<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 September 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, 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 [_], 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
November 13, 2000.
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US SEARCH.COM INC.
Form 10-Q for the quarterly period ended September 30, 2000
INDEX
<TABLE>
<CAPTION>
Page Number
<S> <C>
Part I FINANCIAL INFORMATION.............................................................................................. 2
Item 1 Financial Statements.................................................................................. 3
Balance Sheets as of September 30, 2000 and December 31, 1999......................................... 3
Statements of Operations for the Three and Nine month periods
ended September 30, 2000 and September 30, 1999 ...................................................... 4
Statements of Cash Flows for the Three and Nine month periods
ended September 30, 2000 and September 30, 1999....................................................... 5
Notes to Financial Statements......................................................................... 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................. 10
Item 3 Quantitative and Qualitative Disclosures about Market Risks........................................... 24
Part II OTHER INFORMATION
Item 1 Legal Proceedings..................................................................................... 25
Item 2 Changes in Securities and Use of Proceeds............................................................. 25
Item 3 Defaults Upon Senior Securities....................................................................... 27
Item 4 Submission of Matters to a Vote of Security Holders................................................... 27
Item 5 Other Information..................................................................................... 27
Item 6 Exhibits and Reports on Form 8-K...................................................................... 27
SIGNATURES.................................................................................................................... 29
INDEX TO EXHIBITS............................................................................................................. 30
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
US SEARCH.COM INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
(Unaudited)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $ 9,238,000 $ 17,382,000
Restricted cash 2,200,000 2,000,000
Accounts receivable, less allowance for doubtful accounts of $63,000 (2000) and
$74,000 (1999) 109,000 131,000
Other current assets 1,647,000 3,608,000
------------ ------------
Total current assets 13,194,000 23,121,000
Property and equipment, net 4,729,000 2,218,000
Other assets 182,000 311,000
------------ ------------
Total assets $ 18,105,000 $ 25,650,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 6,987,000 $ 5,438,000
Accrued liabilities 1,800,000 623,000
Notes payable, current portion 600,000 25,000
Capital lease obligations, current portion 266,000 22,000
------------ ------------
Total current liabilities 9,653,000 6,108,000
Notes payable, net of current portion 192,000 15,000
Capital lease obligations, net of current portion 278,000 22,000
Other non-current liabilities 4,000 16,000
Total liabilities 10,127,000 6,161,000
Commitments and contingencies (Note 3)
Mandatorily redeemable preferred stock $.001 par value; authorized 1,000,000
shares, 350,000 shares designated Series A; 100,000 shares issued and
outstanding (liquidation preference - $10,027,000)
5,968,000 -
Stockholders' equity:
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 60,154,000 53,790,000
Note receivable from officer (491,000) -
Unearned deferred compensation (29,000) (1,099,000)
Accumulated deficit (57,642,000) (33,219,000)
------------ ------------
Total stockholders' equity 2,010,000 19,489,000
------------ ------------
Total liabilities and stockholders' equity $ 18,105,000 $ 25,650,000
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
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US SEARCH.COM INC.
STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine months Ended
------------------ -----------------
September 30, 2000 September 30, 1999 September 30, 2000 September 30, 1999
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Net Revenue $ 5,213,000 $ 6,163,000 $ 18,581,000 $ 13,442,000
Cost of Services 2,426,000 2,341,000 8,679,000 4,646,000
------------ ------------ ------------ ------------
Gross Profit 2,787,000 3,822,000 9,902,000 8,796,000
------------ ------------ ------------ ------------
Operating expenses:
Selling and marketing expenses (including
non-cash charges of $2,179,000 in 2000) 8,095,000 7,450,000 23,092,000 14,290,000
General and administrative expenses 3,870,000 2,167,000 12,058,000 4,761,000
Charge (credit) for compensation related to
stock options (322,000) 305,000 (332,000) 1,834,000
------------ ------------ ------------ ------------
Total operating expenses 11,643,000 9,922,000 34,818,000 20,885,000
------------ ------------ ------------ ------------
Loss from operations (8,856,000) (6,100,000) (24,916,000) (12,089,000)
Interest income (expense), net 112,000 370,000 494,000 (4,596,000)
Amortization of debt issue costs - - - (3,096,000)
------------ ------------ ------------ ------------
Loss before income taxes (8,744,000) (5,730,000) (24,422,000) (19,781,000)
Provision for income taxes - - 1,000 -
------------ ------------ ------------ ------------
Net Loss (8,744,000) (5,730,000) (24,423,000) (19,781,000)
Beneficial conversion feature on preferred
stock 1,029,000 - 1,029,000 -
Accretion of warrant costs and other rights 30,000 - 30,000 -
Accretion of preferred dividends 27,000 - 27,000 -
------------ ------------ ------------ ------------
Net loss attributable to common stockholders $ (9,830,000) $ (5,730,000) $(25,509,000) $(19,781,000)
============ ============ ============ ============
Basic and diluted net loss per share $(0.54) $(0.33) $(1.42) $(1.61)
Weighted-average shares outstanding used in
per share calculation 18,258,244 17,421,644 17,943,649 12,280,553
</TABLE>
The accompanying notes are an integral part of these statements.
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US SEARCH.COM INC.
STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine months Ended September 30
------------------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities
Net loss $(24,423,000) $ (19,781,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 613,000 125,000
Provision for doubtful accounts 195,000 146,000
Charge for warrants and beneficial conversion feature 2,179,000 4,639,000
Amortization (credit) of unearned compensation (332,000) 1,834,000
Amortization of debt issue costs - 2,546,000
Loss on disposal of property and equipment 148,000 -
Change in assets and liabilities:
Accounts receivable 22,000 (171,000)
Accounts payable 1,549,000 (7,000)
Accrued liabilities 1,177,000 60,000
Prepaid and other 2,854,000 (2,864,000)
------------ -------------
Net cash used in operating activities (16,018,000) (13,464,000)
------------ -------------
Cash flows from investing activities:
Purchase of property and equipment (2,557,000) (489,000)
Proceeds from disposal of property and equipment 7,000 -
------------ -------------
Net cash used in investing activities (2,550,000) (489,000)
------------ -------------
Cash flows from financing activities:
Increase in restricted cash (200,000) (2,000,000)
Repayments of line of credit - (372,000)
Repayments of third party notes payable (218,000) (764,000)
Advances from related parties - 200,000
Repayments to related parties - (2,782,000)
Proceeds from warrant exercise - 2,752,000
Proceeds from initial public offering 36,109,000
Net proceeds from convertible preferred stock 9,463,000
Proceeds from convertible notes - 5,500,000
Repayments of capital lease obligations (222,000) (32,000)
Proceeds from stock option exercises 1,601,000 -
------------ -------------
Net cash provided by financing activities 10,424,000 38,611,000
------------ -------------
Net (decrease)/increase in cash and cash equivalents (8,144,000) 24,658,000
Cash at beginning of period 17,382,000 99,000
------------ -------------
Cash at end of period $ 9,238,000 $ 24,757,000
============ =============
Non cash investing and financing activities:
Conversion of notes payable to common stock - 5,500,000
Capital lease 703,000 -
Exercise of stock options through issuance of note receivable 491,000 -
Conversion of accounts payables into notes payable 970,000 -
</TABLE>
The accompanying notes are an integral part of these statements.
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US SEARCH.COM INC.
NOTES TO FINANCIAL STATEMENTS
(unaudited)
1. Organization and Business:
US SEARCH, 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 Corporation in April
1999.
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 September 30,
2000, and the results of its operations for the three and nine month periods
ended September 30, 2000 and 1999. Interim results are not necessarily
indicative of results to be expected for a full fiscal year.
Restricted Cash
As of September 30, 2000, $2,200,000 was pledged as collateral principally in
connection with an outstanding letter of credit relating to a building lease
agreement. Subsequent to September 30, 2000, restrictions on $1,000,000 were
released in connection with a reduction of such letter of credit.
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 September 30, 2000 the number of stock options that were
antidilutive amounted to 6,690,744. As of September 30, 1999, there were
1,777,324 options which are excluded from the computation of diluted earnings
per share because their inclusion would have been antidilutive.
6
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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 September 30, 2000,
the minimum non-cancelable payments due under these agreements are
approximately $2,470,000 for the remainder of 2000, $2,720,000 for 2001 and
$600,000 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 $750,000 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.
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 and unfair
competition. The Company believes the suit is without merit and intends to
defend itself aggressively.
On August 14, 2000 a proposed class action complaint was filed against the
Company in the Superior Court of the State of California for the County of
Los Angeles, Dorothy Pilkington and Alice Schwartz-Scholl on behalf of
themselves, and all other similarly situated, and on behalf of the general
public vs. US Search.com, Inc., Case No. BC234858. The Complaint claims
damages for breach of contract, violation of Unfair Practices Act, violation
of the Consumer Legal Remedies Act, fraud and negligent misrepresentation in
connection with the Company's adoption services. The Company has answered
the Complaint and is engaged in settlement discussions.
4. Preferred Stock
On September 9, 2000, the Company issued 100,000 shares of Series A
mandatorily redeemable preferred stock ("Preferred Stock"), stated value
$100 per share, and warrants to purchase 75,000 of Preferred Stock to an
investor for gross proceeds of $10 million. The warrants are exercisable for
$100 per share at any time from the date of issuance through September 2005.
The investor is also required to purchase in a second tranche an additional
100,000 shares of Preferred Stock for $100 per share in the event the
Company meets certain performance metrics and other requirements. In
connection with the offering the Company incurred legal, accounting and
other offering expenses of approximately $537,000. The net proceeds of the
offering of $9,463,000 has been allocated, based on an estimated relative
fair value, between the issuance of Preferred Stock ($5,911,000) and the
warrants and right to invest in the second tranche ($3,552,000). The amount
ascribed to the warrants and the right to invest in the second tranche is
accreted to the carrying value of the Preferred Stock over the redemption
period. Accretion for the period from issuance to September 30, 2000 was
approximately $30,000.
The Preferred Stock has the following rights and preferences:
Conversion:
The Preferred Stock is convertible into common stock at the option of the
holder at any time after issuance at a conversion price of $1.70 per share.
The Preferred Stock automatically converts to common stock if the daily
market price of common stock exceeds $10.00 for ten days during a 25 day
period at any time after the first anniversary and (ii) upon the closing of
a firmly underwritten public offering raising more than $25,000,000 at a
price not less than $10 per share.
