Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

I'm Sameer Kalucha, information services analyst here at Deutsche Bank. On behalf of DB, I'm extremely pleased to welcome Verra Mobility CEO, David Roberts; and CFO, Patricia Chiodo with us today. We're -- it's a pleasure to have you here, gentlemen, and lady.

Thank you.

Glad to be here.

Yes. So just to start with David, maybe we'll kick off with a brief intro about the company overview of the business in terms of what you do, how you make money. And then, of course, then we'll like to get deeper into segments and the business trends. So David, maybe you can start.

Yes, of course. So Verra Mobility is a global leader in smart transportation. What that means to us right now is that shows up in 2 primary segments. The first is Commercial Services, where we are the #1 provider of toll management, violation management and title and registration here in North America for commercial fleets, that's principally rental car companies like Hertz, Avis and Enterprise as well as fleet management companies like Element, Donlen and others. On the other side of our -- we have another business unit that's called Government Solutions, where we're the #1 provider of photo enforcement here in North America, that is red light cameras, speed camera, school bus stop-arm cameras. We recently acquired an Australian-based competitor called Redflex, which allows us now to compete globally. So we'll -- we've expanded our reach into territories like Australia as well as in Europe. And so those are the 2 segments. The other question is how we make money. So just going in reverse order, on Government Solutions, we effectively -- both of our businesses are fully outsourced. We are kind of a tech-enabled BPO, if you will. And on the Government Solutions side, we get paid either, a, on a fixed fee per camera per month; or b, a revenue share against paid citation. And that depends on the customer, the product that varies greatly across the portfolio. And on the rental car side, most of the revenues generated through rental car tolling, which is where we have a margin share relationship based upon the administration fee that is charged by the rental car company to the end user. As well as we also make money based upon paying the -- we pay the electronic rate, build the cash rate and there we make money on that as well. So those are the principal ways in which we make money. I think that covered all your questions in the shortest form, as I could.

Yes, that's great. So the 2 main segments of business. So maybe we can dive a little bit deeper into the commercial side of things. You mentioned, you make the margin difference between the cash and the electronic. Just to get a sense of what is the opportunity size you target? And what are the typical growth rates that you see in the business near term and longer term? And what are the drivers?

Yes. So on Commercial Services, we -- there's a couple of what I would call sort of macro tailwinds. Again, the growth rate is unique because we are the market when it comes to rental car tolling because we serve the 3 major players as well as a few others. The first one is, one is the conversion of cash to cashless lane. So when cash lanes go cashless that sort of increases the adoption of the program because people have less options to avoid paying a toll. So that's one. And #2 would be an increase in the total number of toll roads. So toll roads have proven to be highly efficient ways to move people in a reliable, safe way from point A to point B, and they also happen to generate revenue for the local authorities. And so you're going to see more and more of those. And in fact, those are referenced as a potential solution within the recent infrastructure bill as well. So those 2 tailwinds will help us continue to grow. We think at what I would call the upper end of the mid-single digits, but we look at kind of 6% to 8% long term. Obviously, with the recovery this year, we're growing much higher than we were over last year, but once things kind of settle back to normal, that's the kind of growth rate that we would anticipate in that business.

Got it. So it seems like you're benefiting from the macro tailwinds. And one of the discussion points during the earnings call was the revenue is kind of coming back to -- so COVID is obviously a big event that is still unfolding. So as revenues came back to pre or closer to pre-COVID level, it seems like the volume is still trailing and it was more pricing. So what are the trends you are seeing in volume and pricing and how they have trended, especially as you look out past Labor Day as the travel volume like tail-off, how do you see those trending?

Yes. And I don't -- this is Tricia. I don't know that it's necessarily pricing. So what we're really seeing is you're right that overall demand, the total number of rental cars in play is lower. We do not expect rental car volumes to return even through the end of this year. We're still modeling that they'll be 10% down at the end of this year. What we're seeing is not necessarily pricing. I'd sort of align it to driver behavior is that people are using these rental cars differently. And as they do, it's benefiting us. So they're holding the rental car longer. And therefore, there's more opportunities to have more billable days within that rental agreement. They're using more toll roads, and they're hitting higher volume toll. All of those things benefit our revenue generation. So it's not necessarily that we've changed price, it's that the consumer has changed their behavior towards the product.

