Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

So it looks like we can go ahead and get started as everybody is sitting down. Thank you, everyone, for coming out to the second day of the 25th Annual Credit Suisse Technology Conference. We are so excited to be back in person this year as I believe we are the first technology conference to be back in person. So seeing a lot of faces that honestly, I have never met in person before. It's been great and very excited today to be joined by Verra Mobility up here on the stage. We have David Roberts, CEO; and Tricia Chiodo, the CFO of Verra. So thank you guys for coming out to Arizona. Hopefully, you've enjoyed the beautiful weather because I know I have.

Good news is we live here. We're -- it's about 12 minutes from my house. So this was convenient.

You get to enjoy it all year long. Let’s jump right in. Why don't we start with a brief overview of the 2 business segments. And I mean, we can just talk about the secular drivers of each of those segments and the trends that we've seen thus far this year and maybe what you expect going into just an early 2022 outlook.

Sure. So just for those of you that are not as familiar, Verra Mobility is a global leader in smart transportation. Today that shows up in 2 principal areas of business, and we have a brand new one that we'll close on next week that I'll talk about. In our Government Solutions business, we're the #1 provider of photo enforcement in North America, that's red light cameras, speed cameras, school bus stop arm cameras. We also through acquisition earlier this year, bought a company called Redflex, which was a competitor here in the U.S., but also we now are operating in Australia and Europe as well, where we both engineer and deliver the same types of products that I just referenced. The other business unit is what we call Commercial Services. Commercial Services, we are the #1 provider of toll management solutions for commercial fleets, and that's principally rental car. So for any of you that have ever rented a car from Hertz or Avis or Enterprise and ran a toll then we were a part of your journey because everything related to that service is a Verra Mobility offering or technology. We also work with fleet management companies as well. And that business is principally in North America, although we have done some acquisitions and are expanding into Europe with that business as well. And then our third business, which again, we'll close on, on Tuesday, which we've already announced, is a company called T2, which is a parking management company. They provide technology to colleges and universities as well as municipalities for parking and parking management. That includes the meters and the pay stations as well as the management systems software to manage that. So that's the business overview. In terms of -- this year has been a great year. We just announced Q3, which was absolutely fantastic. And obviously, with the rebound from COVID and travel, that has a real positive impact on our business in our Commercial Services business where we're seeing our Q3 of this year was actually better than our Q3 in '19. So we're really seeing some strong growth in that side of the business, which has been fantastic. And in our Government Solutions business, we've been really fortunate to partner with New York City on the largest expansion of photo enforcement, certainly in North America and probably the world, which continues to drive some real strong returns for them in terms of their safety initiative around Vision Zero as well as for the company. So we feel like as we head into next year, we are really set up to have a strong year. We have a new kind of “third leg” of the stool in terms of diversification, and we still have all the strong sort of financial underpinnings of our business, which is strong revenue growth along with free cash flow. And so we're excited to see what the year will bring.

Absolutely. And we'll definitely be touching on the T2 systems a little bit later on in the conversation because that was a very exciting acquisition. But why don't we just quickly touch on the Redflex acquisition, because that one has been great so far. You've made significant progress on the synergy execution. And I believe it's already $5 million run rate as of Q3. When should we expect the full $8 million to $12 million annualized run rate to be achieved?

Yes. I think for most, in any M&A transaction when you're getting synergies, the first part is the easy part. It's the second part that is a little longer because the first part is relatively pro forma. There's kind of a playbook to run. And then as you really get to know the business and the intricacies of running a business that was formerly headquartered in Melbourne, Australia as well as operating in the Middle East and in Europe, we're being much more thoughtful about what are the long-term strategic drivers of how we want to make sure that we're getting the best and highest use of our platforms, our software platforms, our camera technology. So we're going through that. So I would say it's going to be another year or so, because in addition, we've obviously had to add cost to the business related to being a U.S.-based public company and the compliance requirements that we have. Those have increased in cost. So we're going to go look over the next year or 18 months to get the rest of those synergies.

