<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 June 30, 2000
or
[_] Transition Report Pursuant to Section 13 or 15(d)of the Securities Exchange
Act of 1934 for the transition period from __________ to __________
Commission File No. 0-26149
US SEARCH.COM INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4504143
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5401 Beethoven Street, Los Angeles, California 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 [_], and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
There were 18,258,244 shares of outstanding Common Stock of the registrant as of
August 13, 2000.
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US SEARCH.COM INC.
Form 10-Q for the quarterly period ended June 30, 2000
<TABLE>
<CAPTION>
INDEX Page Number
<S> <C> <C>
Part I. FINANCIAL INFORMATION 2
Item 1. Financial Statements 2
Balance Sheets as of June 30, 2000 and December 31, 1999 2
Statements of Operations for the six month
periods ended June 30, 2000 and June 30, 1999 3
Statements of Cash Flows for the six month
periods ended June 30, 2000 and June 30, 1999 4
Notes to Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures about Market Risks 20
Part II. OTHER INFORMATION 21
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3 Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
INDEX TO EXHIBITS 24
</TABLE>
1
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
US SEARCH.COM INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
-------------- ------------------
(Unaudited)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $ 8,987,000 $ 17,382,000
Restricted cash 2,200,000 2,000,000
Accounts receivable, less allowance for doubtful
accounts of $102,000 (2000) and $74,000 (1999) 89,000 131,000
Other current assets 1,178,000 3,608,000
------------ ------------
Total current assets 12,454,000 23,121,000
Property and equipment, net 3,570,000 2,218,000
Other assets 181,000 311,000
------------ ------------
Total assets $ 16,205,000 $ 25,650,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 8,444,000 $ 5,438,000
Accrued liabilities 1,731,000 623,000
Notes payable, current portion 29,000 25,000
Capital lease obligations, current portion 256,000 22,000
------------ ------------
Total current liabilities 10,460,000 6,108,000
Notes payable, net of current portion 1,000 15,000
Capital lease obligations, net of current portion 337,000 22,000
Other non-current liabilities 5,000 16,000
------------ ------------
Total liabilities 10,803,000 6,161,000
------------ ------------
Commitments and contingencies (Note 3)
Stockholders' equity:
Preferred stock, $.001 par value; authorized 1,000,000
shares; none issued and outstanding - -
Common stock, $.001 par value; authorized 40,000,000 shares;
issued and outstanding 18,258,244 (2000)
and 17,421,644 (1999) 18,000 17,000
Additional paid-in capital 55,153,000 53,790,000
Note receivable from officer (491,000) -
Unearned deferred compensation (380,000) (1,099,000)
Accumulated deficit (48,898,000) (33,219,000)
------------ ------------
Total stockholders' equity 5,402,000 19,489,000
------------ ------------
Total liabilities and stockholders' equity $ 16,205,000 $ 25,650,000
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
2
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US SEARCH.COM INC.
STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2000 1999 2000 1999
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Net revenues............................ $ 5,918,000 $ 3,983,000 $ 13,368,000 $ 7,279,000
Cost of services........................ 3,080,000 1,254,000 6,253,000 2,305,000
----------- ----------- ------------ ------------
Gross profit....................... 2,838,000 2,729,000 7,115,000 4,974,000
Operating expenses:
Selling and marketing.............. 7,552,000 4,111,000 14,997,000 6,840,000
General and administrative......... 4,307,000 1,748,000 8,188,000 2,594,000
Charge (credit) for compensation
related to stock options. 107,000 653,000 (10,000) 1,529,000
----------- ----------- ------------ ------------
Total operating expenses. 11,966,000 6,512,000 23,175,000 10,963,000
----------- ----------- ------------ ------------
Loss from operations............... (9,128,000) (3,783,000) (16,060,000) (5,989,000)
Interest income (expense).......... 155,000 (2,180,000) 382,000 (4,966,000)
Amortization of debt
issue costs................... -- (1,493,000) -- (3,096,000)
----------- ----------- ------------ ------------
Loss before income taxes. (8,973,000) (7,456,000) (15,678,000) (14,051,000)
Provision for income taxes......... 1,000 -- 1,000 1,000
----------- ----------- ------------ ------------
Net loss...................... $(8,974,000) $(7,456,000) $(15,679,000) $(14,052,000)
=========== =========== ============ ============
Basic and diluted net
loss per share................ $(0.50) $(0.75) $(0.88) $(1.44)
=========== =========== ============ ============
Weighted-average shares
outstanding used in per
share calculation............. 18,043,570 9,955,301 17,784,623 9,739,455
=========== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
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US SEARCH.COM INC.
STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................ $(15,679,000) $(14,052,000)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization................... 364,000 77,000
Provision for doubtful accounts................. 28,000 91,000
Charge for warrants and beneficial conversion
feature issued to majority stockholder......... - 4,639,000
Amortization (credit) of unearned
compensation................................... (10,000) 1,529,000
Amortization of debt issue costs................ - 2,546,000
Loss on disposal of
property and equipment......................... 147,000 -
Change in assets and liabilities:
Accounts receivable............................ 14,000 (88,000)
Accounts payable............................... 3,006,000 (482,000)
Accrued liabilities............................ 1,108,000 556,000
Prepaid and other.............................. 2,550,000 (2,372,000)
------------ ------------
Net cash used in operating activities............ (8,472,000) (7,556,000)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment.............. (1,165,000) (161,000)
Proceeds from disposal of property and
equipment...................................... 7,000 -
------------ ------------
Net cash used in investing activities............ (1,158,000) (161,000)
------------ ------------
Cash flows from financing activities:
Increase in restricted cash..................... (200,000) -
Repayments of line of credit.................... - (372,000)
Repayments of third party notes payable......... (10,000) (210,000)
Advances from related parties................... - 200,000
Repayments to related parties................... - (2,740,000)
Proceeds from warrant exercise.................. - 2,752,000
Proceeds from initial public offering........... - 36,263,000
Proceeds from convertible notes................. - 5,500,000
Repayments of capital lease obligations......... (156,000) (21,000)
Proceeds from stock option exercises............ 1,601,000 -
------------ ------------
Net cash provided by financing activities........ 1,235,000 41,372,000
------------ ------------
Net decrease in cash and cash equivalents........ (8,395,000) 33,655,000
Cash at beginning of period...................... 17,382,000 99,000
------------ ------------
Cash at end of period............................ $ 8,987,000 $ 33,754,000
============ ============
Non cash investing and financing activities:
Conversion of notes payable to common stock..... - 5,500,000
Capital lease obligations....................... 703,000 -
Exercise of stock options through issuance
of note receivable 491,000 -
</TABLE>
The accompanying notes are an integral part of these statements.
4
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US SEARCH.COM INC.
NOTES TO FINANCIAL STATEMENTS
(unaudited)
1. Organization and Business:
US SEARCH.COM Inc. (the "Company") provides individual, corporate and
professional clients with a single, comprehensive access point to a broad range
of individual reference services and background screening services. Individual
reference services include personal identifying information about individuals
that can be used to identify, locate or verify the identity and background of an
individual. The Company was formed as a California S Corporation in 1994, and
reincorporated as a Delaware C Corporation in November 1997.
In June 1999 the Company completed its initial public offering and sold
4,500,000 shares of common stock raising net proceeds from the offering of
$36,109,000. The Company's shares are now traded on the NASDAQ national market
system under the symbol "SRCH".
2. 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.
