Earnings Call Transcript - VRRM Q4 2022

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to Verra Mobility's Fourth Quarter 2022 Earnings Conference Call. My name is Julie, and I will be your conference operator today. This call is being recorded. I would like to turn the presentation over now to your host for today's call, Mark Zindler, Vice President of Investor Relations for Verra Mobility. Please go ahead, Mr. Zindler.

Mark Zindler, Vice President of Investor Relations

Thank you. Good afternoon, and welcome to Verra Mobility's fourth quarter 2022 earnings call. Today, we'll be discussing the results announced in our press release issued after the market closed. With me on the call are David Roberts, Verra Mobility's Chief Executive Officer; and Craig Conti, our Chief Financial Officer. David will begin with prepared remarks, followed by Craig, and then we'll open up the call for Q&A. During the call, we'll make statements related to our business that may be considered forward-looking, including statements concerning our expected future business and financial performance, our plans to execute on our growth strategy, the benefits of our strategic acquisitions, our ability to maintain existing and acquire new customers, expectations regarding key operational metrics and other statements regarding our plans and prospects. Forward-looking statements may often be identified with words such as we expect, we anticipate or upcoming. These statements reflect our view only as of today, March 1, 2023, and should not be considered our views as of any subsequent date. We undertake no obligation to update or revise any forward-looking statements. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from our expectations. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained in our annual report on Form 10-K and our Form 10-Qs filed during 2022, which are available on the Investor Relations section of our website and on the SEC's website. Finally, during today's call, we'll refer to certain non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measure is included in our earnings release, which can be found on our website and on the SEC's website. With that, I'll turn the call over to David.

