Earnings Call Transcript - VRRM Q1 2023

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to Verra Mobility's First Quarter 2023 Earnings Conference Call. At this time all lines are on listen-only mode. This call is being recorded on Thursday, May 4, 2023. I would like to turn the conference over to Mark Zindler, Vice President, Investor Relations. Please go ahead.

Mark Zindler, Vice President, Investor Relations

Thank you. Good afternoon, and welcome to Verra Mobility's first quarter 2023 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, May 4, 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 2022 annual report on Form 10-K which is 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. With that, I'll turn the call over to David.

David Roberts, CEO

Thank you, Mark, and thanks, everyone, for joining the call today. I'll start with an overview of our excellent first quarter results and provide an update on key business drivers. I'll move on to a discussion of the industry trends that are driving our results and influencing our future views of the business. I'll close with a recap of our strategic priorities across each of our business segments and share a summary tracking our progress. We delivered exceptional first quarter results highlighted by strong revenue and adjusted EBITDA and solid free cash flow generation. We delivered $192 million of revenue in the first quarter, representing 13% growth over the prior year quarter. This was primarily driven by strong tolling trends and commercial services and increased recurring service revenue in government solutions. Adjusted EBITDA of $88 million for the first quarter increased 17% over the prior year, and was driven by volume-based operating leverage in both commercial services and government solutions. As a note, we had a catch-up entry in government solutions that benefited revenue and adjusted EBITDA by about $2 million. Craig will provide the details in his remarks. Starting with commercial services, I'll provide an overview of the first quarter performance for each of our segments. TSA team again delivered strong performance revenue of approximately $86 million for the quarter which represented a 17% increase over the same period last year. The primary factor driving this performance was increased volume. TSA throughput reached 100% of pre-pandemic 2019 volume, driving an increase in adopted rental agreements. We also experienced strong adoption rates from renters for our all-inclusive tolling product offering. I'm pleased to announce that we recently entered into a partnership with Telepath for rental car tolling in Italy. This partnership effectively allows Verra Mobility to offer our toll management solutions in Italy for our rental car partners and allows for interoperability across Italy, Spain, France, and Portugal by utilizing Telepath's integrations with the tolling authorities in Italy and existing integrations in the other markets. While we do not anticipate current year revenue from the partnership, this is another important milestone in building our European tolling business. Moving to our government solutions business, we generated total revenue of $86 million with $83 million being recurring service revenue. Service revenue increased 14% over the first quarter of last year, driven by the transition from product sales to recurring service revenue. Government solutions margins were about 37% in the first quarter and up about 430 basis points over the prior year quarter, primarily due to increased annual recurring revenue that I mentioned. T2 systems delivered revenue of $20 million, representing growth of about 12% over the prior year quarter, and adjusted EBITDA of $3 million, all of which were directly in line with our expectations. SaaS services and hardware sales were all in line with expectations, benefiting from the push of several sales from the fourth quarter due to customer requests in installation timing. Regarding first quarter sales activity in T2, we had a strong booking for a large tier-one university in the mid-Atlantic region to extend their T2 solutions to include our parking access and control systems. On the municipal side, Ashland, Kentucky was a great example of a multiple solution sale that included our permits and enforcement software, T2 stations, mobile paying, license plate recognition technology, and citation and collection services. Turning to the macro perspective, I'm very pleased with the demand outlook across all of our segments. Despite market sentiment that a U.S. recession remains quite possible, we have not seen any evidence that travel demand is waning. The major U.S. airlines are all reporting strong bookings through the second quarter and the outlook from our rental car partners remains strong as well. In fact, while leisure travel appears to have returned to pre-COVID levels, there is still more opportunity for business travel. According to a recent survey by Deloitte, corporate travel spend in the U.S. and Europe is projected to be about 60% of 2019 levels in the first half of 2023, rising to about 70% by the end of the year. The report projects full recovery of business travel by late 2024 or early 2025. A second macro trend is the continued push for safer roads and communities, which drives the need for investments in automated safety enforcement. The latest National Highway Traffic Safety data from earlier this year estimated just a 2.2% decrease in U.S. traffic fatalities in 2022. So there is still much work to do to address this trend. In addition, U.S. traffic volumes are increasing. According to the Federal Highway Administration, U.S. travel on all roads and streets increased by 2%, which equates to 4.5 billion additional vehicle miles for February 2023 compared with the same month last year. The need for road safety technology remains strong, as evidenced by recent legislative activity in the states of Florida, Colorado, and Washington, which I'll address later in my remarks. Lastly, we provided our top three strategic priorities for each business during our fourth quarter call. On slide 5 of our earnings overview presentation, you'll see a summary of each of these priorities. While several are ongoing and difficult to quantify on a quarterly basis, we're tracking well against each of our priorities and I'll highlight a few here. In commercial services, we are earnestly working toward renewing our agreement with Enterprise. Regarding adjacent expansion opportunities, we continue to execute well in the fleet management space with FMC revenue growing 13% over the same period last year. We ultimately see FMC growing to a comparable growth rate with the overall commercial services business. In government solutions, we're seeing positive momentum on photo enforcement legislation in several states including Florida, Colorado, and Washington with the state of Washington recently signed into law. Florida is evaluating school zone speed, and Colorado is looking at both expanding current programs and authorizing new photo enforcement use cases. All of these states represent attractive opportunities for future growth, and we will keep the market apprised as new details emerge. In addition, the investments we're making in our software platform and related projects are tracking toward our plan, and regarding the timeline and budget perspective, we expect to complete these initiatives in the second quarter of 2024, no change from our initial expectations. And finally, in T2 systems, all priorities remain on track. Our bookings in our core business are in line with our annual plan, and we expect continued growth in the municipal market in the second half of the year. In summary, our operating results and trends are all positive, business fundamentals are durable, and our outlook has not changed and remains very positive. Craig, I'll turn it over to you to guide us through the financial results and the current year outlook.

