Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

Welcome, everyone, to day 2 of the Credit Suisse FinTech -- Credit Suisse Technology Conference. My name is Nick Cremo. I help lead the payments and fintech team here at Credit Suisse. Delighted to have the Verra Mobility team here with us today. We have David Roberts, CEO; and Craig Conti, CFO. Thank you very much for being here.

Great to be here.

So I know first, they have a presentation that we're going to run through briefly just to provide a brief overview of the company. So I'll let you guys take it away.

Great. Thank you, and thank you all for being here. Hopefully, we're local to Arizona. So I hope the weather has been okay. I know it's been a little chilly for you. So I hope it's worked out for you. . I don't need to say anything on forward-looking statements you all are well aware. So great to have you here. Let me -- what we'd like to do is just kind of frame the business for you. I would put just a footnote that we did a really a more thorough work on this at Investor Day that we did last year that's online. So if you want to get a deeper dive, it's a traditional 2.5 hour presentation. It's online. I'd highly recommend it to you if any of this peaks your interest. So starting on the left-hand side, so Verra Mobility, we're a global leader in smart transportation. I'll talk about the categories of what that means in terms of the markets that we serve and the customers, but what you see on the left is that the -- as we provide services to rental car companies or local municipalities or even universities, we have a really, really unique business model with -- if you look at our trailing 12 months of 3Q, $726 million, 91% is out of recurring. So we have highly durable, consistent revenue streams. And below that, you see our margins as well at 46% adjusted EBITDA margins and free cash flow conversion of 50%. So one of the really great things about our business is both the consistency and durability of cash and cash flow, and we'll talk a little later and certainly in the Q&A about how we think about using that cash as a lever for growth and shareholder value creation. Those numbers that you see on the left are created by our world-class team with 1,500 employees globally. We operate in the United States, Canada, Europe and Australia, and I'll talk about that a little bit more in just a second. And we have over 2,400 customers. And you'll see, if you look at our businesses in Commercial Services, where we're the #1 provider of toll management solutions to commercial fleets in North America. We have a #1 position in government solutions for automated enforcement in North America as well as the #1 provider of full-scale parking solutions for universities in North America. We have really strong market share and market positions in each of these markets, and they're all growing at a really significant rate as well. So strong markets with a strong position and really great financial model to support that. Let me briefly -- I'm going to just take a second to describe kind of the -- so you can orient you -- some of you may actually be customers of our business and not even know it. On the commercial services side, we're -- again, as I mentioned, we're the #1 provider of toll and violation management solutions for commercial fleets that mostly shows up where we work with rental car companies, Hertz, Avis and Enterprise, for toll management solutions. So if any of you have ever rented a car from Hertz, Avis or Enterprise and ran a toll, we were a part of your journey. Because everything related to that toll taking place within a rental car is a Verra Mobility solution. It's a fully outsourced from the integration with the toll authorities to the procurement of the transponder to actually putting it in your vehicle to connecting to the billing system and ultimately, billing both paying the toll on your behalf as well as billing your credit card at the end is all done by Verra Mobility. It's a really strong business, and we look at the long term with high single-digit growth rates for that business. It's grown significantly higher than that and we can talk later about some of the growth drivers that are going to continue that as we look out to '26 and beyond of a high single-digit grower with really strong margins. In Government Solutions, we are -- so some of you probably rented a car. Hopefully, not all of you have ever gotten a ticket from one of our cameras because we are the #1 provider of photo automated enforcement in North America. That is red light cameras, speed cameras and school bus stop arm cam, any customers here. We do see all your faces. So I don't recognize any of you off the top of my head, but -- to be fair, my daughter just got one, I just wanted -- my 16-year-old daughter just got her first ticket from 1 of our very own cameras and Scott still I'm very proud. In that business, we work with municipalities around the world around safety initiatives, and that's principally through changing driver behavior through automated enforcement. Here in the United States, our market share is around 70% because we work with really the leaders, including New York City, which is our largest customer, not only in the business unit, but in the business as a whole. That business is going to -- we look at a mid-single-digit grower over the time frame because you have a lot of tailwinds around both favorable legislation to support it, international growth. We've done some acquisitions recently to support international growth. And overall, our renewal rates and customer retention rate is 99% plus. So we have a really strong position, growing market, higher level of attention to the needs of changing behavior. So we're really excited about that business. And thirdly, the newest addition to our portfolio is T2, which is our Parking Solutions segment, that was an acquisition we closed about 1 year ago. That business where we are serving universities as well as municipalities with parking solutions. That's everything from the payment kiosk to a mobile phone, a pay by phone to literally the gates that come in out of the parking lots. That's all -- those are all capabilities that we provide. It's also a high single-digit grower. It's a SaaS-based business, so high recurring revenue as well. All these businesses have leading positions with differentiated solutions and I'll contribute to the financials that you saw on the previous slide. To contextualize where we are, the markets themselves are large and growing. So we compete in the landscape of smart mobility, which is a really, really big term to sort of narrow that scope, so you can understand where we compete. On my left, the connected fleet solutions, we live in the world where we're working with commercial fleets, which is a really expanding area of vehicle and vehicle ownership and use. Today, we work principally with rental car and fleet management companies, but we look at those as opportunities to provide new technologies to those beyond toll and violation. So if you think about fleet administration, driver behavior, vehicle payments, telematics, these are all sort of the landscape of the world that we compete in today. So we're excited about looking at how we might add some of those solutions to our portfolio, not only here in the U.S. but in Europe as well. And on the right, urban mobility is really the principal area that we operate in relative to smart mobility. This is everything that -- all the technology that cities need and use to kind of keep traffic moving both reliably and safely and also with a nod to the impact on the environment. Those are all areas that we work in today. We partner with cities like New York and Chicago, and we work with New South Wales and London. So we're partnered with really some of the prime cities in the United States and globally to work on those. And each of those markets is large and growing, and we're excited to see what the future holds for us given the position that we have in each of those markets. With that, I'll turn it over to Craig to talk about the financials.