David Roberts, CEO

Thank you, Mark, and thanks, everyone, for joining us today. For today's call, I'm going to first provide a high-level discussion on our outstanding fourth quarter results and key drivers. I'll move on to a discussion of several key trends that are shaping the smart mobility market before closing with our strategic priorities that will influence our 2023 operating plan and build upon the foundation for the long-term outlook we outlined at our Investor Day in July 2022. We delivered fantastic fourth quarter results, highlighted by robust revenue and adjusted EBITDA generation and strong free cash flow. Fourth quarter revenue of $186 million exceeded our expectations and was primarily driven by strong tolling trends in our Commercial Services segment. Adjusted EBITDA of $84 million for the fourth quarter also exceeded our forecast, driven by volume-based operating leverage in both Commercial Services and Government Solutions. Our strong results are aligned with two macro trends across our operating segments. First, we're seeing continued strong travel demand by both consumers and businesses, particularly in the U.S. The major U.S. airlines have cited strong or significant bookings in their recent quarterly earnings announcements. The second macro trend is the continued push for safer roads in communities, which drives the need for investments in automated safety enforcement. Traffic fatalities in the U.S. reached a 16-year high in 2021. And while early estimates are showing a very slight improvement in 2022, these numbers are simply unacceptable. Transportation officials, elected officials and safety advocates will be looking for technology solutions that can save lives, making transportation more efficient for everyone. Starting with Commercial Services, the team again delivered strong performance. Revenue of approximately $82 million for the quarter represented a 14% increase over the same period last year. And compared to pre-pandemic levels, we achieved 20% growth over the fourth quarter of 2019. There were several factors driving this performance. First, TSA throughput continued to approach pre-pandemic volume, reaching 94% of 2019 levels for the fourth quarter. In addition, key performance indicators included adopted rental agreements and rental duration experienced growth over the same period last year. Lastly, the secular trends underpinning these business drivers, continued conversion to cashless tolling, rack refleeting and new toll roads continue to positively impact our business. Cashless tolling reached 64% this past year and 6 new U.S. toll roads were implemented in 2022 as well. In addition, Florida and Georgia recently announced significant investment plans to expand toll lanes over the next 3 to 5 years. Moving to our Government Solutions business, we generated total revenue of $85 million with $82 million being recurring service revenue. Service revenue increased 10% over the fourth quarter of the last year, driven by the completion of New York City's school zone speed installation. Government Solutions margins were about 36% in the fourth quarter, basically flat with the prior year. T2 Systems delivered revenue of $20 million with adjusted EBITDA of $4 million; and for the full year, revenue of $79 million and adjusted EBITDA of $14 million. Full year revenue growth was about 11%, which was slightly below our expectations. SaaS and service revenues were in line. However, hardware sales were slightly below expectations for both the fourth quarter and the full year due to customer-requested installation timing. Craig will further elaborate, including the actions being taken in his prepared remarks. In summary, the fourth quarter was another outstanding quarter of top line growth, strong adjusted EBITDA, and free cash flow generation; the secular trends driving our performance are durable, and we continue to experience strong operating momentum in each of our business segments. Turning to the balance sheet and capital allocation, I'm pleased to report that we lowered net leverage a full turn over the course of 2022, ending the year at 3.3x adjusted EBITDA. In addition, we repurchased $125 million of shares over the course of 2022. And in November, as we previously reported, our Board of Directors authorized a new share repurchase plan of $100 million. Furthermore, we also remediated all material weaknesses reported in our 2021 Form 10-K. This is a significant accomplishment by the entire organization. Thank you to all the employees that drove this change in the implementation of our new controls and processes. Compliance is critical to our company, our customers and our shareholders, and we take it very seriously across the organization. Overall, 2022 was a record year in Verra Mobility's history, setting new all-time highs in revenue, adjusted EBITDA, adjusted EPS and free cash flow. We entered 2023 with significant business momentum in each of our segments, underpinned by strong secular trends. Travel demands remain strong and durable. TSA throughput in the first quarter of 2023 is currently exceeding 2019 levels, and forward-looking travel demand as communicated by major U.S. airlines remains strong. Second, we continue to experience a shift towards cashless tolling across the U.S. in an effort to improve efficiencies and reduce congestion. For example, in the second half of 2022, both the Lincoln Tunnel and George Washington Bridge transitioned completely to cashless tolling. With that, all bridge or tunnel crossings into New York City have eliminated toll booths for payments. We expect the automated payments trend to continue on more toll roads across the country. Third, we expect to see cities place a renewed focus on Vision Zero safety programs, which includes investments in automated enforcement to reverse a troubling trend of traffic-related fatalities. Finally, over the longer term, we expect to see cities make efforts to improve urban mobility in their communities through investments in curve management solutions and automated bus lane enforcement, which our parking and government platforms are well positioned to serve. With that as a background, I will turn to our top strategic priorities in 2023. Over the past year, we have implemented what we call the Verra Mobility Operating System, or VMOS. It's a robust standard business system that drives growth, efficiency and talent development. At the heart of VMOS are three strategic pillars: drive core business outcomes, build the Verra Mobility of the future, and create an engaging and fulfilling workplace. In 2023, we have established key objectives for each of these 3 pillars, focusing on financial execution of the 2023 annual plan, furthering our position in core markets, pursuit of accretive expansion opportunities, accelerating our portfolio model adoption, and making Verra Mobility a best place to work. Through execution of our three strategic pillars, we are poised to deliver superior long-term value creation for all stakeholders. Next, I'll drill down a layer and focus on key priorities for each of our business segments. In Commercial Services, where we benefit from strong secular tailwinds, including increased adoption of cashless tolling, new toll roads, and rack refleeting, we are focused on growing the core while simultaneously capitalizing on numerous expansion opportunities. Our top priorities are renewing our agreement with Enterprise, adjacent expansion opportunities primarily focused on fleet management, expansion into Europe, and laying the foundation to capitalize on next-generation connected fleet opportunities. In Government Solutions, we benefit from a strong and growing interest in automated enforcement for road safety and improved traffic flow. Our top priorities include opening new cities and states through enabling legislation, continued investments in our industry-leading software platform, and pursuing emerging opportunities across urban mobility through strategic mergers and acquisitions and partnerships. Finally, in T2 Systems, where we have significant runway for continued growth and profitability, our focus is on pursuing new logo business, increasing share of wallet with existing customers, expansion into mid- and large-scale municipalities, and investing in platforms to drive new revenue streams, such as dynamic pricing. These are our top priorities as we execute our strategy in 2023, and I'm incredibly excited about the business. The fundamentals are strong and durable. We have the right management team in place and a proven operating model to create significant value. Before I turn things over to Craig, I want to close with a message about our July 2022 Investor Day and the long-term outlook we provided. I am pleased to report that the fundamentals we contemplated in our long-term outlook have not changed, and we remain upbeat about meeting or exceeding the financial forecast we provided. Craig, I'll turn it over to you to guide us through our financial results and 2023 guidance.

