Earnings Call Transcript - VRRM Q2 2022

Operator, Operator

Good day, and welcome to the Verra Mobility Second Quarter 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Mark Zindler, Vice President, Investor Relations. Please go ahead sir.

Mark Zindler, Vice President, Investor Relations

Thank you. Good afternoon and welcome to Verra Mobility's second 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 attract 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, August 3rd, 2022, 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-Q for the first quarter 2022, which are available on the Investor Relations section of our website at ir.verramobility.com and on the SEC's website at sec.gov. 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 at ir.verramobility.com and on the SEC's website at sec.gov. With that, I'll turn the call over to David.

David Roberts, CEO

Thank you, Mark, and thanks everyone for joining us today. We've had a very busy and productive second quarter as well as the first few weeks of the third quarter, including our recent Investor Day. I'll spend a few minutes recapping these events and then turn to the trends that are influencing our strong results in each of our business segments. I'll begin with a brief recap of our Investor Day on July 19. First, we announced an increase to our guidance for total revenue and adjusted EBITDA based upon our performance to date and outlook for the remainder of the year. Following that announcement, we had what we believe was a successful, well-attended Investor Day, at which we articulated our long-term growth strategies, provided a deep dive into each of our business segments, discussed our M&A criteria, and concluded with our long-term financial outlook and capital allocation priorities. The event also provided the opportunity to communicate our long-term vision of operating in the broader connected fleet solutions and urban mobility markets and how these emerging opportunities provide upside to the long-term outlook provided by Craig in his presentation. My goal is to leave investors and analysts with one key message: Verra Mobility is a great business with a bright future, and our results and outlook validate that message. If you weren't able to attend Investor Day in person or virtually, I encourage you to review the presentation materials and the webcast replay available on our Investor Relations website. Prior to Investor Day, we announced several key developments in commercial services. As you'll recall, when we announced first quarter earnings, we signed a five-year contract extension with Hertz for our US operations and also signed a contract with Hertz Spain for a new European tolling pilot. Moreover, immediately leading up to Investor Day, we announced several new partnerships we expect will contribute to core business growth, European expansion, and long-term emerging opportunities. While these partnerships will not lead to significant revenue generation in the near term, they are the building blocks to drive the future of our connected fleet solutions portfolio over the long term. Now, moving on to our results. We had an outstanding second quarter highlighted by strong revenue growth and free cash flow generation. Commercial services delivered exceptional top-line and bottom-line results, driven by continued strong demand for travel in the US. In addition, government solutions continued to drive strong year-over-year growth, fueled by the New York City school zone speed camera implementation, and T2 Systems delivered results in line with our deal thesis. Going into a little more detail and beginning with commercial services, the team again delivered a strong quarter, taking full advantage of the surge in travel demand across the U.S. Revenue of approximately $85 million for the quarter represented a 28% increase over the same period last year, and compared to pre-pandemic levels, we achieved 25% growth over the second quarter of 2019. As we noted during our Investor Day presentation, we achieved these results despite the fact that rental car fleet volumes and TSA traveler throughput are below 2019 levels. This is predominantly due to an increase in cashless tolling and customer adoption across the U.S. Moving to our government solutions business, we generated total revenue of $84 million, representing growth of 34% over last year. In addition, the 265-camera install commitment for New York City remains on track. Through the first half of the year, we've installed 121 cameras and plan to complete the remainder of the installations by the end of the third quarter, barring any supply chain risks, which we do not currently anticipate. Finally, T2 Systems delivered $19 million of revenue for the quarter, directly in line with our deal model, and they remain on track to deliver full-year results in line with our internal expectations. Q2 was another strong quarter of growth in free cash flow generation. We are excited to build on the momentum of our Investor Day and continue to drive extraordinary results across the portfolio. Now, I'll turn it over to Craig to guide us through our financial results.