Thanks, David. I'll go through this relatively quickly. I want to make sure we leave some time for some good discussion and Q&A. So financially, $726 million in the TTM period ending the third quarter of 2022. That's a 20% total revenue CAGR, if you started back in 2018. You can see on the slide here, we spiked out T2 Systems, as David just mentioned, we closed that acquisition is actually around the first week of December in 2021. So when we talk TTM, not quite a true TTM for T2 with $66 million, business is growing nicely, as David mentioned, high single-digit grower in the future. 91% of our revenue was recurring in the drill, as David mentioned, the drill down maybe just 1 level deeper. When these contracts come up, we have about a 95% plus renewal rate across the entire company. So when we talk about the consistency of the business, I think it's really important to think about that. From a profitability standpoint, $335 million of Q3 TTM adjusted EBITDA. That's 46% margin. If we look at this as a 5-year CAGR, 15% growth, 50% conversion to free cash flow. And before I leave this page, I want to back up to 2020 for a second. As David was walking through the businesses and we talked about commercial services and the RAC business and how dependent that is on travel, I want you to think about what 2020 looks like and what it might have looked like for Verra Mobility. So as we all know, travel went to 0, not 5%, 0 in the second quarter of 2020 and stayed there for the balance of 2020, and that's 42% of our business. But take a look at the financial results for 2020 in totality. The business still generated $182 million of adjusted EBITDA of 46% margins and we made over $20 million of free cash flow with travel went 0 for 3 quarters of a year. So something to think about when you think about staying power of the company in the future. Quickly on the balance sheet, we'll talk about leverage. We closed the fourth quarter of 2021 at 4.3x net levered. We did 2 deals in the back half of 2021. We purchased the Redflex business, which was a nice add to our Government Solutions business. Big international footprint. We did that in June of 2021 -- or July, 1 of the 2. And we purchased T2, as I said, in December 2021. So our leverage was quite high when we closed the year. We'll close the 2022 at 3.4x net leverage. And during this time, not only have we delivered the business, we've also done $225 million worth of buybacks over this term. So when you think about the leverage of the company, I think it's really important that the strong free cash flow generation allows us to delever over a period of quarters, not over a period of years. A little bit on our capital allocation strategy, if you got a chance to see it, we put out a press release the Monday before the Thanksgiving holiday, talking about how we're thinking about near-term capital allocation. So from a share buyback perspective, I mentioned we did $225 million in the last 5 quarters. We have a new authorization for $100 million, which goes out for the next 18 months. On the debt side, again, we'll close the year at 3.4x net levered. We're going to take that down to 3x net levered by the end of 2023, and we're going to look to some of our stack. I'm sure we'll talk about it at the Q&A, is floating, right? So we're looking to manage our interest rate exposure by both debt paydown and the potential of putting a derivative on top of that, that we're still evaluating. The other thing that's important is we look to pay down debt and do repurchases, it's not at the expense of the organic investment in business. So we did about $50 million worth of CapEx in 2022. We're going to do that again in 2023. So we are fully funded from an organic investment standpoint and we're still opportunistically pursuing strategic M&A, not a Verra Mobility specific comment. But I think as you look at the M&A environment right now, price expectations have not come in line with the current financing market is, so that certainly slowed down, but that is something that we pay a lot of attention to and are very active with the pipeline. And then finally, if you had a chance to hear our earnings call, that was just a few weeks ago, you would have heard this. Our previous guidance for the year for total 2022 on a revenue basis was $720 million to $740 million. We put that out in our Investor Day, which was July 19 of this year. We've gone to the higher end of that revenue guidance. And we did this by continuing to see strength in the travel market and really solid performance from Government Solutions in T2. We did the same thing on EBITDA. Our prior range was $325 million to $335 million. We went to the higher end of that range. And we're excited about where we'll close 2022 and going into 2023 as well. So Nick, that's what we had.

