SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
| x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2002
OR
| o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number 0-26149
US SEARCH.COM INC.
| Delaware (State or other jurisdiction of incorporation or organization) |
95-4504143 (I.R.S. Employer Identification Number) |
5401 Beethoven Street, Los Angeles, CA 90066
(Address of principal executive offices, including zip code)
(310) 302-6300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) Yes x No o and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
There were 96,992,327 shares of outstanding Common Stock of the registrant as of November 1, 2002.
US SEARCH.COM INC.
Form 10-Q for the quarterly period ended September 30, 2002
INDEX
| Part I. | FINANCIAL INFORMATION | |||||
| Item 1. | Financial Statements | |||||
| Consolidated Statements of Operations for the three and nine month periods ended September 30, 2002 and 2001 | ||||||
| Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 | ||||||
| Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2002 and 2001 | ||||||
| Notes to Consolidated Financial Statements | ||||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | |||||
| Item 4. | Controls and Procedures | |||||
| Part II. | OTHER INFORMATION | |||||
| Item 1. | Legal Proceedings | |||||
| Item 2. | Changes in Securities and Use of Proceeds | |||||
| Item 3. | Defaults Upon Senior Securities | |||||
| Item 4. | Submission of Matters to a Vote of Security Holders | |||||
| Item 5 | Other Information | |||||
| Item 6. | Exhibits and Reports on Form 8-K | |||||
| SIGNATURES | ||||||
| CERTIFICATIONS | ||||||
| INDEX TO EXHIBITS | ||||||
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
US SEARCH.com Inc.
| Nine Months Ended | Three Months Ended | |||||||||||||||||
| September 30, 2002 | September 30, 2001 | September 30, 2002 | September 30, 2001 | |||||||||||||||
| (unaudited) | ||||||||||||||||||
Net revenue |
$ | 22,616,000 | $ | 14,464,000 | $ | 8,427,000 | $ | 4,517,000 | ||||||||||
Cost of services |
6,713,000 | 3,516,000 | 2,511,000 | 1,039,000 | ||||||||||||||
Gross profit |
15,903,000 | 10,948,000 | 5,916,000 | 3,478,000 | ||||||||||||||
Operating expenses: |
||||||||||||||||||
Selling and marketing |
8,887,000 | 7,703,000 | 2,974,000 | 2,456,000 | ||||||||||||||
Information technology |
2,611,000 | 3,395,000 | 674,000 | 1,024,000 | ||||||||||||||
General and administrative |
9,594,000 | 7,270,000 | 2,818,000 | 2,652,000 | ||||||||||||||
Total operating expenses |
21,092,000 | 18,368,000 | 6,466,000 | 6,132,000 | ||||||||||||||
Loss from operations |
(5,189,000 | ) | (7,420,000 | ) | (550,000 | ) | (2,654,000 | ) | ||||||||||
Interest expense, net (including non-cash charges
relating to warrants, beneficial conversion
features, and amortization of debt issuance costs
of $15,707,000 and $13,807,000 for the nine and
three months ended September 30, 2002,
respectively, and $948,000 and $92,000 for the
nine and three-months ended September 30, 2001,
respectively) |
(15,956,000 | ) | (897,000 | ) | (13,882,000 | ) | (96,000 | ) | ||||||||||
Other (expense) income, net |
(134,000 | ) | 26,000 | (140,000 | ) | 3,000 | ||||||||||||
Loss before income taxes |
(21,279,000 | ) | (8,291,000 | ) | (14,572,000 | ) | (2,747,000 | ) | ||||||||||
Provision for income taxes |
2,000 | 2,000 | — | — | ||||||||||||||
Net loss |
(21,281,000 | ) | (8,293,000 | ) | (14,572,000 | ) | (2,747,000 | ) | ||||||||||
Deemed dividend on exchange of preferred stock |
— | 12,575,000 | — | — | ||||||||||||||
Accretion of discount on preferred stock |
— | 203,000 | — | — | ||||||||||||||
Accrued preferred stock dividends |
— | 200,000 | — | — | ||||||||||||||
Net loss attributable to common stockholders |
$ | (21,281,000 | ) | $ | (21,271,000 | ) | $ | (14,572,000 | ) | $ | (2,747,000 | ) | ||||||
Net loss per share attributable to common
stockholders |
$ | (0.46 | ) | $ | (1.18 | ) | $ | (0.18 | ) | $ | (0.15 | ) | ||||||
Weighted-average shares outstanding used in per
share calculation |
45,809,470 | 17,968,189 | 83,298,856 | 18,025,816 | ||||||||||||||
The accompanying notes are an integral part of these statements.
