Verra Mobility Corporation (VRRM) Earnings Call Transcript & Summary

Thank you very much to everybody for joining us this afternoon. I'm going to chat with the CEO and CFO of Verra Mobility here in a moment. But before we get started, I have an important disclosure to read. Please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley rep. I'm James Faucette, one of the senior analysts here at Morgan Stanley. Very pleased to have with me David Roberts, President and CEO of Verra Mobility; as was Craig Conti, CFO.

Maybe we'll just start with the basics. I think for a lot of investors that we talk to, Verra screens quite well from a valuation perspective, durability of earnings, et cetera. So maybe you can give us an overview of the business segments, at least for those that may not be familiar with the company and as we're doing this, let's talk about high-level view and mix percentages would probably be helpful for people. Just like what percentage of the business is this and that, et cetera.

Okay. So I'm David, I'm the CEO. Thanks for being here today. So Verra Mobility is the global leader in smart mobility, and the way that shows up to contextualize it, we operate today in 3 business segments. The first one, which is, I don't know, the [indiscernible] for Government Solutions.

About 40 -- 45%.

45%, yes. 45 -- 40.

45, 45 and -- yes.

Yes, yes. As Government Solutions, where we're the #1 provider of photo enforcement in North America. So those of you that have ever gotten one of those tickets in the mail with your picture looking kind of oddly because you were going 55 in a 35, we were the portrayers of that. That's our technology. That looks like red-light cameras, speed cameras, school bus stop-arm cameras. We operate that business not only in North America but also in Australia and in Canada and in Europe. We've done that mostly through acquisitions. The other primary business is Commercial Services, where we're the #1 provider of toll management solutions in North America for commercial fleets. That mostly shows up where we serve rental car companies. So for those of you that may have rented a car even while you're here, or whenever you're on a business trip, and you see that little -- that badge up in the window for tolling, that is us. So everything related to that program is a Verra Mobility solution, from the integration to the toll authorities to the payment of the toll on your behalf and to the billing of you and partnering with the rental car companies to deliver that. That business operates, not only in rental car but also in fleet management companies. We operate that business in North America and Europe. And then finally, our most recent acquisition is a company called T2, which is a leader in parking management for universities. That's a full suite of parking solutions, everything from the access control and the cameras that lets you go into the lot to the software to manage that to the permits enforcement and to the mobile payment. So that's the sort of breadth and depth of the company today.

So let's start with the different pieces. Maybe I'll start with commercial to begin with is your longer-term growth algorithm calls for high single-digit revenue growth. But how should we think about the primary drivers of that business, whether it's continued shift to cashless, penetration of existing customers, adding new customers? What are the pieces that kind of make it -- make up for it to get that high single-digit revenue targets?

Yes. First and foremost, we're obviously a part of travel. And travel is still recovering from the sort of post-COVID, and that looks to be a durable trend. So Number 1 is, obviously, travel has to maintain and pick up. Number 2 is the ongoing development of new toll roads in North America. There are several new toll roads that are under construction today, and more are being added regularly. Third would be those toll roads being cashless. So our -- the solution that we provide is best used in a cashless environment, meaning you can't pull over and stop and pay someone at the toll booth. You're actually going straight through, and you're using our technology to effect that. Currently today, about 60 -- what was it, 64%...

64%.

64% of toll roads today are cashless, and that'll continue to go on. Now that's going to take some time. Toll roads don't make changes quickly, but that's the expectation of that going forward. And then in addition to that, we have a fleet management company business or we partner with fleet management companies in North America, where we do violations in title and registration where we continue to expect that to grow. And then finally, we do have capabilities inside of Europe where we're trying to build out rental car tolling and fleet management tolling across for a pan-European solution. We've done some acquisitions to put that together, and we anticipate over the longer term that will grow as well. So those are sort of the disaggregated view of growth for that business.

Got it. So you mentioned travel. And in terms of car rental trends, that seems to be a big underlying driver for that part of the business. How are you thinking about room for continued recovery in 2023 based on either what you're seeing or what you're hearing from your rental car company partners?