All right. Great. Maybe we could just start with just by reviewing the trends that you saw in Q3 and maybe like what you're seeing quarter-to-date, I know that there's the TSA data for the Commercial Services segment that investors track. So maybe we start on Commercial Services.

Yes, David, I'll take that one. Yes. So for those who might not know exactly what we're talking about here, this is TSA throughput and it's the number of people going through checkpoints in the United States of America. In a good way I think that's been a good indicator of our business as we've looked at where we are in 2022 versus 2019, so pre-pandemic. And the way that's trended, if we look at the first quarter of 2022, it was about 83% of the throughput that we saw in the first quarter of 2019. And then in the middle 2 quarters, Q2 and Q3, it was around 90% to 91%. And in the fourth quarter, we're at trending right now quarter-to-date around 94% to 95%. So I think there's kind of 2 things you take away from that. Number 1 is that travel recovery out of COVID is still going, right? And it's increasing quarter-over-quarter. The other thing is, if you look at it spatially, right? We're still not back even. A lot of you traveled here today. You saw a packed airport, you're seeing a busy hotel. We're still not back at 2019 levels yet as we're 95% quarter-to-date.

Great. And then in the other 2 segments in Government Solutions, are there any trends to call out? I know in the last earnings call, you guys mentioned with the New York contract that was not extended, but now you guys are picking up like an incremental 5% in revenue. Maybe we can go over Government?

Yes, sure. So what that is, that is -- it's school zone speed and when New York City announced that they were going to do is instead of having the cameras on recording just during school hours or daylight hours, going to 24/7 right? So that's going to be an increase of -- assumed increase of violations as folks continue to drive through those school zones. So what we think that's going to be for us. It's about a 5% increase in our total New York City volume. It will be about $5 billion to $7 billion of incremental revenue in 2023 versus 2022.

Maybe just to contextualize for people that may not be aware. So New York City over the last 3 years has deployed the largest automated enforcement program in the world. We are the sole provider of that. They've deployed over 2,000 speed cameras in school zones across the 5 boroughs. We've installed every single 1 of them, and they recently took that from operating during school hours to a 24/7 opportunity. So it's been a real win for the organization.

