First Advantage Corporation (NASDAQ:FA) Q4 2023 Earnings Call Transcript
First Advantage Corporation (NASDAQ:FA) Q4 2023 Earnings Call Transcript March 1, 2024
First Advantage Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, everyone. My name is Leo, and I will be your conference operator today. I would like to welcome you to the First Advantage Fourth Quarter and Full Year 2023 Earnings Conference Call and Webcast. Hosting the call today from First Advantage is Stephanie Gorman, Vice President of Investor Relations. At this time, all participants have been placed in a listen-only mode to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] Please note, today's event is being recorded. It is now my pleasure to turn the call over to Stephanie Gorman. You may begin.
Stephanie Gorman: Thank you, Leo. Good morning, everyone. I'm joined on our call today by Scott Staples, our Chief Executive Officer; and David Gamsey, our Chief Financial Officer. As you may have seen today, we announced the definitive agreement to acquire Sterling Check Corp. We will first discuss the transaction, then cover First Advantage's fourth quarter and full year 2023 results as well as our 2024 outlook. Then we will open the call for questions. In the Investors section of our website, you will find a press release on the Sterling acquisition, in addition to our earnings press release and slide presentation to accompany today's discussion. This webcast is being recorded and will be available for replay on our Investor Relations website.
Before we begin our prepared remarks, I would like to remind everyone that our discussion today will include forward-looking statements. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are discussed in more detail in our filings with the SEC, including our 2022 Form 10-K and our 2023 Form 10-K to be filed with the SEC. Such factors may be updated from time to time in our periodic filings with the SEC, and we do not undertake any obligation to update forward-looking statements. Throughout this conference call, we will also present and discuss non-GAAP financial measures. Reconciliations of our non-GAAP financial measures to their most directly comparable GAAP financial measures to the extent available without unreasonable efforts appear in today's earnings press release and presentation, which are available on our Investor Relations website.
I will now hand the call over to Scott.
Scott Staples: Thank you, Stephanie, and good morning, everyone. This is an exciting day for First Advantage as we announced our agreement to acquire Sterling. This strategic and accretive acquisition will benefit customers and investors and drive long-term value creation. I'll start by walking through an overview of the rationale behind this acquisition. Against the backdrop of a highly fragmented large and growing market for our services, adding Sterling to First Advantage will allow us to further strengthen our high-quality and cost-effective background screening, identity and verification solutions for the benefit of customers of all sizes across industry verticals and geographies. Our product offerings are highly complementary, which should unlock upsell and cross-sell opportunities and enable improved customer experiences across our combined customer base.
The transaction will enable us to increase investment and drive innovation in key development areas of our business, like artificial intelligence and next-generation digital identification technology, all with the goal of helping our customers hire smarter and onboard faster. With this investment, we will be increasingly well positioned to meet the evolving needs of our customers, deliver an even better customer and applicant experience and do so more efficiently by leveraging best practices and technologies from both companies. With the addition of Sterling, First Advantage will have a more balanced revenue mix across customer verticals and geographies, which will reduce seasonality and improve resource planning, operational efficiency and resilience across macro cycles.
This acquisition is also compelling from a financial perspective for First Advantage, for Sterling, and for investors of both companies. It's just the beginning of a new value creation journey. As David will cover in more detail shortly, we are acquiring Sterling for approximately $2.2 billion in cash and stock. The combination of our companies is expected to generate at least $50 million in run rate synergies in the first 18 months to 24 months with potential material upside. This positions us well to both reduce cost for our customers and create long-term value for our shareholders. We expect the transaction to deliver immediate double-digit accretion to adjusted earnings per share on a run rate synergy basis and to accelerate our objectives to drive long-term profitable growth.
And importantly, we're excited about bringing together the world-class talent of First Advantage and Sterling. We have two high-performing cultures that share a dedication to delivering excellent customer experiences. We look forward to building on that together to deliver substantial value for our customers and shareholders through this acquisition. As the CEO of the combined company, I personally look forward to welcoming the talented Sterling team to First Advantage. Overall, this combination is a transformative step for First Advantage in all our stakeholders. Turning to Slide 5, which highlights some key metrics of our combined company. This acquisition will create a combined company with approximately $1.5 billion in revenue that conducts over 200 million background screens annually and serves 80,000 customers across more than 200 countries and territories.
