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Sterling Check Corp. (STER)·Q3 2023 Earnings Summary

Executive Summary

  • Q3 revenue of $180.6M declined 9.4% year-over-year; GAAP diluted EPS was $0.03 and Adjusted diluted EPS was $0.26. Adjusted EBITDA was $47.6M with a 26.3% margin, in line with expectations despite softer base volumes .
  • Management cut FY23 guidance: revenues to $720–$730M (from $760–$780M), Adjusted EBITDA to $186–$191M (from $198–$208M), and Adjusted Net Income to $95–$99M (from $106–$114M), citing macro-driven base volume weakness .
  • Base hiring volumes were weaker than anticipated in the back half of Q3; management disclosed base revenue down approximately 17% in Q3, but expects positive year-over-year total revenue growth in Q4 at the midpoint of guidance due to easier comps and ramping new wins .
  • Catalysts: guidance reset and CFO transition announced in late September; cost optimization ($10M savings in 2023; $25M annualized target) supports margin credibility; identity and post-hire solutions continue to gain traction, underpinning structural share gains .

What Went Well and What Went Wrong

What Went Well

  • Double-digit growth from new clients plus up-sell/cross-sell has been delivered in 12 of the past 13 quarters; Q3 saw increased win rates, more signed enterprise logos, and year-over-year improvement in retention .
  • Identity and post-hire solutions combined comprised more than 10% of revenue for the third consecutive quarter; active U.S. identity clients increased ~80% year-over-year and the U.S. identity pipeline more than doubled versus Q2 .
  • Cost optimization on track: Q3 Adjusted EBITDA margin held at 26.3% despite revenue shortfall; $10M 2023 savings and $25M annualized target progressing, setting up for margin expansion as base revenue inflects .

What Went Wrong

  • Base hiring volumes were weaker than expected in the latter half of Q3, driving base revenue down about 17% year-over-year for the quarter and necessitating the FY23 guidance cut .
  • Macro choppiness pressured several verticals (financial/business services, industrials, tech & media), offsetting strength in healthcare and EMEA .
  • GAAP profitability compressed: net income fell to $2.4M with a 1.3% margin versus $9.3M and 4.7% a year ago; interest expense increased year-over-year .

Financial Results

Revenue, EPS, and Margins vs Prior Periods and Estimates

MetricQ3 2022Q1 2023Q2 2023Q3 2023
Revenue ($USD Millions)$199.3 $179.3 $190.4 $180.6
GAAP Diluted EPS ($)$0.09 $0.01 $0.00 $0.03
Adjusted Diluted EPS ($)$0.29 $0.24 $0.28 $0.26
Net Income Margin (%)4.7% 0.3% 0.2% 1.3%
Adjusted EBITDA ($USD Millions)$53.1 $45.6 $50.0 $47.6
Adjusted EBITDA Margin (%)26.6% 25.4% 26.3% 26.3%
Consensus Revenue ($USD Millions)N/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailable
Consensus EPS ($)N/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailableN/A – S&P Global consensus unavailable

Note: Wall Street consensus from S&P Global was unavailable for STER; estimate comparisons could not be performed due to missing mapping in the S&P system.

Additional KPIs

KPIQ3 2022Q1 2023Q2 2023Q3 2023
Operating Income ($USD Millions)$20.0 $9.9 $8.8 $15.1
Free Cash Flow ($USD Millions)$35.5 $7.0 $16.7 $27.2
LTM Client Retention (%)———95% LTM; 96% in Q3
Net Leverage (x)—2.3x 2.4x 2.4x
Total Debt ($USD Millions)—$503.6 $501.7 $499.9
Cash & Equivalents ($USD Millions)—$51.0 $48.8 $49.9

Segment breakdown: quantitative segment revenue was not disclosed; management noted U.S. healthcare strength, EMEA-led international, and softness in financial/business services, industrials, and tech & media .

Guidance Changes

MetricPeriodPrevious Guidance (Aug 8, 2023)Current Guidance (Nov 8, 2023)Change
Revenues ($USD Millions)FY 2023$760–$780; (1.0%)–1.0% YoY $720–$730; (6.0%)–(4.5%) YoY Lowered
Adjusted EBITDA ($USD Millions)FY 2023$198–$208; 0%–5% YoY $186–$191; (6.0%)–(4.0%) YoY Lowered
Adjusted Net Income ($USD Millions)FY 2023$106–$114; 0%–7% YoY $95–$99; (11.0%)–(7.0%) YoY Lowered

Rationale: management cited weaker-than-expected base volumes in late Q3 and tempered expectations through Q4; inorganic contribution ~2.5% remains in FY guidance .

