Earnings Call Transcript - VRRM Q4 2020

Operator, Operator

Greetings, and welcome to Verra Mobility Fourth Quarter 2020 Earnings Call. Please note that this conference is being recorded. I will now turn the conference over to Marc Griffin, Investor Relations. Thank you. You may begin.

Marc Griffin, Investor Relations

Thank you. Good afternoon, and welcome to Verra Mobility's Fourth Quarter and Year-End 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 this afternoon is David Roberts, Verra Mobility's Chief Executive Officer, and Tricia Chiodo, Chief Financial Officer. They will begin with prepared remarks, 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 plans to execute on our growth strategy, our ability to maintain existing and acquire new customers, and other statements regarding our plans and prospects. Forward-looking statements may often be identified with words such as expect, anticipate, or upcoming. These statements reflect our views only as of today and should not be considered our views as of any subsequent date. We undertake no obligation to update or revise these 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 form on Form 10-K, which is available on the Investor Relations website of our website at ir.verramobility.com and on the SEC's website at sec.gov. Finally, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures included in our press release issued after the market closed today, which is located, again, on our website at ir.verramobility.com and the SEC's website at sec.gov. With that, let me turn the call over to David.

David Roberts, CEO

Thank you, Marc, and thank you to everyone joining us on the call today. As you are all aware, the global pandemic remains persistent, but we are beginning to see a broad decline in its effect on the economy. And with the vaccination process beginning, we feel confident that its effect on our business will subside throughout 2021. While we have experienced difficulties associated with this global event, we are quite optimistic about the future that lies ahead. We are pleased with our execution throughout this challenging year, and we ended 2020 on a high note with a solid quarter. Our fourth quarter performance showed a continued improvement in our Commercial Services segment and demonstrated robust strength in our Government Solutions segment. Moreover, our EBITDA margin levels during 2020 had remained very strong, and we generated strong free cash flow despite an accounts receivable issue, which we will discuss in more detail later. Our fourth quarter revenue declined 11% year-over-year to $100.2 million, and our adjusted EBITDA came in at $45.8 million, down 23% year-over-year. For 2020, revenue declined 12% year-over-year to $393.6 million, and our adjusted EBITDA came in at $181.8 million, down 25% year-over-year. Now I'll move on to our segment results. Our Commercial Services segment reported revenues of $48.2 million and adjusted EBITDA of $25.2 million for Q4 2020. We continue to see month-over-month revenue increases throughout the quarter. As a reminder, the largest portion of revenue in the Commercial Services segment is highly correlated to rental car volume. And while we are optimistic about the trend line we are seeing, we still anticipate ongoing pressure to this business segment until late 2021, a view that is widely shared by many companies in travel-related industries. That said, traction with our fleet management customers remained strong. As challenged as the U.S. rental car market is, we are preparing for a recovery and continuing to work on optimizing our customers' offerings. Our partners continue to value the strength of our platform, highlighted by an extension we signed with six during the quarter. Regarding Enterprise, we are continuing our efforts to extend the relationship beyond the current contract. On the fleet management side, we renewed a number of contracts, including one with the largest U.S. retail banking chains and another with the Canadian subsidiary of a large fleet management customer. Like the U.S., the European rental car market has been severely impacted by COVID-19. The result of this has been slower decision-making and a lack of resources for our partners to help accelerate the implementation of our tolling solutions. We are continuing to have active dialogues with many large rental car companies throughout Europe. Additionally, we are happy with the progress that Rent A Car in France is making and look forward to providing more detail as the program matures. As a reminder, the origins of our European business started with the acquisition of EPC, and we continue to service customers with that product. During the quarter, we signed a multiyear agreement with the Danish transport authority to process violations of foreign registered vehicles. Before I move on to the Government Solutions segment, I want to welcome Steve Lalla to the Verra Mobility team as our Executive Vice President of Commercial Services. We believe that Steve's proven leadership and abilities and deep technology experience make him the perfect person to take our Commercial Services segment to the next level. Our Government Solutions segment reported revenues of $52 million and adjusted EBITDA of $20.6 million for Q4 2020, both solid improvements year-over-year. Growth in the Government Solutions segment continues to be driven primarily by the expansion of the school zone speed program in New York City. We are pleased to report that we have fulfilled the order we received for 720 cameras with the installation of the final 127 cameras. I wanted to take a moment to discuss the issue of our outstanding receivables related to New York City contracts. During 2020, we worked with the New York City Department of Transportation to address various administrative issues that we understood at the time were holding up payments on the two contracts we have with them: one contract is a 2014 legacy contract for red-light bus lane, mobile-speed, and fixed-speed photo enforcement cameras; and the second is the 2020 emergency contract for the purchase, installation, maintenance and operation of an expanded speed camera program that began in 2020. In late 2019, we concluded that some of our system installations under the legacy contract did not meet New York City requirements related to the depth of the buried electrical conduit and color of grounding wire, and we disclosed those issues to the Department of Transportation. We agreed to remediate those sites, which is substantially completed. These installation issues did not have any impact on the camera operations or the overall effectiveness of the photo enforcement programs, but they may have contributed to the delays we are experiencing in receiving payment. As noted in our 10-K, we learned in January of this year that the City of New York is investigating matters related to the company's past installation practices, including the conduit depth issue that is being remediated. We are fully cooperating with the investigation and believe that it will be resolved. Furthermore, while the timing remains unclear, we expect to be paid on the outstanding accounts receivable. In the interim, we will continue to perform work for the New York City Department of Transportation under those contracts. Tricia will discuss in more detail its effects on our balance sheet and cash flow. We maintained our consistently high renewal rates in Q4. During the quarter, we renewed contracts with key customers in Orlando and San Antonio. In addition to renewals, earlier this month, we announced a partnership with three additional counties in the State of New York to deploy CrossingGuard, our automated stop arm photo enforcement solution for school buses. We are pleased to have contracted with a total of six counties in New York, and many individual school districts have signed on with the potential to cover approximately 6,500 school buses. Over the years, we have voiced that mergers and acquisitions would be an important and strategic part of our growth strategy, and we were excited about the pending transaction with Redflex Holdings. The combination of Verra Mobility and Redflex will enable global delivery of leading road safety products and services and will result in increased resources, scale, enhanced technology capabilities, and expanded global reach. We are very excited to bring a team of this caliber into the organization. Additionally, Redflex's technology and global capabilities will complement our services and provide us with some important new geographic markets. We anticipate the transaction to close in late May of this year. In summary, the foundation for a thoughtfully constructed and accurate forecast is still challenging, and therefore, we will refrain from offering guidance in the near term, but we can offer some qualitative thoughts on our business going forward. We continue to anticipate a slow recovery in our Commercial Services segment and expect to return to 2019 service revenue levels by late 2021, possibly early 2022. The primary cause of this is the reduction in air travel and related rental car volume decreases, both for personal and for business purposes. But as these industries return to pre-COVID levels, we should see a correlated increase in our tolling revenue. Additionally, the school environment remains challenged, but we are seeing more schools physically open as vaccines and COVID protocols allow for more in-person learning. Until then, we anticipate ongoing revenue impact associated with our school bus programs and variable rate school zone speed. We continue to believe our balanced product portfolio provides stability in these uncertain times and for growth in the future. With that, let me hand it over to Tricia to walk through the financials in more detail.