Yes, sure. So I think when you think about Verra Mobility and the demand, the first longer-term indicators what you're hearing from the airlines. And I think with this earnings season, you heard very bullish forecasts for what travel is going to look like at least into 2023. Then maybe a little further down the trough, if you look at the hotel book at these companies like Expedia. And then I think, quantitatively for the company, what we tend to focus on is the TSA throughput. So let me give you an idea, and we'll look at this as a percentage of 2019, so prepandemic travel. Let me give you an idea what the trajectory looked like in 2022 in terms of the recovery and what we think that looks like in 2023. So as a percentage of 2019, we started the first quarter of 2022, 83%. 83% of what we saw in prepandemic. That was up to about 90% to 91% in the second and third quarter. We exited the year at about 94% throughput. Now we'll fast-forward the tape to 2023. On a year-to-date basis, it's right at about 100%, maybe a tick above. So as we look at 2023, we expect for Commercial Services, the TSA throughput to be roughly in line with 2019, maybe a tick more.

I think that trend is also supported by -- if you listen to the public airline CEOs, they've sort of been very bullish on the -- on their outlook for travel for the next 12 months as well.

Yes. And I think just today, there was a survey of consumers that was published by third parties saying that the intention to travel was continuing to accelerate and grow right now so -- in spite of concerns around the macroeconomic conditions. So that's definitely encouraging. So if that's kind of the core driver, one of the other key things is that you've talked a lot about is the opportunity for geographic expansion, for example, to Europe, et cetera. I know you've been in testing in -- with at least a couple of companies there in different countries. What's the update on Europe? And the progress maybe has been slower than at least we would have anticipated, but it's hard to gauge what's happening given pandemic and everything else. So just give us an update what you're seeing there, what the opportunity set is and what the milestones may be?

Yes. So maybe let me start with why Europe. First and foremost, our customers asked us about it. So the same customers that we serve here in North America have operations across Europe, and they wanted us to see if we could help them in a couple of areas. And then two, it was effectively greenfield for us. So when you're looking at adjacent expansion, you have the same product, same customer, new geography, that's kind of a recipe for hopeful success. What did happen is the pandemic and the impact of COVID-19 inside of Europe. Obviously, travel came to a screeching halt here. It maintained at a halt in Europe for much longer. They defleeted the vehicles more and the recovery back to sort of full fleet has been much slower. And so that has slowed progress. And obviously, when you're dealing with that type of sort of exogenous environment, you're also saying that, well, ancillary things like tolling weren't as important. But we are -- we do have pilots currently in both Ireland and in -- well, Spain. We had done some pilots inside of France. But the real trend that we anticipate that's going to accelerate here over the next several years is the conversion of those toll roads to cashless. Currently, the 2 largest countries we're tolling are both France and Italy. Both are barrier based, meaning the arm actually still comes in. You go up and put your credit card in or pay someone. As those go away, the value of our program increases, and just at the end of last year, 2 toll roads in France went cashless, which is sort of hopefully a harbinger of good [indiscernible] and maybe just by way of context, there's more toll roads in France than all of the United States. So that just kind of gives you the concept of the potential opportunity which is why we're spending so much time there.

And -- can you maybe delve a little bit into the economics of like how you guys get paid on like where your spread comes from, et cetera? So -- and then we can compare and contrast now versus where that might go.

Sure. principally, we -- there is a fee that the rental car companies charge their customers that they are totally in charge of. And we have an arrangement with them on a fee based upon what that fee is. It's obviously not disclosed, but that's something that's different for each product as well as for each customer.

So if I can just interrupt. So a lot of times, rental car companies will charge like X amount per day plus the tolls or whatever that are collected. And then so you're collecting -- so your revenue is a piece of that per day amount or the per toll amount? Or how does that [indiscernible]?