Got it. That's really helpful to know. It's good to have that clarification, especially after earnings, we did get a lot of investor kind of interest in clarifying those, are you changing pricing? Or is this the driver behavior? So thanks for clarifying that. So digging a little bit deeper on the rental car side of things. There's a segment of business that generates revenue from toll management and you have violation servicing in there. Any difference you're seeing in the mix of those 2 as the volumes come back or as the revenues come back, any difference you see between those 2 businesses?

No. The tolling segment in and of itself is such a large part, by far and away, the majority of this segment's revenue that it would take some big shifts in the other ones in order to make a material difference. We did see a really strong title and registration quarter for Q2 of 2021. But I think that's more of a timing aspect of how titles and registrations are flowing through. We're showing recoveries in both the tolling segment for RAC and the tolling segment for our FMC customers. Really returning nicely to the levels that we had in 2019.

That's good to know. So everything is going to be back to there -- you're seeing broad-based revival of the revenue stream. So that's good to know. Then one of the other things that we hear from investors quite a bit is the corporate travel. When we hear about corporate travel, we hear all kinds of estimates and forecasts over there. Typically, people are thinking 20%, 30% down. But you could have it down a little bit more right now, even our internal forecasts are down like 40%, 50% for right now. I'm wondering what are the trends you are seeing there in terms of the corporate and leisure mix? And how is that split for you? And when do you think the corporate travel comes back and to what levels?

Yes. We -- so the only way that we can determine whether it's a corporate traveler or a leisure traveler is that the rental agreement has flagged a corporate account on it. Right now, we're seeing that, that is very few. We believe that the volume returns that we're seeing now are truly driven by the leisure traveler. And we've said that all along that we thought the leisure traveler would return first and partly because they make their own decision. Some of us even on this call, we still may not be able to travel for business because our corporations that we work for have policies in place that may prevent that. So -- but the leisure traveler and the strength of that market has allowed us to sort of recapture a lot of the growth that -- or recapture almost to the volume states that we had in 2019. So we believe that when the corporate traveler returns, it will just further boost what we're seeing today. And you may see a little bit of pullback in those positive trends and driving behaviors that I mentioned earlier.

Got it. So it seems like it will take time, and that's pretty much what the general opinion is right now. And kind of along those lines in terms of the COVID impact on business. So obviously, cashless tolling has increased. But how specific is the COVID impact in there? And any color you can provide on as you move more and more to cashless tolling, wouldn't it happen that the spread between cash and the electronic rate kind of like go down? And how does that impact you as a business?

I think 2 separate trends. cashless tolling in and of itself actually is a catalyst for growth for us. So that drives growth for us. And the reason is because if you're in a rental car, the -- one of the ways to avoid using our program would be to not drive on the toll road, stop and pay cash or if there's other various means you can do, there's a lot of -- you can mail in toll payments afterwards based on the toll authorities' websites and things. But for the most part, what we're seeing is that people are opting in for convenience. We live in a convenience culture. And so they're opting in to say, I don't want to wait in line. I don't want to go on to a website and pay afterwards. I want to just use the program that it provided for me within the car and within the rental agreement that I have. So that trend in and of itself sort of improves the take rate of our product. So cashless tolling is a catalyst for growth for us. And then on your other point, does cashless totally impact the differential between the cash and the electronic rate? And the answer really there is no. We use the term cash versus electronic. And really what it is, it's the difference between the highest and lowest posted rates. So if you were to not be in a rental car to be in your own car, not to have a transponder or a plate registration and drive through with toll, you would pay a higher rate than if you had gotten a transponder or had registered your plate. And we're just taking advantage of that differential in what those rates are.

Got it. So it seems like -- I'm sorry, David, you had something to say?

No, sorry, I don't.

Okay. So yes, that makes sense. So we did get that point from investors. So I just wanted to kind of get more color on that, too. Now from moving to like higher drivers for this segment, the one thing that keeps coming up quite a bit is so you have rental contract with the big 3 out there. And there's been talk about a big contract coming up for renewal towards the end of the year and 2 are already in place or are in process. So any color you can provide for the details on these 3 large rental car players that you are involved with?

Sure. We renewed the Enterprise contract earlier this year, and we -- the Hertz contract is up at the end of this year, similar in terms of the way in which we communicated around the Enterprise contract, which is we feel very good about the Hertz contract. We have a great relationship. They're a fantastic customer to work with. We'll continue -- we began to have dialogue with them, and we would anticipate an extension of that relationship, hopefully, with materially the same terms that we have today, and that's kind of the playbook that worked out with the Enterprise discussions as well.

