Sterling Check Corp.

Hello, everyone, and welcome to the Sterling third quarter 2023 earnings call. My name is Seb, and I will be the operator for your call today. If you would like to ask a question on today's call, you may do so by pressing star 1 on your telephone keypad. If you would like to withdraw your question, please press star 2. I will now hand over to Judah Sokol to begin the conference. Please go ahead. Thank you, operator.

Welcome to Sterling's third quarter 2023 earnings calls. Joining me today on the call are Josh Perez, Chief Executive Officer of Sterling, and Peter Walker, Chief Financial Officer of Sterling. The slides we will reference during this presentation can be accessed on Sterling's IR website under News Events. The slides have been posted to our website, and a replay will be made available on the website. After prepared remarks, we will open this call to questions. Before we discuss our results, I encourage all listeners to review the legal notice on slide 2, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. Additionally, please refer to our most recent Form 10-K and 10-Q filed with the SEC for a discussion of risk factors that could cause actual results to differ materially from these forward-looking statements. Our slide presentation and discussions on this call will include certain non-GAAP financial measures. For such measures, reconciliations to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued this morning. I'll now turn the call over to Josh Perez.

Thank you, Judah. Good morning, and thank you for joining us. Before we begin, I want to provide an important update. Since July 2019, I have had the pleasure of working in partnership with Peter Walker, Sterling's Chief Financial Officer. As we announced in late September, Peter has found an exciting new role outside of Sterling, and I couldn't be happier for him to pursue this opportunity. Peter has played a critical role at Sterling in so many ways over the past four and a half years, including leading our successful IPO two years ago. Peter has put in place a very strong team, culture, and finance discipline that sets us up well for the future. I am grateful for all he has done to make Sterling the great company it is. While Peter will be missed when he leaves at the end of this week, we are in the midst of a CFO search process, and we feel confident that we will find a CFO who will guide Sterling into the next chapter of the company's leadership and growth strategy. In the meantime, I am happy that Teresa Strong, who is here with us today, will serve as Sterling's interim chief financial officer during this transition period. Having joined Sterling through our acquisition of TalentWise in 2016, Teresa has nearly 20 years of experience leading finance teams and plays an instrumental role at Sterling as chief accounting officer. I am looking forward to working with Teresa in this capacity. Turning now to slide four, the third quarter of 2023 was a quarter of successful execution towards our long-term strategy and 2023 goals. We continue to focus on what is in our control, a strategy that has produced meaningful results both on the top line and our cost profile, as well as in several other critical areas I will talk more about shortly. In the third quarter, we delivered revenues of approximately $181 million including strong year-over-year trends within new client growth, upsell and cross-sell, and customer retention. At the same time, our Q3 revenues came in below our prior expectations due to lower base hiring volumes resulting from a softer macro than we anticipated in the second half of the quarter. However, thus far in Q4, we have seen an improvement in our year-over-year base trends, leading us to expect that the fourth quarter will see year-over-year total revenue growth at the midpoint of our revised guidance range. Even in the face of this challenging macro, our clients continue to hire at a steady pace and recognize that background screening is a critical component to helping them keep their employees safe while hiring faster and smarter. While cyclical hiring trends will come and go, the long-term health of this industry and our business is exciting. Clients are increasingly adding more services to their background screening packages. In particular, both prospective and existing clients are attracted to our innovative solutions within identity verification, pre-hire screening, and post-hire monitoring. As a result, we continue to drive strong market share gains and larger deal sizes on both new and existing clients. Our Q3 adjusted EBITDA margin was in line with our prior expectations despite the revenue shortfall, a result we are very proud of and which was driven by our progress on cost optimization efforts. We expect these strategic initiatives centered around focused automation, efficiency, and process reengineering to result in a stronger, more scalable, and more profitable company for the long term. We are on track to deliver a $10 million savings in 2023 and our full cost savings target of $25 million in annualized savings. I couldn't be prouder of the Sterling team as we took significant steps forward in Q3 toward achieving our goals. Beginning with our first goal, organic revenue on slide five. Our culture of innovation, technological excellence, and elevated client experiences once again enabled strong results in Q3 on the revenue drivers in our control. Despite the macro environment remaining choppy and uncertain, we are proud to have delivered 10% year-over-year organic revenue growth in Q3 from the combination of new clients and upsell cross-sell consistent with our prior expectations. We have achieved this double-digit growth from these two factors for 12 of the past 13 quarters which is a compelling reflection of the market share gains we have been able to consistently generate regardless of the macro environment. During the third quarter, we saw increased win rates, more signed enterprise logos, and improving customer retention year over year. This success is the result of hard work by the entire team as we continuously use a customer-centric lens to deliver the technology, service, and solutions the market craves. With that in mind, we are pleased to have just announced a new partnership with Confer, a leading provider of instant employment verifications for UK workers, leveraging payroll, tax, and open banking data instantly. We expect this partnership to transform employment verifications for Sterling UK clients by enhancing an otherwise manual fulfillment process and greatly improving turnaround times. Beyond the initial UK launch, we are working with