Patricia Chiodo, CFO

Thanks, David, and good afternoon, everyone. I'll provide a more detailed overview of our full-year and fourth quarter 2020 financial performance, and then we'll open up the call for questions. We provided a short earnings deck on our website that provides some insight into the quarter and reconciliations from our GAAP to non-GAAP results. If you're following along in the earnings deck, I'm on Slide 2, where you can see total company's full-year results for 2020. Total revenue for the full year of $393.6 million declined $55 million or 12.3% from $448.7 million in 2019. Within that change in revenue was an $80.4 million decline in service revenue, resulting from lower demand for our tolling products due to reduced rental car demand, lower citation rates on the variable photo enforcement program, and the loss of certain Texas customers. The revenue loss was offset by a year-over-year increase in product sales of $25.3 million with the sale and installation of 720 school zone speed cameras in 2020 compared to 300 in the prior year. We'll discuss both these revenue streams further in our segment detail portion of the call. Adjusted EBITDA of $101.8 million declined $59.5 million or 24.7% from $241.4 million in 2019. Growth in product sales and well-executed cost control measures offset declines in service revenue and helped maintain a robust adjusted EBITDA margin of 46.2%. We are proud that we have the structure and discipline to maintain best-in-class margins even in the worst of times. In early March, when the reality of COVID-19 started to sink in, we said that Verra Mobility would be free cash flow positive in 2020. Once again, we've done what we said we were going to do, generating $22.6 million in free cash flow. Now we did expect this number to be much higher earlier in the year, and we didn't anticipate a $91 million accounts receivable headwind. David had discussed New York earlier in this call, but I wanted to outline the impact on our financial position. The New York Department of Transportation represents 31.1% of 2020 total revenue, driven in large part by the increased product sales. With outstanding receivables of approximately $99 million, they represent nearly 59% of our outstanding account receivable balance at year-end. Because this accounts receivable balance is past due, it's not eligible for inclusion in our borrowing base, and that's limiting the available borrowing on our $75 million revolver to $48.8 million at year-end. New York has always been a great partner, and we expect to clear the accounts receivable balance in upcoming quarters. With that said, let's do a deeper dive into our reporting units. If you're following along in the earnings deck, I'm on Slide 3, which outlines revenue and adjusted EBITDA performance for our Commercial Services segment. As you recall, the Commercial Services segment serves large rental car and fleet management companies providing tolling, violation processing, and title and registration services. Given its close ties to travel demand and driving patterns, this segment had a very challenging year. Full-year service revenue declined $95.6 million from $276.5 million in 2019 to $180.9 million in 2020. The decline was due to a significant impact on rental car demand caused by the impact of COVID on the travel industry and, to a lesser extent, the usage of large fleets. We took decisive actions early in 2020, reducing operating expenses and SG&A expenses by nearly $15 million and reporting adjusted EBITDA of $97.2 million for the full year 2020. Despite strong headwinds in revenue, our adjusted EBITDA margins for this year remained robust at 54%. For the quarter, service revenue declined 29% to $48.2 million in the fourth quarter of 2020 from $68.2 million in the same quarter in the prior year. Although we are still experiencing the impact of COVID on the underlying industries we serve, we've seen three quarters of sequential revenue improvement, with Q4 revenue growing $21 million or 77% over the second quarter trough, adjusted EBITDA for the quarter of $25.2 million, and adjusted EBITDA margins were 52.4%. Turning to the next slide. You can see the results of the Government Solutions business segment. This segment operates photo enforcement programs for municipalities and school districts with an end-to-end solution. Government Solutions grew full year revenue by $40.5 million to $212.7 million for the full year 2020. Total revenue is comprised of service revenue, which is the monthly fee that we generate from the operation of photo enforcement programs, and product revenue, which results from the selling and installation of camera systems. Service revenue for the full