First Advantage Corporation (NASDAQ:FA) Q1 2023 Earnings Call Transcript

First Advantage Corporation (NASDAQ:FA) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good day, everyone. My name is Todd, and I will be your conference operator today. I would like to welcome you to the First Advantage First Quarter 2023 Earnings Conference Call and Webcast. Hosting the call from First Advantage is Stephanie Gorman, Vice President of Investor Relations. [Operator Instructions]. It is now my pleasure to turn the call over to Stephanie Gorman. You may begin.

Stephanie Gorman: Thank you, Todd. Good morning, everyone, and welcome to First Advantage’s first quarter 2023 earnings conference call. In the Investors section of our website, you will find the 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 need 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 is 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 Form 10-Q for the first quarter 2023 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 the 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’m joined on our call today by Scott Staples, First Advantage’s Chief Executive Officer; and David Gamsey, our Chief Financial Officer. After our prepared remarks, we will take your questions. I will now hand the call over to Scott.

Scott Staples: Thank you, Stephanie, and good morning, everyone. Thank you for joining our first quarter 2023 earnings conference call. I would like to start by thanking our First Advantage team members across the globe for their ongoing dedication to helping our customers truly put their applicants first. We have a great team who is constantly helping our clients hire smarter and onboard faster as they navigate these uncertain times. Since we became a public company, we’ve highlighted many aspects of our business that underpin the resilience of our operating model and the confidence we have in our ability to weather any economic environment and generate superior profitability. We had a solid first quarter, delivering as expected.

We successfully leveraged our flexible and efficient cost structure as we remain laser-focused on operational excellence. Our approach to innovation and differentiated technology continue to win in the marketplace. Our customers value expertise in human capital, our focus on automation and quality and our successful track record of innovation. This is a winning formula for First Advantage. Our gross retention rate of 97% remains near record levels, and our 13-year average tenure for our top 100 customers are impressive metrics we pride ourselves on. These are big reasons we have been able to deliver consistent results. Our customer base is strong, broad-based and continues to expand. We booked 7 new logo enterprise customers in the first quarter and 30 new logo enterprise customers in the past 12 months.

As a reminder, we define new logo enterprise customers as those with $500,000 or greater in annual expected revenues. Turning to our first quarter results, revenues came in just above the upper end of our expectations, and adjusted EBITDA was in line with our expectations despite the ongoing uncertainty from the economic environment that began to impact hiring demand in late November 2022. In the first quarter, we generated revenues of just over $175 million and adjusted EBITDA of approximately $49 million. You’ll recall that we grew revenues by 44% and adjusted EBITDA by 46% in Q1 of [Technical Difficulty] driven primarily by a disportionate decline in India, given the region’s exposure to BPO and IT services and APAC given regional market dynamics.

Verticals, including transportation and healthcare continue to see stable hiring demand, while other verticals saw moderation primarily attributable to macro factors, which continue to impact hiring trends. Despite varying levels of demand across our verticals, we remain energized and focused on serving our customers and driving strong and sustainable outperformance in our markets over the long-term. Our first quarter adjusted EBITDA margin performance was in line with our expectations and prior year trends. Remember that Q1 is historically our seasonally lowest quarter as large retail and logistics companies annually reduce their holiday season staffing. We believe our profitability remains best-in-class in our industry, and we continue to expect that our adjusted EBITDA margins will return to above 30% levels in Q2 and for the balance of the year.

These results speak to the adaptability of our operating model, our cost discipline and the strong execution by our team members across our markets. I’d also like to remind you that we have a robust, very well-capitalized balance sheet, which includes over $400 million in cash. We continue to generate significant free cash flow, and our leverage is a modest 0.7x. This gives us significant flexibility during these difficult times. David will provide additional color on our financial performance and full year outlook in a moment. Turning now to key highlights from the quarter, which are summarize [Technical Difficulty]. The overall U.S. labor market continues to show some pockets of resilience and while activity has moderated relative to the extremely strong levels from a year ago and overall hiring remains generally stable.

We are also encouraged by our monthly revenue progression through the first quarter, particularly in our Americas business, where we [Technical Difficulty]. However, the U.S. labor market continues to be broadly impacted by macro headwinds, which has forced companies to look at areas to reduce cost and prune headcount. These actions, along with current expectations for these headwinds to continue, are already reflected in our guidance. We continue to believe meaningful structural tailwinds remain in place to support a return to our long-term organic revenue growth target. We are excited about our long-term prospects given the systemic changes we are seeing in employment dynamics. Preferences toward greater flexibility, work life balance, working multiple jobs and higher pay are expected to continue to drive increased churn and structural changes, which result in increased hires and quits.