3
US SEARCH.com Inc.
| September 30, | December 31, | ||||||||||
| 2002 | 2001 | ||||||||||
| (unaudited) | |||||||||||
ASSETS: |
|||||||||||
Current assets: |
|||||||||||
Cash and cash equivalents |
$ | 2,450,000 | $ | 3,148,000 | |||||||
Restricted cash |
1,055,000 | 750,000 | |||||||||
Accounts receivable, net of allowance for
doubtful accounts of $72,000 as of September 30,
2002 and $24,005 as of December 31, 2001 |
1,924,000 | 696,000 | |||||||||
Prepaids and other current assets |
1,393,000 | 1,854,000 | |||||||||
Total current assets |
6,822,000 | 6,448,000 | |||||||||
Property and equipment, net |
9,052,000 | 9,409,000 | |||||||||
Goodwill |
10,588,000 | 8,648,000 | |||||||||
Intangibles, net |
2,728,000 | 2,960,000 | |||||||||
Other assets |
249,000 | 270,000 | |||||||||
Total assets |
$ | 29,439,000 | $ | 27,735,000 | |||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY: |
|||||||||||
Current liabilities: |
|||||||||||
Accounts payable |
$ | 4,594,000 | $ | 7,182,000 | |||||||
Accrued liabilities |
1,890,000 | 1,930,000 | |||||||||
PRSI acquisition obligations, current portion |
528,000 | 902,000 | |||||||||
Bank debt, current portion |
1,185,000 | 1,375,000 | |||||||||
Notes payable, current portion |
50,000 | 3,896,000 | |||||||||
Capital lease obligations, current portion |
200,000 | 280,000 | |||||||||
Total current liabilities |
8,447,000 | 15,565,000 | |||||||||
Bank debt, net of current portion |
38,000 | — | |||||||||
PRSI acquisition obligations, net of current portion |
1,417,000 | 1,654,000 | |||||||||
Capital lease obligations, net of current portion |
9,000 | 156,000 | |||||||||
Other non-current liabilities |
5,000 | 5,000 | |||||||||
Total liabilities |
9,916,000 | 17,380,000 | |||||||||
Commitments and contingencies (Note 6) |
|||||||||||
Stockholders’ equity: |
|||||||||||
Preferred stock $0.001 par value; 1,000,000 shares
authorized, 0 and 203,113 shares issued and
outstanding at September 30, 2002 and December 31,
2001 respectively |
— | — | |||||||||
Common stock $0.001 par value; 300,000,000 shares
authorized; 96,992,327 and 26,183,058 shares issued
and outstanding as of September 30, 2002 and
December 31, 2001, respectively |
97,000 | 26,000 | |||||||||
Additional paid-in capital |
115,225,000 | 84,847,000 | |||||||||
Accumulated deficit |
(95,799,000 | ) | (74,518,000 | ) | |||||||
Total stockholders’ equity |
19,523,000 | 10,355,000 | |||||||||
Total liabilities and stockholders’ equity |
$ | 29,439,000 | $ | 27,735,000 | |||||||
The accompanying notes are an integral part of these statements.
4
US SEARCH.com Inc.
| Nine Months | ||||||||||
| Ended September 30, | ||||||||||
| 2002 | 2001 | |||||||||
Cash flows from operating activities: |
||||||||||
Net loss |
$ | (21,281,000 | ) | $ | (8,293,000 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: |
||||||||||
Depreciation and amortization |
2,295,000 | 965,000 | ||||||||
Non-cash interest expense and beneficial conversion feature |
15,707,000 | 948,000 | ||||||||
Change in assets and liabilities: |
||||||||||
Accounts receivable |
(1,228,000 | ) | (77,000 | ) | ||||||
Prepaid and other assets |
(10,000 | ) | (77,000 | ) | ||||||
Accounts payable and accrued expenses |
(2,434,000 | ) | (460,000 | ) | ||||||
Net cash used in operating activities |
(6,951,000 | ) | (6,994,000 | ) | ||||||
Cash flows from investing activities: |
||||||||||
Purchase of property and equipment |
(1,705,000 | ) | (3,615,000 | ) | ||||||
PRSI acquisition costs |
(220,000 | ) | — | |||||||
Net cash used by investing activities |
(1,925,000 | ) | (3,615,000 | ) | ||||||
Cash flows from financing activities: |
||||||||||
Increase in restricted cash |
(305,000 | ) | — | |||||||
Repayments of third party notes payable |
(586,000 | ) | (664,000 | ) | ||||||
Repayment of PRSI acquisition obligation |
(697,000 | ) | — | |||||||
Repayments of bank debt |
(309,000 | ) | — | |||||||
Repayments of capital lease obligations |
(227,000 | ) | (168,000 | ) | ||||||
Proceeds from bank financing |
— | 1,418,000 | ||||||||
Proceeds from notes payable, net |
10,233,000 | 10,000,000 | ||||||||
Debt issuance costs |
— | (256,000 | ) | |||||||
Proceeds from stock option exercises |
69,000 | 43,000 | ||||||||
Net cash provided by financing activities |
8,178,000 | 10,373,000 | ||||||||
Net decrease in cash and cash equivalents |
(698,000 | ) | (236,000 | ) | ||||||
Cash at beginning of period |
3,148,000 | 2,831,000 | ||||||||
Cash at end of period |
$ | 2,450,000 | $ | 2,595,000 | ||||||
Supplemental cash flow disclosure is comprised of: |
||||||||||
Cash paid for interest |
$ | 267,000 | — | |||||||
Non-cash investing and financing activities: |
||||||||||
Conversion of notes payable to preferred stock |
$ | — | $ | 10,000,000 | ||||||
Conversion of accounts payable to notes payable |
