Sterling Check Corp

NASDAQ:STER

Earnings Call Transcript 2023-Q2

[Operator]

Good morning. And welcome to the Sterling Second Quarter 2023 Earnings Call. My name is Carla, and I will be the operator of today’s call. [Operator Instructions]

I would now like to pass the conference over to our host Judah Sokel, Senior Vice President of Finance to begin. Please go ahead when you are ready.

[Judah Sokel, Senior Vice President, Finance]

Thank you, Operator. Welcome to Sterling’s second quarter 2023 earnings call. Joining me today are Josh Peirez, Chief Executive Officer of Sterling; and Peter Walker, Chief Financial Officer of Sterling.

The slides we will reference during this presentation can be accessed on Sterling’s 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 this 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 these forward-looking statements.

Our slide presentation and discussions on this call will include certain non-GAAP financial measures. For 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 will now turn the call over to Josh Peirez.

[Josh Peirez, Chief Executive Officer]

Thank you, Judah. Good morning and thank you for joining us. Sterling’s second quarter of 2023 was another quarter of successful execution towards our long-term strategy and 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.

Our unique focus on product innovation, technological excellence and client service differentiates 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 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 towards achieving our goals.

Turning now to slide five, which summarizes our long-term strategy and 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 data 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, scaling our scaling 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.

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 have made to our recently released fully-integrated Sterling Monitoring solution and the upcoming release of our Sterling I-9 virtual inspection capabilities enabled by our partnership with ID.me.

We have 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 methods to manage their programs.

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 solutions 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 we have seen continued success winning new clients and growing through up-sell 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 the 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 have seen better win rates and have closed more business in 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 cement our culture of innovation, our 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 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 Yoti. The Sterling Yoti partnership expands Sterling’s 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 rates and delivers more accurate screening results.

In the U.S., we were thrilled to recently expand our exclusive partnership with ID.me 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 unveil the upcoming launch of a new Virtual I-9 Document Review Service. For more than 35 years, the Form I-9 process has remained largely unchanged and burdensome with in-person verification requirements. Now in partnership with ID.me, Sterling can offer a secure compliant and convenient alternative virtual inspection option via ID.me’s trusted referee video chat.

Shifting to Post-Hire on the right side of the slide, demand continues to grow for our subscription-based Monitoring solution, which tracks among other things, criminal arrests and conviction records, motor vehicle registry records, licensing and credentials, 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 are 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, 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; two, 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 and automation, the closure or downsizing of several facilities and the continuation of actions to streamline functional alignment with the 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 goals.

We are very excited about the opportunities we are unearthing 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 the first quarter, we made two strategic acquisitions, Socrates and A-Check, and started on deal integration to drive cost synergies and geographic expansion benefits.

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 deal integration by the end of 2023 for Socrates and the end of second quarter 2024 for A-Check.

As part of these integrations, we are leveraging and refining the M&A playbook we developed for our 2021 EBI acquisition giving us increased confidence in potential future deals due to our ability to integrate cultures, operations 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 of pre-deal expectations and we remain on track to realize our cost synergies as planned. In particular, the Socrates integration is offering substantial benefits 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?

[Peter Walker, Chief Financial Officer]

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 a 328-basis-point contribution from M&A, partially offset by a 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 2Q. First, we saw growth from new clients of approximately 5% in line with our expectations. Notably, new client revenue dollars increased sequentially from 1Q to 2Q, 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 5% at the top of our long-term target range and a strong sequential revenue dollar increase from 1Q to 2Q. Client adoption has been strong for services we provide to our Identity partnerships and we continued 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 continued 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 improved from 1Q to 2Q, while the year-over-year rates are being impacted by year-over-year comps. This quarter we lapped a particularly strong 2Q 2022 during which we reported a company record quarterly revenues of $206 million, as well as a strong 23% growth rate.

Moreover, current industry hiring volumes remain strong relative to history and are down year-over-year only when measured against 2022’s record levels. Looking further back our Q2 2023 revenues grew at a 10% CAGR over the past four years since 2019 demonstrating the strong secular growth we have 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 and attractive vertical mix, which has been instrumental in supporting our compelling revenue growth in recent years. In the second quarter, our U.S. performance was led by our healthcare 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 is down 10% in the quarter, including a 3-point drag due to foreign currency translation. Similar to the U.S. base volume declines offset good trends in revenue drivers we control.

