Earnings Call Transcript - VRRM Q4 2021

Operator, Operator

Good day, and welcome to the Verra Mobility Corporation Fourth Quarter 2021 Earnings Call. My name is Jenny and I will be your conference operator today. Today's conference is being recorded. At this time, I would like to turn the conference over to Mark Zindler, Vice President of Investor Relations. Please go ahead, sir.

Mark Zindler, Vice President of Investor Relations

Thank you. Good afternoon and welcome to Verra Mobility's fourth quarter 2021 earnings call. Today, we'll be discussing the results announced in our press release issued after the market close. With me on the call are David Roberts, Verra Mobility's Chief Executive Officer; Tricia Chiodo, our Chief Financial Officer; and Craig Conti, our newly appointed Incoming Chief Financial Officer. David will begin with prepared remarks, followed by Tricia, and then we'll open up the call for Q&A. During the call, we will 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, and 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, April 21st, 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, which we are targeting to file tomorrow and will thereafter be made available on the Investor Relations section of our website and on the SEC's website. Finally, during today's call, we will refer to certain non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measures included in our earnings release can be found on our website and on the SEC's website. With that, I will turn the call over to David.

David Roberts, CEO

Thank you, Mark, and thanks everyone for joining us today. As Mark mentioned, Tricia will lead today's discussion on our financial results, but I'll take a moment to introduce everyone to Craig Conti, Verra Mobility's newly appointed Executive Vice President and Incoming Chief Financial Officer. Craig brings over 20 years of corporate financial management and leadership experience in global publicly-traded companies. He previously served as the Executive Vice President and CFO of Century Aluminum Company, a global producer of primary aluminum. And prior to Century Aluminum, Craig served in senior financial leadership positions with ITW and GE. I'm sure many of you will be getting to know Craig over the coming weeks and months, so please join me in welcoming him to Verra Mobility. For the agenda for today's call, I'll start with the key highlights and trends that are driving our results. I'll also provide a status update on the integration efforts with Redflex and T2 Systems, and then I'll conclude my remarks with a discussion on recent wins and our business development pipeline. We closed out 2021 with a very strong fourth quarter as our combined businesses continued to perform well. We're pleased with the consistent execution from our teams globally and we believe this momentum will serve as a platform for acceleration in 2022. Our results in the fourth quarter were primarily driven by the ongoing school zone speed expansion in New York City and a strong recovery in travel in the US, which has had a positive impact on our rental car tolling business. As Tricia will discuss in more detail later, we exceeded the high end of our full year guidance range for total revenue and adjusted EBITDA, delivering 40% top-line growth, of which 28% is organic growth. Moving to our recent strategic initiatives, the fourth quarter was a strong affirmation of our strategy to drive core business results, diversify the business, and redeploy capital to strategic and expansive M&A opportunities. On December 7, we closed our acquisition of T2 Systems, a leading provider of end-to-end parking management solutions in North America to universities and a growing presence among municipalities and healthcare providers. As we highlighted last quarter, T2 also provides us with a strong position in the rapidly growing curbside management market. Each of the existing market segments, North American municipalities, universities, and healthcare providers represent up to a $4 billion market according to a 2020 market estimate. Cities are faced with unprecedented competition has curb with ride-share services, delivery vehicles, and food trucks competing for the same valuable real estate for parking. Effective curb management solution combines a parking program with an enforcement solution. T2's SaaS offering for parking management, coupled with our existing photo enforcement solutions, should enable us to help customers solve curbside challenges such as defining parking areas and dynamic rates, enforcing parking rules, and handling payments in the future. While this market is still in its early stages, we expect that Verra Mobility Government Solutions segment in combination with T2 Systems, will be well-positioned to provide a holistic solution to our city and municipality customers, enabling us to expand our solutions portfolio. We're thrilled to have T2 as a part of the Verra Mobility family, and our team has been hard at work delivering strong results in the fourth quarter. They secured 11 new logo municipal customers for their citation and enforcement software offering, and they continue to expand the university and healthcare customer base. Moving on to Government Solutions, in the fourth quarter, revenue for Government Solutions grew 77% year-over-year