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The Company has recorded a non-cash charge to the net loss attributable to
common stockholders of $1,029,000 relating to a beneficial conversion
feature ("BCF"). The beneficial conversion feature has been computed based
on the number difference between the fair market value of the stock on the
date of close of the agreement ($1.875 on September 9, 2000) and the
conversion price of $1.70, multiplied by the number of shares into which the
preferred stock is convertible. The Company may record additional BCF
charges on the second tranche funding ($10 million) if the fair market value
of the Company's common stock on the date of the second closing is greater
than $1.70 per share of common stock.
Redemption:
The Preferred Stock is redeemable at the option of the holders of the Series
A Preferred after the fifth anniversary at a redemption price equal to the
liquidation price plus any accrued and unpaid dividends. The Company may at
its own option, after the fifth anniversary, redeem all, but not less than
all, of the then issued and outstanding shares of Preferred Stock for an
amount equal to $103 per share plus accrued and unpaid dividends.
Dividends:
The preferred stockholder is entitled for the period until September 2001,
when, as and if declared by the Board, non-cumulative dividends of 6.0% per
annum. After September 2001, the preferred stockholders are entitled to
receive cumulative dividends, at a rate of 6.0% per annum in the form of
additional preferred stock.
Liquidation Preference:
The liquidation preference is an amount equal to $100 per share. In the
event of liquidation the preferred stockholder is entitled to receive the
Liquidation preference plus all amounts of declared, accrued and unpaid
dividends.
Voting:
The Preferred Stock has immediate voting rights equivalent to the number of
common shares on an as-converted basis. The Preferred Stockholder has the
right to elect two directors to the Board and is required to approve payment
of other dividends, capital expenditure and amendment of bonus plans.
5. Stock Options and Warrants:
During the quarter ended September 30, 2000, 2,287,500 options were granted
pursuant to the 1998 Stock Incentive Plan, at an average exercise price of
$1.84 and 774,000 options were granted pursuant to the 2000 Stock Incentive
Plan at an average exercise price of $2.35. During the quarter ended
September 30, 2000, no shares were exercised. As of September 30, 2000,
there were 6,690,744 options outstanding of which 905,044 were exercisable.
In May 2000, the Company received from its president and chief executive
officer a partial recourse note receivable of $491,000 in connection with
the exercise of options to purchase 320,000 shares of the Company's common
stock.
In September 2000, the Company issued warrants to purchase 1,750,000 shares
of common stock for $0.01 per share, in connection with the restructuring of
one of its online advertising agreements. The non-forfeitable warrants have
a ten year term and are exercisable from the date of issuance. The Company
has recorded a non-cash charge of approximately $2,179,000 million in
connection with these warrants.
8
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PART I. FINANCIAL INFORMATION
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 and background
screening 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 hour to
10 days, 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
9
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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 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. While our cost of services generally varies with revenues, we
believe that as we increase the portion of our business to higher volume
corporate accounts, volume discount pricing is likely to offset any reduction
we may achieve in data costs and labor as a percentage of net revenues.
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
$750,000 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 certain of our operating expenses to
continue to increase substantially as we attempt to expand our sales and
marketing force, improve our technology infrastructure and develop new
technologies, while we expect other costs will decline or remain at current
levels.
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 September 30, 2000.
With the growth of our Internet-based services, an increasing portion of our
advertising expenses has consisted of Internet-based advertising such as
arrangements with Internet search engines and popular Web sites. We have
recently restructured two such arrangements, and have begun to achieve a
reduction of sequential quarterly advertising expense. This reduction
includes savings from the establishment of revenue-share deals with a number
of portal advertising partners, and a reduction in our television advertising
to levels which can improve the returns achieved from that medium. We expect
to further reduce our advertising expense by reassessing other existing
relationships as they expire. 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. While advertising aimed at
consumers is being reduced, we expect certain 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 September 30, 2000, the minimum non-cancelable payments required under
these agreements are approximately $2.5 million during the remainder of 2000,
$2.7 million in 2001, and $600,000 in 2002.
Our general and administrative expenses consist primarily of compensation and
related costs for administrative personnel, fees for outside professional
advisors and our occupancy costs and other overhead costs. Although costs
associated with executives and consumer operations overhead are not expected
to grow, we expect the trend of increased general and administrative costs to
continue in the areas of technology personnel, as well as sales and marketing
and personnel to promote services to corporate and professional clients.
10
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We incurred significant net losses of approximately $399,000 in 1997, $6.8
million in 1998, $26.4 million in 1999 and $24.4 million for the nine month
period ended September 30, 2000. At September 30, 2000, we had an accumulated
deficit of approximately $57.6 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 nine months 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. 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 nine months 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.
In the three month period ended September 30, 2000 we recorded a $2.2 million
non-cash charge relating to warrants issued in connection with the
restructuring of one of our online advertising agreements. This charge had
been recorded in sales and marketing expenses.
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 and the 2000 Stock Incentive Plan. In 1999 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 nine
months ended September 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 September 30, 2000 of approximately $30,000 in the
fourth quarter of 2000.