year was $155.4 million, an increase of $15.2 million or 11% from $140.2 million for the full year of 2019. This growth was the net effect of reduction in revenue due to the loss of certain clients in Texas and the reduction in variable rate programs due to COVID offset by the growth in school zone speed programs resulting from the New York expansion. Product revenue for the full year 2020 was $57.3 million, up from $32 million for the full year 2019. This increase was driven by a large order from New York City to install school zone speed cameras. For the fourth quarter, total revenue for the segment was $52 million, up from $44.3 million in the fourth quarter of 2019. Service revenue for the fourth quarter was $42.8 million and grew 17% year-over-year from $36.7 million in the fourth quarter of 2019. The service revenue growth is driven by our expansion of the school zone speed program, which increased $7.7 million over the same quarter in the prior year. The growth was offset by the impact of COVID-19, which halted virtually all revenue from our school bus stop arm programs and reduced volumes for our variable clients. As schools return to in-person learning, revenues will return to this program. Product revenue of $9.2 million for the quarter increased $1.6 million or 20% from $7.6 million in the same period of the prior year. We installed 127 cameras in the fourth quarter. Adjusted EBITDA of $20.6 million increased $3.2 million or 18.1% from $17.4 million in the same period of the prior year, and adjusted EBITDA margins for this business remained steady at 40%. We're very proud of the performance of the Government Solutions business during these very difficult times. If you turn to the next slide, you can see the combined results of the business segments that we just discussed. The company reported a net loss of $1.4 million for the quarter compared to $9.2 million of income in the same quarter of the prior year. Tax expense for the quarter was $2 million, representing an effective tax rate of over 5,000%. For the full year 2020, the tax rate was over 400%, taking a pretax net income of $2 million to a net loss of $3.4 million. Book income is low, and therefore, the impact of several large permanent differences, such as TRA expense, disallowed executive compensation, and lobbying expense, drive an unusually high effective tax rate. I want to spend some time discussing our liquidity position. The company generated $2.6 million of cash flow from operating activities during the quarter and $46.9 million for the full year. This compares to $133.8 million in the same period in the prior year. The change resulted from a reduction in net income and was further impacted by the accounts receivable, which increased $91 million during the year. The increase is directly related to the issues discussed with New York City earlier. Free cash flow, defined as cash flow provided by operating activities less CapEx, was $22.6 million in the full year, and our cash balance at the year-end was $120.3 million. As of December 31, we had total debt of $865.6 million, net of cash on hand. Our debt was $745.4 million, which is 4.1 times trailing 12-month EBITDA of $181.8 million. Our first lien doesn't mature until 2025, and we had $48.8 million available on the revolver. As we look to the future, we are encouraged by the progress of the COVID vaccine and are optimistic that the country will return to some form of normal. However, uncertainty surrounding COVID's continued impact on travel and school reopening makes it difficult to provide full-year guidance. However, we've said for the last couple of quarters, without the specific installation order from New York, that you should think about product revenue for 2021 similar to 2018 in the range of $3 million to $5 million. We also believe that 2021 will return to previous seasonal trends, and Q1 service revenue should be slightly below Q4. As we move beyond the first quarter, we should return to year-over-year growth as we cross over the trough of the revenue declines at the beginning of the pandemic. In summary, we are pleased with the performance throughout 2020. If you needed to describe us in a single word, it would be resilient. We entered the pandemic with strong customer relationships and a strong balance sheet. We remained free cash flow positive, showed discipline in cost-cutting, and produced best-in-class margins. We continue to believe that Verra Mobility remains well-positioned for the long term and has the operating discipline to manage through the current volatility in our business and capture growth as demand returns to the underlying industries we serve. With that, I'll open the call up for questions.