And then the Parking Solutions segment with T2, it's been about a year since the acquisition closed. How is that tracking relative to your expectations?

Yes. I think the service revenue growth has remained strong. It's a SaaS business. It's sort of a hardware-enabled SaaS business, I guess, you might describe. And so what we've seen is continued growth in the SaaS revenue, which we've been really excited about. Starting to make more traction into smaller municipalities and hoping to tap more into our relationships to start moving sort of up the value chain in 2023 and 2024 for larger parking mandates. And so we feel like we're in a really good situation with the business.

Okay. Great. Now Craig, maybe 1 for you. Just touching back on the press release out last week, how you have a new $100 million share repurchase authorization and they intend to take leverage down to 3x by the end of the next year. What should we think about for capital allocation over the next 12 to 18 months?

Yes. I mean I think when you look at how do you get to 3x net levered by the end of 2023, there's 2 ways to do it, right? There's to leave the cash on the balance sheet or we pay down the debt. And I would say I'm kind of agnostic to those if we have a deal in the pipeline. If we don't have a deal in the pipeline, we'll probably pay down the debt because you eliminate the interest expense to do that. So -- and if you look at what we've done historically with our buybacks, we're an intrinsic value -- we look at intrinsic value to determine when a buyback makes sense, right? So looking at intrinsic value of the company, discount that back to year-end share price and then compare that to where we're trading today, compare that return to other uses of capital, which would be the pay down of debt or potential M&A. So that will continue to run that playbook. But I think 1 thing on the leverage we talked about being at 3x net levered by the end of the year. At Investor Day, we talked about a 3.5x net levered business. I still think over term in 5 to 7 years, 3.5% is probably the right flight path for the company. But given where we are in this interest rate environment, the uncertainty today, we thought it prudent to take down to $3 million. And we have the operational cash flow to do both.

Absolutely. Yes. So just a follow-up question on that. So when you view cash on the balance sheet, is there like a minimum level that you think is like a good sweet spot for Verra Mobility or like a minimum cash that you need to run the business?

Yes. I mean I'd like to think about -- so first of all, I think about total liquidity, right? So cash plus our revolver is undrawn. It's a $75 million revolver at any given time, certainly, where we sit today, $65 million to $70 million of availability net of the locker. So I look at that plus about $40 million worth of cash. So $100 million of liquidity. I can go $10 million, $15 million less than that. That's about the Kanban line for the company, right. To feel comfortable, I'd like to have $50 million to $75 million of cash and an undrawn revolver, but anywhere in between those levels. That's where we closed the third quarter. It was about $50 million of cash on the balance sheet. And if I project out to 2023 and we're 3x net levered, we may again be at that level. That's about where we want to take it.

Got it. Yes. So just kind of shifting to the M&A side of capital allocation. Like #1, how is the M&A pipeline looking? And then is there any notable shift in like the size of transactions you guys are looking at or maybe different types of capabilities for your various segments?

Yes. I mean, I think overall, we have a team that's committed to M&A. It's been a strong driver of our growth over the long term, and we'll continue to be an acquirer and on offense. I think certainly, the market today has sort of given a moment of pause to larger-sized transactions just given the availability for funding and financing. I think what -- the nice thing is we are starting to see more private equity deals starting to shake loose because those guys are going to need to sell at some point. And so I think we're starting to see a higher level of potential opportunities. And the great thing about our business model is that we can commit to a share repurchase and debt pay down, but we can still remain opportunistic because of our cash flow to take advantage of perhaps some pricing that may come down as a result of the current market environment, which would be good for us. In terms of the size of the deals, it is really varied. There are I would think that the T2 size of the deal is probably like in the middle of what we would look at, some smaller, some bigger.

Got it. That makes sense. And then possible just to shed a little bit of light on the M&A framework. I know you guys talked extensively at the Investor Day on that.