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 June 30, 2000, and
the results of its operations for the three and six month periods ended June 30,
2000 and 1999. Interim results are not necessarily indicative of results to be
expected for a full fiscal year.
Restricted Cash
As of June 30, 2000, $2,200,000 was pledged as collateral principally in
connection with an outstanding letter of credit relating to a building lease
agreement.
Net Loss Per Share
Basic net loss per common share is computed using the weighted average number
of shares of common stock 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 stock options
and warrants are excluded from the computation when their effect is
antidilutive. As of June 30, 2000 the number of stock options that were
antidilutive amounted to 4,404,607. As of June 30, 1999, there were 1,548,678
options which are excluded from the computation of diluted earnings per share
because their inclusion would have been antidilutive.
5
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US SEARCH.COM INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(unaudited)
3. 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. The Company also has committed to purchase television
advertising from various media companies. At June 30, 2000, the minimum non-
cancelable payments due under these agreements are approximately $5,685,000 for
the remainder of 2000, $3,920,000 for 2001 and $1,000,000 for 2002.
Purchase Commitments:
In July 1999, the Company entered into an agreement with a supplier of online
information services data pursuant to which the Company has committed to
purchase approximately $20 million worth of such data and information over a
five and one-half year term. The minimum non-cancelable payments due under this
agreement are $1,500,000 for the remainder of 2000, $3,600,000 for 2001 and
$4,200,000 for 2002-2004.
Lease Agreement
In September 1999, the Company entered into a five-year lease for a 52,500
square foot facility located in the Marina Del Rey area of Los Angeles,
California. Under the terms of the lease agreement, the Company is committed to
make total rental payments of $4.8 million over the remaining term of the lease.
4. Stock Options:
During the quarter ended June 30, 2000, 1,264,000 options were granted
pursuant to the 1998 Stock Incentive Plan, at an average exercise price of $2.14
and 462,500 options were granted pursuant to the 2000 Stock Incentive Plan at an
average exercise price of $1.53. During the quarter ended June 30, 2000, 323,600
shares were exercised at an average exercise price of $1.55. As of June 30,
2000, there were 4,404,607 options outstanding of which 170,839 were
exercisable.
In May 2000, the Company received from its president and chief executive
officer a recourse note receivable of $491,000 in connection with the exercise
of options to purchase 320,000 shares of the Company's common stock.
5. Subsequent Events:
The Company is in advanced discussions with a strategic investor that may
result in an investment of up to $27.5 million, with $10.0 million anticipated
in August 2000 and the remainder of the investment to be made upon the Company
meeting certain financial performance objectives and satisfying certain other
conditions. Notification of the transaction has been sent to the Company's
stockholders. A term sheet for the financing has been signed with the
transaction subject to completion of definitive documentation. In the event that
the transaction is completed, the Company's majority stockholder's ownership
interest will be significantly diluted.
6
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO
THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH
FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND
PROJECTIONS ABOUT THE COMPANY'S BUSINESS, MANAGEMENT'S BELIEFS AND ASSUMPTIONS
MADE BY MANAGEMENT. WORDS SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS,"
"BELIEVES," "SEEKS," "ESTIMATES," "LIKELY," VARIATIONS OF SUCH WORDS AND SIMILAR
EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE
STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN
RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT; THEREFORE,
ACTUAL RESULTS AND OUTCOMES MAY DIFFER MATERIALLY FROM WHAT IS EXPRESSED OR
FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES
INCLUDE THOSE SET FORTH BELOW UNDER "FACTORS AFFECTING OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION" AND ELSEWHERE IN THIS REPORT AS WELL AS THOSE
NOTED IN OUR ANNUAL REPORT ON FORM 10-K (FILE NO. 0-26149) AND OUR OTHER PUBLIC
FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. THE COMPANY UNDERTAKES NO
OBLIGATION TO UPDATE PUBLICLY ANY FORWARD- LOOKING STATEMENTS, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. FACTORS THAT COULD CAUSE
OR CONTRIBUTE TO THESE DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN THE SECTION TITLED "FACTORS AFFECTING OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION" IN THIS REPORT.
Overview
We provide individual, corporate and professional clients with a single,
comprehensive access point to a broad range of individual reference services and
background screening services. Individual reference services include personal
identifying information about individuals that can be used to identify, locate
or verify the identity and background of an individual. Our services can be
accessed through our Web site, http://www.ussearch.com, or by calling our toll
free telephone number, 1-800-USSEARCH.
We generate revenues by performing individual reference search services for
clients. Our services include individual locator, individual profile report,
employment screening, nationwide court record search, real property, criminal
conviction and other related information search services. Individual locator
services provide clients with the address and listed phone number for
individuals, as well as, where applicable, date of death, and the city, state
and zip code where the death benefits were issued. Our Internet-based "Instant
Searches" provide a subset of this information in a completely automated fashion
and at a lower price. Individual profile report services provide clients with
the first and last name, alias, current and previous address, listed phone
number, vehicle ownership where permitted by law, bankruptcy, property
ownership, nationwide court record and corporate affiliation information about
an individual into a single report. The typical time required to complete a
search is one day to four weeks, with "Instant Searches" requiring as little as
a few seconds or minutes. We publish the prices for our services directly on our
Web site and typically determine a client's manner of payment prior to beginning
the search process. Prices for our non-instant searches have ranged from
approximately $20 to $500 per search. Prices for "Instant Searches" have ranged
from approximately $5 to $10 per search. The prices for our services vary based
on the nature and amount of information and whether or not the search is
assisted by a search specialist.
We recognize revenue from our services when we deliver the results to our
clients. The terms of sale do not provide for refunds after our services have
been delivered, however, in instances where the clients indicate that the
initial search result was unsuccessful, we may perform another search or provide
a refund at our discretion. In addition, where clients desire additional
information they can request to broaden the scope of their "Instant Searches"
and we may apply a portion of the cost of the client's "Instant Searches"
towards the cost of the more comprehensive search.
We are expanding our available services to corporate and professional clients.
We expect a longer sales cycle as we collaborate with clients and educate them
on the use and benefits of our services. We expect our revenues in the future,
especially
7
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from corporate and professional clients, to be dependent in large part on our
ability to establish relationships with partners that integrate and market our
services as part of their own product and service offerings. We have little or
no influence over the marketing efforts of these partners and the success of the
products and services offered by them. Our partners are generally under no
minimum payment obligations. As a result, we have limited ability to evaluate
the success of our partnership efforts and predict the realization or timing of
any revenues from corporate and professional clients.
Our cost of services consists primarily of payroll expenses, data acquisition
costs, local and long distance telephone charges associated with providing our
services, and an allocable portion of network and technology infrastructure. Our
cost of services is likely to increase substantially as we obtain access to new
data and information sources and expand infrastructure to support an increase in
marketing and sales personnel to address existing and anticipated demand for our
services.
We have an agreement with a supplier of online information services data to
purchase approximately $20 million worth of such data over a five and one-half
year term. The minimum non-cancelable payments under this agreement are $1.5
million for the remainder of 2000, $3.6 million for 2001 and $4.2 million for
2002-2004.
Our operating expenses consist primarily of selling, marketing, general and
administrative expenses. We expect our operating expenses to continue to
increase substantially as we attempt to expand our sales and marketing force and
hire additional technology, administrative, sales, advertising, financial and
accounting personnel.
