Earnings Call Transcript - VRRM Q3 2022

Operator, Operator

Good day, and welcome to the Verra Mobility Third Quarter 2022 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to 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 Third Quarter 2020 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; 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, November 2, 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-Qs for the first and second quarters of 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 to everyone for joining the call today. Before I discuss our results, I'd like to take a minute to acknowledge our employees, customers, and vendors in Florida; the impact of Hurricane Ian was significant, and I hope that you and your loved ones are safe and moving towards a level of normalcy during these challenging times. For today's call, I'm going to focus primarily on our third quarter results, but first, I'd like to start with a brief discussion to contextualize these results by looking at the trends driving the two broader smart mobility markets in which we operate. We delivered an outstanding quarter, highlighted by strong revenue and adjusted EBITDA growth and solid free cash flow generation. These results are underpinned by two key macro trends across our operating segments: continued travel demand by consumers and businesses; and strong and growing interest in automated enforcement for road safety. To better understand the significance of these macro trends, I'll take a minute to discuss the two broader markets that we serve: connected fleet solutions and urban mobility. We provided a thorough discussion of these markets at our Investor Day in July, and it's important to understand how our business units support these markets. The connected fleet end markets consist of technology solutions to improve process efficiency and optimize vehicle asset utilization. Our Commercial Services business unit serves customers in the connected fleet market with three primary solutions: tolling management, violation management, and title and registration services. We expect the $7 billion market to grow to $27 billion by 2030, driven by growing vehicle fleet sizes, increasing complexity of services, and new use cases focused on vehicle connectivity. Our Government Solutions and Parking Solutions business units reside in the broader urban mobility market, which is primarily focused on safety, sustainability, and increasing efficiency for the use of existing infrastructure in cities of all sizes. This is an $18 billion market that industry analysts expect to double over the next 10 years, driven by road safety initiatives and growing city populations necessitating congestion and parking solutions. With that as a background, I'll move on to our results. We had an outstanding third quarter highlighted by strong revenue and growth and margins, and solid free cash flow generation. The factors influencing our performance are largely unchanged from recent quarters. Starting with Commercial Services, the team again delivered strong performance; revenue of approximately $86 million for the quarter represented an 11% increase over the same period last year. And compared to pre-pandemic levels, we also achieved 11% growth over the third quarter of 2019. The key drivers have been consistent throughout the year. Travel demand remained strong despite rising inflation and fuel prices. As we have discussed previously, TSA throughput has been tracking upward throughout 2022. First-quarter 2022 was a little less than 85% of 2019 levels. The second quarter was approximately 90% of 2019 and the third quarter came in slightly above 90% of 2019. Revenue is far exceeding 2019 due to the growth in cashless tolling, the increased number of toll roads in the U.S., and the longer duration of rentals, which drives more billable days to increase toll margin revenue. Moving to our Government Solutions business, we generated a total of $90 million, representing growth of 6% over the same period last year. In addition, we all but completed the 265 camera install commitment for New York City. I'd like to thank both our customer and the Verra Mobility operations teams for making this happen. It's a testament to your dedication and steadfast results and rich lives by making mobility safer and easier. I'm also pleased to report that we were awarded a pilot project for a 12-month automated work zone speed enforcement program in Connecticut. The revenue contribution from the pilot program is not material but serves as a potential stepping stone for permanent legislation and future long-term, full-scale work zone speed programs in Connecticut. Moreover, we recently executed a contract modification with New York City for the transition to 24/7 camera operations. And we expect these changes in operations to contribute to 2023 revenue growth. Finally, T2 Systems delivered $22 million of revenue for the quarter, in line with our internal expectations and on track to deliver double-digit growth over full-year '21 results. In summary, Q3 was another strong quarter of growth 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. 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. I'll start out today by providing an overview of our third quarter 2022 results, followed by some commentary on our current financial guidance, and I'll conclude with a brief discussion on expected free cash flow generation and the resulting net leverage target to close out 2022. Let's turn to slide four, which outlines revenue and adjusted EBITDA performance for the consolidated business. Total revenue increased approximately 22% year-over-year to about $198 million for the quarter, driven by strong operating performance across the company and the inclusion of T2 Systems in our financial results. On an organic basis, we grew more than 8% year-over-year. Q3 service revenue grew about 27% over the same period last year, of which 15% was organic growth. This growth was attributable to several factors. First, commercial services grew 11% year-over-year. Second, Government Solutions service revenue increased by about 20% over the prior year. And finally, T2 Systems contributed about $17 million of service revenue. Product revenue was $17 million for the quarter, of which about $5 million was from T2 Systems. Finally, from a profit standpoint, consolidated adjusted EBITDA of $91 million increased by approximately 11% year-over-year. Moving to Commercial Services on slide five, we delivered revenue of about $86 million, increasing $9 million or 11% year-over-year. This improvement was driven by continued strong demand for travel, particularly in the U.S. as well as the resulting increase