Yes, the way that it works is there's the administration fee. We get a piece of that. We then pay the toll. And when we pay the toll, because of our usage and the relationships with toll roads, we pay the electronic rate, which is the lowest posted rate. We bill at the cash rate, and that percentage or that difference is something that goes to us as well.

And so therein lies kind of, I guess, one of my questions is like, as tolls go or as roads go entirely electronic, does there still tend to be a "cash rate" or like an unsubscribed rate that allows you to manage that spread?

Yes, it stays with it even when they go cashless, and the reason being is that, while the rate is sort of called the electronic or the cash rate, it's also for people that actually have account there. So their incentive is for the people to have an account to not get violations to have a transponder in the vehicle. And so because we have accounts, effectively, we have prepaid accounts at 54 toll [indiscernible] across the United States, we get to avail ourselves of the rate that anyone is available to get. It's not a special thing for Verra Mobility. It's anyone that has those accounts.

Got it. Got it. And so then when you think about moving into places like France and like their massive toll road systems or Ireland, where you said you were piloting, is that -- is it -- will it be a similar structure in those markets? And...

No. It'll be a totally different structure, more of a fee per type of arrangement because just the structure's so different there.

Got it. Got it. But what -- like how should we think about that then as terms of potential revenue per rental day compared to the U.S.? Similar once it's all netted out or hard to say still?

I think it's early to say that because we haven't had enough volume, I would say. In the United States, we have 2.5 million vehicles that are running [indiscernible] basis. We have less than 10,000 right now. So I wouldn't want to say [indiscernible].

Yes. So it's still a lot to be determined.

That's right. That's right.

Got it. So another question that we tend to get from investors is how you view your customer concentration risk on the commercial side specifically? You have contracts with some of the largest RACs? How should we think about timing of customer renewals and potential of Verra losing one of these primary RAC customers. And I think a lot of times people wonder -- like would the company's internalize what you guys are doing is probably the most common question.

Sure. We -- I guess the important context is that, collectively, Verra Mobility has been the sole provider in many cases to these rental car companies for over a decade. So if you were to look at the experience and understanding of how to work with these companies, we have that inside the 4 walls of Verra Mobility. What I would also say is that like we're not oblivious to the fact that we have 3 customers that have a large percentage of our total revenue. Like, we get that. But it's really our privilege to serve them, and we feel like we're going to be doing so for many, many years to come. First and foremost, what we would tell you is we have a mantra inside the company that we serve our customers at their highest point of need. So while we do tolling, we do that, we also have diversified our products and services with them. So we do violation processing. We do asset management for them. We do title and registration. So we've tried to find other ways that we can be meaningful to them other than just tolling. And that being said, as you think about tolling, it's a fair question to say, hey, could they do this themselves. And the answer is, yes, of course, they could. But the question would be why would they do that? Ultimately, their job is to make sure that the assets that they purchased are out there being rented. It's not so much whether they care about the ancillary service, whether there's a baby carriage in it or whether there's tolling, they want to make sure that the rental car is being rented on a regular, regular basis. And so they would have to decide that they want to get into creating integrations with 54 toll authorities, that they want to learn how to -- all the other things that we do that they've given more to us over time, not less, it would be a nontrivial amount of effort for them to do that.

Right, right, right. So I want to let everybody know, if you have any questions, follow-up, raise your hand. I'll be happy to get you a microphone. I'm wanted to shift now to government. But if anybody does have any questions back on the commercial, just let us know. So on the government side, within Government Solutions, you've talked about mid- to mid-single-digit growth roughly longer term. Can you talk about the opportunity in that segment from a different product offerings, whether it's speed, safety, red-light safety, bus stops, how should we think about the growth of those different business lines or products?