Selling and marketing expenses constitute the largest portion of our operating
expenses. Internet-based advertising expenses comprised over 47% of our total
operating expenses for the 3-month period ended June 30, 2000. Prior to the
introduction of our Internet-based services, advertising consisted primarily of
radio and television advertising. With the growth of our Internet-based
services, an increasing portion of our advertising expenses consists of
Internet-based advertising such as arrangements with Internet search engines and
popular Web sites. Production costs associated with such advertising are
expensed in the period first aired or displayed to the public. Costs relating to
actual airing or display of such advertising are expensed in the quarter the
advertising appears. We expect our selling and marketing expenses to increase as
we attempt to expand our sales to businesses and professionals. We plan to
target an increasing portion of our marketing and advertising programs and
related expenditures toward business and professional clients rather than
consumers.
We have non-cancelable advertising and marketing agreements with several
Internet companies. These agreements provide for varying levels of exclusivity
and require us to make monthly minimum payments based on the number of
impressions displayed on affiliate Web sites. The Company also has committed to
purchase television advertising from various media companies. As of June 30,
2000, the minimum non-cancelable payments required under these agreements are
approximately $5.7 million during the remainder of 2000, $3.9 million in 2001,
and $1.0 million in 2002.
Our general and administrative expenses consist primarily of compensation and
related costs for administrative personnel, fees for outside professional
advisors, our occupancy costs and other overhead costs. Under an administrative
services agreement that terminated on June 30, 1999, Kushner-Locke provided
human resources services, accounting services and management services. In
connection with this agreement, we paid Kushner-Locke a monthly fee of $35,000.
We have hired additional human resources, finance and accounting personnel to
replace the services provided by Kushner-Locke under this agreement. We expect
the trend of increased general and administrative costs to continue as we hire
additional technology personnel, as well as sales, marketing and executive
personnel to promote new services to corporate and professional clients.
We incurred significant net losses of approximately $399,000 in 1997, $6.8
million in 1998, $26.4 million in 1999 and $15.7 million for the six month
period ended June 30, 2000. At June 30, 2000, we had an accumulated deficit of
approximately $48.9 million. We expect to incur significant additional losses
and continued negative cash flow from operations for the foreseeable future.
We recorded a non-cash interest charge of approximately $4.6 million in the
first half of 1999 relating to the beneficial conversion feature of the
convertible subordinated note issued to the Kushner-Locke Company ("Kushner-
Locke") in January 1999. This charge was calculated using the deemed fair value
of common stock on the date each advance was made to us by subtracting the
conversion price and multiplying the resulting amount by the number of shares
into which the advance is convertible.
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The value assigned to the beneficial conversion feature was no greater than the
amount of each advance made under the convertible subordinated note.
We also recorded in the first half of 1999 a $2.5 million charge relating to
warrants issued to Kushner-Locke in January 1999. This charge represents the
deemed fair value of the warrants, which is the per share value derived by
applying the Black-Scholes option pricing model to our underlying shares of
common stock and multiplying that value by the number of shares of common stock
issuable upon exercise of the warrants.
Since the first quarter of 1999, we have granted certain stock options to
employees and non-employee directors and will continue to grant options under
the Amended and Restated 1998 Stock Incentive Plan and the 1999 Non-Employee
Directors' Stock Option Plan. We recorded unearned deferred compensation of
approximately $3.2 million, representing the difference between the deemed fair
value of our common stock for accounting purposes and the exercise price of such
options at the date of grant. This amount was recorded as a reduction of
stockholders' equity and amortized over the vesting period of the applicable
options. During the six months ended June 30, 2000, a credit was recorded to
deferred compensation to account for the cancellation of certain options granted
in 1999. As a result, we currently expect to amortize the remaining unearned
deferred compensation at June 30, 2000 as follows: $162,000 in the remainder of
2000; $185,000 in 2001; $32,000 in 2002; and $1,000 in 2003.
Results of Operations
Comparison of the Three Months Ended June 30, 2000 to the Three Months Ended
June 30, 1999
Net Revenues. Our net revenues increased from approximately 4.0 million for
three months ended June 30, 1999 to approximately $5.9 million for the three
months ended June 30, 2000, representing a 48% increase. The increase is
primarily attributable to an increase in the number of Internet-based
transactions which occurred as a result of increased web site visitor traffic.
The growth in Web site traffic was driven by increased advertising on a greater
number of Internet search engines and popular Web sites.
Gross Profit. Gross profit increased from approximately 2.7 million for the
three months ended June 30, 1999 to approximately $2.8 million for the three
months ended June 30, 2000, representing a 4% increase. Gross profit as a
percentage of net revenues was approximately 48% and 69% for the three month
periods ended June 30, 2000, and June 30, 1999, respectively. Cost of services
increased to approximately $3.1 million for the three months ended June 30,
2000, or 146%, from approximately $1.3 million for the three months ended June
30, 1999. As a percentage of net revenues, cost of services was approximately
52% and 31% for the three month periods ended June 30, 2000 and June 30, 1999,
respectively. Data acquisition and fulfillment costs as a percentage of revenues
increased due to the use of a higher cost, higher quality data provider for
certain products. Labor costs increased as a percentage of net revenues
primarily due to increased hourly wage rates and the growth in personnel
involved in handling the increased volume of service requests. In addition,
refunds increased as a percentage of gross revenues which decreased gross
profit. We encountered three major issues during the quarter which impacted our
results. The first related to interruptions of service by one of our data
providers that precluded us from offering certain of our search services, most
significantly our "rush" and certain "instant" search services. Second, the
Company experienced growth-related capacity and infrastructure problems. This
resulted in partial system interruptions and an inability to process some
customer orders. Third, the Company received a significant number of "make good"
(free) impressions by our advertising partners in the first quarter that were
not repeated in the second quarter.
Selling and Marketing Expenses. Selling and marketing expenses increased from
approximately $4.1 million for the three months ended June 30, 1999 to
approximately $7.6 million for the three months ended June 30, 2000. As a
percentage of net revenues, advertising and marketing expenses increased to
approximately 128% for the three months ended June 30, 2000, from approximately
103% for the three months ended June 30, 1999. This increase is primarily
attributable to an increase in the level of Internet-based advertising.
General and Administrative Expenses. General and administrative expenses
increased from approximately $1.7 million for the three months ended June 30,
1999 to approximately $4.3 million for the three months ended June 30,
2000. As a percentage of net revenues, general and administrative expenses
increased to approximately 73% for the three months ended June 30, 2000, from
approximately 44% for the three months ended June 30, 1999. This increase is
primarily attributable to the costs associated with hiring additional
management, technology and administrative personnel, as well as an increase in
rent expense.
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Charge for compensation related to stock options. During the three month
period ended June 30, 2000, a charge of approximately $107,000 was recorded in
connection with options granted in 1999 as compared to $653,000 for the same
period in 1999. We expect to incur charges of approximately $162,000 for the
remainder of 2000, $185,000 for 2001, $32,000 for 2002 and $1,000 for 2003 in
connection with these options.
Interest Income/Expense. Interest income, net of interest expense, increased
to $155,000 for the three months ended June 30, 2000 compared to interest
expense of $2.2 million for the three months ended June 30, 1999. For the three
months ended June 30, 2000, interest income was earned on the cash proceeds from
the sale of our common stock in the initial public offering, while no material
cash balances were available for investing during the three months ended June
30, 1999. Interest expense during the quarter ended June 30, 1999 contains $2.1
million of expense with respect to the beneficial conversion feature associated
with the convertible subordinated notes issued to Kushner-Locke in January 1999.