Results of Operations
Comparison of the Three Months Ended September 30, 2000 to the Three Months
Ended September 30, 1999
Net Revenues. Our net revenues decreased from approximately $6.2 million for
the three months ended September 30, 1999 to approximately $5.2 million for
the three months ended September 30, 2000, representing a 15% decrease. The
decrease is primarily attributable to a decrease in the number of Internet-
based transactions which occurred as a result of decreased web site visitor
traffic. The decline in Web site traffic was likely a result of decreased
advertising expense (excluding non-cash charges for the restructuring of a
certain advertising agreement).
Gross Profit. Gross profit decreased from approximately $3.8 million for the
three months ended September 30, 1999 to approximately $2.8 million for the
three months ended September 30, 2000, representing a 27% decrease. Gross
profit as a percentage of net revenues was approximately 53% and 62% for the
three month periods ended September 30, 2000, and September 30, 1999,
respectively. Cost of services increased to approximately $2.4 million for
the three months ended September 30, 2000, or 4%, from approximately $2.3
million for the three months ended September 30, 1999. As a percentage of net
revenues, cost of services was approximately 47% and 38% for the three month
periods ended September 30, 2000 and September 30, 1999, respectively. Data
acquisition and fulfillment costs as a percentage of revenues in 2000
increased compared to 1999 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 incurring
of overtime expense incurred in pursuit of improvement in customer service
and order fulfillment response time. In addition, refunds increased as a
percentage of gross revenues which decreased gross profit.
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Selling and Marketing Expenses. Selling and marketing expenses increased from
approximately $7.5 million for the three months ended September 30, 1999 to
approximately $8.1 million for the three months ended September 30, 2000. As
a percentage of net revenues, selling and marketing expenses increased to
approximately 155% for the three months ended September 30, 2000, from
approximately 121% for the three months ended September 30, 1999. This
increase is primarily attributable to the recording of a $2.2 million non-
cash charge for warrants issued to one of our Internet advertising partners
in connection with the termination of a long-term commitment. Excluding such
non-cash charge, online advertising declined in the three months ending
September 30, 2000 compared to the same period in 1999 due to a reduction in
the number of impressions ordered.
General and Administrative Expenses. General and administrative expenses
increased from approximately $2.2 million for the three months ended
September 30, 1999 to approximately $3.9 million for the three months ended
September 30, 2000. As a percentage of net revenues, general and
administrative expenses increased to approximately 74% for the three months
ended September 30, 2000, from approximately 35% for the three months ended
September 30, 1999. This increase is primarily attributable to the costs
associated with the hiring of additional management, technology and
administrative personnel, severance costs on certain terminated executives,
as well as an increase in rent expense.
Charge(Credit) for compensation related to stock options. During the three
month period ended September 30, 2000, a credit of approximately $322,000 was
recorded in connection with the cancellation of options (granted in 1999) on
the termination of certain employees as compared to a charge of $305,000 for
the same period in 1999. We expect to amortize the remaining deferred
compensation balance of approximately $30,000 in the fourth quarter.
Interest Income(Expense) Net. Interest income, net of interest expense,
decreased to $112,000 for the three months ended September 30, 2000 compared
to $370,000 for the three months ended September 30, 1999. The decline is
attributable to the decline in the cash balances available for investment.
Comparison of the nine months ended September 30, 2000 to the nine months ended
September 30, 1999
Net Revenues. Our net revenues increased from approximately $13.4 million for
the nine months ended September 30, 1999 to approximately $18.6 million for
the nine months ended September 30, 2000, representing a 38% 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 $8.8 million for the
nine months ended September 30, 1999 to approximately $9.9 million for the
nine months ended September 30, 2000, representing a 13% increase. Gross
profit as a percentage of net revenues was approximately 53% and 65% for the
nine months ended September 30, 2000 and the nine months ended September 30,
1999, respectively. Cost of services increased to approximately $8.7 million
for the nine months ended September 30, 2000 from approximately $4.6 million
for the nine months ended September 30, 1999. As a percentage of net
revenues, cost of services was approximately 47% and 35% for the nine months
ended September 30, 2000 and the nine months ended September 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.
Selling and Marketing Expenses. Our selling and marketing expenses increased
from $14.3 million for the nine months ended September 30, 1999 to
approximately $23.1 million for the nine months ended September 30, 2000. As
a percentage of net revenues, selling and marketing expenses increased to
approximately 124% for the nine months ended September 30, 2000, from
approximately 106% for the nine months ended September 30, 1999. This
increase is primarily attributable to the expansion of Internet-based
advertising and increased television promotional fee advertisements, and to
the recording of
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a non-cash charge of $2.2 million for warrants issued in connection with the
restructuring of an online advertising agreement.
General and Administrative Expenses. Our general and administrative expenses
increased from approximately $4.8 million for the nine months ended September
30, 1999 to approximately $12.1 million for the nine months ended September
30, 2000. As a percentage of net revenues, general and administrative
expenses increased to approximately 65% for the nine months ended September
30, 2000, from approximately 35% for the nine months ended September 30,
1999. This increase is primarily attributable to severance costs, the hiring
of new management, technology and administrative personnel as well as an
increase in rent expense.
Charge(Credit) for Compensation related to stock options. During the nine
month period ended September 30, 2000, a credit of approximately $332,000 was
recorded in connection with the cancellation of options (granted in 1999) on
the termination of certain employees. We expect to amortize the remaining
deferred compensation balance of approximately $30,000 in the remainder of
2000.