to $92 million, and adjusted EBITDA was $34 million, representing 63% year-over-year growth. Our success in the quarter was driven by the continued expansion of the New York City school zone speed program, for which we installed 312 speed cameras, bringing our total for the full year to 695. The remaining 25 were installed in January, which fulfilled the 720 camera commitment. I'd like to also acknowledge our announcement in early February that we officially received the second three-year renewal option of our 2014 legacy photo enforcement contracts of New York City. As we stated in the press release, the renewal includes an additional 100 red-light cameras and 150 bus lane cameras, and it covers the maintenance of the speed cameras installed under the 2019 emergency contract. In February, we also received a notice to proceed from New York City on the remaining 240 school zone speed cameras under the emergency contract, which we anticipate will be installed in 2022 and will generate approximately $11 million in annual recurring revenue once installed. We continue our integration efforts with Redflex and have adopted cohesive ways of working to pursue the synergy targets we identified as a part of the acquisition. We've achieved about $5 million in synergies to date and believe there are $3 million to $7 million yet to be realized. However, the timeline to achieve those will be longer than we had originally anticipated. Furthermore, from a revenue perspective, we are beginning to see the strategic impact in the market with recent wins like Denver, our first major city that we bid on as a collective organization and one in the first quarter of 2022. This win shows the collective power and experience of the combined organization to win key customers like Denver from incumbent competitors. As we announced on March 23, with the addition of Jon Baldwin, our newly appointed EVP of Government Solutions, we will continue to pursue additional revenue and cost synergies to deliver the full benefits of the acquisition to our stockholders. Overall, I'm very pleased with the health of the business development pipeline along with the quantity and quality of the bids being submitted. Our pipeline combined with other positive trends in the industry creates a promising competitive landscape. One prominent example is the transportation bill that was recently enacted in Washington State, effective July, which expands the use of automated speed enforcement and extends the sunset period for other photo enforcements through 2025. We are well positioned to capitalize on this expansion given our market position in the state with 21 existing customers. This is exciting news and a prime example of the momentum focus on traffic safety that we're poised to execute on. Lastly, I'm pleased to report a new government solutions contract win in the Netherlands, in which Verra Mobility, through Redflex International, as a part of a consortium with DXC Technology, is one of the three vendors selected to supply, operate and support fixed systems for speed and red-light enforcement. The contract has an initial term of up to six years for the supply and installation of cameras, followed by an additional term of up to eight years for the camera maintenance. We expect to start generating revenue in the first quarter of 2023. In the fourth quarter, Commercial Services revenue grew 48% year-over-year to $71 million, and our adjusted EBITDA was $44 million, which was up 74% year-over-year. Success for this segment was driven by the continued strong travel recovery in the US, which has led to increased total usage. While fleet levels among our RAC customers haven't fully returned to pre-pandemic levels, we are seeing increased adoption of our product with consumers opting for longer rental agreements, resulting in more billable days and increased toll rates, all of which are driving our strong revenue performance. Next, I'll provide a brief update on our European expansion efforts. The tolling program we launched in Ireland with Enterprise continues to provide beneficial information about the tolling market in Europe. We've exceeded the saturation rate in our service level agreement, and we have more than 2,000 vehicles equipped with transponders. Overall, 2021 was a great year for Verra Mobility, and more than three months in 2022 is already shaping up to be another exciting year for us. As previously announced, Tricia is retiring, and therefore, this will be your last earnings call as the CFO of Verra Mobility. We are deeply grateful for her leadership and service over the past six years and wish her all the best in her new adventures. With our Form 10-K expected to be filed tomorrow, Craig Conti will take over immediately, and Tricia will provide advisory services over a 90-day transition period. As we noted in the press release announcing Craig's appointment, we have scheduled our inaugural Investor Day for July 19, which will allow Craig and John the time needed to get up to speed and fully participate in this exciting event. The conference will be held at the NASDAQ MarketSite building in Times Square, starting at 1:00 p.m. Eastern, and we look forward to sharing more details as the July 19 date approaches. Now I'll turn it over to Tricia to guide us through our financial results.

