Morning, everybody, and thank you for joining. My name is Shlomo Rosenbaum. I'm the business services analyst here at Stifel, and I wanna welcome you all, welcome you all to Stifel's 2024 Cross-Sector Insight Conference. With me today is David Gamse, who's the CFO of First Advantage. First Advantage is a background screener. I wanna welcome you, and thank you for joining us. I thought we would just kinda start it out, just take a minute and just give the intro. You know, what is the main things that go into a background screen, and how does First Advantage get paid? And then we'll kinda jump into the Q&A.
Okay, glad to do it. So background screen's a little more complicated than it sounds. There are a lot of elements that can be included in a background screen or not. The most common element of any background screen is a criminal background check. Within a criminal background check, you can do 1 name or multiple names. You can do 3 years, 5 years, 7 years. You can do city, county, state, FBI. You can do sex offender. You can do global sanctions. As part of a background check, you can do employment verification, education, Social Security number, DMV. You can do drug screening. You can do fingerprinting. So there are a lot of different elements that go into it, and you, as the client, have to make the determination of what that package looks like.
Very good. So thank you. So one of the, the business, very much, it's a transactional business, and, there's four elements to, two kind of the story, right? You have, existing client growth, you have, new logos, you have, cross-sell and up-sell, and then you have attrition. And what's been happening recently with the hiring environment is that we saw the base growth has actually been negative, and that's been challenging the revenue over the last year or so. But in the last quarter, the company talked a little bit about the staffing vertical turning barely positive. And usually, I look at staffing as a leading indicator in either direction, either upwards or downwards. So I want to ask you, like, what, what are you looking at over here?
Does it look like things have kind of bottomed and we should—or is it just like, you know, hey, things kind of move around, up and down? How are you viewing that?
Well, there clearly are some green shoots that we're looking at. Staffing did turn positive for one quarter. We're not sure that's a trend just yet, but it is a positive indicator. Healthcare continues to be positive. Transportation continues to be positive. Retail went a little soft in the first quarter. Financial services and professional and business services are still struggling a little bit, but not as badly as they were 12 and 18 months ago. Internationally, we think India has bottomed. We've seen the same volumes now for about the past four or five months, so we're encouraged by that. APAC, still a little bit soft, driven by financial service companies, but that's maybe a quarter or two away from bottoming, but it's pretty close. So we're cautiously optimistic.
Having said that, we do think base is gonna continue to be negative for the balance of the year, but improving sequentially, quarter by quarter.
Can you talk about, you know, with the cyclical changes that we've been through over the last, say, 12-15 months or so, what happened to the other three elements that were not base? Maybe you could talk about what happened to the business in terms of new logos, cross-sell, and attrition. How did those fare during the time?
So we feel really good about that. We're controlling what we can control. So if you look at new logo, it averages 4, 5, 6% growth every single quarter, every single year. And you can go back to 2020, 2021, same thing, 4, 5, 6% growth, quarter in, quarter out. Same with up-sell, cross-sell, 4, 5, 6% every single quarter, every single year. Attrition runs between 3% and 4%. We've been running towards the lower end of that at 3%, so we feel really good about that. So if you think about that, you got 10% positive growth on new logo, up-sell, cross-sell, minus 3 from attrition, you're at plus 7, just to start with, and then you have to deal with base growth. Historically, base growth has averaged 2%-4%.
For the last 18 months, it has been negative, but it'll come back, and when it does, you're gonna see some pretty good growth numbers.
When do the easy comps start, or when do the tougher comps end? Put it that way. Is it the fourth quarter of this year, or what would you say?
The fourth quarter for sure, a little bit in the third quarter. So sequentially, you will start to see it get a little bit easier with comps.
Great, thank you. I would say the biggest, you know, up until the very end of February, beginning of March, the macro part was the biggest discussion in the story for First Advantage. And then, all of a sudden, this other element crept in, and had to do with your pending acquisition of Sterling that was announced. And maybe you could just give us, you know, your high-level thoughts about why you're so excited about that acquisition.