Makes sense. On the Commercial Solutions side of the business, we just recently found out that there was a very large infrastructure bill that passed. Is that something that could be a driver for the business? Or do you expect any impacts coming from there?

Yes. Certainly, at the highest level, investment in infrastructure is good for our business. There is actually call-outs for photo enforcement to potentially have funding for cities related to photo enforcement. So that could be quite positive for us. And then if you look at the expansion of toll systems, toll roads are -- they're highly reliable, safe ways of transportation that generate income for local municipalities and you would anticipate that the expansion of those toll roads or new toll roads is going to be something that will be beneficial to us as well. So clearly, the details are to be settled over the next many years. But I would say that, in general, we were supportive and are excited about what the infrastructure bill will mean for our company.

Absolutely. Yes, it's definitely something that has been a hot topic now that it is actually coming to fruition, officially passed. So why don't we dig in just a little bit deeper. You gave a great overview of the segments of your business. But just go through each one. So we'll start out with the Commercial Solutions in terms of the trends for the recovery in travel, the longer rental car agreements that we're seeing that just had more billable days, and what you're seeing right now in the Commercial Solutions segment?

Yes. So the Commercial Services segment has returned in Q3 to where we were in 2019, so for the same quarter of 2019. We've done that without actually getting back to the rental volumes that were needed -- that rental car companies had in those years. So we've had a lot of drivers in our business that are creating profitability, some of which we think are going to continue as we move forward. And you mentioned some of them. You mentioned the longer rental agreements, you mentioned that we have got more administration fees per rental agreement. We've got higher tolls and higher toll margins. And then when you look at it, we've also looked at a little microcosm. Instead of looking at the aggregate population of rental agreements across the country, we looked at a specific airport. And we did a comparison of Q3 of 2019 to Q3 of 2021. And what we found is one of the big driving factors was take rate, that although rental agreements were lower in Q1 and Q2 than they were in 2019, they leveled out with where they were in 2019 in Q3. But the take rate of our product within those rental agreements moved from 62% to 72%. So you would say that the adoption of our product is increasing, that people are opting in for the convenience of the program. They're using the program more than they did with the same number of rental agreements in previous years. We think that is a trend that's going to stay, and we think that the higher toll margins are going to stay only from the fact that toll authorities aren't going to reduce the toll rates now. They've increased them and they're not going to turn around and lower them. So a lot of those trends are really benefiting us, and we think they will, as volumes return to the rental car companies continue to benefit us.

That's great. On the Government Solutions side, there's been -- I mean, all of the talks that we've had with investors when we talk about this is, of course, on the school speed program in New York City and how that's been driving growth. So why don't you just explain what that program is and how it's been helping to really support the business' growth?

Well, as I mentioned earlier, it's the largest expansion of photo enforcement for a single municipality in the world. The New York City made a significant commitment to Vision Zero, which is the concept that was actually started in Europe where they would have zero pedestrian fatalities due to car crashes. And they see photo enforcement as one of the primary sort of planks in that platform. So we've been expanding the total number by the end of this -- current tranche will be...

So just the expansion will be -- after this current tranche will be 1,440 cameras.

Yes. So 1,440 cameras and they have been very committed to it. They did not stop during COVID. They continued to expand through COVID. And so we'll get to the end of this current sort of part of the tranche of it by probably sometime in January, we'll finish installing the final pieces of it.

And the key to these installations is that New York City buys their cameras. So they're unique in that they buy the cameras rather than us expanding CapEx. The total amount of revenue from product revenue in 2021 will be approximately $50 million just from these installations alone. But more importantly to that is that each of these cameras generates recurring revenue into the future. So you think what we've installed in the back half of the year will increase annual recurring revenue for the organization by greater than $30 million into the future as we run the program. And on the current contract that they have, they have the ability to install 1,687 cameras. So we've got about 240 cameras that if they wanted to, they could continue to install into the next year without altering the contract, without increasing legislation, they’ve got the ability to go ahead and expand further.

