HireRight - Q3 2022

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to HireRight Q3 2022 conference call. Joining today's call is the company's President and Chief Executive Officer, Guy Abramo, and Chief Financial Officer, Thomas Spaeth. At this time, all participants are in a listen-only mode. I remind everyone that management will refer to certain non-GAAP financial measures. An explanation and reconciliation of these measures to the most comparable GAAP financial measures is included in the press release issued today, which is available in the investor relations section of HireRight's website. Also, during this call, management's remarks will include forward-looking statements related to HireRight's market opportunities, customer retention, competitive differentiation, growth expectations, operational improvements, strategies to increase revenue and margins, growth prospects for industry sectors and our international business, labor market and economic trends, effects of macroeconomic uncertainty, future cash flows, and financial performance, including 2022 guidance.

Such statements are predictions and actual results may differ materially. Additional information concerning factors that could cause actual results to materially differ from those in forward-looking statements is contained in Form 10-K filed with the Securities and Exchange Commission, in particular in the sections of that document entitled Risk Factors, Forward-Looking Statements, and Management's Discussion and Analysis of Financial Condition and Results of Operations. Now it's my pleasure to turn the call over to Guy Abramo. Please go ahead.

Guy Abramo (President and CEO)

Thank you operator, and good afternoon, everyone. We're pleased to have you with us today as we celebrate one year as a public company and report another solid quarter of results in an increasingly uncertain environment. For this fiscal Q3, revenue was $210 million, an increase of $5 million over last year's solid results. Importantly, our strength reflects continued high client retention of 97%, increased upsells and package expansion to existing customers, new logo wins in our targeted end markets, and our team's commitment to growing our core verticals. Our account management and go-to-market teams have focused on developing new global client relationships while expanding existing relationships across all of our regions. I indicated on our last call that we expected to see more normalizing trends as the year progressed, and Q3 reflects just that.

It is our first year-over-year normalized results following the impact of the pandemic on prior quarterly results and demonstrates the demand for our high-quality solutions across all of our regions and verticals. We are pleased with the growth we were able to deliver notwithstanding the well-known macro headwinds. For example, even though order volumes in the U.K. were up 15%, the dramatic fall of the British pound had a nearly $2 million negative impact on revenue during the quarter, resulting in EMEA revenue being flat year-over-year. Also in the US, one of our largest customers discontinued their verification products due to a substantial price increase from one of our suppliers. This impact was approximately $6 million in the quarter.

Although the first half of the quarter saw continued strong order volumes, we began to experience a noticeable decline in volumes from many of our enterprise customers during the back half. Account reviews and ongoing dialogue with many of them are starting to reflect a genuine nervousness about the macro environment and its impacts on their own business outlooks. This uncertainty is causing some of our customers to slow the pace of hiring. To be clear, we are not observing a cessation in hiring, nor have we seen a significant drop-off in new business, and our pipeline remains very strong. Rather, the pace of hiring with existing customers has slowed, and we expect that pressure to be felt until such time companies have a more confident economic outlook. This macro slowdown will have an impact on the Q4 and therefore our guidance, which Tom will review in a minute.

However, make no mistake, our important initiatives to optimize long-term growth and enhance our margins are continuing at the same rapid pace. This includes upselling to existing customers, bringing on new logos, and growing our core verticals through new global client relationships and expanded business with existing clients. It also includes continued strong execution on our platform and fulfillment technology initiatives that I'll discuss in a moment. Turning to profitability in the quarter, we delivered a 5% increase in adjusted EBITDA versus the prior year period, with a 50 basis point increase in adjusted EBITDA margin. Our efficiency improvements, increased automation, and strict fiscal discipline drove these gains and improvement in adjusted margin. Quality and thoroughness in our investigations remain key selling points for us, particularly in our core markets that tend to be more demanding, and our single global platform and automation initiatives continue to be key differentiators.

This focus on speed, precision, and innovation played a significant role in adding 44 new logos. Most importantly, new logos in the quarter were distributed across all of our key focus verticals. As I have said repeatedly in previous calls, we are willing to prove to clients and prospects that our solutions will outperform anyone in the market. The key is to show that not all background checks and background screening companies are created equal, and none are more thorough than we are. Regarding our vertical and geographic success, healthcare has continued to be one of our strongest performers, growing nearly 11% over the prior year period. Transportation also showed strength during the quarter, growing more than 14% year over year. Turning to our international markets, where revenue growth was impacted by foreign currency fluctuations, particularly the weakness in the British pound.