Craig Conti, CFO

Thanks, David. Good afternoon, and thanks to everyone for joining us on the call. I'll start out today by providing an overview of our fourth quarter and full year 2022 results followed by our 2023 financial guidance. I'll conclude with discussions on clients, capital allocation, and our long-term outlook. Total revenue increased approximately 9% year-over-year to about $186 million for the quarter, driven by strong operating performance across the company and the inclusion of T2 Systems in our financial results for a full year. On an organic basis and excluding New York City hardware sales, we grew 16% year-over-year. Expanding on this point, given the prior year included an incremental $21 million of product sales from the New York City camera installations, revenue growth is the best proxy for our performance. Service revenue grew 24% over the same period last year, of which 16% was organic growth. This growth was attributable to several factors: first, Commercial Services grew 14% year-over-year; second, Government Solutions service revenue increased by about 19% over the prior year; and finally, T2 Systems contributed about $15 million of service revenue. As a reminder, we closed the T2 Systems acquisition in early December 2021, so only three weeks of T2 revenue was included in the prior year quarter. Product revenue was $7 million for the quarter, of which $5 million was from T2 Systems. Finally, from a total profit standpoint, consolidated adjusted EBITDA of $84 million increased by approximately 5% over last year. On an organic basis, excluding T2 Systems and New York City product sales, adjusted EBITDA growth was approximately 14% versus 2021. For the full year, we delivered total revenue of $742 million and adjusted EBITDA of $339 million, resulting in margins of about 45.6%, all of which exceeded our most recent financial guidance provided during our third quarter earnings call. From a free cash flow perspective, our conversion rate from adjusted EBITDA was 50%, resulting in $170 million of free cash flow for the year, consistent with our expectations. Moving to Commercial Services, we delivered revenue of about $82 million in the fourth quarter, increasing $10 million or 14% year-over-year. RAC tolling increased 9% over the same period last year, driven by robust travel volume, increased product adoption, and a slightly smaller impact in Florida from Hurricane Ian than we originally anticipated. Our non-RAC fleet expansion efforts continue to pay off, with FMC revenue increasing 18% over the prior year quarter. The FMC business is now a $50 million annual revenue stream for the company and growing. Fourth quarter adjusted EBITDA in Commercial Services was $49 million, representing $12 million or a 12% year-over-year growth. Adjusted EBITDA margins of about 60% reflected normal sequential seasonality and were down slightly compared to the fourth quarter of last year, primarily due to growth investments. For the full year, Commercial Services generated $326 million of revenue or 25% growth over last year. Adjusted EBITDA of $209 million resulted in margins of about 64%, a 250 basis point improvement over the prior year driven by volume-based operating leverage. Turning to the results of the Government Solutions business, driven primarily by our New York City photo enforcement expansion efforts, service revenue increased by $13 million or 19% over the same period last year to $82 million for the fourth quarter. Due to the completion of the New York City camera installations, Q4 2022 product revenue of $2 million declined by about $21 million compared to the fourth quarter of last year. This was completely in line with our expectations. Going forward, we expect the Government Solutions quarterly product revenue run rate to be approximately $3 million per quarter and primarily driven by international programs. Adjusted EBITDA was $31 million for the quarter, representing margins of 36%, roughly flat with the prior year quarter. For the full year, Government Solutions generated $337 million of total revenue, a 19% increase over 2021, and adjusted EBITDA was $116 million for the year, a 7% increase over last year. Full year revenue and adjusted EBITDA growth were driven by New York City installations and a full year of Redflex included in our financials. Let's take a look at the results of T2 Systems, which is our Parking Solutions business segment. Revenue of $20 million and adjusted EBITDA of approximately $4 million were slightly below expectations for the quarter due to customer-requested installation timing on certain product sales. We're very pleased with the levels of software and service sales. These were in line with expectations, but hardware sales proved to be slightly choppier than we had anticipated. We are leveraging the Verra Mobility Operating System to drive initiatives to build and strengthen the quality of the pipeline and to improve the forecasting process. For the full year, T2 delivered revenue of $79 million or approximately 11% growth over last year and adjusted EBITDA of $14 million. In Q4, we reported net income of approximately $28 million for the quarter, which compares to net income of $19 million in the same period in the prior year. Adjusted EPS, which excludes amortization, stock-based compensation, and other non-recurring items, was $0.25 per share for the current quarter compared to $0.24 per share in the fourth quarter of 2021. For the full year, we generated net income of approximately $92 million, including a tax provision of $35 million, representing an effective tax rate of 27%. Adjusted EPS was $1.02 for the year, a 29% increase over fiscal year 2021. On the right-hand side of the page, you can see that we ended the year with a net debt balance of about $1.1 billion, resulting in net leverage of 3.3x for the year. This is down from 4.3x net leverage at the close of 2021. The gross debt balance at quarter end was slightly over $1.2 billion, of which approximately $886 million was floating rate debt. During the fourth quarter, we entered into