hello, and welcome, everybody. Thank you for joining us for this session as part of our Financials and Payments Conference here at Morgan Stanley. In this time slot, we're very excited to have the senior management from Verra Mobility. Before we start with David and Tricia, I do have a quick disclosure to read. For important disclosures, please see morganstanley.com/researchdisclosures. So as I said, I'm very excited to have Verra Mobility with us this afternoon. And joining us today is David Roberts, CEO; as well as Patricia Chiodo, CFO. And thanks a lot to both of you for joining us today. For those of you that are following along on the webcast, you can post questions via the portal. As we go along here, we'll try to incorporate those and certainly look forward to having a very good discussion with both David and Tricia here.

So maybe to start off, what I would do is just ask really quickly, David, let's talk about your core business. The pandemic seems like would have been a double whammy gut punch. Less traffic, fewer car rentals. That's, I think, the presumption that a lot of people had. But what really happened? And perhaps more importantly, what are you seeing now that things are starting to reopen?

Yes, sure. So I think your assumptions are fair. I mean we are obviously impacted by travel and vehicles on the road. Where we saw the biggest headwind was in our rental car tolling here in North America, which is clearly given the fact that for the better part of the year, the people were not really renting cars, and that has a direct impact because if they're not renting cars, they're not running tolls, which is where our -- that's where we make our money. In addition to that, we have variable rate photo enforcement programs, where we are paid on issued citations and there's a split related to that with the city. And if there's less vehicles going then there's going to be less revenue, and in particular, in our school bus program. So there were no school buses effectively last year and there was a point in time where that business effectively went to 0. But the great news is about our business overall is that even inside of a pandemic and the hits that we took, sort of the ones that I just described, we still generated positive operating cash flow. We still generated growth within our business to the extent that we had New York City, which continue to expand the largest photo enforcement program in the world as we know it. And so with that, we actually produced -- we like to say we produced margins that other people would like to have in the best of times, and we produced them in the worst of times. So I think coming out of it, our hope is that investors really see a very strong resilient business that was exposed to travel and emerge much, much better than many of our peers.

So now that we're starting to see reopening, particularly in some of these regions where you're strongest like New York, we're starting to see in the data not only improved travel and travel numbers. We're also hearing about at least anecdotally, high demand for rental cars and maybe in cases, outstripping supply. How are you just starting to see elements come back into the business? And are they ramping about like you would think commensurate with the return in activity in travel?

Tricia, do you want to take that?

Yes. So what we've seen over time is it's a little different than what we expected. We actually expected volumes to return more than they had by this time, but we didn't expect this sort of change in driving patterns that we're seeing. So what we're seeing is that rental agreements are lasting longer. When they're out there, they're using more tolls, which allows us to charge more administration fees. And then the number of tools that they're using are also higher dollar value. All of those things are good for us from a profitability perspective. And so we're seeing lower volumes than we anticipated, driving behavior that's beneficial to us overall. And that's one of the reasons why some of the rental car companies are still 40% off on their volume, and in Q1, we were 25% off from our revenue on a year-over-year basis. So we are being buoyed up a little bit by those activities. And we would -- we believe that right now that those activities will continue through the rest of the year, that is probably attributed to being leisure travelers versus this blend of corporate and leisure travelers that's making that difference.

Got it. And so from your perspective, what we're seeing is just the mix has shifted towards these leisure travelers. And as business travel comes back, we'll see what happens with business travel, maybe it doesn't come fully back. But at least right now, you're seeing a beneficial mix and what that looks like over the long run is still to be determined, is that fair?

That's fair.

And I guess, one of the things that we -- one of the anecdotes that's been shared, for example, is in key tourist destinations, for example, is that there aren't enough cars to rent. And there -- people are -- rental car agencies and others are resorting to things like vehicles or vans or other things that they may have extra of. But at the same time, obviously, the production constraints around new vehicles has been widely publicized. Is that hurting your rental car partners' ability to reconstitute their fleets? And is that going to slow the recovery in your rental car business at all? I know that you're -- Tricia, you're saying you're anticipating that it will continue about with this type of mix. But if cars were more available, do you think it could come back faster? And I guess the big question is when do you think we get back to pre-pandemic levels?