As I said earlier, despite foreign currency headwinds, UK volumes grew 15% over the prior year. Canada also continues its strong year with 34% growth. While international growth has slowed similar to the U.S., our investments in our international operations positions us to be the global leader in the space where we continue to support our customers by leveraging our unified global platform. Lastly, I would like to provide an update on our platform and fulfillment technology initiatives. As a reminder, we partnered with a leading global IT services firm to streamline and automate our back-office fulfillment processes through the continued and expanded use of a full suite of automation technologies that will improve how we conduct a background screen.

Leveraging smart technology to identify, learn, and map all the variations of a specific search term with our industry-leading data assets reduces the number of manual data re-reconciliations, enabling us to continue to drive improvements in both quality and profitability. We are nearly a year into this competitively differentiating journey, and as I have said previously, we expect only modest financial benefit this year, with a ramping of savings beginning next year and benefits throughout 2023 and to 2024. In closing, we're pleased with today's results, given the backdrop of significant uncertainty around the broader future macro environment. The underlying demand for talent and our ability to cross-sell and add new customers gives us confidence in the long-term outlook and our ability to create significant shareholder value over time.

With that, I'll turn the call over to Tom for a closer look at our Q3 financial performance and our outlook for the balance of the year. Tom?

Thomas Spaeth (CFO)

Thank you, Guy. Good afternoon, everyone, and thank you for joining our call today. I am pleased to report we have delivered our sixth consecutive quarter of growth with revenues of $210 million in spite of macroeconomic headwinds, which started to impact ordering patterns towards the tail end of the quarter. Part of this impact included a nearly $2 million decrease in our international revenues resulting from the weakened pound. As Guy also mentioned, we had a $6 million negative impact from one of our customers discontinuing their verification program due to pricing increases from the leading employment verification vendor. This was a very isolated case as we have not seen other customers take similar actions. We continue to benefit from high retention rates and our ability to upsell existing customers while continuing to build a strong pipeline.

Gross retention year to date is 97%, while net retention sits at 117% year to date. As in previous quarters, our revenue growth is 100% organic. While we are actively evaluating M&A opportunities in the market, we continue to be disciplined in our approach. Diving deeper into Q3 revenue, despite some early signs of the macroeconomic slowdown, our healthcare vertical continued to outperform both industry and company averages and achieve double-digit year-on-year growth. Transportation, which had been the slowest of our core four verticals to recover from the pandemic, was our leading growth vertical during the quarter, growing 14%. While manufacturing distribution is not a core focus for us, that vertical also grew in excess of 13% during the quarter. Financial services showed modest growth.

However, it had particular exposure to the weakened pound, as we have tremendous market share among the large U.K.-based banks. Technology was the first vertical to demonstrate hiring softness, declining a few points year-over-year. Revenue from all core verticals of technology, healthcare, transportation, and financial services as a percentage of our total revenue dipped slightly during the quarter to 57%. Services and manufacturing and distribution each represented approximately 10% of revenue during the quarter. International markets began to show impacts from the macro changes sooner than the U.S. did, particularly in markets such as India, where many of our technology clients have a significant presence. This, coupled with the FX headwinds, led our international markets to slightly underperform the U.S. One continued bright spot in international markets was Canada, which continued to grow at double-digit rates.

One of the clear highlights of the quarter was our continued improvement in margin. Our focus on productivity improvements and cost control resulted in an adjusted EBITDA margin of 25.7%, a 50 basis point improvement over last year, and a 150 basis point improvement over Q2. The vast majority of our improvement is being driven at the gross profit or cost of service level. We continue to focus on delivering the important technology automation projects that Guy touched on earlier, in addition to driving cost improvements through the optimization of our onshore and offshore labor mix and increased focus on managing data costs. Gross margin, excluding depreciation amortization, was a multiyear high of 47.3%, an increase of 160 basis points over the prior year period.

Year-to-date gross margin now sits at 45.6%, and year-to-date adjusted EBITDA margin is 23.7%, an increase of 160 basis points versus the same period in 2021. It is important to note that gross margin improvements from the technology transformation are not tied to revenue growth. The streamlining of our fulfillment processes will drive future profitability and cash flow. Our variable cost structure enables us to flex our labor in response to any slowing market demand. As we demonstrated in the early days of the pandemic, we quickly reduced our direct costs in response to slowing demand, allowing us to minimize the impact on gross margin. Turning to SG&A. Expenses excluding stock-based compensation were down by $2 million from Q2. However, they were higher by $1.5 million versus Q3 2021.