Craig Conti, CFO

Thanks, David. Good afternoon and thanks to everyone for joining us on the call. First, I'll start off by providing an overview of our second quarter 2022 results, then provide commentary on our current financial guidance, followed by a recap of our Investor Day. Let's turn to slide six, which outlines revenue and adjusted EBITDA performance for the consolidated business. Total revenue increased approximately 46% year-over-year to about $187 million for the quarter, driven by strong operating performance across the company and the inclusion of Redflex and T2 Systems in our financial results. As a reminder, we closed the Redflex and T2 Systems acquisitions in June and December of 2021, respectively. So, Q2 2021 is not a full quarter from Redflex comparisons. Q2 service revenue grew about 50% over the same period last year, of which 26% was organic growth. This growth was attributable to several factors. First, commercial services revenue grew 28% year-over-year. Second, government solutions service revenue increased by about 50% over the prior year, of which 23% was organic growth. And finally, Redflex and T2 Systems contributed $17 million and $15 million of service revenue, respectively. Product revenue was $13 million for the quarter, of which $6 million was from Redflex and T2 Systems. Finally, from a profit standpoint, consolidated adjusted EBITDA of $89 million increased by approximately 29% over last year. Moving to commercial services on slide seven, we delivered revenue of about $85 million, increasing $18 million or 28% year-over-year. The improvement was driven by continued strong demand for travel, particularly in the U.S., and the resulting increase in demand for rental cars. As David mentioned, while rental car volumes remain below pre-pandemic levels, the percentage of cashless tolls, toll rates, and billable days are all increasing. In addition to the continued strength of the rental car market, our ongoing growth initiatives within the commercial fleet management space drove a $3 million increase in tolling-related revenue versus prior year levels. Adjusted EBITDA in commercial services was $57 million, representing a 32% year-over-year growth. Let's turn to slide eight, and we'll take a look at the results of the government solutions business. Driven primarily by our New York City photo enforcement expansion efforts, total revenue increased by $21 million or 34% over the same period last year to $84 million for the second quarter. Service revenue for the second quarter was $75 million, which grew $25 million or about 50% year-over-year. Organic service revenue growth, excluding Redflex, was approximately $11 million, or 23%, which was primarily driven by the aforementioned expansion of the New York City school zone speed program. In addition, adjusted EBITDA grew 13% year-over-year to approximately $29 million for the quarter. Let's turn to slide nine and we'll review the results of T2 Systems, which is our parking solutions business segment. Revenue of $19 million and adjusted EBITDA of about $3 million was in line with our expectations for the quarter. As I discussed last quarter, we expect T2 to drive sequential revenue and adjusted EBITDA growth through the balance of the year and anticipate low double-digit growth for their top-line and bottom-line results this year. In addition, we expect T2 to generate margins in the low 20% range, which are modestly lower than their pre-acquisition levels due solely to allocations for cost, including audit and stock fees, D&O insurance, and other corporate public company costs that the business would not have incurred prior to our acquisition. The company reported net income of approximately $30 million in the quarter compared to net income of $4 million in the same period in the prior year. Adjusted EPS, which excludes amortization and stock-based compensation and other non-cash and non-recurring items, was $0.29 per share for the current quarter compared to $0.10 per share in the second quarter of 2021. The tax provision for the quarter was about $13 million, representing an effective tax rate of approximately 30%. As a reminder, our tax rate is impacted by permanent differences related to mark-to-market adjustments for our private placement warrants. Before I close out the financial review for the quarter, I'd like to give you an update on where we stand on the material weaknesses we addressed in our most recent 10-K. Specifically, these weaknesses were associated with monetary controls and accounting activities over the acquisition of Redflex and in the design and maintenance of reporting controls related to a third-party application utilized to perform certain control activities and in the preparation of our consolidated financial statements. In response to the Redflex-related item, we have implemented new controls over the monitoring and recognition of revenues by acquired companies and have hired additional qualified personnel to perform month-end oversight activities, including the selection and application of Generally Accepted Accounting Principles. In response to the third-party financial reporting application item, we have instituted a series of compensating controls designed to independently confirm the accuracy and reliability of the data utilized in our control activities and in the preparation of our consolidated financial statements. At this time, we expect the remediation of these material weaknesses to be complete by December 31st, 2022. While our remediation work isn't materially complete, the new controls are required