Comparison of the Six months ended June 30, 2000 to the Six months ended June
30, 1999
Net Revenues. Our net revenues increased from approximately $5.0 million for
the six months ended June 30, 1999 to approximately $13.4 million for the six
months ended June 30, 2000, representing a 84% increase. The increase is
primarily attributable to an increase in the number of Internet-based
transactions which occurred as a result of increased web site visitor traffic.
The growth in web site traffic was driven by increased advertising on a greater
number of internet search engines and popular web sites.
Gross Profit. Gross profit increased from approximately $5.0 million for the
six months ended June 30, 1999 to approximately $7.1 million for the six months
ended June 30, 2000, representing a 46% increase. Gross profit as a percentage
of net revenues was approximately 53% and 68% for the six months ended June 30,
2000 and the six months ended June 30, 1999, respectively. Cost of services
increased to approximately $6.3 million for the six months ended June 30, 2000
from approximately $2.3 million for the six months ended June 30, 1999. As a
percentage of net revenues, cost of services was approximately 47% and 32% for
the six months ended June 30, 2000 and the six months ended June 30, 1999,
respectively. Data acquisition and fulfillment costs as a percentage of revenues
increased due to the introduction of certain lower- priced public record report
products and the use of a higher cost, higher quality data provider for certain
products. Labor costs increased as a percentage of net revenues primarily due to
increased hourly wage rates and the growth in personnel involved in handling the
increased volume of service requests. In addition, refunds increased as a
percentage of gross revenues, which decreased gross profit due to the
implementation of new customer service policies.
Advertising and Marketing Expenses. Our advertising and marketing expenses
increased from $6.8 million for the six months ended June 30, 1999 to
approximately $15.0 million for the six months ended June 30, 2000. As a
percentage of net revenues, advertising and marketing expenses increased to
approximately 112% for the six months ended June 30, 2000, from approximately
94% for the six months ended June 30, 1999. This increase is primarily
attributable to the expansion of Internet-based advertising and increased
television promotional fee advertisements.
General and Administrative Expenses. Our general and administrative expenses
increased from approximately $2.6 million for the six months ended June 30, 1999
to approximately $8.2 million for six months ended June 30, 2000. As a
percentage of net revenues, general and administrative expenses increased to
approximately 61% for the six months ended June 30, 2000, from approximately 36%
for the six months ended June 30, 1999. This increase is primarily attributable
to the hiring of new management, technology and administrative personnel as well
as an increase in rent expense.
Charge for Compensation related to stock options. During the six month period
ended June 30, 2000, a credit of approximately $10,000 was recorded in
connection with stock options granted in 1999. The credit was recorded to
adjust for the cancellation of options issued in 1999 to a former employee. We
expect to incur charges of approximately $162,000 for the remainder of 2000,
$185,000 for 2001, $32,000 for 2002 and $1,000 for 2003 in connection with these
options.
Interest Income/Expense. Our interest income increased to $382,000 for the six
months ended June 30, 2000, compared to interest expense of $5.0 million for the
six months ended June 30, 1999. Included in interest expense for the six months
ended in June 30, 1999 is approximately $4.6 million relating to the beneficial
conversion feature on the convertible subordinated note issued to Kushner-Locke.
In addition, the interest expense for the six months ended June 30, 1999 also
includes interest on outstanding short term and long term debt, and other inter-
company advances from Kushner-Locke.
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Amortization of debt issue costs. In connection with the convertible
subordinated note issued to Kushner-Locke, we granted to Kushner-Locke warrants
to purchase 906,782 shares of our common stock. Relating to these warrants we
have recorded a non-cash charge of $2.5 million that we have amortized over the
six month period that the convertible subordinated note was outstanding. Also,
the $5.5 million convertible subordinated note included a $550,000 origination
fee payable to Kushner-Locke, which was fully amortized over the same six month
period.
Income Taxes. As of December 31, 1999 we had approximately $23.8 million of
federal and $13.7 million of state net operating loss carryforwards to offset
future taxable income. Our net operating loss carryforwards expire beginning in
2017 for federal and 2002 for state. Our ability to utilize net operating loss
carryforwards may be limited in the event that a change in ownership, as defined
in the Internal Revenue Code, occurs in the future. We have recorded a full
valuation allowance against our deferred tax assets as we believe that it is
more likely than not that the deferred tax assets will not be realized based
upon our expected future results of operations.
Liquidity and Capital Resources
Cash and cash equivalents decreased from $17.4 million at December 31, 1999 to
$9.0 million at June 30, 2000 (excluding $2.2 million of restricted cash pledged
as collateral principally in connection with our new building lease), primarily
as a result of operating losses.
Cash used in operations increased from $7.6 million for the six months ended
June 30, 1999 to $8.5 million for the six months ended June 30, 2000. This
increase is primarily attributable to increased expenditures on Internet-based
advertising and increased general and administrative expenses relating to the
hiring of executive personnel and the development of information technology
infrastructure.
Cash used in investing activities increased from $161,000 for the six months
ended June 30, 1999 to $1.2 million for the six months ended June 30, 2000. This
increase is primarily attributable to increased purchases of computer hardware
and software and other fixture and equipment in connection with our new
premises.
Cash provided by financing activities decreased from $41.4 million for the six
months ended June 30, 1999 to approximately $1.2 million for the six months
ended June 30, 2000. During the six months ended June 30, 2000, we received $1.6
million from the exercise of employee stock options, while during the six months
ended June 30, 1999 we received $36.2 million from the proceeds of our initial
public offering of common stock.
We are in advanced discussions with a strategic investor that may result in an
investment of up to $27.5 million, with $10.0 million anticipated in August 2000
and the remaining $17.5 million to be received at a later date if we meet
certain financial performance objectives and satisfy certain other conditions.
We have provided written notification of this proposed transaction to our
stockholders. If this transaction is completed, the percentage ownership of our
stockholders will be reduced, stockholders will experience dilution in net book
value per share, and the equity securities to be issued in connection with the
proposed transaction will have rights, preferences or privileges senior to those
of the holders of our common stock.
Since inception we have experienced negative cash flow from operations and
expect to continue to experience significant negative cash flow from operations
in the foreseeable future. We currently believe that our existing capital
resources together with the proceeds of our anticipated financing transaction
will be sufficient to meet our cash requirements through the next 12 months.
There is no assurance that this proposed financing will be consummated. In
addition no assurance is given that we will not be required to raise additional
financing prior to that time. There can be no assurances that additional
financing will be available when we need it or that, if available, the financing
can be obtained on favorable terms. If the financing is not available when
required or is not available on acceptable terms, we may be unable to develop or
enhance our services, take advantage of business opportunities or respond to
competitive pressures, any of which could have a material adverse effect on our
business and results of operations.
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FACTORS AFFECTING OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION
The following is a discussion of certain risks, uncertainties and other factors
that currently impact or may impact our business, operating results and/or
financial condition. Anyone evaluating us and making an investment decision with
respect to our Common Stock or other securities is cautioned to carefully
consider these factors, along with similar factors and cautionary statements
contained in our filings with the Securities and Exchange Commission.
We have incurred significant net losses and we may never achieve profitability
We incurred significant net losses of approximately $399,000 in 1997, $6.8
million in 1998, $26.4 million in 1999 and $15.7 million through the six months
ended June 30, 2000. As of June 30, 2000, we had an accumulated deficit of
approximately $48.9 million. We expect to incur significant additional losses
and continued negative cash flow from operations for the remainder of 2000. We
may never achieve profitability.
Our revenues and operating results may fluctuate significantly.