Our international business is benefiting from a consistent trend of clients looking to consolidate globally to a single staff provider. 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 3.2% of inorganic revenue growth from Socrates and A-Check, the two acquisitions we closed in Q1 of this year. We continued 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 and a robust synergy potential A-Check. 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 are pleased that our adjusted EBITDA margins this quarter were 26.3% ahead of the expectations we communicated in our May earnings call. This outperformance was 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 of $9 million which were added back for the purposes of adjusted EBITDA. Through the first half of 2023, we are pleased with the progress we made on cost optimization initiatives and we will continue to keep laser focused on execution.

In the second quarter of 2023, we had adjusted net income of $26 million or $0.28 per diluted share, representing a year-over-year decline in adjusted EPS at 15%. 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 PP&E 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 was 2.4 times net debt to adjusted EBITDA at the lower end of our 2 times to 3 times target. Year-to-date, we 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 would have fallen below 2 times without our M&A or buyback activity.

We ended the quarter with total debt of $5.2 million cash and cash equivalents of $49 million and $195 million available under our credit facility, providing us 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 fixed 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 and a lower growth environment as we see macro uncertainty as opportune times 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 $706 million to $708 million, representing year-over-year change of minus 1% to positive 1%, adjusted EBITDA of $198 million to $208 million, representing year-over-year growth of 0% to 5% and adjusted net income of $106 million to $214 million, representing year-over-year growth of 0% to 7%. Our revenue guidance range includes full-year organic constant currency revenue change of minus 3% to minus 1.5%.

As we discussed earlier, we continued 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 have 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 softness.

Our implied second half revenue guide shows marked improvement over the first half of 2023 and year-over-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.

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

Looking at revenue cadence by quarter, we expect year-over-year declines in Q3 total reported revenues that are narrower than 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 comes online and we lap far easier year-over-year comps.

Included in our total reported revenue guidance is 2.5% 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 of 0% to 5%. We expect margins over the back half of 2023 to improve from the first half as our revenue trends improve. The benefits from our cost actions ramp 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 when more new business has gone live and year-over-year comps ease.

Finally, turning to our adjusted net income guidance 0% to 7%, we expect a similar cadence to reported revenue and margins. We are benefiting this year from reduced G&A, which should drive growth to the bottomline in excess of our adjusted EBITDA growth. We are 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 EBITDA growth. 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 and adjusted net income growth of 15% to 20% per year. Even in the absence of robust revenue growth this year, 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.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Mark Marcon from Baird. Your line is now open, Mark. Please go ahead.

[Mark Marcon, Baird]

Hey. Good morning. Thanks for the update. Really encouraging to hear about the margins in the second half. I am 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 compared to say 2018, 2019 type levels, is it higher or lower? And then I have a couple of follow-ups.

[Josh Peirez, Chief Executive Officer]

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 we are a little bit better than what we saw in June and July more in line with what we had been seeing and 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 numbers, but it was a little bit lighter than we had expected. It 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 are assuming that the macro, we have seen kind of in June, July continues more or less through the year in terms of the guide that we have set now.

[Peter Walker, Chief Financial Officer]

Hey, Mark. Good morning, Mark.

[Mark Marcon, Baird]

And then…

[Peter Walker, Chief Financial Officer]

It’s Peter. 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 set at a negative level reported.

[Mark Marcon, Baird]

Great. And then with regards to 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 and potentially include more modules or more screens and more solutions. I am wondering, can you talk a little bit about what the source of those clients are. Are they domestic or international, are they coming from some of the other big players or is that part of the consolidation that’s occurring across the industry?

[Josh Peirez, Chief Executive Officer]

Hey Mark. It’s Josh. Let me go first and then if Peter wants to add. So I think, first of all, what we are counting on for the remainder of the year 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 added as well. But that’s really more of thinking forward into next year where we are comfortable.

And I think as we have 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 are very encouraged by the trends we are 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 -- in late June, on the cross-sell, upsell, we are doing a really good job, really proud of the teams in being able to do more with those accounts.

And I mentioned that, because when you talk about, is this consolidation or who are we winning from? We went 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 this time to consolidate vendors and that’s benefiting us in that cross-sell and upsell space, because we are displacing people who are doing a little piece of the work and we are able to bring that on. So we are excited.

