HireRight Holdings Corporation

Good afternoon, ladies and gentlemen, and welcome to HireRight's fourth quarter 2022 conference call. Joining us today is the company's president and chief executive officer, Guy Abramo, chief financial officer, Tom Spaeth, and Andrew Hay, vice president of treasury and investor relations. At this time, all participants are in listen-only mode. I remind everyone that management will refer to certain non-GAAP financial measures. An explanation and reconciliation of these measures to the most comparable GAAP financial measures is included in the press release issued today, which is available in the investor relations section of HireRight's website. Also during this call, management's remarks will include forward-looking statements, including related to macroeconomic conditions, demand for the company's services and the company's technology improvement, and cost reduction initiatives. Such statements are predictions, and actual results may differ materially. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the Form 10-K filed with Securities and Exchange Commission in the sections of the document entitled Risk Factors, Forward-Looking Statements, and Management Discussion and Analysis of Financial Condition and Results of Operations. It's now my pleasure to turn the call over to Guy Abramo. Mr. Abramo, please go ahead.

Thank you, Operator, and good afternoon, everyone. I appreciate everyone taking the time with us today as we share our fourth quarter and full year 2022 results. To begin, I am very pleased that despite continued macroeconomic headwinds, we achieved strong results in 2022 and exceeded the guidance we provided on our third quarter earnings call. As we noted during that call, we observed a slowing trend in hiring volumes, which continued throughout the fourth quarter with many companies announcing staffing reductions, or the delay in hiring driven primarily by a general nervousness on the economic outlook. Since that third quarter call, that apprehension has been confirmed with additional announced workforce reductions, as well as national data which showed an 11% reduction in hires in the fourth quarter versus the prior year. With that said, our revenue for fourth quarter was $175 million, down 12% versus the prior year period. It is important to note that the significant majority of the decline came from just two verticals, technology and government, both of which saw a 30% decline. Technology sector layoffs and slowing of replacement hiring is not surprising, given the press we've all read for the last six months. In the case of the government sector, the slowdown appears to have more to do with difficulty in finding qualified applicants than an elimination of positions. Excluding these two verticals, Q4 showed a much more modest decline of 4% relative to the prior year. It's also key that despite the clear slowing of hiring in this macro environment, there continues to be relatively healthy activity, just not at the pace we experienced in the first half of 2022. As you have heard me say many times, quality and thoroughness in our investigations remain key selling points for us, particularly in our core markets that tend to be more demanding, and our single global platform and automation initiatives continue to be differentiators. To leverage these strengths, our account management and go-to-market teams continue to focus on developing and expanding new global client relationships. During the quarter, we added 42 new enterprise customers, two-thirds of which are distributed across our four core verticals. Turning to profitability, our adjusted EBITDA margin improved 70 basis points over the prior year period, on adjusted EBITDA of $38.9 million. Despite the challenging demand environment, we were able to increase our gross margins over 300 basis points to 47.3%. This improvement was driven by increased automation, overall greater workforce productivity, rebalancing our labor mix by increasing our offshore presence, and increased cost management of data providers. All these initiatives are focused on reducing the cost of delivering our services. Turning to our annual results, we generated revenue of $807 million, a 10.5% increase from fiscal year 21. Our gross margin increased 169 basis points to 46%. Adjusted EBITDA grew 18% to $188 million. and adjusted net income, including the effects of the reversal of our deferred tax asset valuation allowance, increased 148% to $194 million from $78 million. These results reflect our ability to upsell, expand packages to existing customers, and onboard domestic and international new logos won in previous quarters, as well as our ability to continue to expand margins. Our industry leadership continues to be evidenced by the performance of our top tier customer base and our core verticals of healthcare, technology, financial services, and transportation. Annually, despite the lower Q4 hiring trends, our core verticals collectively grew 14% versus 2021, led by healthcare, which grew 23%. Transportation continued its rebound from pandemic lows, growing 17%, while financial services and technology grew 11 and 7% respectively. I would also like to highlight our recent announcement that we have entered into a partnership with Griffin HR, a Form I-9 and E-Verify compliance solutions provider that will allow higher-eds customers to benefit from access to their interactive I-9 program dashboards, self-service reporting, customized workflows, auditing capabilities, and real-time platform updates to help meet regulatory compliance requirements. As we previously stated, we are always looking for ways to bolster our services to offer our customers innovative background screening solutions. Lastly, I would like to provide an update on our platform and fulfillment technology initiatives. As the improving margin results validate, we are already benefiting from automation of our back office fulfillment processes, a project that began in the fall of 2021. We have completed the build out of the core platform and several key pieces of functionality. We are continuing to scale that new platform with our U.S. customers and will soon be extending it internationally. We will continue to enhance our overall delivery platform in a measured manner while keeping an eye on the broader macro environment. This will enable us to further control costs while making incremental improvements to automation, quality, and profitability. We continue to expect modest financial benefits in 2023 from these initiatives, and remain committed to overall margin expansion this year and in the foreseeable future. In closing, we're pleased with our results, given the backdrop of the broader macro environment. And as is always the case, the macro cycle will run its course, and we will be well positioned as a leaner and more efficient organization as the hiring market picks up yet again, whether this year or next. The underlying demand for talent remains strong, and the underlying drivers of increased hiring velocity we believe are here for the long term. In the meantime, we will continue to focus on expanding margins, upselling to existing customers, adding new logos, and growing our core verticals through new global client relationships while continuing to manage costs. Our talented and dedicated team's focus on these principles gives us confidence in the long-term outlook and our ability to create significant shareholder value over time. With that, I'll turn the call over to Tom for a closer look at our fourth quarter financial performance and our outlook for 2023. Tom?