in demand for rental cars. As David mentioned, while rental car volume remains below pre-pandemic levels, the percentage of cashless tolls and toll counts are increasing. In addition to the continued strength of the rental car market, our ongoing growth initiatives within the commercial fleet space drove an approximate 15% increase in tolling-related revenue versus prior year levels. Adjusted EBITDA in Commercial Services was $56 million, representing 10% year-over-year growth. Adjusted EBITDA margins of about 65% continued to benefit from volume leverage, which is consistent with seasonal trends. Let's turn to slide six, 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 $5 million or 6% over the same period last year to $90 million for the third quarter. Service revenue for the third quarter was $77 million, which grew $13 million or about 20% year-over-year. Product revenue declined $8 million to about $12 million for the quarter, which is in line with expectations as we effectively completed the New York City school zone speed installation programs. 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 roughly flat with prior year at $30 million for the quarter. Adjusted EBITDA margins of 34% were in line with expectations. Let's turn to slide seven, and we'll take a look at the results of T2 Systems, which is our Parking Solutions business segment. Revenues of $22 million and adjusted EBITDA of approximately $4 million were in line with our expectations for the quarter. As I mentioned in our previous discussions, we expect T2 to drive sequential revenue and adjusted EBITDA growth through the balance of the year and anticipate double-digit revenue growth versus 2021 levels. Overall, total Verra Mobility reported net income of approximately $25 million in the quarter, which compares to net income of $27 million in the same period in the prior year. Adjusted EPS, which excludes amortization, stock-based compensation, and other nonrecurring items was $0.27 per share for the current quarter compared to $0.26 per share in the third quarter of 2021. The tax provision for the quarter was about $8 million, representing an effective tax rate of approximately 25%. As a reminder, our tax rate is impacted by permanent differences related to mark-to-market adjustments for our private placement warrants as well as other nonrecurring items. Moving on to cash generation for the third quarter, we generated approximately $52 million in cash flow from operating activities, resulting in $39 million of free cash flow for the quarter or a 43% conversion of adjusted EBITDA. Taking a slightly longer view on a trailing 12-month basis, free cash flow per share was $1.05, and the conversion rate is 50% of adjusted EBITDA. We expect a modest sequential increase in free cash flow generation in the fourth quarter, driven by working capital trends. And on a total 2022 basis, we expect free cash flow to be about 50% of adjusted EBITDA. Turning to slide eight, we ended the third quarter with a net debt balance of about $1.2 billion, resulting in net leverage of 3.5x for the quarter. 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 $890 million is floating rate debt. At the end of June, we locked in LIBOR at about 2.85%, and in the beginning of January of 2023 when we next lock in LIBOR, we'll evaluate locking it in at either a one-month, three months, or six-month rate. Next, I'd like to give you a brief update on the share repurchase program the company's Board of Directors authorized in May 2022, for up to an aggregate amount of $125 million over a 12-month period. As we previously disclosed, we repurchased over 3 million shares in the second quarter through an accelerated share repurchase program for a total purchase price of $50 million. In addition, we've repurchased about 446,000 shares through open market transactions through September 30 for a total purchase price of about $7 million. The company elected to discontinue open market repurchases during the third quarter of 2022 in favor of an ASR for the remaining availability under the share repurchase program. During the third quarter of 2022, we repurchased 3.3 million shares for $68 million through the second ASR program. The settlement is expected to occur during the fourth 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. At this time, we expect the final outcome of the full $125 million share buyback program to result in the repurchase of approximately 8 million shares. As I discussed earlier, we ended the quarter with net leverage of 3.5x trailing 12 months adjusted EBITDA. This is flat versus the second quarter due to the decision to execute and fund the second ASR in the third quarter. Next, let's take a look at our current guidance on page nine. During our second quarter call on August 3, following an increase in guidance at our July 19 Investor Day, we reiterated 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. Based on our year-to-date results and our outlook for the remainder of the year, we're now expecting to deliver results at the higher end of this range for revenue and adjusted EBITDA. Our revenue guidance incorporates a modest reduction in RAC tolling we typically experience in the fourth quarter, which is consistent with historical trends. We have also factored in an approximate $3 million impact from toll road suspensions across 13 counties in Florida over an approximate 18-day period following Hurricane Ian. In addition, we have also factored in an approximate $2 million headwind related to foreign exchange currency exposure in Government Solutions, primarily related to the depreciation of the Australian dollar. These revenue impacts are partially offset by sequential service revenue growth in Government Solutions, primarily driven by the New York City school zone speed camera installations and the expansion of photo enforcement operations outside of New York City. In addition, our Parking Solutions business is expected to generate sequential revenue growth as the fourth quarter is typically the strongest revenue-generating quarter in that business due to university spending cycles. Finally, based on achieving the higher end 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 3.4x or less by year-end 2022. The expected net leverage target reflects a reduction of nearly a full turn of net leverage over the past year, including the completion of the $125 million stock repurchase program. We feel this performance highlights strong free cash flow generation capabilities of the company. This concludes our prepared remarks, thank you for your time and attention today. At this time, I'd like to invite Jenny to open the line for questions; Jenny, over to you.