And I should say, I didn’t answer your first question on kind of trends before COVID. I think you have mentioned kind of 2018, 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 you are seeing if not all of it. So we are encouraged by the trends and we do feel like we have got good guidance here for the rest of the year.

[Mark Marcon, Baird]

That’s terrific. Josh, Peter, thanks.

[Josh Peirez, Chief Executive Officer]

Thanks, Mark.

[Peter Walker, Chief Financial Officer]

Thanks, Mark.

[Operator]

Thanks, Mark. Our next question comes from Andrew Nicholas from William Blair. Andrew, your line is now open. Please go ahead.

[Andrew Nicholas, William Blair]

Thank you and good morning. I wanted to ask about just the vertical level stabilization, it seems like Peter from your comments, tech media, staffing had some weakness in the quarter, but healthcare was strong year-over-year. Just wondering if you could make any comments on kind of how you expect the vertical level cadence to kind of to progress as we move through the year or any signs at that level of stabilization, because it does look like from what I am -- as a math I am doing that you are expecting now a sequential uptick in dollars or revenues, third quarter, fourth quarter. So just wondering outside of new business, if there’s any other areas at the vertical level that’s giving you that conviction.

[Peter Walker, Chief Financial Officer]

Yeah. Sure. I appreciate the question. Good morning, Andrew. So, as we shared in our prepared remarks, we are really excited that healthcare continued to grow year-over-year in the quarter and by EMEA’s 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 the 7% in Q2 and we expect 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, our cross-sell/upsell and easing year-over-year comps.

[Andrew Nicholas, William Blair]

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 you have been public, you have talked pretty strongly about Identity, but Post-Hire. Is there anything specific to call out there in terms of adoption rates or regions or verticals where you are seeing strength there in particular, any other color would be great. Thank you.

[Josh Peirez, Chief Executive Officer]

Yeah. Hey, Andrew. It’s Josh. Thanks for the question. I think that we haven’t shared specific information broken out on the Monitoring. We did share that the combination of Identity and Monitoring crossed that 10% threshold in Q1, crossed it again in Q2, we are pleased to see that progress with these newer solutions 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 gives 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 are seeing that momentum gain.

In addition to what we have shared previously on things like licensing and motor vehicle monitoring, those other areas that are not the 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 are in healthcare for example, you have to be monitoring whether people continued to have their licenses or else you can get into really bad trouble.

And I think the last thing I would note, which is actually on your previous question where you talked about the sort of growth in raw dollars that we are expecting through the year, it is actually consistent with what we have seen where growth from Q4 to Q1 to Q2 in raw dollars throughout is consistent with what we would have 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 are 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 as the Fed and other banks are trying to cool off job market, we are very proud of how we are performing where other than last year continues to be very, very high. That’s why we mentioned, we are still seeing strong hiring volumes from our clients and more clients, it’s just really relative to last year.

[Peter Walker, Chief Financial Officer]

And then maybe just the other point on Identity and Post-Hire, 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.

[Andrew Nicholas, William Blair]

Makes sense. Thank you.

[Operator]

Thanks, Andrew. Our next question comes from Toni Kaplan from Morgan Stanley. Toni, your line is now open. Please go ahead.

[Toni Kaplan, Morgan Stanley]

Thanks very much. I 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 the bottom end of that revenue guidance.

[Josh Peirez, Chief Executive Officer]

Hi, Toni. It’s Josh. Thanks for the question. I think, first, we do have good visibility into what we are counting on for the second half, again, assuming the macro consistent with kind of what we have seen in June, July. So that’s really the bigger question. I think we are confident in what we are seeing from the new and the cross-sell/upsell.

In terms of visibility on a number of these bigger deals, I am having direct conversations myself with the clients to understand their plans for the year and we feel good about where we have set the guidance at this point.

[Toni Kaplan, Morgan Stanley]

Terrific. And earlier in the year, I think, you are seeing some integrations being pushed out, is that still taking place and does that impact timing at all in terms of deals coming online? Thanks.

[Josh Peirez, Chief Executive Officer]

Yeah. Hey, Toni. Thanks. No. We have seen more of a normalization of the onboarding again. What we had seen before was really the client telling us we are going live here and then pushing it, we haven’t seen that behavior since Q4 changes that we had mentioned.