Yes. I always want to be careful about sort of prognosticating about somebody else's business. But what I would tell you is, clearly, right now, the demand is surging quite high. There is a lag in terms of the total number of vehicles, although you would imagine that they're going to be putting vehicles in the hotter locations that are going to be airport locations, which are also generally the ones that are connected to tolling, which is better for us. So the mix will shift to those locations. They're also tapping into the used car market. So while they dispose the vehicles into the used car market last year, they're now buying back. They'll also extend the life of many of the vehicles that they have today, whereas before they roll off of vehicles pretty quickly, maybe 18 months oftentimes. They may extend that by a year while they're trying to round out both their used car inventory as well as, hopefully, this chip -- the chip manufacturing gets back to normal. So given that, our anticipation, at least how we think about it today, and we like to say this is pencil, not pen, is that we still think that we have line of sight to 2019 volume based upon the activity that we're seeing today. It's not yet kind of come into our system. What -- how long and how protracted this lack of vehicles will be is still TBD. It kind of changes every day. So we'll continue to watch it. It would eventually have an impact on our business. But right now, we're not seeing it directly.

And David, remind me, but I think one of the questions that comes up a lot and what people always worry about is the relationships and agreements with rental car companies. Can you just kind of recap where we are on those? And I imagine if there is an agreement that's coming up is that, if I was a rental car company, I'd be very preoccupied with a whole list of other things before I'd be worried about asking myself the question do I want to run my own tolling business or not. So -- but is that a fair characterization from your perspective?

Yes. It's -- from the outside in, and I certainly understand why investors would want to know more about that. But to your point, rental car companies have a lot going on. They've got -- they have a supply-demand issue in North America, they have an issue in Europe, which is the exact opposite of what's happening here in the U.S. But relative to the contracts, as we said recently, we basically finalized terms on an extension -- a 2-year extension with EHI. We also have already extended Avis Budget Group until 2025. The Hertz agreement comes up later this year. And we feel we have a great relationship, have served them for many, many, many years. And we feel very confident in our ability to continue to serve them as well. And to your point, they are very, very busy focusing on their core business, which is renting -- procuring assets and deploying those assets. I don't see them, at least anytime soon, deciding that they want to be in the tolling business.

So let's turn to your photo enforcement in traffic, starting specifically in the state of New York. You recently announced some new wins for camera deployments in New York. Can you maybe, Tricia, walk us through the economics? When that comes onto the P&L from a hardware perspective and how much we should be looking for? And then what about the services portion? What does that ramp look like? And how long does it take to get to full productivity?

Yes. So that was -- it was exciting news. So we've been continuing to expand our New York City’s program. We got an order, I'm going to call it, in April of this year, right around April, maybe it was March of this year for another 720 school-zone speed cameras that we would install. Those cameras will generate between $50 million and $55 million of product revenue in 2021. Right now, we believe that we have our supply chain in order and our construction teams geared up that we can install all 720 of those cameras this year. Each of those cameras, once they're installed, will generate roughly $3,800 per month, that's the average price that we get across our portfolio. So call it, $3,800 per month every month into perpetuity. So that's $32 million of annual recurring revenue once those cameras are fully deployed. That's on top of already the healthy generation of service revenue that we have from New York City.

And you said that you -- and I'm sure everybody's relieved and not least of which is you. You have your supply chains pretty well confirmed and you're feeling good about those. What is the timing roughly of deployment? Is this a summer [ heavy ] deployment ahead of schools going back? Or will that continue into the fall? But I would imagine you probably want to get them done before November, December for weather reasons. Just like -- help us think through like what that timing is.

Yes. Well, last year, we were installing at what we thought was lightning speed at about 60 cameras per month. In order to do this in just the back half of the year, we're going to have to increase that. So you're going to see sort of us -- we're going to be upscaling and up ramping our process through the summer, and it will then continue to accelerate through the back half of the year. Right now, we intend to install all the way through December. I don't think we will be able to get them, all of those cameras in the ground before the holiday season. So we expect that we will be installing right up to the end of the year.

And then in terms of the ramp in productivity, is this something that once the camera is turned on, it's productive at that roughly $3,800 a month immediately? Or is there a ramp time where maybe the city is giving some leeway? Like how does that work?

Yes. Usually, it's probably the first full month of operation after installation. So call it -- it may be up and out there for, call it, 2 weeks before it starts generating revenue. But it should start generating revenue right away.

Got it. And then speaking of New York, I'm sure you guys get a lot of [questions] on what the latest update is. I know that you've gotten some emergency approvals and maybe starting to receive some of that accounts receivable from New York. But can you give us an update of what you're thinking about in terms of timing? And when they can get fully back up to date?