Yes, sure. We are a DCF buyer. So we look for opportunities to generate cash flow, so we don't look at pre-revenue companies for things other than partnerships. We certainly have partnerships with start-ups to help sort of see if there's an opportunity later, but we are a true DCF buyer. So we look at strategic fit. Does this advance the cause of the markets that we serve in today? Does it address the need of our customers that's either expressed or we think is going to happen in the future? We try to look for, hey, can we accelerate the growth of the businesses in the markets there today? And then also we look at, hey, are there other sort of "third leg of the stool similar to T2" where we can expand the portfolio of offerings within Smart Mobility because we would be a really credible buyer and that we can invest in a company to make it to have the sort of similar types of dynamics that we've had in our other 3 businesses.

Got it. Very helpful. So I got to hit you guys with a macro question. I know Craig touched on this briefly in the presentation, but we just think about the recession resistance of your business and your margins, how should we think about that? Like what percentage of your revenue is on long-term contracts?

Yes. So let's go business by business, right. So I think if you look at macroeconomic environment. And when you look at our business, you have to separate macroeconomic environment, what's going on with travel because right now, those are 2 kind of different things. Macroeconomy slowing down, travel still stayed. So at some point, if travel were to slowdown where would that impact us, that would be in the CS business, right? That's our most profitable business. So you would see as favorable as the incrementals are as that business grows, is unfavorable as the decrementals as they go down. The reason is a lot of fixed cost to support that infrastructure not -- not a lot you can take out. So -- and to gauge that, right, you would probably hear of a slowdown in travel. It's not going to come from Verra Mobility, you'll hear from the airlines first, right? And you're not -- certainly not hearing that today. So to be crystal clear, we are not hearing that, right? But when that does come, you'll hear it there first and then it will be a good way to gauge that, would say, how is that PSA throughput coming. As it starts to slow down, you'll see that slowdown in CS. Now let's go to the parking business. About 1/3 of the parking business, so David mentioned, this is a hardware-enabled SaaS business. 1/3 of that business is equipment, 2/3 is SaaS on long-term contracts. So if you were to see a recessionary impact in that business, it would be a portion of that 1/3 would be impacted, that 2/3 not really. Then you go to the Government business, talking 45% of the business, very low impact from a recession. Almost all of that business is on long-term contracts. And one thing I think that's been proven is that in a recession, people don't drive less and they don't necessarily drive more carefully because it's a recession. So to summarize what I said in 2.5 minutes, right, it's the CS business is travel. A little bit of equipment you would see exposed on T2, not a lot on GS.

Okay. Got it. And then just kind of taking that free cash flow generation in a recession, is there any notable callouts there? Or should the EBITDA conversion still the...

The EBITDA conversion should be pretty close. I mean you have a good cash flow on the CS business because it's a higher margin business. So -- but it's -- I mean, it's not going to take you to 10% or anything like that. There would be a bit of an impact, but it wouldn't be cataclysmic at all.

Got it. So just looking ahead to 2023, and I'm not asking for guidance, but I mean, you guys did give these longer-term targets at your Investor Day of 6% to 8% revenue growth over the medium term as well as 8% to 10% EBITDA growth. So I mean, what are the main things that Verra Mobility needs to execute on to hit those targets?

Yes. The nice thing about the sort of perspective view that we gave of the business at Investor Day is that, that's our business as is, meaning we don't have to do a deal or launch a new product per se to achieve those of the markets and the products and the positions that we have put us in that. So we feel very confident that effectively, what we said at Investor Day is exactly the same that we're going to be within that range. I'm sure there's going to be years where we'll be well above. And there may be years where you saw those are macroeconomic factors that we don't get to predict. But we still feel very -- we just have to execute on the businesses that we have today, continue to sell and serve the customers in the markets, and continue to make traction in some of the strategic initiatives around what we think the future is going to hold for each of those businesses, whether that's updating platforms and making sure that the technology stacks that we have that are serving customers so they are able to serve them and serve the business well into the future.

Got it. So just looking ahead to '23 and short of providing any guidance, are there any like main puts and takes that you think investors should be aware of?

Interest. I mean interest cost.

Interest cost.