Interest Income(Expense) Net. Our interest income, increased to $494,000
for the nine months ended September 30, 2000 compared to interest expense of
$4.6 million for the nine months ended September 30, 1999. Included in
interest expense for the nine months ended September 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 nine months ended September 30, 1999 also includes
interest on outstanding short term and long term debts, and other inter-
company advances from Kushner-Locke, offset by interest income.
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 $5,500,000 convertible subordinated note included
a $550,000 origination fee in the amount of $550,000 payable to Kushner-
Locke, which was fully amortized in the prior-year 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 $9.2 million at September 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 $ 13.5 million for the nine months
ended September 30, 1999 to $16.0 million for the nine months ended September
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 $489,000 for the nine months
ended September 30, 1999 to $2.6 million for the nine months ended September
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 $38.6 million for the
nine months ended June 30, 1999 to approximately $10.4 million for the nine
months ended September 30, 2000. During the nine months ended September 30,
2000 we received $9.5 million from the sale of convertible preferred stock
and $1.6 million from the exercise of employee
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stock options, while during the nine months ended September 30, 1999 we
received $36.1 million from the proceeds of our initial public offering of
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 the sale of an additional
100,000 shares of Series A Convertible Preferred Stock to Pequot Private
Equity Fund II, L.P. will be sufficient to meet our cash requirements through
the next 12 months. Because Pequot Private Equity Fund II, L.P. is not
obligated to purchase the additional 100,000 shares of Series A Convertible
Preferred Stock if we do not meet certain performance criteria and satisfy
certain other conditions, there is no assurance that this additional
financing will be consummated. If we do not complete the sale to Pequot
Private Equity Fund II, L.P. of the additional 100,000 shares of Series A
Convertible Preferred Stock, we will not have sufficient resources, absent
additional financing, to meet our cash requirements through the next 12
months without significantly limiting our expenditures. In addition no
assurance is given that we will not be required to raise additional financing
prior to completing the sale of the additional 100,000 shares of Series A
Convertible Preferred Stock to Pequot Private Equity Fund II, L.P..
Furthermore, there is no assurance that additional financing will be
available when needed or that, if available, the financing will be 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,
financial condition 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 $24.4 million through the nine
months ended September 30, 2000. As of September 30, 2000, we had an
accumulated deficit of approximately $57.6 million. We expect to incur
significant additional losses and continued negative cash flow from
operations for the remainder of 2000. We have never achieved profitability in
our consumer business, and to that end, we have reduced our staff and
advertising expenses related to that business.
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.
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,
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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.
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 and background checks 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.
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.
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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, financial condition, 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, financial condition, and results of operations. In
September 2000 we sold 100,000 shares of Series A Convertible Preferred Stock
to Pequot Private Equity Fund II, L.P. for an aggregate purchase price of
$10.0 million. We may sell an additional $10 million of Series A Convertible
Preferred Stock to Pequot Private Equity Fund II, L.P. if we meet certain
financial performance objectives and satisfy certain other conditions. We may
receive an additional $7.5 million if Pequot Private Equity Fund II, L.C.
fully exercises its outstanding warrants to purchase common stock. We may not
meet the financial performance objectives or satisfy the other conditions
required to sell the additional shares of Series A Convertible Preferred
Stock to Pequot Private Equity Fund II, L.P. Further we can give no
assurance that Pequot Private Equity Fund II, L.P. will exercise in full its
warrants to purchase shares of our common stock. If we raise additional
capital 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 such as InfoSpace, Inc., 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 are related 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 financial condition, 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
MSN Web sites, independent of any agreements with AOL or MSN. Our advertising
on these Web sites depends on the continued relationship InfoSpace has with
companies such as AOL and MSN. 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 MSN, our advertising will no
longer appear on their Web
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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.
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 financial condition, and
results of operations.
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.
We depend on attracting qualified employees and responding to employee turnover
for our success
As of September 30, 2000, we had 224 full-time employees and 36 part-time
employees. Although we have announced and intend to implement a 22% staff
reduction, we nonetheless anticipate that the number of employees may
increase significantly during the next 12 months if we are successful in we
expanding our existing service offerings and introducing and marketing 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. Further, our efforts to implement a
22% staff reduction may result in a decrease in staff morale which may result
in the loss of other employees or absenteeism, and which may make the hiring
of additional employees more difficult. 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, financial condition 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.
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<PAGE>
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 two competitors that have a corporate name
and domain name similar to ours. These competitors also have 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, financial condition, and results of operations. We have
sent several cease-and-desist letters to these competitors and have engaged
in settlement discussions. If these discussions do not result in resolution,
we may be required to file lawsuits 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.
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
21
<PAGE>
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.
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 September 2000 we sold 100,000 shares of Series A Preferred
Stock to Pequot Private Equity II, L.P. Because Series A Preferred Stock was
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
the Series A Preferred Stock and any preferred stock that may be issued in
the future. 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
22
<PAGE>
stockholders to act by written consent without a meeting and procedures
required for director nomination and stockholder proposal.