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 first quarter results, followed by our 2023 financial guidance, and I'll conclude with a brief discussion on capital allocation. Total revenue increased approximately 13% year-over-year to about $192 million for the quarter, driven by strong operating performance across the company. Excluding domestic government solutions product sales in the first quarter of last year, we grew 15% year-over-year. Recurring service revenue grew 15% over the prior year quarter, driven by strong travel demand in the expansion of the New York City School Zone Speed program. At a segment level, commercial services revenue grew 17% year-over-year. Government solutions service revenue increased by about 14% over the prior year, and T2 systems service revenue grew 10% over the first quarter of last year. Product revenue was $7 million for the quarter, about $4 million of which came from T2 systems, while $3 million was from international product sales within government solutions. From a total profit standpoint, consolidated adjusted EBITDA of $88 million increased by approximately 17% over last year. The core business, defined as excluding one-time domestic government solutions product sales, generated adjusted EBITDA of approximately 18% versus the first quarter of 2022. As David mentioned in his remarks, we had a catch-up entry that benefited revenue and adjusted EBITDA in the first quarter. The underlying activity was operational in nature and hence was not adjusted out of our reported revenue or adjusted EBITDA. We recognized approximately $2 million in government solutions revenue for photo enforcement contract activity for a prior period resulting from a contract amendment in the first quarter of 2023. Since the expenses associated with this program had already been accrued, the approximate $2 million of revenue flowed through in its entirety to adjusted EBITDA and income before taxes. Moving on, we've generated about $351 million of adjusted EBITDA on approximately $763 million of revenue on a trailing 12-month basis, representing a 46% adjusted EBITDA margin. Over the same period, we've generated about $177 million of free cash flow for a 50% conversion rate of adjusted EBITDA, representing $1.13 of free cash flow per share. Next, I'll turn to commercial services where we delivered revenue of about $86 million in the first quarter, increasing 17% year-over-year. Rental car tolling revenue also increased 18% over the same period last year, driven by robust travel volume and increased product options. Additionally, our FMC business grew 13% versus Q1 of 2022 as our growth initiatives are beginning to take hold. First quarter adjusted EBITDA and commercial services was $54 million, representing 15% year-over-year growth. Adjusted EBITDA margins of about 63% reflect normal seasonality and were down slightly compared to the first quarter of last year, due primarily to growth investments. Now, let's discuss the results of the government solutions business. Driven primarily by New York City's photo enforcement expansion efforts, service revenue increased by $10 million or 14% over the same period last year to $83 million for the quarter. With New York City's school zones now fully implemented, product revenue of nearly $3 million was driven by international programs. Adjusted EBITDA was $31 million for the quarter, representing margins of 37% and an increase of about 430 basis points compared to the prior year, driven by the catch-up entry I previously discussed, the transition from product sales to annual recurring revenue, and a reduction in bad debt expense due to improvements in cash collections. We reported net income of approximately $5 million for the quarter, including a tax provision of $8 million, representing an effective tax rate of 63%. Our tax rate is heavily impacted by permanent differences related to mark-to-market adjustments for our private placement warrants. Adjusted EPS, which excludes amortization, stock-based compensation, and other nonrecurring items, was $0.26 per share for the current quarter compared to $0.22 per share in the first quarter of 2022. On the right-hand side of the page, we ended the first quarter with a net debt balance of about $1.1 billion, resulting in net leverage of 3.2 times for the first quarter. This is down from 3.8 times net leverage in Q1 of 2022. During the first quarter, we paid down approximately $65 million of term loan debt, bringing the gross debt balance down to about $1.2 billion, of which approximately $820 million is floating rate debt. We generated approximately $45 million in cash flow from operating activities, resulting in $27 million of free cash flow for the quarter. Finally, as for our year 2023 guidance, we will remain unchanged from our discussion last quarter, with our slightly elevated Q1 performance being offset by moderate investment cost increases and the back half of the year. Based on our first quarter results and our outlook for the remainder of the year, we're reaffirming all of the following guidance ranges: 6% to 8% revenue growth in constant currency, margin expansion of about 50 basis points, adjusted EPS of $1 to $1.10 per share, and free cash flow of $135 million to $155 million. This concludes our prepared remarks. Thank you for your time and attention today. At this time, I'd like to invite Julie to open the line for any questions.