Our quarterly revenues and operating results have fluctuated in the past, and
may significantly fluctuate in the future due to a variety of factors, many of
which are outside of our control. These factors include:
. service interruption, delays and costs relating to expansion of our
networking infrastructure and facilities;
. fluctuations in the cost of television, radio, print and Internet-based
advertising;
. the inability to maintain or develop relationships with, or continue
advertising on, various key Internet companies and popular Web sites;
. delays and costs associated with unsuccessful service introductions;
. loss of or service interruptions from one or more of our database
providers;
. service interruptions from one or more of our credit card processing
companies;
. anticipating and responding to the introduction of new or enhanced
services by our competitors, or more generally to increase demand for
our services; and
. service interruption and delays or inability to access our services as a
result of problems with our internal hardware, software, and/or coding,
computer viruses, physical or electronic break-ins and similar
disruption.
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We face competition from many sources
The market in which we operate is highly competitive and highly fragmented.
Currently, our competition falls into four categories:
. free individual locator and information services, including services
offered by Internet search engines, telephone companies and other third
parties who publish free printed or electronic directories;
. fee-based Internet search services offering comparable services, such
as KnowX.com, which, during the quarter ending September 30, 1999 was
acquired by DBT Online, our primary data supplier; firms offering more
comprehensive data and information, and which are already serving the
business to business market, such as ChoicePoint, Inc., (which merged
with DBT Online); LEXIS- NEXIS, a division of Reed Elsevier Inc., The
Dun & Bradstreet Corporation, Equifax, Experian, Trans Union, Reuters
Limited and Avert, Inc.
. local, regional and national private investigation firms, such as
Kroll-O'Gara Company, Pinkerton, the Proudfoot Reports Division of ASI
Solutions, Inc., and a significant number of companies operating on
either a national scale or a local or regional basis.
Some of these competitors do not currently offer their individual reference
services or background checking over the Internet, but they may do so in the
future. There are no significant barriers that would prevent new companies from
entering the market in which we operate. In addition, some of our current
suppliers and companies with which we have advertising agreements may compete
with us in the future, which may make it more difficult to advertise our
services effectively on their Web sites.
We may be unable to respond to the competitive efforts of other companies
Many of our competitors have greater financial and marketing resources than we
do and may have significant competitive advantages through other lines of
business, their existing client base and other business relationships. These
competitors and other potential competitors may undertake more extensive
marketing campaigns, adopt more aggressive pricing policies and devote more
resources to developing information search services for individual or corporate
clients than we are willing or able to accomplish. Our competitors or potential
competitors may develop services that are superior to ours, develop services
less expensive than ours or that achieve greater market acceptance than our
services. We may not be able to successfully compete against our current or
future competitors with respect to any of these factors. As a response to
changes in the competitive environment, we may make pricing, service or
marketing decisions such as reducing our prices or increasing our advertising,
all of which may affect our operating results. If we are unsuccessful in
responding to our competitors, our business, financial condition and results of
operations will be materially adversely affected.
We are dependent on a limited number of third party database and other
information suppliers for information used in our services
We obtain data used in our services from a limited number of third party
suppliers. Some of these suppliers offer services that may compete with ours.
Our primary data supplier, DBT Online, acquired Know-X.com, which provides fee-
based internet search services comparable to some of our service offerings.
Moreover, DBT Online recently merged with ChoicePoint, Inc., one of our
competitors. If our current suppliers raise their prices, or if, due to
limitations or restrictions placed on a supplier by government regulations or
its own contractual arrangements, or for other reasons, the information they
provide becomes unavailable or unreliable, we may need to find alternative
sources of information. The time it takes to identify and contract with suitable
alternative data suppliers, as well as integrate these data sources into our
service offerings, could cause service disruptions, increased costs and reduced
quality of our services. Additionally, costs of obtaining data that may be
necessary in our new service offerings, such as criminal record searches, could
be significantly higher, on a per transaction basis, than our current
information costs. Termination of existing agreements, or, failure after
termination, to enter into new agreements with third party suppliers on terms
favorable to us, could have a material adverse effect on our business, financial
condition and results of operations. Additionally, failure to obtain the data
and information necessary for our intended service offerings at commercially
reasonable costs or at all could prevent us from offering these new services and
our business, financial condition and results of operations could be materially
adversely affected.
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We may incur liability based on consumer complaints.
A substantial amount of our business involves sales of services to consumers.
We have received customer complaints concerning the quality of our services
directly and have received inquiries from consumer agencies such as the Better
Business Bureau and state attorney general consumer divisions. We could in the
future experience similar complaints and inquiries from consumers and
governmental and consumer agencies. If we are unable to resolve existing and
future complaints and inquiries, we could be subject to governmental regulatory
action as well as civil liability. This could in turn have a material adverse
effect on our business, financial condition and results of operations.
Our business and financial performance may suffer if we are unsuccessful in
expanding our service offerings
Our strategy includes expanding the market awareness of our existing services.
We intend to offer a greater number of new services available through our Web
site and to develop and promote service offerings to address the needs of
corporate and professional clients. We have very limited experience in providing
services to corporate and professional clients. Attracting these clients will
require us to hire new sales and marketing personnel and spend money to develop
and promote these new services. We may fail in our efforts to provide these new
services in a timely and cost-effective manner. If individual or corporate
clients are unwilling to pay for the aggregation of data and information, or if
the market for our services fails to develop or develops more slowly than
anticipated, our business and prospects will be materially adversely affected.
Implementing these measures will substantially increase our operating expenses
and will place considerable strain on our existing management and operational
resources. We will incur a substantial portion of these expenses before we
achieve any meaningful revenues or market acceptance of new services. Our new
services may not achieve a sustainable level of market acceptance or ever become
profitable. If a new service is unsuccessful, our reputation and brand position
may be damaged and this may make it more difficult to sell our existing
services. A significant amount of our future growth depends on our ability to
offer these new services.
We depend on a limited number of service offerings for a significant portion of
our revenues
We have historically derived a substantial portion of our revenues from a
small number of service offerings, particularly our individual locator,
individual profile reports and "Instant Searches" services. If we are unable to
continue to offer these services or if our costs of providing these services
increase such that we can no longer offer these services at competitive prices,
our business and results of operations may be materially adversely affected.
We may need to raise additional capital that may not be available
Our existing capital resources may not be sufficient to meet our cash
requirements through the next 12 months. We may need to raise additional capital
and we may not be able to obtain additional financing on favorable terms, if at
all. If we cannot raise necessary additional capital on acceptable terms, we may
not be able to develop or enhance our services, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which could have a material adverse effect on our business and results of
operations. We are in advanced discussions with a strategic investor that may
result in an initial investment of up to $10.0 million in August 2000 and an
additional $17.5 million if we meet certain financial performance objectives and
satisfy certain other conditions. We have provided written notification of this
transaction to our stockholders. If this transaction is completed, the
percentage ownership of the stockholders of US SEARCH will be reduced,
stockholders will experience dilution in net book value per share, and these
equity securities will have rights, preferences or privileges senior to those of
the holders of our common stock. If additional capital is raised through a debt
financing, it may involve covenants limiting, or restricting our operations or
future opportunities.
We are dependent upon the success of the products and services offered by our
partners
In our efforts to increase the market acceptance of our services and to more
effectively market our services to corporate and professional clients, we intend
to continue to develop and establish relationships with key partners and enter
into affiliate and co-marketing programs. Our intent is that these partners will
promote our services or incorporate our services into their products and
services intended for the corporate and professional markets. We have little or
no ability to influence the marketing efforts of these partners and these
partners may fail to dedicate adequate resources necessary to successfully
develop and market products which incorporate our services. As a result, our
success in the corporate and professional market is dependent in part on factors
which are outside our control which include the performance of our partners and
the market acceptance of our partners' products and services.