So the Sterling acquisition makes sense for so many reasons, but let's talk deal rationale to start with. First of all, we think First Advantage and Sterling are the two best employment background screening companies in the world. So that's a great place to start. You're starting from a position of strength. They focus primarily in verticals that are salaried workers, white collar. We're primarily 70% of our business is blue collar, hourly employees. So it's a great complement to one another from a vertical perspective. From a large client perspective, we've only done some amount of diligence that we're allowed to do, but based on what we've done so far, there is zero overlap of our major customers. So we feel really, really good about that. Then you look about seasonality.
First Advantage has seasonality with an October, November peak, particularly with retail and transportation. Sterling doesn't have that. So putting the two companies together, you're going to smooth out that seasonality, you're going to have diversification with your verticals. Your client concentration, which Sterling had very little of, but First Advantage had one 10% client, that now becomes 5%. It had a handful of other 4% and 5% clients that are now 2%. So great diversification, risk play there as well. And if you look geographically, and you put their map on top of us, it's like a perfect fit. They're a little bit stronger in LATAM, a little bit better, stronger in Australia. We're deeper in India and in Hong Kong and Singapore, but the fits are just really good. So, we think it makes a lot of sense.
Plus, we're buying it at a very good valuation at a very good time. Those talks have been ongoing for several years, but we could never get there on valuation. We finally got there at a point where we think it's a fair value to everyone, but base has been negative, as you alluded to before, for the last six quarters. Well, we didn't pay for that. So when the economy turns and when the base comes back, we're going to get that bump from not just First Advantage, but Sterling, and we didn't have to pay for it. So we feel really good about that.
That sounds good. And you talked about about $50 million in anticipated cost synergies. And could you talk about how you expect those to materialize over that 18-24 months that you talked about? And, you know, are there... You know, just from the ground up, what are you looking at to get there? And then what would be, what's- what would be upside that's not included in there, that's, that, that might be something that you, you could think about?
Well, so we said at least $50 million, and we're pretty confident about that number, and we actually think it's a pretty conservative number, and I'll tell you why. But let me answer the first part of your question. There's some low-hanging fruit, right? Rarely have you seen a deal done with two public companies. Well, when you eliminate public company overlapping costs, that's about $4 million right away. Then, if you look at their insurance programs and you combine the two insurance programs, that's about a $3 million save. So you've got $7 million without having done anything. Then, if you look at all of the back-office functions between accounting, finance, HR, legal, we'll certainly combine all of those operations. From a sales force perspective, we'll combine the sales force.
You don't need 100% of both sales forces 'cause you're calling on the same clients to a large extent, so you'll see savings from that. So we think it's going to be pretty easy to go get that $50 million. We're more highly automated than Sterling. We have our own proprietary database that we hope the Sterling clients will be able to utilize. And then the other way that we looked at it was, last year, First Advantage did $44 million in revenues greater than Sterling, but they had 900 more FTEs. Well, we're more efficient, we're more productive, and we think we can bring that to the table and go get that really quickly. From a long-term perspective, the first thing we're going to do technology-wise is point their front-end system towards their back-end system.
But we're going to leave their front-end platform in place 'cause we don't want this to be disruptive to their clients. Where other companies in our sector have failed in the M&A market is by forcing their clients onto a new platform, because it takes time, effort, resources, money, and the clients don't want to be disrupted. So we're not going to do that. And if the clients like their customer success team that's in place, we're going to keep them, and we're going to bring them over. We're going to be $1.5 billion in revenue, $500 million in EBITDA. We need good people, so we're going to keep them in place, and we're going to make it as painless as possible to all of our clients.
Great, and that's on the cost side. When I think about putting these companies together, how do you think about the revenue synergy potential?
So there's revenue synergy opportunity, clearly. We did not bake that into our model because we also did not bake in any significant customer attrition beyond historical rates. So we figured any attrition that did occur would be offset by revenue synergies. There are clearly revenue synergies. So we could bring to Sterling our I9 product, our WOTC product, our Fleet products. Sterling, they have a little bit of a head start on their digital identity product in the U.S. We're a little bit ahead of them in the U.K. We've recently introduced it in India and Australia. We think that's a huge opportunity. We can bring that to our client base. So there are clearly some revenue synergy opportunities, but that's all upside.
