HireRight Holdings Corporation (NYSE:HRT) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good afternoon, ladies and gentlemen, and welcome to HireRight’s First Quarter 2023 Conference Call. Joining today’s call is the company’s President and Chief Executive Officer, Guy Abramo; Chief Financial Officer, Tom Spaeth; and Andrew Hay, VP of Treasury and Investor Relations [Operator Instructions]. 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 Web site. 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 the Securities and Exchange Commission in the sections of that documented entitled Risk Factors, Forward-Looking Statements and Management’s Discussion and Analysis of Financial Conditions and Results of Operations. Now, it’s my pleasure to turn the call over to Guy Abramo.

Guy Abramo: Thank you, operator, and good afternoon. I appreciate everyone taking the time with us as we share our first quarter 2023 results. We are very pleased to announce that despite continued macroeconomic headwinds, our first quarter 2023 revenue was $175 million, which, although down 12% versus previous year has us tracking to our full year plan. We continue to see hiring patterns during the first quarter, which were consistent with our previous commentary. Deferment of essential but noncritical roles continues across many industries. However, let me reiterate there is still strong demand for talent and hiring continues just not at the pace we saw during the pandemic recovery. Hesitation appears to be driven primarily by a general nervousness on the economic outlook and the impact of Federal Reserve actions.

As was the case last quarter, the headwinds continue to be strongest in the technology sector, where we saw demand decline 42% year-over-year despite essentially 100% retention within that customer base. We expect this year-over-year comparison challenge to continue in the second quarter and begin to alleviate in the second half of the year. Although we have seen a significant decline in the number of screens in the technology vertical, this result is aligned with the public announcements of staff rightsizing that has dominated the headlines and is already reflected in our guidance. Similarly, the service sector showed a decline of 22% as many of these customers are dependent or aligned very closely with the tech industry. Our remaining verticals showed a decline of just 3% on average and outperformed our expectations.

Healthcare and Transportation, in particular, continued to show resiliency and posted modest year-over-year gains. In total, our core verticals reported approximately a 15% decline versus the same period last year. 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. Our new business engine remains healthy with strong customer wins, upsells and late-stage pipeline. New logos added since the beginning of 2022 contributed more than $9 million in revenue to the quarter, a strong start to the New Year. We have more than $24 million of annual contract value in late-stage pipeline that we expect to close over the next few months.

And as is typical for our account management teams, we continue to exceed our upsell targets with our existing customers. The exceptional service our account managers and customer service teams provide has also driven our strong gross retention rate of 99%. This indicates the market continues to value the quality and thoroughness in our investigations. Turning to expenses and profitability for the quarter; we continued to improve our cost of service delivery, driving gross margins, excluding depreciation and amortization, up 50 basis points versus Q1 of ’22 to 44%. This improvement has been driven by the geographical optimization of our labor mix and implementation of data cost-cutting initiatives. Q1 is historically our seasonally lowest quarter, and we fully expect to grow these margins for the remainder of the year similar to 2022.

Adjusted EBITDA of $33 million compares to $42 million a year earlier, reflecting a combination of lower revenues and negative operating leverage. In the first quarter, we announced and began executing a restructuring plan focused on reducing and rightsizing our global expense base, including direct and indirect costs. We anticipate these changes will continue over the remainder of the year and will begin to favorably flow through our results as soon as the current quarter. Tom will provide additional details on that shortly. At HireRight, we understand the significance of local expertise with conducting employment background screens and believe that our local presence and global platform continues to set us apart from other screening providers.

As such, this capability is opening the door for new business in our international regions. Subsequent to the quarter, we –continued our international expansion in Latin America with our acquisition of Inquiro Vitae in Argentina, enabling us to extend our in-country background screening services to small and medium businesses. HireRight customers and employees in Argentina will benefit from faster identity checks, local fulfillment of verifications through direct connections to local data sources and commercial vendor-to-vendor screening services. Turning to our technology initiatives; we continue to make measured progress in line with the broader macroeconomic environment. We are expanding our development team in India as we continue to further our automation efforts while leveraging leading cloud-based technologies.

Our focus remains on precision first and foremost, while simultaneously improving speed and innovation. In closing, we are pleased with our results given the backdrop of the broader macroeconomic environment. Unlike previous downturns, which have had an identifiable catalyst, this cycle continues to be unique with as many positive as negative signals. While always maintaining financial discipline, we are focused on our key initiatives that include growing gross margins, upselling and expanding packages to existing clients, adding new global logos and enhancing our technology stack with the objective of delivering thorough and accurate searches to help our customers reduce risk. The underlying demand for talent remains very strong and the underlying drivers of increased hiring velocity are here for the long term.

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 first quarter financial performance and our outlook for the remainder of the year. Tom?

Tom Spaeth: Thank you, Guy. Good afternoon, everyone, and thank you for joining our call today. As Guy mentioned, our first quarter revenue was $175 million, down 12% versus the prior year. The demand environment has been consistent with our views going into the year as well as those underlying our annual guidance. First quarter revenue also includes a $1.1 million negative impact from foreign currency. As Guy noted, our technology vertical saw the steepest decline at 42%, and our services vertical declined 22%. Some of our leading services customers, our large technology-oriented BPOs or professional service firms that have significant exposure to the same underlying labor dynamics as our technology customers. As for our other verticals, healthcare and transportation were up slightly year-over-year, and the remaining verticals were down a combined 5% year-over-year.

