UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2004
OR
For the transition period from to
Commission file number: 000-50285
FIRST ADVANTAGE CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
One Progress Plaza, Suite 2400
St. Petersburg, Florida 33701
(Address of principal executive offices, including zip code)
(727) 214-3411
(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), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There were 7,214,837 shares of outstanding Class A Common Stock of the registrant as of November 4, 2004.
There were 16,027,086 shares of outstanding Class B Common Stock of the registrant as of November 4, 2004.
INDEX
Part I.FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2004 and September 30, 2003
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2004
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and September 30, 2003
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II.OTHER INFORMATION
Legal Proceedings
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Defaults Upon Senior Securities
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
Item 6.
Exhibits and Reports on Form 8-K
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements -
First Advantage Corporation
Consolidated Balance Sheets (Unaudited)
Assets
Current assets:
Cash and cash equivalents
Accounts receivable (less allowance for doubtful accounts of $1,737,000 and $1,327,000 in 2004 and 2003, respectively)
Income taxes receivable
Prepaid expenses and other current assets
Total current assets
Property and equipment, net
Goodwill
Intangible assets, net
Database development costs, net
Other assets
Total assets
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
Accrued compensation
Accrued liabilities
Due to affiliates
Income taxes payable
Current portion of long-term debt and capital leases
Total current liabilities
Long-term debt and capital leases, net of current portion
Deferred income taxes
Other liabilities
Total liabilities
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.001 par value; 1,000,000 shares authorized, no shares issued or outstanding
Class A common stock, $.001 par value; 75,000,000 shares authorized; 6,771,308 and 4,866,362 shares issued and outstanding as of September 30, 2004 and December 31, 2003, respectively
Class B common stock, $.001 par value; 25,000,000 shares authorized; 16,027,286 shares issued and outstanding as of September 30, 2004 and December 31, 2003
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Income (Unaudited)
Service revenue
Reimbursed government fee revenue
Total revenue
Cost of service revenue
Government fees paid
Total cost of service
Gross margin
Salaries and benefits
Other operating expenses
Depreciation and amortization
Total operating expenses
Income from operations
Other (expense) income:
Interest expense
Interest income
Total other (expense), net
Income before income taxes
Provision for income taxes
Net income
Per share amounts:
Basic and diluted
Weighted-average common shares outstanding:
Basic
Diluted
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Consolidated Statement of Changes in Stockholders’ Equity
For the Nine Months Ended September 30, 2004 (Unaudited)
CommonStock
Shares
AdditionalPaid-in
Capital
Balance at December 31, 2003
Class A Shares issued in connection with acquisitions
Class A Shares issued in connection with stock option plan and employee stock purchase plan
Class A Shares issued in connection with convertible notes
Other comprehensive income
Balance at September 30, 2004
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Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2004 and 2003 (Unaudited)
For the Nine Months Ended
September 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Change in operating assets and liabilities, net of acquisitions:
Accounts receivable
Due (from) to affiliates
Income taxes
Accrued compensation and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Database development costs
Purchases of property and equipment
Cash paid for acquisitions
Cash balance of companies acquired
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from long-term debt
Repayment of long-term debt
Cash contributions from First American
Proceeds from class A shares issued in connection with stock option plan and employee stock purchase plan
Net cash provided by financing activities
Increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosures of cash flow information:
Cash paid for interest
Cash paid for income taxes
Non-cash investing and financing activities:
Class A shares issued in connection with acquisitions
Class A shares issued in connection with convertible notes
Notes issued in connection with acquisitions
Operations contributed by First American
Shares issued in connection with US SEARCH.com acquisition
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September 30, 2004 and 2003 (Unaudited)
In June 2003, First Advantage Corporation (the “Company”), a holding company, acquired US SEARCH.com and six operating subsidiaries of The First American Corporation (“First American”) that formerly comprised its First American Screening Technologies (“FAST”) division. The operating subsidiaries included HireCheck, Inc., First American Registry, Inc., Substance Abuse Management, Inc., American Driving Records, Inc., Employee Health Programs, Inc., and SafeRent, Inc. First American owns approximately 70% of the shares of capital stock of the Company as of September 30, 2004. The Class B common stock owned by First American is entitled to ten votes per share on all matters presented to the stockholders for vote.