The holder of our Series A Convertible Preferred Stock may acquire voting
control upon the occurrence of certain events
In September 2000 we sold 100,000 newly-issued shares of our Series A
Convertible Preferred Stock to Pequot Private Equity Fund II, L.P., a
Delaware limited partnership for an aggregate purchase price of $10 million
and issued to Pequot Private Equity Fund II, L.P. a warrant to purchase up to
75,000 additional shares of our Series A Convertible Preferred Stock. Pequot
Private Equity Fund II, L.P. has also agreed to purchase an additional
100,000 shares of our Series A Convertible Preferred Stock for $10 million if
certain performance criteria and other conditions are satisfied. The Series
A Convertible Preferred Stock has a stated value of $100 per share and is
convertible into Common Stock of the Company at $1.70 per share of Common
Stock.
In October 2000 Pequot Private Equity Fund II, L.P. purchased from The
Kushner-Locke Company 3.5 million shares of our Common Stock at a purchase
price of $1.20 per share. The Kushner-Locke Company also granted Pequot
Private Equity Fund II, L.P. a right of first refusal with respect to the
remaining shares of our Common Stock held by The Kushner-Locke Company.
Pequot Private Equity Fund II, L.P. currently beneficially hold 46.8% of our
Common Stock of the Company, assuming an immediate conversion of the Series A
Convertible Preferred Stock currently held by it, exercise in full of the
warrant and an immediate conversion of the Series A Convertible Preferred
Stock underlying the warrant. If certain performance criteria and other
conditions are satisfied and, as a result, Pequot Private Equity Fund II,
L.P. acquires an additional 100,000 shares of our Series A Convertible
Preferred Stock, Pequot Private Equity Fund II, L.P. will beneficially hold,
as of the date thereof, 55.7% of our Common Stock, assuming immediate
conversion of all Series A Convertible Preferred Stock, an exercise in full
of the warrant and an immediate conversion of the Series A Convertible
Preferred Stock underlying the warrant.
We have also entered into a Stockholders Agreement, with Pequot Private
Equity Fund II, L.P. and The Kushner-Locke Company. The Stockholders
Agreement provides, among other things, that Pequot Private Equity Fund II,
L.P. and The Kushner-Locke Company will vote the shares of capital stock held
by them in favor of (i) one member of the Board of Directors being nominated
by Kushner-Locke, (ii) one member, if Pequot Private Equity Fund II, L.P.
owns between 10 and 35% of the shares of Common Stock issued upon conversion
of the Series A Preferred Stock, or two members, if Pequot Private Equity
Fund II, L.P. owns at least 35% of the shares of Common Stock issued upon
conversion of the Series A Preferred Stock, of the Board of Directors being
nominated by Pequot Private Equity Fund II, L.P., (iii) our the Chief
Executive Officer as a member of our Board of Directors, and (iv) three
independent members of the Board of Directors, each of which shall be
nominated for election by the consent of the Board Members nominated by
Pequot Private Equity Fund II, L.P. and a majority of all other members of
the Board of Directors other than Board Member nominated by The Kushner-Locke
Company.
If certain performance criteria and other conditions are satisfied and, as a
result, Pequot Private Equity Fund II, L.P. acquires an additional 100,000
shares of our Series A Convertible Preferred Stock, Pequot Private Equity
Fund II, L.P. will be able to exercise voting control over issues presented
to our stockholders for approval. Further, by virtue of the Stockholders
Agreement and the rights, preferences and privileges of the Series A
Convertible Preferred Stock, Pequot Private Equity Fund II, L.P. possesses
certain special voting and approval rights which could prevent us from taking
certain major corporate actions such as the issuance of additional
securities, the payment of dividends, or the merger of us with or into
another entity or sale of substantially all of our assets.
If the trading price per share of our common stock remains below $1.00, we may
be delisted from The Nasdaq National Market
The closing sale price of our Common Stock on November 10, 2000 was $0.625 per
share. Under the rules and regulations of The Nasdaq Stock Market, Inc., to
maintain listing on the Nasdaq National Market System we must maintain a
trading price
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<PAGE>
per share of more than $1.00. If the trading price per share of
our common stock remains below $1.00, we may be delisted from the Nasdaq
National Market System. If we were delisted from the Nasdaq National Market
System, trading in our common stock, if any, may have to be conducted in the
over-the-counter market in so-called "pink sheets" or, if then available, the
OTC Bulletin Board. As a result, the holders of our common stock would find it
more difficult to dispose of, or to obtain accurate quotations as to the
market value of, our common stock.
If our common stock is delisted from trading on The Nasdaq Stock Market and
the trading price is less than $5.00 per share, trading in our common stock
would also be subject to the requirements of Rule 15g-9 promulgated under the
Securities Exchange Act of 1934. Under such rule, broker/dealers who recommend
these low-priced securities to persons other than established customers and
accredited investors must satisfy special sales practice requirements,
including a requirement that they make an individualized written suitability
determination for the purchaser and receive the purchaser's written consent
prior to the transaction. The Securities Enforcement Remedies and Penny Stock
Reform Act of 1990 also requires additional disclosure in connection with any
trades involving a stock defined as a penny stock (generally any equity
security not traded on an exchange or quoted on The Nasdaq Stock Market that
has a market price of less than $5.00 per share, subject to certain
exceptions), including the delivery, prior to any penny stock transaction, of
a disclosure schedule explaining the penny stock market and the risks
associated with the penny stock market. These requirements would likely
severely limit the market liquidity of our common stock and the ability of our
shareholders to dispose of their shares, particularly in a declining market.