Our core four verticals of healthcare, technology, transportation and financial services now represent approximately 54% of total revenue and were down slightly from prior year. Revenue from new customers added over the past year contributed nearly $10 million to the quarter, and revenue from existing customers, excluding new and lost customers, was down 12%. Looking at our geographic split, international revenue based on applicant location was approximately 14% of total revenue. EMEA after adjusting for the $1 million currency impact was down approximately 8% versus the prior year. APAC and India continue to be impacted by the softness in technology, and were down a combined 24% from the prior year. Gross margins, defined as revenue less cost of service and excluding depreciation and amortization, improved 50 basis points versus Q1 2022 to 44%.

When further adjusting for restructuring charges, the year-over-year improvement was more than 120 basis points. Although down when compared to Q4, this is consistent with our historical seasonality and our expectations. We expect to grow these margins in a similar trajectory as 2022 and are confident that our team’s attention to rightsizing our domestic and offshore labor mix, flexing variable labor, increasing automation and vendor cost management is in line with our plan. First quarter adjusted EBITDA margin declined to 18.8%, primarily attributable to the lower operating leverage from declining revenue. To address the operating leverage issue, we have embarked on a restructuring plan targeted at reducing operating expenses, which includes a reduction in global SG&A positions, offshoring and outsourcing certain nonstrategic functions, further streamlining our real estate footprint and pulling back on certain discretionary costs.

These targeted actions will begin to show benefit in our overall 2023 results beginning in the current quarter. Taking these actions like other organizations are doing allows us to drive better bottom line margins resulting from our improvements in gross margin. In addition to these actions, we continue to flex and rebalance our direct labor, increase our focus on data cost reductions and continue to see incremental benefits from our automation initiatives. Our overall focus on continued cost optimization and efficiency is in support of achieving our long-term EBITDA margin goals of 30%. Digging deeper into SG&A expenses in the quarter, excluding stock-based compensation and restructuring charges, employee costs increased 5% or $1.3 million, driven in part by hiring and technology and go-to-market positions as well as higher health care costs.

Other non-restructuring related operating expenses were up $1.4 million, driven primarily by third-party technology costs. Adjusted net income for the quarter was $13.5 million compared to $29.8 million in Q1 2022. The reduction of $16.3 million was driven by lower operating profits and a $4.8 million increase in interest expense. Finally, adjusted diluted EPS for the quarter was $0.18 compared to $0.37 a year prior. Interest expense increased from $7.6 million to $12.4 million, driven by higher interest rates on our floating rate debt. Free cash flow for the quarter was down $3.1 million compared to the prior year period, largely driven by higher interest payments. Historically, Q1 results in a use of cash as we prepare for a stronger Q2 and Q3.

At the end of the quarter, we had no draws against the revolver and had $697 million outstanding on our first lien loan. Our leverage ratio ended the quarter at 3.2x and we also ended the quarter with $127 million of unrestricted cash on the balance sheet compared to $162 million as of December 31, 2022. The primary use of cash during the quarter stems from our previously announced share repurchase program. For the quarter ended March 31, 2023, the company repurchased over 2.3 million shares of common stock for approximately $26 million. We will continue to evaluate our cash allocation options and monitor market conditions with respect to the repurchase program. We remain confident in our business prospects and our ability to generate ongoing positive cash flow, and we believe we have sufficient liquidity to operate and grow the business while maximizing shareholder value.

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 has historically been our seasonally lower quarters, with Q2 and Q3 being stronger and in line with each other. Our Q1 results exceeded our expectations and support our annual guidance. With this in mind, we are reiterating our full year guidance for 2023 of revenue in the 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, 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.

Operator: [Operator Instructions] Our first questions come from the line of George Tong with Goldman Sachs.

Operator: Our next questions come from the line of Andrew Nicholas with William Blair.

Q&A Session

Operator: Our next questions come from the line of Kyle Peterson with Needham.

Operator: Our next questions come from the line of Mark Marcon with Baird.

Operator: Our next questions come from the line of Andrew Jeffrey with Truist Securities.

Operator: Our next questions come from the line of Jason Celino with KeyBanc Capital Markets.

Operator: Our next questions come from the line of Stephanie Moore with Jefferies.

Operator: There are no further questions at this time. I would now like to hand the call back over to Guy Abramo for any closing remarks.

Guy Abramo: All right. Thanks, operator. Appreciate it, and thank you, everyone, for joining the call today. As you gathered from the call and in fact, the current earnings season, the macro environment continues to dominate and impact our investment decisions, including hiring those of our clients. Our management team continues to be focused on managing up in cross-sells, internal and data costs and, of course, customer retention, all activities that we can influence through great execution. And while we’re making good progress on our automation and other margin expansion initiatives. And while we are confident in our ability to deliver results, we’ll continue to monitor the greater macroeconomic environment and customer activity and respond accordingly to focus on driving profitability.

So we look forward to keeping you posted as we move through the next three quarters. And as always, please don’t hesitate to reach out to us with any questions. Thanks again, and enjoy your evening.

Operator: Thank you. This does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.