From a geographic perspective, First Advantage and Sterling have complementary international footprint, deepening our local presence and advancing our growth in attractive geographies like EMEA, APAC, LATAM and India. If we look at the verticals where our customers operate, Sterling has strength in serving employers in health care, industrials and financial services, which make up over half its business today, while First Advantage particularly excels in the transportation, retail and e-commerce verticals. Together, we will have greater product and vertical diversification that generates cross-selling opportunities and reduces seasonality in our business, which will enable more accurate planning for greater operational efficiency. And the combination is expected to greatly reduce customer concentration by diversifying our customer base.
Together, we will be able to better support companies as they manage risk and hire the best talent. Turning to Slide 6. The combination of First Advantage and Sterling's technology products, data and capabilities will further enrich our offerings across background checks, digital identity and biometrics, verification solutions, drug and health screening, continuous monitoring and beyond. We expect feature functionality that will reduce turnaround time and cost for customers. We see exciting opportunities to use our complementary portfolio to sell incremental products and services to both companies' customers. For example, we expect to be able to bring First Advantage's I-9 and WOTC offering to Sterling's customers and certain of Sterling's digital identity solutions to First Advantage customers.
We'll also have an opportunity to bring First Advantage's leading automation expertise to Sterling. We expect that as we find new ways to utilize our technologies and capabilities, the combined company will be able to leverage First Advantage's AI-driven intelligent routing and proprietary data assets to reduce reliance on third-party data providers, advancing our commitment to delivering cost-effective solutions to our customers. This transaction also creates the opportunity to accelerate innovation in ways that will meet the dynamic needs of customers and deliver an elevated applicant experience while also improving operational efficiencies. For example, with greater capacity for investment, the combined company will accelerate innovation focused on artificial intelligence, impacting both the front-end applicant experience and the back-end fulfillment process and other technologies that will shape this industry over the long-term.
Similarly, the transaction will enable greater combined investment in next-generation digital identification technologies, building on our existing services and the acquisition of Infinite ID. Digital identification has been a core part of First Advantage's strategy and bringing together our identity verification and identity fraud solutions will enable First Advantage to further innovate in delivering state-of-the-art digital identity solutions to our customers. Overall, our acquisition of Sterling will accelerate our strategic objectives toward sustainable long-term value creation for customers and shareholders. Our enhanced growth opportunities and improved diversification set us up to deliver a stronger, more comprehensive value proposition to customers in a large, growing and highly fragmented $13 billion market for our services.
And this combination enables accelerated investment in our products to fuel innovation and growth. I am confident that this acquisition is the right step to create meaningful value for First Advantage's current customers and shareholders, and those of the combined company. I will now turn the call over to David to discuss the financial details of the transaction.
David Gamsey: Thank you, Scott. Turning to Slide 7, I'll take you through the financial aspects and structure of the transaction. Total purchase price consideration for this transaction is $2.2 billion. The consideration will include $1.2 billion in cash, 27.15 million shares of newly issued First Advantage common stock and the assumption of Sterling debt, which will be retired at closing. This translates to a purchase price of $16.73 per share, which represents a premium of 35% to Sterling's closing price yesterday and 26% premium to the 30-day VWAP. We will be acquiring Sterling at a synergized adjusted EBITDA buy-in multiple that represents a discount to First Advantage's current trading multiple. We expect the transaction to deliver significant total shareholder return in the long run.
This transaction essentially doubles First Advantage's revenues and adjusted EBITDA, and we expect the transaction to deliver immediate double-digit accretion to adjusted earnings per share, assuming run rate synergies. I'll discuss the pro forma profile in more depth shortly. It also provides greater trading liquidity for investors, creating an even more compelling opportunity for investors in this industry. Within 18 months to 24 months after closing, First Advantage expects to achieve at least $50 million in synergies as identified by our team and supported by an adviser. These synergies would be driven by a reduction in third-party data costs and efficiencies across operations, product and technology and SG&A, including the elimination of duplicative public company costs, such as the combination of insurance programs and one audit and one set of tax returns.