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Agreements with partners may not result in any increase in our revenues or
improvement in our operations or financial conditions
Existing arrangements with partners, for example, those with NetHot
Development, BeFree and Employee Matters, generally do not contain minimum
purchase commitments or payment obligations. Similarly, new agreements with
additional partners may not contain any minimum purchase commitments or payment
obligations or may be limited to a pilot or test program. As a result, existing
agreements and new agreements, if any, with partners may not result in any
meaningful increase in our revenues, or any improvement in our operations or
financial condition.
We have substantial fixed costs which may not be offset by our revenues
A substantial portion of our operating expenses, such as costs relating to
management personnel, administrative support and our advertising agreements. Our
advertising is typically conducted under non-cancelable fixed term contracts. We
also have minimum payment obligations under the agreement with our key database
and information supplier. As a result, a substantial portion of our expenses in
any given period is fixed and based in part on our expectations of future
revenues and advertising and sales productivity. We may be unable to adjust our
spending in a timely manner to compensate for any unexpected revenue shortfall.
If we are unable to generate sufficient revenues to offset our advertising costs
or the minimum payment obligations under the agreement with our key database and
information supplier, or if we are unable to lower our advertising costs to
respond to lower than expected revenues, our results of operations will suffer
and the market price of our common stock could fall.
Our senior executive officers are relatively new to US SEARCH
Our Chief Executive Officer, Brent N. Cohen, joined US SEARCH in February
2000. In addition, several other members of our executive management team joined
us after March 1, 2000, and therefore may take some time to adequately
familiarize themselves with the nature of our business and operations. If these
executives are unable to learn about and adjust to our business quickly and
efficiently, our business and results of operations may be materially adversely
affected.
We depend on our marketing agreements with Internet companies
An important element of our current business strategy is to maintain
relationships with an increasing number of Internet search engines and popular
Web sites for advertising and to direct and attract traffic to our Web site.
Advertising on the Internet is expensive, new and evolving. The effectiveness of
Internet-based advertising is not clear. Under our marketing and advertising
agreements, we are typically required to make payments in advance of running ads
on a Web site. Internet companies display our text, banner or logo, often
referred to as "impressions," on their Web sites. These impressions may not lead
to sales of our services, and our payment is required whether or not the
advertising was effective. We may not be able to maintain our existing marketing
relationships with other Internet companies. We may also be unable to enter into
new marketing relationships with Internet companies, which generate adequate
returns to offset related costs. We currently anticipate that these expenses
will continue to constitute a significant portion of our total operating
expenses in future periods although we are examining various ways of controlling
these costs. Any termination of existing agreements or failure to enter into new
agreements with Internet companies on terms favorable to us, could have a
material adverse effect on our business, financial condition and results of
operations.
Our access to key Internet advertising depends on marketing agreements between
other Internet companies that are beyond our control
Advertising arrangements with one Internet company may provide us access to
another company's Web site. For example, our arrangement with Infospace provides
us with advertising within the white page directories of the AOL and Netcenter
Web sites, independent of any agreements with AOL or Netcenter. Our advertising
on these Web sites depends on the continued relationship Infospace has with
companies such as AOL and Netcenter. If this relationship is terminated for any
reason and if we are either unable to enter into an agreement with these
companies or unable to enter into an agreement with another company that has an
agreement providing access to AOL and/or Netcenter, our advertising will no
longer appear on their Web sites. This could significantly reduce our
advertising reach and, consequently, lower the number of potential clients
visiting our Web site which could in turn materially adversely affect our
business, financial condition and results of operations.
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Service interruptions may have a negative impact on our revenues and may damage
our reputation and decrease our ability to attract clients
We depend on the satisfactory performance, reliability and availability of our
Web site and telecommunications infrastructure to attract clients and generate
sales. Our revenues, reputation and brand would be harmed and the value of our
services to clients would be reduced if we experience technical difficulties
that result in slower response times, disruptions or unavailability of the
services. We have experienced unanticipated system interruptions in the past and
we believe that these interruptions may occur again in the future. For example,
we have experienced system disruptions and slower response times as we change or
upgrade the software and hardware running on our network. In addition, telephone
systems and networks are subject to unanticipated downtimes due to national
disasters, power outages and similar events. Our servers may be vulnerable to
computer viruses, physical or electronic break-ins and similar disruptions,
which could lead to interruptions, delays, loss of data or the inability to
accept and fulfill client orders. The occurrence of any of these events may have
a material adverse effect on our business, financial condition and results of
operations.
Our limited experience offering business services on the Internet could make it
difficult for us to expand this business
Our success and future growth depends on our ability to expand the nature and
number of our services offered on the Internet especially our business to
business product offerings. Initially, we offered our services primarily through
our toll free telephone number, 1-800 U.S. SEARCH. Since December 1998, we began
offering our Internet-based "Instant Searches." Additionally, we intend to
increase the number and range of business services and "Instant Searches"
available on our Web site. Our limited experience may make it difficult for us
to continually increase Internet traffic and transactions on our Web site. In
particular, it may be difficult for us to adequately predict business response
to our Internet advertising, causing us to spend more on Internet advertising
than planned. Our Internet advertising may also be ineffective in strengthening
our brand, increasing awareness of our business services, particularly our
business to business services, or generating additional traffic or sales. The
loss of one or more marketing relationships with Internet companies could
adversely impact our ability to generate additional traffic or sales. If we fail
to generate additional traffic, or if we fail to increase demand for our
Internet-based services as a result of any additional traffic, our business,
financial condition and results of operations could be materially adversely
affected.
If we are unable to expand and improve our infrastructure and operational
capacity, we will be unable to grow and our business and our financial condition
will suffer
The recent growth of our business has placed significant strain on our
communication and networking infrastructure. From time to time, demand for our
services following television or Internet-based advertising has exceeded our
infrastructure and operational capacity. Clients may experience delays during
times when demand for our services exceeds our operational capacity. These
instances are independent of any service interruptions related to disruption of
our Web site or other systems. For example, we have in the past experienced
longer response times to client telephone calls during periods of high calling
volume because we lacked adequate capacity through our telephone systems and
operations and support personnel to handle the increased number of calls.
Similarly, we have experienced slower Web site response times during periods of
high traffic because our Internet servers lacked adequate capacity. If these
events occur again, we may lose clients and our reputation may be damaged. This
growth has also increased the demands on our management team and technical,
sales and operational resources. We anticipate that continued growth will
require us to implement and improve our operational, financial and management
information systems. In addition, we are and will continue to invest in new and
expanded computer, telecommunication and information systems that address our
existing capacity constraints. We have relocated to a larger facility that
better addresses our operational and personnel needs. We have also added
executive personnel to manage our infrastructure. Significant improvements have
already been made to our infrastructure, including relocating our customer
facing data center to Exodus, upgrading our internal and external communications
capabilities and increasing capacity and redundancy in our SUN/Oracle
environment. As we offer new services and pursue corporate and professional
markets, we will need to increase our executive and sales and support personnel.
Our business and results of operations will be adversely affected if we are
unable to expand and continually improve our infrastructure.
