HireRight Holdings Corporation (NYSE:HRT) Q3 2023 Earnings Call Transcript
HireRight Holdings Corporation (NYSE:HRT) Q3 2023 Earnings Call Transcript November 9, 2023
Operator: Good morning, ladies and gentlemen, and welcome to HireRight's Third Quarter 2023 Conference Call. Joining today's call are the company's President and Chief Executive Officer, Guy Abramo; Chief Financial Officer, Tom Spaeth; and VP of Treasury and Investor Relations, Andrew Hay. At this time, all participants are in a 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 on 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, new business and customer retention, partnerships with HCM providers, biometric screening capabilities, cost reduction initiatives and improving profitability, cash flow and updated outlook.
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 Annual Report on Form 10-K filed with the SEC, in particular, the section of that document entitled Cautionary Note Regarding Forward-Looking Statements and Risk Factors summary in the 10-K and Management's Discussion and Analysis of Financial Condition and Results of Operations. It is now my pleasure to turn the call over to Guy Abramo.
Guy Abramo: Thank you, operator, and good morning. I appreciate everyone taking the time with us as we share our third quarter 2023 results. For the past four quarters, we successfully executed in a challenging macro environment with inconsistent economic data, geopolitical turmoil and an ever-evolving employment market. With this as a backdrop, we remain focused on what we can control, and we are pleased with our execution to-date. For the third quarter, revenue was $188.3 million, down $22 million year-over-year. Base hiring volumes remained significantly lower than this time last year, and Tom will provide a breakdown by our growth algorithm later in the call. To refresh your memory, when we say base hiring volumes, that is analogous to same-store sales and does not indicate client losses.
For the quarter, we generated adjusted EBITDA of $52.1 million, despite lower revenues, while improving margins more than 200 basis points, demonstrating our ability to improve profitability in a challenging environment. During the quarter, our gross margin, excluding depreciation and amortization exceeded 50%, driving the adjusted EBITDA margin to 27.7%. Labor markets in general remain in flux with plenty of conflicting data. While job openings remain higher than pre-pandemic levels, there has been a clear slowing of employee turnover. Uncertainty in the macro outlook, coupled with geopolitical concerns have certainly slowed the recovery. The quarter was, however, in line with our typical seasonal patterns similar to the first two quarters of the year.
We spent a lot of time discussing our technology and services verticals last quarter, and I am pleased to report that our technology customer base has stabilized as the vertical was essentially flat to Q2 after showing a bit of a rebound in that quarter. Part of that improved performance was driven by some significant upsells and expansion, which I will get to in a minute. Our transportation and healthcare businesses were down slightly from Q2, but remained in line with our expectations. Lastly, our remaining core vertical of financial services declined 14% compared to Q2, primarily driven by our European-based banking customers. Those customers have indicated that volumes have softened mainly due to slowing employee turnover and not necessarily from job cuts.
During the quarter, revenue from new business increased more than 30% versus the second quarter of this year. Year-to-date, new business revenue has driven more than $36 million in growth and our pipeline remains as strong as it has ever been. During the quarter, we added five new enterprise customers with combined estimated annual contract value of $11 million. Our go-to-market and onboarding teams are fully engaged, working to transition these wins and converting our strong pipeline into revenue. Retention of our top customers remains strong as well at just under 97%. And as I mentioned earlier, we had some major upsell success, particularly in healthcare and in technology, where we have expanded our presence with a very large ride-sharing company.
In addition to the high customer satisfaction that drives our impressive retention, we are very pleased to announce we have enrolled in the Oracle independent software vendor, ISV Accelerator Program, expanding beyond our Gold level Oracle partnership. This program highlights the integration of HireRight's comprehensive background screening products such as verifications, drug testing, Form I-9 and E-Verify services into Oracle Talent Management Solutions. Our seamless integrations improve and streamline the company's background screening process by automatically pre-populating recruiting forms, reducing redundant data entry, automating background request accuracy and providing timely tracker updates. In addition, customers benefit from increasing administrative efficiency through our integrated support and ongoing platform updates.