We see potential for upside on the expected synergies value over time. We have secured fully committed financing for this transaction with $1.8 billion of new seven-year term debt. The new financing is in addition to the existing debt on our balance sheet. I'll talk through the balance sheet impacts of the transaction in more detail shortly. Regarding timing, the transaction is expected to close approximately in the third quarter of 2024, subject to required regulatory approvals, clearances and other customary closing conditions. We cannot control the exact timing, but we will be prepared to close as soon as all approvals have been received. First Advantage shareholders will own approximately 84% of the combined company and Sterling shareholders will own approximately 16%.
There will be approximately 173 million diluted shares outstanding. As a result of the transaction, we have suspended purchases under our share buyback program. Our primary focus upon closing will be on integration, synergies, deleveraging and most importantly, on our customers. The acquisition of Sterling is a significant step forward in our value creation playbook. It is just the beginning. We have the leadership team, industry expertise, technology and systems to successfully execute and integrate this transaction and deliver shareholder and customer value. Now turning to Slide 8. Our proposed acquisition of Sterling generates a strong pro forma financial profile. Using the year-end figures that First Advantage and Sterling reported today, we will have pro forma $1.5 billion in 2023 revenues and $473 million in combined EBITDA, including expected run rate synergies.
This represents a 32% adjusted EBITDA margin, which is approximately 100 basis points above First Advantage's current margin. We expect to generate double-digit EPS accretion on a run rate basis with continued ability to compound EPS at teens growth rate over time. Now on Slide 9, I'll focus on how the transaction impacts our capital structure. First Advantage will assume and retire Sterling's outstanding debt at closing. As previously mentioned, this along with the cash consideration portion of the purchase price will be funded through a new $1.8 billion seven-year term loan and cash on the balance sheet. We have already secured financing commitments for this new facility from a consortium of banks. Additionally, as part of this financing agreement, we will be upsizing our current $100 million revolver to $250 million and extending the maturity date to 2030.
Net leverage at closing will be in the range of 4x depending on the exact timing of closing. The debt will be covenant-light, consistent with our current agreement, further reducing risk and increasing flexibility. Our long-term goal is to reduce and maintain net leverage between 2x and 3x. Our expected liquidity at closing and our combined company's ability to generate cash flow will leave us with greater than 2.5x interest coverage, ample room to achieve our capital allocation priorities and deleverage organically over time. For context, pro forma combined cash flow from operations was approximately $300 million based on actual 2023 results. Our well-built financial foundation and resilient business model have supported our history of strong adjusted EBITDA margins and robust operating cash flows, creating a healthy balance sheet that has given us the flexibility to acquire Sterling.
Looking ahead, and as previously mentioned, we expect First Advantage to continue compounding EPS at a teens growth rate over time through the combination of top line growth, ongoing synergy capture and significant deleveraging via strong organic free cash flow generation. We will continue to selectively and strategically invest in the business to fuel long-term organic growth and to successfully integrate Sterling, particularly to drive the innovation that we know will most benefit our customers. Consistent with our historical capital allocation strategy, going forward, we plan to focus our uses of capital on prudent deleveraging towards our long-term net leverage target range, which will help support earnings growth. Now let me take you through our full year and fourth quarter results as well as our stand-alone First Advantage 2024 outlook.
Turning now to a recap of our full year results on Slide 12. We are pleased with our overall annual performance coming in within 1% of our original 2023 guidance ranges for revenues and adjusted EBITDA and performing in line with what we communicated for adjusted net income and adjusted diluted EPS. This is further evidence that we continue to be diligent and successful at controlling what can be controlled within our business despite the challenging macro environment. Revenues grew sequentially throughout the year in every single quarter, including Q4, coming in at $764 million, a decrease of 5.7% from the prior year, with constant currency revenues of $766 million. For the year, Infinite ID, which we acquired in September 2023, contributed approximately $3 million to our revenues.
