Q2 2023 Sterling Check Corp Earnings Call

August 8, 2023

Yeah.

Good morning, and welcome to the styling second quarter 2023 earnings call. My name is Carla and I Hope you deal for a tough today's call. If you would like to register a question for the Q&A portion of the call. Please press star followed by one on your telephone keypad when asking your question. Please ensure your telephone.

It's Amit it lately.

I have a quick question you compress stocks went up by two I would now like to pass the conference over to ice Judah cycle Senior Vice President of Finance to begin. Please go ahead when you're ready.

Thank you operator welcome to the Sterling second quarter 2023 earnings call. Joining me today are Josh Perez, Chief Executive Officer of Sterling, and Peter Walker, Chief Financial Officer of Sterling.

Slides, we will reference during this presentation can be accessed on Sterling <unk> Investor Relations website under news and events.

The slides have been posted to our website and a replay will be made available on the website. After prepared remarks, we will open the call to questions.

Before we discuss our results I encourage all listeners to review the legal notice on slide two which explains the risks of forward looking statements and the use of non-GAAP financial measures. Additionally, please refer to our most recent Form 10-K, and 10-Q filed with the Securities and Exchange Commission for a discussion of risk factors that could cause actual results to differ materially.

From the forward looking statements.

Our slide presentation and discussions on this call will include certain non-GAAP financial measure.

Such measures reconciliations to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued this morning, I'll now turn the call over to Josh for Ed.

Thank you Judah good morning, and thank you for joining us.

Sterling second quarter of 2023 with another quarter of successful execution towards our long term strategy in 'twenty two 'twenty three focus areas results were at or above our prior expectations and I am very proud of the team's accomplishments.

The macro environment recently slowed during the second half of June and July and we have narrowed our full year expectations to reflect that slow down.

Even in the face of this macro softness our clients continue to hire at a rapid pace and are increasingly relying on us to help them keep their employees safe, while hiring faster and smarter.

Our unique focus on product innovation technological excellence in client service differentiate us. Moreover, our global scale and capabilities are attracting more new clients, who seek a global player capable of handling complex screening programs with compliance and quality worldwide.

As a result, we are succeeding in the areas. We can control while also building a stronger foundation for the future.

Turning to our highlights of the quarter on slide four in.

In Q2, we delivered revenues of approximately $190 million in line with our expectations as we continue to see success in the organic revenue drivers in our control.

This quarter our results included growth of 10% year over year from the combination of new clients and increased client spend through upsell and cross sell.

Our Q2, adjusted EBITDA margin exceeded our expectations and was fueled by the progress we have made on our cost optimization efforts. We expect these strategic initiatives centered around focused automation efficiency and process reengineering to result in a stronger more scalable.

And more profitable company for the long term.

We are well on track to achieve our cost savings target of $10 million in 2023 and $25 million of annualized savings.

We also saw continued momentum this quarter with global adoption of our newer and differentiated solutions identity verification and post hire monitoring, which I will touch on shortly.

Overall, our passion for client service innovation and operational excellence is evident and I could not be prouder of the Sterling team as we took significant steps forward in Q2 toward achieving our goals.

Turning now to slide five which summarizes our long term strategy in 2023 goals in recent earnings calls we shared our company's long term goal of becoming the world's most trusted background and identity services company differentiated by our deep market expertise unrivaled client service.

Best in class, Canada, and seamless workflows.

This strategic framework directly fueled our 2023 focus areas with concrete near term goals.

Specifically, we are focused this year on doubling down on the organic revenue drivers we can control.

Our identity verification and post hire monitoring solutions op.

<unk>, our cost profile and M&A.

In the second quarter, we saw a positive result on each of these four areas.

Starting with organic revenue on slide six we continue to be a global leader in background screening and identity services due to our deep market expertise robust cloud platforms and exceptional client service.

In Q2, we again delivered on our commitment to drive high impact innovation and elevated client experiences within our core offering.

We have many milestones to highlight from the past few months. These include the significant enhancements we've made to our recently released fully integrated Sterling monitoring solution.

And the upcoming release of our Sterling I nine virtual inspection capabilities enabled by our partnership with IDB.

We've also launched several new enhanced features that provide strong improvements to client experiences, including our new sub report functionality and new drug and health capabilities.

Both of these allow clients more flexibility and convenient method to manage their program.

Our continued focus on innovation has enabled us to enhance our revenue regardless of the macro environment.

During the second quarter, we continued to gain market share through new client wins and increased client spend on newer and higher margin solutions, such as identity verification and post hire.

We have also seen an increase in the number of new and expanded client rfps.

Prospects and existing clients are attracted to our differentiated solution and are using the current environment to evaluate consolidation with scale providers possessing an increased scope of services.

Our success is spanning all regions of the world as well as.

As we have seen continued success, winning new clients and growing through upsell cross sell in our international region. This includes our new Latin America region, where our improved capabilities. Following the acquisition of Socrates are better positioning us to win more multinational deals.

Looking ahead to the back half of 2023, we expect to see improved year over year performance, particularly in the fourth quarter from the combination of several factors.

First we expect new business to improve through the second half based on deals coming online.

In the first half of this year, we've seen better win rates and have closed more business and new logo and upsell cross sell opportunities than a year ago.

Third we have a very strong opportunity pipeline, including larger and more advanced stage deals when compared to last year.

These factors help underpin our belief that results will strengthen in coming quarters, notwithstanding the uncertain macro.

Turning now to slide seven our continued investment into identity and post hire products are bending our trajectory with fast growing and higher margin solutions.

These products are meant our culture of innovation are clear competitive differentiators and significantly increase our addressable market.

We are thrilled to see our continued investments paying off.

Administrated by the identity and post hire solutions, representing more than 10% of our revenue for the second quarter in a row and increasingly being included in client packages.