Operator, Operator

Thank you. We will go to our first question from Daniel Moore with CJS Securities.

Dan Moore, Analyst

Thank you. Good afternoon. Thanks for taking the questions. I'll start with the observation that consumer behavior on the commercial services side shows that contract lengths are continuing to extend compared to pre-pandemic levels. Are you noticing any return to historic levels, or does this seem to be more permanent at this stage?

David Roberts, CEO

I think we're still sort of observing generally the same trend. It's certainly not gone back to what we had seen previously in 2019, so far so good in terms of that trend remaining durable through the end of the year.

Dan Moore, Analyst

Got it, really helpful. David, you provided great insight into the overall strategy. Could you discuss some of the conversations you're having about capabilities related to congestion pricing and dynamic parking pricing solutions with your municipal customers as you integrate T2? While I understand you can't disclose specific names, are you noticing more organic opportunities in this area, and what is the timeline for monetizing that?

David Roberts, CEO

Yes, regarding your question about congestion pricing, we currently do not have a solution in place. We are keeping an eye on that sector and believe there could be potential. As you may remember, New York was the first to adopt congestion pricing, but it has not yet been implemented in the United States, and it looks like that won't happen until 2024. So, we are observing from the sidelines and will get involved when it makes sense. We are enthusiastic about the momentum with T2 as we approach the end of the year. We are beginning to notice some competitive trends from larger municipalities. Historically, T2 has operated in smaller urban areas, and we are now focusing on larger ones. I expect that we will start to see movement in that direction, likely aligned with RFP cycles in the second half of next year, at which point we could see some significant progress.

Dan Moore, Analyst

Okay, got it. And how should we think about the incremental revenue opportunity in '23 of transitioning to a 24-hour monitoring in NYC? Is that meaningful to your growth rate?

Craig Conti, CFO

Yes, I think so, Dan. This is Craig. Thanks for the question. I do think it's meaningful. To size that, we size it at approximately 5% of total New York City revenue. So, if you were to look at total New York City revenue for 2022 or if you were to take 2021 and grow it at our growth rate into 2022, it should be about a 5% add around that on a total year basis.

Dan Moore, Analyst

Great. And then last for me, I appreciate the color on the product revenue in government. T2's product revenue, has that been lumpy historically like yours has? I think you said it was $5 million in the quarter. Just what's the kind of typical pattern, and how should we kind of think about that going forward?

Craig Conti, CFO

Yes, there is some variability. However, the overall trend shows consistent growth. If you examine total product sales for nearly any timeframe we've experienced, both during our ownership and prior, sales tend to be lowest in the first quarter and increase progressively, with the fourth quarter seeing the highest figures. This aligns with the university buying cycle, which has been our primary market for these products.

Dan Moore, Analyst

Very good. I'll jump back in queue for any follow-ups. Thank you.

Craig Conti, CFO

Thank you.

Operator, Operator

And we'll go next to a question from Faiza Alwy with Deutsche Bank.