Right. So it's -- that's probably the big 1 that -- just to go through our debt stack for those who may not be familiar with it, it's $1.25 billion of total debt, $350 million of that is fixed. $900 million of that is floating. Floating at L plus 325. Now that L plus 325 talking of room full of bankers and investors right, so everybody knows exactly what I mean. That's great. So the L plus 325 is the term loan B. So it's covenant light, which is great that I can prepay it at our option. So when we talk about delevering the company, that's an option that's available to us and that we're going to do. The other thing is we can select the interest rate or the interest rate duration within that loan. And this is important if you're looking at the company year-over-year. So in 2022, fortuitously, I'm not saying I anticipate was going to happen with rates. At January 1, 2021, we locked for 6 months. And then on June 30, 2021, we locked for another 6 months. So we've really lagged the curve here. So interest is going to be artificially kind of compressed in 2022. And it will go forward in 2023. And the quantum is not hard. So we think about 5% for that L adder, if you will, on that debt stack, and we'll pay some of that down. So that would be one. I think the other thing as you look across the businesses, nothing has changed from what we said at Investor Day. We're expecting organic growth. We're expecting margin expansion, and we'll have some nice free cash flow generation. We're finishing up the plan and we'll come back, obviously, in February with a more holistic answer on that.

Got it. Sounds good. We have a few minutes left here. I have more questions prepared, but I wanted to check if there's any questions from the audience.

Can you just help us understand the free cash flow conversion of 50%. It seems a little low. Is there something per payment company? I don't know if it's like a CapEx or net working capital? How should I think about that.

There's 2 big things, not really a full pure-play payment company, right? So that's one thing. But the -- you think about the dynamics in the commercial business, right, when you're a renter, you drive under a toll gantry, Verra Mobility actually pays that toll. And the reason I make that distinction, there's 54 toll authorities in the United States, we have funds on deposit with all of them. So as that business grows, that's a working capital draw on the business, so year-over-year you're always going to see that. That's number one. And it's relatively significant, tens of millions of dollars. The second one is CapEx, but it's not CapEx like you would see in an industrial company, it's a revenue-generating CapEx. So the way that we go to market in our Government Solutions business for the majority of customers, in fact, to make it overly simplistic just about everybody, but in New York City. That photo equipment stays on our balance sheet. So we go with a cost-neutral solution to a municipality. And the way I like to think about it is our cost of goods sold comes through depreciation, in large part for our ARR business and Government Solutions. So those are the 2 big pieces that you would say, if you felt 50% felt kind of low. You bet.

Again, any other questions from the audience or -- all right. So I think these are some good ones to end on just on the large TAM that you guys highlighted at the Investor Day, a large portion of it for both Commercial and Government Solutions related to emerging opportunities. So maybe if you could just shed some light on what you're most excited about in the near to medium term.

Yes. I think outside of just the opportunity for our core business to continue to deliver the way that it has over the last several years and into the future. I would say that within -- as an example, Government Solutions, there really has been a nice what I would call a legislative tailwind related to automated enforcement. And what I mean by that is you have to have legislation at a state level that a state can then select to use or a city can then use red light or speed or school bus or bus lane. We have seen a higher level of adoption of those types of legislations, I think, sort of triggered by New York and that sort of caught fire as it were across the country. So we look at a lot of favorable legislation coming out over the next several years, which supports not only our core business, but even as we expand into new opportunities like bus lane where we do bus lane enforcement in New York City as well as in Seattle, and we look at that as a new emerging use case that's going to expand just like work zone speed. So those are some sort of near and present examples of new opportunities that we're already doing that have a nice tailwind with them that I think we're quite excited about.

Great. Well, it looks like we are almost out of time here. Any last words you want to leave the audience with.

It's a great business with a bright future. And if you want to learn more, our Investor Day is on the Investor Relations, you could see the presentation. There is a full digital replay and it's really contemporary, we just did in July of this year. So if you want to learn more about the company, that's a great resource.

Yes. Great.

Thanks everyone for coming.