First Advantage Corp Q4 FY2023 Earnings Call

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. Please note, today's event is being recorded. It is now my pleasure to turn the call over to Stephanie Gorman. You may begin.

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.

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 footprints, 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.

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 a 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 the 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 one-time 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 one-time 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 one-time 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.

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 maximizing value for all stakeholders. With that, we will open the line for questions.

Thank you. Our first question is coming from Shlomo Rosenbaum of Stifel.

When you are merging two of the top three companies in the industry, I would like your thoughts on your interactions with the DOJ and the efforts you've made in that regard. I also have a follow-up question regarding the merger itself.

Yes, Shlomo, so I mean, first of all, I'll tell you, we've hired some great experts in the space who will guide us through the process. But let's keep coming back to the market on this, because this is a large $13 billion market, and we've always told you how fragmented it is. I mean there's lots of competitors of all sizes and shapes across the world. We think we got a great case, but we'll let the experts guide us through the process and we'll see where it takes us. But like I said, this is a very large but very fragmented market, lots of competitors.

Okay. In terms of the combination, you mentioned $50 million in synergies. Is that entirely from cost synergies? Can you elaborate on the practical aspects of merging the two companies and how you plan to boost organic revenue growth? Could you provide some specific examples? For instance, if one company has a customer, how could that lead to additional sales opportunities with that customer, and vice versa? Please share some real-world examples of why this combination is beneficial.

Yes. David, why don't you take the synergy part, and I'll take the second part of that.

Okay. So Shlomo, from a synergy perspective, the $50 million, at least $50 million, that is from a cost perspective basis. We think there is upside relative to revenue synergies from a cross-sell perspective, and Scott can give you some specific examples relative to that. We think we can get that $50 million in 18 months to 24 months. Some of it is very low-hanging and we're going to go get right away.

Yes, to address your question about cross-selling, I believe it's part of a larger topic you're bringing up. One aspect we appreciate is the overlap in verticals. As mentioned in our script, Sterling's main verticals, including healthcare, financial services, and commercial services, align well with our own significant verticals like transportation, retail, and e-commerce. This alignment is exciting because it means our strengths in different areas correspond nicely. We now have access to a much larger customer base of 80,000 clients. We believe that our I-9 and WOTC products can be marketed to Sterling's customers, while their digital identity solutions can be offered to our clients. However, we are still in the early stages, and we need to strategize further, but we see promising opportunities ahead based on what I've outlined.

We'll take our next question from Ashish Sabadra of RBC Capital Markets.

Just wanted to drill down further on the cost synergy front. I think there was a reference to a reduction in third-party costs. I was wondering if you could provide any more clarity on that front? And then also during the last question, there was a reference to certain low-hanging fruits. I was wondering can you provide color on that front as well?

So Ashish from a third-party data perspective, as you know, we have our Verified database, and we have our SmartHub technology that's AI-driven. And that allows us to use our own database and other sources for employment and education verification. Sterling does not currently have access to that database or to that technology. And we believe that we can help drive down costs once we can integrate them into that SmartHub technology. As far as low-hanging fruit, there are a lot of opportunities, right? We're only going to need one audit. We're only going to need one set of tax returns. We're going to consolidate our insurance programs. You eliminate one complete public company cost scenario. So there are a lot of really easy costs we can go after really quickly.

That's very helpful color. And as we look out to 2024, thanks for providing some good commentary on trends by quarter. I was just wondering if you could also provide some color by end markets or verticals, where are you seeing better hiring strength versus verticals which are still weak in '24?

Yes, Ashish, not much has changed here. It's been similar to what we've seen over the past year, with strong performance in the transportation and home delivery sectors. Retail and e-commerce have remained relatively flat for us. However, it’s important to note that our retail and e-commerce presence is primarily among large discount retailers and online sellers, which still enjoy strong demand for their products and services due to inflation and related factors. Throughout the year, sectors like staffing and financial services have experienced declines and continue to do so. The healthcare sector, however, has performed exceptionally well for us this year, especially in the last couple of quarters. Overall, our results and guidance reflect a consistent outlook, and we anticipate more of the same from these sectors, at least for the first three quarters.

We'll take our next question from Andrew Steinerman of JPMorgan.

I wanted to ask about SmartHub and the identification of third-party costs that you mentioned first. You listed it before operational efficiencies. Is the reduction of third-party costs, which I understand is typically passed on to the customer, a greater savings for FA compared to the operational savings across your products? Also, regarding SmartHub, is it up to the customer whether they choose to use SmartHub for your verifications?

