**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM10-Q**

 
| **(Mark One)** |   |                                                                                         |
|----------------|--------|----------------------------------------------------------------------------------------------|
|           |   |                                                                                         |
| **ý**     |   | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |

** **

**For thequarterly period ended June 30, 2002**

** **

**OR**

** **
| **o** |   | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |
|-------|--------|-----------------------------------------------------------------------------------------------|

** **

**For thetransition periodfrom                  to             **

** **

**Commissionfile number 0-26149**

** **

| **US  SEARCH.COM INC.**                                     |
|------------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)          |
|                                                             |   |   |
| **Delaware**                                                     |   | **95-4504143** |
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                             |   |   |
| **5401  Beethoven Street, Los Angeles, CA 90066**                |
| (Address of principal  executive offices, including zip code)    |
|                                                             |   |   |
| **(310)  302-6300**                                              |
| (Registrant’s telephone  number, including area code)       |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports)Yes ý No o,and (2) has been subject to such filing requirements for the past90 days.    Yes  ý    No  o

 

There were 97,376,901 shares of outstanding CommonStock of the registrant as of July 26, 2002.

 

 

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**USSEARCH.COM INC.**

 

**Form 10-Qfor the quarterly period ended June 30, 2002**

 

**INDEX**

 
| Part I.           | FINANCIAL INFORMATION |
|-------------------|-----------------------|
|              |                  |   |
|              | Item 1.               | Financial Statements |
|              |                  | Consolidated  Statements of Operations for the three and six month periods ended June 30,  2002 and June 30, 2001 |
|              |                  | Consolidated Balance  Sheets as of June 30, 2002 and December 31, 2001 |
|              |                  | Consolidated  Statements of Cash Flows for the six month periods ended June 30, 2002 and  June 30, 2001 |
|              |                  | Notes to  Consolidated Financial Statements |
|              | Item  2.              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|              | Item  3.              | Quantitative  and Qualitative Disclosures about Market Risk |
|              |                  |
| Part II.          | OTHER INFORMATION     |
|              |                  |
|              | Item 1.               | Legal Proceedings |
|              | Item  2.              | Changes  in Securities and Use of Proceeds |
|              | Item 3.               | Defaults Upon  Senior Securities |
|              | Item  4.              | Submission  of Matters to a Vote of Security Holders |
|              | Item 5                | Other Information |
|              | Item 6.               | Exhibits  and Reports on Form 8-K |
|              |
| SIGNATURES        |
|              |
| INDEX TO EXHIBITS |

 

2

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**PART I. FINANCIAL INFORMATION**

 

Item 1. Financial Statements

 

**USSEARCH.com Inc.**

**CONSOLIDATEDSTATEMENT OF OPERATIONS**

**(unaudited)**

 
|                                                                                                                                                                                                                                                                                                                 |   | **Six Months Ended** |       | **Three Months Ended** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|------------|------------------------|--------|
|                                                                                                                                                                                                                                                                                                                 |   | **June 30, 2002**    |       | **June 30, 2001**      |   | **June 30, 2002** |   | **June 30, 2001** |   |
|                                                                                                                                                                                                                                                                                                                 |   | **(unaudited)**      |       |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |
| Net revenue                                                                                                                                                                                                                                                                                                          |   | $                    | 14,189,000 |                   | $      | 9,946,000 |   | $ | 7,526,000 |   | $ | 5,005,000 |   |
| Cost of services                                                                                                                                                                                                                                                                                                     |   | 4,202,000            |       | 2,477,000              |   | 2,214,000 |   | 1,053,000 |   |
| Gross profit                                                                                                                                                                                                                                                                                                         |   | 9,987,000            |       | 7,469,000              |   | 5,312,000 |   | 3,952,000 |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Operating expenses:                                                                                                                                                                                                                                                                                                  |   |                 |       |                   |   |   |   |   |   |
| Selling and marketing                                                                                                                                                                                                                                                                                                |   | 5,913,000            |       | 5,246,000              |   | 3,131,000 |   | 2,654,000 |   |
| Information technology                                                                                                                                                                                                                                                                                               |   | 1,937,000            |       | 2,371,000              |   | 999,000 |   | 1,128,000 |   |
| General and administrative                                                                                                                                                                                                                                                                                           |   | 6,776,000            |       | 4,618,000              |   | 3,746,000 |   | 2,131,000 |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Total operating expenses                                                                                                                                                                                                                                                                                             |   | 14,626,000           |       | 12,235,000             |   | 7,876,000 |   | 5,913,000 |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Loss from operations                                                                                                                                                                                                                                                                                                 |   | (4,639,000           | )          | (4,766,000             | )      | (2,564,000 | ) | (1,961,000 | ) |
| Interest expense, net (including non-cash charges  relating to warrants, beneficial conversion features, and amortization of  debt issuance costs of $1,863,000 and $1,036,000 for the six and three months  ended June 30, 2002, respectively, and $695,000 for the six and  three-months ended June 30, 2001) |   | (2,099,000           | )          | (802,000               | )      | (1,164,000 | ) | (819,000 | ) |
| Other income, net                                                                                                                                                                                                                                                                                                    |   | 31,000               |       | 23,000                 |   | 14,000 |   | 22,000 |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Loss before income taxes                                                                                                                                                                                                                                                                                             |   | (6,707,000           | )          | (5,545,000             | )      | (3,714,000 | ) | (2,758,000 | ) |
| Provision for income taxes                                                                                                                                                                                                                                                                                           |   | 2,000                |       | 2,000                  |   |   |   | — |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Net loss                                                                                                                                                                                                                                                                                                             |   | (6,709,000           | )          | (5,547,000             | )      | (3,714,000 | ) | (2,758,000 | ) |
| Deemed dividend on exchange of preferred stock                                                                                                                                                                                                                                                                       |   |                 |       | 12,575,000             |   |   |   | 12,575,000 |   |
| Accretion of discount on preferred stock                                                                                                                                                                                                                                                                             |   |                 |       | 203,000                |   |   |   | 77,000 |   |
| Accrued preferred stock dividends                                                                                                                                                                                                                                                                                    |   |                 |       | 200,000                |   |   |   | 87,000 |   |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Net loss attributable to common stockholders                                                                                                                                                                                                                                                                         |   | $                    | (6,709,000 | )                      | $      | (18,525,000 | ) | $ | (3,714,000 | ) | $ | (15,497,000 | ) |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Net loss per share attributable to common stockholders                                                                                                                                                                                                                                                               |   | $                    | (0.25      | )                      | $      | (1.03 | ) | $ | (0.14 | ) | $ | (0.86 | ) |
|                                                                                                                                                                                                                                                                                                                 |   |                 |       |                   |   |   |   |   |   |
| Weighted-average shares outstanding used in per share  calculation                                                                                                                                                                                                                                                   |   | 26,754,092           |       | 17,945,327             |   | 26,887,645 |   | 17,952,255 |   |

 

The accompanying notesare an integral part of these statements.

 

3

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**US SEARCH.com Inc.**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                             |   | **June 30,  2002** |       | **December 31,  2001** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-----------------------------|------------|
|                                                                                                                                                                             |   | **(unaudited)**    | ** ** |                        | ** ** |
|                                                                                                                                                                             |   |               |       |                        |       |
| **ASSETS:**                                                                                                                                                                      |   |               |       |                        |       |
| Current assets:                                                                                                                                                                  |   |               |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                       |   | $                  | 2,739,000  |                        | $          | 3,148,000 |   |
| Restricted cash                                                                                                                                                                  |   | 2,300,000          |       | 750,000                     |       |
| Accounts  receivable, net                                                                                                                                                        |   | 1,435,000          |       | 696,000                     |       |
| Prepaids and  other current assets                                                                                                                                               |   | 1,817,000          |       | 1,854,000                   |       |
| Total current  assets                                                                                                                                                            |   | 8,291,000          |       | 6,448,000                   |       |
|                                                                                                                                                                             |   |               |       |                        |       |
| Property and  equipment, net                                                                                                                                                     |   | 9,166,000          |       | 9,409,000                   |       |
| Goodwill                                                                                                                                                                         |   | 8,868,000          |       | 8,648,000                   |       |
| Intangibles, net                                                                                                                                                                 |   | 2,805,000          |       | 2,960,000                   |       |
| Other assets                                                                                                                                                                     |   | 277,000            |       | 270,000                     |       |
| Total assets                                                                                                                                                                     |   | $                  | 29,407,000 |                        | $          | 27,735,000 |   |
|                                                                                                                                                                             |   |               |       |                        |       |
| Current  Liabilities:                                                                                                                                                            |   |               |       |                        |       |
| Accounts payable                                                                                                                                                                 |   | $                  | 4,065,000  |                        | $          | 7,182,000 |   |
| Accrued  liabilities                                                                                                                                                             |   | 2,375,000          |       | 1,930,000                   |       |
| PRSI acquisition  obligations, current portion                                                                                                                                   |   | 541,000            |       | 902,000                     |       |
| Bank debt                                                                                                                                                                        |   | 1,185,000          |       | 1,375,000                   |       |
| Notes payable,  current portion                                                                                                                                                  |   | 13,463,000         |       | 3,896,000                   |       |
| Capital lease  obligations, current portion                                                                                                                                      |   | 224,000            |       | 280,000                     |       |
| Total current  liabilities                                                                                                                                                       |   | 21,853,000         |       | 15,565,000                  |       |
|                                                                                                                                                                             |   |               |       |                        |       |
| Notes payable,  net of current portion                                                                                                                                           |   | 114,000            |       | —                      |       |
| PRSI acquisition  obligations, net of current portion                                                                                                                            |   | 1,500,000          |       | 1,654,000                   |       |
| Capital lease  obligations, net of current portion                                                                                                                               |   | 55,000             |       | 156,000                     |       |
| Other  non-current liabilities                                                                                                                                                   |   | 5,000              |       | 5,000                       |       |
| Total  liabilities                                                                                                                                                               |   | 23,527,000         |       | 17,380,000                  |       |
| Commitments and  contingencies (Note 6)                                                                                                                                          |   |               |       |                        |       |
| Stockholders’  equity:                                                                                                                                                      |   |               |       |                        |       |
| Preferred stock  $0.001 par value; 1,000,000 authorized, 203,113 shares issued and outstanding  as of June 30, 2002 and December 31, 2001                                   |   | —             |       | —                      |       |
| Common stock  $0.001 par value; authorized 150,000,000 shares; 26,932,451 and 26,183,058  shares issued and outstanding as of June 30, 2002 and December 31, 2001,  respectively |   | 27,000             |       | 26,000                      |       |
| Additional  paid-in capital                                                                                                                                                      |   | 87,080,000         |       | 84,847,000                  |       |
| Accumulated  deficit                                                                                                                                                             |   | (81,227,000        | )          | (74,518,000                 | )          |
| Total  stockholders’ equity                                                                                                                                                 |   | 5,880,000          |       | 10,355,000                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                                 |   | $                  | 29,407,000 |                        | $          | 27,735,000 |   |

 

The accompanying notesare an integral part of these statements.