[Peter Walker, Chief Financial Officer]

And just a reminder Toni, right, in terms of absolute dollars, we saw an increase in absolute dollars from new clients in revenue Q1 to Q2, an 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 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 have expected new business to be closer to the lower end of the 7% to 8% range in the second quarter.

[Toni Kaplan, Morgan Stanley]

Terrific. Thanks a lot.

[Josh Peirez, Chief Executive Officer]

Thanks, Toni.

[Operator]

Thanks, Toni. Our next question comes from Kyle Peterson from Needham. Kyle, your line is now open. Please go ahead.

[Kyle Peterson, Needham]

Great. Thanks, guys. Good morning. I wanted to touch a little bit on some of the slower base growth that you guys called out in the latter part of June and in July. Is there any more specific color whether it’s been concentrating specific verticals or geographies or even kind of sub-sections of pyramid, any more color there would be really helpful?

[Peter Walker, Chief Financial Officer]

Yeah. Hey. Good morning, Kyle. Yeah. So we saw the reduced space really in the last half of June, continue in July, and then as Josh shared, overall revenues, we have seen pick up in August, that was broad-based in terms of where we saw the base declines and I think it’s very consistent with what you have 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.

[Kyle Peterson, Needham]

Okay. That’s helpful. And then I know you guys kind of touched on better win rates in the first half of this year. Just wanted to see, are you guys having better win rates specifically, again, maybe some of the smaller mom-and-pop or mid-market players, more than some of the larger competitors or these improved win rates, just across the Board in terms of what you guys are seeing in the first half of the year?

[Josh Peirez, Chief Executive Officer]

Hey, Kyle. Thanks for the question. I think, 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 are able to release enhancements and new code and constantly be innovating.

We think we are at the front end. So things like we just mentioned, the enhancements we have made to I-9 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 and our clients recognize that as do prospects.

And so when we get the opportunity to go and talk about a cross-sell/upsell opportunity or talk about a new business win, it doesn’t really matter who we are 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 the 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 space 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 there’s a lot of addressable market. We think people need our services more and more.

So we think that it’s a strong industry, there’s is a strong case for being very long on the background check and Identity Services industries. We also think we are 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.

[Kyle Peterson, Needham]

Got. That’s very helpful. Thanks, guys.

[Josh Peirez, Chief Executive Officer]

Thanks, Kyle.

[Operator]

Thanks, Kyle. Your next question comes from George Tong from Goldman Sachs. Your line is now open. Please go ahead.

[George Tong, Goldman Sachs]

Hi. 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 in cross-sell/upsell? And then also discuss assumptions around new customer growth in cross-sell/upsell in the second half of the year, that’s reflected in your guide. Are you assuming stable performance from 2Q or improved performance relative to 2Q?

[Josh Peirez, Chief Executive Officer]

Hey, George. It’s josh. Thanks for the questions. I think, first, I will take the second part of your question first and then maybe talk about the things that are driving it and the way we are doing it. But I think, as we have shared previously, our long-term goal on cross-sell and upsell is 4% to 5$. We are happy that we have been in that range both first quarter and 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/upsell through the year. So we are 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 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 7% by the end of the year, which is what we have previously shared.

In terms of how we go about selling, I think, there is 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 are 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, right now as clients are looking to control costs themselves, they really want 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 clients are consolidating around what they do and we are one of their providers today we are likely to get more and when someone is looking for a new provider, even if they are 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 is, I will put myself team up against any sales team in this business, we think that we have 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 the question or says, hey, can we do this, it’s something we have likely seen or done before with other clients and our tools are flexible enough to allow them to do that without us having to build a whole 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 almost 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 are start -- we are 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 are taking what we have learned and were able to use the experiences of these new clients to go after the base and help that to drive. So that we really do believe is a significant differentiator for us in new business, in cross-sell and upsell.

[George Tong, Goldman Sachs]

Got it. That’s very helpful context. And then with respect to margins, you are 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?