The Company operates in three primary business segments: Enterprise Screening, Risk Mitigation and Consumer Direct. The Enterprise Screening segment includes employment background screening, occupational health services, resident screening services and tax incentives. The Risk Mitigation segment includes motor vehicle records and investigative services. The Consumer Direct segment provides consumers with a single, comprehensive access point to a broad range of information to assist them in locating people and other public data searches.
Basis of Presentation
The consolidated financial information included in this report has been prepared in accordance with the instructions to Form 10-Q and does not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments are of a normal recurring nature and are considered necessary for a fair statement of the results for the interim period. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission.
First Advantage completed two acquisitions during the third quarter of 2004. The Company’s operating results for the three and nine months ended September 30, 2004 include results for the acquired entities from their respective dates of acquisition. The Company’s operating results for the three and nine months ended September 30, 2003 include results for the FAST division from January 1, 2003 and the results for US SEARCH.com from June 1, 2003.
Operating results for the three and nine months ended September 30, 2004 and 2003 are not necessarily indicative of the results that may be expected for the entire fiscal year.
Reclassifications
Certain amounts in our prior period condensed consolidated financial statements have been reclassified from salaries and benefits, and other operating expenses to cost of sales in order to conform with the current period’s presentation.
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Comprehensive Income
Comprehensive income is as follows:
Three Months Ended
Nine Months Ended
Net Income
Other comprehensive income:
Foreign currency translation adjustments
Impairment of Intangible and Long-Lived Assets
First Advantage carries intangible and long-lived ssets at cost less accumulated amortization. Accounting standards require that assets be written down if they become impaired. Intangible and long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is not recoverable. At such time that an impairment in value of an intangible or long-lived asset is identified, the impairment will be measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Fair value is determined by employing an expected present value technique, which utilizes multiple cash flow scenarios that reflect the range of possible outcomes and an appropriate discount rate.
Stock Based Compensation Plan
The Company adopted SFAS 148 as of January 1, 2003 with respect to the disclosure requirements. The Company has elected to continue accounting for stock-based compensation using the intrinsic value method prescribed in APB 25 and related interpretations. If the Company had elected or was required to apply the fair value recognition provisions of SFAS 123 to stock-based employee compensation, net income and net income per share would have been reduced to the pro forma amounts indicated in the following table.
Net income, as reported
Less: stock based compensation expense, net of tax
Pro forma net income
Earnings per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
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During the first quarter of 2004, the Company acquired Quantitative Risk Solutions LLC, Proudfoot Reports Incorporated, MVR’s, Inc., Background Information Systems, Inc., Infocheck Ltd. and Landlord Protect, Inc. During the second quarter of 2004, the Company acquired U.D. Registry, Inc., CoreFacts, LLC, Realeum, Inc. and created a new subsidiary, CIC Enterprises, LLC, which acquired substantially all of the assets of CIC Enterprises, Inc., STEPS, Inc., and Horton, Inc. During the third quarter 2004, the Company acquired BackTrack Reports, Inc. and National Background Data, LLC. These acquisitions have been included in the Company’s Enterprise Screening and Risk Mitigation segments. The preliminary allocation of the purchase price is based upon estimates of the assets and liabilities acquired in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141. The allocations may be revised in 2004. The acquisition of these companies is based on management’s consideration of past and expected future performance as well as the potential strategic fit with the long-term goals of the Company. The expected long-term growth, market position and expected synergies to be generated by inclusion of these companies are the primary factors which gave rise to an acquisition price which resulted in the recognition of goodwill.
In connection with the acquisition of CIC Enterprises, LLC, up to $14 million of additional purchase price was contingent upon the renewal by the United States government of the Work Opportunity Tax Credit (WOTC) program or a similar program. The Working Families Tax Relief Act of 2004 became law on October 4, 2004. The Act extended the WOTC program through 2005. The additional consideration that is comprised of $11 million of subordinated debt and $3 million of stock was released from escrow on November 2, 2004.