 

4

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**USSEARCH.com Inc.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(unaudited)**

 
|                                                                         |   | **Six Months  Ended June 30,** |       |
|------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                         |   | **2002**                       |       | **2001** |   |
| Cash flows from  operating activities:                                       |   |                           |       |   |   |
| Net loss                                                                     |   | $                              | (6,709,000 | ) | $ | (5,547,000 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                           |       |   |   |
| Depreciation and  amortization                                               |   | 1,652,000                      |       | 600,000 |   |
| Interest on  convertible notes payable                                       |   |                           |       | 161,000 |   |
| Non-cash  interest expense                                                   |   | 1,863,000                      |       | 695,000 |   |
| Change in assets  and liabilities:                                           |   |                           |       |   |   |
| Accounts receivable                                                          |   | (739,000                       | )          | (82,000 | ) |
| Prepaid and  other                                                           |   | (289,000                       | )          | 307,000 |   |
| Accounts payable  and accrued expenses                                       |   | (2,473,000                     | )          | (2,204,000 | ) |
|                                                                         |   |                           |       |   |   |
| Net cash used in  operating activities                                       |   | (6,695,000                     | )          | (6,070,000 | ) |
|                                                                         |   |                           |       |   |   |
| Cash flows from  investing activities:                                       |   |                           |       |   |   |
| Purchase of  property and equipment                                          |   | (1,255,000                     | )          | (1,891,000 | ) |
| PRSI acquisition  costs                                                      |   | (220,000                       | )          | — |   |
|                                                                         |   |                           |       |   |   |
| Net cash used by  investing activities                                       |   | (1,475,000                     | )          | (1,891,000 | ) |
|                                                                         |   |                           |       |   |   |
| Cash flows from  financing activities:                                       |   |                           |       |   |   |
| Increase in  restricted cash                                                 |   | (1,550,000                     | )          | — |   |
| Repayments of  third party notes payable                                     |   |                           |       | (687,000 | ) |
| Repayment of  PRSI acquisition obligation                                    |   | (600,000                       | )          | — |   |
| Repayments of  bank debt                                                     |   | (234,000                       | )          | — |   |
| Repayments of  capital lease obligations                                     |   | (157,000                       | )          | (124,000 | ) |
| Proceeds from  notes payable, net                                            |   | 10,233,000                     |       | 10,000,000 |   |
| Issuance costs  of preferred stock                                           |   |                           |       | (138,000 | ) |
| Proceeds from  stock option exercises                                        |   | 69,000                         |       | 37,000 |   |
|                                                                         |   |                           |       |   |   |
| Net cash  provided by financing activities                                   |   | 7,761,000                      |       | 9,088,000 |   |
|                                                                         |   |                           |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                        |   | (409,000                       | )          | 1,127,000 |   |
| Cash at  beginning of period                                                 |   | 3,148,000                      |       | 2,831,000 |   |
| Cash at end of  period                                                       |   | $                              | 2,739,000  |   | $ | 3,958,000 |   |
|                                                                         |   |                           |       |   |   |
| Supplemental  cash flow disclosure is comprised of:                          |   |                           |       |   |   |
| Non-cash  investing and financing activities:                                |   |                           |       |   |   |
| Conversion of  notes payable to preferred stock                              |   | $                              | —     |   | $ | 10,000,000 |   |
| Conversion of  accounts payable to notes payable                             |   | $                              | —     |   | $ | 241,000 |   |
| Issuance of  warrants in connection with convertible notes payable           |   | $                              | 1,937,000  |   | $ | 250,000 |   |
| Issuance of  warrants to third parties                                       |   | $                              | 228,000    |   | $ | — |   |

 

The accompanying notesare an integral part of these statements.

 

5

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**USSEARCH.COM INC.**

**NOTES TOFINANCIAL STATEMENTS**

**(unaudited)**

 

**1.****             Organization andBusiness:**

 

US SEARCH.com Inc. (the “Company”) providesindividual reference services and background information about individuals. TheCompany was formed as a California S Corporation in 1994, and reincorporated asa Delaware corporation in April 1999. On December 28, 2001 theCompany acquired all of the outstanding stock of Professional ResourceScreening, Inc. (“PRSI”), which provides pre-employment screening servicesprimarily to large corporations, including Fortune 1000 companies in the UnitedStates.

 

**2.****             Summary ofSignificant Accounting Policies:**

 

**Basis of Presentation**

 

These unaudited financial statements and accompanyingnotes prepared in accordance with instructions to Form 10-Q have beencondensed and, therefore, do not contain certain information included in theCompany’s annual financial statements and accompanying notes. Therefore, youshould read these unaudited condensed financial statements in conjunction withthe Company’s annual financial statements.

 

The unaudited condensed financial statements reflect,in the opinion of management, all adjustments which are of a normal recurringnature, necessary to present fairly the financial position of the Company as ofJune 30, 2002, and the results of its operations for the three and six monthperiods ended June 30, 2002 and 2001. Interim results are not necessarilyindicative of results to be expected for a full fiscal year.

* *

*Principlesof Consolidation.*    The financialstatements include the accounts of US SEARCH.com Inc. and its whollyowned subsidiary. All material inter-company accounts and transactions havebeen eliminated in consolidation.

** **

**Net Loss Per Share**

 

Basic net loss per common share is computed using theweighted average number of shares of common stock outstanding and diluted netloss per common share is computed using the weighted average number of sharesof common stock and common equivalent shares outstanding. Common equivalentshares related to convertible preferred stock, convertible notes payable, stockoptions and warrants are excluded from the computation when their effect isantidilutive. As of June 30, 2002, stock options representing 19,615,054 sharesof common stock and warrants representing 10,400,443 shares of common stockhave been excluded from the calculation of diluted earnings per sharebecause  their inclusion would beanti-dilutive. As of June 30, 2001, stock options representing 13,320,992shares of common stock and warrants representing 1,750,000 shares of commonstock and  5,000 shares of preferred stock,have been excluded from the calculation of diluted earnings per share becausetheir inclusion would be anti-dilutive. Also excluded at both June 30, 2002 and June 30, 2001 are 42,107,303common shares issuable on conversion of Series A-1 convertible preferredstock.

** **

**Management’s Plans**

 

Since inception, the Company has experienced negativecash flows from operations. The Company had a working capital deficit of$13,562,000 and an accumulated deficit of $81,227,000 as of June 30, 2002.Based on our current operating plans, management believes existing cashresources and cash forecasted by management to be generated by operations andavailable from the April 2002 bank financing arrangement will besufficient to meet working capital and capital requirements through at leastthe next twelve months. Management’s plans to attain profitability and generateadditional cash flows include, increasing revenues from enterprise and consumerservices, focusing on cost reductions and operational efficiencies to be derivedfrom further deployment of US SEARCH’s technologies, and the launch ofadditional products. There is no assurance that management will be

 

6

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successful with these plans. However, if events and circumstances occursuch that US SEARCH does not meet its current operating plan as expected, andUS SEARCH is unable to raise additional financing, US SEARCH may be required toreduce certain discretionary spending, which could have a material adverseeffect on US SEARCH’s ability to achieve our intended business objectives.

** **

**Reclassifications**

 

Certain reclassifications have been made to the 2001financial statements to conform with the 2002 presentation.

** **

**3.****             Notes Payable:**

 

In December 2001, the Company issued a $3,500,000promissory note to Pequot Private Equity Fund II, L.P. (“Pequot”). Thepromissory note bore interest at a rate of eight percent (8%) per annum and, ifnot previously converted into common stock, was due and payable on December 20,2002. The note was convertible on approval by the shareholders of the Companyor waiver of shareholder approval by NASD. The conversion price was the lowerof (a) $0.783 or (b) 90% of the 10-day average closing bid price of thecompany’s common stock prior to the earlier date the Company received (x)approval from its stockholders or (y) the approval of the Nasdaq NationalMarket for the transaction. In connection with this note, the company issued toPequot a warrant to purchase 1,340,996 shares of common stock at an exerciseprice of $1.044 per share. The warrant expires on December 20, 2005. At the2002 Annual Meeting of Stockholders, held on July 18, 2002, Stockholdersapproved the issuance of the shares of common stock underlying these notes.These notes and accrued interest automatically converted into 6,922,399 sharesof common stock at the conversion price of $0.5292 on July 18, 2002.

 

In January 2002, the Company issued 8%Convertible Promissory Notes due January 17, 2003 in the aggregateprincipal amount of $4,600,000 and four year warrants to purchase up to anaggregate of 1,782,176 shares of common stock at an initial exercise price of$1.044 per share. These notes were convertible into the number of shares ofcommon stock calculated by dividing the amount of principal and accrued butunpaid interest due under the notes by the lower of i) $0.783 or(ii) 90% of the 10-day average closing bid price of the Company’s commonstock on the Nasdaq National Market for the 10 business days prior to theconversion date of the notes.  At the2002 Annual Meeting of Stockholders, Stockholders approved the issuance of theshares of common stock underlying these notes. These notes and accrued interestautomatically converted into 9,143,182 shares of common stock at the conversionprice of $0.5292 on July 18, 2002.