Confer toward rolling out similar offerings in select international markets. Additionally, we are leveraging our comprehensive offerings to strategically expand the size of deals we are winning, both for new clients and upsell of additional products and services to existing clients. This approach is also amplifying our market opportunity to displace niche vendors due to our ability to consolidate more specialized services as a single vendor solution. The right side of slide five shows an example of one such win, our largest upsell in company history. By selling additional products and enhanced workflows beyond pre-employment screening, we expect to substantially increase this client's spend with us. The new program began ramping during Q3 and is expected to grow our total revenue from this client by over 200%. Our API-driven technology and drug and health screening suite played critical roles in this upsell and is one example of the products through which we are expanding our services to clients. As we look to the future, we see strong evidence that we can continue executing on the organic revenue drivers in our control. In particular, we are excited by our robust opportunity pipeline representing new client, upsell, and cross-sell deals, both in the US and international. Even as we continue to close new deals, the pipeline of prospects keeps building through our targeted sales and marketing efforts, a trend which supports our expectation that we will return to our 7% to 8% long-term target range for new client growth by year end. Turning to slide six, our relentless focus to innovate and bring unmatched solutions to our clients has enabled us to significantly grow our addressable market and our right to win. As we've shared in recent earnings calls, our investments in faster growing and higher margin identity and post-hire solutions are paying off. We are pleased to see another quarter of positive outcomes, including a third consecutive quarter where these two areas comprised more than 10% of our revenues combined. Starting with identity. We have seen significant success over the past couple years due to our identity-first workflow solutions that enhance pre-employment screening and strengthen hiring practices. During Q3, we saw continued growth in global identity adoption on a year-over-year and quarter-over-quarter basis in the U.S. and internationally. Clients are becoming acutely aware of identity as an essential step in the background screening process. And in Q3, we saw an approximate increase of 80% in active U.S. identity clients. Furthermore, we grew our advanced stage U.S. opportunity pipeline by over 100% compared to Q2. Our clients are recognizing that the foundation of a reliable background check lies in the careful verification of candidates' identities. By incorporating our identity verification workflow at the beginning of the background check, clients can guard against the escalating threat of identity fraud. Furthering that point, Sterling's identity solutions generate a significant and quantifiable return on investment by helping our clients make more informed hiring decisions and keep their workforces safe. In particular, our data shows that adding identity verification at the beginning of a workflow can increase the amount of criminal records discovered by approximately 45%, a striking data point which resonates significantly with clients. Shifting to post-hire on the right side of the slide, Sterling was one of the first CRAs to introduce worker monitoring services several years ago. Through continued investment, we've transformed our post-hire screening, and we are optimistic about our consistent progress to grow our monitoring footprint and penetrate this large and growing market opportunity. During Q3, demand continued to grow for our subscription-based monitoring solutions, which enables clients to monitor, among other things, criminal arrest and conviction records, motor vehicle registry records, licensing and credentials, and social media. While clients from all industries are benefiting from Sterling's monitoring solution, we are thrilled to see particularly strong growth opportunities in the gig industry, as those companies especially benefit from effortless compliance monitoring through a scalable and API-driven solution. Moving on to slide seven, we are focused on driving long-term meaningful cost savings and efficiency gains. Over the course of 2023, we have been executing on a comprehensive cost optimization program aimed at building a more scalable, effective, and profitable company now and into the future. Our cost initiatives fall into three key pillars. One, reducing our cost of revenue through a focus on labor and data costs. Two, decreasing our facilities costs by leaning even more into our virtual first strategy. And three, reducing SG&A costs by streamlining our organization and enhancing functional alignment. We also continue to maintain strong focus on opportunities to drive further fulfillment process improvements, including increased automation and the use of generative AI. Finally, turning to page eight, I will discuss M&A, the final goal. Our strategic acquisitions of Socrates and Acheck in the first quarter remain well on track to hit their integration timelines and drive the expected cost synergies and geographic expansion benefits. As we've shared in previous earnings calls, we continue to target the completion of these deal integrations by the end of 2023 for Socrates and the end of second quarter 2024 for Acheck. We continue to view M&A as a key element of our growth strategy. Given our success with EBI, Socrates, and ACHEC, we are confident in our ability to execute on future M&A opportunities. We will continue to pursue deals that enable us to expand our addressable market and grow revenue with accretive margins, either as tuck-ins, geographic expansion opportunities, or the strategic insourcing of our supply chain, where we can create competitive advantages and operational efficiency. In conclusion, I am proud of what we accomplished this quarter and excited for the opportunities in front of us. Our customers continue to be impressed with Sterling's industry-leading and highly differentiated suite of products that empower clients throughout the full employee lifecycle from pre-hire to post-hire. We're excited about the growth of the global market and believe that our strong competitive advantages, innovation-led culture, and financial discipline will help us remain at the forefront of the industry for years to come. With that, I will hand it over to Peter Walker, our CFO, to take you through our financial results. Peter?