In fact during the first half of 2023 nearly half of all new deals. We won in the U S included identity as part of the package.

Even with this recent success the penetration rate of digital identity within our existing client base remains very low suggesting that the runway for additional growth is very robust.

In Q2, we also extended our industry, leading identity position through the release of our new exclusive verification workflow with Jody.

Sterling EOD partnership expand Sterling digital identity capabilities into the EMEA and Asia Pacific region.

By exclusively enabling the verification process at the beginning of a background check the new solution decreases turnaround time by approximately 80% improved completion rate and delivers more accurate screening results.

In the U S. We were thrilled to recently extend our exclusive partnership with IDB through 2028 building on our proven success. This extension will allow us to continue to drive innovation and adoption of identity verification solutions.

In that spirit, we were very pleased to recently unveiled the upcoming launch of a new virtual I nine document review service.

For more than 35 years, the form I nine process has remained largely unchanged and burdensome with in person verification requirement.

Now in partnership with IDB Sterling can offer a secure compliant and convenient alternative virtual inspection option via <unk> trusted referee video chat.

Shifting to post higher on the right side of the slide demand continues to grow for our subscription based monitoring solution, which tracks among other things criminal arrest and conviction Records motor vehicle Registry records licensing and credential and social media.

We continue to re imagine monitoring and in Q2, we announced new capabilities that help clients to effortlessly manage and scale their post hire monitoring in our client hub.

We're optimistic about our consistent progress to streamline and simplify the post hire experience, which has traditionally involved a more limited fragmented experience with multiple providers.

Moving on to slide eight we shared in our first quarter earnings call that we are focused on driving long term meaningful cost savings and efficiency gains.

Over the course of 2023 and 2024, we are executing on a comprehensive cost optimization program aimed at building a more scalable and effective and profitable company now and into the future.

Our cost initiatives fall into three key pillars.

One reducing our cost of revenue through a focus on labor and data costs too.

To decreasing our facility costs by leaning even more into our virtual first strategy and three reducing SG&A costs by streamlining our organization and enhancing functional alignment.

I am happy to share that Q2 was another quarter of strong execution against that goal.

We implemented several new initiatives driving efficiency in automation, the closure or downsizing of several facilities.

And the continuation of actions to streamline functional alignment with go to market strategy.

We expect that initiatives already implemented will drive the vast majority of the projected $10 million of savings during 2023.

On a run rate basis.

Equates to over two thirds of our $25 million annualized target, giving us confidence we will achieve our goal.

We are very excited about the opportunities we are under a thing to drive further process improvements, including increased automation and the use of generative AI.

We believe generative AI can be leveraged to improve the client and candidate experience internal productivity and client and candidate care teams engineering and other internal areas.

We have identified exciting opportunities to leverage AI in various parts of our fulfillment business already some of which include enhancing our criminal reporting processes.

And creating intelligent data extraction capabilities.

Once complete all of these initiatives are expected to bring our total annualized savings to our $25 million goal.

The final 2023 goal I will discuss is M&A shown here on slide nine during.

During the first quarter, we made two strategic acquisitions, Socrates NHS and started on deal integration to drive cost synergies and geographic expansion benefit.

In the second quarter of 2023, we continued that journey with strong execution against our integration timelines, including on track migration of client facing and fulfillment platforms.

We expect to complete integration by the end of 2023 for Socrates and the end of second quarter 2024 for HVAC.

As part of these integrations, we are leveraging and refining the M&A playbook, we developed for our 2021 <unk> acquisition, giving us increased confidence in potential future deals due to our ability to integrate cultures operation and performance goals effectively and efficiently.

Our integration efforts are driving meaningful financial benefits as of Q2, our year to date inorganic revenue from the two acquisitions has been performing ahead pre deal expectation and we remain on track to realize our cost synergies as planned.

In particular, the Socrates integration is offering substantial benefit to multinational and local Latin American clients.

In conclusion, I am proud of what we accomplished this quarter and excited for the opportunities in front of us.

While cyclical hiring trends will come and go the long term health of this industry and our business is exciting.

Moreover, we believe we are well on track to achieving our 2023 goals and realizing the vision of our long term strategy.

We look forward to continuing to update you on our progress in the second half of the year with that I will hand, it over to Peter Walker, our CFO to take you through our financial results Peter.

Thank you Josh and good morning, everyone, turning now to an overview of our financial performance starting with revenues on slide 11.

During the second quarter of 2023, we reported revenue of approximately $190 million, a 7% decline compared to the second quarter of 2022 on a reported basis and a 10% decline on an organic constant currency basis.

The second quarter included 320 basis point contribution from M&A, partially offset by 50 basis points drag due to foreign currency translation.

These results were in line with the expectations. We provided on our May earnings call as our team continues to execute on our 2023 goals.

We are seeing consistent success in the areas of our business most within our control including growth from new clients and cross sell upsell alongside strong revenue retention rates, our momentum in winning market share and expanding wallet share with clients can help offset the unpredictability of base growth over time.

Let me provide some detail on our revenue drivers in <unk>.

We saw growth from new clients or approximately 5% in line with our expectations.

Notably new client revenue dollars increase sequentially from <unk> to Q.

Consistent with what Josh shared about our strong opportunity pipeline, we expect new client growth to return to our 7% to 8% target range by end of the year.

Second we realized solid growth from upsell cross sell of 5%.

At the top of our long term target range and a strong sequential revenue dollar increase from <unk> to <unk>.

Adoption has been strong for services, we provide to our identity partnerships and we continue to expand our unique global capabilities through innovative new solutions.

We view identity verification as a significant opportunity to expand our addressable market and revenue growth along with accretive margins and it's exciting to see our investment coming to fruition.

Third our LTM client retention was 95% also within our long term target range as we continue to focus on client service excellence and enhancing client and candidate experiences.