 

In March 2002, the Company issued 8% ConvertiblePromissory Notes due December 20, 2002 in the aggregate principal amountof $6,075,000 ($5,700,000 in proceeds net of issuance costs) and five yearwarrants to purchase up to an aggregate of 2,144,118 shares of our common stockat an initial exercise price of $1.044 per share. The Company also issuedwarrants to purchase 714,706 shares of common stock at an exercise price of$0.85 per share to the principals of the offering placement agent. These noteswere convertible into the number of shares of common stock calculated bydividing the amount of principal and accrued but unpaid interest due under thenotes by the lower of (i) $0.85 and (ii) 90% of the 10-day averageclosing bid price of the Company’s common stock on the Nasdaq National Marketfor the 10 business days prior to the conversion date of the notes. At the 2002Annual Meeting of Stockholders, the Stockholders approved the issuance of theshares of common stock underlying the notes. These notes and accrued interestautomatically converted into 11,798,471 shares of common stock on July 18,2002.

 

In accordance with Accounting Principles Board OpinionNo. 14 “Accounting for Convertible Debt and Debt Issued with Stock PurchaseWarrants”, the relative fair value of the warrants issued in conjunction withthe December, January and March notes (the “Notes”) totaled $452,000 and$730,000 and, $892,000, respectively. Warrants issued to the placement agenthad a fair value of $315,000. Such amounts were being recorded as interestexpense over the terms of the notes. As of June 30, 2002, the Company hasamortized approximately $978,000.

 

7

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In July 2002, upon the conversion of the 8%Convertible Promissory Notes with an aggregate principal amount of $14,226,000,the Company recorded as additional interest expense a non-cash charge of$11,749,000 for a beneficial conversion feature (BCF) relating to the Notes.  The BCF was computed based on the differencebetween the effective conversion price per share and the fair value of thecommon stock on the commitment date, multiplied by the number of shares intowhich the promissory notes were convertible, limited to the amount of proceedsallocated to the notes at the commitment date. Additionally, approximately $1,900,000 of remaining discount relating towarrants and issuance costs was charged to interest expense on the conversiondate.

 

Included in notes payable is $526,000 net of discountof $55,000 due to a vendor. In conjunction with the terms of the note, theoutstanding balance is due and payable within 90 days of the Companyclosing a financing, as defined, in excess of $10,000,000. As of June 30, 2002the Company has closed financing in excess of $10,000,000.

** **

**4.****             Bank Debt**

 

On April 1, 2002, the Company entered into anagreement with Comerica Bank to amend its existing loan and security agreement(“Amendment Number One”). The Comerica facility has been amended to increasethe revolving credit line to $3,000,000 from $2,000,000, of which $1,000,000has been designated as a borrowing base line. Amounts under the borrowing baseline may be advanced based on up to 80% of eligible receivables as defined inthe agreement. Borrowings under the revolving credit line are due and payableon March 26, 2003. Total borrowings under the revolving credit facilitytotaled $1,000,000 at June 30, 2002.

 

The Comerica agreement was also amended to remove theletter of credit sublimit from the revolving credit line. Under AmendmentNumber One, the Company will maintain a deposit with the bank of $750,000 tocollateralize its outstanding standby letter of credit. The letter of creditand the required deposit is reduced by $83,333 per month and matures on November 30,2002. The amount of the letter of credit and the collateral deposit at August1, 2002 was $333,000.

 

Significant financial covenants with which the Companymust comply under Amendment Number One include operating performance, minimumEBITDA requirements and a debt/tangible net worth ratio. At June 30, 2002, theCompany was also required to maintain not less than $1,250,000 of itsunrestricted cash on deposit with the bank at all times, and $1,050,000relating to credit card processing and security for a standby letter ofcredit.  In July 2002, Comerica agreedto amend the loan agreement to, among other things, reduce the amount ofunrestricted cash the Company must maintain on deposit with the bank from $1,250,000to $250,000.  Based on this amendment,the required restricted cash was reduced from $2,300,000 at June 30, 2002 to$833,000 at August 1, 2002.  The Companywas in compliance with or had received bank commitment to waive financialcovenants at June 30, 2002.

 

In connection with Amendment Number One, the Companyagreed to issue the bank a warrant to purchase 55,487 shares of the Company’scommon stock at an exercise price of $0.85 per share. The warrant expires onMarch 27, 2008.  As a result of theissuance of the warrant, the Company recorded a non-cash charge of $12,000,which is included in debt issuance costs for the period ended June 30, 2002.

** **

**5.****             Capital Stock**

 

During the six months ended June 30, 2002, the Companyissued to certain vendors a warrant, which matures March 5, 2007, to purchase75,000 shares at an exercise price of $1.20 per share; and a warrant, whichmatures on January 3, 2005, to purchase 137,143 shares at an exercise price of$0.01 per share.

 

As of close of business on July 18, 2002, PequotPrivate Equity Fund II, L.P., the holder of all 203,113 shares of Series A-1Convertible Preferred Stock currently outstanding, elected to convert all ofits Series of A-1 Convertible Preferred Stock into Common Stock. The conversionprice of the Series of A-1 Convertible Preferred Stock was $0.48237 per share,which resulted in the issuance of an aggregate of 42,107,303 shares of CommonStock upon conversion of the Series of A-1 Convertible Preferred Stock.

 

8

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**6.****             Commitments And Contingencies**

** **

**Strategic Alliance Commitments**

 

The Company has several cancelable and non-cancelabledistribution and marketing agreements with various Internet companies. Theterms of these agreements provide for varying levels of exclusivity and minimumand maximum fees payable based on the number of banners, buttons and text linksdisplayed on affiliate web sites. At June 30, 2002, the minimum non-cancelablepayments due under these agreements are approximately $900,000 for theremainder of 2002 and $1,350,000 for 2003.

 

The Company has entered into an agreement with asupplier of online public records data. At June 30, 2002, the non-cancelablepayments under this agreement are $414,000 due in 2002 and $690,000 due in2003.

** **

**Legal Proceedings**

 

On April 3, 2000, a two count trade name andservice mark complaint was filed against US SEARCH in the United StatesDistrict Court for the Eastern District of Virginia, styled U.S. Search, LLC vUSSearch.com Inc. Civil Action No. 00-554-A. On January 26,2001, our motion for summary judgment was granted and the court ordered thatboth counts of plaintiff’s complaint be dismissed with prejudice. The Plaintiffhas appealed the judgment to the U.S. Court of Appeals, Fourth Circuit. Thehearing on appeal was held June 6, 2002. The parties are awaiting theoutcome of the appeal.

 

In May 2001, ChoicePoint, Inc., thesuccessor entity to DBT Online, Inc., filed a complaint against us in PalmBeach County, Florida alleging breach of contract, fraudulentmisrepresentation, unjust enrichment, quantum meruit and breach of the impliedcovenant of good faith and fair dealing. The Complaint sought approximately$1.5 million in damages, as well as interest and attorneys’ fees. Weremoved this action to the United States District Court for the SouthernDistrict of Florida. The United States District Court for the Southern Districtof Florida ordered the matter to arbitration. An arbitration hearing was heldin April 2002 and in June 2002 the arbitration awarded us a credit of$297,671 to be deducted from invoices of $1,418,731. ChoicePoint has filed aMotion to Confirm the Arbitration Award to provide additional credits and wehave filed a Motion to Modify and correct the Arbitration Award to proviceadditional credits. We are awaiting the District Court's ruling on thesemotions. We currently have approximately $1,079,000 accrued for this liability.The costs related to this litigation to date have been less than $100,000.

 

On June 25, 2002, a complaint seeking $434,000 indamages was filed against Professional Resource Screening, Inc. in SuperiorCourt of California, County of Contra Costa, styled Wood Warren & Co. v.Professional Resource Screening, Inc., No.C02-01816, alleging breach of an oralagreement relating to investment banking services, negligent misrepresentation,promissory estoppel, equitable estoppel and quantum meruit.  Although it is too early to predict theoutcome of this litigation, the Company believes it has meritorious defenses toplaintiff’s claims.

 

The Company may from time to time become a party tovarious legal proceedings arising in the ordinary course of business.

** **

**7.****             Unaudited Pro FormaResults of Operations for the Six and Three Months Ended June 30, 2001**

 

Unaudited proforma consolidated results of operationsare presented in the table below for the six and three months ended June 30,2001. The proforma results of operations reflect the acquisition ofProfessional Resource Screening, Inc., which are not reflected in the June30, 2001 historical results, as if the acquisition was consummated as ofJanuary 1, 2001. Historical results for the six and three months endedJune 30, 2002, which includes the results of Professional ResourceScreening, Inc. for the entire period, are presented for comparability. 

 
| **(in thousands)­­**                          |   | **Six Months  Ended  June 30, 2002  Historical** |   | **Six Months  Ended  June 30, 2001  Pro Forma** |   | **Three Months  Ended  June 30, 2002  Historical** |   | **Three Months  Ended  June 30, 2001  Pro Forma** |   |
|---------------------------------------------------------|--------|--------------------------------------------------|--------|-------------------------------------------------|--------|----------------------------------------------------|--------|---------------------------------------------------|--------|
| Net revenue                                             |   | $                                                | 14,189 |                                            | $      | 14,576                                             |   | $                                                 | 7,526  |   | $ | 7,266 |   |
| Net loss                                                |   | (6,709                                           | )      | (5,606                                          | )      | (3,714                                             | )      | (2,806                                            | )      |
| Net loss  attributable to common stockholders           |   | (6,709                                           | )      | (18,584                                         | )      | (3,714                                             | )      | (15,545                                           | )      |
| Net loss per  share attributable to common stockholders |   | $                                                | (0.25  | )                                               | $      | (0.69                                              | )      | $                                                 | (0.14  | ) | $ | (0.58 | ) |

 

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These unaudited pro forma results have been preparedfor comparative purposes only and include material adjustments, such asamortization of identifiable intangible assets and interest on installmentobligations. The results do not purport to be indicative of the results ofoperations which actually would have resulted had the combination been ineffect on January 1, 2001, or of future results of operations of theconsolidated company.

** **

**8.****             Related PartyTransactions**

 

In accordance with the Agreement and Plan of Merger,dated as of December 28, 2001, by and among the Company, ProfessionalResource Screening, Inc. (“PRSI”), Irwin R. Pearlstein, CherylPearlstein-Enos and David Pearlstein (the “Merger Agreement”), onDecember 28, 2001, the Company issued 8,148,148 shares of common stock tothe former shareholders of PRSI. Pursuant to the Merger Agreement onJanuary 31, 2002 the Company issued an additional 651,852 shares of commonstock to the former shareholders of PRSI.