Yes. And this is just actually really good news. We've been sort of -- every time we get a new little piece of information out in New York City, we're letting the investor community know because it is such an important topic. At the end of March, New York City owed us $120 million. So that's a nontrivial headwind in your net working capital as we're moving forward. And we got -- we needed a few things to happen. We needed our contract to be registered, that did happen after we had our quarterly call. And originally, we thought that we would start getting paid sort of on this paid current plus some chunks of other invoices that were past due. New York City came back and said, no, we're going to pay you on a FIFO basis. Your oldest invoice is the one that we're going to pay first, and we're going to pay you several invoices across the course of a month. They've even said, hey, some weeks we're going to pay you multiple invoices during those weeks. We received -- and true to their word, they paid the oldest invoice on our legacy contract of $3.8 million on a Friday. The following Wednesday, they paid the next one for $3.8 million. We can see in their portal that there's about $17 million worth of invoices that are lined up to pay and come out. At this rate, they will be current by the end of the year. So when you think about that, you've got $120 million positive net working capital impact for this year and will create a really nice cash flow year for us.

Yes, for sure. I mean I think for a lot of investors, I mean, even for us, is the idea would be -- has been like, yes, we think that New York will eventually get caught up, and I don't think that a lot of people have felt like that did that amount or that they wouldn't. But certainly, the longer -- it took longer, the risk could increase that maybe they wouldn't. But the fact that they're at that pace right now and can be up-to-date by the end of the year has certainly got to be a relief, as you said, from a working capital perspective and planning perspective, as you start to think about next year.

Yes. And I think the relief portion of it is that we get to tell you that they're paying. I think from our perspective, we've always trusted that the relationship with New York City was fairly strong. And that the outcome of the nonpayment was sort of inconsistent with the internal talks that we had on the partnership and the strength of the relationship. So we're excited that you get to see what we get to see is the quality in the work today.

Right. That's great. Dave, let's turn to Redflex. This was a deal that -- an acquisition. And obviously, you guys have talked about going through regulatory process, getting essentially everything that you needed other than the country of Saudi Arabia. Can you give us an update on that and when we should think about that closing?

Yes. So we have cleared all the hurdles, including Saudi Arabia. And we would anticipate to close it later this week.

That's great news. Now to me, it seems like a really interesting acquisition. They clearly have footprint in some states and areas of the country. At the same time, though, it's a business that really hasn't been profitable at least in a while and has in fact, been shrinking for multiple years. And even when it was profitable, it really never had the level of profitability and margins that Verra does. What do you think about the revenue and earnings synergies could be? Over what time frame? What are you looking to get leverage on the acquisition?

Yes. I think that -- yes, I agree. I mean, I think ultimately -- so for a good portion of their business, they operate a different model than we do here in the U.S. So internationally, the model is more of a selling of the equipment than necessarily the sort of install and just have the revenue per camera per month. And then they obviously have their U.S. business. So our belief is that any time that you can solidify a strong position in a great market like North America, that's a great win. And then in addition, we get expansion into global markets, which we -- Verra Mobility doesn't compete in today. We don't have products or services that we offer globally. And when you look at sort of smart cities and smart mobility, you need to be a global player. So from that standpoint, we're excited about the -- not only the people that are coming along with the transaction, but also the relationships that they have in places like Australia and Europe. The goal would be to bring their North American business to the margins that we have. And we would anticipate that we're thinking between the $8 million to $10 million cost synergies there, which is going to be obviously accretive. And then ultimately, we're still going to be learning a little bit on the international business, but that won't get to the same level of margin because the model in and of itself is fundamentally different overseas. It's much more of a larger project cell service than necessarily the recurring nature that we have here in the U.S.

And on those -- so if you think about -- and I think that's an appropriate framework, at least as you're putting together your initial objectives. How do you think about like the opportunity to take what Redflex is doing internationally and bring it to the U.S.? And would that include a model change in terms of the type of implementations they're being used for? And similarly, what about the U.S. model? Is that exportable event, the Redflex customer groups, et cetera?