Operator, Operator

Our first question is from Justin Forsythe with Credit Suisse.

Justin Forsythe, Analyst

I just wanted to dig in a little bit to the Redflex opportunity. Again, we know that they have a variety of programs that are different from those that you have. We know you have some similar ones, similarities being red-light, for instance, and new ones being railroad crossing, work zone speed, etc. Can you talk a little bit about what the loose-hanging fruits might be there as far as cross-sell goes? Meaning, would you expect to see the impacts of work zone first or perhaps some of your existing solutions into maybe their clients?

David Roberts, CEO

Yes. I think it's more about geographic-based opportunities than necessarily product-based. What I mean by that is in different countries outside the U.S., they use different types of technology solutions. For example, in Australia, they use a product called point-to-point speed, which consists of two fixed cameras in two different locations, tracking how fast you go between the two points. That's a solution that they offer there in Australia that we don't offer here. Effectively, there are opportunities for us with our scale and capabilities being a larger company with a larger balance sheet to think about how we can take some of those things globally and accelerate them outside the U.S. As we look inside the U.S., certainly, there will be plenty of opportunities for synergy, and to their credit, they are in some product areas that we have not been in historically. We would anticipate some of those being prioritized. But the international opportunity is probably the higher level of focus, at least initially. Then clearly, we'll continue to look for synergy opportunities across both sides of the equation.

Justin Forsythe, Analyst

Got it. No, that's super helpful. And I guess in terms of from whenever the deal closes, let's say, in late May, is there a relative timeline you can give as to when you think you might be able to achieve some of these and/or the loose-hanging fruits, as you mentioned, the international expansion stuff, when you might expect to achieve that by?