$ | — | $ | 285,000 | ||||||
Issuance of warrants in connection with convertible notes payable |
$ | 1,937,000 | $ | 250,000 | ||||||
Issuance of warrants to third parties |
$ | 228,000 | $ | 1,100,000 | ||||||
Goodwill recorded upon the resolution of purchase price contingencies |
$ | 1,720,000 | $ | — | ||||||
Conversion of notes payable and accrued interest to common stock |
$ | 14,746,000 | $ | — | ||||||
Beneficial conversion feature on convertible notes payable |
$ | 11,749,000 | $ | 445,000 | ||||||
The accompanying notes are an integral part of these statements.
5
US SEARCH.COM INC.
1. Organization and Business:
US SEARCH.com Inc. (the “Company”) provides individual reference services and background information about individuals. The Company was formed as a California S Corporation in 1994, and reincorporated as a Delaware corporation in April 1999. On December 28, 2001 the Company acquired all of the outstanding stock of Professional Resource Screening, Inc. (“PRSI”), which provides pre-employment screening services primarily to large corporations, including Fortune 1000 companies in the United States.
2. Summary of Significant Accounting Policies:
Basis of Presentation
These unaudited financial statements and accompanying notes prepared in accordance with instructions to Form 10-Q have been condensed and, therefore, do not contain certain information included in the Company’s annual financial statements and accompanying notes. Therefore, you should read these unaudited condensed financial statements in conjunction with the Company’s annual financial statements included in the annual report on Form 10-K.
The unaudited condensed financial statements reflect, in the opinion of management, all adjustments which are of a normal recurring nature, necessary to present fairly the financial position of the Company as of September 30, 2002, and the results of its operations for the three and nine month periods ended September 30, 2002 and 2001. Interim results are not necessarily indicative of results to be expected for a full fiscal year.
Principles of Consolidation. The financial statements include the accounts of US SEARCH.com Inc. and its wholly owned subsidiary. All material inter-company accounts and transactions have been eliminated in consolidation.
Net Loss Per Share
Basic net loss per common share is computed using the weighted average number of shares of common stock outstanding and diluted net loss per common share is computed using the weighted average number of shares of common stock and common equivalent shares outstanding. Common equivalent shares related to convertible preferred stock, convertible notes payable, stock options and warrants are excluded from the computation when their effect is anti-dilutive. As of September 30, 2002, stock options representing 19,757,470 shares of common stock and warrants representing 10,407,019 shares of common stock have been excluded from the calculation of diluted earnings per share because their inclusion would be anti-dilutive. As of September 30, 2001, stock options representing 13,237,561 shares of common stock and warrants representing 1,750,000 shares of common stock and 8,750 shares of preferred stock, have been excluded from the calculation of diluted earnings per share because their inclusion would be anti-dilutive. Also excluded at September 30, 2001 are 42,107,303 common shares that were issuable on conversion of Series A-1 convertible preferred stock.
Management’s Plans
Since inception, the Company has experienced negative cash flows from operations. The Company had a working capital deficit of $1,625,000 and an accumulated deficit of $95,799,000 as of September 30, 2002. Based on our current operating plans, management believes existing cash resources and cash forecasted by management to be generated by operations and potentially available from a renegotiated bank financing arrangement will be sufficient to meet working capital and capital requirements through at least the next twelve months. Management’s plans to attain profitability and generate additional cash flows include, increasing revenues from enterprise and consumer services, focusing on cost reductions and operational efficiencies to be derived from further deployment of US SEARCH’s technologies, and the launch of additional products. There is no assurance that management will be
6
successful with these plans. However, if events and circumstances occur such that US SEARCH does not meet its current operating plan as expected, and US SEARCH is unable to raise additional financing, US SEARCH may be required to reduce certain discretionary spending, which could have a material adverse effect on US SEARCH’s ability to achieve its’ intended business objectives.