Faiza Alwy, Analyst

Thank you for taking my question. I would like to ask a broader question since I assume you're currently in the planning stages for 2023. During Investor Day, you presented some long-term goals, and I was wondering if you could share any initial insights on where we should set our expectations. As we look towards 2023, should we anticipate growth that aligns with those long-term objectives, or are there any key considerations we should be aware of?

Craig Conti, CFO

Yes, Faiza, this is Craig. Thanks for the question. I understand exactly where you're going, and I think the first part of your question kind of is the answer. We're really in the middle of that right now. So, we'd like to come back to you on our next call; we'll certainly have a much better view of that. So, unfortunately, we're going to have to bump that one to the next call. We'll be happy to walk through at that time.

Faiza Alwy, Analyst

Okay, I understand. Is there anything you can share about your capital allocation philosophy as we enter 2023? Also, how should we consider interest expenses in a rising rate environment and your approach to this? I would appreciate more details on your thoughts regarding capital allocation.

Craig Conti, CFO

Yes, sure. From Verra Mobility's perspective, our capital allocation focuses on three key areas. First, we consider any accretive mergers and acquisitions, which can be somewhat unpredictable in terms of timing and market conditions. Second, regarding our share repurchase program, I want to clarify that the $125 million authorization from our Board of Directors will be fully utilized in the fourth quarter, leading to the repurchase of about 8 million shares year-over-year. The third area of focus is potential debt pay-down. While we initially prioritized this lower on our list, recent developments may prompt us to reassess it regularly. As we approach year-end, our strategy will likely involve maintaining cash on our balance sheet, similar to our positions in the second and third quarters. We'll continue to evaluate buybacks monthly based on intrinsic value and have flexibility with our floating debt, allowing us to make informed decisions on the best use of capital moving forward.

Faiza Alwy, Analyst

All right, great. That's really helpful. Just last one for me. On Government Solutions, is there any color you can share in terms of what you're hearing from various municipalities? How would you characterize the environment at this point?

David Roberts, CEO

I would say it's very positive. I mean I think overall, we're seeing a recognition of the benefit of having those types of programs that we offer. The pipeline is continuing to get more and more full, and we would anticipate we're heading into next year with really strong momentum across the country.

Faiza Alwy, Analyst

Great, thank you.

Operator, Operator

And we'll hear next from Dave Koning of Baird.

David Koning, Analyst

Yes, hi, guys, thank you and nice job.

Craig Conti, CFO

Thank you.

David Koning, Analyst

I have a question regarding the performance in Commercial Services for Q3. Typically, we see an increase of about $8 million to $10 million, but this year it wasn’t as significant. Were there any one-time factors that positively impacted Q2 and caused a decline in Q3? Can you explain what happened sequentially?

Craig Conti, CFO

Yes, I think your understanding is correct. What we observed qualitatively was that the summer driving season started earlier than usual. In past years, we typically saw a significant increase in the third quarter, but this time it happened in the late second quarter. This was also reflected in the way the rental car companies managed their fleet sizes, with many cars becoming available in the second quarter, leading to more rentals. Overall, in commercial services, the business grew 1% sequentially, which is less than usual, but our year-to-date growth aligns with our expectations. In the second quarter, we usually see growth between 5% and 10%, but last year it grew 16%. This growth was partly due to more cars on the road for tolling during the second quarter compared to the third quarter. Additionally, the growth was influenced by our title and registration business as rental car companies expanded their fleets in the second quarter, resulting in an increase in those services through Verra Mobility. Generally, from the second quarter to the third quarter, this business remains flat or declines slightly, but this year it saw a significant decline because the majority of the work was completed in the second quarter. The summer driving season and fleet updates occurred earlier this year than in the past, and our year-to-date results are right where we anticipated.

David Koning, Analyst

Yes, it looks like year-to-date, I mean, you're still so far ahead of TSA level, so it's impressive. And then I guess my follow-up, just because it's our first year kind of looking at T2, this quarter was up a lot sequentially. Like I know what you said the sequential pattern; like I think Q2 was up 5%, give or take, sequentially Q3 up like 15% or something, a big, big number. Is that just truly just sequential patterns that are normal? And maybe why would that happen? And is it actually some cross-selling that's starting to happen just that you're fundamentally making that business better?

