I want to start with First Advantage recently closed its acquisition of Sterling Check, which essentially doubled the size of the firm that you run. When did the idea of acquiring Sterling first cross your mind, and what was the high-level thesis here?
Well, as I'm still struggling from the 30-plus years that you mentioned of my information services experience, I'm feeling old today. We actually had thought about this opportunity for probably a good 18-24 months. As we've been consistently telling investors, we think about M&A and M&A strategy all the time, and that strategy can evolve and move depending on what's going on in the market.
As we kept looking at Sterling, we kept liking more and more of what we saw. We started in earnest talking to them about 18 months ago. Very high level, very conceptual. Then, obviously, things got real about a year ago, and then we announced the deal on February 29th.
Excellent. And your high-level thesis behind the deal?
So as we started talking to Sterling, what became really clear and what made us really exciting about the deal was really the complementary vertical nature. As you know, we believe strongly in a vertical go-to-market. We feel that is the secret sauce of our company. And we're very strong in a handful of verticals.
And when we looked at Sterling, they were also very strong in verticals, but not necessarily any overlap verticals. In fact, they really only had one overlap vertical with us. And so we saw it as a way to immediately, sort of overnight, become strong or stronger in a number of verticals, particularly healthcare. They also had a pretty good gig story, bolster our transportation story, retail story, etc. So it was just really a nice fit vertically.
We feel that one of the really hot products in this space going forward is going to be all around digital identity and eliminating fraud in the recruiting and onboarding of talent. It really felt like Sterling and First Advantage were the only two companies out there really talking about it with really good products. We felt like technology-wise and product-wise, we were really aligned. We also felt culturally we were aligned to very high-performance cultures, and that makes integration a whole lot easier.
That's really great to hear. So one of the things that you've done as part of this acquisition is you now have a new sort of organizational reporting structure, if you will, with the general managers who report up to Joelle. Those are broken out by verticals, I believe, in the US and then by regions ex-US. And those now, they don't just oversee sales and product. They oversee the whole sort of soup to nuts, mini firms within a firm, if you will, it sounds like. Can you explain maybe why you decided to deepen that strategy and why post-combination was the time to deepen that?
Yeah, so in my mind, org structures are secondary to strategy. Your org structure is built to support your strategy, and what we saw in this industry was it maybe helps to do a little historical view of the industry, so if you go back in the background screening space 20, 30 years ago, it was really a BPO industry.
It was humans going to courthouses, pulling records, and literally faxing them to employers. That's obviously evolved over time, and I'd say about starting around 2010, it started to become more of a tech-enabled services industry, and then over the last, I'd say, about five-ish years, it's become really a tech industry. This is all about AI. It's all about APIs. It's all about robotic process automation. It's hitting its database to database.
And as you go through that tech and product transformation, it became really clear to us that the future of the company and the future of the industry is really being product-led. Obviously, we're selling compliance. We're selling safety. We're selling security. We're selling risk management. But at the same time, companies are looking for more high-tech products using AI and other technologies that will enable them to make sure they're eliminating fraud in their hiring process.
They're hiring the best talent, and they're onboarding them as fast as possible. So for us, it made complete sense to then merge our go-to-market and our product and tech organizations under one roof. And that's now all under Joelle, who was running all of tech and product before, and now we're rolling in the go-to-market.
Putting go-to-market and product and tech under one roof enables us to closer align our customers and our product team so that we're developing products faster. We're releasing products faster. We're building products that our customers really want, and we're getting their inputs. And it's all under one roof. And for us, moving to the general manager role, our model was to put a little bit more ownership right at that field level.
So general managers are aligned by verticals in the U.S. and regionally outside of the U.S. And regionally outside of the U.S. just because the scale is really just not there to verticalize. There is some subtle verticalization internationally, but we look at it more regionally. And this model then puts sales, customer success, marketing, all the go-to-market under a GM who can then control that vertical and get deeper and deeper in that vertical.
Got it, Scott. So just maybe to drill down on one thing you said, in moving from sort of a BPO model to a tech model, you guys pro forma still have over 10,000 employees. If I just look at the two 10-Ks and add them up, shall we see that be an area maybe where you don't need 10,000 in a few years? You might need 9,000. And of course, I understand there will always be some headcount growth with volumes, but.