Yes, it would technically be up to the customer, but I can't recall any customer who doesn’t want to use it. Think of it as a router; it's an excellent piece of technology with built-in algorithms that we have developed over four to five years. It incorporates AI-driven technology and interacts with the algorithms. Ultimately, it provides our customers with options for finding data based on their criteria. I can't think of a customer who doesn't use it. What we really offer is multiple data sources, including our own, which continues to expand every quarter and month. With the acquisition of Sterling, we will also be able to access their data, which they aren't currently leveraging. While we can't quantify that just yet since we haven't analyzed the specifics of those records, we are optimistic about how we can utilize this in the future.

Scott, the other part of my question was, you listed the reduction of third-party cost before efficiencies in operations and products and technology and SG&A. Like are you saying the reduction of third-party cost in that $50 million target savings is going to be bigger than the efficiencies that follow in that list?

I don't believe it will be larger; it's simply a matter of how it was presented. I think we will gain much more from efficiencies. As David pointed out, there are overlapping tax, insurance, and similar costs. Therefore, I don't think it's a larger figure; it's just the way it was expressed.

We'll take our next question from Manav Patnaik of Barclays.

I was hoping just to touch on base growth. I know you gave us some directional color for the year, but just I was hoping you might be able to quantify what you're assuming for '24, just because it sounds like for both you guys and Sterling, the base growth got worse than what you guys kept guiding to. So I was just curious if that was changes in the large customers that I know you talk to regularly or was it the tail end that kind of came short of what you expected?

So base growth, consolidated base growth was down 13% in Q4, which was greater than we anticipated. As a result of that, we're taking a pretty conservative posture to it. If you look at the midpoint of our guidance for 2024, we're projecting base to be down a little over 5% for the full year. But it's more in the 9% to 13% negative range in Q1 and then improving sequentially from there. But again, down about 5% for the full year.

Can you discuss the current pricing trends? I understand it's not a significant factor in the algorithm, but does having a larger scale play a role in that?

Pricing in this industry has been very consistent and very stable. We've had no conversations with Sterling about pricing, nor will we until after closing.

We'll move next to Kyle Peterson of Needham & Company.

I wanted to discuss the balance sheet and capital allocation. Clearly, leverage is expected to increase with this transaction. How quickly do you think you can reduce the leverage on the balance sheet towards your target range, whether the macro environment remains stable or improves? Specifically, how do you plan to move from 4x to 2x or 3x?

So Kyle, after the closing, our main goals will be integration and reducing debt. We generate a significant amount of cash, as reflected in our numbers. Together, we had over $300 million in cash flow from operations. We plan to use that to lower our debt as quickly as we can.

Got it. That's helpful. And maybe just a follow-up in terms of some of the other competitive benefits after this deal. It seems like you guys will be kind of the clear #1 player in the screening space. I just wanted to see if you guys had some thoughts on whether it is kind of how you guys are going to go to market or the value prop of having more scale globally. Maybe just anything in terms of how you guys think it will influence the sales process or ability to kind of push the snowball down the hill on new logos and upsell, cross-sell.

I believe there are significant benefits for our customers. Sterling excels in certain areas, and we also have our strengths. When we combine our capabilities, it enhances the customer experience and allows us to launch top-notch products across our customer base. However, we are still in the early stages of this process, and there is a lot of planning ahead. So, it's difficult for me to provide a clear picture of what it will ultimately look like. But I want to emphasize that one of the main reasons for this deal is the complementary nature of our verticals. The sectors in which they are strong do not overlap with the sectors where we excel, creating a promising narrative for the market.

We'll take our next question from Heather Balsky of Bank of America.

I have another question regarding the acquisition. You mentioned the diversification in your customer mix. Could you elaborate on how that aligns with your long-term strategy? You've discussed your high-growth vertical strategy, which is driving significant growth. Once the companies merge, how do you plan to concentrate on higher growth verticals, particularly where Sterling shows strong potential? What proportion of your business will fall into that higher growth area? Additionally, are there any segments of your business or theirs that you might consider trimming to achieve the optimal growth profile?

Heather, I can address that by reflecting on our situation. We're still in the early stages, and we'll provide more insights into our go-to-market strategies over time. However, I don't believe there will be a need for pruning. Our approach of high-volume hiring corresponds to about 71% of our revenue, particularly across sectors like transportation, retail, and health care, even though our involvement in staffing and hospitality is minimal. If we look at Sterling, their health care vertical is performing strongly at 23%, alongside 18% in manufacturing and industrials. Our contribution from transportation is 24%, retail e-commerce is 22%, and health care accounts for 15%. With the integration of both organizations, some numbers will adjust, but their health care strategy aligns closely with ours, focusing on high-volume hiring. There's a strong complementary narrative between our verticals. As we move forward through the closing process, we will be able to share more about our go-to-market strategies, so we appreciate your patience. Yes, great question. So as we, again, talked to you guys about for literally all of 2023, international has been a drag on the business. And again, let's separate it too, because EMEA has actually done pretty well. So when we talk about international, we're really talking about India and APAC. And India and APAC have been down as David mentioned in his remarks. But I would tell you that starting in Q4 of 2023, we actually started to see stabilization in APAC and India. And obviously, we're hoping that, that continues. It's still early days on stabilization. But we think we hit bottom sometime in 2023, and now we're starting to see stabilization and maybe even slight improvement. It's still a bit early days to call it a trend. But again, I think we're starting to see India and APAC come back a little bit.