Convertible promissory notes totaling $8,722,000 had been issued in connection with the acquisitions of CoreFacts, LLC, Realeum, Inc. and CIC Enterprises, LLC. In September 2004, the debt was converted into 563,257 shares of Class A common stock.
The aggregate purchase price of acquisitions completed during 2004 is as follows:
Cash
Notes
Stock
Purchase price
The preliminary allocation of the aggregate purchase price of these acquisitions is as follows:
Identifiable intangible assets
Net assets acquired
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Unaudited pro forma results of operations assuming all acquisitions were consummated on January 1, 2003 are as follows:
The changes in the carrying amount of goodwill, by operating segment, are as follows for the nine months ended September 30, 2004:
Balance, at December 31, 2003
Acquisitions
Adjustments to net assets acquired
Balance, at September 30, 2004
The changes in the carrying amount of intangible assets are as follows for the nine months ended September 30, 2004:
Amortization
Amortization expense totaled $2,349,000 and $831,000 for the nine months ended September 30, 2004 and 2003, respectively.
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Long-term debt consists of the following at September 30, 2004:
Acquisition notes:
Weighted average interest rate of 3.9% with maturities through 2007
Bank notes:
$20 million Loan Agreement, interest at 30-day LIBOR plus 1.25% (3.08% at September 30, 2004), matures July 2006
$25 million Line of Credit, interest at 30-day LIBOR plus 1.39% (3.22% at September 30, 2004), matures March 2007
Promissory Notes with First American:
$10 million revolving loan, interest at 30-day LIBOR plus 1.75% (3.58% at September 30, 2004), matures July 2006
$20 million revolving loan, interest at 30-day LIBOR plus 1.75% (3.58% at September 30, 2004), matures July 2006
Promissory Note (related to US SEARCH.com acquisition):
Interest rate of 5%, principal and interest payments monthly of $127,000, matures December 2004
Capital leases and other debt:
Various interest rates with maturities through 2006
Total long-term debt and capital leases
Less current portion of long-term debt and capital leases
On March 18, 2004, the Company entered into a three year $25 million unsecured revolving line of credit with a bank (the “Line of Credit”). The Line of Credit is guaranteed by First American. The Line of Credit bears interest at a rate equal to the 30-day LIBOR Rate plus an applicable margin ranging from 1.29% per annum to 2.29% per annum. Accrued interest is payable monthly.
On April 27, 2004, the Company entered into a Promissory Note with First American. The loan evidenced by the Promissory Note is a $20 million unsecured revolving loan, with interest payable monthly. The principal balance of the Promissory Note is due on July 31, 2006. The Promissory Note is subordinated to the bank Loan Agreement and Line of Credit and bears interest at the rate payable under the $20 million bank Loan Agreement plus 0.5% per annum. At September 30, 2004, the Company was in compliance with the financial covenants of its Loan Agreement.
On September 7, 2004 the Company amended its Loan Agreement (“Amended Loan Agreement”). As part of the amendment, the Company’s available borrowings thereunder were increased from $15 million to $20 million with a two year maturity date of July 31, 2006. The Amended Loan Agreement is secured by a security interest in the Company’s accounts receivable, as well as the accounts receivable of certain subsidiaries.
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A reconciliation of earnings per share and weighted-average shares outstanding is as follows:
Net Income - numerator for basic earnings per share
Interest on convertible notes, net of tax
Net Income - numerator for fully diluted earnings per share
Denominator:
Weighted-average shares for basic earnings per share
Effect of dilutive securities
Employee stock options and warrants
Convertible notes
Denominator for diluted earnings per share
For the three months ended September 30, 2004 and 2003 options and warrants totaling 2,163,305 and 1,729,732, respectively, were excluded from the weighted average diluted shares outstanding as they were antidilutive. For the nine months ended September 30, 2004 and 2003 options and warrants totaling 1,853,676 and 1,221,052, respectively, were excluded, as they were antidilutive.
The Company operates in three primary business segments: Enterprise Screening, Risk Mitigation and Consumer Direct.