to operate for a sufficient length of time and will undergo additional rigorous testing to ensure they are operating as intended. Now, back to our financial results. Moving on to cash generation for the second quarter, we generated approximately $65 million in cash flow from operating activities, resulting in $54 million of free cash flow for the quarter or a 61% conversion of adjusted EBITDA. In addition, on a trailing 12-month basis, free cash flow per share was $1.31. Free cash flow benefited from higher than average cash collections attributable to the growth in commercial services in the back end of the first quarter that was subsequently collected in the second quarter. Additionally, New York City accounts receivable has declined to $43 million at the end of the second quarter compared to $63 million at December 31st, 2021. Our expectation for the business is to drive roughly comparable levels of free cash flow in the third quarter and to slightly level off in the fourth quarter. As you can see on slide 10, we ended the second quarter with a net debt balance of less than $1.2 billion, resulting in net leverage declining to 3.5 times for the quarter. This is down from 4.3 times net leverage at the close of 2021. Next, I'd like to give you a brief update on the share repurchase program the company's Board of Directors authorized on May 7th for up to an aggregate amount of $125 million over the next 12 months. During the quarter, the company paid $50 million, which represented the aggregate amount authorized for an accelerated share repurchase, or ASR, and received an initial delivery of 2.7 million shares. The final settlement is expected to occur during the third quarter of 2022, at which time a volume-weighted average price calculation over the term of the ASR agreement will be used to determine the final number and average price of shares repurchased and retired. In addition, the company paid about $5 million to repurchase over 336,000 shares through open market transactions during the second quarter, which we subsequently retired. Of the $125 million approved repurchase program, the company authorized an aggregate purchase amount of $75 million related to the open market repurchases, of which about $70 million is available for future repurchases as of June 30th, 2022. Next, let's take a look at our current guidance on page 11. In conjunction with our Investor Day on July 19th, we increased guidance as follows; total revenue in the range of $720 million to $740 million and adjusted EBITDA in the range of $325 million to $335 million. Our guidance implies modest sequential growth in comparing the second half of the year to the first six months. This is consistent with historical trends, as we typically experience strong tolling revenue in the third quarter driven by summer travel demand and a sequential reduction in the fourth quarter. You'll also note we experienced strong adjusted EBITDA margin expansion in the second quarter of this year compared to the first quarter of 2022. In commercial services, we benefited from volume leverage as the business continues to scale. We expect commercial services margins to remain at comparable levels in the third quarter, and then to level off in the fourth quarter in line with normal seasonality. In government solutions, we also experienced strong margin expansion in Q2 compared to Q1 of 2022. This was primarily attributable to the revenue mix impacted by New York City camera sales. We expect margins to remain at elevated levels in the third quarter for the same reason and then to level off in the fourth quarter. The macro trends that have helped drive the outperformance in commercial services over the first half of the year continue to exceed our expectations. If the current trends continue in the third quarter, we will likely revisit our guidance again, assuming the rest of the business performs consistently with our plan, albeit incorporating the historical leveling off of RAC tolling we typically experience in the fourth quarter. Additionally, based on achieving the midpoint of the adjusted EBITDA guidance range and an expected free cash flow conversion rate of about 50% of adjusted EBITDA for the year, we expect net leverage to be 3.5 times or less by year-end 2022. This net leverage result includes the full completion of the stock repurchase program discussed today. Lastly, I'll provide a brief recap of the financial overview discussed during Investor Day and reiterate some of the key takeaways. We provided a long-term financial outlook, of which we believe we can generate 6% to 8% annual organic revenue growth through 2026. This topline growth will result in 8% to 10% annual adjusted EBITDA and free cash flow growth, again, on an organic basis. These forecasted results yield about $1.2 billion of cumulative organic free cash flow by 2026, and assuming we maintain net leverage at a target of 3.5 times over the forecast period, that provides for up to $500 million in incremental re-levering capacity. With this $1.7 billion in deployable capital capacity over the next five years, we provided a range of capital allocation scenarios focused on stock repurchases and M&A. The central message of our Investor Day was that organic free cash flow is our strongest value creation lever. Coupling this with our capital allocation priorities, the company has multiple paths to double free cash flow per share by 2026. This is the end of our prepared remarks. Thank you for your time and attention today. And at this time, I'd like to invite Cody to open the line for questions.