PART I. FINANCIAL INFORMATION
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
September 30, 2000 and our total liabilities as of September 30, 2000 consist
primarily of notes payable and accounts payable which have fixed interest
rates and were not subject to any significant market risk.
24
<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 US Search.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 and unfair competition.
The Company believes the suit is without merit and intends to defend
itself aggressively.
On August 14, 2000 a proposed class action complaint was filed against
the Company in the Superior Court of the State of California for the
County of Los Angeles, Dorothy Pilkington and Alice Schwartz-Scholl on
behalf of themselves, and all other similarly situated, and on behalf of
the general public vs. US Search.com, Inc., Case No. BC234858. The
Complaint claims damages for breach of contract, violation of Unfair
Practices Act, violation of the Consumer Legal Remedies Act, fraud and
negligent misrepresentation in connection with the Company's adoption
services. The Company has answered the Complaint and is engaged in
settlement discussions.
Item 2. Changes in Securities and Use of Proceeds.
(a) Not Applicable
(b) and (c)
On September 7, 2000 the Company sold 100,000 newly-issued shares (the
"Series A Shares") of its Series A Convertible Preferred Stock to Pequot
Private Equity Fund II, L.P., a Delaware limited partnership (the
"Purchaser") for an aggregate purchase price of $10 million and issued
to the Purchaser a warrant to purchase up to 75,000 shares of Series A
Convertible Preferred Stock (the "Warrant") pursuant to a Purchase
Agreement, dated as of September 7, 2000, by and between the Company and
the Purchaser (the "Agreement"). The Purchaser has also agreed to
purchase an additional 100,000 shares of Series A Convertible Preferred
Stock of the Company if certain conditions set forth in the Agreement,
including performance criteria of the Company, are satisfied, for an
additional purchase price of $10 million (the "Additional Purchase"). If
the Warrant is exercised in full by the Purchaser, the Company will
receive an additional $7.5 million upon exercise thereof. The Series A
Convertible Preferred Stock has a stated value of $100 per share and is
convertible into Common Stock of the Company at $1.70 per share of
Common Stock. The issuance and sale of the Series A Shares to the
Purchaser was exempt from the registration requirements of the
Securities Act of 1933, as amended (the "Act") by virtue of Section 4(2)
of the Act and Rule 506 of Regulation D promulgated thereunder.
The following is a summary of the principal terms of the Series A
Convertible Preferred Stock and is qualified in its entirety by
reference to the Amended Certificate of Designations of Series A
Convertible Preferred Stock of the Company filed as an exhibit to the
Company's Current Report on Form 8-K filed September 15, 2000.
Dividends
---------
From the date of original issuance of the Series A Convertible Preferred
Stock through September 7, 2001, the holders of such preferred stock, in
preference to the holders of shares of any class or series of capital
stock of the Company with respect to dividends, shall be entitled to
receive, when, as and if declared by the Board of Directors of the
Company, non-cumulative cash dividends at an annual rate of 6%. After
September 7, 2001, the holders of Series A Convertible Preferred Stock
shall receive cumulative dividends at an annual rate of 6%, which
dividends shall be paid quarterly in the form of additional shares of
Series A Convertible Preferred Stock. In addition, in the event any
dividends are
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declared with respect to the Common Stock of the Company, the holders of
Series A Convertible Preferred Stock shall be entitled to receive as
additional dividends an amount equal to the amount of dividends that each
such holder would have received had the Series A Convertible Preferred
Stock been converted into Common Stock as of the date immediately prior to
the record date of such dividend.
Liquidation Preference
----------------------
In the event of a liquidation, dissolution or winding up of the affairs of
the Company, the holders of Series A Convertible Preferred Stock shall be
entitled to receive out of the assets of the Company an amount equal to
$100 per share of Series A Convertible Preferred Stock plus an amount
equal to all declared and unpaid and any accrued and unpaid dividends
through the date of the distribution before any payment is made or assets
distributed to the holders of any class or series of the Common Stock of
the Company or any other class or series of the Company's capital stock
ranking junior to the Series A Convertible Preferred Stock with respect to
liquidation. The acquisition of the Company resulting in a transfer of
more than 50% of the outstanding voting power of the Company or the sale
of all or substantially all of the assets of the Company shall be treated
as a liquidation of the Company unless the holders of a majority-in-
interest of the Series A Convertible Preferred Stock shall agree not to
treat such event as a liquidation.
Redemption
----------
At any time after September 7, 2005 at the request of a majority-in-
interest of the holders of the Series A Convertible Preferred Stock, the
Company shall redeem for cash the then issued and outstanding shares of
Series A Convertible Preferred Stock in accordance with the following
schedule: (i) one third (33.33%) of the then issued and outstanding
shares of Series A Convertible Preferred Stock within 120 days of receipt
of notice from the holders of the Series A Convertible Preferred Stock
(the "First Redemption"), (ii) one half (50%) of the then outstanding
shares of Series A Convertible Preferred Stock on the first anniversary of
the First Redemption, and (iii) all (100%) of the then issued and
outstanding shares of Series A Convertible Preferred Stock on the second
anniversary of the First Redemption.
At any time after September 7, 2005 the Company may redeem all, but not
less than all, of the then issued and outstanding shares of Series A
Convertible Preferred Stock for an amount equal to $103.00 per share plus
all accrued and unpaid dividends.