The Enterprise Screening segment includes employment background screening, occupational health services, resident screening services and tax incentives. Products and services relating to employment background screening include criminal records searches, employment and education verification, social security number verification and credit reporting. Occupational health services include drug-free workplace programs, physical examinations and employee assistance programs. Resident screening services include criminal background and eviction searches, credit reporting, employment verification and lease performance and payment histories. Tax incentives specialize in the identification and processing of tax and incentive credits, sales and use-tax services, transportation tax services and tax consulting services. Revenue for the Enterprise Screening segment includes $8,000 and $32,000 of sales to the Consumer Direct segment for the three and nine months ended September 30, 2004, respectively.
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The Risk Mitigation segment includes motor vehicle records and investigative services. Products and services provided by the Risk Mitigation segment include: driver history reports, vehicle registration, financial responsibility filings, surveillance services, statements and field interviews and due diligence reports. Revenue for the Risk Mitigation segment includes $226,000 and $427,000 of sales to the Enterprise Screening segment for the three months ended September 30, 2004 and 2003, respectively, and $1,283,000 and $1,062,000 of sales for the nine months ended September 30, 2004 and 2003, respectively.
The Consumer Direct segment provides consumers with a single, comprehensive access point to a broad range of information to assist them in locating people and other public data searches. Revenue for the Consumer Direct segment includes $4,000 and $93,000 of sales to the Enterprise Screening segment for the three months ended September 30, 2004 and 2003, respectively, and $86,000 and $124,000 of sales for the nine months ended September 30, 2004 and 2003, respectively.
The elimination of inter-segment revenue and cost of service revenue is included in Corporate. These transactions are recorded at cost.
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The following table sets forth segment information for the three and nine months ended September 30, 2004 and 2003.
Three Months Ended September 30, 2004
Enterprise Screening
Risk Mitigation
Consumer Direct
Corporate and Eliminations
Consolidated
On October 11, 2004, the Company acquired substantially all of the assets of the Business Tax Credit Corporation d/b/a The Alameda Company, under the terms of an asset purchase agreement. In consideration for the purchase of the assets, the Company paid the sellers an aggregate purchase price of $7.6 million comprised of $2.5 million in cash and $5.1 million of subordinated notes.
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On November 3, 2004, the Company acquired CompuNet Credit Services, Inc, under the terms of the purchase agreement. In consideration for the purchase of the assets, the Company paid the sellers an aggregate purchase price of $18 million comprised of $5 million in cash, $9 million in subordinated notes, and $4 million of the Company’s Class A common stock.
Unaudited pro forma results of operations assuming all acquisitions to date were consummated on January 1, 2003 are as follows:
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Note of Caution Regarding Forward Looking Statements
Certain statements in this quarterly report on Form 10-Q relate to future results of the Company and are considered “forward-looking statements”. These statements, which may be expressed in a variety of ways, including the use of future or present tense language, relate to among other things, sufficiency and availability of cash flows and other sources of liquidity, current levels of operations, anticipated growth, future market positions, synergies from integration, ability to execute its growth strategy, levels of capital expenditures and ability to satisfy current debt. These forward-looking statements, and others forward-looking statements contained in other public disclosures of the Company are based on assumptions that involve risks and uncertainties, and that are subject to change based on various important factors (some of which are beyond the Company’s control). Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. Factors that could cause the anticipated results to differ from those described in the forward-looking statements include: general volatility of the capital markets and the market price of the Company’s Class A common stock; the Company’s ability to successfully raise capital; the Company’s ability to identify and complete acquisitions and to successfully integrate businesses it acquires; changes in applicable government regulations; the degree and nature of the Company’s competition; increases in the Company’s expenses; continued consolidation among the Company’s competitors and customers; unanticipated technological changes and requirements; the Company’s ability to identify suppliers of quality and cost-effective data; and other factors described in this quarterly report on Form 10-Q. Actual results may differ materially from those expressed or implied as a result of these risks and uncertainties. The forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
First Advantage Corporation (Nasdaq: FADV) (“First Advantage” or the “Company”) was created by the June 5, 2003 merger of The First American Corporation’s Screening Technologies (“FAST”) division with US SEARCH.com Inc. (“US SEARCH”). First Advantage provides global risk management screening services to enterprise and consumer customers. The Company operates in three primary business segments: Enterprise Screening, Risk Mitigation and Consumer Direct. First Advantage is headquartered in St. Petersburg, Florida, and has more than 1,700 employees in offices throughout the United States and abroad. Since its formation, First Advantage has acquired 22 companies as of September 30, 2004 and completed two of those acquisitions in the third quarter of 2004.