Tricia Chiodo, CFO

Thanks, David. Good afternoon, and thanks to everyone for joining us on the call. I'll start by the slides providing an overview of our fourth quarter and full year 2021 results, followed by a discussion of 2022 guidance. Looking at the big picture, there are three important takeaways. First, we are benefiting from several macro trends that are driving growth, such as the recovery in leisure travel, along with increased cashless tolling and the growing demand for photo enforcement programs in counties, municipalities, and school districts. Second, our business development team across our businesses have been very busy and very successful, as evidenced by the new business and contract renewal awards David described in his remarks. And third, we put ourselves in a position of strength for the future with the acquisition and integration efforts of Redflex and T2 Systems that further expand our capabilities, market segments, and geographic footprint. Today, I'm going to briefly summarize the financial performance of the three segments, discuss our consolidated results for 2021, and spend more time as it relates to the 2022 guidance and the key trends shaping our plan. The detailed results by segment are provided in our press release and earnings presentation, both of which can be found in the Investors section of our website. I'll start with fourth quarter revenue. Total revenue consisted of approximately $145 million in service revenue and about $25 million in product revenue. Excluding about $14 million from Redflex and $4 million from T2 Systems acquisitions, we delivered approximately $127 million of consolidated organic service revenue, representing nearly 40% year-over-year organic growth and 21% growth over 2019. Government Solutions delivered $92 million of growth for the quarter, along with $34 million of adjusted EBITDA. Commercial Services generated $71 million of total revenue and $44 million of adjusted EBITDA for the fourth quarter. Lastly, T2 Systems delivered $6.5 million and $2.6 million of revenue and adjusted EBITDA, respectively, for the post-closing period in the fourth quarter. Our adjusted EBITDA of $80 million increased $34.1 million for the same quarter in the prior year, and adjusted EBITDA margins were 47% in the quarter. The company reported net income of approximately $19.1 million in the quarter, compared to a net loss of $14.1 million in the same period of the prior year. Adjusted EPS, which excludes amortization, stock-based compensation, and other non-cash items was $0.25 per share in the current quarter, compared to $0.13 per share in the fourth quarter of 2020. The tax provision for the quarter was $8.9 million, representing an effective tax rate of 32%. The effective tax rate is impacted by permanent differences related to market-to-market adjustments for both the private placement warrants and the tax receivable agreement. Moving to cash generation and working capital, we generated $193 million in cash flow from operating activities for the year, in large part due to changes in net working capital. We continue to make strong progress collecting outstanding receivables with New York City in the fourth quarter. At the start of 2021, we had an outstanding receivable from New York City of approximately $98 million. Throughout 2021, we invoiced New York City $146 million for products and services and collected $182 million on aged receivables. The New York City balance was $63 million at year-end and $40 million at March 31, and we expect to further reduce our open receivable balance over the course of 2022. As previously noted, we closed T2 acquisition in December. As David mentioned in his remarks, the integration of Redflex and T2 Systems is on track. We ended the fourth quarter with a $101 million cash balance and a total debt balance of $1.3 billion, resulting in net leverage of 4.3 times at the end of 2021. The net leverage reflects the company's use of the accordion feature on our Term Loan B in the amount of $250 million used to close the T2 Systems acquisition. Before I discuss our 2022 guidance, I want to provide some color around the delay in the Form 10-K filing. As we previously disclosed, we determined that revenues for the company's recently acquired Australian subsidiary, Redflex, may not have been recorded in accordance with GAAP. Consequently, our audit committee began an investigation of the circumstances surrounding these issues to determine, among other things, whether any related adjustment was necessary for previously issued financial statements. Based on the results of the investigation, the audit committee determined there is no reason to believe that there was any material error in the company's financial statements. The Audit Committee also found no basis to question the integrity of management and no reason to believe that anyone in the company engaged in intentional wrongdoing. The company has already instituted new processes to shore up the control environment, identified new financial practices over acquisitions, and integrated the accounting for Redflex North America into the legacy Verra Mobility control environment. You'll see in our 10-K, which we expect to file tomorrow, that we had a material weakness associated with a third-party application called Vena. This is a financial reporting tool utilized in performing certain control activities. In summary, it was determined that Vena's SOC1 Type 2 report was deemed unreliable. And because we utilized Vena for several SOC controls, those controls using these reports were determined to be ineffective. Please note, however, that the material weakness had no impact on our financial statement outcomes. We are committed to the cycle of continuous improvement in our financial process and control environment. Now turning to the discussion for 2022. We're reiterating our guidance provided in the press release dated March 31. In total, we expect total revenue in the range of $694 million to $715 million, with a midpoint of $704 million, representing approximately 28% growth over 2021. Included in that growth, we expect sales to be in the range of $59 million to $63 million for product sales. We expect adjusted EBITDA in the range of $312 million to $322 million, representing 17% growth at the midpoint over 2021. We expect an adjusted EBITDA margin of 45%, which reflects the impact of the full year of Redflex and T2 Systems, as well as expected increases in R&D and SG&A expenses to fund continued growth. In commercial services, we expect the trends that have been building over the past 18 months to continue with higher toll fees, increased take rates of our services, and more billable days for rental agreements. We are expecting revenue to surpass 2019 levels with growth rates in the low double digits. We should see higher growth rates in the first half of the year and tightening as we cross over more difficult comps in Q3 and Q4. Remember that all the revenue in the segment is service revenue. Government Solutions has both service and product revenue. Service revenue should grow more than 25% year-over-year, driven primarily by the year-over-year impact of New York City school zone speed cameras installed in 2021 and the full year impact of Redflex. Product revenue, which is more episodic, is expected to be in line with 2021 levels. We're expecting a reduction in New York speed camera installation from 720 cameras in 2021 to 240 in 2022, creating a nearly $35 million headwind. The decline will be offset by the full-year impact of Redflex. Lastly, Parking Solutions revenue is expected to deliver low double-digit revenue growth, driven primarily by strong recurring subscription-based revenue. We anticipate revenue and adjusted EBITDA to decline in the first quarter relative to the fourth quarter of 2021 performance, followed by sequential increases in the second and third quarter and then a modest reduction in the fourth quarter level, all of which is consistent with historical seasonal trends. Lastly, based on the adjusted EBITDA guidance and the expected free cash flow conversion rate of approximately 50%, we expect to reduce net leverage to the range of about 3.3 times to 3.2 times by the end of 2022. And with that, I'll open the call for questions.