an interest rate swap agreement to hedge approximately 80% of our floating rate debt with a float-for-fixed rate swap. The floating portion of our LIBOR plus 325 basis point Term Loan B will be fixed at a rate of 5.2% for 3 years with a monthly option to cancel beginning in December of 2023 that we can exercise in the event rates move in our favor. Moving on to cash, we generated approximately $70 million in cash flow from operating activities, resulting in $57 million of free cash flow for the quarter. For the full year, we generated $170 million of free cash flow or a 50% conversion of adjusted EBITDA, which represented $1.07 free cash flow per share. During the fourth quarter, we completed the final settlement of our $125 million share repurchase program. In total, we repurchased approximately 8 million shares under the program. In addition, our Board of Directors authorized a new 18-month $100 million share repurchase program in November of last year. We will provide quarterly updates as to the repurchases made under this new authorization. Now let's shift gears a bit and talk about our views on 2023, which is looking like it will be another solid year for the company. We have broadened the financial measures we are guiding to in fiscal year 2023 to better align with our shareholder value creation objectives. We expect total revenue in the range of $780 million to $800 million, representing approximately 5% to 7% growth over 2022. On a constant currency basis, the growth is adjusted upward to a range of 6% to 8%, consistent with the long-term outlook we shared at our Investor Day in July. We expect adjusted EBITDA in the range of $360 million to $370 million, representing approximately 8% growth at the midpoint over 2022. We expect an adjusted EBITDA margin of about 46%, representing approximately 50 basis points of margin expansion year-over-year. In Commercial Services, we expect high single-digit revenue growth, driven by increased TSA volume and increased product adoption. In addition, we are expecting increased FMC revenue. Consistent with historical trends, the first quarter is forecast to be our lowest revenue-generating quarter followed by sequential revenue increases in the second and third quarters, followed then by a revenue decline in the fourth quarter as the summer driving season comes to a close. Government Solutions is expected to generate high single-digit service revenue growth driven by previous year's completion of the New York City camera installations. The shift to 24/7 monitoring in New York City, the expansion of camera installations with other existing customers, and new customers awarded in fiscal year 2022. While New York City service revenue is expected to increase almost 10% year-over-year, total 2023 New York City revenue will decline by about $6 million due to the decline in product revenue versus 2022. For Government Solutions overall, we're expecting low single-digit total revenue growth over last year. However, on a constant currency basis, Government Solutions is expected to drive mid-single-digit growth consistent with our Investor Day long-term outlook. Lastly, Parking Solutions revenue is expected to deliver high single-digit total revenue growth, driven by strong demand and a continued shift to SaaS and services with a lower weighting of hardware and revenue contribution. Consistent with T2's historical trends, we anticipate revenue, adjusted EBITDA, and margins to ramp sequentially throughout 2023. For the company as a whole, we are guiding to a 2023 non-GAAP adjusted EPS range of $1.00 to $1.10, and the key assumptions supporting this outlook can be found in our materials. Most notably, total interest expense, including non-cash charges, is expected to increase to about $96 million in fiscal year 2023, up from $69 million in the prior year due to the cost of the floating rate term loan debt. Beginning in 2023, we entered into an interest rate swap agreement, which fixes the cost of floating term rate loan debt at about 5.2% plus the 325 basis point spread with a monthly option to cancel beginning in December of 2023. Expanding on the balance sheet and our capital allocation priorities, I'm pleased to report that we paid down $50 million of our floating rate debt during the first quarter of 2023. This action, combined with the interest rate swap I detailed earlier, demonstrates our commitment to a balanced capital allocation approach and managing interest rate risk. The $1 to $1.10 adjusted EPS range provided assumes a balanced approach to paying down debt and share repurchases and includes the $50 million debt repayment discussed. We expect to generate a range of free cash flow of approximately $135 million to $155 million or a conversion rate of about 40% of adjusted EBITDA. The difference between the 40% conversion rate and our 50% long-term target is primarily attributable to higher interest payments in 2023, as well as increased cash taxes driven by reduced NOL utilization in 2023. Lastly, based on the adjusted EBITDA and free cash flow guidance, we expect to reduce net leverage to about 3x by year-end 2023. In addition to our 2023 financial guidance, we also reconfirmed our long-term financial outlook, and I'm pleased to report that we remain on track. In addition to meeting or exceeding all of our 2022 commitments, we see no changes to the fundamentals of our business performance. While we expect to see pressure on our 50% free cash flow conversion target in 2023 and 2024 due to interest rates, we are confident in reaffirming our 2026 financial estimates. Lastly, as David briefly mentioned, we are pleased to report that we have fully remediated all of the material weaknesses disclosed in our 2021 Form 10-K. In 2022, we hired additional resources and successfully instituted new controls to support purchase accounting activities and to more substantively monitor the ongoing activities of acquired companies. This concludes our prepared remarks. Thank you for your time and attention. At this time, I'd like to invite Julie to open the line for any questions.