Operating results for the three and nine months ended September 30, 2004 included total revenue of $71.9 million and $198.3 million, respectively, representing an increase of 51% and 70% over the same periods in 2003. Net income for the three and nine months ended September 30, 2004 was $4.2 million and $8.0 million, respectively. Net income increased $2.7 million and $4.2 million for the three and nine months ended September 30, 2004 in comparison to the same periods in 2003.
Critical Accounting Policies
Critical accounting policies are those policies used in the preparation of the company’s financial statements that require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosure of contingencies. A summary of these policies can be found in Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for year ended December 31, 2003.
The following is a summary of the operating results by the Company’s business segments for the three months ended September 30, 2004 and 2003 and for the nine months ended September 30, 2004 and 2003.
Income (loss) from operations
Gross margin percentage of service revenue
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Three Months Ended September 30, 2003
Nine Months Ended September 30, 2004
Nine Months Ended September 30, 2003
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Enterprise Screening Segment
Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003
Total service revenue was $47.5 million as of September 30, 2004, an increase of $17.0 million compared to service revenue of $30.5 million in the same period of 2003. Acquisitions accounted for approximately $15.1 million of the revenue increase. There were sixteen businesses acquired since the third quarter of 2003. Revenue increased by $1.9 million, or 6.4%, at businesses owned in the third quarter of 2003 due to expanded market share and an increase in products and services.
The gross margin percentage of service revenue increased from 69.2% to 72.9% primarily as a result of an increase in resident screening revenue and the contribution of the tax incentive revenue, which have generally higher gross margins.
Salaries and benefits increased by $5.2 million. Salaries and benefits were 34.1% of service revenue for the third quarter of 2004 compared to 36.0% of service revenue in the same period of 2003. This decrease reflected economies achieved in 2004 by consolidating certain operations and leveraging databases.
Other operating expenses increased by $2.0 million and were 16.8% of service revenue in the third quarter of 2004 compared to 19.5% in the same period of 2003. This decrease in other operating expenses, as a percentage of revenue, is due to operating efficiencies in connection with the consolidation of the businesses.
Depreciation and amortization increased by $0.6 million. Depreciation and amortization were 4.5% of service revenue in the third quarter of 2004 compared to 5.1% in the same period of 2003. This decrease, as a percent of service revenue, is primarily due to several assets being fully depreciated offset by an increase in the amortization of intangible assets as a result of acquisitions.
Income from operations was $8.3 million in the third quarter of 2004 compared to income from operations of $2.6 million in the same period of 2003. The increase in income from operations was the result of increased revenue, primarily from acquisitions. Operating costs as a percent of revenue declined due to consolidation of businesses and leveraging of databases.
Risk Mitigation Segment
Total service revenue was $10.7 million as of September 30, 2004, an increase of $6.1 million compared to service revenue of $4.6 million in the same period of 2003. The acquisition of two investigative service businesses account for a substantial part of the increase in service revenue.
The gross margin percentage of service revenue decreased from 74.0% to 63.6% primarily due to the acquisition of the investigative service businesses, which generate margin levels that are lower as a percentage of service revenue, than the motor vehicle records operations of this segment.
Salaries and benefits increased by $1.8 million. Salaries and benefits were 27.1% of service revenue in the third quarter of 2004 compared to 25.0% in the same period of 2003. The percentage increase is primarily due to the acquisition of the investigative service businesses.
Other operating expenses increased by $0.7 million. Other operating expenses were 11.9% of service revenue in the third quarter of 2004 and 11.7% in the third quarter of 2003. The increase is primarily due to the acquisition of the investigative service businesses.