These results from the revenue drivers in our control were offset by base business declines caused by continued macroeconomic uncertainty it's worth noting that our base revenues improve from <unk> to <unk>, while the year over year rates are being impacted by year over year comps this quarter, we lapped.

Particularly strong <unk> 2022, during which we reported a company record quarterly revenues of $206 million as well as a strong 23% growth rate.

Moreover, our current industry hiring volumes remained strong relative to history and are down year over year, only when measured against 2020 two's record levels.

Looking further back Q2, 2023 revenues grew at a 10% CAGR over the past four years since 2019, demonstrating the strong secular growth we've delivered through this cycle.

Looking at revenues by region, our U S business is down 7% year over year in the second quarter within the U S. We have a diversified in attractive vertical.

She has been instrumental in supporting our compelling revenue growth in recent years and the second quarter. Our U S performance was led by our health care vertical which continues to grow year over year, we saw softness in some other verticals, including tech media and staffing.

Revenue in our international business was down 10% in the quarter, including a three point drag due to foreign currency translation similar to the U S H volume.

Lines offset good trends and revenue drivers we control our international business is benefiting from a consistent trend of clients looking to consolidate globally to a single scalable provider <unk>.

International results were led by the EMEA region, which saw year over year growth driven by robust new client wins.

In the second quarter, we delivered three 2% of inorganic revenue growth from Socrates in HVAC. The two acquisitions. We closed in Q1 of this year, we continue to be pleased with both companies' results matching or exceeding our initial expectations.

As Josh described our integration work is tracking well to deliver on the upside potential from these deals, including the attractive geographic expansion capabilities presented by Socrates.

The robust synergy potential in HVAC. Our continued success in integration gives us increased confidence to execute on additional M&A in the future when synergistic targets become available at the right valuation.

Turning to slide 12, our second quarter, adjusted EBITDA was $50 million, an 11% decline compared to last year due to the base revenue decline. We were pleased that our adjusted EBIT margins. This quarter were 26, 3% ahead of the expectations that we communicated in our May earnings call.

This outperformance is driven by continued progress on our cost optimization initiatives and financial discipline.

As Josh described earlier, we have several cost initiatives underway, which are aimed at driving meaningful cost savings and efficiency gains. These programs will be executed over 2023 and 2024. When complete we are targeting an annualized cost savings of $25 million and expect to see in year savings of 10 million.

In 2023.

We plan for these initiatives to drive permanent reductions in our cost profile and position the company to scale efficiently and profitably over the long term.

One of the cost savings initiatives on our 2023 roadmap is the closure and downsizing of facilities as part of our virtual first strategy.

In the second quarter, we executed on seven such closures or downsizings, resulting in impairment charges and accelerated rent expense $9 million, which are added back for purposes of adjusted EBITDA.

Through the first half of 2023, we are pleased with the progress we've made on cost optimization initiatives and we'll continue to keep laser focused on execution.

In the second quarter of 2023, we had adjusted net income of $26 million or 28 cents per diluted share representing a year over year decline in adjusted EPS of 15%. This.

This year over year decline was primarily driven by the decline in adjusted EBITDA with a lower tax rate, partially offset by higher interest expense.

Turning to slide 13 free cash flow year to date was approximately $24 million, a 6% increase from the prior year period.

The drivers of the increase include an improvement in cash flow from our interest rate hedging program and lower <unk> spend partially offset by higher interest payments. We remain very focused on free cash flow and are pleased that our free cash flow conversion of adjusted EBITDA over the past 12 months has been 45%.

Solidly within our annual target.

Our net leverage at quarter end, the two four times net debt to adjusted EBITDA at the lower end of our two to three times target.

Year to date, we've spent $49 million of net cash on our two acquisitions and $25 million on share repurchases, including $17 million during the second quarter.

Our net leverage remains at an attractive level and is poised to continue declining and what has fallen below two <unk> without a M&A or buyback activity.

We ended the quarter with total debt of 502 million cash and cash equivalents of $49 million and $195 million available under our credit facility.

<unk> is with ample capacity to execute our growth strategy of reinvesting in organic revenue growth and pursuing M&A. This year. We have also enhanced our capital structure through the implementation of an interest rate hedging program, which takes approximately 60% of our floating rate debt.

Our capital allocation priorities remain investing in organic revenue growth pursuing M&A and maintaining a healthy balance sheet. This includes opportunistic share buybacks under our previously announced share repurchase program. These priorities hold true in a lower growth environment as we see macro uncertainty is opportune.

Time to build the foundation for future success.

On Slide 14, we show our updated guidance for 2023 for 2023, we expect to generate revenues of $760 $780 million representing year over year change of minus one to positive 1% adjust.

Adjusted EBITDA of $198 million to $208 million, representing year over year growth of theory of 5% and adjusted net income of $106 million to $114 million representing year over year growth of zero to 7%.

Our revenue guidance range includes full year organic constant currency revenue change of minus three to minus one 5% as we discussed earlier, we continue to see solid growth in items within our control, including new client wins and upsell cross sell.

That said these items are being offset by base revenue declines as Josh shared we've seen softness in base revenue in the back half of June and in July and as a result, we have tightened the ranges for 2023 revenue adjusted EBITDA and adjusted net income guidance to better reflect that toughness.

Our implied second half revenue guide shows marked improvement over the first half of 2023 and year every year. This improvement is being driven by robust new revenue coming online over the back half from new clients and upsell cross sell as well as easing year over year comps.

A significant amount of revenue from new clients that have gone live are expected to go live in the coming months. We also have a stronger pipeline of advanced opportunities and seeing better win rates compared to last year.