As we have discussed throughout 2023, we have been pleased that our upsell, cross-sell, new logos and attrition rates have broadly aligned with our historical revenue growth rates. Our base growth, which is more sensitive and correlated to changes in the macro environment, declined on lower volumes. We believe that when the macro environment stabilizes, our base growth will normalize to our historical rate of 2% to 4%. In our Americas segment, revenues of $673 million or 87% of consolidated revenues were down 3.1% from the prior year. In our International segment, revenues of $97 million or 13% of consolidated revenues were down 21% from the prior year. On a constant currency basis, international revenues were $99 million or down 19% year-over-year.
Adjusted EBITDA for the year was $238 million, and our adjusted EBITDA margin was a robust 31.1%, representing year-over-year expansion. Our adjusted effective tax rate was 23.5%. Adjusted net income was $146 million and adjusted diluted EPS was $1. Looking now at our fourth quarter results on Slide 13. The fourth quarter exemplified the continued strength of our flexible business model, disciplined cost management and investments in technology and automation, which were key drivers of achieving a record adjusted EBITDA margin of nearly 34% and strong cash flow from operations of $57 million. Our fourth quarter revenues were $203 million, a decrease of 4.7% from the prior year. Given the mix of our domestic and international businesses, currency had little impact on fourth quarter results with constant currency revenues of $202 million.
For the quarter, Infinite ID contributed approximately $2 million to our revenues. We continue to make great progress building our customer base during the fourth quarter and the year. We had 10 bookings in the fourth quarter of $500,000 or more of expected annual contract value and [46] for the year, of which approximately half were new logos and the other half were upsell cross-sell. That said, total base continued to be under pressure in the fourth quarter, declining $28 million or 13%, driven by peak season ending earlier than expected and continued macro-driven weak performance in our India and APAC markets. We are well positioned to take advantage of the upside from a market recovery when it materializes. The base decline for the quarter was partially offset from upsell and cross-sell, which contributed $12.7 million or nearly 6% to our performance.
Revenues from new customer logos contributed an additional $8.3 million or approximately 4%. In our Americas segment, revenues of $182 million or 89% of consolidated revenues were down 3.1% from prior year. This quarter held up relatively well, which is primarily attributable to our broad-based resilient customers. All of our fundamentals remain strong. As a reminder, JOLTS data is correlated to our Americas-based growth. Looking at December 2023 JOLTS data, openings and hires increased slightly month-over-month and remained relatively high by historical standards, but separations declined. Employers are holding on to talent longer. Quits fell to the lowest monthly level in nearly three years. These declining hiring trends continue to impact our Americas space, which for the quarter was down 12%.
In our International segment, revenues of $22 million or 11% of consolidated revenues were down 16% from the prior year. On a constant currency basis, international revenues were $21 million or down 18% year-over-year. The decrease was due primarily to base weakness in India and APAC, offset in part by relative strength in EMEA. As a reminder, our direct exposure to China is less than 1% of our total revenues and has little impact on our business. In the fourth quarter, India was down approximately 36%, given our regional exposure to BPO and IT services-related businesses and APAC was down 21%, driven by the financial services sector and other regional market dynamics. We achieved a record consolidated adjusted EBITDA margin of 33.7% on adjusted EBITDA of $68 million, which represented an improvement of 140 basis points sequentially and 60 basis points on a year-over-year basis.
This is another proof point that our business remains resilient in the face of top line headwinds. Our adjusted effective tax rate was 21.2%, which reflects a onetime favorable adjustment. Adjusted net income was $43 million, and adjusted diluted EPS was $0.29, which includes a $0.02 negative impact from our August 2023 special dividend. Now turning to Slide 14. I'd also like to highlight that in 2023, we generated operating cash flows of $163 million, ending the year with $214 million of cash on the balance sheet. We continue to return capital to shareholders through our $218 million onetime special dividend and repurchasing $59 million of stock as part of our buyback program. We spent $41 million on the acquisition of Infinite ID, growing our vertical capabilities and expanding our product suite.