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Depreciation and amortization increased by $0.4 million due to an increase in amortization of intangible assets as a result of the acquisitions.
Income from operations was $2.1 million for the third quarter of 2004 compared to $1.5 million in the third quarter of 2003.
Total service revenue was $2.8 million as of September 30, 2004, a decrease of $2.2 million compared to service revenue of $5.0 million in the same period of 2003. The decrease is due to the reduction in the number of distribution channels in May 2004.
The gross margin percentage of service revenue increased from 89.5% to 92.0% primarily due to vendor negotiations to reduce fulfillment costs.
Salaries and benefits decreased by $0.7 million. Salaries and benefits were 19.5% of service revenue in the third quarter of 2004 compared to 25.7% in the same period of 2003. The percentage decrease is primarily due to the centralization of some of the key functions of accounting, human resource and technology to the corporate office.
Other operating expenses decreased by $1.0 million. Other operating expenses were 47.7% of service revenue in the third quarter of 2004 and 48.0% for the same period of 2003. The decrease is primarily due to reduced advertising expenditures.
Depreciation and amortization decreased by $0.1 million.
Income from operations was $137 thousand for the third quarter of 2004 compared to income from operations of $117 thousand in September 2003.
Corporate
Salary and benefits increased primarily due to an increase in the number of senior management, administrative and technology personnel. Other operating expenses increased due to additional regulatory and professional fees.
Consolidated Results
Consolidated service revenue for the three months ended September 30, 2004 was $60.7 million, an increase of $21.1 million compared to service revenue of $39.6 in the same period in 2003. Acquisitions accounted for $20.8 million of the increase.
The consolidated gross margin of service revenue was 72.6% for the three months ended September 30, 2004 compared to 73.0% for the same period in 2003. The decrease is due to the change in the mix of margins related to the acquired businesses.
Salaries and benefits were 36.0% of service revenue for the three months ended September 30, 2004 and 36.1% compared to the same period in 2003.
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Other operating expenses were 18.4% of service revenue for the three months ended September 30, 2004 and 24.5 % compared to the same period for 2003. The decrease is due to the consolidation of acquired businesses in the Enterprise Screening segment and reduced advertising expenditures in the Consumer Direct segment.
Depreciation and amortization increased by $0.9 million due to an increase in amortization of intangible assets as a result of acquisitions.
Income from operations was $7.8 million for the three months ended September 30, 2004 compared to $2.5 million for the same period in 2003. The increase of $5.3 million is comprised of an increase in operating income of $5.7 million in the Enterprise Screening segment, an increase in operating income of $0.6 million in the Risk Mitigation segment and an increase of corporate expenses of $1.0 million.
Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003
Total service revenue was $126.0 million as of September 30, 2004, an increase of $47.8 million compared to service revenue of $78.2 million in the same period of 2003. Acquisitions accounted for approximately $41.7 million of the revenue increase. There were sixteen businesses acquired since September 2003. Revenue increased by $6.1 million, or 7.8%, at businesses owned at September 2003 due to expanded market share and an increase in products and services.
The gross margin percentage of service revenue increased from 69.8% to 71.4% and was primarily due to an increase in resident screening revenue and the contribution of the tax incentive revenue, which have generally higher gross margins.
Salaries and benefits increased by $14.9 million. Salaries and benefits were 35.2% of service revenue for the nine months ended September 2004 compared to 37.6% of service revenue in the same period of 2003. This decrease reflected economies achieved in 2004 by consolidating certain operations and leveraging databases.
Other operating expenses increased by $8.4 million and were 18.1% of service revenue for the nine months ended September 2004 compared to 18.5% in the same period of 2003. This increase in other operating expenses was primarily due to the addition of the tax incentive group to the segment.
Depreciation and amortization increased by $1.3 million. Depreciation and amortization was 4.7% of service revenue for the nine months ended September 30, 2004 compared to 5.8% in the same period of 2003. This decrease, as a percent of service revenue, is primarily due to several assets being fully depreciated offset by an increase in the amortization of intangible assets as a result of acquisitions.