Yes. The business is really well positioned. There's been -- unfortunately, the challenge in the United States of deaths related to traffic fatalities has only increased at a precipitous rate coming out of COVID. And so cities are much more in tune, and not only cities, but state legislatures are more in-tune to the fact that these are powerful tools to help address a really compelling need. That being said, what we have seen is what we call purpose-built enforcement, which is, instead of just putting a camera in an intersection, we can put it either in a mobile unit or in a school zone. So school zone speed is a very -- I guess I can use the word popular, but it's one that more and more cities are adopting. New York City just put -- they put 2 cameras in every school zone in the 5 boroughs, so that they were sort of setting the tone there, so 2,100 cameras total. And other cities and municipals are recognizing, hey, protecting kids in school zones and speeding in school zones is a very rational request on our behalf, and we're going to enforce that. Now you are starting to see things like work zone speed where, hey, workers in construction zones on highways, they should also have the opportunity to be safe. And then you add that in school zone what we call school bus, which is school bus safety is when the stop arm is extended and the lights are on, if someone kind of blows by the other side when kids are trying to get on the bus, we can issue tickets -- issue violations to them as well. So we're really trying to modify the uses of automated enforcement to very specific use cases that people can get behind and understand the value to.

Got it. Well, and I think that's one thing that's interesting because there are jurisdictions that either have had speed cameras specifically or even red-light cameras, and they say, "Well, we don't want these in these areas," but then you start to see pilots pop up specifically around school zones and school bus, et cetera. So it's interesting to see like how that discussion kind of moves back and forth in different places.

Yes, there's a clear -- there has to be enabling legislation at the state level to allow cities to do it. And I know you guys may not believe this, but sometimes, politicians have disagreements. And so there can be disagreements even on things like this.

And then what is your sense right now on movement around some of those laws and regulations and allowances? Where are states that we should be paying attention to? Do you feel like it's probably the next point of movement.

Yes, I think what you can look at is there are states that have, over the last, call it, 3 to 5 years, really increased the level of penetration of not just 1 use case, but multiple. So Georgia is a great example, a very conservative state by nature but has adopted both red light, speed and school bus because they recognize that this is -- it works in terms of increasing safety. It's a force multiplier as well as it's effectively cost neutral or even revenue generating in many cases. So they don't have -- it's a fully outsourced program, and they can trust in us, or they can trust in us to do it. But I would say on the margin that automated enforcement has been around for 2 decades now. I think people understand the efficacy of that. Cities have gotten quite used to it. And I would say that, on the margin, state-legistative bodies are more prone to it. We certainly are excited about looking at places like here in California and Florida for some expansion of some different use cases outside of the ones that are there today.

So you guys -- I can't remember, it was a couple years ago that you bought -- closed the deal for Redflex. Is that right?

That's right.

And from a profitability standpoint, my understanding was at the time that you acquired Redflex is that they weren't quite profitable, et cetera. You were -- maybe they were close to profitability. But where are we on like realizing those synergies? What was important to do as part of that acquisition that allowed you to improve the profitability of that operation, et cetera.

Yes, sure. So it was profitable when we bought it. And I would say from the synergies that we identified, we're roughly 3/4 of the way. This was a best of both type of integration, right? And we're not running the business anymore with what I would say would be legacy government solutions they had Redflex. And the best of both has allowed us to do this, but that ended up being a great buy for us, and the acquisition has gone very well.

So -- and so you're about 3 quarters of the way through the synergies that you'd expected with that?

That's right.

Okay. Got it. Got it. So wanted to -- so let's turn now to parking. You acquired T2 at the end of 2021, which was kind of your entrance into the parking part of the market. Can you talk about why parking? Why T2? And then maybe bigger picture, how do you think about the path to achieving your high single-digit longer-term growth targets for that segment?

We had been looking at parking for some time. If you were to look -- if you go back to our Investor Day presentation, we talk about urban mobility, which is one of the categories that we're clearly in inside of our Government Solutions business, and if you listen to the needs of customers that we work with and they recognize that the curb is becoming an area of both challenge as well as opportunity. More assets are looking to use the curb, whether that be delivery or shared economy via Ubers and Lyfts as well as things like charging and bikes and e-bikes and things like that. They're just becoming into more congested areas. So they need solutions to help manage that, to enforce it, and to make sure that they're getting paid appropriately for the use of that very valuable resource. Now that's a little bit into the future. That's the future that we think quite comparably is coming. That's effectively parking today. And so what we had been looking for was what was a really strong asset that had really great portfolio products that was profitable that we could bring in to our portfolio, we could help accelerate that growth by partnering with government solutions to get into larger municipalities as well as help just accelerate into some of these other areas of curbside management. So we have been looking for some time, found T2, and we were excited to close that deal.