This increase is largely due to higher personnel costs and higher public company expenses such as D&O insurance and accounting fees. Personnel-related costs for SG&A were relatively flat to Q2, however, up $3 million over the prior year period, reflecting our investments in technology and our go-to-market teams. Adjusted net income increased to $112 million, largely driven by the reversal of our tax allowance. This reversal is a non-cash transaction that resulted in a one-time benefit to income tax expense of $70 million. We do not anticipate a meaningful change in the effective current cash tax rate as the allowance will offset future U.S. cash taxes. Further, this release will not impact our TRA calculations and the timing of those projected payments.

In addition to the improvements we saw in our operating performance, we benefited from a reduction in interest expense, largely driven by our improved capital structure compared to a year ago. I would also like to provide some color on our cash flow and balance sheet. This is another area where we had delivered exceptional results with year-to-date operating cash flow of nearly $71 million, up from $19 million a year earlier. Excluding our technology transformation project, operating cash flow year to date would be more than $94 million. Year to date, free cash flow is approximately $58 million. As of the quarter end, we had no draws against our revolver and had approximately $702 million outstanding on our first lien loan.

Our leverage ratio now sits at 2.9 times, and we ended the quarter with $147 million of unrestricted cash on the balance sheet. Turning to our updated outlook for full year 2022. While our year-to-date performance has been strong, the macro environment has certainly softened in recent months, and there remains uncertainty around the length and depth of any potential recession. While we continue to hold to our long-term growth objectives for this industry and believe the secular changes we have discussed in labor markets will continue over the long term, there is clear softness and uncertainty as we stand here today.

With that in mind, we are updating our full year revenue guidance from a range of $820-830 million to a new range of $798-805 million. We are updating our adjusted net income guidance from a range of $130-140 million to a new range of $200-204 million inclusive of the tax adjustment. We are updating our full year adjusted EBITDA guidance from a range of $190-197 million to a new range of $178-185 million.

We are updating the corresponding adjusted diluted earnings per share guidance from a range of $1.64-$1.76 to a new range of $2.52-$2.57 per share. Both adjusted net income and adjusted diluted earnings per share include the impact of the $70 million reversal of our tax allowance made this quarter. I also want to note that the implied Q4 guidance reflects approximately another $6 million headwind from the aforementioned customer who discontinued verifications, as well as another roughly $2 million from FX headwinds, with the remaining year-over-year decline attributed to lower volumes resulting from the changes in the macro environment.

Finally, with respect to 2023 guidance, we are finalizing our 2023 operating budget, taking into consideration the headwinds of potential recessionary macroeconomic environment domestically and internationally, incremental interest rate actions by the Federal Reserve, quit rates, available job openings, and the pent-up demand for talent, and will provide full year 2023 guidance when we release our year-end results. However, I will comment that our commitment and focus on margin improvement will continue regardless of the demand environment, and much of the margin improvement actions we are taking through technology with our vendors and operations are not volume dependent. With that, operator, we can open up the call for questions.

Operator (participant)

Thank you. Ladies and gentlemen, if you'd like to register a question, please press the one followed by the four on your telephone. You will hear a three tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. Once again, to register for a question, please press the one followed by the four. Our first question comes from the line of George Tong with Goldman Sachs. Please proceed with your question.

George Tong (Managing Director and Senior Equity Analyst)

Hi. Thanks. Hi. Thank you.

Thomas Spaeth (CFO)

Hey, George.

George Tong (Managing Director and Senior Equity Analyst)

Good afternoon. Hi. You mentioned that, the business is progressing well. You're not really seeing any meaningful signs of slowdown. I guess if you look at the business and look at past downturns, where would you see it first? What are the leading indicators? What are the KPIs that you would watch for? Are there any such inflections that you're seeing in the business that might point to perhaps early signs of a moderation?

Thomas Spaeth (CFO)

George, we did mention that we are seeing signs of a slowdown. In fact, what we said specifically was in this quarter, Q3, the back half of the quarter, we started to see some volumes move downward, and are sort of projecting that through the Q4, which is why our annual guidance was moved down. But I can tell you it's an interesting trend because I would classify it as an inch deep and a mile wide, right? It's not a huge drop in volume. It's modest drops in volume, but it's modest drops in volume everywhere. In our conversations with our clients, what we're hearing is sort of what you saw today announced by, you know, Amazon and Lyft, is just general nervousness and outlook on macroeconomic conditions is making people adjust their hiring.