We'll take our next question from Scott Wurtzel of Wolfe Research.

Just wanted to go back to the synergy side, and appreciate the color on sort of what the low-hanging fruit is on the cost side. So just want to maybe touch on what on the cost side is maybe going to require the most work. And you also mentioned that revenue synergies aren't embedded in the $50 million. I'm just wondering also if there's anything on the cost side that isn't embedded in the $50 million of synergies.

We believe we can achieve at least $50 million in synergies over the next 18 to 24 months. In the long term, we see significant potential in merging fulfillment operations, implementing best practices, and refining our processes through AI. We are initiating a $3 million AI project focused on U.S. criminal data, which we hope will yield valuable results that enhance productivity and lower costs. Merging two companies presents numerous opportunities, and we will leverage best practices, utilizing our internal team of experts and seeking help from external advisors. We see a lot of potential for long-term gains, but our immediate focus will be on securing that initial $50 million.

Got you. That's helpful. And then just wondering, I think you just mentioned it in your answer, but just wondering if you can expand on what some of these incremental investments in AI could look like as you sort of realize the savings associated with the synergies?

Yes, Scott, let me jump in there. I mean, I don't think we want to give you too much information for competitive reasons on what these projects are about. But I will tell you, in general, we are looking at all aspects of the business of where we can leverage AI and not only how it improves the candidate and customer experience and the offering, but where it potentially also can reduce headcount. And I think we've mentioned to you in the past or to others in the past of where we've already rolled out AI in our call centers with our CLICK. CHAT. CALL. initiative that we announced a couple of quarters ago, which not only has improved our CSAT scores but has allowed us to reduce headcount because people are clicking and chatting with AI chatbots, but these are live AI chatbots and things like that, but less of the phone. So we think there's a similar type of story across fulfillment on the U.S. criminal side. But again, we're going to sort of keep the secret sauce on that to us, and we'll keep you posted as we actually roll out things.

Understood. Congrats on the deal.

We have a follow-up from Shlomo Rosenbaum of Stifel.

I want to chip a couple more in, if you don't mind. Scott, one of the critical areas in combining two companies that are background screeners is making sure you don't have a lot of client losses post the deal. And given the complexity of the integration of an acquisition that is close to your guys' size and all that's involved in that, how are you going to really minimize any client losses? And then I have a financial one for David.

That’s a great question, and it’s likely the most significant topic we’ve been discussing. I’ll provide a few high-level insights, but we’re still in the early stages and haven’t fully mapped everything out. First, we will have a dedicated integration team focused solely on this task, staffed with some of our best people. We’ll also involve third parties and seek advice from various experts. Historically, this industry has faced significant challenges not just in integrating operations or sales but primarily in technological integrations that encounter hurdles. I want to emphasize that we will adopt a very cautious approach to tech integration to reduce the risk of client loss. We won’t push large customers onto platforms or technologies they don’t prefer. At this moment, our strategy is theoretical and high-level, but we will begin refining it starting tomorrow. However, we need to wait until the deal closes before we can engage in any substantial planning or implementation. Overall, we are committed to a thoughtful approach to technology to avoid disrupting our customers.

Okay. And then just from the financial side, David, when I do the math using kind of end of year '23 numbers and you assume $50 million of synergies, I'm getting closer to 4.5x leverage. Is the difference the assumption of free cash flow from both companies for another two-plus quarters?

That's right. So it all comes down to timing. If it closes June 30, if it closes September 30, both companies throw off a significant amount of cash quarter-over-quarter. Plus there will be a minimum amount of cash on the balance sheet of at least $150 million, maybe up to $200 million at closing. So from a net leverage perspective, that will drive that down even further.

I see no further questions in the queue. I will now turn the call over to Mr. Staples for closing comments. Please go ahead.

Yes. Thank you, operator. And thank everyone for your time this morning and for your ongoing support. Take care.

Thank you. This concludes the First Advantage fourth quarter and full year 2023 earnings conference call and webcast. Thank you all for your participation. At this time, you may disconnect your line. Have a wonderful day.