Looking at the revenue cadence by quarter, we expect year over year declines in Q3 total reported revenues that are narrower in Q2, 7% decline in Q4, we expect to see substantial improvement, including double digit year over year growth in total reported revenues as more business come.

Online and we lap far easier year over year comps.

Included in our total reported revenue guidance to 5% to 3% of inorganic revenue growth from our two M&A deals. We are also assuming no impact from foreign currency in line with previous assumptions.

Turning to profitability, our 2023 guidance includes adjusted EBITDA growth.

Zero to 5%.

<unk> margins over the back half of 2023 to improve from the first half as our revenue trends improve the benefits from our cost actions.

And year over year margin comps ease Q3's margin will likely be similar to Q2's margin of 26, 3%. While we expect substantial improvement in Q4 were more new business has gone live and year over year comps eased.

Finally, turning to our adjusted net income guidance zero to 7%, we expect a similar cadence to reported revenue and margin.

We are benefiting this year from reduced DNA, which should drive growth to the bottom line in excess of our adjusted EBIT growth. We're encouraged by the leverage in our financial model driving adjusted EBITDA growth. During 2023 ahead of our revenue growth and driving adjusted net income growth ahead of adjusted EBIT crowd to further.

Help with your modeling we have included a page in the appendix with our updated assumptions for 2023, and a detailed breakdown of our revenue guidance.

In closing we are reaffirming our long term targets on slide 15 over the long term, we are targeting 9% to 11% organic revenue growth level with margins expanding to 29% to 32% plus adjusted net income growth of 15% to 20% per year, even in the absence of robust revenue growth this year.

Here, we expect 2023 to be a healthy step towards achieving our profitability targets.

That concludes our prepared remarks at this time operator, please open the line for questions.

Thank you if you would like to ask a question you may do so by pressing star followed by one on your telephone keypad.

Your question. Please press star one if I take one for paying for your question. Please ensure you're fine is Amit here lately.

Our first question comes from Mark Marcon from that your line is now eight <unk>. Please go ahead.

Good morning, Thanks for the for the update really encouraging too.

To hear about the margins and the <unk>.

Second half Im wondering with regards to the second half guidance.

You did see a little bit of a decline with regards to the base growth in June and July what are you assuming in terms of the base.

For the second half of the year, and how would that base level compare to say.

2018 2019 type.

Levels.

Is it is it higher or lower and then I have a couple of follow ups.

Hey, Mark it's Josh good morning, and thanks for the question. So let me just start by.

Saying that I think first of all we have seen August so far it's early but be a little bit better than what we saw in June and July more inline with what we had been seeing in kind of the April may timeframe.

But as we thought about our guidance for the year going back to when we first set it we shared that we had set a pretty wide range relative to prior years because of the uncertainty in the macro so as we saw June and July have a slight change in the base. So it wasn't huge.

<unk> numbers, but it was a little bit lighter than we had expected.

Caused us to really just gravitate towards that lower part of our previously set range. It was one of the scenarios, we had foreseen in setting guidance and so we're assuming that the macro we've seen kind of in June July continues more or less through the year in terms of the guide that we've set now.

Hey, good morning can weigh market Amir I would just add that we did see base revenue grow Q1 to Q2, it's just the year over year comp in Q2, given Q2's record quarter is driving the base.

Negative level reported.

Great.

Then with regards to the.

The pipeline you mentioned.

That particularly for Q4 it looks like.

There are some rfps that are looking really good.

And that those are larger deals.

Essentially include.

More modules or more screens and more solutions.

I'm wondering can you talk a little bit about.

What's the source of those clients or are they domestic or international.

Are they coming from.

The other big players or is it part of the consolidation that's occurring across the.

The industry.

Hey, Mark It's Josh Let me go first and then if Peter wants to add so I think first of all what we're counting on for the remainder of the year is is deals that are largely already signed and locked and loaded I think our commentary on the pipeline. We do have some that we would expect to get at it as well, but that's really more.

More of thinking forward into next year, where we're comfortable and I think as we've shared on previous calls we do expect our new business to return to our long term target of 7% to 8% by the end of the year. We continue to expect that based on the pipeline and the signed deals that are already there as well as the deals that are already billing so.

We're very encouraged by the trends, we're seeing there as well as on the cross sell and upsell, which we should mention is at the high end of our range for Q2, even in.

The uncertain macro and even with what we saw in June late June on the cross sell upsell, we're doing a really good job really proud of the teams and being able to do more with those accounts and I mentioned that because when you talk about is this consolidation of who are winning from.

Win from all competitors really all around the world, we do see though more and more consolidation in our existing clients, who are looking to use the time to consolidate vendors and that's benefiting us and that cross sell and up sell space because we're displacing people who are doing a little piece of the work and we're able to bring.

That answer we're excited and I should say I Didnt answer. Your first question on kind of trends before Covid. I think you mentioned kind of 2018 to 2019 in terms of base.

And revenues in general and I think what we would say is.

In dollars our revenues are really strong this year relative to before Covid. They are also really strong frankly relative to 2021, which had been a record year. So it really is the comps to 2022 that is driving most of the base growth decline that youre seeing if not all of it. So we are incurred.

<unk> by the trends and we do feel like we've got good guidance here for the rest of the year.

That's terrific Josh Peter Thanks.

Thanks, Mark Thanks, Mark.

Thanks, Bob Our next question comes from Andrew Nicholas from William Black Andrew. Your line is now open. Please go ahead.

Yes.

Thank you and good morning, I wanted to ask about just the vertical level stabilization it seems like.

Peter from your comments tack media staffing had some weakness in the quarter, but.

Healthcare was strong year over year, just wondering if you could make any any comments on kind of how you expect the vertical level cadence to kind of.

Progress as we move through the year or any signs at that level of stabilization because it does look like from what I'm.