No, no question about it. This is not a linear industry where adding revenue equates to adding headcount, and actually, if you look at standalone First Advantage business over the, I'd say, the last three to five years, we've added a lot of revenue, and we've actually decreased headcount, so that comes in a couple of different areas.
For one, we launched a Click Chat Call feature, which has enabled our customers to interface with us from a care standpoint a lot more digitally and with faster turnaround times and without the need to pick up a phone and call an 800 number. So we've been able to reduce headcount in our call centers due to just AI chat and other features, but there's a lot of other things that we're doing sort of behind the scenes on the fulfillment side that is going to reduce the need for headcount.
So, we don't actually have it mapped out yet because we've just put the two companies together like 14 days ago. But ultimately, yes, you should see our headcount gradually go down and our revenue gradually go up.
Hopefully more than gradually go up, but if you're running a business.
At historical, yeah, at our growth algorithms, we'll be very happy with that.
Well, you touched on sort of the tech is really the value driver here, one of the big value drivers. And when I look at what you guys do well and what, not you guys, but the heritage Sterling team did well, it looks something like this. First Advantage, you have your great RPAs and automation efforts, and they've obviously done some of that as well, a good amount of that as well.
Then you have your customer service resolution capabilities. You've touched on that Click Chat Call. I presume that will go over to them. SmartHub, the order routing solution, will go over to them. You'll add some of their customers to your databases, excuse me. And then maybe you'll take, at least in the US, their identity offering and sort of put that into your with your customers. Is that about right when I think about the tech roadmap just from what's been presented publicly?
There's a lot of yes, maybes, and TBDs. So again, going through the HSR process with the government, you're really limited on some of the things you can do ahead of time. So we did a lot of planning and now that we own the company, we're hitting the ground running on a lot of what I would call the due diligence around what you just talked about, so yes, yes, that there's no need for two identical products to exist.
It doesn't mean we've already come to the conclusion that it'll be the Sterling digital identity product versus our digital identity product. There's slight nuances. Both products are really good, so I mean, the good news is you're choosing between two goods in that, but we still haven't had enough time to really get under the cover.
But you're absolutely right in that our plan, no question, is to roll out Click Chat Call, especially chat to the Sterling customer base as soon as possible because Sterling did not have that feature. So that's a no-brainer. We'll do that. That'll be like number one on the list, but it'll still take us a couple of months to get it in their hands.
We've already talked to a lot of Sterling customers who are extremely excited about getting that feature. It's just easier to do business. Obviously, part of our thesis was doing the verifications through our SmartHub technology and through our verified database and adding the Sterling data to that. So you're right that we want to bring that feature and functionality to all Sterling customers as well.
But again, we're probably talking about four-to-six months of hard work just to get that planned and mapped out. So ultimately, our goal is we went into this saying, yes, First Advantage is acquiring Sterling, but we have a mindset where we're going to do best of breed on any product and best athlete on any person that's doing a job.
So just because it's a First Advantage person doesn't mean they're the ones that get to move forward. It's the best athlete that gets to move forward. And the same thing with product. We obviously are very proud of the products that we've built. But if Sterling has a better mousetrap on something, we'll use it. So that's the mentality we're going into. It's just a little too early to say this is exactly what we're doing.
So the way I sort of laid it out, let's say somewhat feature by feature, that's not dissimilar to what you're thinking, is what it sounds like, but the option is open in case you discover 14-plus days in, you haven't yet discovered the whole organization.
So the option's open to consider other alternatives as we learn more. But again, we still need time.
That makes sense. I don't think I knew where the cafeteria was 14 days into being here. So I want to pivot to the subject of base growth. You guys call it base growth. We prefer base revenue because it hasn't been growing in the last two years.
All right, fair enough.
We think of that as sort of a proxy for like-for-like volumes. And as you look into the Q4, the Heritage First Advantage side, your guidance implies a 2%-4% decline. And then for Sterling, you're penciling in something larger. Can you walk through some of the differences in what each side of the business is seeing in the job market today?