David Roberts, CEO

Tricia is looking at me funny. So I was going to say six weeks, but she seems to think...

Patricia Chiodo, CFO

We're not going to say.

David Roberts, CEO

Yes, we're not going to say six weeks. I mean, it's a complex global organization. It's going to take some time for us to figure out. We've obviously been doing this via a clean team sort of an arm's length process generally. I would anticipate we will get a lot of opportunities in the first year. As we look at diversification and revenue growth, that may take a little bit longer. But I think that the first 12 months will probably be when we're going to focus a lot of energy on synergizing costs and identifying the key areas where our products can accelerate one another, as well as placing the right talent in the right place.

Patricia Chiodo, CFO

I think the technology end will take longer. So I don't think you'll see the full synergy impact probably until the 24-month cycle because the technology will take a little longer.

Justin Forsythe, Analyst

Got it. No, super helpful. And I guess one more, if I might, real quick. We heard or saw Avis report recently, and it seemed as if they had also cited kind of improving trends. But despite there may be some tough comparisons coming up, obviously, in January and February, coupled with some incremental lockdowns. I mean if you could just provide a little bit of detail on the exit rate at the end of Q4, as you mentioned. I think it was continual improvement in the Commercial segment business and how that fared going into early Q1.

Patricia Chiodo, CFO

Yes. So I think what you're going to see is kind of what I said in my forward-looking statement that Q1, the first quarter of 2021, we actually think from just a raw-dollar service revenue, will be just on par or slightly below Q4. That's sort of a normal seasonal trend pattern that you might see as we move forward. Then we'll move into this year-over-year growth as we move into Q2. By that time, we'll be crossing over the trough of the pandemic cycle. So you'll start to see growth at that time. Beyond that, it's difficult for us to project those numbers. As we get closer to those numbers as we do the Q1 earnings call, we'll probably be able to give a little bit further out into the view of where we're going to be. But we've said we didn't think we'd return to 2019 levels for the Commercial Services segment until the end of 2021.

Operator, Operator

Our next question is from Ashish Sabadra with Deutsche Bank.

Unidentified Analyst, Analyst

This is Ashish calling here. I just had a quick question about the New York City contract. Is there any possibility for the contract to be extended before you receive payment for the outstanding receivables? Or are those two separate matters?

David Roberts, CEO

Yes. I wouldn't expect so. The contract currently goes through February next year. Our optimistic view is we're going to tighten these outstanding issues over the next couple of months. I don't think that would be their next step in the process.

Unidentified Analyst, Analyst

And then the follow-on to that or maybe a different way to think about it. Are there opportunities in other states and cities that are of similar scale that you could pursue after New York?

David Roberts, CEO

In terms of New York City? No. They are a purple-speckled unicorn from that perspective. Their commitment to photo enforcement as a part of their Vision Zero is unparalleled across the globe. They just have a scale and a commitment that's much higher, so no, they would certainly be an outlier related to full deployment. As you look outside the U.S. and one of the reasons that we're excited about the Redflex acquisition is that there is potential for like-minded cities outside the U.S. that have resources and a higher level of commitment to using photo enforcement and other road safety technologies. Even then, they would still not be nearly the size and scale of New York City.

Operator, Operator

Our next question is from David Koning with Baird.

David Koning, Analyst

Yes, great job. I was wondering if you could share the monthly revenue trends by segment for the last three months of the year.

Patricia Chiodo, CFO

Yes. For the last three months in the Commercial Services segment, they were sort of more flat. We do know that the quarters continue to trend. We had consecutive improvement from Q2 to Q3 and Q4, all improving from an overall growth perspective, but we didn't report the individual months.

David Koning, Analyst

Okay. Got you. One thing, just to understand the way the business works a little better. In the 10-K, you talked about toll transactions being about $171 million. So that was down something like 30%, or maybe a little more traffic violations in commercial were down almost 50%. I'm just wondering what was different about COVID in terms of how it impacted the toll transactions compared to traffic violations? And is it anything we should even care about?