 

**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

** **

**Forward-Looking Statements**

 

*THEFOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADEPURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF1995. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON OUR CURRENT EXPECTATIONS,ESTIMATES AND PROJECTIONS ABOUT THE COMPANY’S BUSINESS, MANAGEMENT’S BELIEFSAND ASSUMPTIONS MADE BY MANAGEMENT. WORDS SUCH AS “ANTICIPATES,” “EXPECTS,”“INTENDS,” “PLANS,” “BELIEVES,” “SEEKS,” “ESTIMATES,” “LIKELY”, VARIATIONS OFSUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCHFORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTUREPERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONSTHAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS AND OUTCOMES MAYDIFFER MATERIALLY FROM WHAT IS EXPRESSED OR FORECASTED IN ANY SUCHFORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE THOSE SETFORTH BELOW UNDER “FACTORS AFFECTING OUR BUSINESS, OPERATING RESULTS ANDFINANCIAL CONDITION” AND OUR OTHER PUBLIC FILINGS WITH THE SECURITIES ANDEXCHANGE COMMISSION. WE UNDERTAKE NO OBLIGATION TO UPDATE PUBLICLY ANYFORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTUREEVENTS OR OTHERWISE.*

** **

**Overview**

 

US SEARCH provides a full range of location andverification services to enterprises, consumers and small and medium sizedbusiness clients including identity verification, individual location, criminalrecord checks, employment and education verifications, professional referencechecks, credit and motor vehicle record checks, drug screening, andpre-employment screening services. We are able to deliver location verificationand screening services through our proprietary web-based applications and ourpatent pending US SEARCH DARWIN technology. Our services can be accessedthrough our Web sites, USSEARCH.com, ussearch.com/business or prsinet.com, orby calling our toll free telephone numbers, 1-800-USSEARCH for consumers, 1-877-327-2410for small and medium businesses or 1-800-232-0247 for large businesses.

 

Our consumer and small and medium enterprise productsprovide direct (Internet and telephone) individual locator, and other publicrecord searches to consumers and these services and pre-employment screening

 

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services to small- and medium-sized businesses. Our enterprise productprovides employment screening and risk mitigation services to large enterprisesand organizations.

 

Due to the high level of automation, certain of ourservices can be conducted instantly online. We also offer assisted searches andscreening services, both online and through our toll free telephone number.

 

•                         Corporateservices. We provide businesses, government agencies and other employers with avariety of employment screening, background check and risk mitigation productsand services via an online, Web-based system that enables instant ordering andprompt delivery of results. Customers can customize their search and decisionparameters online using a “drag-and-drop” browser interface. Our employmentscreening products include social security number traces, federal and statefelony and misdemeanor record searches, employment and education verification,and credit histories. We also provide character reference checks and drugscreening via third party providers. We also offer a Management Servicesprogram that provides customers with an outsourced solution to backgroundinvestigations, which includes analysis of developed investigation data,management of FCRA communications, legal compliance, and direct applicantcontact.

 

•                         Consumer-focusedservices. We provide consumer clients with a single, comprehensive access pointto a broad range of information to assist them in locating friends andrelatives or to learn more information about people in their lives. Ourconsumer clients can obtain public information including addresses, aliases,phone numbers, property ownership, court records, professional licenseverification, corporate affiliations and death record information.

 

Prices for our non-instant consumer and small and medium businessservices have ranged from approximately $20 to $395 per search. Prices for“Instant Searches” range from approximately $10 to $15 per search. Prices forour large business services range from $3 to $495. The prices for our servicesvary based on the nature and amount of information and whether or not thesearch is assisted by a search specialist.

 

Revenue for our services is recognized when theresults are delivered to the client. The terms of sale do not provide forrefunds after our services have been delivered, however, in instances where theclients indicate that the initial search result was unsuccessful, we may performanother search or provide a refund at our discretion. In addition, whereclients desire additional information they can request to broaden the scope oftheir “Instant Searches” and we apply up to a portion of the cost of theclient’s “Instant Searches” towards the cost of the more comprehensive search.

 

Our cost of services consists primarily of payroll andbenefits, data acquisition costs, and local and long distance telephone chargesassociated with providing our services, and payment processing costs. Our costof services is likely to increase with increasing revenue levels. The Companyhas entered into an agreement with a supplier of online public record data. AtJune 30, 2002, the non-cancelable payments under this agreement are $414,000 in2002 and $690,000 in 2003.

 

Our operating expenses consist primarily of selling,marketing, general and administrative expenses and information technologycosts. We expect our operating expenses to increase as we attempt to expand ourcorporate sales force and our product lines.

 

Selling and marketing expenses constitutes asignificant portion of our operating expenses. Internet advertising expensesare the most significant selling and marketing expense. The Company has severalcancelable and non-cancelable distribution and marketing agreements withvarious Internet companies. The terms of these agreements provide for varyinglevels of exclusivity and minimum and maximum fees payable based on the numberof banners, buttons and text links displayed on affiliate web sites. At June30, 2002, the minimum non-cancelable payments due under these agreements areapproximately $900,000 and $1,350,000 for the remainder of 2002.

 

We expect our selling and marketing expenses toincrease as we attempt to expand our products and our market reach in both theconsumer and enterprise services groups.

 

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Information technology expenses consist primarily ofthe compensation and benefits for employees and consultants involved in development,network administration, planning and maintenance of our infrastructure. Certaincosts associated with the development of software for internal use arecapitalized.  Information technologycosts are expected to increase with the continuing development of proprietarytechnology.

** **

**Results of Operations**

** **

**Comparison of the Three Months EndedJune 30, 2002 to the Three Months Ended June 30, 2001**

* *

*NetRevenues.*    Our net revenues increasedfrom approximately $5.0 million for the three months ended June 30, 2001to approximately $7.5 million for the three months ended June 30, 2002,representing a 50.0% increase. The $2.5 million increase is primarilyattributable to our acquisition of PRSI in December 2001 and the Company’sentrance into the enterprise services sector.

* *

*GrossProfit.*    Gross profit increased fromapproximately $4.0 million for the three months ended June 30, 2001, toapproximately $5.3 million for the three months ended June 30, 2002,representing a 33% increase. Gross profit as a percentage of net revenues wasapproximately 71% and 79% for the three month periods ended June 30, 2002 and2001, respectively. The decrease in gross margin reflects the change in productmix as a result of the Company’s December 2001 acquisition of PRSI offsetby cost reductions in the Company’s consumer business. Increased automation inour consumer business also contributed to the increase in gross profit,resulting in a reduction in direct labor expense in our consumer business.

* *

*Sellingand Marketing Expenses.*    Selling andmarketing expenses increased by $477,000 to $3.1 million for the threemonth period ended June 30, 2002 as compared to $2.7 million for the 2001period. The change is the net result of an increase of $450,000 due to theDecember 2001 acquisition of PRSI and $609,000 due to the addition of newInternet advertising providers partially offset by reductions in other costs,consisting primarily of selling and marketing labor costs.  Although costs increased, selling andmarketing expenses were 41.6% of sales for the three months ended June 30, 2002compared to 53.0% of sales for the three months ended June 30, 2001.

* *

*InformationTechnology Expenditures.*    Informationtechnology expenditures decreased by $129,000 for the three-month period endedJune 30, 2002 as compared to the 2001 period, primarily due to reduction inheadcount.

* *

*Generaland Administrative Expenses.*    Generaland administrative expenses for the three months ended June 30, 2002 increasedby $1,615,000 compared to the same period in 2001. The change is primarily theresult of a $756,000 increase due to the December 2001 acquisition ofPRSI,  a $225,000 increase indepreciation expense as a result of initial implementation of certain of theCompany’s internally developed software, a $290,000 increase in legal fees andlegal settlements, and a $200,000 charge for severance benefits, of which$120,000 has been allocated to general and administrative expenses.

* *

*InterestExpense, Net.*    Interest expense, netof interest income, was $1,164,000 for the three months ended June 30, 2002 ascompared to $819,000 for the same period in 2001. Included in interest expensefor 2002 are non-cash interest charges of $910,000 related to the amortizationof discounts on the Company’s convertible and vendor notes payable. Alsoincluded is $126,000 related to the amortization of debt issuance costsincurred in conjunction with the Company’s bank credit facility.

** **

**Comparison of the Six Months EndedJune 30, 2002 to the Six Months Ended June 30, 2001**

* *

*NetRevenues.*    Our net revenues increasedfrom approximately $9.9 million for the six months ended June 30, 2001 toapproximately $14.2 million for the six months ended June 30, 2002,representing a 43.4% increase. The $4.3 million increase is primarilyattributable to our acquisition of PRSI in December 2001 and the Company’sentrance into the enterprise services sector.

* *

*GrossProfit.*    Gross profit increased fromapproximately $7.5 million for the six months ended June 30, 2001, toapproximately $10.0 million for the six months ended June 30, 2002,representing a 33% increase.

 

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Gross profit as a percentage of net revenues was approximately 70% and75% for the six month periods ended June 30, 2002 and 2001, respectively. Thedecrease in gross margin reflects the change in product mix as a result of theCompany’s December 2001 acquisition of PRSI offset by cost reductions inthe Company’s consumer business. Increased automation also contributed to theincrease in gross profit, resulting in a reduction in direct labor expense inour consumer business.

* *

*Sellingand Marketing Expenses.*    Selling andmarketing expenses increased by $667,000 to $5.9 million for the six monthperiod ended June 30, 2002 as compared to $5.3 million for the 2001period. The change is the net result of an increase of $990,000 due to theDecember 2001 acquisition of PRSI, and $800,000 due to the addition of newInternet advertising providers partially offset by an $840,000 reduction inselling and marketing labor costs. Although costs increased, selling andmarketing expenses were 41.7% of sales for the six months ended June 30, 2002compared to 52.7% of sales for the six months ended June 30, 2001.

* *

*InformationTechnology Expenditures.*    Informationtechnology expenditures decreased by $434,000 for the six-month period endedJune 30, 2002 as compared to the 2001 period, due primarily to a $660,000reduction in payroll costs offset by increased costs due to the December 2001acquisition of PRSI.

* *

*Generaland Administrative Expenses.*    Generaland administrative expenses for the six months ended June 30, 2002 increased by$2,158,000 compared to the same period in 2001. The change is primarily theresult of a $1,427,000 increase due to the December 2001 acquisition ofPRSI and a $439,000 increase in depreciation expense as a result of initialimplementation of certain of the Company’s internally developed software,$114,000 increase in legal and settlement costs, and a $200,000 charge forseverance benefits of which $120,000 has been allocated to general andadministrative expenses.