Income from operations was $16.8 million for the nine months ended September 2004 compared to income from operations of $6.2 million in the same period of 2003. The increase in income from operations was the result of increased revenue, from acquisitions and organic growth. Operating costs as a percent of revenue declined due to consolidation of businesses and leveraging of databases.
Total service revenue was $30.2 million as of September 30, 2004, an increase of $20.0 million compared to service revenue of $10.2 million in the same period of 2003. The Company acquired two investigative service businesses, which account for a substantial part of the increase in service revenue.
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The gross margin percentage of service revenue decreased from 86.0% to 60.9% primarily due to the acquisition of the investigative service businesses, which generate margin levels lower than the motor vehicle records operations of this segment.
Salaries and benefits increased by $5.2 million. Salaries and benefits were 26.8% of service revenue year to date September 2004 compared to 27.8% in the same period of 2003. The percentage decrease is primarily due to the acquisition of the investigative service businesses.
Other operating expenses increased by $2.4 million. Other operating expenses were 12.0% of service revenue for the nine months ended September 2004 compared to 11.5% in the same period of 2003. The change is primarily due to the acquisition of the investigative service businesses.
Depreciation and amortization increased by $0.9 million due to an increase in amortization of intangible assets as a result acquisitions.
Income from operations was $5.3 million for the nine months ended September 2004 compared to $4.3 million in the same period of 2003.
Total service revenue was $10.0 million as of September 30, 2004, an increase of $3.5 million compared to service revenue of $6.5 million in the same period of 2003. This segment was formed in connection with the acquisition in June 2003 of US SEARCH and represents only four months of operating results for year-to-date September 2003. On a per month basis, revenue decreased due to a reduction in the number of distribution channels in May 2004.
The gross margin percentage of service revenue increased from 89.5% to 92.2% primarily due to vendor negotiations to reduce fulfillment costs.
Salaries and benefits increased by $0.3 million. Salaries and benefits were 20.5% of service revenue for the nine months ended September 2004 compared to 26.7% in the same period of 2003. The percentage decrease is primarily due to the centralization of some of the key functions of accounting, human resource and technology to the corporate office.
Other operating expenses increased by $2.4 million. Other operating expenses were 54.9% of service revenue for the nine months ended September 2004 and 47.0% for the same period of 2003. The increase in other operating expenses, as a percent of revenue is due to the reduction in the number of distribution channels in May 2004.
Depreciation and amortization increased by $0.8 million due to an increase in amortization of intangible assets as a result of the acquisitions.
Loss from operations was $6 thousand for the nine months ended September 2004 compared to income from operations of $136 thousand in September 2003.
Prior to June 2003, corporate expenses were for the FAST division only. Salary and benefits increased primarily due to an increase in the number of senior management, administrative and technology personnel. Other operating expenses increased due to additional regulatory and professional fees.
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Consolidated service revenue for the nine months ended September 30, 2004 was $164.7 million, an increase of $70.8 million compared to service revenue of $93.9 in the same period in 2003. Acquisitions accounted for $64.2 million of the increase.
The consolidated gross margin of service revenue was 71.3% for the nine months ended September 30, 2004 compared to 73.7% for the same period in 2003. The decrease is due to the change in the mix of margins related to the acquired businesses.
Salaries and benefits were 36.8% of service revenue for the nine months ended September 30, 2004 and 38.4% compared to the same period in 2003. The decrease was primarily due to reductions in salaries and benefits as a percentage of revenue in all the segments offset by an increase in corporate salary and benefits incurred since the creation of First Advantage in June 2003.
Other operating expenses were 19.9% of service revenue for the nine months ended September 30, 2004 and 21.9% compared to the same period for 2003. The decrease was primarily related to the efficiencies realized from consolidating and integrating the acquisitions.
Depreciation and amortization increased by $3.1 million due to an increase in amortization of intangible assets as a result of acquisitions.