Daniel Moore, Analyst

Thank you. Good afternoon. Just quickly, welcome, Craig. And Tricha, thank you for all your help. You've been tremendous and a pleasure to work with. Maybe start, David, high level question, but you started to touch on this in the prepared remarks. Can you give us a little bit of a preview of the Analyst Day just as it relates to T2 and the strategy for integrating that business and how you plan to leverage it over the longer term?

David Roberts, CEO

Yeah. Good question, Dan, good talk to you. What I would say is we've actually spent some time serving our investors and the investment landscape to really hone in on the messages that we think matter most. And I think the clarification of long-term strategy goes to the top of the list. And so I think what you'll see, and I'll just say this structurally is, one, a clear definition of the markets that we play in, what are the dynamics of those markets and how we feel like we compete today and into the future. And then more specifically, how T2 looks to create value in the market it competes within and how we can accelerate that growth through being a part of the Verra Mobility operating system. And so I think that's going to be the principal way you'll see that as, I think, clarifying the broader world of what we would call urban mobility and how parking is a really important part of that globally, and that's why we're excited to have T2 in the family.

Tricia Chiodo, CFO

So I think the pace is that will be done there starting in the third quarter. Should be completed by the end of the third quarter.

David Roberts, CEO

Should be completed by the end of the third quarter. So it will look a little bit off from where we were last year, because remember, we started installing the 720 cameras last year in the back half of the year. So you're going to see some probably positive comps in Q1, but negative comps in Q4. So once again, you'll see product revenue being a little lumpy throughout that time frame.