The math I'm doing that Youre expecting now a sequential uptick in dollars of revenues third quarter to fourth quarter. So just wondering outside of new business. If there's any other areas at the vertical level that that's giving you that conviction.

Yes sure I appreciate the question good morning, Andrew So as we shared in our prepared remarks were really excited that healthcare continued to grow year over year in the quarter and by EMEA performance growing year over year in the quarter.

In terms of go forward guidance, we don't provide that at the vertical level, but as you mentioned, we did provide that we expect the Q3 year over year decline on a total reported revenue basis to narrow from 7% in Q2 and we expect.

A substantial acceleration in terms of Q4 growth. This year over Q4 of last year, and that's driven by our confidence in our new client wins are cross sell upsell and easing year over year comps.

Understood. Thank you and then for my follow up I wanted to hone in on post hire specifically I know over the past several quarters and really ever since <unk> been public you've talked pretty.

Hi.

Pretty strongly about about identity, but post higher is there anything specific to call out there in terms of of adoption rates are there regions or verticals, where youre seeing strength there in particular or any other color would be great. Thank you.

Hey, Andrew its Josh Thanks for the question I think that we haven't shared specific information broken out on the monitoring what we did share that the combination of identity and monitoring cross that 10% threshold in Q1 crossed it again in Q2, we're pleased to see that progress with these newer solution.

<unk> that are more adjacent to our core business historically.

I think that what we shared though previously on monitoring is that we have in our view found a way to have a more subscription based offering that give us more certainty of price to our clients as well as us.

And that allows us to actually push that product.

In a way that we think competitively differentiates us and is starting to gain traction with clients in areas, where that's something that's important to them and so we're seeing that momentum gain in addition to what we've shared previously on things like licensing and motor vehicle monitoring those other areas that are not be criminal.

Monitoring area those have been strong and continued to be strong and there are things that clients in certain segments. Just absolutely have to do so if you're in health care. For example, you have to be monitoring whether people continue to have their licenses or else. You can you can get into really bad trouble and I think the last thing I would note, which is actually on your.

Your previous question, where you talked about the sort of growth in raw dollars that we're expecting through the year. It is actually consistent with what we've seen where growth from Q4 to Q1 to Q2 in raw dollars throughout is consistent with what we would've expected to see from a seasonality perspective again muted relative to 2022.

But if you kind of look at the first half of this year versus 2021 from a CAGR perspective, we're performing at the top of our long term range over that two year period, and even stronger if you go back to 2019. So again this is a year, where given the strength of last year. Some of the softness this year at the fed and other.

Banks are trying to cool off a job market. We're very proud of how we're performing where other than last year. It continues to be very very high. That's why we mentioned, we're still seeing strong hiring volumes from our clients and more clients. It's just really relative to last year.

And then maybe just the other point on identity and post higher right as we March towards our adjusted EBITDA long term market margin targets of 29% to 32, plus identity and post hire is accretive to our gross margin on the pre hire business.

Makes sense. Thank you.

Yes.

Thanks, Sanjay our next question comes from Toni Kaplan from Morgan Stanley Tony Your line is now open. Please go ahead.

Thanks very much wanted.

Wanted to dive into the second half ramp I think you highlighted some new deals that are coming online I guess, maybe how much visibility do you have into those deals actually starting in second quarter second half and in other words I guess, how conservative is that bottom end.

The revenue guidance.

Hey, Tony It's Josh Thanks for the question I think first we do have good visibility into what we're counting on for the second half again, assuming the macro consistent with kind of what we've seen in June July so.

That's really the bigger question I think we're confident in what we're seeing from the new and the cross sell upsell in terms of visibility on a number of these bigger deals I'm, having direct conversations myself with the clients to understand their their plans for the year and we feel good about where we've set the guidance at this point.

Terrific and earlier in the year I think you were seeing some integrations being pushed out is that still taking place.

And just does that impact timing at all in.

In terms of of you know.

Deals coming online.

Yeah, Hey, Tony Thanks, now we've seen more of a normalization of the Onboarding again.

What we have seen before was really clients, telling us we're going live here and then pushing it we haven't seen that behavior since.

Q4 changes that we had mentioned.

And just a reminder, Tony right in terms of absolute dollars. We saw an increase in absolute dollars from new clients and revenue Q1 to Q2 and increase in absolute dollars Q1 to Q2 and cross sell upsell.

Really proud obviously the cross sell upsell was at 5% at the high end of the range new.

New business at 5% New business is being muted by what's happening in the macro so if it wasn't for the macro we would've expected new business to be closer to the lower end of the seven to eight range in the second quarter.

Terrific. Thanks, a lot.

Thanks, Tony.

Thanks, Tony Our next question comes from Karl Peterson from Needham <unk> Co. Your line is now open. Please go ahead.

Great. Thanks, guys.

Good morning wanted to touch a little bit on some of the slower base growth that you guys called out in <unk>.

The latter part of June and in July .

Is there any more specific color, whether it's been concentrated in any specific verticals or geographies or even kind of sub sections of pyramid anymore color there would be really helpful.

Hey, good morning, yes, so we saw the.

Reduced space.

Really in the last half of June continue in July and then as Josh shared overall revenues, we've seen a pickup in August that was broad based in terms of where we saw the base declines.

It's very consistent with what you've heard from others like Equifax, Robert half et cetera, whether it's an anomaly a lot of people on vacation et cetera.

Or something else, obviously lots of thoughts out there on that I think what we are pleased about again, we have seen August more in the range of what we would expect for total revenue.

Okay.

That's helpful. And then I know you guys kind of touched on better win rates.

First happened this year just wanted to see are you guys, having better win rates specifically against maybe some of the smaller mom and pop or Midmarket players more against some of the larger competitors or are these improved win rates just across the board in terms of what you guys are seeing in the first half of the year.

Okay.

Thanks for the question I think you know what.