Guy Abramo (President and CEO)

For perhaps the rest of this year. That would certainly have an impact on the background screening industry as a whole.

George Tong (Managing Director and Senior Equity Analyst)

Right. You mentioned that certain verticals like healthcare, transportation, they're outperforming and doing really well. Are there any particular verticals that are doing less well and are lagging in performance?

Guy Abramo (President and CEO)

The one we highlighted was technology. You know, it's interesting because as I said on the call after Q2, we weren't even though there were reports in the media that technology was going to slow hiring, we were not seeing that in our volumes in the Q2. But in this quarter reported, we started to see a slowdown in ordering patterns. Again, across the board, I would tell you all the major technology players are clients of ours, and every single one of them had dips in their volumes.

George Tong (Managing Director and Senior Equity Analyst)

Great. Thank you.

Operator (participant)

Our next question comes from the line of Ashish Sabadra with RBC Capital Markets. Please proceed with your question.

Ashish Sabadra (Managing Director and Senior Equity Analyst)

Thanks for taking my question. I just wanted to focus on that $6 million impact. What I want to understand is that a quarterly or annual impact? Is the right way to think about the annual impact, would that be like, multiplying it by four times?

Guy Abramo (President and CEO)

Yeah. That was a quarterly impact, Ashish. You can't necessarily annualize it multiplying it by four because this particular customer has a little bit more volume weighted towards the second half of the year, including the Q3. Their peak tends to be Q3, Q4. While you can't necessarily multiply it by four, you know, you could probably multiply it by, you know, three in terms of an overall impact. There is some uncertainty involved in this as well, Ashish, in that they could start ordering verifications again. We're clearly working with them on alternative solutions. It's not that business is going to someplace else. They just decided to stop.

Ashish Sabadra (Managing Director and Senior Equity Analyst)

Right.

Guy Abramo (President and CEO)

That's why it would be difficult to project that move, moving forward. We do believe that that will be the case in the Q4.

Ashish Sabadra (Managing Director and Senior Equity Analyst)

Yeah. Okay. Thanks for that color. If I back in, even if I take the high end of your guidance range, both for revenue and EBITDA, on the revenue, and even if I add back that $6 million of a one-time impact and $2 million of FX effects, I get like revenues being down 8%. I understand you talked about some of the slowdown at the end of the quarter and slowdown in volume. Is my math right? Is that the right way to think about it? 12.5% or 8% excluding? Okay. Maybe just on the margin.

Sorry, one more on margins. Like, when I back it in, I get margins of 20.5%, which is down 100 basis points year-over-year. I would think that $6 million would be mostly pass-through revenue, so it shouldn't have impacted margins as much. Is that because of the revenue weakness that we are seeing, the impact on margins as well?

Guy Abramo (President and CEO)

Yeah. There's really two things going on there. One, historically, Q4 margins tend to be a little bit softer based on just the way the holidays, our staffing levels work, and the volumes flow through. That, that's clearly a driver of what you're seeing there. The second impact is just the overall volume decline that we're forecasting for Q4 based on the guidance and the implied guidance for Q4.

Ashish Sabadra (Managing Director and Senior Equity Analyst)

Okay. That's helpful. Thanks. Thanks for the color.

Operator (participant)

Our next question comes from the line of Kevin McVeigh with Credit Suisse. Please proceed with your question.

Kevin McVeigh (Managing Director)

Great. Thanks so much. You know, as we think about. I know you're not giving formal 2023 guidance, but is it fair to maybe annualize what the Q4 is kind of implied for 2023? I know there's some seasonality in there, things like that, but if we wanted to think about a potential range or, you know, are there other things to just call out? You know, obviously you've got the one client, some FX in there. I'd imagine the FX probably is a little bit more of a headwind beyond the $2 million. But just, you know, again, I know it's not kind of formal guidance, but is there any way to think about other puts and takes? Just to follow up with that, you know, the client, how are they doing it now? Is it you know, how are they doing those screens now?

Guy Abramo (President and CEO)

It's a full package that we have with this client, Kevin. Thanks for the question.

Kevin McVeigh (Managing Director)

Sure.

Guy Abramo (President and CEO)

They just decided to just stop doing verifications. We're still doing background screening and all the other things that we do. But verifying employment specifically has been stopped because of the significant price increase by a very well-known vendor. What they're doing is they're stopping it and then looking for an alternative solution that would likely run through us anyway. You know, your question on long-term guidance. There's a reason why we're not giving long-term guidance, right? The reason why, you know, what you see reflected in our rest of year guidance is us trying to trend line a phenomenon that's only existed for about five or six weeks, right?