* *

*InterestExpense, Net.*    Interest expense, netof interest income, was $2,099,000 for the six months ended June 30, 2002 ascompared to $802,000 for the same period in 2001. Included in interest expensefor 2002 are non-cash interest charges of $1,461,000 related to theamortization of discounts on the Company’s convertible and vendor notespayable. Also included is $402,000 related to the amortization of debt issuancecosts incurred in conjunction with the Company’s bank credit facility.

** **

**Liquidity and Capital Resources**

 

As of June 30, 2002, cash and cash equivalents hasincreased to $5.0 million (including $2.3 million of restricted cashpledged as collateral in connection with the Company’s credit facility) from$3.9 million (including $750,000 of restricted cash) at December 31,2001.

 

Cash used in operations increased to $6.7 millionfor the six-month period ended June 30, 2002 as compared to $6.1 million forthe six-month period ended June 30, 2001. The increase in cash used during the 2002 period is the result ofcontinued operating losses and an acceleration of our vendor payments.

 

Cash used in investing activities decreased to $1.5million for the six months ended June 30, 2002 as compared to $1.9 million forthe six months ended on June 30, 2001. This is primarily attributable to thereduced investment in software development because of completion of certainprojects.

 

Cash provided by financing activities wasapproximately $7.8 million for the six months ended June 30, 2002 ascompared to $9.1 million for the six months ended June 30, 2001. The cashprovided in the 2002 period is primarily attributable to $10.2 million innet cash proceeds from issuance of our January and March 2002 convertible notespayable, partially offset by $600,000 of payments made in conjunction with ourDecember 2001 acquisition of PRSI, and the increase in restricted cash of$1.56 million in accordance with our amended credit facility, subject toavailability of 80% of eligible receivables.

 

On April 1, 2002, we entered into an agreementwith the bank to amend our credit facility (“Amendment Number One”), toincrease the revolving credit line to $3,000,000 from $2,000,000, of which$1,000,000 has been designated as a borrowing base line and, to revise certainfinancial covenants. Amounts under the

 

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borrowing base line may be advanced based on up to 80% of eligible receivablesas defined in the agreement. Borrowings under the revolving credit line are dueand payable on March 26, 2003. As of June 30, 2002, we were not incompliance with our revised bank covenants relating to maximum merchant cardchargeback ratios. In July 2002, the bank has agreed to waive the covenantdefault and amend this covenant requirement. As of June 30, 2002 the Companywas in compliance with the revised covenant. As of June 30, 2002, there is$1.0 million outstanding and $2.0 million available under therevolving credit facility, subject to availability of 80% of eligiblereceivables.

 

On April 1, 2002 the credit facility was also amendedto remove the letter of credit sublimit from the revolving credit line. UnderAmendment Number One, we are required to maintain a deposit with the bank of$750,000 to collateralize our outstanding standby letter of credit. The letterof credit and the required deposit will reduce by $83,333 per month and matureon November 30, 2002. As of June 30, 2002, there is $500,000 remainingunder the standby letter of credit.

 

Significant financial covenants with which we mustcomply under Amendment Number One include operating performance, minimum EBITDArequirements and a debt/tangible net worth ratio. Effective March 31, 2002, wewere also required to maintain not less than $1,250,000 of  unrestricted cash on deposit with the bankat all times. In July 2002, the bank agreed to amend the loan agreement toreduce the amount of the unrestricted cash required to be held on deposit withthe bank from $1,250,000 to $250,000. Based on this revised loan agreement, the required restricted cash willbe reduced from $2,300,000 at June 30, 2002 to $833,000 at August 1, 2002.

 

In connection with the Amendment Number One, we issuedthe bank a warrant to purchase 55,487 shares of the Company’s common stock atan exercise price of $0.85 per share. The warrant matures on March 27,2008.

 

In December 2001, we issued 8% ConvertiblePromissory Notes due December 20, 2002 in the aggregate principal amountof $3.5 million. In January 2002, we issued 8% Convertible PromissoryNotes due January 17, 2003 in the aggregate principal amount of$4.6 million. In March 2002, we issued 8% Convertible PromissoryNotes due December 20, 2002 in the aggregate principal amount of$6.1 million with net proceeds of $5.7 million. At the 2002 AnnualMeeting of Stockholders, held on July 18, 2002, the Company’s stockholdersapproved the issuance of the shares of common stock underlying the notes and,consequently, these notes and accrued interest automatically converted intocommon stock on July 18, 2002. These notes, with an aggregate principal amountof $14.2 million and accrued interest, converted into 27,864,052 shares ofcommon stock.

 

As of close of business on July 18, 2002, PequotPrivate Equity Fund II, L.P., the holder of all 203,113 shares of Series A-1Convertible Preferred Stock currently outstanding, elected to convert all ofits Series of A-1 Convertible Preferred Stock into Common Stock. The conversionprice of the Series A-1 Convertible Preferred Stock was $0.48237 per share,which resulted in the issuance of an aggregate of 42,107,303 shares of commonstock upon conversion of the Series of A-1 Convertible Preferred Stock.

 

Since inception, we have experienced negative cashflows from operations. We had a working capital deficit of $13.6 millionand an accumulated deficit of $81.2 million as of June 30, 2002. Based onour current operating plans, management believes existing cash resources andcash forecasted by management to be generated by operations and availabilityfrom the April 2002 credit facility amendment will be sufficient to meetworking capital and capital requirements through at least the next twelvemonths. Management’s plans to attain profitability and generate additional cashflows include, increasing revenues from enterprise and consumer services,focusing on cost reductions and operational efficiencies to be derived fromfurther deployment of our technologies, and the launch of additional products.There is no assurance that management will be successful with these plans. Ifwe are unable to meet our current operating plan and are unable to raiseadditional financing, we may be required to reduce certain discretionaryspending, which could have a material adverse effect on our ability to achieveour intended business objectives.

 

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*Contractual Obligations andCommercial Commitments.*

 

The following table summarizes all significantcontractual payment obligations as of June 30, 2002, by payment due date: 

 

|                          |   |      |   | **Payments by Period  ($Thousands)** |   |          |   |
|-------------------------------|--------|-----------|--------|--------------------------------------|--------|---------------|--------|
| **Contractual Obligation**    |   | **Total** |   | **Remainder  of 2002**               |   | **2003-2004** |   | **2005-  thereafter** |   |
| Notes payable  (a)            |   | $         | 15,373 |                                 | $      | 15,373        |   | $ | — |   | $ | — |   |
| Bank debt                     |   | 1,299     |   | —                               |   | 1,299         |   | — |   |
| Advertising  commitments      |   | 2,250     |   | 900                                  |   | 1,350         |   | — |   |
| Capital lease  obligations    |   | 279       |   | 109                                  |   | 166           |   | 4 |   |
| Operating lease  obligations  |   | 4,222     |   | 753                                  |   | 3,006         |   | 463 |   |
| Minimum purchase  commitments |   | 1,104     |   | 414                                  |   | 690           |   | — |   |
| PRSI payment  obligations (b) |   | 2,370     |   | 300                                  |   | 2,070         |   | — |   |
| Total                         |   | $         | 26,897 |                                 | $      | 17,849        |   | $ | 8,581 |   | $ | 467 |   |

 

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(a)          Includes our December2001, January 2002 and March 2002 8% Convertible promissory notes in theaggregate principal amount of $14.2 million and $520,000 of accrued interest onthe notes. On July 18, 2002 these notes automatically converted into commonstock on receipt of approval of our stockholders.

 

(b)         Includes paymentobligations of $1,520,000, payable in equal monthly installments of $127,000commencing January 2004. These payments may be accelerated commencing July 2002based on the profitability and cash flows of PRSI.

 

**Risk 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 ourbusiness, operating results and/or financial condition. Anyone evaluating usand making an investment decision with respect to our Common Stock or othersecurities is cautioned to carefully consider these factors, along with similarfactors and cautionary statements contained in our filings with the Securitiesand Exchange Commission.

* *

*The number of freely tradable sharesof our common stock has increased substantially as a result of registrationrights agreements we entered into with some of our stockholders. This couldadversely impact the trading price of our common stock.*

 

Our current stockholders hold a substantial number ofshares, which they will be able to sell in the public market immediately. As ofMay 28, 2002 we had 27,343,222 shares issued and outstanding, ofwhich 18,408,080 were restricted. We registered for resale 49,027,948 shares,including 11,800,000 of the restricted shares currently outstanding.  In addition to the shares discussed above,Pequot Private Equity Fund II, L.P. elected to convert its Series A-1Convertible Preferred Stock into 42,107,303 shares of our Common Stock.

 

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The following chart summarizes the number of shares ofour Common Stock that are available for resale as of July 26, 2002 as comparedto May 28, 2002.

 
|          |   | **Total  Outstanding  Shares** |   | **Restricted  Shares  Outstanding** |   | **Freely  Tradable  Shares  Outstanding** |   | **Percentage  Increase of  Freely  Tradable  Shares** |   |
|---------------|--------|--------------------------------|--------|-------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------------------|--------|
| May 28, 2002  |   | 27,343,222                     |   | 18,408,080                          |   | 8,935,142                                 |   | —                                                |   |
| July 26, 2002 |   | 97,376,901                     |   | 45,215,383                          |   | 52,161,518                                |   | 484                                                   | %      |

 

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* *

*Our stock price may be volatile, andyou may lose all or part of your investment*

 

The market price of our Common Stock has fluctuatedsignificantly. Since going public in June 1999, the closing price of ourCommon Stock on Nasdaq has ranged from a high of $17.375 to a low of $0.1888.During the last twelve months, the closing price of our Common Stock has rangedfrom a high of $1.95 to a low of $0.26. On August 9, 2002, the closing price ofour Common Stock was $0.50. The market price of our Common Stock could continueto be subject to significant fluctuations as a result of numerous factors, manyof which are beyond our control. Among the factors that could affect our stockprice are:

 

•                 quarterlyvariations in our operating results;

 

•                 changes inrevenue or earnings estimates or publication of research reports by analysts;

 

•                 speculation inthe press or investment community about our business;

 

•                 fluctuations instock market prices and volumes, particularly of similar companies;

 

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•                 changes in marketvaluations of similar companies;

 

•                 strategic actionsby us or our competitors such as acquisitions or restructurings;

 

•                 regulatorydevelopments;

 

•                 additions ordepartures of key personnel;

 

•                 general marketconditions, including the effect of market conditions on our customers andsuppliers; and

 

•                 domestic andinternational economic factors unrelated to our performance.