I would say is first of all we consider ourselves a very strong competitor. We think the offering we provide is best in class. That's our goal. We believe we are delivering on that we believe we have the most comprehensive set of services. We believe that we have the best technology, we believe being in the cloud differentiates us that we're able to release enhancements and new code and constantly.

Innovating.

We are at the front end so things like we just mentioned the enhancements we've made to <unk> for virtual remote inspection and that is something that we are the only player out there that said that so far and so we think we tend to really be at the forefront in our clients recognize that as do prospects and so when we get the opportunity to go.

Go and talk about the cross sell upsell opportunity or talk about a new business win it doesn't really matter who were competing with we feel like we have competitive advantages against everyone and we feel like we take advantage of those and we win those and that's why we do think that we have.

Best New business win rates that are out there I think that.

Our view is that the market for services in the background and identity spaces is very strong we think that the industry is poised as the macro does ultimately shift back to really grow in a very strong way, we think theres a lot of addressable market, we think people need our services more and more.

So we think that it's a strong industry. There is a strong case for being.

Very long on the background checks and identity services industries. We also think we're the best player in that industry. So we think both things are true and we are winning deals really from competitors of all sizes in all geographies, there's nothing to call out in terms of specifically this or that is more likely.

Got it that's very helpful. Thanks, guys.

Thanks, Scott Thanks, Kyle.

Next question comes from George Tong from Goldman Sachs. Your line is now open. Please go ahead.

Alright, thanks, good morning.

New customer growth and cross sell upsell have continued to mitigate base volume business declines can you elaborate on some of the product and sales initiatives you have to drive sustained.

Performance with new customer growth and cross sell upsell and then also discuss assumptions around new customer growth and cross sell upsell in the second half of the year. That's reflected in your guide are you assuming stable performance from <unk>.

Improved performance relative to two two.

Hey, George.

Thanks for the questions I think first.

Take the second part of your question first and then maybe talk about the things that are driving it and the way we're doing it but I think.

As we've shared previously our long term goal on cross sell and upsell is four to five we're happy that we've been in that range. Both first quarter on second quarter at the high end in the second quarter. We would expect to continue performing in line with our long term target on cross sell up sell through the year. So we're not calling out a specific jump there on new business we have been.

Clear I think since the beginning of the year that we expect by the end of the year to a return to our long term target of 7% to 8%. So our view is obviously that would imply an improvement we haven't broken that out in Q3 Q4 for you, but we do expect that to get back to the 7% by the end of the year, which is what we've previously shared in.

Terms of how we go about selling I think theres.

A number of things that we do and it starts with the very very basic point that you have to have a product people are going to want and when we get an opportunity to demo the experience that clients will have on our tool if they're not currently a client.

That tends to be something that in and of itself opens the door for them to want to work with us because they want to use that tool relative to what they are using today from one of our competitors and that really puts us on great footing I think the second thing is <unk>.

Right now as clients are looking to control costs themselves. They really wanted to have a provider that they can consolidate around so that they can save money by not having multiple providers when they could have one that's benefiting us because of the wide range of services that we can offer that others can't and that helps us both in a cross sell upsell world, where spirit, where our clients consolidate.

Dating around what they do and we're one of their providers today, we're likely to get more and when someone is looking for a new provider, even if theyre not looking for all the services at once they want to know what's available to them if and when they choose to make that change and then the next thing I would say as you know I'll put myself team up against.

Any sales team in this business, we think that we've got really strong sellers, they understand sterling's products and what we do but more importantly, they specialize in the industries. They are supporting they really understand the client needs to a very detailed level and when a client asks a question or says hey can we do this it's something we'd likely seen.

Or done before with other clients and our tools are flexible enough to allow them to do that without us having to go build a whole customer that customized system for them. So we think that those things really do add up and then the final piece I will say is we think identity is winning a lot of business for US right now and as I mentioned in my prepared remarks, having <unk>.

Most 50% of all new deals in the first half of this year include identity.

Is a great trend for us and it really sets us up to now go hunt in existing clients because they should be doing it too and we're starting we're having really strong conversations with them about it. It's obviously easier when you are in the context of an RFP with a contract to add that service, but now we're taking what we've learned and we're able to use the experiences of these new clients.

To go after the base and helped US drive so that we really do believe is a significant differentiator for us in new business and cross sell and up sell.

Got it that's very helpful context.

And then with respect to margins Youre continuing to expect margin expansion for the full year. Despite lack of revenue growth because of your cost optimization plans can you talk a little bit about some of the remaining initiatives you have around cost optimization in the second half of the year and heading into 2024.

Hey, George Good morning, It's Peter Yeah happy to talk about that so as we've.

Discussed really there's three pillars to our cost optimization program. The first is our work in our product fillman areas and optimizing the global process there.

<unk> is our virtual first model closing or reducing facility sizes and then the third is our functions. So we expect to deliver $10 million of in year saves from all three of these in 2023 and a phase for the majority to come through in the back half of the year of.

Saves generating that $10 million Thats, an $18 million run rate on those saves and then in totality. We expect the program to deliver a $25 million run rate with the other things that we currently have in process developing.

So when we think about the rest of the year and margins right. As we've guided Q3, we expect to come into a similar margin of Q2, which was a beat at $26. Three and then we expect margins to further expand in Q4 as revenues increase from new business Cross sell upsell and we're lapping easing.

Comps and we have additional savings delivered during that quarter, bringing us to the full year guidance, we shared for adjusted EBITDA at the midpoint of $203 million.

Got it very helpful. Thank you.

Thanks, Joe Our next question comes from Scott <unk> from Wolfe Research.

Your line is now open. Please go ahead.

Okay.