Voting Rights
-------------
The holders of Series A Convertible Preferred Stock shall be entitled to
vote together with the holders of Common Stock on all maters submitted for
a vote of the stockholders of the Company, including the election of
directors. The holders of Series A Convertible Preferred Stock shall also
have the right, voting separately as a single class, to elect up to 2
members of the Board of Directors of the Company (the "Series A
Directors").
If there shall occur certain material events with respect to the Company,
including, among other events, the Company's failure to timely declare or
pay the required dividends on the Series A Convertible Preferred Stock, or
any obligation of the Company, whether as principal, guarantor, surety or
other obligor for the payment of indebtedness or borrowed money in excess
of $5,000,000 becoming or being declared due and payable prior to the
express maturity thereof and not being paid when due or within any grace
period and such default remaining uncured for 15 days, the holders of
Series A Convertible Preferred Stock shall have the right, voting as a
separate class, to elect a sufficient number of additional directors of
the Company to such that the Series A Directors constitute a majority of
the Board of Directors of the Company. This right shall terminate upon
the curing of the event which gave rise to it.
Preemptive Rights
-----------------
In the event that the Company proposes to issue any shares of its Common
Stock or securities convertible into or exchangeable or exercisable for
shares of Common Stock in any transaction (other than certain specified
exceptions) each holder of Series A Convertible Preferred Stock shall have
the right to purchase its pro rata amount of such shares (computed on an
as-converted and fully diluted basis).
Conversion
----------
The conversion price per share of the Series A Convertible Preferred Stock
shall be $1.70, subject to adjustment under certain circumstances.
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<PAGE>
Special Approval Rights
-----------------------
As long as the Purchaser and/or its affiliates, in the aggregate, hold
more than 25% of the Series A Convertible Preferred Stock, the Company
will not take certain actions without the consent of the Board of
Directors and the consent of the Series A Directors.
(d) Not applicable
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information
None
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.
3.1.2** Amended Certificate of Designations of Series A Convertible
Preferred Stock of US SEARCH.com Inc.
3.2* Bylaws
4.1* Form of Common Stock Certificate
10.1. Contract Cancellation, Settlement and Release Agreement,
dated as of September 29, 2000, by and between US SEARCH.com
Inc., and The Kushner-Locke Company, and InfoSpace, Inc.
10.2 Sales Agency Agreement, dated as of October 1, 2000, by and
between US SEARCH.com Inc. and InfoSpace, Inc. ***
10.3 Registration Rights Agreement, dated as of September 29,
2000, by and between US SEARCH.com Inc. and InfoSpace, Inc.
10.4 Warrant, dated September 29, 2000, by US SEARCH.com Inc. in
favor of InfoSpace, Inc.
10.5 Promissory Note, dated August 23, 2000, by US SEARCH.com
Inc. in favor of Lycos, Inc.
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 as exhibit 3.1 of the Company's Report on Form 8-K filed
September 15, 2000, incorporated herein by reference.
*** CERTAIN PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED AND FILED
SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT
TO A REQUEST FOR AN ORDER GRANTING CONFIDENTIAL TREATMENT OF SUCH
INFORMATION IN ACCORDANCE WITH RULE 24b-2 PROMULGATED UNDER THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
27
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(b) Reports on Form 8-K:
On September 15, 2000, the Company filed a Report on Form 8-K with
the Securities and Exchange Commission under Item 5 to report the
sale of 100,000 shares of Series A Preferred Stock to Pequot Private
Equity Fund II, L.P..
28
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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)
<TABLE>
<S> <C>
Date: November 14, 2000 By: /s/ Brent N. Cohen
-------------------- -----------------------------------
Brent N. Cohen
President and Chief Executive Officer
By: /s/ Alan S. Mazursky
-----------------------------------
Alan S. Mazursky
Vice President, Finance and Interim Chief Financial Officer
(Principal Financial and Accounting Officer)
</TABLE>
29
<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.
3.1.2** Amended Certificate of Designations of Series A Convertible
Preferred Stock of US SEARCH.com Inc.
3.2* Bylaws
4.1* Form of Common Stock Certificate
10.1. Contract Cancellation, Settlement and Release Agreement, dated as
of September 29, 2000, by and between US SEARCH.com Inc., and The
Kushner-Locke Company, and InfoSpace, Inc.
10.2 Sales Agency Agreement, dated as of October 1, 2000, by and
between US SEARCH.com Inc. and InfoSpace, Inc. ***
10.3 Registration Rights Agreement, dated as of September 29, 2000, by
and between US SEARCH.com Inc. and InfoSpace, Inc.
10.4 Warrant, dated September 29, 2000, by US SEARCH.com Inc. in favor
of InfoSpace, Inc.
10.5 Promissory Note, dated August 23, 2000, by US SEARCH.com Inc. in
favor of Lycos, Inc.
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 as exhibit 3.1 of the Company's Report on Form 8-K filed
September 15, 2000, incorporated herein by reference.
*** CERTAIN PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED AND FILED
SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A
REQUEST FOR AN ORDER GRANTING CONFIDENTIAL TREATMENT OF SUCH
INFORMATION IN ACCORDANCE WITH RULE 24b-2 PROMULGATED UNDER THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
30
