FIRST ADVANTAGE CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Note of Caution Regarding Forward Looking Statements Certain statements in this quarterly report on Form 10-Q relate to future results of the Company and are considered “forward-looking statements.” These statements, which may be expressed in a variety of ways, including the use of future or present tense language, relate to among other things, sufficiency and availability of cash flows and other sources of liquidity, current levels of operations, anticipated growth, future market positions, synergies from integration, ability to execute its growth strategy, levels of capital expenditures and ability to satisfy current debt. These forward-looking statements, and others forward-looking statements contained in other public disclosures of the Company are based on assumptions that involve risks and uncertainties, and that are subject to change based on various important factors (some of which are beyond the Company’s control). Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. Factors that could cause the anticipated results to differ from those described in the forward-looking statements include: general volatility of the capital markets and the market price of the Company’s Class A common stock; the Company’s ability to successfully raise capital; the Company’s ability to identify and complete acquisitions and to successfully integrate businesses it acquires; changes in applicable government regulations; the degree and nature of the Company’s competition; increases in the Company’s expenses; continued consolidation among the Company’s competitors and customers; unanticipated technological changes and requirements; the Company’s ability to identify suppliers of quality and cost-effective data; and other factors described in this quarterly report on Form 10-Q. In addition to the risk factors set forth above and in this quarterly report on Form 10-Q, you should carefully consider the risk factors set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as well as the other information contained the Company’s Annual Report, as updated or modified in subsequent filings. The Company faces risks other than those listed in the Annual Report, as updated, including those that are unknown and others of which the Company may be aware but, at present, considers immaterial. Actual results may differ materially from those expressed or implied as a result of these risks and uncertainties. The forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. 18 Table of Contents MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview First Advantage Corporation (Nasdaq: FADV) (“First Advantage” or the “Company”) provides global risk mitigation, screening services and credit reporting to enterprise and consumer customers. The Company operates in five primary business segments: Credit Services, Data Services, Employer Services, Multifamily Services, and Investigative & Litigation Support Services. In the first quarter of 2009, the Company consolidated the previous Lender Services and Dealer Services segments and moved the consumer credit business from the Data Services segment to create the Credit Services segment. The prior periods have been recast to reflect the changed segments. First Advantage is headquartered in Poway, California and has approximately 3,700 employees in offices throughout the United States and abroad. The current economic downturn has caused decreased service revenue in the Credit Services segment related to the mortgage and auto industries and the Data Services segment related to the transportation and specialty finance businesses. Management expects continued weakness in the real estate and mortgage markets to continue impacting the Company’s Credit Services segment and the transportation and specialty credit businesses in the Data Services segment. In addition, the effect of the issues in the real estate and related credit markets together with the other macroeconomic matters has resulted in higher unemployment rates negatively impacting the volumes in the Employer Services segment. Given this outlook, management is focusing on expense reductions, operating efficiencies, and increasing market share throughout the Company. Given the current economic environment and the uncertainties regarding the impact on the Company’s business, there can be no assurance that the Company’s estimates and assumptions regarding the duration of the ongoing economic downturn, or the period or strength of recovery, made for purposes of the Company’s goodwill impairment testing during the year ended December 31, 2008 will prove to be accurate predictions of the future. If the Company’s assumptions regarding forecasted revenue or margin growth rates of certain reporting units are not achieved, the Company may be required to record additional goodwill impairment losses in future periods, whether in connection with the Company’s next annual impairment testing in the fourth quarter of 2009 or prior to that, if any such change constitutes a triggering event in other than the quarter in which the annual goodwill impairment test is performed. It is not possible at this time to determine if any such future impairment loss would result or, if it does, whether such charge would be material. Operating results for the three months ended June 30, 2009 included total service revenue of $164.7 million, this represents a decrease of 9.7% over the same period in 2008. Operating results for the six