Thanks, Good morning, guys. Thanks for taking my questions. Maybe first on the you talked about on the margin profile for identity and post hire verification being higher I'm just wondering what the drivers of that or is it because maybe there were clients are upselling to your already there on the implementation side, so theres lower costs or are there any other drivers there that is.

Producing a higher margin profile on those products.

Hey, Scott Good morning, it's Josh So I think if you if you think about those products in.

In the case of the identity solutions.

Use the U S. As an example, we're working with I D me they have a database they have the records were accessing it.

The deal has been structured as a revenue share, which we have previously.

<unk> provided to you, but that's really the extent of our costs, we're not having to go pull things from multiple places we know exactly what is there and that is higher margin theres not a lot of SG&A for us to support that because it's a product that we're leveraging through the partnership that we have now renewed through 2028.

The monitoring.

Our solution is also much more consistently checking databases and historical things versus in the context of a normal background check where we may need to go check courthouses. Those are gonna have pass through fees in the case of a verification, we're going to need to probably go to equifax to the work number and that's going to have a pretty hefty fee.

In the case of drug and health screening, we're gonna have lab services that are going to be a big chunk of the revenue. So when you think about the profile of the core products that we offer those are very much based on us doing the right work for the client getting the best answer and in order to do that the data sources that we go.

To access the vendors that we have to use half costs that as we've shared before equate to roughly 80% of our cost of revenues and in the case of the identity offerings with IDB annuity as well as our monitoring solution. They don't have that level of underlying cost associated with them.

And they don't have the same SG&A for our team to have to go do all this work researching information that we gather to make sure that it's accurate before we deliver it because we're able to access things that have been cultivated and managed more on an ongoing basis.

Got it that's Super helpful. And then maybe just as a follow up going back to the trends by verticals. I mean, you called out the strength in health care and talked about a little bit of softness in tech media and staffing just wondering if you can maybe give a little bit more color on some of the other verticals, whether it's financial services transportation and industrials.

Also would be helpful.

Yeah happy to so yes, as we as I shared in prepared remarks health care, we're quite pleased with continuing year over year growth. It's obviously been a strategic vertical for us and EMEA with continuing year over year growth in the quarter Tech media, we saw softness staffing we saw softness in there.

I'd say the rest of the verticals in terms of performance.

The base growth impact that we saw kind of end of June was pretty much uniform across the rest of the verticals in the U S and internationally.

Okay. That's helpful. Thanks, guys.

Thanks.

Thanks Scott.

Thanks, Scott as a reminder, if you'd like to ask a question. Please press star followed by one on your telephone keypad.

Next question comes from Shlomo Rosenbaum from Stifle. Your line is now open. Please go ahead.

Hi, This is Adam on for Shlomo.

Hiring at any products now over 10% of revenue consistent with first quarter.

This growth expected as growth expected to accelerate further in that area or is growth in this area. We're steady as it has been while the prescreen business has been shrinking.

Yeah.

Oh, Hey, Adam it's Josh Thanks for the question I think what I would start with is we've been seeing our identity and monitoring solutions have strong growth really since 2019 and as we've added new features and new functions and come out with better products like we did with the partnership with <unk> like we did with <unk>.

The work that we've done to have a subscription based monitoring solution that we now have in market, we've seen that growth accelerated we'd shared some figures about that on our Q4 call and additionally on our Q1 call.

So we expect those to continue to grow I think your question, which is the mix question like do we expect them to grow as a percentage of revenue over time, we do and we've certainly said that.

Obviously in our view, we want to see our background check revenues also grow.

And once that is happening we will expect to see the post hire and the identity solutions. Once we get to a normalized growth rate those should grow faster than the rest of the business and become a bigger piece of the pie and we're pleased that we're at that point already I would note, particularly on the on the identity side you know those are generally orders.

That are being combined with her background and experience. So I think part of the point that that Peter with making if you look at our.

Our <unk>.

Base revenues and you think about the decline that we saw there in the quarter and then you think about our new business in our cross sell and upsell business. Those also are muted from what we would expect those clients to be doing in a different macro. So we're pleased with where we are.

Based on the fact that.

We think that overall ordering has been muted and nonetheless, we're delivering at the high end of our cross sell upsell target and.

<unk> amount of new business and again growth in new business in raw dollars from Q4 to Q1 to Q2, which is what we'd like to see.

Okay. Thanks.

Yeah.

Thanks, Sam I, we have no further questions. So with that we can now conclude the call.

Okay.

Thank you all for joining you may now disconnect your lines.

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Good morning, and welcome to the styling second quarter 2023 earnings call. My name is Carla and I will be the operator today's call. If you would like to register a question for the Q&A portion of the call. Please press star followed by one on your telephone keypad when asking your question. Please ensure your telephone.

It's Amit.

Joe If I ask a question you can press star one if I <unk> I would now like to pass the conference over to our Hey, Judah cycle Senior Vice President of Finance to begin. Please go ahead when you're ready.

Thank you operator, welcome to Sterling second quarter 2023 earnings call. Joining me today are Josh Perez, Chief Executive Officer of Sterling, and Peter Walker, Chief Financial Officer of Sterling.

Slides, we will reference during this presentation can be accessed on Sterling <unk> Investor Relations website under news <unk> events.

The slides have been posted to our website and a replay will be made available on the website. After our prepared remarks, we will open the call to questions.

These forward looking statements.

Our slide presentation and discussions on this call will include certain non-GAAP financial measures.

<unk> measures reconciliations to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued this morning, I'll now turn the call over to Josh for Ed.

Thank you Judah good morning, and thank you for joining us.

Sterling second quarter of 2023 was another quarter of successful execution towards our long term strategy in 2023 focus areas results were at or above our prior expectations and I am very proud of the team's accomplishments.

The macro environment recently slowed during the second half of June and July and we have narrowed our full year expectations to reflect that slowdown.