So you mentioned in the past from talking about T2, the ability to leverage your existing government relationships to accelerate T2's revenue with cities and municipalities. I guess I'm curious if you have a time line when you'd expect to realize some of those synergies or any sense of magnitude that the opportunity on [indiscernible] could represent?

Yes. To be clear, when we bought the company, we don't ever use revenue synergies as a part of the transaction. Just we're always -- that wasn't part of the deal model in any way, shape or form, but it's certainly upside to the opportunity. That being said, I know this would be surprising to know that parking decisions don't get made quickly. It's a long gestation period, and then once you get them, can have them for a very long time. So I would anticipate, toward the end of this year, we would start to see some of the fruit of our labor in terms of partnering with that. But the good news is T2 on its own has a really great business with universities. It's continuing to grow. It's a highly recurring software business model that continues to recur and grow. And so we're super excited about that and really just layering on some acceleration to it through partnering with government solutions.

Got it. Got it. So what about other opportunities potentially on the horizon that we should be thinking about? You added tightened registration business in the past, which is a really small percentage of revenue, I think. But you did it given that it was something your clients were looking for, and then you acquired T2 and Parking. If we're thinking 3, 5 years down the road, what should we be thinking about that could make the business look a lot different than it is today.

Well, I would say we really like our business today. If you look at our margins and our growth and our free cash flow, it looks great today. So if we just replicate that and be a little bigger, we would be super happy with that. It really comes down to 2 things. One is we have committed ourselves to be a portfolio company, so in the likes of a Danaher or a Fortive, which is we're going to have a portfolio of assets inside of smart mobility that have great businesses with great leadership teams that produce ongoing recurring revenue that we can continue to redeploy through thoughtful capital allocation. The segments that which we'll apply that model, we talked about at Investor Day, which are in the connected fleet space and in urban mobility. So connected fleet would be, hey, what are other use cases that we could be a credible provider to the customers that we already serve today with other products that we probably need to buy versus build, things like -- these are just illustrative please. I'm not pointing to anything specific. But things like asset tracking or telematics or vehicle payments, those are all areas -- and EV charging are areas that we're excited about to look at to decide, hey, how can we lean into those into the future 4 or 5 years from now. And on the urban mobility side, congestion pricing, road user charging, traffic management, connected -- or V2X, which is the infrastructure speaking to vehicles, those are all very exciting areas as well that we'll continue to investigate.

Got it. What about competition? I mean, it seems like market leader, as you said, across your business lines, but anything that you're seeing in the competitive environment, even if it's not direct competition but maybe it could be substituted?

Yes. I mean, look, across our businesses, we do have competitors across all the segments that we compete in. In some cases, we have really strong positions, and others, we're not quite as big. So I guess the way that I look at it is there is always somebody with newer technology. I think the pace of change inside automated enforcement and how cities are thinking about the future of AI and using that roadside for multipurpose use cases is something that's really accelerating. We're seeing more and more in that area in terms of manufacturers of what can a single camera do today that it couldn't do 5 years ago was really compelling. And certainly, that's something that we need to watch as we look to who we're going to be partnering with to manufacture our cameras. And then I would just say within the concept of connected vehicles, that's a future that has competitive potential for us. But at least today, we still feel pretty good about our position in that market.

Got it. So getting into some of the financial details here to wrap up. We've kind of outlined what the different growth rates that you're targeting, so kind of overall high-ish single digits. But what about our margin, margin expansion? Where are we at on that from a potential perspective?