HireRight is now the exclusive background screening provider in Oracle's ISV Accelerator Program, and we look forward to providing the best experience possible through closer alignment with Oracle. Further demonstrating that strength in partnering with leading HCM players, after an extensive evaluation process, HireRight was selected by UKG, otherwise known as the Ultimate Kronos Group, to be their sole go-to-market partner for their newly branded employment screening solution called UKG Screen by HireRight. UKG is a leading global provider of human capital management, payroll, HR service delivery and workforce management solutions. HireRight and UKG have been strategic partners for 10 years. And under this new partnership agreement, UKG will market, promote and co-sell HireRight's global solutions to their customers and prospects worldwide under the UKG Screen product name.
UKG Screen by HireRight is being externally launched at the UKG Aspire Customer Conference just this week. These premier global partnerships further exhibit the value of our single global integrated platform, which simplifies global implementations of human capital management and applicant tracking systems. Also during the quarter, we began integrating our acquisition of DTIS and are excited about the opportunities to leverage our FBI-approved channeler capabilities. The growth of our biometric-based screening capabilities will enable future product, service and revenue opportunities as we expand solutions supporting our complex, highly regulated customers. During our first quarter call, we announced plans to streamline costs, including rebalancing and reducing our global headcount, shrinking our real estate footprint and managing discretionary expenses.
We are nearing the completion of our labor force rebalancing enabled by our improved technology stack. We will continue to implement our plans throughout the remainder of this year and into 2024. These self-help actions are well within our control, and are designed to improve operating leverage regardless of the economic environment. Looking at current market trends and the murky macroeconomic outlook, we firmly believe that over the long term, our markets will benefit from the favorable secular changes in the employment market, such as growth in the freelance economy and increasing turnover rates. These changes result in more churn and higher velocity in labor markets. However, while recent labor reports indicate there is still a strong demand for talent, there has been a noticeable slowing of turnover as recessionary concerns linger.
As we are now in the middle of our seasonally slower quarter, we expect inbound volumes to moderate, but remain confident in our previously provided outlook, which Tom will discuss shortly. In closing, we are pleased with our results, especially given the backdrop of the broader macro headwinds. Our business remains resilient, and we have demonstrated our ability to expand margins regardless of the economic environment. We are managing the business for the long-term. However, we will be proactive in our near-term decision making to maintain our positive momentum. Our relationships with our key customers provide us with a front-row view of hiring patterns prior to the reported numbers and surveys, which enables us to provide updated outlooks based on near real-time hiring estimates.
And we continue to be laser-focused on our margin improvement initiatives while maintaining industry-leading quality and service for our customers, and that focus is clearly reflected in our results. With that, I'll turn the call over to Tom for a closer look at our third quarter financial performance and our outlook for 2023. Tom?
Tom Spaeth: Thank you, Guy. Good morning, everyone, and thank you for joining our call today. As Guy mentioned, our third quarter revenue was $188.3 million, down 10.5% versus the prior year due to reduced hiring volumes driven by economic headwinds. Deconstructing our results based on our growth algorithm provides the following breakdown. Base growth from our top roughly 1,800 customers, which represent approximately 75% of total revenue, was negative 16% year-over-year. Upsells into these customers offset that decline by approximately 2%. Customer churn represented a 3% decline year-over-year. New logos contributed 7% year-over-year, with more than $15 million added during the quarter. Growth relating to our recent acquisition contributed 1%.
And finally, our long-tail SMB business consisting of more than 30,000 customers represented a 2% decline year-over-year. Looking at our verticals. As Guy mentioned, our technology customers' orders has stabilized. After material declines earlier in the year and while still down 24% year-over-year, it was consistent with last quarter in which we saw a rebound from Q4 and Q1 level. Layoff data related to this vertical appears to have peaked during Q4 2022 and the first half of 2023. And we are slowly beginning to see some green shoots. Retail and hospitality grew year-over-year in this quarter, largely driven by new business wins. Guy also mentioned the softness in financial services, which declined nearly 19% year-over-year, largely driven by a slowdown in turnover at our large European-based banking customers.
Healthcare was down nearly 7% year-over-year, nearly exclusively driven by our largest customers who have completed a number of rescreening projects in the year prior. Absent that change, our healthcare vertical would have been flat year-over-year. Overall, our core verticals accounted for 55% of the revenue this quarter, fairly consistent with prior periods. Turning to our geographic split. Non-U.S. revenue based on applicant location was approximately 14% of total revenue. EMEA posted a 15% decline versus the prior year, consistent with our financial services decline. APAC and India continued to be impacted by the softness in technology and services, and were down to combined 20% from the prior year. Currency fluctuations had minimal impact on reported revenue.