Additionally, we spent $28 million on capital-related investments. In December, we entered into two new interest rate swap agreements that take the place of our existing interest rate collars that mature today. Now moving to Slide 15 and a discussion of our outlook. In developing our stand-alone guidance for 2024, we considered many factors. First was the current macroeconomic environment, including the softening in hiring trends and the reduction in employee churn. These dynamics were partially offset by discussions with our customers who are becoming more optimistic and seem ready to start investing in new growth opportunities. On top of this, the Sterling acquisition announced today will require significant amounts of management time and resources to complete and integrate.
As such, the midpoint of our guidance reflects a conservative posture towards growth and profitability in 2024. For First Advantage on a stand-alone basis throughout 2024, we expect sequential quarter-over-quarter growth for revenues, adjusted EBITDA and adjusted EBITDA margins similar to 2023. We expect customer retention to remain in line with our strong historical performance of around 97%. We also expect continued execution of upsell, cross-sell and new logo growth consistent with historical trends and long-term targets. The midpoint of our guidance range assumes that there will be further macro-driven base declines, with base remaining negative in the first three quarters, though improving sequentially and then turning positive in Q4. However, assuming the economy begins to recover later in the year and into 2025, we are extremely well positioned to benefit.
For 2024, we expect to generate full year revenues in the range of $750 million to $800 million. Based on the midpoint of $775 million, this results in positive year-over-year organic revenue growth. This includes revenues related to Infinite ID, which is expected to contribute approximately $7 million in the first eight months of the year as we approach the anniversary of the acquisition at the beginning of September. At our midpoint, we expect to maintain full year adjusted EBITDA margins of approximately 31% and adjusted EBITDA in the range of $228 million to $248 million. This is after considering approximately $10 million in increases in employee wages and benefits and normalization of management incentive plans, as well as approximately $7 million in new investments in product, technology and sales.
We are continuing to selectively invest in our business to strengthen our client relationships and to bring them the best possible offering in the industry. At the midpoint, we expect our 2024 adjusted net income to be approximately $135 million and adjusted diluted EPS of $0.93. We have provided an adjusted diluted EPS bridge on Slide 16 that walks you through the puts and takes in comparing 2023 results to what we expect in 2024. This is very important to understand. On a like-for-like basis, after adjusting for impacts, including our 2023 onetime special dividend, expiring interest rate swaps and the positive impact from our 2023 share buybacks, adjusted 2023 EPS would have been $0.92. We expect diluted EPS expansion at the midpoint of our guidance range in 2024 when taking into account these and other items.
We have also provided a summary of selected 2024 modeling assumptions in the appendix including a range of $30 million to $33 million of capital expenditures, of which $3 million relates to a new U.S. criminal data AI project and $4 million relates to a large-scale computer refresh project. The balance, consistent with 2023, primarily relates to capitalized software development costs. Looking now at the quarterly phasing of our 2024 guidance. We expect Q1 year-over-year consolidated revenues to decline by approximately 5%. We expect sequential top line improvement as we move throughout 2024 with Q2 results coming in relatively flat year-over-year. We expect positive overall growth in the second half of the year more heavily weighted toward Q4.
We expect our Q1 adjusted EBITDA margin to be between 27% and 28%, which is consistent with the first quarter of the last three years. Starting with Q2, we expect adjusted EBITDA margins to be above 30% and to improve in the second half of the year following a similar pattern to 2023. Overall, we are extremely well positioned to benefit when the macro environment improves. Please note that we expect to provide guidance on the combined company after the Sterling acquisition closes. Let me now turn the call back over to Scott before we open the line for questions.
Scott Staples: Thank you, David. I want to acknowledge the great progress our First Advantage team made throughout 2023. I'm especially proud that we did not take our foot off the gas pedal even as we continue to navigate an uncertain macro environment and evolving labor market. We are well positioned to weather the current environment and benefit greatly once it stabilizes and starts to improve. We are excited about today's definitive agreement to acquire Sterling, which will allow us to extend our high-quality and cost-effective background screening, identity and verification technology solutions for the benefit of customers of all sizes across industry verticals and geographies. Looking forward, we remain focused on long-term profitable growth and maximize value for all stakeholders. With that, we will open the line for questions.
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