Thank you, Guy. Good afternoon, everyone, and thank you for joining our call today. As Guy mentioned, our fourth quarter revenue was $175 million, down 12% versus the prior year. This includes a 1% negative impact from foreign currency, as well as a 30% decline from our technology and government verticals. Excluding these two verticals and the foreign currency impact, revenue would have been down 3% versus the prior year. Revenue from new customers and upsells exceeded $13 million in the quarter, partially offsetting existing customer declines. Diving deeper into Q4 revenue, a few of the more resilient verticals were manufacturing and transportation, each of which posted modest gains in the quarter over the prior year. Additionally, healthcare and retail and hospitality showed only modest reductions compared to the prior year. Healthcare, with its strong growth over the prior year, is now our largest vertical. Our core four verticals of healthcare, technology, transportation, and financial services continue to represent approximately 56% of total revenue. Looking at our geographic split, international revenue based on applicant location remained steady at approximately 15% of total revenue. International markets reported a similar decline to the U.S. and North America. India, which is largely driven by our multinational technology clients, declined 22% in the quarter. Our customer retention in upsell and cross-sell continued to be strong. Gross retention finished the year at 95%, while net retention was 108%. And our 2022 revenue was 100% organic. One of the clear highlights of the quarter was our continued margin improvement. For the quarter, we reported a 308 basis point improvement in gross margin to 47.3% up from Q4 2021's 44.2%, demonstrating our ability to manage variable costs despite the revenue decline. Fourth quarter adjusted EBITDA margin improved to 22.2%, a 70 basis point improvement over Q4 2021, driven by our focus on managing data costs, optimizing our onshore and offshore labor mix, and multiple ongoing operating efficiency projects. We continue to flex and rebalance our labor in response to the slower market demand. Total SG&A expenses in the quarter, excluding stock-based compensation and the prior year facility cease-use charge of $9 million, improved by approximately $1 million versus Q4 2021, driven largely by lower third-party fees and expenses. Adjusted net income for the quarter, including the tax valuation allowance reversal, increased 15% to $26.8 million, largely driven by our gross margin improvements. And lastly, adjusted diluted EPS for the quarter was $0.34, up from $0.33 the prior year. Turning to a review of full-year results, revenue was $807 million, up 10.5% from the prior year, led by our healthcare vertical, which was up 23% for the year, and quickly followed by transportation, which was up 17%. As mentioned earlier, healthcare is now our largest vertical at approximately 16% of revenue. Gross margins showed a 169 basis point improvement for the year to 46%, primarily driven by operational labor efficiencies. For the full year, SG&A increased by $12.6 million. This annual increase is primarily due to higher personnel costs of $19 million and higher public company costs of $5.1 million. Employee costs were driven by investments in technology and go-to-market, as well as higher stock comp and employee benefits. Public company costs consist of insurance, accounting, audit, and legal fees. The increases were partially offset by a decrease in facility-related expenses of $14.9 million as we right-sized our real estate footprint in the prior year due to the increased remote work environment. We reported adjusted net income of $194 million, including our tax valuation allowance reversal. The tax valuation allowance reversal has no impact on our TRA calculations or the timing of payments. We expect to make our first payment in Q1 2024 following the filing of our federal tax returns. We do not anticipate paying any US federal taxes in 2023 as we utilize the tax allowance. And our tax rate is based primarily on our international revenues and subject to change based on revenue mix. Even though market interest rates are significantly higher than Q4 2021, We benefited from a reduction in interest expense of $43 million, largely driven by our improved capital structure compared to a year ago. I would also like to provide some color on our cash flow generation, liquidity, capital allocation, and balance sheet. This is another area where we have delivered exceptional results with full year operating cash flow of nearly $108 million, up from $47 million in 2021. Excluding our technology initiative, operating cash flow from operations was $138 million. Free cash flow increased 172% to $91 million, an increase of $57 million versus 2021. At quarter end, we had no draws against our revolver and had approximately $700 million outstanding on our first lien loan. Our leverage ratio ended the year at 2.85 times. an improvement versus the 3.7 times at the end of 2021. We also ended the year with $162 million of unrestricted cash on the balance sheet, up from $111 million. This increase in cash was driven by our team's attention to driving working capital improvement. When combined with our revolver availability, we ended the year with over $300 million of liquidity. As announced in November, the company's board of directors approved a share repurchase program authorizing the repurchase of up to $100 million over a two-year period. Through December 31, 2022, the company repurchased over 1.5 million shares of common stock for $16.8 million. We believe currently, as we continue to evaluate cash allocation options, The repurchase program is the right use of our excess capital and reflects our confidence in our business prospects and our ability to generate ongoing positive cash flow. Looking ahead, we continue to see steady volume across almost every vertical, however, lower than the same period a year ago. In the near term, we anticipate some of our customers may continue to defer some hiring decisions primarily driven by uncertainty regarding the sustained direction of the macro environment. As we've noted on previous calls, Q4 and Q1 have historically been our seasonally lower quarters, with Q2 and Q3 being stronger and in line with each other. With this in mind, we are providing the following guidance for full year 2023. Revenue in a range of $720 million to $745 million. Adjusted EBITDA in a range of $165 million to $175 million. adjusted net income in a range of $100 million to $110 million, and adjusted diluted earnings per share in a range of $1.30 to $1.43, based on a fully diluted share count of $77 million. We will continue to monitor the macro environment, actions by the Federal Reserve, hires, quits, and job openings, and actively engage with our customers to monitor demand, manage vendor relationships and costs, and adjust our operating practices to reflect market conditions, maximize margins, and create long-term shareholder value. With that, operator, we can open the call for questions.