 

The stock markets in general, and the markets fortechnology stocks in particular, have experienced extreme volatility that hasoften been unrelated to the operating performance of particular companies.These broad market fluctuations may adversely affect the trading price of ourcommon stock. We have experienced previous fluctuations in our common stock inthe past and the price of our stock remains volatile.

* *

*If trading price per share of ourcommon stock remains low, we may be delisted from The Nasdaq National Market.*

 

The trading price of our Common Stock has fallen below$1.00 per share, and, therefore, it may be delisted from the Nasdaq NationalMarket. If our Common Stock is delisted from the Nasdaq National Market, youmay be unable to dispose of your shares. In February 2001 we received anotice from the Nasdaq Stock Market that we were not in compliance with the$1.00 minimum bid requirement for continued listing on the Nasdaq NationalMarket and that our common stock was subject to delisting from the NasdaqNational Market. In March 2001 we participated in a hearing before theNasdaq Listing Qualifications Panel to appeal the earlier decision to delistout common stock. In June 2001 we received a notification from Nasdaq thatthe Nasdaq Listing Qualifications Panel had determined that we regainedcompliance with the requirements for continued listing on the Nasdaq NationalMarket and, accordingly, determined to continue to list our common stock on theNasdaq National Market. If we are unable to maintain compliance with therequirements for continued listing on the Nasdaq National Market, including the$1.00 minimum bid requirement and the net tangible assets maintenancerequirement, we may be subject to delisting from the Nasdaq National Market. OnAugust 9, 2002, the closing price for our common stock was $0.50 per share. Ifwe are delisted from the Nasdaq National Market System, trading in our commonstock could occur, if at all, in the over-the-counter market in so-called “pinksheets” or, if then available, the OTC Bulletin Board. As a result, the holdersof our common stock would find it more difficult to dispose of, or to obtainaccurate quotations as to the market value of, our common stock.

 

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If our common stock is delisted from trading on TheNasdaq Stock Market and the trading price is less than $5.00 per share, tradingin our common stock would also be subject to the requirements of Rule 15g-9promulgated under the Securities Exchange Act of 1934. Under such rule,broker/dealers who recommend these low-priced securities to persons other thanestablished customers and accredited investors must satisfy special salespractice requirements, including a requirement that they make an individualizedwritten suitability determination for the purchaser and receive the purchaser’swritten consent prior to the transaction. The Securities Enforcement Remediesand Penny Stock Reform Act of 1990 also requires additional disclosure in connectionwith any trades involving a stock defined as a penny stock (generally anyequity security not traded on an exchange or quoted on The Nasdaq Stock Marketthat has a market price of less than $5.00 per share, subject to certainexceptions), including the delivery, prior to any penny stock transaction, of adisclosure schedule explaining the penny stock market and the risks associatedwith the penny stock market. These requirements would likely severely limit themarket liquidity of our common stock and the ability of our shareholders todispose of their shares, particularly in a declining market.

* *

*We have incurred significant netlosses and we may never achieve profitability*

 

We incurred significant net losses of approximately$26.4 million in 1999, $29.4 million in 2000, $11.9 million in2001 and $6.7 million in the first half of 2002. As of June 30, 2002, we had anaccumulated deficit of approximately $81.2 million. If our revenue doesnot grow as expected or capital and operating expenditures exceed our plans,our business, operating results and financial condition will be materiallyadversely affected. We cannot be certain if or when we will be profitable or ifor when we will generate positive operating cash flow.

* *

*Our acquisition of ProfessionalResource Screening, Inc., and future acquisitions, could have a materialadverse effect on our business, results of operations or financial condition.*

 

In December 2001, we acquired ProfessionalResource Screening, Inc. The acquisition will present numerous challenges tous, including the integration of the operations and personnel of ProfessionalResource Screening. We will also be subject to special risks such as possibleunanticipated liabilities and costs, diversion of management attention and lossof personnel. In addition, we may not achieve the revenue levels, increasedearnings, profitability, efficiencies or synergies that we believe justifiedthe acquisition. In addition, while we have no current plan to acquire anyspecific business or businesses, we may, from time to time, pursue otheracquisitions of businesses that complement or expand our existing business.There can be no assurance that the anticipated economic, operational and otherbenefits of any future acquisition will be achieved. In addition, acquisitionsmay involve the expenditure of significant funds and involve a number of risks,including diversion of management attention, unanticipated problems,liabilities or contingencies and risks of entering markets in which we havelimited or no direct expertise. We cannot assure you that Professional ResourceScreening or any businesses we acquire in the future will generate sufficientrevenue to offset the associated costs or other adverse effects or that we willbe able to successfully integrate or manage Professional Resource Screening.The occurrence of some or all of these events could have a material adverseeffect on our business, results of operations or financial condition.

* *

*We face risk resulting from ourlitigation with ChoicePoint, Inc.*

 

In May 2001, ChoicePoint, Inc., thesuccessor entity to DBT Online, Inc., served us with a complaint that itfiled against us in Palm Beach County, Florida alleging breach of contract,fraudulent misrepresentation, unjust enrichment, quantum meruit and breach ofthe implied covenant of good faith and fair dealing. ChoicePoint soughtapproximately $1.5 million in damages, as well as interest and attorneys’fees. We removed this action to the United States District Court for theSouthern District of Florida. The United States District Court for the SouthernDistrict of Florida ordered the matter to arbitration. The arbitration hearingwas concluded in April 2002 and in June 2002 the arbitrator awarded us acredit of $297,671 to be deducted from invoices of $1,418,731. ChoicePoint hasfiled a Motion to Confirm the Arbitration Award and we have filed a Motion toModify and Correct the Arbitration Award to provide additional credits. Wecurrently have approximately $1,079,000 accrued for this liability. To date, wehave incurred an estimated $100,000 in costs and legal fees in connection withthis litigation.

 

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*We face competition from manysources. We may be unable to successfully compete with other companies in ourindustry.*

 

We operate in a number of geographic and servicemarkets which are fragmented and highly competitive. Currently, our competitionfalls into three categories:

 

•                 free individuallocator and information services, including services offered by Internet searchengines, telephone companies and other third parties who publish free printedor electronic directories such as Yahoo, Inc. and Infospace, Inc.;

 

•                 fee-basedInternet search services offering comparable services, such as KnowX.com;

 

•                 local, regionaland national private investigation firms, such as Kroll-O’Gara Company,Pinkerton, the Proudfoot Reports division of ASI Solutions, Inc., and asignificant number of companies operating on either a national scale or a localor regional basis; and the employment screening market, where our competitorsinclude Avert, Inc., ChoicePoint, Inc., Employee Relations, Inc., Hire Check,Inc. and IMI Data Search Inc.

 

There are no significant barriers that would preventnew companies from entering the market in which we operate. In addition, someof our current suppliers and companies with which we have advertisingagreements may compete with us in the future, which may make it more difficultto advertise our services effectively on their Web sites.

 

Many of our competitors have greater financial andmarketing resources than we do and may have significant competitive advantagesthrough other lines of business, their existing client base and other businessrelationships. These competitors and other potential competitors may undertakemore extensive marketing campaigns, adopt more aggressive pricing policies anddevote more resources to developing information search services, backgroundchecks for individual or corporate clients and internet trust services than weare willing or able to accomplish. In addition, our competitors or potentialcompetitors may develop services that are superior to ours, develop servicesless expensive than ours or that achieve greater market acceptance than ourservices. We may not be able to successfully compete against our current orfuture competitors with respect to any of these factors. As a response tochanges in the competitive environment, we may make pricing, service ormarketing decisions such as reducing our prices or increasing our advertising,all of which may affect our operating results. If we are unsuccessful inresponding to our competitors, our business, financial condition and results ofoperations will be materially adversely affected.

* *

*We are dependent on a limited numberof third party database and other information suppliers. If we are unable tomanage successfully our relationships with these suppliers, the quality andavailability of our services may be harmed.*

 

We do not independently maintain most of the databasesfrom which we gather information. We obtain the data used in our services froma limited number of third party suppliers. If our current suppliers raise theirprices, or are no longer able, due to government regulations or contractualarrangements, or are unwilling to provide us with certain data, we may need tofind alternative sources of information. If we are unable to identify andcontract with suitable alternative data suppliers and integrate these datasources into our service offerings, we could experience service disruptions,increased costs and reduced quality of our services. Additionally, if one ormore of our suppliers terminates our existing agreements, we cannot assure youthat we will be able to obtain new agreements with third party suppliers onterms favorable to us, if at all. If one or more of these events were to occur,our business, financial condition and results of operations could be materiallyadversely affected by increased costs, reduced revenue and lower profitmargins.

* *

*We may incur liability based onconsumer complaints*

 

A substantial amount of our business involves sales ofservices to individual consumers. We have received customer complaintsconcerning the quality of our services, including complaints about the currencyand/or

 

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completeness of the data returned to customers. In addition, ourcustomers have lodged similar complaints with consumer agencies, such as theBetter Business Bureau and state attorney general consumer divisions. Theseconsumer agencies, in turn, send us an inquiry regarding the consumercomplaint. We could in the future experience similar complaints from consumersor inquiries from governmental and consumer agencies based on consumercomplaints. If we are unable to resolve existing and future complaints andinquiries, we could be subject to governmental regulatory action as well ascivil liability, which may have a material adverse effect on our business,financial condition and results of operations.

* *

*Our business and financialperformance may suffer if we are unsuccessful in expanding our services,especially those related to employment screening and risk mitigation services,to corporate and professional clients.*

 

We intend to expand the number of services availablethrough our Web site and develop and promote service offerings to address theneeds of corporate and professional clients. We have limited experience inproviding risk mitigation services to corporate and professional clients.Attracting these clients will require us to hire new sales and marketingpersonnel or acquire companies already providing these services. We will alsobe required to spend money to develop and promote these new services. We may beunsuccessful in our efforts to provide these new services in a timely andcost-effective manner and these services may never become profitable. Ifindividual or corporate clients are unwilling to pay for these services or ifthe market for these services fails to develop or continues to develop moreslowly than anticipated, our business financial condition and results ofoperation will be materially adversely affected.