Okay. That's great. The other thing is these are large volume players. So isn't it possible for the rental car companies to build out the services in-house? What are your competitive advantages in the moat around the business that really drive the business and is the incentive for the customers to work with you?

Yes. I mean the reality is that the principle is that these are companies that have many other things to do other than worry about managing a full outsourced toll management program or bringing it in-house because to bring it in-house, they'd have to build integrations with all the toll authorities. They have to procure the transponders themselves. They have to put the transponder in the vehicles. They'd have to do a lot of -- they take on the call center, add staff, all those kind of things. And the reality is they make really good money on this program, and we manage all of those details and all of those technological challenges with a software platform that we've built and customize over years and years of which they would have to build. And so if you look at the rental car companies and you say, well, like what's on there -- if you're running that business and you say, what's on their top 5 list of where I'm going to invest, this isn't anywhere near it. It's just not worth it given the fact that they have a strong partner that does an outstanding job that they can hold to very strict SLAs and they still -- they make really good profitable dollars on as well.

Got it. So kind of -- yes, it's probably not an incentive enough for them to invest as long as they can get good business returns by working with you. So that makes sense. Now guys, staying on a little bit on the macro and the commercial side of things. Obviously, the infrastructure bill is supposedly on its way to get passed. Just wondering what kind of potential upside does it provide in terms of what are your thoughts in terms of what are the benefits you will see from this in terms of additional roads, additional cashless roads? Any color you can provide there?

Yes. The way we -- so first, I'd caveat that it's way, way too early. The final ink is not dry. And so what I would say is that we're certainly optimistic, but we'll obviously wait until the final law is passed. I think there are really basically just some tailwinds that the infrastructure bill will continue to help support, which is it allows for investments in things like toll roads, it even has some reference to using things like photo enforcement while the specificity is not there. What it means is that cities will have access to federal funds to help support them if they're looking at these types of initiatives, which bodes well for our business. And so we're quite bullish on the program. Obviously, it's a wait and see. And obviously, the impact also will not be immediate. It will take some time for those dollars to flow through the system. But if you were to look at something that's going to carry a tailwind for our business as it stands today, you would say that that's a good thing for us.

Got it. And then you mentioned photo enforcement. That probably is a good segue into the Government Solutions side of things, just want to get -- if we can start with like an overview of what you services provide -- services and products you provide. What is your penetration? And more than that, who are your competitors in that space because we do talk about the NYC speed camera program, we'll talk about it. But what is the competitive landscape over there? And what's the opportunity?

Okay. So as I mentioned earlier, so we -- in the Government Solutions business, we are the #1 provider of photo enforcement in North America. That shows up as like red light cameras, speed cameras, things like school-zone speed, work-zone speed as well as school bus or stop arm. And so if you were to look at our share, we are approximately 70% of the market in North America that is most recently driven by an acquisition of a competitor, which was called Redflex, they're Australian-based, but they also had a decent chunk of market share here in the U.S. and we acquired them and closed that just a couple of months ago. So the -- outside of Redflex, there are other competitors, a company called Conduent has a transportation segment that has a photo enforcement business, as well as other companies, Sensys Gatso, RedSpeed, BusPatrol, others that are kind of regionalized competitors in North America. As we now have the capacity to compete outside the U.S., we'll sort of start to look at other competitors as we get to grow in Australia and others. And those are more on the manufacturing side because the model of deployment outside the U.S. is different. That's much more of a purchasing a hardware and a service contract. And there'll be companies like [indiscernible] and Jenoptik and others that will look at outside the U.S. We're still kind of getting our feet wet on that particular side of the business, but that's the landscape right now. And that's also very country-specific as well. Different competitors have different footholds in different countries around the globe.

Got it. And diving a little bit deeper into the school speed camera. The NYC speed camera program was a great kind of offsetting impact from COVID and you already have the extension or another 720 camera program. What's the latest on that? How much progress you've made, how many cameras you installed? And what are the time lines to install the remaining?

Yes, we had suggested that we would get the majority of that second batch of 720 done by the end of the year with the potential to have some [ leak ] in the next year based upon weather and/or any supply chain-related issues that might occur. At this point, we still feel very confident about that estimate. The teams are doing a fantastic job of deploying very quickly. We've been able to manage our supply chain very, very well despite some of the headwinds that most companies are dealing with, which we do too as well. But that being said, we feel very confident about the progress that we're making, and we would anticipate to remain on track to our original estimates.

Got it. What is the total market for the addressable -- the addressable market for speed cameras in the U.S. once you are done with these 2 contracts for the New York City, what are the additional opportunities you can go after?

