Sabadra, I cover an Info Services company here at RBC Capital Markets. Steven, David, thanks for coming. We are really excited to host you.
Thanks for having us.
Thank you. Steven, if you want to give a quick overview of FA, just given the recent Sterling merger that you closed.
Yeah, absolutely. So First Advantage is now very clearly the leading global provider of human resource risk management solutions that we focus on background screening, drug testing, and all sorts of other risk management tools and services that support our clients on their onboarding and post-onboarding risk management process. The Sterling acquisition obviously is a big change for us. It doubles the size of the company, so we're now a $1.5 billion revenue company. Pro forma for the synergies will be roughly $500 million in adjusted EBITDA. So we'll have scale that really transcends from what was a very small mid-market player group of background screeners to a true real large enterprise. We'll have over 10,000 employees now across over 19 countries. And we service over 80,000 customers and everything from the largest of the largest Fortune 500 to small business customers.
And we focus that on key verticals. So First Advantage is historically focused, as you know, what we would call high volume hirers. So that's companies in verticals that orient themselves to the hourly or blue-collar workers. So transportation, retail, healthcare, some staffing. And then we add in Sterling, which has a good blue and white-collar salaried worker. So business services, financial services, but their core focus is healthcare. So that healthcare now becomes our largest vertical. Add that in with the high volume hiring aspects that we have. We've got the technology to make us best in class in turnaround time, best in class in compliance, and a user experience, which has become a huge issue in terms of making it easy for your candidate to do a background screen. That's second to none. So we're really excited about a, where we've come from.
David and I have been around now for over eight and nine years, where First Advantage was around $400 million to double the company from where we started to where we took it, and now to double it again with the Sterling acquisition, so an exciting time.
Absolutely. Very exciting time. So on the call, you laid out the FA 5.0 strategy. Can you just provide some more details on that?
We laid out the beginnings of the FA 5.0 strategy. First Advantage has worked in, you know, when Scott joined, and we set a series of three-year plans. Each one, when Scott joined, it was actually FA 3.0. 2.0 and 1.0 predated all of us. FA 5.0 is going to really focus on a, generating the value that is the Sterling acquisition, realizing the synergies, completing that integration, and not just from a very transactional bring two companies together, but bring out the best of what both companies have to offer, whether that's product set, go-to-market approach. Sterling's been really good at marketing and what we can learn from that and leverage that into the business. Also setting up the company internally to grow for that success.
You've seen some of that with the org chart changes that we announced with the new president, a new Chief Operating Officer, new heads of HR, and things like that. And then I think what we'll be talking about more in 2025 is the product outlook and how that helps, you know, set First Advantage up. It's a quickly changing environment. We've got AI, machine learning, you know, with blockchain years ago. The technology environment changes rapidly, and core tenets of 5.0 will be around leveraging that into the next generation of product users.
That's great. That's fantastic. I want to drill down onto a few of these topics that you mentioned, if that's okay with you. You mentioned Sterling was really good at marketing and talked about the go-to-market strategy evolving. I was just wondering if you could provide any high-level color on that front.
Yeah, I mean, if you look at First Advantage and Sterling, what we really liked about the, you know, the acquisition is both companies have a very similar revenue model. Put base revenue aside because that's macro, and I'm sure we'll get there in the next 25 minutes, but both companies have been incredibly productive with consistent new logo growth, upsell and cross-sell generation, whether that be via package density or selling the full suite of products that we have, and very solid customer retention, 96%-97% level, and if you look, you know, First Advantage, we always prided ourselves and thought we were top of the market, generating 4%, 5%, 6% new logo growth every single quarter, every single year, and we don't like admitting it, but Sterling actually outperformed us there.
Now that we've owned them for all of 18 days, but have spent a lot of time with them over the last six months as the deal was being reviewed by the DOJ, we really got to learn a lot about how they go -to -market. They're just, you know, First Advantage's marketing approach was built around enterprise clients, but around events and trade shows. Sterling has a very shrewd and creative approach around actual real marketing and product marketing and account-based marketing. That's some of what our, I know our commercial teams are really excited to learn and leverage from is take what they've been able to accomplish in their marketing team, which has helped drive their new logo growth, leverage that across the full portfolio of pipeline and go-to-market sales force, and generate truly a differentiated go-to-market, you know, proposition, which is really exciting.