Operator, Operator

Thank you. Your first question comes from Daniel Moore from CJS Securities. Please go ahead.

Daniel Moore, Analyst

Thanks, David, Craig, for taking questions and all the color. Good afternoon. Start with the guide. Obviously, a very strong quarter above our expectations and I believe consensus. It sounds like TSA is back to pre-pandemic levels. So just maybe talk about your thoughts on holding the guide into this stage of the year versus potentially raising it. And how much conservatism may be in there? Thanks.

David Roberts, CEO

Sure. Yes. Thanks for the question, Dan, and thanks for being on the call. So as we think about this from the revenue side, you're right, the TSA throughput came to 100% for the first quarter of 2019. As I discussed in the prepared remarks, we modeled in the high 90s for the balance of the year. We just want to see this play out for another quarter. We don't have any reason to believe it's going to be any different right now. But I want to get another quarter under our belt, I think, at this level to see if we would go ahead and raise that's one piece. I think the second piece, Dan, on the revenue side is the government solutions business that favorable $2 million catch up that we had was one-time non-recurring. That's another thing I'd throw out there. And then if I take those revenue comments and slow them down to EBITDA and EPS, the only other thing I'd add is that we're making those investments on the commercial services and government solutions side of the house. So in commercial services, those are product investments about running faster in our core markets, especially in the fleet business, which, as you heard, was up 13% in the first quarter, and then it's continued costs. We had some delayed hiring, and some of the work that we're going to do in government solutions on our platform in the future. So as I add all those things up, I still think I'm in the same spot for the year. But if travel continues strong, we'd certainly relook at it in another quarter or so.