Yes. It's -- right now, it's better to think about it at a state-by-state level because there does need to be enabling legislation at the state level to allow different types of photo enforcement. So for example, in Florida, they have legislation for red light, but they don't have any legislation for speed. So effectively, the TAM there is 0 for speed. But when you look at -- so what we look at is where are the states that we've recently opened up legislation and that would be places like Georgia and Virginia for speed. And those are -- call those approximately a $25 million to $50 million TAM each. So we're really excited about those because it does take a lot of effort to get those states open. And then -- so that's how we think about the TAM. So with that, we're obviously going to be continuing to focus on other states as well, places like California and others, we'll continue to work on to try to open up opportunities for the portfolio of solutions that we have today.

Got it. And in addition to the speed camera, there's a bus stop camera opportunity that you target as well. And I'm curious in terms of how the back to school is driving the opportunity or revenue there? And what is your sense on the new Delta variant in terms of what kind of impact does it have on the schools program and probably even broader market as well. What are your thoughts right now?

It's -- we're going to -- obviously, it's starting -- we're starting to see activity. Our revenue is delayed a lot. So given the fact that school just opened up past Labor Day, you start to see violations and the revenue will come much later in the quarter. We're starting to see the activity. I mean, given last year, the activity was literally 0 in some months. There was no violations as you might imagine, given COVID and the restrictions at the time. Right now, it's really dependent on the state and the local, how they're dealing with the Delta variant. It seems as if schools are still pretty committed to having in-school opportunities. I think you've heard that both from the President's administration as well as in most states. And so it may be lighter, which may potentially have an impact on the number of school buses from our perspective, but it does seem as though the school buses are running and will continue to run. But it's still early for us to tell. And so we'll probably have a better view of that toward the end of the quarter, first of the next quarter -- I'm sorry, the end of the -- probably the middle of Q4.

Got it. So that seems to be coming back, makes sense. And then staying on the cameras, the speed camera in New York, there was the issue with outstanding receivables. And you have already received some money during the quarter. So how is that trending? And when do you think the account becomes current, and this becomes like more of a rearview-mirror kind of a situation.

Yes. So you're exactly right. We had a backlog in receivable balances with New York City, and they had just started paying that in June. Since they opened up payments in June, they have paid us to date, nearly 70 -- actually just a little over $79 million on their open account balance. So that's very good progress towards clearing up those old receivables that were out there. We also have the indication that in their current payment portal, there's $21 million that should be released this week. So we're happy with the progress that they've made on this because in the meantime, we're continuing to build them for all these new camera installations. So I think I said on one of our previous conference that we were expecting to build them about $13 million a month, and that number has upticked to nearly $15 million as we've increased the pace of installation. So -- but I'm very happy that New York City is doing everything that they said they were going to do. They're giving us -- they're paying multiple invoices in given weeks. They're staying on top of what needs to go through their system. We've been pleased with the progress on that receivable.

Got it. That makes sense. So it seems like you have a line of sight into roughly $100 million. And what was the total outstanding amount if I think you mentioned something like $120 million?

Yes. It was $127 million on June 30. It was $97 million on the time of our last earnings call. And even with even with additional billing cycles, it's still right around $85 million right now.

Got it. Okay. So it seems like a good traction. So everything seems to be on track with things moving along, taking their normal course of line.

Yes.

That's wonderful. And one of the things I do get from investors and maybe it's good to clarify. What was the root cause of the problem that led to this? And what are the mitigation strategies you've put in place so that this does not happen for the ongoing -- additional camera installation that's going on?

Yes, I think there were a couple of things that came into play. One was just that we were working under an emergency contract. And so the procurement cycle is different on an emergency contract. So normally, you would get an award, you would go work through the contract, you would get a notice to proceed and then you would start work. Under an emergency contract, you get the award. They give you the notice to proceed, which is a binding agreement to do work on behalf of the city. Then you go through all of the items of getting the contract negotiated, getting it registered with the comptroller's office and all of those things. But until you reach all of those hurdles, you can't be paid. We were in the process of that already started work in the beginning of January of 2020, right before everybody went home for COVID. So we experienced some hurdles there. Then we also had self-disclosed an issue of some electrical coding, how [ deeply bared are wires ] on earlier installations. That created some backlog in the system as well and meaning that several departments within New York City, one of them was waiting on the other ones to make sure that we were all aligned in going forward in the right direction. In all of that, we worked really hard to partner with the city of New York. The dialogue with them during all of this was much more positive than what was reflected in our aging AR balance. And you can see that, that was a true statement just by how well they've cleaned up this balance in just a few short months.