And we just recently got a question about this, so I want to make sure that we can ask it while we're up on stage. Have you seen any supply chain impacts to those cameras that could impair that growth at all?

So I will tell you that on this particular product, we buy these cameras from a German manufacturer called Jenoptik. We work with them all on their upstream of their parts as well. So we actually placed a risk buy order for long lead time parts back in February. We didn't even get the order for this installation until, I want to say, May -- late May. So we did put some money at risk in order to make sure that we were ahead of the supply chain cycle. And what we found is that the things that are holding us up in supply chain are not the big things. They're not the camera, they're not the radar systems. It's the latches for the doors. It's the weird things that are creating supply chain issues for us. What we've done is -- I will tell you that our operations team is phenomenal. They have been incredibly creative. They altered their method by which they were installing cameras to say that they dug all the poles and installed all the electrical wiring without the camera systems available, so that when we did -- when the cameras land, they put them up like just choong, choong, choong one right after another. And we installed 116 cameras in the month of September alone. So our ability to put these cameras up has really moved through. So we've navigated very well.

That's great to hear. Glad that you've been able to navigate so well. Another exciting opportunity for [V] business has been the CRP and tolling opportunity, and you recently announced the Enterprise Ireland pilot. Interested to hear how that's moving along and what you expect that to contribute to the medium-term growth rate to the business?

Yes. I think -- so the pilot's branding, it’s probably been 5 weeks now. So I think still in the beginning stages of getting it executed. But it's a part of our thesis. It's why we went to Europe for commercial when we did and we bought EPC and then subsequently Pagatelia was that there was not a fully outsourced toll management solution for Pan-European travel for rental car. And given the density of toll roads, we felt like that was an opportunity for us to be there. There was no provider. There was no competitor. So we are greenfielding. I mean we're actually starting from scratch. So we have to do there what we have done here in the United States, which is going to toll authorities, getting established with them, setting up accounts. It's a relatively elongated process, but we're very bullish about the long-term future. But in terms of growth for next year, the growth next year for Europe on that particular part of the business won't be measured as much in revenue as it will be in traction with pilots. So our goal is to be working with multiple customers in multiple locations across Europe so that we can really get the sort of understanding of how the European market works. We can have the proof points to go to customers to say how this solution helps their renters and that, that would turn into run rate revenue leaving next year. So that's how -- and the one thing we've said frequently is COVID obviously had a financial impact to us when it hit, but the biggest strategic impact was the slowness in Europe. The travel restrictions inside of Europe have been much more heavily in force, and therefore, it's been a bit slower related to getting these types of programs off the ground, given the -- how the rental car companies are responding to the economy inside of Europe.

Understood. And of course, greenfield opportunity is something investors love to hear. As I promised, we are going to touch on T2 Systems because that is arguably the most exciting announcement out of Verra very recently. So just provide a quick overview of T2 Systems, we'll start there, and we'll dive a little bit deeper.

Yes. So we've been saying for many, many conferences now that we think of M&A as an accelerator to our growth. It's kind of our principal lever if you look at the history of the business. When you look at one of the areas that we've been very interested in is parking. Parking is a highly adjacent market to our Government business when you think about how we work with cities and municipalities and what challenges they have with mobility today and into the future. And parking is one of those. In the U.S. market alone, it's a $13 billion TAM; it’s growing. And more importantly, there is an opportunity there for what we call curbside management. So in the future, while today, certainly parking and parking meters and parking violations, those are all things that cities work with, it's really how do they deal with the changes in technology that are coming with the increase of the car share rideshare platforms, the increase of deliveries, the eventuality of autonomy and then the eventuality of EV charging. What does that mean to a city in terms of how they manage the curbs, how they get -- how do they set pricing for the curbs and how they enforce those curbs. Well, we needed a platform to do that. It's not something that we did today and T2 was a perfect platform for us to do that. So T2, their history is actually -- they work mostly with colleges and universities. But that heritage has also allowed them to diversify into smaller cities, but their platform is a SaaS-based platform that we're real excited about to say, how can we take this to our customers and start to really get into, both not only the parking side of it, but the eventuality of curbside. And so it was a strategic purchase from that standpoint. But also, there's not a lot of companies of T2’s size and caliber in the United States. So we were really excited that we had a chance to get it.