* *

*We depend on a limited number ofservice offerings for a significant portion of our revenues*

 

We have historically derived a substantial portion ofour revenues from a small number of service offerings, particularly ourindividual locator, individual profile reports and “Instant Searches” services.If we are unable to continue to offer these services or if our costs of providingthese services increase such that we can no longer offer these services atcompetitive prices, our business, financial condition, and results ofoperations may be materially adversely affected.

* *

*We have substantial fixed costswhich may not be offset by our revenues*

 

A substantial portion of our operating expenses isrelated to management personnel, administrative support and our advertisingagreements. Many of these agreements have non-cancelable fixed terms andminimum payment obligations. As a result, a substantial portion of our expensesin any given period is fixed costs. If we are unable to generate sufficientrevenues to offset our operating costs or if we are unable to lower ouradvertising costs to respond to lower than expected revenues, our results ofoperations would be materially adversely affected. Our minimum non-cancelablepayments under certain distribution and marketing agreements with variousInternet companies is $3.4 million as of June 30, 2002.

* *

*We depend on our marketingagreements with Internet companies*

 

An important element of our current business strategyis to maintain relationships with a number of Internet search engines andpopular Web sites for advertising and to direct and attract traffic to our Website. The most significant of these agreements are with Yahoo!, Inc. andInfoSpace, Inc. Our agreement with Yahoo! expired on July 31, 2002and we are in the process of negotiating a new agreement with Yahoo! and ouragreement with InfoSpace expires on September 30, 2003. These advertisingagreements constitute a significant portion of our operating expenses. If thecosts associated with these advertising agreements increases, we may not beable to maintain our existing marketing relationships or enter into futuremarketing relationships with other Internet companies. Any termination ofexisting agreements or failure to enter into new agreements with Internetcompanies on terms favorable to us could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

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*Our access to key Internetadvertising depends on marketing agreements between other Internet companiesthat are beyond our control*

 

Advertising arrangements with one Internet company mayprovide us access to another company’s Web site. For example, our arrangementwith InfoSpace provides us with advertising within the white page directoriesof the AOL and MSN Web sites, independent of any agreements with AOL or MSN.Our advertising on these Web sites depends on the continued relationshipInfoSpace has with companies such as AOL and MSN. If this relationship isterminated for any reason and if we are either unable to enter into anagreement with these companies or unable to enter into an agreement withanother company that has an agreement providing access to AOL and/or MSN, ouradvertising will no longer appear on their Web sites. This could significantlyreduce our advertising reach and, consequently, lower the number of potentialclients visiting our Web site, which could in turn materially adversely affectour business, financial condition and results of operations.

* *

*Service interruptions may have anegative impact on our revenues and may damage our reputation and decrease ourability to attract clients*

 

We depend on the satisfactory performance, reliabilityand availability of our Web site and telecommunications infrastructure toattract clients and generate sales. We cannot assure you that we will be ableto protect our operations from a system outage or data loss by events beyondour control. Events that could cause system interruptions include:

 

•                 fire;

 

•                 earthquake;

 

•                   terroristattacks;

 

•                   naturaldisasters;

 

•                   computerviruses;

 

•                   unauthorizedentry;

 

•                   telecommunicationsfailure; and

 

•                   power loss andCalifornia rolling blackouts.

 

We have experienced unanticipated system interruptionsin the past and, although we have upgraded our infrastructure, theseinterruptions may occur again in the future. During the past twelve months oursystem interruptions have been limited to less than two hours and have includeda denial of service attack, after which we installed a Network IntrusionDetection System, and a power management module outage at Exodus, ourco-location facility. Substantially all of our computer and communicationshardware is currently located at facilities in Southern California, which is anarea susceptible to earthquakes. We do not carry business interruptioninsurance sufficient to compensate fully for all losses, and in some cases, anylosses from any or all these types of events. The occurrence of any of theseevents may have a material adverse effect on our business, financial conditionand results of operations.

* *

*We may be subject to federal andstate laws relating to the Internet and the use of personal information andprivacy rights*

 

Many privacy and consumer advocates and federalregulators have become increasingly concerned with the use of personalinformation, particularly “credit header” information. For certain qualifiedbusiness customers, we use the social security numbers of individuals to searchvarious databases, including those of consumer credit reporting agencies. Forexample, we search the “credit header” information contained in variousconsumer credit reporting agencies’ databases to find, among other items, dateof birth, current and previous addresses, social security numbers used by anindividual or possible other names (such as married

 

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names, etc.). We also search these databases to determine if acustomer’s social security number is being used by any other party. Attemptshave been made and can be expected to continue to be made by various federalregulators and organized groups to adopt new or additional federal and statelegislation to regulate the use of personal information. Our results ofoperations could suffer materially if federal or state laws or regulations areamended or enacted in the future, or cases decided relating to the access anduse of personal information, or privacy and civil rights, in general, or withrespect to the Internet or commercial online services covering issues such asproperty rights, distribution, taxation, access charges and other fees, andquality of products and services. Cost increases relating to this governmentregulation could result in these increased costs being passed along to Internetend users and could dampen the growth in use of the Internet as acommunications and commercial medium, which could have a material adverseeffect on our business and results of operations.

* *

*We depend on our key managementpersonnel for our future success*

 

Our success depends to a significant degree upon thecontinued contributions of our executive management team and its ability toeffectively manage the anticipated growth of our operations and personnel. Theloss of Brent Cohen, our CEO, David Wachtel, our CTO, or other members of ourmanagement team and the inability to hire additional senior management, ifnecessary, could have a material adverse effect on our business and results ofoperations. In addition, increased costs of new personnel, including members ofexecutive management, could have a material adverse effect on our business andoperating results.

* *

*The Internet may fail to support thegrowth of electronic commerce*

 

The rapid rise in the number of Internet users and thegrowth of electronic commerce and applications for the Internet have placedincreasing strains on the Internet’s communications and transmissions infrastructure.This could lead to significant deterioration in transmission speeds and thereliability of the Internet as a commercial medium and, consequently, couldreduce the use of the Internet by businesses and individuals. The Internet maynot be able to support the demands placed upon it by this continued growth. Anyfailure of the Internet to support growth due to inadequate infrastructure orfor any other reason would seriously limit its development as a viable sourceof commercial and interactive content and services. This could materiallyadversely affect the acceptance of our services and our business.

* *

*Our success depends on our abilityto protect and enforce our trademarks and other proprietary rights*

 

We rely on a combination of patent, trademark, servicemark, copyright and trade secret laws, restrictions on disclosure andtransferring title and other methods to protect our proprietary rights. We alsogenerally enter into confidentiality agreements with our employees, businesspartners and/or others to protect our proprietary rights. It may be possiblefor a third party to copy or otherwise obtain and use our proprietaryinformation without authorization or to develop similar technologyindependently.

 

Our registered trademarks include: “1-800 U.S. SEARCH”,our logo, “The Public Record Portal”, “Trust Identity,” “Fraud Identity,” and“Reuniting America Two People at a Time”. In addition, we have applied for apatent on our DARWINTM technology and for registered trademark status for “USSEARCH.com”, and “VeroTrust” service marks in the United States and intend topursue registration internationally through applications. Effective patent,trademark, service mark, copyright and trade secret protection may not beavailable in every country in which our products and services are madeavailable, online or otherwise. Also, policing unauthorized use of our patent,trademark, service mark or other proprietary rights might be difficult andexpensive and we may be unable to protect our brand, patents, and trademarksfrom third party challenges. Our brand may suffer and our business and resultsof operations could be materially and adversely affected if we are unable toeffectively protect or enforce our patent, trademark, service marks or otherproprietary rights.

 

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*We may be unable to prevent thirdparties from developing Web sites and acquiring domain names similar to ours*

 

We have registered several domain names, including1800USSEARCH.com, ussearch.com, verotrust.com and prsinet.com. Competitors mayobtain a corporate name and domain name similar to ours which may causeconfusion on the part of potential clients. We may be unable to prevent thirdparties from acquiring domain names that are similar to, infringe upon orotherwise decrease the value of our trademarks and other proprietary rights andwe may be required to file law suits to protect our interests. This would becostly and time consuming and our business could suffer.

* *

*We face significant security risksrelated to our electronic transmission of confidential information*

 

We rely on encryption and other technologies toprovide system security to effect secure transmission of confidentialinformation, such as credit card numbers. We license these technologies fromthird parties. We cannot assure you that our use of applications designed fordata security, or that of our third-party contractors will effectively counterevolving security risks. A security or privacy breach could:

 

•               expose us toadditional liability;

 

•               increase ourexpenses relating to resolution of these breaches; and

 

•               deter customersfrom using our services.

 

Any inability to protect the security and privacy ofour electronic transactions could have a material adverse effect on our profitability.

* *

*We face risks related to chargebacksprocessed from our merchant bank*

 

Like many other service providers who accept creditcard information without a signature over the telephone or Internet, we haveissued credits as a result of orders placed with fraudulent credit cardinformation. We may suffer losses or damage to our reputation as a result offraudulent use of credit card information in the future. Moreover, because weoffer services over the Internet and accept credit card information without asignature, a certain percentage of our transactions are automatically chargedback by the credit card companies pursuant to their policies if the customerdisputes the validity of the charge. Our chargeback rate has periodicallyexceeded the permissible rates in our merchant card agreements, and we havebeen subject to significant fines.

 

Under the terms of our Merchant Card Agreement withVisa, chargebacks as a percentage of interchange transactions must not exceed2.5% and the ratio of customer dispute chargebacks to interchange transactionsmust not exceed 1%.  Although ourchargeback rate has periodically exceeded the permissible rates, in ourmerchant card agreements, during May and June 2002, the company was incompliance with the rates.  At June 30,2002 our Visa chargebacks as a percentage of interchange transactions was 1.31%and our ratio of customer dispute chargebacks to interchange transactions was..74%.

 

Loss of credit card processing rights could materiallyadversely affect our business and results of operations. In addition, pursuantto the terms of our bank credit facility, we agreed to reduce our chargebackrate to bring it within the permissible rates in our merchant card agreements.To accomplish this we have introduced several fraud prevention features, mostnotably CVV2 checks and we only accept VISA transactions which pass thesechecks. CVV2 is a new authentication procedure established by credit cardcompanies which requires a cardholder to enter the CVV2 number (the last 3digits after the credit card number in the signature area of the card) attransaction time to verify that the card is on hand.