Operator, Operator

Thank you. We'll now take our first question from James Faucette with Morgan Stanley. Please go ahead.

Jeff Goldstein, Analyst

Hey, guys. This is Jeff Goldstein on for James. Just thinking about your revenue growth by segment in the back half, should those growth rates generally line up with your Investor Day guidance around long-term growth maybe if we strip out the New York City benefit to the government business? I'm just trying to understand if there are other factors in play right now that would cause you to under or overperform those long-term targets.

Craig Conti, CFO

Yes, there are a couple of things. This is Craig, by the way, thanks for the question. When you examine Verra Mobility, you can't directly compare the second half of the year to the annual target because each quarter is quite different. The business grows sequentially, starting with Q1 as the lowest quarter, then increasing to Q2, with Q3 being the highest and Q4 again being the second lowest. Therefore, comparing the highest and second lowest quarters to an annual target isn't appropriate. Looking at the latter half of the year, the rental car business continues to exceed expectations. A relevant comparison can be made with TSA throughput; pre-pandemic in 2019, Q1 to Q2 saw a 17% growth, whereas in 2022, that same metric shows a 27% growth. As I evaluate the second half of the year, I haven’t factored in all that positive outlook yet since I want to observe trends over the next 60 days to see if they materialize in the top line. Overall, I anticipate growth in the latter half of the year. From a total revenue perspective, we will see an increase in Q3, followed by a decrease in Q4, as is historically typical. However, we may revisit our guidance if the rental car performance remains as robust as it was in Q2.

Jeff Goldstein, Analyst

Got it. Okay. That was all very helpful. And then as my follow-up, you talked a lot about at your Investor Day, the bus-stop camera opportunity. So maybe you can just remind us of how much revenue you're currently doing there and how you view the pipeline. Is that a six to 12-month opportunity to move the needle or more like a four to five-year opportunity?

David Roberts, CEO

Just to clarify, we're discussing CrossingGuard, which is our school bus stop arm. Are we referring to the same thing?

Jeff Goldstein, Analyst

Yes.

David Roberts, CEO

Okay, great. Okay. Yes, so that's a business that's really been in recovery because as you can imagine, during the pandemic, it effectively went to zero because of the schools not being around and things like that. So, it's actually growing right now. I would anticipate that the business is performing well. We're continuing to see opportunities, especially up in the Northeast category. So, I think it's not a large business for us. So, what I would say is that over the next two to four years is probably where we'll see the optimization of that business.

Jeff Goldstein, Analyst

Okay, fair enough. Thanks, guys.

Craig Conti, CFO

Yes.

David Roberts, CEO

Yes. Thank you.

Operator, Operator

Thank you. We'll take our next question from Dan Moore with CJS Securities. Please go ahead.

Stefanos Crist, Analyst

This is Stefanos Crist calling in for Dan. Thanks for taking our questions.

David Roberts, CEO

Sure.

Stefanos Crist, Analyst

Could you just talk a little bit more about T2, maybe about the integration so far to date and some updates on cross-selling opportunities you expect to achieve?