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We may be subject to federal and state laws relating to the use of personal
information and privacy rights
Many privacy and consumer advocates and federal regulators have become
increasingly concerned with the use of personal information, particularly so-
called credit header information. For certain qualified business customers, we
use the social security numbers of individuals to search various databases,
including those of consumer credit reporting agencies. For example, we search
the "header" information contained in various consumer credit reporting
agencies' databases to find, among other items, current and previous addresses,
social security numbers used by an individual, or possible other names (such as
maiden names, married names, etc.). "Header" information consists of such
information as the name, social security number, date of birth, and current and
previous addresses on a consumer credit report. We also search these databases
to determine if a customer's social security number is being used by any other
party. Attempts have been made and can be expected to continue to be made by
various federal regulators and organized groups to adopt new or additional
federal and state legislation to regulate the use of personal information. If
federal and/or state laws are amended or enacted in the future relating to
access and use of personal information, in particular, and privacy and civil
rights, in general, there could be a material adverse effect on our business and
results of operations.
We have been a majority owned subsidiary of the Kushner-Locke Company and we may
fail to succeed as an independent operating company.
Peter Locke and Donald Kushner, the Co-Chairmen of US SEARCH, are also the Co-
Chairmen and Co- Chief Executive Officers of the Kushner-Locke Company
("Kushner-Locke"), which owns approximately 52.6% of the outstanding common
stock. If our financing transaction is completed, Kushner-Locke's ownership
interest will be significantly diluted. If the transaction is not completed,
Kushner-Locke may continue to have significant influence over us, giving
Kushner-Locke the ability to take a broad range of corporate actions without the
approval of the other stockholders, such as:
. electing a majority of our Board of Directors;
. removing any of our directors;
. amending our certificate of incorporation or bylaws;
. delaying or preventing a change in control, impeding a merger or other
business combination involving us; and
. otherwise controlling management and operations and the outcome of most
matters submitted for a stockholder vote.
Actions taken by Kushner-Locke could conflict with interests of other
stockholders. Also, as a result of Kushner-Locke's ownership and control, a
potential acquiror may be discouraged from attempting to obtain control of us
which could have a material adverse effect on the market price of our common
stock.
We depend on our key management personnel for our future success
Our success depends to a significant degree upon the continued contributions
of our executive management team and its ability to effectively manage the
anticipated growth of our operations and personnel. The loss of any members of
our management team and the inability to hire additional senior management, if
necessary, could have a material adverse effect on our business and results of
operations. In addition, increased costs of new personnel, including members of
executive management, could have a material adverse effect on our business and
operating results.
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We depend on attracting qualified employees and responding to employee turnover
for our success
As of June 30, 2000, we had 224 full-time employees and 36 part-time
employees. We anticipate that the number of employees may increase significantly
during the next 12 months as we expand our existing service offerings and
introduce and market new services to corporate and professional clients.
Competition for qualified employees is intense. Our success depends upon our
ability to attract and retain additional highly qualified technical, sales and
marketing personnel to support growing operations. The process of locating and
hiring personnel with the combination of skills and attributes required to carry
out our strategy is time-consuming and costly. Our success also depends on our
ability to effectively train and maximize the productivity of our existing and
future employees. We may also experience higher costs and possible disruption of
our business as we hire and train new personnel to replace those lost in the
ordinary course of our business or lost in an expansion or relocation of our
facility. The loss of key personnel or the inability to attract additional
qualified personnel to supplement or, if necessary, to replace existing
personnel, could have a material adverse effect on our business and results of
operations.
The Internet may fail to support the growth of electronic commerce
The rapid rise in the number of Internet users and the growth of electronic
commerce and applications for the Internet have placed increasing strains on the
Internet's communications and transmissions infrastructure. This could lead to
significant deterioration in transmission speeds and the reliability of the
Internet as a commercial medium and, consequently, could reduce the use of the
Internet by businesses and individuals. The Internet may not be able to support
the demands placed upon it by this continued growth. Any failure of the Internet
to support growth due to inadequate infrastructure or for any other reason would
seriously limit its development as a viable source of commercial and interactive
content and services. This could materially adversely affect the acceptance of
our services and our business.
Our success depends on our ability to protect and enforce our trademarks and
other proprietary rights
We rely on a combination of trademark, service mark, copyright and trade
secret laws, restrictions on disclosure and transferring title and other methods
to protect our proprietary rights. We also generally enter into confidentiality
agreements with our employees, business partners and/or others to protect our
proprietary rights. It may be possible for a third party to copy or otherwise
obtain and use our proprietary information without authorization or to develop
similar technology independently.
"1-800 U.S. SEARCH" and "Reuniting America Two People at a Time" are our
registered trademarks. In addition, we have applied for registered trademark
status for "US SEARCH", "The Public Record Portal" and our logo and service
marks in the United States and intend to pursue registration internationally
through applications. Effective trademark, service mark, copyright and trade
secret protection may not be available in every country in which our products
and services are made available, online or otherwise. Also, policing
unauthorized use of our trademark, service mark or other proprietary rights
might be difficult and expensive and we may be unable to protect our brand and
our trademarks from third party challenges. Our US SEARCH brand may suffer and
our business and results of operations could be materially and adversely
affected if we are unable to effectively protect or enforce our trademark,
service marks or other proprietary rights.
We may be unable to prevent third parties from developing Web sites and
acquiring domain names similar to ours
We have registered several domain names, including 1800USSEARCH.com and
ussearch.com. We know of at least one competitor that has a corporate name and
domain name similar to ours. This competitor also has a Web site with a similar
look and feel to our Web site. We believe that these similarities may cause
confusion on the part of potential clients, and this confusion may harm our
business and results of operations. We have sent several cease-and-desist
letters to this competitor and have engaged in settlement discussions. If these
discussions do not result in resolution, we may be required to file a law suit
to protect our interests. We may be unable to prevent third parties from
acquiring domain names that are similar to, infringe upon or otherwise decrease
the value of our trademarks and other property rights.
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We face significant security risks related to our electronic transmission of
confidential information
We rely on encryption and other technologies to provide system security to
effect secure transmission of confidential information, such as credit card
numbers. We license these technologies from third parties. Advances in computer
capabilities, new discoveries in the field of cryptography, or other events or
developments may result in a compromise or breach of the security measures used
by us to protect customer transaction data. If any compromise of our security
were to occur, it could materially adversely affect our reputation and business.
A party who is able to circumvent our security measures could misappropriate
proprietary information or cause interruptions in our operations and damage to
our reputation and customers' willingness to engage in electronic commerce on
our Web site. We may be required to expend significant capital and other
resources to protect against these security breaches or to alleviate problems
caused by these breaches. If our third-party contractors experience security
breaches involving the storage and transmission of proprietary information, such
as credit card numbers, our reputation may be damaged and we may be exposed to
risk of loss or litigation.
We face risks of fraud related to fraudulent credit card information and 900
telephone service
Like many other service providers who accept credit card or check-by-phone
checking account information without a signature over the telephone or Internet
or who provide 900 telephone service, we have issued credits as a result of
orders placed with fraudulent credit card information. We may suffer losses as a
result of fraudulent use of credit card information or the continued reliance on
900 telephone service in the future.
We could face liability based on the nature of our services and the content of
the materials that we provide
We may face potential liability from individuals, government agencies or
businesses for defamation, invasion of privacy, negligence, copyright, patent or
trademark infringement and other claims based on the nature and content of the
materials that appear on our Web site or in our search reports sent to
consumers. Although we carry a limited amount of general liability insurance,
our insurance may not cover claims of these types or may not be adequate to
indemnify us for all liability that may be imposed. In addition, this insurance
may not remain available to us on acceptable terms. Any imposition of liability,
particularly liability that is not covered by insurance or is in excess of our
insurance coverage, could have a material adverse effect on our reputation and
our business and results of operations.