Even in the face of this macro softness our clients continue to hire at a rapid pace and are increasingly relying on us to help them keep their employees safe, while hiring faster and smarter.

As a result, we are succeeding in the areas. We can control while also building a stronger foundation for the future.

Turning to our highlights of the quarter on slide four in.

In Q2, we delivered revenues of approximately $190 million in line with our expectations as we continue to see success in the organic revenue drivers in our control.

This quarter our results included growth of 10% year over year from the combination of new clients and increased client spend through upsell and cross sell.

And more profitable company for the long term.

We are well on track to achieve our cost savings target of $10 million in 2023, and $25 million of annualized savings and.

We also saw continued momentum this quarter with global adoption of our newer and differentiated solutions identity verification and post hire monitoring, which I will touch on shortly.

Best in class Canada.

Seamless workflows.

This strategic framework directly fueled our 2023 focus areas with concrete near term goal.

Specifically, we are focused this year on doubling down on the organic revenue drivers we can control.

Kelly, our identity verification and post hire monitoring solutions.

Optimizing our cost profile and M&A.

In the second quarter, we saw positive results on each of these four areas.

Q2, we again delivered on our commitment to drive high impact innovation and elevated client experiences within our core offering.

We have many milestones to highlight from the past few months. These include the significant enhancements we've made to our recently released fully integrated Sterling monitoring solution.

And the upcoming release of our Sterling I nine virtual inspection capabilities enabled by our partnership with IDB.

We've also launched several new enhanced features that provide strong improvements to client experiences, including our new sub report functionality and new drug and health capabilities.

Both of these allow clients more flexibility and convenient method to manage their program.

Our continued focus on innovation has enabled us to enhance our revenue regardless of the macro environment.

During the second quarter, we continued to gain market share through new client wins and increased client spend on newer and higher margin solutions, such as identity verification and post hire.

We have also seen an increase in the number of new and expanded client RFP.

Prospects and existing clients are attracted to our differentiated solutions and are using the current environment to evaluate consolidation with scale providers.

<unk> an increased scope of services.

Our success is spanning all regions of the world as well.

As we have seen continued success, winning new clients and growing through upsell cross sell in our international regions.

This includes our new Latin America region, where our improved capabilities. Following the acquisition of Socrates are better positioning us to win more multinational deals.

Looking ahead to the back half of 2023, we expect to see improved year over year performance, particularly in the fourth quarter from a combination of several factors.

First we expect new business to improve through the second half based on deals coming online.

Second in the first half of this year, we've seen better win rates and have closed more business and new logo and upsell cross sell opportunities than a year ago.

Third we have a very strong opportunity pipeline, including larger and more advanced stage deals when compared to last year.

These factors help underpin our belief that results will strengthen in coming quarters, notwithstanding the uncertain macro.

Turning now to slide seven our continued investment into identity and post hire products are bending our trajectory with fast growing and higher margin solutions.

These products are meant our culture of innovation are clear competitive differentiators and significantly increase our addressable market.

We are thrilled to see our continued investments paying off.

Demonstrated by the identity and post hire solutions, representing more than 10% of our revenue for the second quarter in a row and increasingly being included in client packages.

In fact during the first half of 2023 nearly half of all new deals. We won in the U S included identity as part of the package.

Even with this recent success the penetration rate of digital identity within our existing client base remained very low suggesting that the runway for additional growth is very robust.

In Q2, we also extended our industry, leading identity position through the release of our new exclusive verification workflow with Sidoti.

Sterling Yoda partnership expands Sterling digital identity capabilities into the EMEA and Asia Pacific regions.

By exclusively enabling the verification process at the beginning of a background check the new solution decreases turnaround time by approximately 80% improves completion rate and delivers more accurate screening results.

In that spirit, we were very pleased to recently unveiled the upcoming launch of a new virtual <unk> document review service.

For more than 35 years, the form I nine process has remained largely unchanged and burdensome with in person verification requirement.

Now in partnership with IDB Sterling can offer a secure compliant and convenient alternative virtual inspection option via IDB its trusted referee video chat.

We continue to re imagine monitoring and in Q2, we announced new capabilities that help clients to effortlessly manage and scale their post hire monitoring in our client hub.

We're optimistic about our consistent progress to streamline and simplify the post hire experience, which has traditionally involved a more limited fragment that experience with multiple providers.

Moving on to slide eight we shared in our first quarter earnings call that we are focused on driving long term meaningful cost savings and efficiency gains.

Over the course of 2023 and 2024, we are executing on a comprehensive cost optimization program aimed at building a more scalable and effective and profitable company now and into the future.

Our cost initiatives fall into three key pillars.

One reducing our cost of revenue through a focus on labor and data costs too.

To decreasing our facility costs by leaning even more into our virtual first strategy and three reducing SG&A costs by streamlining our organization and enhancing functional alignment.

I am happy to share that Q2 was another quarter of strong execution against that goal.

We implemented several new initiatives driving efficiency in automation, the closure or downsizing of several facilities.

And the continuation of actions to streamline functional alignment with go to market strategy.

We expect that initiatives already implemented will drive the vast majority of the projected $10 million of savings during 2023.

On a run rate basis. This equates to over two thirds of our $25 million annualized target, giving us confidence we will achieve our goal.

We are very excited about the opportunities we are under a thing to drive further process improvements, including increased automation and the use of generative AI.

We believe generative AI can be leveraged to improve the client and candidate experience internal productivity and client and candidate care teams engineering and other internal areas.

We have identified exciting opportunities to leverage AI in various parts of our fulfillment business already.

Some of which include enhancing our criminal reporting processes, and creating intelligent data extraction capabilities.

Once complete all of these initiatives are expected to bring our total annualized savings to our $25 million goal.

The final 2023 goal I will discuss is M&A shown here on slide nine.