As I characterize it as a, you know, maybe it's a half inch deep and a mile wide, and it's just difficult to say what that trend will be, you know, going out, heck, even going out the next several months, right?

Kevin McVeigh (Managing Director)

Right. Is there risk that other clients? Like, are there any other clients obviously, with this particular vendor, is there any other risk potentially of any other maybe $6 million clients out there or anything like that?

Guy Abramo (President and CEO)

No.

Kevin McVeigh (Managing Director)

You talked about the margin. No. Okay.

Guy Abramo (President and CEO)

No, no on the.

Kevin McVeigh (Managing Director)

All right. Thank you.

Guy Abramo (President and CEO)

Verification question.

Ashish Sabadra (Managing Director and Senior Equity Analyst)

Okay. Thank you.

Guy Abramo (President and CEO)

Thank you, Kevin.

Operator (participant)

Our next question comes from the line of Kyle Peterson with Needham. Please proceed with your question.

Kyle Peterson (Senior Analyst)

Hey, good afternoon, guys. Thanks for taking the questions. Just wanna get some clarity on the implied, you know, 4Q guide. It seems like at least in 3Q, you know, a lot of the weakness was kind of in the technology vertical. Is that where a lot of the kinda fallout in the guide, at least from the top line, is concentrated for 4Q? Or have you guys forecasted, you know, a more broad-based headwind in areas, you know, like healthcare, transportation, where they seem to be holding in pretty well right now?

Guy Abramo (President and CEO)

Hi, Kyle. Appreciate the question. So if you look at all of our verticals, I mean every one, you know, everything from energy, manufacturing, distribution, financial services, technology. The reason why I characterize this as an inch deep and a mile wide is we're seeing drops, modest drops in volume from almost everybody, right? Now, obviously, there's some clients that are up and some that are down, but as industries go, it's a very small number. Because it's across every industry, there's obviously gonna be an impact. So there's no trend in a specific industry other than of course, you know, quarter over quarter for the Q3, some industries outperformed others, but that was the Q3. We don't know what we're gonna see in the Q4. It's generally broad-based geographically as well. We're seeing it overseas as well.

Kyle Peterson (Senior Analyst)

Okay. That's helpful and that makes sense. Just a quick follow-up. I know you guys called out the one client on the verification side. Are you guys seeing really any other signs of trading down in screens, whether it's going shorter duration or less comprehensive outside of that one instance, kind of a lower ARPU, or is this purely a base growth volumes type of headwind?

Guy Abramo (President and CEO)

It's purely that. It's purely base growth.

Kyle Peterson (Senior Analyst)

All right. That's helpful. Thanks, guys.

Guy Abramo (President and CEO)

Thanks, Kyle.

Operator (participant)

Our next question comes from the line of Mark Marcon with Baird. Please proceed with your question.

Andre Childress (Analyst)

Hey, this is Andre Childress on for Mark Marcon. Thank you for taking our questions. So my first question is, you've said several times that you saw a modest drop that was pretty broad. I just wanna clarify. I assume that's sequentially, but there's a year-over-year rate is obviously exacerbated given the incredible comps as we rebounded from COVID last year. Is there any way to quantify that by either order volume or hiring trends, whatever it may be, throughout the quarter and into October thus far?

Guy Abramo (President and CEO)

Yes, I'll answer the first part of the question. That modest drop I talked about is sequentially. Think of it ending the Q3 coming into, you know, coming into the Q4.

Andre Childress (Analyst)

Yeah. Certainly the guidance that we've indicated earlier on the call reflects our latest thinking, obviously through October results, right? That is certainly baked into our guidance. It's reflected on a sequential, you know, basis from what we saw in Q3, you know, going into Q4. Great. Thank you. My other question, I know this is kind of a tough question because it's gonna be around historical recessions and each one varies dramatically. You gave some perspective in terms of how you're gonna manage your expenses. You know, we only have, you know, the financials in terms of what happened over COVID, and that was obviously a very unique recession. Assuming this environment continues and we do go into recession, how should we expect, you know, the revenue to trend?

Would it be kind of, you know, maybe less deep, but longer lasting than we experienced during COVID? Or is there any way, you know, we should think about that?