It'll take a little bit of time to train everyone, transition, get all those right resources in place, but we can see the writing on the wall that they're really good at it, and that's an asset that for the purchase price we plan to keep.
That's fantastic. And then the second or a very important component is the people. As you mentioned, there were some organization changes that we did, but just in terms of keeping the Sterling employees that came over from Sterling, can you just provide some color around how are you thinking about retention there?
Yeah. Well, first, the changes we made were really to help set the company up to scale. And like I mentioned, you know, a few years ago, this was a $450 million business, and we're now a $1.5 billion business. So being able to operate requires some changes because we're at, you know, 10,000 employees. We're a much larger global scale. So part of what Scott and the board had worked on, and this transition is part of it, and there's several others, is making sure that we've re-engineered the company for its new scale so it can enable the growth and not be a speed bump to it.
So whether that be in our go-to-market approach by, and this is actually a kind of an org structure that we actually got from Sterling, is the general concept of having general managers, a single stop executive who is responsible for sales, customer success, marketing, and then bringing the product resources for their vertical set. We didn't have that before. We kind of treated it very geographically speaking. So we now have those general managers in place. Again, it's a very 50/50 blend, the First Advantage and Sterling folks, and that's true throughout the commercial organization.
But that kind of structural change with the COO I mentioned before, a new head of HR, really helped the company be scaled for its new, you know, growth and combined scale. And then, you know, the overall changes are really built around getting deeper into the verticals. We love that strategy.
Sterling had a vertical focus. First Advantage has a vertical focus. We think it's truly differentiating when you can be a vertical expert, especially in the industries like transportation with its DOT compliance or healthcare with all of the different rules and regulations that come with hiring a doctor or a nurse or a medical staff and being compliant with 50 states of different rules and regulations. If you can't walk into a client's office and speak that language, you're not going to win that business consistently, so we think this new org structure has really set us up for growth, for success, modernizes it, gets the right resources in place, and then to your question around, you know, how do we retain the key assets externally, that's been a big board-level conversation for First Advantage.
I mean, obviously, you know, with part of any kind of acquisition, there was a lot of leadership changes. A lot of those have already been made. The quote unquote benefit of the HSR process was we had six months then to plan hand in hand with Sterling. We couldn't execute, but we could certainly get plans and frameworks in place, and they've got some great people. We've put them in position to succeed, and then, you know, obviously their equity carried over. So they've got a lot of reasons to want to be a part of the value as well.
Absolutely.
Actually, the only thing I would add to that is the cultures are very complementary. You have two high-charge, highly energized companies. They've come together. They have common goals. We always viewed Sterling as the second best player in the industry.
Second best.
Second best.
We're proud of our own results, yeah.
And so we've taken the best players and, as Scott said, put in the new infrastructure from a management perspective. But we think it's going to be a highly energized, highly synergized organization.
That's helpful color, David. Thank you. And then if we talk about product, can you talk about product and technology, how it complements one another?
I mean, we like to think of First Advantage almost as a product-first company. I mean, that's really been the FA 4.0 revolution was actually kind of going from, you know, a services org to really a tech-led product organization, and you can look at some of the products that we've released over the last, you know, three or four years, whether that be, you know, PA, NextGen, I know which we've talked about a lot with Scott and you, you know, about our latest generation user experience and applicant experience, which is backed by AI, backed by, you know, it works on your iPhone, like just like any other great mobile experience, but we think that is how you differentiate yourself. What this acquisition should power once we get through the initial integration is more innovation and quicker innovation.
First Advantage has invested almost $80 million every year on product and tech, including its capitalized software. Sterling's roughly $60 million on the same spend. Together, that's $140 million. Yes, there'll be some synergies, so that number comes down a little bit, but we have deprioritized our product savings from our synergy model because we believe that's the future. That is part of the core tenet, if not the tenet of FA 5.0, so between the resources we already had in place, obviously we got some great people and some great tech at Sterling, and we'll integrate that and cross-sell that to the extent it can be, and then we'll keep growing into the future because I think, you know, the product and tech innovation is really what drove us from the $400 million company to the $800 million.
We think we'll empower NIST now as a $1.5 billion company soon to further more growth.