Operator, Operator

Your first question comes from Daniel Moore from CJS Securities.

Daniel Moore, Analyst

Let me start, just kind of high level remind us where we are on the curve as far as the shift to cashless tolling at this stage. How much of a tailwind do you expect that to be? And how long is that likely to last?

David Roberts, CEO

In the remarks, we talked about that we were about 64% in the U.S. market and we certainly see, while it's hard to put a numeric number, you see a lot of trends that I identified several specific ones in Florida and Georgia and others where that seems to be continuing. So we would anticipate that to be a trend for the next several years.

Daniel Moore, Analyst

Very helpful. Curious, David. In terms of Europe, what are your goals for Europe for '23? What kind of milestones would you consider a successful year, whether that be revenue, new agreements, just general progress? Anything that would be helpful for us to track.

David Roberts, CEO

I don't think we're currently finalizing proof of concept, as we are still assessing whether we have enough vehicles with current customers and sufficient locations to enhance value for our customers. It's a combination of factors, as we consider the number of enrolled vehicles in the program as a key driver. Whether we achieve this through one customer or several is acceptable. However, we also aim for a broader perspective that includes multiple countries.

Daniel Moore, Analyst

Understood. Really helpful. And then just maybe talk a little bit about on the government services side, the level of dialogues regarding Vision Zero initiatives. Is it relatively steady? Or is it actually picking up given the traffic fatality numbers that you described there?

David Roberts, CEO

What I would say is, as the traffic fatality numbers were being reported and occurring, there was already a significant increase in the countries that we're providing services in related to newer programs, expansions of current programs and even looking at other use cases. So I think it's a very strong outlook for the next several years based on some of the current dynamics.

Dave Koning, Analyst

I guess my first question, I often think about the Government Solutions, the services revenue kind of in three parts: the New York service, other service, and then Redflex in there. About 30 to Redflex, I think, is a little less than that. How did each of those do in the quarter? Because it seems like that continues to do extremely well.