Guy Abramo (President and CEO)

I think when we get asked that question quite a bit, you know, Andre. You know, I think what one of the answers we say to people is, "When you've seen one recession, you've seen one recession," right? It certainly can't correlate this to something that we saw in COVID. We think that's an extreme. We certainly look back at the great financial crisis, but it was a very different business back in 2008 and 2009. You know, I think we're looking at when we go through our forecasting and budgeting for 2023. We're gonna certainly do some sensitivity planning. We certainly think by the time that we provide guidance, you know, sometime around the March framework, we'll have much better insight into how the year is gonna shape up.

Andre Childress (Analyst)

Thank you. That's great context. Actually just one more on top of that. So you talked about it from an expense perspective, but how should we think about the go-to-market and sales environment? I know you said that you haven't seen a slowdown in terms of, you know, your bookings or the pipeline. But assuming that happens among your enterprise, you know, clients and prospects, would you lean more heavily on cross-sell, up-sell, or what kind of is the go-to-market in a more challenged macro environment?

Guy Abramo (President and CEO)

Interesting. The one proxy we have is the pandemic. In pandemic we had a very, very strong sales pipeline, and new wins even during that time. We're not seeing a slowdown certainly in the opportunities that are in front of us. There's no slowdowns in the RFPs. There's no slowdowns in the wins that we have. We've got a very, very robust pipeline that is adding almost literally weekly. When I say pipeline, I mean both new logos, cross-sells, up-sells. We continue to have good, strong performance and we've made some investments on, in those.

Thomas Spaeth (CFO)

Teams over the last year to grow their numbers. We've, you know, we don't see that necessarily will be an impact.

Andre Childress (Analyst)

Great. Thank you so much for all the answers.

Thomas Spaeth (CFO)

Yep.

Operator (participant)

Our next question comes from the line of Andrew Nicholas with William Blair. Please proceed with your question.

Andrew Nicholas (Analyst)

Hi, good afternoon. I wanted to hone in a bit further on Q4 guidance. I understand that there were some modest declines sequentially as you moved through the quarter and you're embedding October results into that number. Is there anything you could say about kind of what you're assuming for the remaining two months of this quarter? Are you expecting continued deterioration? Just trying to get a sense for maybe the conservatism of what's in the outlook for Q4 or if things could kind of accelerate to the downside if conditions don't improve.

Thomas Spaeth (CFO)

Thanks, Andrew. We typically see some real seasonal impact in November and December anyway, so that's reflected clearly in the guidance, particularly because of the holiday seasons coming up and year-end activities, people tend to slow down hiring. That's certainly reflected in that. Historically, you know, what we've done is taken a look at kind of the month-over-month seasonal trending that we typically see year-over-year from our customers, and really are taking a look at that and basing it off of what we've seen in October so far and kinda extrapolating that into November, December, is generally the way we're coming up with the guidance.

Guy Abramo (President and CEO)

Yeah, the other side of that, Andrew, that I would tell you that in our conversations with our clients, their decisions to slow the pace of hiring seem to be more associated with just general uncertainty and nervousness about their business, not necessarily the actual performance of their business.

Thomas Spaeth (CFO)

Right.

Guy Abramo (President and CEO)

I would just you know classify the markets for you know for our clients to just be uncertain. That uncertainty, as it might with most companies, generally the first thing people do is maybe pause or slow down the pace of hiring because it's the ultimate controllable expense. Doesn't necessarily have to be long-lasting. I guess it's a roundabout way for us both to say, we don't know, but we used you know the trends that we have to make the best estimate we could.

Andrew Nicholas (Analyst)

Absolutely. That's helpful. Then, for my follow-up, I just wanna ask about capital allocation, given the interest rate environment and the debt schedule, the debt balances. Just wondering if that has evolved at all, recognizing you also want to probably keep some cushion given the macro headwinds. Just if you could update us on how you're thinking about, you know, leverage at this point in time, that'd be helpful. Thanks.

Thomas Spaeth (CFO)

No problem. No, no real change there. We continue to, you know, be very cost conscious when it comes to investing capital. In terms of acquisitions, obviously, we haven't been terribly acquisitive, and we'll continue to keep that type of discipline. We do certainly have a pipeline of opportunities we're looking at, but we are gonna be very mindful of the overall leverage ratio. You can see we're under three now, and I would expect to keep it in that level, or under that level, you know, for the time being, and don't foresee that changing. Really no change in our kind of focus in terms of capital allocation. Our single biggest, you know, capital priority right now relates to our technology automation program, and that is going full steam ahead.

Andrew Nicholas (Analyst)

Thank you.