Yeah, so I think, again, think about verticals and think about vertical mix, so the verticals that First Advantage was primarily focused on was skewed more toward the hourly worker. You can call it blue collar, but we like to call it hourly worker. I'd say roughly our business was about 70-30 hourly worker to salaried, and I would say roughly Sterling was the exact inverse of that,
so I think when you look at base volume growth, the hourly worker is still in high demand. And that's why our base is better. The salaried worker is still a TBD, and they're still hiring there, obviously, but it's slightly behind us, and we actually kind of saw this as a good thing because when you put the two companies together, roughly now we're going to be about 50-50.
So that gives us some good resiliency into any type of economic environment. So I think the Sterling base will come back probably later in 2025 versus the legacy First Advantage base, which we think will come back sooner. That's our view as of today.
That's very thoughtful. So one of the things that you highlighted, and I think this was particular to your Heritage business, when you and I last spoke, and Steven, I know you were there as well, so you're aware of this, is that you had a little bit of very modest amount of caution around the U.S. consumer, which of course touches on the vertical side, your transportation business, your e-com, and your retail business. It's a big part of sort of Heritage First Advantage between those. Now that we've seen a more resilient consumer, are you a little bit more comfortable with that part of the business you just can't control, which is the base revenues in those segments?
Yeah, it's interesting and it's a good point, the business that we control, because we keep still crushing it on new logos, upsell, cross-sell, and retention, and Sterling is doing the same, so it's just base that, and that's what's tied to the macro. I mean, the U.S. consumer is resilient and keeps surprising me. You're right. Last time we talked,
I was nervous about the U.S. consumer because if you look at post-COVID, the U.S. consumer was still spending, but they were tapping into their savings to do the spending. The U.S. consumer today is still spending, but now they're racking up debt or credit card debt to do that, but they haven't slowed down. You're right, but it doesn't mean I'm coming off from being cautious. There's a lot going on right now. Obviously, we just got through an election.
There's expected probably two rate cuts in the near future. I think there's some pent-up demand in certain spaces. So it's really hard for me to sit here and predict it. But we are really thinking about this the exact way we've been thinking about it over the last couple of quarters, which is really cautious optimism.
So well.
I would say as much as I want to thank my wife for the strength of the U.S. consumer, I think Scott's right. I mean, it's factored into our guidance, right? In October, we have those results. It kind of came in right where we would have expected. So we're seeing, I would say, the green shoots of stability into that, but they're still a little bit unknown because a lot of change just, again, was passed to them. And I think there's a little bit more to come. So I think there's cautious optimism, like Scott's saying, but we're optimistic that it's more so than recovery. It's stability.
And we talk to our customers all the time. And our customers are saying the same thing they've been saying to us over the past, I'd say, year, which is we're still hiring. We're doing more just-in-time hiring, meaning they're not hiring ahead of the curve. They're doing a lot of backfill hiring.
But they're like, we can't give you what we're going to do over the next couple of quarters because they're in a wait-and-see mode as well. So if I just think through this, maybe take you guys a step further. If I look at sort of normal quarter-to-quarter seasonal patterns in both sides of the business, both Heritage sides, you guys are coming up on some really easy comps.
If you deliver in line with your historical frameworks with easy comps on base revenues, inline performance with those First Advantage and Sterling growth algos on the controllables, that sets you up for pretty good growth next year, does it not?
I mean, I think you hit on a couple of great points.
I mean, we have to go through the job market. It doesn't have to take another leg down, but.
So obviously, you're right on the comps getting a lot easier. You're also right in that we're seeing some green shoots of growth. And the other thing to factor in is that for the first time in two years, we've had back-to-back positive quarters internationally. So our international business was a drag on the business for the last two years.
But over the last two quarters, they're actually growing. And again, you point out, if you look at our growth algorithm, and we typically say base growth will give us a positive 2-4%, new logo will give us a positive 4-5%, upsell, cross-sell will give us 6-7%, 6-8%, back-out attrition of 3-4%, you get into that 8-10% normal growth. But base is the only wildcard, right?