Income from operations was $15.1 million for the nine months ended September 30, 2004 compared to $6.6 million for the same period in 2003. The increase of $8.5 million is comprised of an increase in operating income of $10.7 million in the Enterprise Screening segment, an increase in operating income of $0.9 million in the Risk Mitigation segment, a decrease in operating income of $0.1 million in the Consumer Direct segment and an increase of corporate expenses of $3.0 million.
Liquidity and Capital Resources
The Company’s primary source of liquidity is cash flow from operations and amounts available under credit lines the Company has established with a bank and with First American. Prior to the June 5, 2003 merger with US SEARCH, contributions from First American were also a primary source of liquidity. As of September 30, 2004, cash and cash equivalents were $5.8 million.
Cash provided by operating activities was $9.4 million and $3.1 million for the nine months ended September 30, 2004 and 2003, respectively.
Cash provided from operating activities increased $6.3 million from the nine months ended September 30, 2004 compared to the same period in 2003, while net income was $8.0 million for the nine months ended September 30, 2004 and $3.8 million for the same period in 2003. The increase in cash provided from operating activities was primarily due to an increase in earnings and depreciation and amortization expense offset by an increase in accounts receivable.
Cash used in investing activities was $52.7 million and $11.2 million for the nine months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004, net cash in the amount of $50.0 million was used for acquisitions. Cash used for the purchase of property, equipment and database development was $6.0 million for the nine months ended September 30, 2004 compared to $4.1 million in the same period of 2003.
Cash provided by financing activities was $43.5 million and $8.9 million for the nine months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004, proceeds from existing credit facilities with a bank and First American were $57.0 million. Repayment of debt was $17.0 million for the nine months ended September 30, 2004.
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On April 27, 2004, the Company entered into a Promissory Note with First American. The loan evidenced by the Promissory Note is a $20 million unsecured revolving loan, with interest payable monthly. The principal balance of the Promissory Note is due on July 31, 2006. The Promissory Note is subordinated to the bank Loan Agreement and Line of Credit and bears interest at the rate payable under the $20 million bank Loan Agreement plus 0.5% per annum. The balance outstanding as of September 30, 2004 was $14 million.
At September 30, 2004 the Company had unused lines of credit of $17.6 million.
First Advantage filed a Registration Statement with the Securities and Exchange Commission for the issuance of up to 4,000,000 shares of our Class A common stock, par value $.001 per share, from time to time as full or partial consideration for the acquisition of businesses, assets or securities of other business entities. The Registration Statement was declared effective on July 14, 2003. A total of 1,976,514 of the 4,000,000 shares were issued for acquisitions as of September 30, 2004.
In the future, First Advantage will seek to acquire other businesses as part of its growth strategy. The Company will continue to evaluate acquisitions in order to achieve economies of scale, expand market share and enter new markets. The extent of future acquisitions, however, is dependent upon the availability of capital and liquidity to fund such acquisitions.
While uncertainties within the Company’s industry exist, management is not aware of any trends or events likely to have a material adverse effect on liquidity or the accompanying financial statements. The Company believes that, based on current levels of operations and anticipated growth, the Company’s cash flow from operations, together with available sources of liquidity, will be sufficient to fund operations, anticipated capital expenditures, make required payments of principal and interest on debt, and satisfy other long-term contractual commitments for the following year. However, any material adverse change in our operating results from our business plan, or acceleration of existing debt obligations or in the amount of investment in acquisitions, technology or products could require the Company to seek other funding alternatives.
The following is a schedule of long-term contractual commitments (as of September 30, 2004) over the periods in which they are expected to be paid.
Minimum contract purchase commitments
Operating leases
Long-term debt and capital leases
Total
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the Company’s risk since filing its Form 10-K for the year ended December 31, 2003.
Item 4. Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, have concluded that, as of the end of the fiscal quarter covered by this report on Form 10-Q, the Company’s disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports filed or submitted under such Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There was no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(b) Reports on Form 8-K
During the three months ended September 30, 2004, the Company:
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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.
(Registrant)
Date: November 5, 2004
/s/ JOHN LONG
John Long
Chief Executive Officer
/s/ JOHN LAMSON
John Lamson
Chief Financial Officer
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EXHIBIT INDEX
Description
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