Yes. It's definitely you would -- ideally, you would take the U.S. model or a version there overseas more than bringing the -- I really don't see the buying the CapEx sort of model in the U.S. It's quite rare that we see that today. I mean New York is really one of the only customers that actually purchases the equipment. But they do have used cases around speed that we don't do today. So for instance, they do things around railroad crossings, they do things around work zones that we haven't fully developed. Overseas, they have different types of use cases as well, point-to-point speed. They do some detection around ALPR. There are other use cases that they have that we are hoping that, a, we can learn and bring that to the U.S. where appropriate. Obviously, we have to have the legislation to support it. But hopefully, we're also hoping that they can leverage our balance sheet and our capabilities to grow faster and expand our capabilities overseas to win more of those products to establish ourselves overseas as the global leader.

And in those wins, do you think that, that aspect of the U.S. business, whether it be service or the type of implementations is -- like that can be exported? And then because -- to me, it seems like that, that's probably the most likely path to revenue synergy. I mean, correct me if I'm wrong or where I should be more nuanced on that. And what kind of time frame are you looking at?

Yes. I think the revenue synergy will be how we can help accelerate, continue to win the new opportunities here in the U.S., obviously, in a sort of best of both. And then the new sales of products that we don't currently have overseas. To some of that, I think it should be almost immediate. Certainly, within the first 12 to 18 months, you would anticipate starting to see some of that uplift.

Interesting. So talking about international, let's talk about the trials you've been running in Europe. What is the scope of those trials and that kind of thing? What would that cover? Countries or geographies? And what are you thinking in terms of potential size of these trials if they're converted to full deployments and partnerships?

Yes. So, so far, we have fully deployed one customer in France. It's a company called Rent A Car. So we, pre-COVID, had done some pilots. They really like the program. And they installed in their entire fleet or most of their fleet inside of France, which was 8,000 vehicles. Surely thereafter COVID and those vehicles remained idle for the better part of the year in all reality. And so in addition to that, we are -- I think, close -- we mentioned in our earnings call that we're close to announcing a pilot inside of Ireland, which will be just another country, different challenges. It's a smaller -- Ireland, obviously, is much smaller regardless, but -- so the number of vehicles will be smaller. We announced today that we have our EETS certification in Spain, so that we can -- basically, that allows us to issue transponders on behalf of the Toll 30 inside of Spain. It's something that we can leverage across -- we'll start to do that across other parts of Europe. But the reality is that of all of the -- COVID, obviously had a financial impact on us. But strategically, the one that it hit us the most was in Europe because we were going through positive momentum with a couple of opportunities with rental cars to effectively a standstill on decision-making because those rental car companies were in a really difficult situation in Europe with the defleeting, layoffs, priorities shifted. And so we're just, just now starting to see some of that come back a little bit, but it's going to be a little while before we start to see full fleet. So relative to size, one of the things we haven't had is a strong, call it, 3 to 6 months of active revenue generation, so we can start to get a better idea of how we're going to -- how this will look as we roll out across the country. So we'll have to wait on that a little bit. But we're still very, very bullish on the opportunity. We've got a great team there that's doing really good work. And so we're hoping to get a few more pilots going this year, and then hopefully next year, we can start to have more concrete discussions on the total size and our ability to penetrate that over time.

So when you look at -- just from a sales cycle perspective and engagement cycle perspective, are you starting -- like how are those conversations evolving right now, especially as Europe seems to, at least from a policy perspective feel like it's maybe approaching the reopening, particularly for tourism and that kind of thing? Like is that -- you said that, that the pandemic clearly set you back and that's not surprising. But is it going to take them similarly a while to get their footing in back up to speed on their operations before they can really start to look seriously at what they can do from a tolling perspective? Or is that something that can come on faster? Just trying to get a feel for what that engagement is.

Yes. I mean it's going to be -- and the reality is it will be different by how the pandemic hit each of the customers or the potential customers individually and also what country you're talking about. Whereas with one customer -- we're very close on launching one in Ireland. So they're ready to go. It's one of their priorities. They want to move quickly. Others have sort of deprioritized tolling, so it could be a little bit longer. So -- but you would still anticipate that we'd have a much better lay of the land certainly by the end of the year just because there are -- in a lot of the cases, the people that -- unfortunately, the people that we were working with are no longer at their organizations because they had to do layoffs. So they're going to have to retool and reshuffle staff. So again, we're still looking at the back half of this year is to get a pilot or 2 in. And then hopefully, a better grounding on how we can look into next year.