Because if you look at not only in the last two years, if you go back to as far as we've been tracking 2020, 2021, new logo, upsell, cross-sell, and attrition have been so consistent. I mean, it's like clockwork, bang, bang, bang, all just delivering those numbers. So your point is really good in the fact that we don't need a lot of base improvement to grow in 2025 because of the comps and because of the fact that we're doing so well on the things we can control.
That makes sense, so just on the Heritage side, speaking of controllables with Sterling, there's been really strong performance in those controllables. And then we can get into some of the margin impacts in a bit, but how do you think about the strength of their execution? It's been very strong in a year where they've been basically in a limbo. How do you think about their execution and bringing that in-house? Is there sales for something where maybe they'll have more of the best athlete than might be at the First Advantage side?
I think there's a couple of things there. One, it goes back to your first question, which is, what did you like about the company? This is certainly one of the things we liked about the company is sales performance. But again, if you look at vertical mix, First Advantage, largest vertical is transportation, and that's 24% of our business, legacy business, and that's typically more of your home delivery. So it's done really well. Our third largest vertical was healthcare at 15%. Healthcare is Sterling's largest vertical at 24%. We love the healthcare space. We've always been trying to figure out how to get more into it because it's super resilient. It's obviously growing with an aging population.
So I think a lot of Sterling's new logo wins and upsell, cross-sell have actually happened in the healthcare space, a lot of it on the back of the Vault acquisition that they did January 1st. The good news is that drives a lot of new logo and upsell, cross-sell. There's a little bit of a margin erosion on that product, but we think we can fix that because we have a similar product that we run at a better margin, so we can figure out how to optimize that.
So I think that's been a key factor in driving some of those numbers, which we think is great. So now we end up with a really large healthcare practice when you bring their 24% and our 15% together, which is, we think, one of the best verticals to be in.
But if you look at this org structure that we've rolled out with the GM structure, so if you look at the GMs and then the supporting structures underneath them with head of sales and head of customer success and marketing, all those people, it's basically a 50-50, half Sterling team, half First Advantage team. And I think we think that's great. It helps with integration. It helps with cultural alignment. And it's also an indication of best athlete.
Excellent. So Steven, I want to talk about the progression of synergies.
Yep.
When your team discussed actioning synergies in 24 months, and I put actioning quotes in my notes, but I don't know a better word for it. My mind assumes that it will take three years for all those run rate benefits to actually be in the P&L.
Correct.
Is that fair?
For 100% to be there, yes, but as we mentioned on the call, we've already actioned literally more than 10 million 24 hours after we close. Those don't take three years. Those will be in your full results within a year, and we'll keep bringing that number up as quickly as we can so we have those numbers into reported EBITDA, reported results as quickly as we can, and I think like Scott was walking through, our approach has been very intentional.
We're starting with the internally focused savings, so that's the public company costs, the corporate costs, back office, HR, legal, finance, turning more towards the fulfillment operations, so the back-end fulfillment, so rolling out Click Chat Call, rolling out the RPAs. There's bots that we have that Sterling doesn't have. There's bots that Sterling has that we don't have, putting those together and getting all those cost savings.
And the last step is then getting into product and commercial. We want to keep the customer experience and be very intentional about how we impact things that go there. But those savings, we've also deprioritized the dollars that we allocate there so we don't have to over-rotate to those and cause harm to the customer experience. So you're right that it'll take time to get to the 100%. That takes roughly three years for that to fully cycle through.
But there's not this huge tranche that's happening at exactly 24 months post-close. There's going to be savings actioned almost on a continual basis over that two-year period. And more than half of that will be done before year one or by year one. So you're not going to have to wait 36 months to realize those benefits. And I think this leads into some of the questions on leverage.
We don't want to wait that long to start yielding the cash flow benefits. So we're going to start pushing those things forward as quickly as we can.
So, I'm going to, and we've written about this, but if I look at your LTM pro forma slides, you present them as 27% margin combined just as is today.
Correct.
And then with the synergies, 30%-31%. Now, you just mentioned the three years. So does that not imply 100 basis points plus of margin expansion per year just starting next year?