Patricia Chiodo, CFO

No. Those are just volume because what you're not seeing is the dollar value of those toll transactions, the margins on those toll transactions. I don't know that that's necessarily helpful. What we've said is that what we've seen in the pandemic timeframe, especially as it relates to our rental car customers is that we're seeing that the number of tolls that they're using per rental agreement is up, the dollar value of the tolls are up, but the number of rental agreements in aggregate are way down. So although that sort of gives you directionally correct information, it takes a little bit to extrapolate that to a revenue number.

Operator, Operator

Our next question is from Daniel Moore with CJS Securities.

Daniel Moore, Analyst

I wanted to just start, as we recover in Commercial Services, Tricia, how should we think about incremental EBITDA margins over the next, say, 12-plus months? Any deviation, good or bad from the longer-term algo?

Patricia Chiodo, CFO

Yes. I think what you're going to see as we cross over into Q1, is you're probably going to see some margin compression from where we were in Q4. There are a couple of reasons for that. Even though service revenue is going to be, call it, flattish to where it was in Q4, your product revenue is not going to be there because we don't have an order in hand to do product installation. We've reinstated a lot of things that didn't come into fruition in 2020. Think about that our accruals for bonuses, merit increases, all those things are going to be back into our financial statements in 2021. You should think about a little margin compression as we roll into Q1 and probably into Q2. Then obviously, as we get into those time frames, I can give you some more detail or vision into what the back half of the year might look like as we get closer.

Daniel Moore, Analyst

Okay. And one more Appreciate all the color very much on this topic, and sorry to beat it with a dead horse. The accounts receivable balance, you mentioned clearing in coming quarters. Fair to assume, based on that statement, we haven't done so significantly to date in Q1. Just any commentary and color around timing expectations? I know it's a tough question, but appreciate...

Patricia Chiodo, CFO

Yes. No, it is difficult to predict, but this is what I think is going to happen. We are continuing to perform work for New York, and we will continue to do so. So we would expect that, that receivable balance would continue to grow probably well into Q2. The likelihood that it's going to get cleared up in the next 30 days is unlikely. We know that it will at least extend into Q2.

Operator, Operator

Our next question is from Keith Housum with Northcoast Research.

Keith Housum, Analyst

Just one more point of clarification on New York, if I may. You are not prevented from securing any future contracts as a seller, correct? You can still conduct business as usual, continue to compete, and nothing is hindering that. Is that correct?

David Roberts, CEO

That's correct. Yes. That's exactly right.

Keith Housum, Analyst

Okay. And then in terms of the tolling business, it sounds like it's holding up a lot better than I think a lot of us perhaps feared six months ago. So it sounds like your penetration rate or adoption rate within the rental car companies has improved significantly over the past year. Is that a good assessment?

Patricia Chiodo, CFO

No, not necessarily. What has really happened is that the overall adoption rate, which is based on the total number of rental agreements that include our product compared to the total number of rental agreements, has not changed significantly. However, the number of billable days has improved based on those rental agreements. We are receiving slightly more in admin fees and tolling because there are more tolls and higher-value tolls associated with each rental agreement. This is not strictly an adoption issue. We are also observing that adoption has shifted from airport locations to off-airports and has decreased overall. Customers may have transitioned from higher-quality brands to more budget brands over time, possibly due to a change in traveler demographics, favoring leisure travelers over corporate ones.

Keith Housum, Analyst

No, that's helpful. I appreciate it. If I had to squeeze one more in here. Last year, we go back pre-COVID, Verra Mobility was talking about the need to update a lot of its systems throughout 2020, and of course, COVID happened. So a lot of that was put on the back burner. How should we think about that this year? Is it still on the back burner until the Redflex acquisition is done? Or are you guys moving forward with some of those initiatives?

David Roberts, CEO

No. We are definitely moving forward. We're doing them probably a little bit more serially, meaning we've stretched them out over a longer period of time. We actually did some of them last year just to make sure that we weren't leaving anything aside. We've prioritized what we would consider the most critical items related to performance within our systems and have knocked a few of those out, and we'll continue to do that this year.

Operator, Operator

This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.

David Roberts, CEO

Thank you.

Patricia Chiodo, CFO

Thank you.