Definitely. So, if you could just quickly touch on the numbers that you put out there around the T2 business and spend a little bit of time on that margin expansion opportunity that you've spoken about.

Yes, so T2, if you sort of track back to 2019, which is a comparable year, you'd see that they are an $80 million revenue company, they had $21 million in adjusted EBITDA that year. And really where your margin opportunity is, is that they have been successfully growing their Software-as-a-Service business. And they've got the space that's Software-as-a-Service. They have some other service components that they offer, such as warranties and other things that are paid for. And then they have hardware component. They have been really successful at changing over the percentage of hardware, lowering the percentage of hardware as compared to SaaS. So they're growing their SaaS revenue. And as they do that, the margins of this business could expand. So as we look at this business, I mean, it's just a wonderful opportunity. It's got great cash flow, it's got good margins at 26%. Everybody has asked us like, well, can you make them better? And if we weren't a company that had 50% margins, people wouldn't keep asking if we could improve on everybody else's margins. So we sort of start from a really good space. But there is an opportunity for here. And it gets us where we need to be, which is closer to the curb. It diversifies our overall revenue base, puts less emphasis on those 4 large contracts we have. So from this perspective, keeping us in smart transportation with a company that already is profitable and cash flowing is fantastic.

Definitely. And on this curbside management, I don't want to push you too much, but I'm interested to hear what you think just in terms of sizing that opportunity. What could it become relative to the size of the rest of the business? How big do you expect that to grow? And how long do you think that cross-selling opportunity takes to really emerge?

Well, I would say on the cross-selling side, it's really the commercial activation plan is for next year to start getting that through. Parking decisions, not unlike photo enforcement decisions, are not quick decisions. They're RFP-driven. They're -- they do have a relatively long sales cycle, but between the penetration that we have across the 21 states with which we operate, the relationships we have, we feel confident that we can get some real cross-sell and some revenue upside relative to the timing -- I guess what the top line projections for those businesses.

Yes. So we have the SaaS revenue on this business growing at, call it, high-single-digits, low-double-digit growth rate from the Software-as-a-Service and with the hardware growing less than that, which would create that natural margin expansion over time. And we believe that there's opportunities for us to move into these sort of midsized cities that -- as a market growth, and then move into larger-sized cities overall. When you think of parking, the problems that it has, you think about the universities where you've got on-street parking, you've got lots that have pay to parks, you've got permitting in garages. So there's a lot of complications. And then T2 also plays in other places that are sort of municipalities that aren't big cities but have parking problems, such as seaside cities or places at the shore. And if we can move them across into larger cities into Florida, some of our customers in Florida are sort of these midsized, it gives just a lot of runway.

Excellent. We'll quickly touch on Q4 and then look ahead a little bit more into 2022. But on Q4, are you seeing any impact at all from -- and it might be too early, but from the Delta variant, from Omicron, and just the intense -- or not intense, but the increased scrutiny by consumers increased just attention of what could become the new reality. Are we going back at all? Or is there any potential to what you saw last year? Or have things largely stayed on schedule both in terms of rollouts of existing programs, but also in terms of just the habits and behaviors of...