Recent macro jobs data specifically related to new hires and quits, while modestly down in March, has remained relatively stable, which supports the ongoing generational shift in how people work and apply for jobs. Additionally, we interact with our top enterprise clients on a frequent and ongoing basis. While they are monitoring the economic impact from inflation and rising interest rates, they tell us that the demand for their products and services remains robust, and they are looking to capitalize upon opportunities in the current market environment. Many of these clients have already put cost control measures in place, reduced headcount to appropriate levels and do not anticipate additional changes to their adjusted hiring plans. As our customers continue to navigate the ongoing macroeconomic challenges, it has become even more imperative for them to invest in products that lead to higher productivity, improved accuracy and faster results in the hiring process as they place an even greater emphasis on efficiency and hiring and attracting the best talent.

At First Advantage, our success in meeting these needs is a result of our dynamic product offerings, which are enabled by our investments in differentiated technology, machine learning and automation. We provide a compelling value proposition for our customers who depend on the speed and quality of our solutions to help them succeed in today’s dynamic and fast-moving hire environment. Even during these challenging times, we continue to selectively invest through the cycle and capitalize on opportunities to further strengthen our business. In April, we held our annual customer conference called Collaborate, which is the only background screening user conference of its kind, bringing together customers, partners and thought leaders. We are pleased to have Johnny C.

Taylor Jr. join us as our keynote speaker, where he led a fantastic session on the future of the workforce. Mr. Taylor is the President and CEO of the Society for Human Resource Management, also known as SHRM and is highly regarded as a leading industry expert in human resources. He has renowned global authority on the future of employment, culture and leadership and is nationally recognized best-selling author. During the conference, we also discussed some of our new and evolving products and solutions and engaged in very positive discussions with our customers. One offering we launched was our new product bundles and capabilities powered by our mobile-first next-generation Profile Advantage technology. These product bundles are designed to align with industry best practices and vertical expertise and are delivered within Profile Advantage, providing a seamless applicant experience.

These offerings also provide additional opportunities for new business and upsell, cross-sell growth. Additionally, we continue our commitment to providing our customers with the latest in market-leading technology with the ongoing rollout of our digital identification product in the U.K. in partnership with Yoti. We are pleased to share that we have contracted with over 125 customers, of which more than 75 are now live in the U.K. market with a strong pipeline of additional opportunity. This product provides an innovated and much-needed solution in the U.K. market that allows applicants to use a seamless and fully digital process, replacing what was previously a manual procedure and reducing turnaround time from days to hours. We are well positioned as an early mover in this important and attractive space, particularly as other international markets adopt similar digital identity standards.

Last quarter, we discussed the incredible traction we are getting in our employment and education verification space with our SmartHub technology, which leverages machine learning and our proprietary algorithms to quickly search across multiple data sources to determine the optimal verification source, based on speed, data quality and cost effectiveness. A key component of the success of SmartHub is leveraging our proprietary verified database, which now has over 80 million records. In aggregate, our proprietary databases have now surpassed 700 million records, including our national criminal record file database, which maintains around 625 million records, making it one of the most robust criminal record databases in the industry. At First Advantage, we continue to innovate and deliver new solutions, which is a key differentiator to maintaining and growing our competitive advantage over time.

In the future, we look forward to sharing updates on our progress and how we are helping our customers stay on the leading edge of hiring and providing the best applicant experience in the industry. Turning to Slide 6, I want to take a moment to talk about the progress we’ve made around our sustainability initiatives, which are detailed in our second annual sustainability report published yesterday. Our corporate culture and values drive our approach to sustainability, which is a fundamental part of our business. Our Board and leadership team are firmly committed to our responsibility as a global corporate citizen and advancing even higher ethical standards. Our talented global workforce is inherently diverse and each employee brings their unique strengths and experiences to bear, which is key to our long-term success as a company.

We provide ourselves on fostering a culture of inclusion that helps our employees maximize their potential. We are excited about the collective progress we’ve made at First Advantage with our sustainability efforts. We believe embedding these considerations throughout our business is not only the right thing to do, but also drive stronger and more resilient performance and ultimately maximize shareholder value. I will now turn the call over to our Chief Financial Officer, David Gamsey, for more details on our financial results. David?