[Peter Walker, Chief Financial Officer]

Hey, George. Good morning. It’s Peter. Yeah. Happy to talk about that. So as we have discussed really there are three pillars to our cost optimization program. The first is our work in our product fulfillment areas and optimizing the global process there, the second is our virtual first model and 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 those saves, for the majority, they come through in the back half of the year. Of the saves generating that $10 million, that’s 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 in margins, right as we have guided Q3, we expect to come into a similar margin of Q2, which was a beat at 26.3% and then we expect margins to further expand in Q4 as revenues increase from new business cross-sell/upsell and we are lapping easier 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.

[George Tong, Goldman Sachs]

Got it. Very helpful. Thank you.

[Operator]

Thanks, George. Our next question comes from Scott Wurtzel from Wolfe Research. Scott, your line is now open. Please go ahead.

[Scott Wurtzel, Wolfe Research]

Thanks. Good morning, guys, and thanks for taking my questions. Maybe first on the -- you talked about on the margin profile for Identity and Post-Hire verification beating higher. I am just wondering what the drivers of that are. Is it because maybe there is -- with clients you are upselling to you are already there on the implementation side. So there’s lower costs or are there any other drivers there that’s producing a higher margin profile on those products?

[Josh Peirez, Chief Executive Officer]

Hey, Scott. Good morning. It’s Josh. So I think if you think about those products, in the case of the Identity solutions and use the U.S. as an example. We are working with ID.me. They have a database. They have the records. We are accessing it. The deal has been structured as a revenue share which we have previously provided to you.

But that’s really the extent of our costs, we are not having to go pull things from multiple places. We know exactly what is there and that is higher margin, there’s not a lot of SG&A for us to support that, because it’s a product that we are leveraging through the partnership that we have now renewed through 2028.

The Monitoring 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 court houses, those are going to have pass-through fees in the case of a verification, we are going to need to probably go to Equifax for the work number and that’s going to have a pretty hefty fee with it. In the case of drug and health screening, we are going to 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, have costs that as we have shared before equate to roughly 80% of our cost of revenues.

And in the case of the Identity offerings with ID.me and Yoti, 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 are able to access things that have been cultivated and managed more on an ongoing basis.

[Scott Wurtzel, Wolfe Research]

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 healthcare and talked about a little bit of softness in tech media and staffing. Just wondering if you could maybe give a little bit more color on some of the other verticals whether it’s financial, debt services, transportation, industrials, anything else would be helpful.

[Josh Peirez, Chief Executive Officer]

Yeah. Happy to. So, yeah, as we -- as I shared in prepared remarks, healthcare we are quite pleased with continuing year-over-year growth. That’s obviously been a strategic vertical for us in EMEA with continuing year-over-year growth in the quarter. Tech media we saw softness. Staffing we saw softness.

And then, 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.

[Scott Wurtzel, Wolfe Research]

Got it. That’s helpful. Thanks, guys.

[Josh Peirez, Chief Executive Officer]

Thanks, Scott.

[Operator]

Thanks, Scott. [Operator Instructions] Our next question comes from Shlomo H. Rosenbaum from Stifel. Your line is now open. Please go ahead.

[Adam Parrington, Stifel]

Hi. This is Adam on for Shlomo. The Post-Hire identity products now are 10% of revenue consistent with the first quarter. Is growth expected to accelerate further in that area or is growth in this area more steady as it has been, while the pre-screen business has been shrinking?

[Josh Peirez, Chief Executive Officer]

Hey, Adam. It’s Josh. Thanks for the question. I think what I would start with is, we have been seeing our Identity and Monitoring solutions have strong growth really since 2019 and as we have added new features and new functions and come out with better products like we did with the partnership with ID.me, like we did with the work that we have done to have a subscription-based Monitoring solution that we now have in market, we have seen that growth accelerated. We have shared some figures about that on our Q4 call and additionally on our Q1 call.

So we can -- 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 have 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 are pleased that we are at that point already.

I would note, particularly on the Identity side. Those are generally orders that are being combined with a background. So I think part of the that Peter was making, if you look at our 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 are pleased with where we are based on the fact that we think that overall ordering has been muted and nonetheless we are delivering at the high end of our cross-sell/upsell target and a strong amount of new business and again growth in new business in raw dollars from Q4 to Q1 to Q2, which is what we like to see.

[Adam Parrington, Stifel]

Okay. Thanks.

[Operator]

Thanks, Shlomo. We have no further questions. So with that, we can now conclude the call. Thank you all for joining. You may now disconnect your lines.