Operator (participant)

Our next question comes from the line of Andrew Jeffrey with Truist Securities. Please proceed with your question.

Gus Gala (Equity Research Associate)

Hey, guys. It's Gus on for Andrew. Appreciate you taking our question. This question's for Guy. Appreciate the great color on margins and expense control. On the top line, would it kinda be fair to say that we need to revisit that long-term goal of 8%-10% growth? I appreciate this is likely an industry thing, but how do you think about this internally? Are we starting to realize the elevated employment velocity, like the checks per applicant, like quit levels, that will normalize the pre-pandemic levels? Or just I wanna parse out some of the drivers there.

Guy Abramo (President and CEO)

Yes, maybe let me talk about that from two points of view. One is just the fundamentals for our industry. None of that has changed, right? You still see the job openings and the quit rates and, you know, in the long term, those will continue to drive, we think, you know, good, healthy growth, you know, beyond what a, you know, traditional growth for the industry used to be. A big unknown, though, clearly for forward growth rates is just this recession and what impact it's gonna have.

Thomas Spaeth (CFO)

Yeah, I think long term, we don't change our view at all in terms of, you know, the fundamental changes in the labor market. You know, certainly they're gonna be disrupted for a period of time as people, you know, are uncertain about the outlook over the next number of quarters. You know, who knows if that's, you know, one quarter or five quarters, we don't know. We still feel really good about the long-term growth prospects. We know historically that this industry and this business grew at a nice solid 7% clip, and that was before all the fundamental, secular changes that we've seen in the labor market that we think are only gonna be additive in the next cycle.

Gus Gala (Equity Research Associate)

Great. Appreciate it. You know, it seems there's some share taking in healthcare and transportation, which is great to hear. Is any of that coming from larger competitors, or are we, again, just mostly coming from tier two and tier three?

Guy Abramo (President and CEO)

Well, we don't talk about, you know, where we take business from, but it's generally coming from the whole industry.

Devin Au (Equity Analyst)

Got it. Thank you.

Operator (participant)

Our next question comes from the line of Stephanie Moore with Jefferies. Please proceed with your question.

Stephanie Moore (Senior Equity Research Analyst)

Hi, good afternoon. Thank you. I guess touching on the Q4 guidance, I appreciate the, I think the puts and takes, particularly with the one customer and kind of that expected $6 million headwind. If you just take the, maybe the midpoint of the guidance and the implied, you know, let's just say high single-digit, top-line decline, can you kind of break out how you got to that number in terms of baking in new logos, cross-sells? You know, you were very clear that that the base business, you know, has deteriorated just given the macro environment. I'm trying to understand kind of some of the other offsets, you know, more so on the cross-selling and new logo front that remains, I think, pretty consistent here.

Guy Abramo (President and CEO)

Yeah, sure. Stephanie. We're not gonna deconstruct our guidance quarter by quarter, in terms of kind of the growth algorithm. We, as Guy remarked, are very, you know, comfortable and actually pretty excited about how our pipeline looks going into 2023. Some of that will close and go live in Q4. 2023 is shaping up as a pretty strong year from a new logo perspective. Excited about that, not only from a new logo, but also from an upsell opportunity.

Stephanie Moore (Senior Equity Research Analyst)

Great. Then switching gears, you noted, you know, continued to look to the M&A market as opportunities. In your opinion, and I know you said, you know, one recession is one recession, but would you view that a potential slowdown might actually be a favorable opportunity for maybe you can acquire a business that's smaller and struggling a bit more, but has still, you know, good assets and good customer contracts? Is that something that we could think that this could actually be a positive from an M&A standpoint if we do hit a slowdown?

Guy Abramo (President and CEO)

Yeah, I don't know that it's positive or negative in terms of our approach at M&A, Stephanie. We, you know, continue to look for businesses that fit either a product capability that we think is better to buy than build, or a geographic market where we want to expand some presence or some, you know, unique adjacency. Then just do the math on whether or not, you know, it's the right purchase for us. But I don't know that you would expect any more or less M&A activity out of us because of a, you know, moderate slowdown.

Stephanie Moore (Senior Equity Research Analyst)

Understood. Thank you.

Operator (participant)

Our next question comes from the line of Devin Au with KeyBanc Capital Markets. Please proceed with your question.

Devin Au (Equity Analyst)

Great. Thanks for taking our question here. Curious to hear about BackgroundChecks.com and what you're seeing in the SMB market. How is that platform performing in the past quarter, and are you seeing the same type of nervousness from that SMB customer segment?