Yes. I think for 2023, we're looking at about 50 basis points of margin expansion across the portfolio. And we discussed that -- that's with some investments in the platform, by the way. And we discussed at Investor Day that out through 2026, we expect to be about 50 to 75 basis points of expansion in margin. And a lot of that is volume leverage. And if you think about the -- how we spend as a company, A lot of our spend comes through CapEx, and a lot of that CapEx is revenue-generating CapEx. When I talk about making investments in the business and those that are hitting margin in the near term, that's about adding commercial resources an additional tool that will immediately benefit our customers.

Got it. Got it. And then what about capital allocation and structure. I think you'd said that you expect net leverage to get to around 3x by year-end '23. How should we think about the capital allocation priorities at the moment? And how do you plan to balance M&A potential versus buybacks versus debt paydown, especially since it doesn't seem like debt paydown. Is this top of mind maybe given recent swap agreement, but?

Right. A lot to unpack there, but... So if we -- let's go back to Investor Day, we talked about 3.5x net leverage being the right flight path for [indiscernible]. And I still think over term, that's the right answer, right? We decided at the end of last year, and we announced publicly, and we're making progress towards a 3% net leverage by the end of 2023. And it's kind of within this macroeconomic nanosecond of elevated rates. And then let's take a look at the 3 stools of capital allocation and what we've done historically and what we plan to do in the future. So from a share buyback perspective, we've done $225 million in the last 18 months, right? So that's always on the table. I'll give you a second. I'll tell you how we think about that. In terms of paying down debt, we did pay down $50 million of our floating debt here in February, which was great that would say that, that is a lever that we'll use. And as you mentioned, we did do a floating for fixed swap, which fixed our debt at a ceiling for the next 3 years. And then on the M&A side, as you talked about a little bit earlier, we have done 2 deals in the last 18 months or so. So going forward, this is how we're going to make this decision. We're going to look at -- given the cash generation of the company at between 40% and 50% conversion of adjusted EBITDA to free cash flow, we generate a lot of cash. We get to make this decision multiple times throughout the year. So we're always looking at what's the best return of that next dollar out the door. So if we look at it from a debt paydown perspective, take our floating stack after tax. That's the return we have to hit. We'll compare that on a buyback, intrinsic value of the company versus the screen. And then finally, on M&A, when we talk about getting down to 3x net lever by the end of 2023, that's written in pencil, and the reason is, is that we're still out there actively on the M&A front. I think what we've seen over the medium term is we haven't seen price expectations really match the current financing environment from asking around here today. I don't think that's Verra Mobility or our sector [indiscernible]. But we would if that deal came on, and we are a DCF buyer, we will simply take the cash flows of the acquisition, take out the known synergies, and we'll discount that at the [ WAC ] of the company or the acquisition, whichever is higher, and we'll compare those 3 uses of cash to make sure we're getting the best return on the next dollar up lever.

Got it. So -- and then finally, to wrap up here, a question that we probably get more frequently than any is just recession resilience of the business. Can you talk about how your business is likely to perform in a recession, what the things you look at are, maybe even kind of how things went through the early stages of the pandemic, et cetera?

Do you want to take that?

You have [indiscernible].

Yes, I can do it. So for commercial, that's probably where we're most exposed, right? And that simply has to do with travelers aren't coming to the rental counter, we're exposed in that business in a larger amount of fixed cost. As great as the incrementals are in the way up in that business is we'll have to watch decrementals on the way down. But that would be a, I would say, a kind of cliff reduction like we saw in COVID. Now we look at the other 2 businesses. Parking, 80% of that business is on service SaaS. That's a high renewal rate, not a lot exposed within the current year. There's some equipment sales that would be but relatively insulated. And then I think the least impacted would be the Government Solutions where the vast majority of that is on long-term contracts.

Got it. Good. We're right at time. David, Craig, thank you very much for joining us today. Thanks, everybody, for sitting in on this long conversation.

Thank you. Thank you so much. Appreciate it.

Thank you.