Can you talk about some of the digital and fraud offerings that Sterling had and how that can help complement some of the offerings that?
Yeah, yeah. Well, we like to think we both had it. So Sterling has a great digital product. It's powered by a partnership with ID.me, which does a lot of stuff with the government and GSA and all the logins there. First Advantage has a similar product. We went first into the market into the UK because the government opened up some abilities to do digital identification there. We call that product suite RightID. And we were just about to roll it out to the US. So now we're doing a side-by-side product comparison, finding out which workflows and client use cases they make sense for. But we are the only two background screeners out there talking about this. And it's a huge, huge issue that we hear from our clients all the time. In fact, I was talking to Scott last week.
He's done a bunch of QBRs with our clients. And in a two-hour meeting, he said 30 minutes will be devoted now to talking about fraud in the hiring process. All interviews, a lot of interviews are done remotely now. The person you interview may not be the first in your background screen, may not be the person who shows up to work that first day. So, you know, in the retail space, when you have inventory and warehouses, we've heard from clients that they interviewed a guy, they made an offer, the day that start date, someone showed up, worked in the warehouse for a half a day, loaded up the truck full of goods out of the warehouse and drove off. And they have no idea who that person was.
So a lot of what the suite of products is, is around making sure the person that you interviewed is the person that you background checked. It's the person they say they are. But then we also can backfeed that digital image that's now been validated through the background check through that hiring system. So when that person shows up to your office day one or on Zoom or wherever it is, you know it's them. The other real thing that we've been hearing is, and especially on the tech companies, is there are state actors who will do the same exact thing to interview for a job just to get their laptop issued to them day one. So then they can inject malware and do bad things.
So it's starting to really transcend not just from, you know, a pure, you know, physical risk or employee risk to IT security and other areas. So we're excited for it. It's a little early, just 18 days after the acquisition to tell you exactly how that product's going to grow and where we're going to take it. But we know us and Sterling have really been the only two in the background screening market talking about it. It's very complementary. Our clients are really excited for when the product we can roll it out. So that's certainly one of those things that we've pulled forward into the synergy process and the integration process, saying, hey, we've got to get this in the hands of more people. And we think can drive some longer-term upsell, cross-sell growth.
As we, you know, Sterling's been very successful in their client- base in the U.S. We're going to copy that. There's some global offerings we have that we want to copy as well.
That's great. Fantastic. And then just going over to the cost part of it, you talked about cost synergies. Can you just lay out that $50-$70 million of cost synergies? How do we think about the timeline there? How much has been executed so far? And yeah, the timeline.
Yeah, no, so yeah, so we've got a $50-$70 million. It's net synergies. So I know that people always ask, you know, hey, there's going to be an investment you have to make. And the short answer is yes. The whole G&A structure as a great example is an investment we made. There's an additional cost, but that's going to be a net part of our synergies. But yeah, you're right. $50-$70 million is our target. It's going to take us two years or so to action the full suite of synergies. But we already did over $10 million, quite literally within hours of close. I think we wrapped up close around 8:00 A.M., 8:15 A.M. And we had already put wheels in motion on that full $10 million suite.
We think we'll have another $10 million action by the time we have our next earnings call, so roughly three and a half months from now. The initial wave of synergies is really what we would call corporate cost. Executive leadership harmonization. You know, the first time in the background screening industry, you've had two public companies, so delisting Sterling as an SEC registrant. They weren't a cheap public company. They had expensive auditors. They had expensive tax advisors, legal advisors, those types of fees. You know, we talked about it a lot, but our D&O and cyber insurance program. You know, we just either Sterling wasn't good at negotiating them or we're really good, and we like to think maybe it's a little bit of both, but that generated a multi-million dollar savings stream, so that's all been action.
Part of that next, you know, $10 million or so that we'll do is we start looking at internal operations, so the HR functions and the HRIS systems that power that finance and our financial systems that are, you know, legal departments and contracting and things like that, as well as like our CRM, and fortunately, you know, us and Sterling use the same HRIS tool. We use the same CRM. We're both in the same ecosystem for financial systems, so it makes those easier to get. There's still a lot of work to go do them, so we've already started working on those things, we use that HSR time to do some pre-planning there as well, but that'll be part of that initial wave, and then beyond that really comes the fulfillment side, so that's using the automation resources that First Advantage has.