Do you think the clients are going to look at you in a better light? I mean, you're viewed anyway as a top-tier provider, but by combining the two companies, does that improve the standing in the clients' eyes in your view?
So it's interesting. We, we've went and talked to every one of our major enterprise clients when the transaction was announced, and let's say we talked to 25, 30 of them, for example. It was a non-event to most of them. They're like: "Look, just don't cause any problems with my business. As long as it's business as usual for me, we're good. Congratulations. It makes all the sense in the world." Where we have greater concern, and we want to focus that attention, are on the Sterling client base, because they're in this limbo period before the deal gets done. But we want to assure them that we are not going to do anything that's going to be disruptive to them, that we're going to leave their platform in place, we're going to leave their team in place, and that it won't be disruptive at all.
We think we have the right formula.
Now, how concerned are you about the message getting to the Sterling clients? Because my experience in dealing with M&A in general and, you know, from my discussions with people in the industry, and background screening in particular, is the biggest risk in M&A is clients that would attrit. Do you feel like that message is going to get through? How comfortable are you about that in terms of, of working with, you know, there's a limited amount you can do from the Sterling client base because you're, you're the FA side.
Well, every opportunity we get to say that we're going to leave the Sterling platform in place and be not disruptive to their client base, we say it, and we're going to do that. We have asked Sterling to deliver the same message. We think that's the critical message. We think that's the game changer, and that's what nobody else did. The reason nobody else did that in the industry is they needed to combine platforms to hit their synergy number to rationalize the valuation. We didn't have to do that, and that's not in our $50 million synergy number.
That's very important, is the fact that you have the latitude to leave those platforms alone. That's basically-
Absolutely.
Okay. And, and culturally, how do you feel about the fit between the two companies?
So culture's really, really important. I was at an integration meeting with the two companies in New York yesterday, and that was the very first topic that we covered, was company culture. And to Scott Staples' credit, our CEO, he is great at corporate culture. He has instilled a fantastic culture at First Advantage. I've learned a lot from him in that process, and I think he'll do that with the entire organization. And that's so important to Scott and to the company that it will be a priority. It is a work stream, and it's something that's going to get a lot of attention. Now, what you have, fortunately, are two very high-performance cultures. We think it's the two best companies in the industry, two really high-performing teams, and they're very motivated employee bases. We think we'll keep it that way.
Okay, good. And then, just on the sales force, I mean, are people compensated the same way, or do you not that level of detail yet in terms of the integration? Because sales is obviously key in retaining the appropriate salespeople.
Right. We're not allowed to have any conversations yet around compensation.
Okay.
So we haven't been able to look at that. Obviously, from competing in the marketplace, we know they have a good competitive sales force. In fact, if you look at their first quarter numbers and their new logo sales and the upsell, cross-sell, they delivered 11% growth in Q1. They beat us by 1%. So they're doing something right, that's for sure, and they are a formidable competitor. So that's something we'll address long term, but clearly, they have a very dynamic sales force that's producing results.
Sounds good. I have a lot of questions here, but I want to make sure that I'm opening it up to the audience. If anyone wants to ask any questions, just signal, raise your hand. Can't see that far from the back, so that kind of winking and stuff that people do in bidding doesn't really work here. But if anyone wants to ask anything, feel free to just kind of raise your hand, and we'll call on you. Okay, then I'll just continue. What... Can you talk a little bit about what changes do you make in your business when the macro environment gets worse and then when it gets better? Like, talk about the flexibility of the cost base, how you run it, what you do with different shifts, and operationally, maybe explain to the investors how you're able to flex.
Okay, that's a really important point, and we think we've done a really nice job of that over the last three years. So even when our base turned negative, we continued to grow EBITDA and EBITDA margins. And how did we do that? Well, let's start at the top and kind of work our way down. Take our cost of sales. 72% of cost of sales are third-party costs. So if we don't do a search, we don't pay a penny. We don't incur any of that 72%. So that is 100% variable. The rest of cost of sales is operations and customer care. So we monitor that very closely to match FTEs with volume. And you can't—it's not always one for one, but we can run five days a week, six days, seven days.