David Roberts, CEO

Yes. Just to remind everyone, the integration for T2 is quite minimal. We consider it as a portfolio company rather than integrating it with our other businesses at this point. Besides some costs related to SOX and public company expenses that Craig mentioned, T2 is still growing. We are witnessing a good recovery for that business, which was significantly affected during the pandemic, and it is now showing strong signs of recovery. I should note, however, that large parking opportunities don’t often materialize quickly. They are currently building a pipeline, and there is extensive collaboration among the businesses to create those opportunities. As of now, we do not have a specific marker to indicate success, so we are still in the early stages of this process.

Stefanos Crist, Analyst

Got it. Thanks. And then just in terms of your RAC customers, what are you hearing about their willingness and ability to grow their fleets looking out to 2023, 2024 and then beyond?

David Roberts, CEO

Yes, I believe it’s best not to comment on those companies’ specific plans since two of them are publicly traded and have ample information available. However, I can say that they are very responsive to demand and remain actively re-fleeting. They have not yet returned to 2019 levels, but this has not affected our business. I expect that they will continue to align their assets with demand as swiftly as possible.

Stefanos Crist, Analyst

Perfect. Thank you so much.

David Roberts, CEO

Yes. Thank you.

Craig Conti, CFO

Thank you.

Operator, Operator

Thank you. We'll take our next question from Faiza Alwy with Deutsche Bank. Please go ahead.

Faiza Alwy, Analyst

Yes. Hi. Thank you. I just wanted to touch on government solutions. Could you just remind us of the puts and takes around service and product revenues, at least for the rest of this year? And what the margin implications of that might be as we look at the back half for Government Solutions?

Craig Conti, CFO

Yes, of course. This is Craig. I will address that part step by step. We mentioned that there are 265 fixed speed installations for the business this year, which relates to the product aspect of government solutions, the legacy segment. I will discuss the international part shortly. To break it down, out of that $265 million, approximately half has been completed in the first half of the year, and the remaining half will be accomplished in the third quarter. Therefore, you can expect another strong quarter of product sales for government solutions in the third quarter. In terms of margins, the core business is currently in the mid to high 30s, and I expect that to continue into the third quarter and remain relatively flat into the fourth quarter, though there may be a slight drop in the fourth quarter. The product sales I mentioned will provide a small incremental increase in margins but not enough to significantly affect the overall segment by more than one percentage point. Does that clarify things, Faiza, regarding some endpoint business?

Faiza Alwy, Analyst

Yes, that provides some clarity. Regarding T2 margins, I understand you mentioned it's primarily about allocation. Given that this quarter is somewhat unique due to incomplete revenue, how should we view T2 margins as we approach the end of the year? Will you be able to mitigate some of these expenses? If it's purely an allocation issue, it should positively impact other segments as well, since lower costs would be attributed to them. Could you please explain how we should consider T2 margins moving forward?

Craig Conti, CFO

Yes, I understand where you're going with that. When we consider the T2 business on a fully allocated basis, taking into account the mentioned costs, we are looking at something around 20%, particularly in the latter half of the year. I believe that's the exit rate you're asking about for 2022. This business shows sequential growth, with our fourth-quarter revenue being 75% higher than in the first quarter. The revenue composition is starting to lean towards higher-margin products, a trend that has persisted for several decades, particularly in the latter half of the year. The revenue trajectory in the first half of the year remains on track, and we anticipate that the latter half will be significantly higher, possibly in the high teens or around 20%. We do expect to close the year with T2 at 20%.

Faiza Alwy, Analyst

Great. Thank you so much.

Craig Conti, CFO

You bet.

Operator, Operator

Thank you. We'll take our next question from Louie DiPalma with William Blair. Please go ahead.

Louie DiPalma, Analyst

David, Craig, and Mark, good evening.

David Roberts, CEO

Hi, Louie.

Craig Conti, CFO

Hi, Louie.

Louie DiPalma, Analyst

Rental car providers, and David, you just mentioned two of them are publicly traded; they have reported record revenue, and this record revenue is partially as a result of the travel rebound and also partially a result of price increases. I was wondering, is there an opportunity for the $5.95 daily fee that's charged to use your tolling service? Is there a chance that it could be increased in the future?