We could face claims from clients or the subjects of our search reports that are
not covered by insurance
We could be held liable to clients and/or to the subjects of individual search
reports prepared by us for inaccurate information or misuse of the information.
We have internal practices designed to help ensure that information contained in
our services meet industry standards for accuracy. We have retained counsel to
ensure that we are in compliance with the Fair Credit Reporting Act and similar
state laws with respect to our pre-employment screening services. However, we do
not currently maintain liability insurance to cover claims by clients or the
subjects of reports. Based on our research, losses from these claims are either
uninsurable or the insurance that is available is so limited in coverage that it
is not economically practicable. We intend to continue our efforts to obtain
insurance coverage for these types of claims but adequate insurance coverage may
not be available on terms acceptable to us. Claims of violations of the FCRA or
similar state laws may be made against us in the future and the claims, if made,
may not be successfully defended. Uninsured losses from claims could materially
adversely affect our business and results of operations.
We face risks associated with government regulation and legal uncertainties
relating to the Internet
We are subject to regulations applicable to businesses generally and laws or
regulations specifically applicable to electronic commerce. Due to concerns
arising in connection with the increasing popularity and use of the Internet, a
number of new or changed laws, governmental policies and/or regulations may be
adopted, or cases may be decided, with respect to the Internet or commercial
online services covering issues such as property ownership, user privacy, libel,
pricing, acceptable content, copyrights, trademarks and/or other intellectual
property rights, distribution, taxation, access charges and other fees, and
quality of products and services. Cost increases relating to this government
regulation could result in these increased costs being passed along to Internet
end users and could dampen the growth in use of the Internet as a communications
and commercial medium, which could have a material adverse effect on our
business and results of operations.
19
<PAGE>
Our services may suffer as a result of natural disasters
Our ability to successfully receive and complete search requests and provide
high-quality client service largely depends on the efficient and uninterrupted
operation of our computer and communications hardware systems. Substantially all
of our computer and communications hardware is currently located at facilities
in Southern California, which is an area susceptible to earthquakes. Our systems
and operations may be vulnerable to damage or interruption from earthquakes,
fire, flood, power loss, telecommunications failure, break-ins and similar
events. We do not carry business interruption insurance sufficient to compensate
fully for all losses, and in some cases, any losses from any or all these types
of events.
Our certificate of incorporation, bylaws and Delaware law contain provisions
that could discourage a third party from acquiring us and consequently decrease
the market value of our common stock
Our certificate of incorporation grants our board of directors the authority
to issue up to 1,000,000 shares of preferred stock, and to determine the price,
rights, preferences, privileges and restrictions, including voting rights of
these shares without any further vote or action by the stockholders. In fact,
the Company is in advanced discussion on a financing arrangement that involves
the issuance of preferred stock. Since the preferred stock is contemplated to
and may be issued with voting, liquidation, dividend and other rights superior
to those of the common stock, the rights of the holders of common stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued. The issuance of preferred stock could have
the effect of making it more difficult for a third party to acquire a majority
of our outstanding voting stock which could decrease the market value of our
stock. Further, provisions in our certificate of incorporation and bylaws and of
Delaware law could have the effect of delaying or preventing a third party from
acquiring us, even if a change in control would be in the best interest of our
stockholders. These provisions include the inability of stockholders to act by
written consent without a meeting and procedures required for director
nomination and stockholder proposal.
Item 3. Quantitative and qualitative disclosures about market risk
We considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent In Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." We had no
holdings of derivative financial instruments at June 30, 2000 and our total
liabilities as of June 30, 2000 consist primarily of notes payable and accounts
payable which have fixed interest rates and were not subject to any significant
market risk.
20
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On April 3, 2000 a tradename and service mark complaint was filed against the
Company 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.
The complaint seeks injunctive relief, damages not less than $5 million, costs
and other further civil and equitable relief. The Complaint alleges violations
of the Lanham Act and common law unfair competition in that the Company's use of
the U.S. Search trade name and service mark created actual confusion or
likelihood of confusion. The Company has answered the complaint and filed
counterclaims against plaintiff U.S.Search LLC for infringement of a federally
registered trademark, false designation of origin under section 43(a) of the
Lanham Act and common law unfair competition. The Company believes the suit has
no merit.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual stockholders' meeting on May 31, 2000. The following
matters were voted on at the meeting:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1. Election of Directors
---------------------
Votes Cast
----------
Name of Director Elected For Against or Withheld
------------------------ --- -------------------
Nicholas Rockefeller 16,889,800 51,705
Harry B. Chandler 16,889,800 51,705
Name of Each Other Director
Whose Term of Office as Director
Continued After the Meeting
---------------------------
Peter Locke
Donald Kushner
Alan Mendelson
Brent Cohen
2. Approval of the Amendment to the Amended
----------------------------------------
and Restated 1998 Stock Incentive Plan
--------------------------------------
For Against Abstain No-Vote
--- ------- ------- -------
12,012,723 365,988 17,915 995,764
3. Ratification of PricewaterhouseCoopers LLP
------------------------------------------
as the Company's Independent Accountants
----------------------------------------
for the Fiscal Year Ending December 31, 2000
--------------------------------------------
For Against Abstain No-Vote
--- ------- ------- -------
16,902,075 33,475 5,955 995,764
</TABLE>
Item 5. Other Information
None
21
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation
3.1.1* Certificate of Amendment of Certificate of Incorporation, dated
May 12, 1999, changing corporate name to US SEARCH.com Inc.
3.2* Bylaws
4.1* Form of Common Stock Certificate
10.1** Employment Agreement, dated February 3, 2000, between US SEARCH
and Brent N. Cohen
10.2 US SEARCH.COM INC. 2000 Stock Incentive Plan
27.1 Financial Data Schedule
* Filed with the Company's Registration Statement on Form S-1, File No. 333-
76099, declared effective on June 24, 1999, incorporated herein by
reference.
** Filed with the Company's Annual Report on Form 10-K for the year ending
December 31, 1999, incorporated herein by reference.
(b) Reports on Form 8-K:
On August 3, 2000, the Company filed a Report on Form 8-K with the Securities
and Exchange Commission regarding notice to the shareholders that the Company is
pursuing a private placement financing.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US SEARCH.COM INC.
(Registrant)
Date: August 14, 2000 /s/ WILLIAM G. LANGLEY
William G. Langley
Vice President, Chief Financial Officer
(Principal Financial Officer)
Date: August 14, 2000 /s/ ALAN S. MAZURSKY
Alan S. Mazursky
Vice President, Finance
(Principal Accounting Officer)
23
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation
3.1.1* Certificate of Amendment of Certificate of Incorporation, dated
May 12, 1999, changing corporate name to US SEARCH.com Inc.
3.2* Bylaws
4.1* Form of Common Stock Certificate
10.1** Employment Agreement, dated February 3, 2000, between US SEARCH
and Brent N. Cohen
10.2 US SEARCH.COM INC. 2000 Stock Incentive Plan
27.1 Financial Data Schedule
* Filed with the Company's Registration Statement on Form S-1, File No. 333-
76099, declared effective on June 24, 1999, incorporated herein by
reference.
** Filed with the Company's Annual Report on Form 10-K for the year ended
December 31, 1999, incorporated herein by reference.
24