There are some automation assets at Sterling that we're going to leverage back into First Advantage as well. Click-Chat- Call, which is our automated customer care AI chat-enabled experience. That's actually something that we're having to pull forward because as Scott and Joelle and other leaders meet with Sterling customers, that's one of the consistent feedback items we get that they're excited about. Because today, Sterling is very old school on their customer care approach, answering the phones, responding to emails. They don't have a self-service. They don't have chat. That's what Click-Chat- Call brings to the table. So we're actually trying to accelerate that into the integration plan, less about the synergies and more giving those customers something of value that they want. But, you know, operation fulfillment, customer care fulfillment.
And then at the tail end of that two-year horizon, 18-24 months, is really where we start looking at product and commercial. So that's a little bit of the go-to-market sales teams. That is, you know, harmonizing the product development team. But we put that at the end very strategically. For those who follow the industry, there have been some rough M&A in the past where they actioned the commercial savings too quickly and you sacrificed the customer experience. Or you force migrate your enterprise-sized clients off of their platform and they have to rebuild their integrations and workflows. We've not put that into our plan, right? Which is why we've promised the number we have, with the timeline we have, that gives us, A, time to really see what Sterling customers value.
It gives us, you know, we've deprioritized the monetary savings that need to come out of those two organizations. So we don't have to force migrate their clients. We'll keep the Sterling front end, their integrations with their hiring systems aligned as long as we need to, which is in theory into perpetuity. Plenty of other background screeners run two platforms. We can run two if we need to. We'll merge everything on the backend fulfillment and get the synergies, whether that be from headcount and scale.
That's where you get your procurement savings on those operational vendors. That's where you can leverage automation. But we think that's just a new approach because we are able to get so much in the synergy bucket from the public company costs and insurance and management and leadership that we don't have to go hunt in those grounds that could risk customer retention.
That's great color. And maybe that was going to be my next question as both the companies have really strong retention, 96%. How do you plan to maintain that retention levels going forward? You answered some of those questions around minimizing the disruption to the customers, but any other color that you?
Yeah, well, let's first talk about why we both have good, strong retention, and then we'll talk about what we're doing to preserve it. What a great part of when you play at the enterprise space of background screening is you are integrated into your customer's environment. You know the big enterprise customers use, you know, services like Workday or iCIMS, SuccessFactors, these big, large-scale enterprise HCM systems. None of them are stopped. If you've ever done one of these implementations, you customize it to meet your specific company's needs. No enterprise customer has canned Workday out of the box. When you go to integrate as a screener, you have to customize your APIs and integrations to match those customer workflows. A lot of work goes into that. Once you do it and do it right, those customer relationships become really sticky.
So if you look at First Advantage, right, top 100 customers for over 12 years average tenure, it would be higher, except we have new logo growth into those. Sterling's a similar tenure. I think they're around nine years, but they have a very similar story in terms of new logo. So you have very sticky customers. And then you add that with vertical experts that make up your customer success organization. So your clients are getting supported by people who really know the compliance needs of their industry. And you back that up with top-end performance out of your fulfillment organization. And you layer in things like Click-Chat- Call that clients value. And you create a very strong customer proposition. So we don't want to break that at all with the acquisition, right? There's a lot of value in having consistent 96%-97% retention.
So, to my earlier point, that's why we're not force migrating enterprise clients. We've deprioritized savings that need to come from the commercial organization. So we have time to literally interview our new Sterling customers, find out what they value. If they value their customer success, we will not have to touch it. And there's not enough pressure in our synergy plan to make us touch it. And then we'll continue to offer the best-in-class user experiences. So making it easy for applicants to do a background check is a huge driver these days because even in a tight labor market and macro, candidate dropout, especially in the hourly employees, is a real thing. Those candidates want to take the first available highest-paying paycheck.
So if you make it too hard of a process to do a background check, odds are that candidate may drop out and go find employment elsewhere. So, you know, again, not causing harm is a key tenet. You know, in fact, we have an internal rally cry that we want zero customer retention issues out of the integration. Zero is a very optimistic goal. But we're really trying to make sure we take a very strategic, very intentional approach towards preserving the Sterling client experience. And then, of course, on the First Advantage side, our clients are, you know, more like, hey, tell us what you learned great about Sterling. And if you can offer us something new, let us know.