Daniel Moore, Analyst

Makes perfect sense. And then maybe one follow-up related, despite the increased investment, SG&A continues to tick lower as a percentage of revenue, obviously aided a little bit by that $2 million you talked about. But is that Q1 level kind of sustainable? And what's a realistic goal, if we look out over the next three to five years embedded in your long-term plan? Thanks again.

David Roberts, CEO

Yes, Dan. Sure. I think it was a little artificially depressed here in the first quarter. If we just take it down to EBITDA percent, that'd probably be the easiest way to do it. So we did get a benefit, obviously from that catch-up entry. I don't know if you caught it in the prepared remarks, but that was 100% flow through. We'd already accrued the cost for that back in 2022. So when you look at the margin, you're going to see a steep jump in government solutions, and then for the overall business. Total margins for the company, I still think we're going to accrete about half a point year-over-year. I still think we're on that trajectory. Operating and SG&A costs as a percentage of revenue, especially in government solutions, those costs, we did see some delays in hiring due to other priorities in the business, and of course, repeated headcount availability. I do expect those costs to increase in the second quarter and in the back half of the year, and expect it to look a lot like the total year that we discussed with you last time out.

Daniel Moore, Analyst

Makes sense. Okay. We'll jump back with and follow up. Thanks.

David Roberts, CEO

Sure. Thanks, Dan.

Operator, Operator

Your next question comes from Faiza Alwy from Deutsche Bank. Please go ahead.

Faiza Alwy, Analyst

Yes. Hi. Thank you. I would love a little bit more color on the Telepath partnership that you mentioned in your prepared remarks. And I think I heard you say that there's no current revenue anticipated, but give us a sense of dimensionalize the partnership for us a little bit? Any further color on that would be helpful.

David Roberts, CEO

Yes. I mean, this really just goes back to the original thesis of going to Europe, which was, can we replicate the value proposition that we have for commercial fleets here in the U.S. related to access to toll roads? In Europe, you're doing that on a country-by-country basis. The partnership with Telepath is allowing us to accelerate our access to several countries. We anticipate being able to provide value to those countries, working with our customers there. The conversion to cashless will need to come alongside that to really realize the full benefit. Telepath is a major player in the tolling market in Europe, and we're excited to have a partnership like this.

Faiza Alwy, Analyst

Got it. Thank you. And then, secondly, you were just talking about certain investments across both segments. I'm curious with respect to your approach, would you characterize these as discretionary expenses where, to the extent revenue comes in better than what you're forecasting, you may end up investing more? If it's a bit lower, you can pull back on some of the spending? Give us a sense of how you're thinking of investments this year?

David Roberts, CEO

Yes. Sure, Faiza. I think I know where you're going with that one. The investments that we have in the business right now are going to be made pretty much regardless of the environment unless, of course, we saw something extreme. So I don't know that I'm waiting on revenue to make these investments. I think what we've seen in the government solutions space is simply timing. We have the same investment that we expected coming into the year, but the pacing of that investment is going to be weighted towards the back three quarters versus the first quarter. On the commercial services side, this is after we've seen the efficacy of the early efforts we've done, especially in the fleet business and rounding out additional tools that will help us capture the small and mid-market players in the space, as well as putting in the right commercial talent. Given the early efficacy of those, we're doubling down on those efforts for future growth.

Faiza Alwy, Analyst

Understood, thank you.

Operator, Operator

Your next question comes from James Faucette from Morgan Stanley. Please go ahead.

Unidentified Analyst, Analyst

Hey, guys, this is Jeff on for James. I wanted to touch on the legislative opportunities, and maybe just touching on Washington, specifically where you said it was recently signed into law there. So how should we think about the timing of you getting on the ground and potentially seeing a financial impact from that? Also, can you talk us through the potential timing around recent events in Florida and Colorado as well?