We can run two shifts or three shifts, and we can flex up with overtime, and we do that. So, when the pandemic hit in second quarter of 2020, we furloughed 850 people for about four months. We brought them all back. We grew in 2020. There are a lot of levers that we can pull. We cannot backfill open positions. We have investments. We said earlier in our last earnings call that we have $17 million of new investments baked into our 2024 budget. If the economy were to turn, we could pull back or slow down on some of those investments. So there are a lot of different things like that, but we look at costs all of the time. It's not a project when something bad happens.
We do it as in the ordinary course of our business.
... Great, and along those lines, maybe you could talk a little bit about how inflation impacted you guys over the last few years? Like, where does it impact your company, and, and what are you seeing from that right now?
Well, let's talk about inflation and interest rates together because they're, they're so correlated at this point. So when inflation comes down or moderates further, there will be an interest rate cut. We don't know when that's gonna happen. I guess right now, I think there will be one in Q4. We think our clients are anxiously awaiting that event. Once the certainty takes place that there will be an interest rate cut, then we think hiring will pick up. We think clients will start to make new investment. If you look at over the last 18 months, clients have been managing costs, they've been managing their budgets, but they've not been making new investment, and we wanna see more expansion, more investment. They have the cash, but they're waiting for more certainty around inflation moderating and an interest rate cut.
So they go hand in hand. Again, we're cautiously optimistic that there will be an interest rate cut in the fourth quarter. We think that could be a good catalyst for growth. From an inflationary perspective, last year, yeah, wages were going up. People were quitting jobs. They were getting paid more. It was tougher to retain people. That's not the case today. Employee churn is way down over the last six months. Employee wage increases and merit increases are way down from wherever they were last year and the year before that. Vendors, they did pass on price increases in 2022 and 2023. We're not, outside of the Work Number. We're not seeing that from anybody else anymore. So, we think all of that has moderated and gotten back into a good place.
Once you touched on The Work Number, maybe we could just talk about that a little bit. That's one thing where when they raise the prices, that reverberates through the industry. So The Work Number, right, it's verification of employment and income. And so, can you talk a little bit about the database that you guys are building in order to try and manage some of the costs for your clients and help them with that cost?
So we didn't sit around and wait. We saw this coming, and we started building out a database called Verified, utilizing SmartHub technology, and we started doing that in 2019. Since that time, we've gotten a significant rate increase from The Work Number, Equifax, every single year. Ridiculously high increases. And I don't know if you saw it, but recently there was a class action lawsuit brought against The Work Number last week by two financial service firms for unfair practices in that area. We saw that coming, so we built out our own proprietary database. It now has 110 million records in it. That's the first place we go. No one else in the industry has it. If we can't get information there, we go to other sources of information, like Experian or Plaid or True.
We can do it manually if they don't have it, or we will utilize The Work Number. They do have the largest and best database in the marketplace. But our total cost to provide that service is less than anyone else in the industry because of the automation, because of the algorithm that we've built in through our SmartHub technology. And our clients love that, and they love the fact that we're not held captive by Equifax, and that they're not having to eat those huge price increases every year.
And how does it work? I mean, is there a certain percentage that you're able to help the clients with in a given year, and does that kinda creep up every year?
Well, as you add more records... And by the way, we're very excited to get Sterling's data because we have confirmed they do have a lot of data. We don't know the exact number yet. They're not currently utilizing it, so we'll have to take it, we'll have to clean it, we'll have to add it to our database, but that will just increase and enhance the size of that database. So we're very excited about that. And the more records you have, the greater number of hits you're going to have. So it will continue to be more advantageous to our clients.
Great. Can you talk a little bit about package density and whether that's going up or down? First, maybe explain to the investors what package density means in the industry, and why that's important to you and what the trends have been.
So package density really goes back to the first comments that we made when we started talking about what elements do you want to include in a background check? And criminal being the first and foremost, there are a lot of different dimensions to it. So what package density really is, is risk management. So clients wanna mitigate risk and have a safe work environment, and make sure they're hiring the right type of employee for their culture and for their company. They want a safe environment. So do you do a 3-year background check or a 5-year? 3 versus 5—sorry, 5 versus 3 is density. 7 versus 5 is density. Do you do John Smith or John R. Smith, or how about Johnny Smith? Or what about maiden name? All of those, we charge for.