Craig Conti, CFO

I'm sure it's a combination of those factors, but I believe the main reason is how the buying cycle operates. Historically, this business, which has existed since the early 1990s, relies heavily on the university segment, accounting for over 60% of its sales in some years. University budgets typically result in procurement occurring in the latter half of the year, particularly in the third quarter before students return and again at the end of the fourth quarter before the new fiscal year begins. This pattern is normal for the business, and we expect to see growth again as we move into the fourth quarter.

David Koning, Analyst

Got you, great. Thanks, good job.

Craig Conti, CFO

Thank you.

David Roberts, CEO

Thank you.

Operator, Operator

We will go next to Keith Housum with Northcoast Research.

Keith Housum, Analyst

Hey, good afternoon guys. Thanks for the opportunity here. Dave, a little expansion on the Connecticut pilot, if we could have that, can you talk about perhaps a little bit of a background there? Do the legislators come to you guys in terms of doing the pilot? I think what I heard is that you will decide how it goes, if it will be enacted into legislation, perhaps, just give a little background there. And then outside of that, is there other opportunities that you guys are working on behind the scenes around the country?

David Roberts, CEO

The answer to the last part is yes. Connecticut is indeed working on an emerging trend as people begin to seek purpose-built use cases for photo enforcement. Similar to school zones, it's hard to argue against protecting individuals who are at risk while working on our highways or specific roads. Pennsylvania has implemented a program like this. In Connecticut, we have partnered with local legislators to establish a pilot program that is not yet enacted. We will have to wait and see how the program performs over the next couple of years, after which they can decide whether to move it into permanent legislation or not. A positive aspect of this initiative is the involvement of the legacy Redflex organization that we acquired, which was a strategic investment for pursuing such opportunities.

Keith Housum, Analyst

Great, I appreciate it. And then, there's been some interesting news in terms of New York City using Bus Lane Cameras. Can you perhaps provide a little bit color on how Verra Mobility is playing in that program?

David Roberts, CEO

Yes. So, we are the back-end processing for that. So, our software, not dissimilar from the other software programs that we use for other forms of photo enforcement, is doing the processing and the violations for that. A different party is providing the cameras for that specific initiative.

Keith Housum, Analyst

Great, I appreciate it. Thank you.

Operator, Operator

We will go next from Louie DiPalma with William Blair.

Louie DiPalma, Analyst

David, and Craig, good evening.

Craig Conti, CFO

Good eve.

David Roberts, CEO

Good evening. How are you?

Louie DiPalma, Analyst

You mentioned the pilot in Connecticut, which sounds promising. At your Analyst Day, you also referenced potentially positive legislation in I think it was California and Florida for speed cameras. Are the things moving forward in those states as well?

David Roberts, CEO

Yes. These cycles naturally have ups and downs, and right now we're in a down phase since we are approaching a voting cycle next week. I believe we have made some progress in California. However, it’s important to note that this isn’t specific to this year; initiatives often get paused depending on who holds power after the election. We will certainly return to discussions with the legislators once we assess if any significant changes have occurred in the legislative body relevant to the legislation we are pursuing.

Louie DiPalma, Analyst

Great. For either David or Craig, I think you mentioned that there was an amendment to the New York City Vision Zero contract related to extending the hours of operation. Should we consider that amendment as significant to your government service revenue for 2023?

Craig Conti, CFO

Yes. Louie, I would say so. I mean so the way I think about it on a total year is about 5% of total New York City revenue. So, if you were to look at total New York City revenue, whether it's in 2021 and you grow that into 2022 or look at 2022 in totality, it's about a 5% add around that total for a total year.

Louie DiPalma, Analyst

Great. And one final one, is there any update on how well the European RAC tolling pilots are going? I know you have, I think, Enterprise in Ireland, Hertz in Spain, and Rent A Car in France. Are those going well?

David Roberts, CEO

Yes. The one in Ireland has recently been extended. So, the pilots that we're doing there have been extended. I don't know the time frame. I believe, through the end of the year but something around that time frame. And then we're sort of just getting started in Spain, and then we're also continuing to look for other pilots in other parts of Europe as well. So, those are moving at a pace that we are comfortable with, but we're still trying to add more pilots to the mix.

Louie DiPalma, Analyst

Great, thanks everyone.

David Roberts, CEO

Yes, thank you.

Operator, Operator

And so, that concludes today's question-and-answer session, and that concludes today's call. Thank you for your participation. You may now disconnect.