Yes. If you look at -- I mean if you look at Thanksgiving, Thanksgiving travel was almost on par with 2019. So I think if you look at the United States, and obviously, Thanksgiving was pre-Omicron coming out. So whether that's going to have an impact in December is obviously TBD. We wouldn't see a hit into our business until 3 or 4 weeks. We have a bit of a delay from that business. But at least, as we would see it, I think we're still quite bullish on the travel in the U.S. still remaining at the levels it has and continuing to recover. Now, overseas, I think it's going to be kind of what I mentioned earlier. Stricter levels of quarantine, stricter levels of restrictions could have an impact in terms of our success of getting the European pilots going. But overall, I mean, we're still, I think, quite bullish on Q4 and in going into next year.

Absolutely. And as can be seen from our conference here, people are eager to be back in person. So definitely in the U.S., that is the case. Moving ahead to 2022, how should we think about those puts and takes? Starting with the Commercial Services segment, what could RACs hit in terms of 2019 levels? What are you expecting there? And what should investors anticipate as we go ahead and they start modeling out 2022 a little bit more discretely?

Yes. I think if you look at the Commercial Services business segment as a whole, I think where you're going to see growth rates -- we've always said, “hey, this is a 6% to 8% growing business.” I think you're going to see it closer to the high-single-digits, low-double-digits growth rate. I think it's going to have a great year as we move out there. But more importantly, on the Government Solutions side of the business, you're going to see phenomenal growth. Just the cameras that we're installing right now in New York should create like a 20% growth rate on service revenue. When you add on top of that the growth that you get from the Redflex acquisition, you're really moving the needle. When you turn around and you -- then T2 on top of that, then you've got the growth rate of where we want to go, which is what we've always said that we would continue to grow organically that we've got good, solid businesses that are going to continue to grow, but -- and they're going to create great cash flow. And as that cash flow comes in, we're going to use them to invest in other businesses that meet and meld with our portfolio. So we're doing exactly what we said we were going to do. The one thing that you might see pull back a little bit is product revenue. We've said that New York buys the products and we installed 720 cameras this year. They've got 240 left. They haven't said that they're going to install those. But if they did, you'd say, okay, well, product revenue would probably pull back a little bit as we moved into 2022. But service revenue is our recurring cycle, highly profitable. We're growing the revenue line that matters.

And that's, of course, what investors want to see is the recurring revenue. So that's great. On the school bus program within the Government Solutions, there's a lot of anticipation for potentially more RFPs. How's the pipeline looking for that side right now?

I think right now, it's looking positive. We -- there was a mandate that we won in New York that allows to go sell to several different counties inside of New York State and we won several of those. Now that the -- there's been, in general, a normal semester of school in the fall, we're starting to see the revenue come back to the levels of '19 than we would anticipate that as schools see that happening that they would start to activate more RFPs going into next year. And so we would anticipate, hopefully, that business getting back to approximately 2019, maybe a little bit below '19, just depending on where the schools are. There is some puts and takes in terms of how school buses are running and only runs 9 months of the year, for the most part in most of the states that we operate. So I think the pipeline is good, and we would anticipate continued growth and recovery in that business next year.

Great. I want to take a moment here to just pause and make sure that we give the opportunity for investors in the audience to ask questions if they have any. So if you do have any questions, please feel free to just step ahead to the microphone and we'd be happy to take those. Otherwise, I have a few more on the list that we can keep walking through. So anybody interested in asking questions?

So I’m new to the company. How does the pricing work? And then who is your main competitor?

Which business?

Commercial or –- is it just the city doing it themselves?

Well, so in the Government Solutions business, the pricing is sort of the market rate. These are all generally RFPs. So the market sort of exposes the rates. So the pricing is set by the market in most cases in the RFP. It also depends on the use case. So red light versus speed versus portable speed versus school bus all have different sort of pricing. Relative to competitors in that market and on the larger end, we work against a company called Conduent, they have a transportation segment where they do photo enforcement, it's kind of a smaller piece of that business, but we do compete against them. And there certainly are some other smaller kind of regionalized competitors that we compete against in different parts of the country. Globally, now we compete -- because of the Redflex acquisition, we do compete against some of the more global manufacturers like Vitronix and others.