Daniel Moore, Analyst

Perfect. And then maybe last for me. I think you mentioned the synergies from Redflex may be getting pushed out a little bit. Just clarifying the overall synergies you still expect to achieve and maybe what's causing that? Thanks.

Tricia Chiodo, CFO

Yeah. I think there's a couple of things in play. I think we needed to just cause regroup. We've got John who's a great addition to the organization who's going to run the organization and create those synergies. But also as we integrate, we lose the ability to separate out what used to be Redflex and what used to be Verra Mobility and it just becomes one entity over time. So I think what you need to look for is just that the North American entity returns to the margins that the legacy Verra Mobility company had. And that's the real sign that synergies are being obtained over time.

Dave Koning, Analyst

Thank you, everyone. Great job. First, we don’t have strong seasonal data for Q1 from previous years due to the complications brought by COVID. However, we can look at Q1 2019, which shows a nice sequential revenue increase of 7%. Are we back to normalized trends? I think we might actually be doing even better now. We receive daily TSA data that suggests an improvement. Should we expect sequential growth in Q1 based on this data?

Tricia Chiodo, CFO

In a segment or the company as a whole?

Dave Koning, Analyst

Oh. This is just commercial. Yeah. I'm sorry, just commercial it was up 7% in Q1 2019 in the TSA data is like kind of really accelerating this Q1. So I'm just wondering can it be even better than kind of normal trends, which seem like they would be up sequentially?

Tricia Chiodo, CFO

Yes, we could. I think we will see a really strong first quarter of 2022. However, I am not certain they will show an increase from the fourth quarter. Typically, there is a slight decline. It would be more likely for us to see that if they remained flat, it would be a very positive outcome. Therefore, I don't expect the performance to rise from the fourth quarter to the first quarter, as that is not the usual pattern.

Dave Koning, Analyst

Okay. Okay, got you. Well, that's good to know. And then secondly, on Redflex, I guess, two parts to a Redflex question. One is what's just kind of the organic growth within Redflex itself like relative to what it was in Q4 of 2020? And then, it was down a little sequentially. Is that the normal trend for in Q4?

Tricia Chiodo, CFO

What you're observing with Redflex is that their product revenue is quite variable, particularly since we shifted to GAAP accounting requirements. Previously, they could recognize product revenue based on a percentage of completion, but the U.S. GAAP rules do not typically allow that for most contracts. As a result, revenue is now recognized only at the project's completion when the cameras are installed and accepted by the customer. This change makes Redflex's overall revenue seem more uneven than it usually is. Looking ahead, the only part of Redflex's revenue you can expect to see is from the international segment, which will include both service and project revenue. However, for everything in the U.S., as David mentioned regarding Denver, we are bidding collectively, and it won't be possible to differentiate between Redflex and Verra Mobility customers.

Trevor Bowers, Analyst

Hi, guys. Congrats on the quarter. Just a couple of quick questions about the toll management business. So how did toll management results in the fourth quarter compare to your expectations prior to the quarter? Would you say the recovery in domestic travel is in line with what you thought or maybe faster or slower?

Tricia Chiodo, CFO

I think the recovery happened faster than we expected. The fourth quarter was very strong and surpassed our performance from 2019, even though rental car companies haven’t fully restored their fleets yet. If we look at TSA data, it's improving but not at the level it was in the fourth quarter of 2019, and rental fleets, while also recovering, have not reached their 2019 status. We were really pleased to exceed 2019 revenue in the fourth quarter of 2021.

Trevor Bowers, Analyst

Okay, great. And that kind of leads me into my follow-up question. So, in terms of revenue per user in the toll management business, how is that compared to 2019, 2021 versus 2019?

Tricia Chiodo, CFO

That's not how we look at those statistics. There are various factors to consider, such as toll rates, rental duration, and whether they're using an all-inclusive, usage-based product. We do track revenue per rental agreement, but I don’t believe that is a figure we have ever disclosed.

Louie DiPalma, Analyst

Good afternoon, David, Tricia, and Craig.