Turning to expenses and our improved profitability. During the quarter, we continued to improve our delivery cost of service, helping to drive gross margins, excluding restructuring charges and depreciation and amortization to 50.3%, which is up more than 300 basis points year-over-year and is consistent with our previous commentary. We reported $52.1 million of adjusted EBITDA just $1.9 million lower than last year despite reduced revenues. Our adjusted EBITDA margin grew 200 basis points to 27.7%. This growth is indicative of our focus on improving operating efficiency and implementing our restructuring program. Even though we have made great progress to-date, we are still implementing some of our initiatives and will continue these activities through the first half of 2024.
We expect to see additional savings throughout this implementation period and a full run rate savings by the end of 2024. Digging deeper into SG&A expenses in the quarter, on a GAAP basis, total SG&A declined from $49.4 million in Q3 2022 to $48.6 million this quarter. Excluding stock-based compensation and restructuring charges, employee costs decreased 15% to $20.7 million, driven by our restructuring actions and lower variable compensation. During the quarter, we had a one-time insurance recovery of approximately $6 million. Excluding this recovery and other one-time items such as restructuring, our other indirect expenses increased from $18.7 million in Q3 2022 to $22.7 million. This increase was driven primarily by increasing technology maintenance costs, recurring legal expenses, partnership royalties and indirect taxes, all of which were partly offset by lower facility expenses, professional fees and marketing costs.
Adjusted net income for the quarter was $24.6 million compared to $29.8 million in Q3 2022. The reduction is a result of lower operating income on lower revenues, coupled with higher cash interest expense of $5.4 million due to higher rates on our floating rate debt. As a reminder, we are using an estimated blended statutory tax rate of 26%. Also note, our estimated statutory rate and our GAAP effective rate will differ from our actual cash taxes paid, which are primarily based on revenue generated outside of the U.S. due to our domestic tax assets in the U.S. We expect to continue to be a nominal cash tax payer through 2025. Finally, adjusted diluted EPS for the quarter was $0.36 compared to $0.37 in the prior year period. The diluted weighted average share count for the quarter was 69.1 million, reflecting the shares purchased through the share buyback program versus 79.5 million in Q3 2022.
Outstanding shares at the end of the quarter were 68.1 million, reflecting our continued share repurchase program. Turning to cash flow. We generated more than $38 million in cash flow from operations during the quarter and year-to-date have generated $50.6 million. Unlevered free cash flow, excluding acquisitions and capitalized software development was $95.8 million. Our leverage ratio ended the quarter at 3.7x, up from 2.9x in Q3 last year and is expected to remain in a range of 3x to 4x. Total cash increased to $103 million, resulting from improved cash collections and approximately $32 million in net proceeds from our refinancing on the term loan. In the quarter, we used $24 million of cash to repurchase shares under the authorized share repurchase program.
In September, we refinanced our existing term loan, extending the maturity from 2027 to 2030. We increased the outstanding principle to $750 million in converting the borrowing index from LIBOR to SOFR, increasing the borrowing spread 25 basis points to 400 basis points. In addition, we increased our revolver to $160 million from $145 million. At the end of the quarter, we had no draws against our revolver and about $262 million of total liquidity. We remain confident in HireRight's balance sheet and ability to generate cash flow, enabling us to invest in the long-term future of the business and opportunistically repurchase shares as well as reducing our debt. Our restructuring program is beginning to generate improved profitability as exhibited by our 200 basis point improvement in adjusted EBITDA margin.
Looking ahead, we continue to operate in a challenging environment driven by both geopolitical concerns as well as an uncertain economic outlook. While we cannot predict short-term hiring patterns or changes, we have generated improved margins and converted revenue to free cash flow in this unique operating environment. With this in mind, we are maintaining our previously provided outlook, which was; revenue forecast in a range of $720 million to $735 million, adjusted EBITDA in a range of $172 million to $177 million, adjusted net income in a range of $75 million to $80 million and adjusted diluted earnings per share in a range of $1.05 to $1.10. As a management team, we monitor both short and long-term trends and will implement actions to capitalize regardless of where we are in the economic cycle.
We remain focused on growing revenues through our key strategic initiatives, while maintaining strict financial discipline. With that, operator, we can open the call for questions.
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