Reclassifications
Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation.
3. Notes Payable:
In December 2001, the Company issued a $3,500,000 promissory note to Pequot Private Equity Fund II, L.P. (“Pequot”). The promissory note bore interest at a rate of eight percent (8%) per annum and, if not previously converted into common stock, was due and payable on December 20, 2002. This note and accrued interest automatically converted into 6,922,399 shares of common stock at the conversion price of $0.5292 on July 18, 2002.
In January 2002, the Company issued 8% Convertible Promissory Notes due January 17, 2003 in the aggregate principal amount of $4,600,000 and four year warrants to purchase up to an aggregate of 1,782,176 shares of common stock at an initial exercise price of $1.044 per share. These notes and accrued interest automatically converted into 9,143,182 shares of common stock at the conversion price of $0.5292 on July 18, 2002.
In March 2002, the Company issued 8% Convertible Promissory Notes due December 20, 2002 in the aggregate principal amount of $6,075,000 ($5,700,000 in proceeds net of issuance costs) and five year warrants to purchase up to an aggregate of 2,144,118 shares of our common stock at an initial exercise price of $1.044 per share. The Company also issued warrants to purchase 714,706 shares of common stock at an exercise price of $0.85 per share to the principals of the offering placement agent. These notes and accrued interest automatically converted into 11,798,470 shares of common stock on July 18, 2002.
In accordance with Accounting Principles Board Opinion No. 14 “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants”, the relative fair value of the warrants issued in conjunction with the December, January and March notes (the “Notes”) totaled $452,000 and $730,000 and, $892,000, respectively. Warrants issued to the placement agent had a fair value of $315,000. Such amounts were being recorded as interest expense over the terms of the notes. On conversion of the notes, on July 18 2002, the remaining unamortized discount relating to these warrants and issuance costs of $1.9 million was recorded as interest expense.
In July 2002, upon the conversion of the 8% Convertible Promissory Notes with an aggregate principal amount of $14,226,000, the Company recorded as additional interest expense a non-cash charge of $11,749,000 for a beneficial conversion feature (BCF) relating to the Notes. The BCF was computed based on the difference between the effective conversion price per share and the fair value of the common stock on the commitment date, multiplied by the number of shares into which the promissory notes were convertible, limited to the amount of proceeds allocated to the notes at the commitment date.
7
During July 2002, the Company entered into an agreement to settle a note payable for $525,000. The settlement agreement resulted in a gain of $61,000 which was recorded in the accompanying statement of operations during the three months ended September 30, 2002. As of September 30, 2002, the Company has repaid $300,000 of the amount due, and is obligated to repay the remaining $225,000 in monthly installments of $75,000 through December 2002.
4. Bank Debt
On August 7, 2002, the Company entered into an agreement with Comerica Bank to amend its loan and security agreement (“Amendment Number Two”). The Comerica facility was amended to reduce the revolving credit line to $1,000,000 from $3,000,000. Amounts under the borrowing base line may be advanced based on up to 80% of eligible receivables as defined in the agreement. Borrowings under the revolving credit line are due and payable on March 26, 2003. Total borrowings under the revolving credit facility totaled $1,000,000 at September 30, 2002.
Significant financial covenants with which the Company must comply include operating performance requirements, minimum EBITDA requirements and a debt/tangible net worth ratio. Additionally, in accordance with the terms of Amendment Number Two, the amount of unrestricted cash the Company must maintain on deposit with the bank was reduced from $1,250,000 to $250,000. As of September 30, 2002, the Company must also maintain deposits of approximately $800,000 with the bank as collateral for credit card processing and a standby letter of credit. Effective April 2002, the Company placed a $750,000 deposit with the bank to collateralize an outstanding standby letter of credit. The letter of credit and the required deposit is reduced by $83,333 per month and matures on November 30, 2002. The amount of the letter of credit and the collateral deposit at October 1, 2002 was $166,000. The Company was in compliance with or had received a bank waiver of covenants at September 30, 2002.
In connection with a previous amendment to the loan and security agreement, the Company agreed to issue the bank a warrant to purchase 55,487 shares of the Company’s common stock at an exercise price of $0.85 per share. The warrant expires on March 14, 2007. As a result of the issuance of the warrant, the Company recorded a non-cash charge of $24,000, which is included in debt issuance costs for the period ended September 30, 2002.