That's good. So it looks like we should be expecting everything to go smoothly here onwards. So that's wonderful. Now switching gears a little bit to the recently completed Redflex acquisition. So that's a good opportunity. very complementary, very -- a lot of synergy opportunities, a lot of opportunities to upsell, cross-sell as well. So I'm curious, how is the integration going along? And how is the progress on synergies that you had targeted when you announced the acquisition?

Yes. I think so far, it's just like any other integration, it's got some really -- you're learning some things as you go, but overall, very positive. They have a great team and great people that work there. So we're excited to have them in the Verra Mobility family. What I would say is that we are on track to the synergy targets that we would achieve over the next year or so, and we feel comfortable about hitting that number.

Got it. So that's good. So good to have the acquisition on -- under the belt and moving to the integration phase. So moving a little bit towards the margin side of the business. As you leverage technology more and automate more of the processes and the volumes recover, how does that impact margins? And how does technology play a part in there because you're a technology infrastructure company as well?

Yes. I think the -- so our margins are very strong. In 2019, the Commercial Services segment had 63% EBITDA margin. We as a company overall in 2019 had 54% margin. And although everybody would like to say we can expand upon that. I think that, that is unlikely. I think one of the advantages of being highly efficient and using our technology wisely is that we have these high margins, and we generate a great deal of cash. Even in the pandemic in 2020, where we lost a $100 million of revenue in just the Commercial Services segment, we still maintained overall margins as a company at 46%. And so our margins in the worst of times are better than most companies at the best of time. And I think what you'll see is that we are -- we're striving for growth. You can see that with the acquisition of Redflex and our inquisitive nature on other M&A targets. And there will be nothing that we will be able to acquire or no product that we will be able to create that will generate the margins that we currently have today. So I think what you'll see is we're going to continue to do the right things using technology to expand margins on core businesses as we buy into other businesses that may have lower margins. So I think you'll see nice expansion, EBITDA expansion, revenue growth, but not necessarily margin expansion.

In fact, that ties into kind of the 2Q earnings story where you implied a little bit of decline in margins for the back half of the year. So what are the factors driving that? Obviously, Redflex is one. What are the other things that are driving that acceleration in margin?

Yes, you're right. Redflex is one of them. We just acquired a company that's roughly $80 million in revenue and has a much smaller EBITDA margin than we do. So that will impact margins in the back half. And the other thing is we're really trying to invest ahead of the cycle. So we were very quick to cut costs in the pandemic, and we have been slow to add them back. But we will have to add them back. We ended the quarter with 120 temp workers that although it gets us through the cycle to capture revenue, it's not sustainable. So as we go through the back half of the year, we're going to stabilize our cost structure, and we're going to invest for other things. We're still investing in Europe for growth there, and we're investing in some products technologies to capture the next growth cycle as well.

Got it. As we get closer to the end, maybe one last question that I would have, the $100 million buyback you announced it's already been used up with the Platinum secondary. What are the other uses of cash we can expect going forward? And can you remind us on the M&A opportunities as well in terms of how is the pipeline looking? And what are your strategic focus for capital allocation going forward?

Yes. I mean, I think since -- even since we've been public, we've always sort of had a pretty clear delineation of how we think about capital, which is we want to invest in growth and whether that's in new products or M&A, primarily M&A, that's something that we'd like to do first; and two, is that when we don't have those opportunities that we think we can capture that we would like to return that to shareholders. And in the course of a few months, we did exactly that. We bought Redflex, which is an accretive deal, really solidifies our position in Government Solutions and gives us expansive opportunities overseas. And then because of our cash flow that we're generating, we're able to turn around and do $100 million share repurchase. So you would -- I think that you can anticipate that type of perspective as we continue to manage the capital of the business with the shareholder value in mind. As it relates to the M&A pipeline, it remains strong. We continue to look for -- globally for opportunities inside of the smart transportation ecosystem that we think we can be relevant in. And we'll continue to -- obviously, right now, it's a pretty frothy M&A market from the seller side. So we have to be mindful of that. But we still maintain a really rich and robust pipeline across a couple of different segments. So we're excited about that.

Great. With that, we'll wrap it up there. Thank you so much for your time, David and Patricia. It's a pleasure to have you.

Thank you. Appreciate it.

Thank you.

Take care. Bye.