David Gamsey: Thank you, Scott, and good morning, everyone. Let’s begin our financial review on Slide 8. Versus the prior year, our first quarter revenue decreased 7.6% to $175.5 million or 6.4% to $178 million on a constant currency basis. It is important to note this is versus very robust revenue growth of 44% in the comparable quarter of 2022 and was slightly better than we originally expected. This results in a 3-year revenue CAGR of just over 18%, substantially higher than our long-term targets. In our Americas segment, revenues of $152 million were down a modest 5% from Q1 2022 as our customers continue to hire, although at a slightly lower rate than Q1 of last year. Our Americas segment held up relatively well given overall market conditions, which is attributable to our broad-based resilient enterprise customers.

In total, our Americas segment represented 86% of consolidated revenues in the quarter. In our International segment, revenues of $25 million were down 22% from Q1 2022. On a constant currency basis, revenues would have been $27 million or down 15% year-over-year. The decrease in revenue was due primarily to weakness in India, given the region’s exposure to BPO and IT services-related businesses. In APAC, while still down, we are starting to see positive signs of trends moving in the right direction across China, Hong Kong and Singapore as lockdown restrictions have been lifted. Additionally, we are cycling over a very strong double-digit growth in the first quarter of 2022. Our EMEA operations have proven more resilient in the face of macro headwinds with the new digital identity products contributing to their sustained success.

In total, international represented 14% of consolidated revenues in the quarter. In the first quarter, the year-over-year revenue decline from existing customers was $22 million net of upsell, cross-sell, which contributed $9 million or 5% to our revenues. Revenues from new customers contributed an incremental $8 million, adding 4% to our results. Contributions from new customer sales and upsell, cross-sell are encouraging and remain consistent. Adjusted EBITDA for the quarter was $49 million, a decrease of 9% compared to Q1 of 2022 during which we grew adjusted EBITDA by a very high 46%. FX had a $0.5 million negative impact on our adjusted EBITDA dollars. Our adjusted EBITDA margin of 27.7% was in line with our expectations and was consistent with the prior 2 years, and we continue to maintain a very high quality of earnings.

We expect adjusted EBITDA margins to return to over 30% starting in Q2. Also just to note, our 3-year adjusted EBITDA CAGR was nearly 25%. Adjusted net income decreased 15% to $28 million from $33 million in Q1 2022. This was primarily attributable to lower revenues, higher interest expense and higher D&A associated with investments in our proprietary platform, partially offset by interest rate swaps and higher interest-bearing deposits. Adjusted diluted EPS was $0.19 for the quarter. Our adjusted tax rate of 25.3% was in line with the prior year period. I’d like to remind you that one of our most significant differentiators is our unique and highly flexible cost structure. The majority of our costs to perform our core background screening services are variable.

So we have a very high degree of confidence in our ability to successfully align our operations with the demand environment while meeting our customers’ needs. Approximately, 70% of our cost of sales are third-party costs, which are essentially 100% variable and usage base. This means, we do not incur these third-party costs if we do not perform a search. We can also flex their staffing levels by adding or removing shifts or overtime. Additionally, prior investments across geographies, technology and automation have structurally reduced our cost base. We are laser-focused on profitability and believe we are well positioned to successfully navigate future macroeconomic environments due to the efficiencies we have driven across the organization.

In addition, we remain focused on productivity and reducing controllable costs, such as reducing our facilities footprint, lowering our overall insurance cost and selectively lowering headcount throughout the organization to match demand. We have demonstrated our ability to act quickly in the past to preserve margins, and we will continue to do so in the future if the situation dictates. Our rock solid balance sheet, strong cash position, free cash flow generation and low leverage give us the flexibility to continue to selectively invest in the business. Turning now to capital allocation and our balance sheet on Slide 9, we are committed to maintaining our strong balance sheet and conservative capital structure. Our low leverage and ample dry powder provides tremendous flexibility to further our strategic priorities.

Our philosophy around capital allocation is to take a balanced approach between M&A, disciplined internal investments, returning capital to shareholders and maintaining our attractive leverage profile. We continue to actively evaluate M&A opportunities and are starting to see more activity. Our available cash, cash flow and strong balance sheet provide us with substantial flexibility to pursue attractive opportunities. Our internal investment priorities remain focused on technology, automation, product innovation and sales initiatives that drive highly profitable organic growth. During Q1, we repurchased $25 million of common stock or 1.9 million shares under our share repurchase program, and we still ended the quarter with over $400 million of cash on our balance sheet.