So in the meantime, you know, we're still focused on making sure we preserve everything that's built the 97%-96% retention on the legacy First Advantage side as well.
That's fantastic. I know it took us 21 minutes to get to the macro question, but we have to. So, but there are so many exciting things going on with Sterling. But macro, how should we think about like the base growth? What are you seeing in the market right now? New administration coming in, how does that position you? So any thoughts?
Yeah, so I mean, base growth, and this has been the conversation at every meeting upstairs all day, every day. I was hoping we could stretch it out for another eight minutes and 37 seconds. But no, it's certainly a process of normalization that we're still in. We think we're approaching the end of it. We've seen a lot of the noise work its way through the system. Right? 2021, been following the story, was a blowout year, hiring volumes across the board in every industry and every type of company went off. Inflation went up, which drove that even more. We're starting to see a very consistent trend of normalization. Obviously, base has gone negative for now almost 10 quarters. But we've seen pockets to be optimistic about. And what we've seen really more just stronger signs of stabilization.
Whereas this same quarter last year, we were looking at some verticals down 20%+ . International, you know, within borderline free fall last year. International was actually a positive contributor to growth for the first time in a long time. It was flat in Q2. It was growing in Q3. And that's only 12% or 13% of the business. But when it's 12% or 13% growing at - 20%, it creates a strength. And what we started to see is really, you know, this normalization process really almost worked its way vertical by vertical. You know, we saw some more, you know, some verticals like financial services and business services, tech, which is only 3% of the business, earlier on be more impacted and stay down longer. You know, more recently, we've seen a lot more convergence within the vertical.
You know, where, you know, like my point, you'd have a ± 20 guy. This quarter, you know, everyone was in ±7 . The only outlier was tech. Again, 3% of the business, and it was down 13%. And that aligns to a lot of the layoff news that you've kind of been hearing. That's really the vertical that's been seeing some of that more recently. You know, we put it in our Q4 guidance. You know, base is still going to be negative into the last part of the year here. But we see it on a slow trajectory towards flat.
As you know, what's nice about the way our business model works, and also Sterling too, because we get the productivity out of new logo, because we get the consistent productivity out of upsell, cross-sell, and because we can maintain that 96%-97% retention. Base growth doesn't need to be a big, huge positive number to get the solid single-digit growth numbers in revenue. What we're really just looking for is that consistent stabilization trend where base can even be flat. Because the net of those three controllable factors is 7% positive growth plus or minus. If base is, you know, not pulling that number down, you're still getting, you know, 7% positive growth. Sterling has a very similar story because they're a little bit more white-collar, salary-oriented in terms of their vertical mix. Their base decline has been a little larger.
They've been also outperforming us a little bit on new logo and upsell. So it kind of, it's a little bit of a wash. But we see them as the normalization trend being a couple to maybe two, three, four quarters behind First Advantage. They've been running about 500 basis points behind First Advantage on base all year. And we see that, you know, again, following the same trajectory. When it hits the exact inflection point and goes positive, too early to call. But to your point, I think there's a little bit more just overall stability. You know, interest rate cuts have started to trickle in. To your point, the election is now behind us. And I think what we're really hearing from our customers is now they're able to actually have a plan.
You know, years ago, and we talked about this a lot, our customers would give us hiring forecasts, and they would be, call it a year out, a good six months out. And they wouldn't be changing them much, and they were very predictable. And lately, they've been cutting them back to three months or 60 days. And they move around a lot more because it's just really hard to plan as a corporation these days. You know, we're hopeful, and our clients are hopeful now that, you know, there's outlook on where the politics are going to take us and tax cuts and things like that potentially. The interest rate environment now has shown signs of, you know, where it's going to head. Our clients and companies can all start to plan.
You know, we haven't seen much in terms of growth hiring for new stores for retail, new distribution centers and transportation. You know, even if you look at the India market, like the BPO and IT outsource providers haven't gotten a lot of new product, you know, project flow from the U.S., we think these stabilization trends start to, you know, give companies the ability to start to plan, and they're all sitting on a lot of cash. They built that up over the last number of quarters, so there's reasons to be optimistic. The exact timing is still a little unpredictable.