Everyone is considered a different search because different databases have their names listed differently. Do you do it just in the city in which they live? What about where they used to live? What about where they work? What about the county they live in? What about the state?... You would think all these databases talk to one another and feed one another, but they do not. So it's the background screeners that have to know what database to go to, to get the best data, to get the most comprehensive search done, and that's where our expertise comes into play. But all of that is package density. We've seen that continue to occur in each of the last several years, and we think it still will, because risk management is now the top priority. It used to be speed.
Compliance is a given, but it was speed and turnaround time. That's now moderated somewhat, and it's risk management. We do an annual survey every year. That was the number one concern of all of our clients. We think that that trend will continue.
That's interesting. When did that switch? 'Cause I remember me looking at it, and speed was, like, the top thing for a little while. When did that switch to risk management?
Over the last 18 months. So the last two surveys have been risk management, but if you go back to second half of 2020, all of 2021, first half of 2022, it was all about turnaround time. Because if you weren't the quickest, if you couldn't complete that background screen, they couldn't put that person to work, and they were gonna lose them, and there was lack of available resources. Well, today, there are more people available for jobs. It's not as competitive. It's a little more methodical. So, it is now risk management has taken over from turnaround time on number one priority.
Okay. Historically, I mean, this has just been the way it is, First Advantage has had the highest margins in the industry. Maybe you could talk a little bit about why you think that is, and, you know, is there a ceiling in where they could go, and how should investors think about this? In other words, if you're merging these two companies together, you have greater scale. Is there a ceiling as to... for where, you know, where the EBITDA margin can go?
So let's start with your ceiling question. Well, let's be reasonable. Is there room for expansion? Absolutely. Do we think it can continue to grow? Absolutely. Right now, last year, we were at 31%. Can it grow into the mid-30s? Absolutely, it can, through more automation, through AI, through proprietary data, through synergies. Sure. Can it inch up beyond there 3-5 years out? Perhaps. Is it gonna go over 40%? Not likely, and the reason for that is all of the out-of-pocket costs that are part of a search, they depress your margin. If we were doing net revenues instead of gross revenues, we'd have 1,000 basis points higher, or 31% would be 41%. So when you're comparing it to a software company, you have to take that into consideration. But as far as the room for expansion, absolutely.
It's automation, it's AI, it's proprietary data, and we're focused on all of that right now. The first thing we're gonna go do is go get those synergies, and the synergies are gonna help a lot. Then we're gonna rationalize Sterling's margins and get them back, or get them up to where First Advantage is. That'll be a huge lift in and of itself. So there's just a lot of opportunity in a lot of different areas for margin expansion.
Great. Maybe as we're coming towards the end of the session here, you could talk a little bit about what First Advantage is doing in AI, and, is that something that's, customer-facing, internally-facing, both? What, what are you doing in that area?
So again, First Advantage was the first in the industry to adopt automation, and it started with bots, and that goes back to 2017. Then we introduced our SmartHub algorithm and our proprietary data in 2019, and that was utilizing machine learning. Then we introduced Click, Chat, Call into our call centers last April, so about 15 months ago, utilizing Salesforce AI. So not building our own, but utilizing what was already in the marketplace. When we brought that into place, we were able to eliminate about 200 FTEs and improve and enhance the quality of our service. So we're early adopters. We believe in that. It's proven time and time again. In our Profile Advantage, which is our front-end mobile app, we utilize AI already.
If you've ever done a background check with First Advantage, and you come back, we know you're back. We say, "Welcome back." We pre-populate data. We ask you questions to get current. And now we're looking at how can AI enhance the criminal background check on the criminal data side, and we're looking at different prototypes right now on how to utilize it in that capacity. So we're a believer, and we're gonna be leading edge there.
Very good. We have one question. We'll just take that question from the rep right before we close. ...
Well, we went after customer care, so that's really your call center, BPO type of operation. That was just under 20%, so pretty significant, meaningful number. Can it also be applied to the fulfillment side of the business? That's what we're looking into now. We think that's the next opportunity.
Great. Thank you very much. I want to thank everybody for joining in. David, thank you very much for being available for this presentation.
Shlomo, thank you.
Great.
Great. Thank you.