Since its inception on August 2, 2022, through May 4, 2023, we have repurchased 7.4 million shares for $97 million. This consistent capital deployment approach allows us to drive sustainable, long-term value creation for our shareholders. In the first quarter, we continued to deliver strong and consistent cash flow generation with operating cash flows of approximately $39 million. Keep in mind, Q1 is historically our lowest cash-generating quarter, and we were still able to generate robust cash flow. During the quarter, we spent $6 million on purchases of property and equipment and capitalized software development costs. We ended the quarter with total debt of $565 million and cash on our balance sheet of over $400 million. We also have $100 million in untapped borrowing capacity under our revolving credit facility with no outstanding balances.

Based on our last 12 months adjusted EBITDA of $244 million, we had a net leverage ratio of just under 0.7x as of March 31. Our debt structure has us well positioned for today’s higher interest rate environment. We have an interest rate collar with approximately 50% of our long-term debt capped at 1.5% 1-month LIBOR rate through February of 2024, and we have no principal payments due before 2027. Recall, we strategically hedged another $100 million of long-term debt in the first quarter, so we now have 70% of our long-term debt hedge. Our interest rate exposure on the remaining unhedged portion of our debt is currently more than offset by our interest income on interest-bearing cash deposits. Now moving to Slide 10. Macroeconomic conditions, including hires and quits preceded in line with our expectations during the first quarter.

This is outside of the regional bank failures which had no direct impact on our business. We expect the Fed to stay diligent on their fight against inflation and the unemployment rate to increase, which will temper near-term growth. This has already been factored into our guidance, including that the current environment continues. Given our current visibility, ongoing dialogue with customers, the diverse nature of their client base and our strategic vertical coverage, we are reaffirming our full year guidance. As a reminder, we expect to generate full year 2023 revenues in the range of $770 million to $810 million, resulting in approximately flat to negative 5% year-over-year revenue growth. As a reminder, we have lapped all acquisitions to this guidance and the associated growth rates are organic figures.

All assumptions, including our expectations for foreign currency and typical seasonality for the remainder of the year are unchanged. This includes our expectation shared last quarter that in Q2, we expect sequential revenue growth, though it will still be negative on a year-over-year basis. We will also still be cycling over double-digit revenue growth in Q2. Our outlook for adjusted EBITDA is also unchanged. We anticipate organic adjusted EBITDA to be in a range of $240 million to $255 million, representing approximately negative 4% to positive 2% year-over-year growth. This represents margin expansion to around 31% for the year with adjusted EBITDA margins above 30% starting in Q2 and improving in the second half of the year following a similar pattern to 2022.

We continue to expect our 2023 adjusted net income to be between USD145 million and USD155 million and adjusted diluted EPS of $1 to $1.07. Our adjusted diluted EPS guidance assumes we maintain a similar run rate of share repurchases for the remainder of the year. As we progress further into 2023, we remain focused on controlling what we can control and on our commitment to creating value for our customers and shareholders. We are in an incredibly strong financial position and a resilient operating model and track record of navigating challenging times underpins our confidence and ability to execute on our strategy in this dynamic environment. Scott, I’ll now turn the call back over to you.

Scott Staples: Thank you, David. I will conclude our prepared remarks today by reiterating my confidence that the future of First Advantage is as bright as it has ever been. We have our playbook to navigate the challenges that are ahead. We are a global leader in a large market with significant long-term growth potential, and our employees continue to work tirelessly to enable us to better serve our customers. Our strategic investments in technology, machine learning, proprietary databases, automation and the actions we’ve taken to enable our customers to hire smarter and onboard faster will continue to drive our success in the future. Thank you very much for your time and your ongoing support. At this time, we will ask the operator to open the call for your questions.

Q&A Session

Operator: [Operator Instructions]. Our first question comes from Shlomo Rosenbaum with Stifel.

Operator: Our next question comes from Ashish Sabadra with RBC.

Operator: Our next question comes from David Togut with Evercore ISI.

Operator: Our next question comes from Stephanie Moore with Jefferies.

Operator: Our next question comes from Andrew Steinerman with J.P. Morgan.

Operator: [Operator Instructions]. Our next question comes from Kyle Peterson with Needham.

Operator: Our next question comes from Heather Balsky with Bank of America.

Operator: Thank you. There are no further questions in queue at this time. I will now turn the call over to Scott Staples for closing comments.

Scott Staples: Thank you, Operator, and thanks everyone, for your participation. Have a great day.

Operator: Thank you. This concludes the First Advantage first quarter 2023 earnings conference call and webcast. Thank you all for your participation. At this time, you may disconnect your lines, and have a wonderful day.