Craig Conti, CFO

Yes. So I'll take a shot at that. If you take out New York City and just look at Government Solutions, this is a double-digit grower. New York City services in the fourth quarter continued to grow and are expected to do so next year. Redflex service, we continue to see mid-single-digit growth there, as you would anticipate. The real idiosyncratic piece there is the New York City install ending in 2022.

Dave Koning, Analyst

Okay. That's good. And then I guess the Parking business, you talked a little bit about Q4. I think you said the product was a little below your expectations. Has T2 overall, you've had it for just about a year now. Has that overall been in line? And did you say all through the year, you should have sequential growth in '23?

Craig Conti, CFO

I would say yes to both of those. It has continued to perform to our expectations. The equipment issue was really a delivery and acceptance of delivery in the last couple of days of the quarter. So when we talk about choppiness, I'm talking about 3 or 4 deals that we'll end up getting here in 2023. So it's continued to perform well.

Faiza Alwy, Analyst

So I wanted to pick up on T2. I guess, give us a bit more color in terms of where you're seeing the most traction. You talked about adjacent categories, you talked about how your market share is lower with Tier 2 and Tier 3. So give us a bit more color in terms of what you're expecting for '23 from T2.

David Roberts, CEO

I would say right now, the strongest is still in their home turf, which is in the university segment and is continuing to grow. They have a long track record of not only keeping customers for long-term contracts but also expanding related services to that. So that's still the core of the business; it's the backbone and it's continuing to grow. We're obviously looking at how do we take those capabilities, especially on permits and enforcements and how we can bring those into other larger municipalities. T2 has done a nice job in smaller, almost coastal vacation-oriented cities, and we're trying to expand that. We're making some investments in sales and marketing and organizational structure to support that with the right level of capability. So we anticipate growth in the back half of this year and into next year to be focused there.

Craig Conti, CFO

We are expecting high single-digit organic growth out of T2 next year. We expect margin expansion of about 1 point from where they landed this year. So that business is on a good trajectory.

Faiza Alwy, Analyst

Great. And my last question was going to be on margins. I was going to ask about the margin expansion you expect from each segment, especially for Commercial Services, as that has been muddied in quarterly cadence for us. Any thoughts around quarterly cadence of margins?

Craig Conti, CFO

Yes, sure. I'll unpack both of those for you. We're expecting about 0.5 points of margin expansion across the portfolio, consistent with what we said at Investor Day. If I look at Commercial Services, I expect that business to be up about 50 basis points. A lot of that is volume leverage as the business continues to grow. I expect Government Solutions to be down slightly, anywhere from 10 to 40 basis points year-over-year. The main driver there is investments we are making in the platform to continue growth at scale both domestically and internationally. For T2, I expect that to be up by about 1 point. We're continuing to win business, and that mix is expected to start favoring SaaS and service businesses. This trends throughout the year: first quarter down slightly, higher growth in the second and third quarters, and then decline in the fourth as the summer driving season ends.

Faiza Alwy, Analyst

That's all very helpful. Thank you!

Keith Housum, Analyst

As we look at some of the legislative fronts out there, are there other states that are pretty far along in passing legislation for more traffic enforcement cameras?

David Roberts, CEO

I wouldn’t say anything specific right now. However, we’re looking at key critical states such as California and Florida. We're also keeping an eye on the legislative sessions for states like Washington. We're always looking into that.

Keith Housum, Analyst

Any additional context you can share in terms of the construction zone area?

David Roberts, CEO

We have two projects currently in the works, and we believe it's a growth vector for us, particularly since the Redflex acquisition. There’s a rational belief that safety and enforcement in construction zones is vital, and that aligns with our goals.

Keith Housum, Analyst

I appreciate it. Last year, there was some discussion about the 150 fixed school busing cameras in New York City. Is that included in your guidance?

David Roberts, CEO

It is not included in our guidance, so therefore, it represents potential upside.

Operator, Operator

There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. You may now disconnect.