Earnings Call Themes & Trends

TopicPrevious Mentions (Q-2 and Q-1)Current Period (Q3 2023)Trend
Identity solutionsExtended exclusive ID.me partnership through 2028; overseas rollout with Yoti (Q2) . Emphasis on identity-first workflows (Q1) .Identity + post-hire >10% of revenue for third straight quarter; active U.S. identity clients up ~80% YoY; pipeline >100% vs Q2; Konfir partnership in U.K. announced .Strengthening adoption and expansion; accelerating pipeline.
Post-hire monitoringStrategic investment emphasis (Q1) .Subscription monitoring demand growing; strong opportunity in gig industry; differentiates via API-driven scale .Expanding use cases; rising demand.
Macro/base volumesExpectation of continued macro headwinds (Q1/Q2 guidance) .Base revenue down ~17% in Q3; softness broad-based; Q4 YoY revenue growth expected at midpoint due to comps .Macro still a headwind; comp-driven improvement expected.
Cost optimizationProgram underway; margin expansion targeted (Q1/Q2) .On track: $10M 2023 savings; $25M annualized target; Q4 adjusted OpEx projected to be lowest in 8 quarters .Executing; margin resilience improving.
M&A integrationSocrates and A-Check integrations progressing (Q1/Q2) .On track to complete: Socrates by YE23; A-Check by Q2’24; inorganic growth ~2.4% in Q3 .Steady progress; contributing to growth.
AI/automationFocus on automation and efficiency (Q1/Q2) .Implementing AI: intelligent document extraction (OCR), AI chatbots, developer productivity tools .Early deployment; potential cost and productivity gains.
Capital allocationBalanced priorities; leverage 2–3x target (Q2) .Buybacks ongoing ($20M in Q3); leverage 2.4x; willingness to adjust buybacks prudently .Opportunistic; maintaining balance sheet health.
Management changes—CFO transition announced late September; Interim CFO in place during search .Leadership transition managed.

Management Commentary

  • “We executed on the items within our control… and remained focused on optimizing the exit velocity and profitability of our business as we approach year-end.”
  • “Our Q3 adjusted EBITDA margin was in line with our prior expectations despite the revenue shortfall, a result we are very proud of… cost optimization efforts.”
  • “We are on track to deliver a $10 million savings in 2023 and our full cost savings target of $25 million in annualized savings.”
  • “We expect this partnership [Konfir] to transform employment verifications for Sterling U.K. clients by… greatly improving turnaround times.”
  • “Included in our total reported revenue guidance is approximately 2.5% of inorganic revenue growth… no material impact for foreign currency.”

Q&A Highlights

  • Base volumes: management disclosed base revenue down ~17% in Q3; no volume improvement yet in Q4 run-rate, but YoY decline moderates due to comps; Q4 expected to show positive total revenue growth .
  • New deals: Ramping in Q4; wins across competitors including mid-tier/smaller players as clients consolidate to single vendors with broader services; more than half of new deals include identity .
  • Cost levers: Additional automation and AI opportunities; COGS highly variable (data costs ~80%); Q4 adjusted OpEx expected to be lowest in 8 quarters .
  • M&A and valuations: U.S. tuck-ins less attractive on price; better opportunities internationally and in supply chain roll-ups; integrations of Socrates and A-Check on track .
  • Buybacks: Continuing opportunistically while maintaining 2–3x leverage target; $20M repurchases in Q3 .

Estimates Context

  • S&P Global consensus estimates for STER were unavailable due to a mapping issue; therefore, comparisons to Wall Street consensus for Q3 2023 revenue and EPS could not be performed. Management’s guidance revision and YoY comparisons versus Q3 2022 were used to contextualize performance .
  • Implication: Sell-side models likely moved lower post-print given the FY23 guidance cut and disclosure of weaker base volumes; watch for estimate revisions reflecting Q4 inflection from easier comps .

Key Takeaways for Investors

  • Guidance reset signals macro-driven demand softness in base hiring volumes; expect Q4 YoY revenue growth at guidance midpoint mainly on comps, not volume recovery .
  • Cost optimization is credible and progressing, underpinning margin resilience despite revenue pressure; $25M annualized savings target positions STER for margin expansion when volumes improve .
  • Strategic differentiation via identity and post-hire solutions is driving share gains; identity adoption rising sharply and partnerships (ID.me, Konfir) expand capabilities .
  • Inorganic growth contribution remains modest but steady; integrations on track and may add incremental cost synergies through mid-2024 .
  • Balance sheet supports flexibility: net leverage at 2.4x with ~$200M revolver availability; buybacks ongoing but disciplined .
  • Vertical mix matters: healthcare and EMEA strength partially offset broader softness in finance/business services, industrials, tech & media; investor focus should remain on mix shift and enterprise wins .
  • Near-term trading: narrative likely driven by estimate revisions on lowered FY guide and monitoring Q4 trajectory; medium-term thesis hinges on cost actions, identity/post-hire penetration, and eventual base volume normalization .

Additional Notes

  • Q3 2023 8-K press release and full financial statements read in full .
  • Q3 2023 earnings call transcript read in full –.
  • Prior quarters’ earnings press releases reviewed for trend analysis (Q2 2023 –; Q1 2023 –).
  • No additional standalone press releases for Q3 2023 were found beyond the 8-K exhibit; CFO transition was referenced in the Q3 call introduction .