Tricia Chiodo, CFO

Afternoon.

David Roberts, CEO

Hi.

Louie DiPalma, Analyst

Tricia, congrats on helping lead Verra where it is today, and Craig, congrats on joining the Verra team.

Craig Conti, Incoming CFO

Thank you.

Tricia Chiodo, CFO

Thanks.

Louie DiPalma, Analyst

For David, in February, you indicated that Verra was still negotiating with Hertz in regards to the tolling contract. Was there any update on that negotiation as seen that everything is status quo based upon the guidance and the implied growth? I was just wondering if there is any update with the negotiation?

David Roberts, CEO

Yes. I think what you surmise is correct, meaning we still feel very good about it. We have not yet signed the final contract. I would say we're in the 8.5 inning, and we're getting very close. As you can imagine, with the recovery and with fleets, the challenge they've had keeping their fleets up not just hurts, but all of rental car, they've obviously had other things. They've also had a major leadership change in the last couple of weeks. So given that there's been some other priorities that they've been working on, but that also speaks to the fact that we've had a long-standing relationship that is quite reliable that we can continue to work forward under the current contract, and we'll have a renewed agreement here shortly.

Louie DiPalma, Analyst

Great. And I was also wondering, David, what are you seeing thus far with strategic synergies with T2 Systems and your photo enforcement division?

David Roberts, CEO

Yes. So right now as you recall, we weren't targeting sort of the cost synergy. We're really leaving T2 is more of a portfolio model. And so what we have started to see is two things. One is, what I would say, cross pipeline opportunities, meaning people within the photo enforcement business are looking for potential parking opportunities for T2 and vice versa. It's mostly us looking at our municipalities and bringing those to T2, which is by the way, that was the strategic concept that we would have that we talked about. And then two, as I mentioned earlier in my opening comments, we definitely see this opportunity as curbside management does a collective significant opportunity. And so there will be, what I would call increased collaboration as we think about go-to-market or on curbside. We've got some time. That market isn't fully activated yet, but I think we've got the right platforms between T2 and Government Solutions to be real played in that space.

Louie DiPalma, Analyst

Great. And do you intend to be very acquisitive in that curbside management market? And the reason I ask is for rental car tolling, you have 100% market share in the U.S. and for photo enforcement, you have the 75% market share. But for parking, it's a very fragmented market, and you just began with T2 Systems. And so should investors think of this as a roll-up opportunity for you, or do you have like the foundation with T2 to organically expand and grow at your own pace?

David Roberts, CEO

Yes, there are a couple of ways to respond to that, Louie. First, regarding our intent to be active in acquisitions, the answer is yes. We will continue to explore opportunities in the smart mobility sector and will invest capital through acquisitions that we believe will allow us to grow, diversify, and provide value to our shareholders. Secondly, concerning parking, it is indeed very fragmented, especially in the U.S. One of the reasons we faced some questions about the price we paid for T2, our recent acquisition, is because it is among the largest and most profitable in the industry here. This is why we were particularly enthusiastic about acquiring it. With our municipal base in government solutions, we feel we have a solid foundation. However, as we consider curbside management, there are additional technologies we could look into, and we will certainly evaluate M&A opportunities when fitting. Currently, I wouldn't say we have a specific roll-up strategy focused on parking.

Daniel Moore, Analyst

Yes, thank you again. Trish, you alluded to this, but as travel has come back and come back a little faster, have you seen any changes in average terms of the contracts, any reversion to the mean in terms of usage, miles driven, length of contract terms, or are we all generally still above pre-pandemic levels, at least at this stage?

Tricia Chiodo, CFO

We don't get miles driven. We do get length of rental agreement, and that has remained longer than 2019 for most of the pending timeframe, including the back half of 2021. And we are seeing that we're getting more billable days per contract, which is awesome because they're keeping for longer and then more days, they're using tools more often in that contract. So that's fairly consistent.

Operator, Operator

And with no other questions in the queue, that does conclude the question-and-answer session. And this concludes today's call. Thank you everyone for your participation. You may now disconnect.