That absolutely makes sense. Maybe just a quick question on the, again, the new administration, the policies of the new administration. It's still very early days, so it's difficult to really parse. But are there anything that you would call out? And in particular, the government efficiency, the new Department of Government Efficiency. I don't believe you have any exposure to public sector, but just wanted to clarify if there's anything.
No, we really don't have much. You know, the little government that we do have, which is really a handful of percentage points of Sterling, is really around higher education and more local government. Federal government really doesn't use private background screeners. They do a lot of the work directly through the Department of Justice and FBI. So that directly won't impact us at all. Again, I think it's really, you know, I think a lot of, like many people, we were pleasantly surprised that the whole election story ended very quickly. It didn't draw out to become a multi-week, month kind of drag on the news cycle. Which again, I think just it gives some visibility to where the economy and where policy will be taking you in terms of, you know, taxes, tariffs, you know, things like that.
Now people can start to plan about what's to come versus having to guess which direction it may head.
Absolutely.
And one comment on immigration, right? If you're illegal, you didn't do a background check anyhow. So it's not like we're going to lose any of that volume. That just never happened. And the law states you have to do an I-9 on everyone that you hire. We do that. And so that's going to continue.
No, that's very helpful color . Absolutely. And as you mentioned, if the corporate tax cut goes through or you see more ensuring that those trends will be positive for you.
Anytime there's a wholesale change that creates job churn, we like, right? I mean, it's whether it's, you know, trends within the hourly employee that cause them to want to, you know, change jobs very rapidly. Or yes, things like, you know, insourcing or outsourcing. We have coverage all over the globe. Whenever there's a wholesale change like that, it is net positive for the trading district. Yeah.
That's very helpful. And maybe if I can just ask you on vertical, you mentioned tech was something which was really weak, but which ones would you say are like the top three or, like, which ones are still in the process of improvement? Any high level that you have.
I mean, if you look at the chemistry of now the pro forma business, First Advantage and Sterling combined, our number one vertical is healthcare, and healthcare is a strong vertical. It's been strong at Sterling for years. It's been in our number three vertical for years, and we're really, you know, I think the outlook there is really positive. Transportation has actually held up really well, but transportation for us, as you know, is more home delivery, and it's not long-haul trucking. It's not boats. It's not planes, and the transportation business has been really strong. I think a lot of that is base, but also a lot of that is where we're able to upsell and cross-sell. You know, we've got the package density concept runs strong across all the verticals.
But within healthcare and transportation, you're able to offer additional product suites, whether it's our RoadReady solutions or within the healthcare space, drug testing and health screening becomes a really big deal around staying compliant as doctors and nurses. So a lot of runway there that we've been able to exercise.
That's great. I have to ask about capital allocation. So can you comment on how do you think about the free cash flow for the combined companies and how quickly can you deleverage from these levels of 4.4?
So historically, we've been really proud about cash flow generation at First Advantage. And even Sterling has done a really good job of it, although not to the same degree as First Advantage. And it starts with high-quality earnings, right? You got to have earnings that you can really count on to generate cash flow. We're very cash-focused and make a lot of decisions based on cash in addition to just overall profitability. You know, we do have the new debt structure in place. That's a $2.185 billion facility. It's a big number when you say it out loud. But that refinanced all of the historical debt for both First Advantage and Sterling, as well as financed the acquisition. It's at spot + 325. That will come down to spot + 300 when we do deleverage on the debt basis by half a turn.
And we have about $835 million of swaps today that fix the rate around 3.9%. So we're able to kind of bring some of those rate cuts forward, support near-term cash flow. Obviously, there's a lot of costs around achieving some of the synergies. So free cash flow will be pretty flat, I would think, for the remainder of the year, just as we've paid off the TLBs and worked through some of those initial synergies. But, you know, the businesses do generate a lot of cash. The deleveraging path, we think it'll take us roughly two years to get into our targeted range, which is two to three times. And that's going to be powered by, A, the synergy realization. As we realize those synergies, those will all convert into cash flow. And then just the organic strength of the businesses.
But until we get into that range, capital allocation story is really simple. To integrate the businesses, we got $50-$70 million of synergies to achieve. We got to keep all of these customers really happy, and then we're going to continue to deleverage a bit.
That's great. Thank you. Thanks, Steven. Thanks, David.
Thanks for having us.
Thanks, everyone.
Thanks.