It's probably not as linear. It's probably got a little more step to it. I think the only thing to keep, there are two things to keep in mind there. One, Q4 of 2024, Sterling results will have Vault in it. They didn't have that last year. So that's a 2-300 basis point impact on their margins, how they've been running. They were 26% or so last year. They've been running 23% or so this year. So that has to run through. But you're absolutely right.
Those synergies kick in, and we'll start to bring that collective margin, that blended margin up. But like I said, more than half the synergies will be actioned by year one. So it won't be 100 per year. It'll certainly have some wave to it in terms of getting some earlier synergies. There's some easy low-hanging fruit we've talked about before.
Brought the executive teams together. There were synergies there. The insurance programs. It's the first acquisition, maybe the only one ever in our industry of two public registrants. So there's a lot of meat on those synergies around delisting a public company, audit, tax, advisory, things like that that we're going after quite literally today.
So now you mentioned at the outset, you've owned Sterling for, I think, 14 days now. So it's literally two weeks.
We're not measuring in hours anymore.
Yeah. One of the things, this is your TEDQ, that's a little too early to do this. We haven't published a Proforma balance sheet and cash flow statement. So there's a little bit of guesswork in your model does some guesswork, but it's guesswork. How do you, if we exclude these unrealized cost synergies, the one thing we know is that this is leveraged, right? It's 4.4x LTM with synergies and tracking somewhere closer to maybe 5x post-synergies. How do you get comfortable with that?
So it's one of, if not our top capital allocation priorities, get that leverage back into our target range. A few things, right? A, this management team and these businesses are both very much accustomed to operating at leverage, but then deleveraging very quickly. If you look at just legacy First Advantage, you would call it heritage First Advantage. When Silver Lake.
Legacy works.
When Silver Lake initiated their position in First Advantage in 2020, obviously, that's private equity LBO. Our leverage is closer to 6.2 times. Since then, every single quarter, when you back out some of the larger capital allocation items like a big dividend or the IPO, but every single quarter except for two, the business deleveraged.
The two were, one, we bought Infinite ID in Q3 of last year, and the other one was Q2 of 2020 that was peak COVID. Every other quarter, the business generates great cash flow that automatically starts deleveraging, and then you got to think of a few other things that we've done strategically as part of this acquisition. One, we've already got $835 million of interest rate swaps at a blended rate of 3.9%. We're trying to bring those interest rate cuts that are in the market forward.
We did 275 million of them last week. Starting to bring those forward, it supports near-term cash flow to the benefit of $7 million a year right now versus the spot rates. First Advantage tightly manages working capital. I think you've seen that over the years and through quality of earnings and just through managing working capital.
We're going to be applying those disciplines to the Sterling business already started to try and create cash flow out of receivables, created out of payables. So these are businesses that just manage it well and delever well. So even though, yes, you're right, when you don't, the synergies will also come in and support that over time, but immediately we'll be at roughly that 5x number. But these businesses will bring it down very quickly.
Got it. I think we're just about at time. So I'll just ask this real quick. For next year, how $168 million-ish in interest expense is the number by my math. And then.
Ours too.
Yeah. It sounds like, what sort of coverage ratio will you have on that? So how should we think about that?
I don't have the exact math in front of me because I had it from when we did it pro forma before the acquisition, but they were all very healthy.
What was it pro forma before the acquisition?
I'll get it to you. I honestly just don't have it. I got a bunch of other numbers in my head, not that one. No, look, we've done a lot of work on this and done a lot of modeling on this to make sure that both from an internally focused, a board focused, that we are comfortable taking on $2.185 billion of debt. It is a big number.
Yeah. But again, you got a big company now that powers it, strong cash flow that powers it. Look at operating cash flow. And even First Advantage has outperformed Sterling historically, and we're proud of that. But the Sterling numbers were pretty good last quarter, over $30 million adjusted operating cash flow. And the adjustment was $1.8 million. It wasn't a huge.
I mean, to bottom line analysis, it's a $1.5 billion business that generates about $500 million of EBITDA every year. So I mean, this is exactly what we're going to do.
Yeah.
Perfect. So with that, we'll call it, and everybody have a lovely day. Thank you.
Thank you.
Thank you, everyone.