And like look, I understand like you kind of have to actually get up and running and see what the behavior looks like and to be able to model it out economically. But on the flip side of it, how should we think about the potential yield or at least transaction counts on a per vehicle basis in Europe versus here? Like I don't really have a great feel for what that potential looks like. But at the same time, I know like if I go rent a car in Albuquerque, New Mexico, chances are it has a transponder, but I'm never going to run into a toll road there. So just wondering like what you're thinking about at least qualitatively in terms of potential productivity.

Well, certainly, the density of tolling in Europe is much, much higher. There's more toll roads in France than there is in the United States. So we would anticipate that there would be a high level of usage and the level of rental cars leaving certain countries and driving into others, especially with vacation are just going to be -- that will be higher and generate opportunity as well. So the density is higher. And so you would anticipate that the usage -- although the fleets are smaller, I mean it's a little bit different than the way the U.S. is set up. So we would anticipate that the usage would still be somewhat comparable, maybe slightly less than what we have here in the U.S. But again, we still need to prove that out a little bit.

Got it. Got it. And I want to go back to the acquisitions, talk a little bit about capital allocation and prioritization. So let's start with Redflex. Like how is that being paid for, that acquisition being paid for? Are there implications in terms of capital structure, interest expense, et cetera? How -- what are the adjustments that people should expect related to that deal once it does close?

Yes. So we've got enough cash right now that we can close Redflex with cash. So we've cleared all our hurdles. Hopefully, we'll be closing by the end of the week, which is fantastic. We did some adjustments to our capital structure at the beginning of the year. So back in March, we went out and did a $350 million unsecured notes transaction at 5.5%, that's at a fixed rate. So that's pretty easy to model out on a go-forward basis. We have $650 million of first lien debt. It's LIBOR plus 325. So also nice and clean there. And it's got some expansion. We have $250 million of opportunity to expand on that term loan. And when you combine those with the fact that we're sitting on about $250 million of cash prior to Redflex we're in here and add the $120 million we're going to get from New York, we very quickly get into a situation where we could very well be underlevered. And we really want to put that cash flow to work, whether that's through finding the third leg of the stool, the next M&A opportunity that we could have. Or whether it's addressing the capital structure in some way. We could delever even further. We could buy back stock. There's lots of things, but this is a good problem to have if the company is generating so much cash that we're trying to think of things to do with it.

For sure. And David, from your perspective on the acquisition front, obviously, Redflex looked like a good opportunity. What is your -- what are you looking for or if you're looking at acquisitions? How much of a priority is that? Is there a general profile that you're looking for acquisitions?

Yes. I mean I think in general, what we're -- what we've always said is that, first, we look to solidify the positions that we're already in. So if you look at a Redflex, that's sort of a textbook example of that. Two, we look at adjacent markets. So what are the emerging needs of the customers we serve today, and what are some products and services that have sort of like characteristics of what we do that we could be credible owners of and deliver to our customers? So things like these are just illustrative, things like parking or congestion pricing or even telematics. Those are 3 sort of examples. And then the third one is diversification. And are there segments within the transportation space that we would say, hey, this could be a third leg of a stool or a fourth leg of stool, what have you, that would -- that we still feel like we can leverage our expertise and run a really good business inside of a kind of a different business that's in the same category than the ones that we do today in terms of specifically commercial or specifically government.

Got it. And what about from a value perspective? I mean Redflex clearly represented a pretty good value for what you paid and the potential there. But in a lot of these other areas, we hear other companies talk about the same things, right? We know that they're on the -- maybe on the other side of tolling, there's competitors who are looking for tolling opportunities. And with that, they talk about parking, the [mats], et cetera, so is it competitive right now? And what do you feel like the right structure is from a valuation perspective to be looking at different types of deals?

Yes. I mean, obviously, that's going to be very, very deal specific in terms of value. Obviously, we have a balance sheet, and we have a currency in our equity, that give us a lot of optionality as to how we want to think about it. We tend to use cash, but it doesn't mean that in the right situation, if it made a lot of sense that we wouldn't be -- we would use our equity. But we tend to be very traditional DCF sort of views of the world, and we would want to kind of hold constant into that. And we would have to have good strategic reason to not follow that sort of operating guideline.

Makes sense. David, Tricia, that's all the time we have. I really appreciate you joining us today. Congratulations on the movement that you're seeing in multiple fronts right now. So that's exciting. And looking forward to catching up with you again in the future. And for everybody that's joining us on the webcast, if you have anything to follow up on, please feel free to reach out to us here at Morgan Stanley. Have a good afternoon, everybody.

Thank you.

Thank you.