David Roberts, CEO

What I would say is that the pricing for the end renter is completely determined by our customers. We do not have any influence over that. If they believe the value proposition aligns with the cost and other factors, then they would make those decisions. They have certainly implemented price increases in the past. I just want to clarify that we are not the ones driving those decisions.

Louie DiPalma, Analyst

Great. And when you say it's been increased in the past, has it been increased in the past 12 months such that has any of your strong growth over the past year from rental car tolling come from price increases? Or has that come from the factors that you referenced at the Analyst Day in terms of the volumes and the shift to electronic tolling?

David Roberts, CEO

Yes, the direct answer is no. Just as a reminder, pricing is very dependent on geography and also on the product. For example, an all-inclusive in the Northeast is significantly different from one in Florida. It really varies based on the product, brand, and location. So, for instance, you don't simply implement a $1 increase across all products. That's not how our business operates for our customers.

Louie DiPalma, Analyst

Right. That makes sense. And another question, David. Two days ago, the New York City school zone speed camera program went into effect 24/7. Does this have any impact on your contract for that program? Or should we expect there to be any impact in the future associated with this?

David Roberts, CEO

Yes. We will be the ones operating the cameras around the clock. This aspect wasn't included in the initial contract. We are currently working through the necessary documentation process to ensure everything is properly recorded.

Louie DiPalma, Analyst

Great. So, would that have, I guess, a positive impact? And is that positive impact already in your guidance?

Craig Conti, CFO

We don't have the pricing yet, so honestly, I don't know. We haven't finalized the contract. I'm assuming it would have a positive impact, but it's not included at this time.

Louie DiPalma, Analyst

Great. That is all I have. Thank you, guys.

David Roberts, CEO

Thank you, Louie.

Craig Conti, CFO

Thanks, Louie.

Operator, Operator

Thank you. We'll now take our next question from Keith Housum with North Coast Research.

Keith Housum, Analyst

Good afternoon, everyone. Thank you for the opportunity. Craig, could you explain the ASR and your timing for it in the third quarter? If I understand correctly, you had 2.7 million shares removed from the diluted share count in the second quarter. Will the remainder be taken out in the third quarter?

Craig Conti, CFO

Yes. Yes. So, the short answer is yes. Let me give you the top of the waves here. Again, Keith, as I read what I prepared today, maybe I gave a little too much information; it wasn't super clear. The ASR was $50 million. The way an ASR works is they're funded upfront at 80% of the value, and then the remaining 20% settles later. What was captured in the second quarter was the 80% of the value. It was actually a $50 million check that the company wrote, but it was $40 million worth of shares retired. When our Q comes out, you'll see that we did that at $14.60. That's the 2.7 million shares. There is another piece that will be trued up here for the remaining 20% or another $10 million in the third quarter. That's the ASR. Is that one clear, Keith?

Keith Housum, Analyst

Yes. And that $10 million that averages the value of the shares from the debt you guys entered into whenever concludes on, maybe it's 60 or 90 days. Is that a fair assumption?

Craig Conti, CFO

You got it; that's exactly correct.

Keith Housum, Analyst

Okay, cool. Appreciate it. Just as a follow-up. In the commercial services segment, you've got obviously the three segments: the toll management, the violations, and title registration business. Can you kind of unpack how each of those three verticals did?

Craig Conti, CFO

In terms of the quarter?

Keith Housum, Analyst

Yes, I mean, obviously, I'm assuming toll management was the biggest driver of the growth here based on the size and success, but how did the violations and title registration do?

David Roberts, CEO

We don't give details at the product segment level within each of our business units. But obviously, the principal driver of our growth has been the commercial services on the RAC tolling, but the other businesses continue to perform as well.

Keith Housum, Analyst

Great. Fair enough. Appreciate it. Thank you.

Operator, Operator

Thank you. And this time, there appears to be no additional questions in the queue. That does conclude today's conference. We do thank you all for your participation, and you may now disconnect.