David Roberts, CEO

Yes, I mean, Washington basically becomes another state that has all three use cases related to speed and red light. We've been working in Washington for some time, now they have all three. I would anticipate the time to revenue being shorter; we could probably see that this year depending on RFP timing and things like that. As for places like Florida and Colorado, while there has been strong positive activity, it hasn't been finalized yet. So we'll wait for that to be confirmed. Those typically take a few months in terms of making sure that all the I's are dotted both legislatively and in terms of policy. I would anticipate discussions with customers this year and potentially revenue for those next year.

Unidentified Analyst, Analyst

Got it. Okay. And then can you talk about the shift to the all-inclusive fee structure within commercial? What are you doing there? How many customers on that type of fee structure? Or what type of lift do you see to revenue when you get customers on that platform? Perhaps just talk us through that.

David Roberts, CEO

Yes. First of all, this is a program that we've developed on behalf of customers and for the market. It's a favorable customer experience because it allows you to predetermine your usage of tolls and have that on your bill when you turn in your vehicle. Traditionally, it was mostly at off-airport brands, but now many of our customers are bringing that online to their airport brands or mainline brands. Overall, it's a much better experience for customers, which makes our clients very pleased. We anticipate further penetration as more toll roads open and more brands decide to adopt it.

Unidentified Analyst, Analyst

That's helpful. Thank you.

Operator, Operator

Your next question comes from Keith Housum from Northcoast Research. Please go ahead.

Keith Housum, Analyst

Good afternoon, guys. Just elaborating further on the prior question. I remember past discussions regarding all-inclusive pricing potentially having a negative impact on margins. Can you talk a little bit about the development of that product further? Do you still expect to see that upon adoption?

David Roberts, CEO

I'm not sure where the negative impact on margin came from, Keith. Overall, it's a great product for customers as well as for us. Adoption is increasing because our customers are seeing how it works well in different regions. They're rolling it out more. Again, it's really at their discretion, not ours.

Keith Housum, Analyst

Got you. Okay. Appreciate that. Craig, a little bit more on the guidance. I can appreciate the desire to be conservative. But can you give us an idea if the TSA travel were to come in at 100% versus a lower percentage? What's the incremental difference in terms of revenue for commercial services?

Craig Conti, CFO

I think it's hard to equate those two. It's not quite that prescriptive. However, if I reflect on the performance we saw in the first quarter and project that forward, we originally assumed a lower percentage for the first quarter. So while I cannot specify an exact number, if we stay at that 100% TSA throughput, there is potential upside for the commercial service business.

Keith Housum, Analyst

Great. Thank you. Appreciate it.

Craig Conti, CFO

Sure.

Operator, Operator

Your next question comes from Louie Dipalma from William Blair. Please go ahead.

Louie Dipalma, Analyst

David, Craig, and Mark, good afternoon.

David Roberts, CEO

Good afternoon.

Louie Dipalma, Analyst

Was the impact from the New York City speed camera program shift from 16 hours to 24 hours in line with the prior expectations that you set?

Craig Conti, CFO

It is. Looking back, we anticipated a total year-on-year decrease in New York City revenue of around $5 million to $10 million, which is still the case. This decline is due to the transition from product sales in 2022 to annual recurring revenue in 2023.

Louie Dipalma, Analyst

Great. Thanks, Craig. And, in general, were speed camera net ads during the quarter strong even though that New York City contract has completed?

David Roberts, CEO

Yes. I mean, I think everything was in line with plan.

Louie Dipalma, Analyst

Great. And another one, switching to the commercial division. There's been a lot of initiatives for different racks to onboard electric vehicles. Has that served as a benefit for your onboarding and title and registration businesses?

David Roberts, CEO

It does. The fact that they are electric doesn't matter as much as if they're onboarded. They inflate new vehicles, which impacts our title violations perspective. Anytime they're adding vehicles, that's good for us.

Louie Dipalma, Analyst

Great. That's it for me. Thanks, everyone.

David Roberts, CEO

Thanks, Louie.

Operator, Operator

There are no further questions at this time. This concludes today's conference call. You may now disconnect. Thank you.