Great. Let's talk about capital allocation and just leverage the business right now after the T2 acquisition. So how quickly should we expect the business now to delever? Are you -- is that a focus right now? Or are you still open to the market, open to opportunities that present themselves? What should we think about there?

Well, I don't think I'm ever going to get David to stop shopping. So I think he's always going to be open to the next M&A opportunity. But you're right, we've got 2 things right now. We've got a digestion problem. We've got 2 acquisitions that we've done in the last 7 months. And we've got -- our leverage is a little higher than we'd normally like it to be. Our financial policy would say that leverage should be right around 3.5x. It's a really nice level. And -- but we will get back to that. With the EBITDA growth that we've got coming up and the opportunity of cash flow generation over the next year, we'll be back down to the 3.5x lever in a matter of quarters. So when people think about, okay, how fast are you delevering, they're thinking about years, we’re delevering in quarters. So we'll be right back in there and have an opportunity to grow. We're willing to tick up our leverage now because we said that we'd be willing to do that for the right acquisition at the right time and now is the time. We didn't want to say we're not going to take this opportunity to buy T2 because our leverage is going to be higher for a little bit of time. So we're still committed to that. Our capital allocation policy is always going to be toward growth first. It's probably towards stock buybacks if the market so sees. If there's not a company that we can buy that's affordable and gives us the right return, we still believe our stock is undervalued, and we would continue to do that, provided that we had Board approval to proceed. And then after that, it's about, we can pay down debt or whatever we’d need to do, but we’d hope we'll always be investing in growth.

I think it's an important message for new investors to know that last year, we -- over this course of this year, we did 2 acquisitions. One, we paid with cash off the balance sheet and we also did a $100 million stock repurchase. So I think we take the concept of capital allocation and shareholder value very, very seriously, and we are a business that is set up to continue to do that for the long run.

Yes. And I think it's interesting, I think in some of our analyst reports, a lot of them, they don't know what to do with the cash. So they hold it out there on the balance sheet as if it's not going to do anything for us, that it's not going to create any return for the shareholders, not you guys, you guys do a great job. But everybody who is out there, it really sort of undermines what we can really do with the cash flow generation that we have. And in 5 years, they have us sitting with between $800 million and $1 billion worth of cash doing nothing, which is not what we as an organization would do. We are a management team who has proven that. And I think that's one of the things we've been public for 3 years now, almost 4 years, and you'd say that I think a lot of people are looking for the show-me opportunity, and we're proving that this year that we will return value to the shareholders.

And on the organic investment side, you now, of course, have the 3 legs to the stool. Where are you prioritizing those investments?

If you look internally, obviously, the European expansion still remains a top priority to continue to grow there. Obviously, we're going to be looking at opening up new states and opportunities inside of the North American business for the Government Solutions business because that creates new TAM and new greenfield opportunities, which can be significant and have a long, long tail to them. So we're going to continue to work on states like California and Florida and places like that. So I think -- and then obviously, we're going to continue to look at new product development where we try to listen to our customers and understand what the needs are and as new use cases develop, we want to respond quickly to either -- potentially through building them ourselves or partnering or acquisition.

Sure. Makes a lot of sense. All right. In these last 60 seconds that we have here, what would you like to share with the investor audience to make sure that they are understanding about the Verra story?

Well, maybe I'll just reiterate what we just said, which is I think as investors are looking at Verra Mobility and they get to know the business, I think you'll start to realize the high level of consistency, not only of the business model, but of how we’ve performed as a team. If you look at what we've done over the last several years in terms of executing on a very aggressive growth strategy, maintaining best-in-class margins and delivering free cash flow into very accretive deals alongside of the stock repurchase, we would say that we are a stock of choice, and we're going to be doing -- and we will continue to do that for the next several years ahead. We have a good line of sight to that.

Excellent. Well, David, Tricia, thank you so much for coming out to Arizona. Hopefully, you get to have a little bit of fun in the sun, although living out here already. Thank you, guys.

Thank you. Appreciate it.