5. Capital Stock
During the nine months ended September 30, 2002, the Company issued to certain vendors a warrant, which matures March 5, 2007, to purchase 75,000 shares at an exercise price of $1.20 per share; and a warrant, which matures on January 3, 2005, to purchase 137,143 shares at an exercise price of $0.01 per share.
As of close of business on July 18, 2002, Pequot Private Equity Fund II, L.P., the holder of all 203,113 shares of Series A-1 Convertible Preferred Stock outstanding on that date, elected to convert all of its Series of A-1 Convertible Preferred Stock into Common Stock. The conversion price of the Series of A-1 Convertible Preferred Stock was $0.48237 per share, which resulted in the issuance of an aggregate of 42,107,303 shares of Common Stock upon conversion of the Series of A-1 Convertible Preferred Stock.
8
6. Commitments And Contingencies
Strategic Alliance Commitments
The Company has several cancelable and non-cancelable distribution and marketing agreements with various Internet companies. The terms of these agreements provide for varying levels of exclusivity and minimum and maximum fees payable based on the number of banners, buttons and text links displayed on affiliate web sites. At September 30, 2002, the minimum non-cancelable payments due under these agreements are approximately $825,000 for the remainder of 2002, approximately $3,300,000 for 2003, and approximately $550,000 for 2004.
The Company has entered into an agreement with a supplier of online public records data. At September 30, 2002, the non-cancelable payments under this agreement are $207,000 due in 2002 and $690,000 due in 2003.
Legal Proceedings
On April 3, 2000, a two count trade name and service mark complaint was filed against US SEARCH in the United States District Court for the Eastern District of Virginia, styled U.S. Search, LLC v USSearch.com Inc. Civil Action No. 00-554-A. On January 26, 2001, our motion for summary judgment was granted and the court ordered that both counts of plaintiff’s complaint be dismissed with prejudice. The Plaintiff has appealed the judgment to the U.S. Court of Appeals, Fourth Circuit. The hearing on appeal was held June 6, 2002. On August 16, 2002, the Court of Appeals affirmed the grant of summary judgment in favor of the Company.
In May 2001, ChoicePoint, Inc., the successor entity to DBT Online, Inc., filed a complaint against us in Palm Beach County, Florida alleging breach of contract, fraudulent misrepresentation, unjust enrichment, quantum meruit and breach of the implied covenant of good faith and fair dealing. The Complaint sought approximately $1.5 million in damages, as well as interest and attorneys’ fees. We removed this action to the United States District Court for the Southern District of Florida. The United States District Court for the Southern District of Florida ordered the matter to arbitration. An arbitration hearing was held in April 2002 and in June 2002 the arbitration awarded us a credit of $297,671 to be deducted from invoices of $1,418,731. ChoicePoint has filed a Motion to Confirm the Arbitration Award and we have filed a Motion to Modify and correct the Arbitration Award to provide additional credits. We are awaiting the District Court’s ruling on these motions. While awaiting a ruling on the motions, we paid $100,000 of the Award during the three months ended September 30, 2002. We have approximately $979,000 accrued for this liability at September 30, 2002. The costs related to this litigation to date have been less than $100,000. As of November 1, 2002 the Company had paid a total of $300,000 towards the settlement amount, resulting in an accrued liability of approximately $779,000.
On June 25, 2002, a complaint seeking $434,000 in damages was filed against Professional Resource Screening, Inc. in Superior Court of California, County of Contra Costa, styled Wood Warren & Co. v. Professional Resource Screening, Inc., No.C02-01816, alleging breach of an oral agreement relating to investment banking services, negligent misrepresentation, promissory estoppel, equitable estoppel and quantum meruit. Although it is too early to predict the outcome of this litigation, the Company believes it has meritorious defenses to plaintiff’s claims.
The Company may from time to time become a party to various legal proceedings arising in the ordinary course of business.
7. Unaudited Pro Forma Results of Operations for the Nine and Three Months Ended September 30, 2001
Unaudited pro forma consolidated results of operations are presented in the table below for the nine and three months ended September 30, 2001. The proforma results of operations reflect the acquisition of Professional Resource Screening, Inc., which are not reflected in the September 30, 2001 historical results, as if the acquisition was consummated as of January 1, 2001. Historical results for the nine and three months ended September 30, 2002, which include the results of Professional Resource Screening, Inc. for the entire period, are presented for comparability.
| Nine Months | Nine Months | Three Months | Three Months | |||||||||||||
| Ended | Ended | Ended | Ended | |||||||||||||
| September 30, 2002 | September 30, 2001 | |||||||||||||||