* *

*We could face liability based on thenature of our services and the content of the materials that we provide whichmay not be covered by insurance*

 

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 basedon the nature and content of the materials that appear on our Web site or inour search reports. We also face potential

 

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liability to clients and/or the subjects of individual search reportsprepared by us for inaccurate information or misuse of the information.Although we carry a limited amount of general liability insurance, ourinsurance may not cover claims of these types or may not be adequate toindemnify us for all liability that may be imposed. In addition, this insurancemay not remain available to us on acceptable terms. Additionally, we do notcurrently maintain liability insurance to cover claims by clients or thesubjects of reports. Any imposition of liability, particularly liability thatis not covered by insurance or is in excess of our insurance coverage, couldhave a material adverse effect on our reputation and our business and resultsof operations.

 

*Our certificate of incorporation,bylaws and Delaware law contain provisions that could discourage a third partyfrom acquiring us and consequently decrease the market value of our commonstock*

 

Our certificate of incorporation grants our board ofdirectors the authority to issue up to 1,000,000 shares of preferred stock, andto determine the price, rights, preferences, privileges and restrictions,including voting rights of these shares without any further vote or action bythe stockholders. Previously, we have issued preferred stock with voting,liquidation, dividend and other rights superior to those of the common stock.Although all preferred stock previously issued has been converted to commonstock, we may issue additional preferred stock in the future and the rights ofthe holders of common stock will be subject to, and maybe adversely affectedby, the rights of any preferred stock that may be issued in the future. Theissuance of preferred stock could have the effect of making it more difficultfor a third party to acquire a majority of our outstanding voting stock whichcould decrease the market value of our stock. Further, provisions in ourcertificate of incorporation and bylaws and Delaware law could have the effectof delaying or preventing a third party from acquiring us, even if a change incontrol would be in the best interest of our stockholders. These provisionsinclude the inability of stockholders to act by written consent without ameeting and procedures required for director nomination and stockholderproposal. 

 

*PequotPrivate Equity Fund II, L.P. ("Pequot") currently beneficially holdsapproximately 51% of our common stock and will be able to exercise votingcontrol over issues presented to our stockholders for approval.*

 

We have entered into a Stockholders Agreement withPequot and Kushner-Locke. The Stockholders Agreement provides, among otherthings, that Pequot and Kushner-Locke will vote the shares of capital stockheld by them in favor of (i) one member of the Board of Directors beingnominated by Kushner- Locke, (ii) one member, if Pequot Private EquityFund II, L.P. owns between 10-35% of the shares of common stock issued uponconversion of the Series A-1 Convertible Preferred Stock, or two members,if Pequot Private Equity Fund II, L.P. owns at least 35% of the shares ofcommon stock issued upon conversion of the Series A-1 ConvertiblePreferred Stock, of the Board of Directors being nominated by Pequot PrivateEquity Fund II, L.P., (iii) our Chief Executive Officer as a member of ourBoard of Directors, and (iv) three independent members of the Board ofDirectors, each of which shall be nominated for election by the consent of theBoard Members nominated by Pequot and a majority of all other members of theBoard of Directors other than Board Member nominated by Kushner-Locke.

 

Pequot will be able to exercise voting control overissues presented to our stockholders for approval. Further, by virtue of theStockholders Agreement and their combined voting control Pequot possessescertain voting and approval rights which could prevent us from taking certainmajor corporate actions such as the issuance of additional securities, thepayment of dividends, or the merger of us with or into another entity or saleof substantially all of our assets.

 

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*Our directors, executive officersand existing stockholders and their affiliates will continue to havesubstantial control over our company, and their interests may differ from andconflict with yours*

 

Our executive officers, directors and principalstockholders beneficially own, in total, 89% of our outstanding common stock.As a result, these stockholders may have interests that are different from andmay conflict with yours, and will be able to influence matters requiringstockholder approval, including the election of directors and approval ofsignificant corporate transactions. This could have the effect of delaying orpreventing a change of control of our company or otherwise cause us to takeaction that may not be in the best interests of all stockholders, either ofwhich in turn could reduce the market price per share of our common stock orprevent you from receiving a premium in such transaction. This concentration ofstock ownership may adversely affect the trading price of our common stock dueto investors’ perception that conflicts of interest may exist or arise.

* *

*Your ownership interest may bematerially diluted upon exercise of options and warrants*

 

As of June 30, 2002, we had granted options andwarrants to purchase an aggregate of approximately 30,015,497 shares of commonstock at exercise prices ranging from $0.01 per share to $11.13 per share. Tothe extent that the stock options and warrants are exercised, material dilutionof the ownership interest of our stockholders will occur. We also expect thatin the ordinary course of our business we will issue additional warrants andgrant additional stock options including, but not limited to, options grantedpursuant to our stock option plans.

** **

**Item 3. Quantitativeand qualitative disclosures about market risk**

 

We considered the provision of Financial ReportingRelease No. 48 “Disclosure of Accounting Policies for Derivative FinancialInstruments and Derivative Commodity Instruments, and Disclosure ofQuantitative and Qualitative Information about Market Risk Inherent InDerivative Financial Instruments, Other Financial Instruments and DerivativeCommodity Instruments.” We had no holdings of derivative financial instrumentsat June 30, 2002 and our total liabilities as of June 30, 2002 consistprimarily of notes payable and accounts payable that have fixed interest ratesand were not subject to any significant market risk.

** **

**PARTII. OTHER INFORMATION**

** **

**Item1. Legal Proceedings**

 

On April 3, 2000 a two count trade name andservice mark complaint was filed against the Company in the United StatesDistrict Court for the Eastern District of Virginia, styled U.S. Search, LLC vUSSearch.com Inc. Civil Action No. 00-554-A. On January 26,2001, our motion for summary judgment was granted and the court ordered thatboth counts of plaintiff’s complaint be dismissed with prejudice. Plaintiff hasappealed this matter to the U.S. Court of Appeals, Fourth Circuit. The hearingon appeal was held on June 6, 2002. We are awaiting the Fourth Circuit'sdecision.

 

In May 2001, ChoicePoint, Inc., thesuccessor entity to DBT Online, Inc., filed a complaint against us in PalmBeach County, Florida alleging breach of contract, fraudulentmisrepresentation, unjust enrichment, quantum meruit and breach of the impliedcovenant of good faith and fair dealing. ChoicePoint sought approximately$1.5 million in damages, as well as interest and attorneys’ fees. USSEARCH removed this action to the United States District Court for the SouthernDistrict of Florida. The United States District Court for the Southern Districtof Florida ordered the matter to arbitration. In June 2002 the arbitratorawarded us a credit of $297,671 to be deducted from invoices of $1,418,731.ChoicePoint has filed a motion to confirm the Arbitration Award and we havefiled a motion to modify and correct the Arbitration award to provide additionalcredits. We are awaiting rulings on these motions. We currently haveapproximately $1,079,000 accrued for this liability. The costs related to thislitigation, including the fees and costs of our attorneys and other litigationsupport professionals, have been less than $100,000.

 

On June 25, 2002, a complaint seeking $434,000 indamages was filed against Professional Resource Screening, Inc. in SuperiorCourt of California, county of Contra Costa, styled Wood Warren & Co. v.Professional Resource Screening, Inc., No. C02-01816, alleging breach of anoral agreement relating to investment banking services, negligentmisrepresentation, promissory estoppel, equitable estoppel and quantum meruit.Although it is too early to predict the outcome, the Company believes it hasmeritorious defenses to plaintiff claims.

 

We may from time to time become a party to variouslegal proceedings arising in the ordinary course of business.

 

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**Item 2. Changes in Securities and Useof Proceeds.**

 

In connection with an amendment to our credit facility, in April 2002we issued to Comerica Bank a warrant to purchase up to 55,487 shares of ourcommon stock at an exercise price of $0.85 per share (the "ComericaWarrant").  The Comerica Warrantexpires on March 27, 2009.  The issuanceof the Comerica Warrant was exempt from the registration requirements of theSecurities Act of 1933, as amended (the "Act"), pursuant to Section4(2) thereof and Rule 506 of Regulation D promulgated thereunder.

 

On July 18, 2002we issued to the holders of our 8% Convertible Promissory Notes an aggregate of27,864,051 shares of common stock upon conversion in full of our thenoutstanding 8% Convertible Promissory Notes (the "Note ConversionShares").  The issuance of the NoteConversion Shares was exempt from the registration requirements of the Actpursuant to Sections 3(a)(9) and 4(2) thereof and Rule 506 of Regulation Dpromulgated thereunder.

 

On July 18, 2002 we issued to Pequot Private Equity Fund II, L.P.("Pequot") 42,107,303 shares of common stock upon conversion in fullof all shares of Series A-1 Convertible Preferred Stock then held by Pequot(the "Series A-1 Conversion Shares").  The issuance of the Series A-1 Conversion Shares was exempt fromthe registration requirements of the Act pursuant to Sections 3(a)(9) and 4(2)thereof and Rule 506 of Regulation D promulgated thereunder.

** **

**Item 3. Defaults upon SeniorSecurities**

 

None

 

**Item 4. Submission of Matters to aVote of Security Holders.**

 

None

 

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**Item5. Other Information**

 

None

 

**Item 6. Exhibits and Reports onForm 8-K**

 

(a)           Exhibits:None

 

(b)           Reportson Form 8-K:

 

During the quarter ended June 30, 2002, we filedcurrent reports on Form 8-K on the following dates:

 

•               April29, 2002 (Item 5. Other Events);

 

•               June14, 2002, as amended (Item 5. Other Events).

 

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signed onits behalf by the undersigned thereunto duly authorized. 

 
|                  | US SEARCH.COM INC. |
|-----------------------|--------------------|
|                  | (Registrant)       |
|                  |               |   |
| Date: August 14, 2002 | By:                | /s/   BRENT N. COHEN |
|                  |               | Brent N. Cohen*President and Chief Executive Officer* |
|                  |               |   |
|                  | By:                | /s/   JEFFREY R. WATTS |
|                  |               | Jeffrey R. Watts*Chief Financial Officer* |

 

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