Guy Abramo (President and CEO)

The SMB market, as we had mentioned on previous quarters, had been one of the slower ones to recover and frankly, was still kind of in recovery mode. What I would say is that nothing's really changed there. We still are, you know, slightly up on that sector of our business, but it's definitely been a lagging sector for us. Frankly, for the last 18 months, it's been the slowest to recover from the pandemic, and that hasn't changed.

Devin Au (Equity Analyst)

Okay. No, that's helpful. Maybe just one more. I want to ask about the pipeline that you're seeing. I know you said that, you know, it's still shaping up really nicely for 2023, and you expect some to go live in Q4. Are there certain industries that you're seeing maybe stronger pipeline development than other verticals at this point?

Guy Abramo (President and CEO)

For the most part, it's well within our wheelhouse. The core verticals that we focus on between, you know, tech, transportation, financial services, and healthcare. Pretty spread across.

Devin Au (Equity Analyst)

Okay.

Guy Abramo (President and CEO)

Yeah, it is. Yeah, pretty evened out.

Devin Au (Equity Analyst)

Okay. Got it. Thanks for the color.

Operator (participant)

Once again, as a reminder to register for a question, please press one followed by four. Our next question comes from the line of Manav Patnaik with Barclays. Please proceed with your question.

Ronan Kennedy (Equity Research Analyst)

Hi. How are you? This is actually Ronan Kennedy on for Manav Patnaik. May I confirm, you said that you don't feel that the fundamentals within the industry have changed. What's happened? Because it seems to have happened.

Guy Abramo (President and CEO)

I'm sorry, you're breaking up. If you can get a little closer.

Devin Au (Equity Analyst)

Yeah. Can't hear you.

Ronan Kennedy (Equity Research Analyst)

Hi, is that better?

Guy Abramo (President and CEO)

Yeah, much better. Thank you.

Ronan Kennedy (Equity Research Analyst)

Apologies. Thank you. You had said based on what you've seen, you don't think the fundamentals within the industry have changed with regards to the secular drivers. Has it changed your view on your visibility, you know, and what you see from the leading indicators, and how does that kind of reconcile with what we have been seeing from the jobs, the JOLTS data, et cetera?

Guy Abramo (President and CEO)

Yeah, look, it's a good question. I think, you know, as I said earlier, our view of the long-term fundamentals on the employment market are very bullish, for the reasons we discussed. What we're seeing right now, which is really, you know, a six week trend, right? It's a lumpy one, right? It's not necessarily this, you know, precipitous decline by any stretch of the imagination. But, you know, softness seems to be reflected in general nervousness about our clients' businesses. In prudence and them managing costs, they're slowing down their pace of hiring. It doesn't mean that the demand for jobs for those businesses isn't still there. It just means they're not filling those jobs, you know, for some period of time here.

It may be temporary, it may be a few quarters, you know, who knows? Right now, the visibility that we have is only born of the last six weeks and the conversations we've had with, you know, our top 100 enterprise clients who are all reflecting just that sense of uncertainty.

Ronan Kennedy (Equity Research Analyst)

Okay. Thank you. Then as a follow-up, if I may, what about in terms of the different products? I know you had commented on the one client, the $6 million no longer doing verifications, but what about, say, in terms of annual rescreens or the continuous monitoring or other things that there was good trends behind, such as inoculation management, immunization management? Are you seeing, you know, different rates of use of certain products and services and has there been any change to the economics or pricing of those?

Guy Abramo (President and CEO)

Yeah, no, not at all. In fact, all the products you just mentioned are, you know, part of the reason why our pipeline is as robust as it is. No impact on pricing that we've seen.

Thomas Spaeth (CFO)

The situation we described is very, very isolated.

Guy Abramo (President and CEO)

Yeah.

Thomas Spaeth (CFO)

The only reason why we mention it is 'cause of, with a larger customer.

Guy Abramo (President and CEO)

Yeah

Thomas Spaeth (CFO)

Had an impact.

Ronan Kennedy (Equity Research Analyst)

Got it. Thank you very much.

Operator (participant)

Mr. Abramo, there are no further questions at this time. I'll now turn the call back to you.

Guy Abramo (President and CEO)

All right. Thanks, operator. We appreciate everyone joining the call. Please don't hesitate to reach out with any additional questions, and we look forward to keeping you posted on our progress in the coming months. Thanks again. Everybody, stay safe and have a great night.

Operator (participant)

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a great day.