months ended June 30, 2009 included total service revenue of $354.7 million, this represents a decrease of 4.3% over the same period in 2008. Operating income for the three and six months ended June 30, 2009 was $21.9 million and $40.8 million, respectively. Operating income decreased $2.1 million for the three months ended June 30, 2009 in comparison to the same period in 2008. Operating income decreased $10.4 million for the six months ended June 30, 2009 in comparison to the same period in 2008. On June 29, 2009, the Company received an unsolicited proposal from First American to acquire all of the issued and outstanding shares of the Company's common stock not owned by First American at a fixed exchange ratio of 0.5375 of a share of First American's common stock for each share of the Company's common stock. First American's proposal is subject to confirmatory due diligence, the negotiation of an acceptable definitive acquisition agreement and the receipt of all necessary stockholder and regulatory approvals. First American's proposal is under consideration by the Special Committee of the Board of Directors of the Company, which is comprised of directors who are unaffiliated with First American. As part of the Company’s streamlining initiative, in the second quarter of 2008, First Advantage sold First Advantage Investigative Services (“FAIS”), which was included in our Investigative and Litigation Support Services segment, and Credit Management Solutions, Inc. (“CMSI”), which was included in our Credit Services segment. The results of these businesses’ operations in the prior period are presented in discontinued operations in the Company’s Consolidated Statements of Income. 19 Table of Contents The following is a summary of the operating results by the Company’s business segments for the three and six months ended June 30, 2009 and June 30, 2008. (in thousands, except percentages) Invest/Litigation Corporate Three Months Ended June 30, 2009 Credit Services Data Services Employer Services Multifamily Services Support Services and Eliminations Total Service revenue $ 67,705 $ 28,842 $ 40,168 $ 19,685 $ 8,694 $ (426 ) $ 164,668 Reimbursed government fee revenue 391 11,570 2,243 - - (863 ) 13,341 Total revenue 68,096 40,412 42,411 19,685 8,694 (1,289 ) 178,009 Cost of service revenue 30,544 15,404 10,666 1,751 526 (630 ) 58,261 Government fees paid 391 11,570 2,243 - - (863 ) 13,341 Total cost of service 30,935 26,974 12,909 1,751 526 (1,493 ) 71,602 Gross margin 37,161 13,438 29,502 17,934 8,168 204 106,407 Salaries and benefits 12,063 4,367 15,615 5,792 5,050 5,243 48,130 Facilities and telecommunications 1,633 659 2,128 730 725 990 6,865 Other operating expenses 4,393 3,832 5,306 2,324 1,396 1,346 18,597 Depreciation and amortization 1,488 2,427 3,772 1,509 727 972 10,895 Income (loss) from operations $ 17,584 $ 2,153 $ 2,681 $ 7,579 $ 270 $ (8,347 ) $ 21,920 Operating margin percentage 26.0 % 7.5 % 6.7 % 38.5 % 3.1 % N/A 13.3 % Invest/Litigation Corporate Three Months Ended June 30, 2008 Credit Services Data Services Employer Services Multifamily Services Support Services and Eliminations Total Service revenue $ 66,984 $ 19,533 $ 55,511 $ 19,986 $ 21,178 $ (769 ) $ 182,423 Reimbursed government fee revenue - 11,906 2,226 - - (1,010 ) 13,122 Total revenue 66,984 31,439 57,737 19,986 21,178 (1,779 ) 195,545 Cost of service revenue 30,392 5,710 16,070 1,759 440 (884 ) 53,487 Government fees paid - 11,906 2,226 - - (1,010 ) 13,122 Total cost of service 30,392 17,616 18,296 1,759 440 (1,894 ) 66,609 Gross margin 36,592 13,823 39,441 18,227 20,738 115 128,936 Salaries and benefits 14,916 5,010 20,339 6,386 8,442 7,834 62,927 Facilities and telecommunications 2,136 640 2,554 896 713 1,145 8,084 Other operating expenses 6,014 1,875 9,952 2,947 3,190 (1,069 ) 22,909 Depreciation and amortization 1,565 2,534 3,295 1,429 858 1,045 10,726 Impairment loss - - 297 - - - 297 Income (loss) from operations $ 11,961 $ 3,764 $ 3,004 $ 6,569 $ 7,535 $ (8,840 ) $ 23,993 Operating margin percentage 17.9 % 19.3 % 5.4 % 32.9 % 35.6 % N/A 13.2 % 20 Table of Contents Invest/Litigation Corporate Six Months Ended June 30, 2009 Credit Services Data Services Employer Services Multifamily Services Support Services and Eliminations Total Service revenue $ 132,124 $ 87,942 $ 77,619 $ 37,588 $ 20,420 $ (985 ) $ 354,708 Reimbursed government fee revenue 391 23,318 4,345 - - (1,735 ) 26,319 Total revenue 132,515 111,260 81,964 37,588 20,420 (2,720 ) 381,027 Cost of service revenue 59,601 56,387 20,716 3,239 871 (1,213 ) 139,601 Government fees paid 391 23,318 4,345 - - (1,735 ) 26,319 Total cost of service 59,992 79,705 25,061 3,239 871 (2,948 ) 165,920 Gross margin 72,523 31,555 56,903 34,349 19,549 228 215,107 Salaries and benefits 24,239 9,745 32,733 12,108 11,705 10,767 101,297 Facilities and telecommunications 3,382 1,207 4,212 1,493 1,310 1,920 13,524 Other operating expenses 9,634 7,872 10,490 4,484 3,666 1,798 37,944 Depreciation and amortization 2,937 4,932 7,287 3,011 1,452 1,962 21,581 Income (loss) from operations $ 32,331 $ 7,799 $ 2,181 $ 13,253 $ 1,416 $ (16,219 ) $ 40,761 Operating margin percentage 24.5 % 8.9 % 2.8 % 35.3 % 6.9 % N/A 11.5 % Invest/Litigation Corporate Six Months Ended June 30, 2008 Credit Services Data Services Employer Services Multifamily Services Support Services and Eliminations Total Service revenue $ 141,886 $ 38,500 $ 109,198 $ 38,335 $ 44,681 $ (1,923 ) $ 370,677 Reimbursed government fee revenue - 24,215 5,031 - - (2,099 ) 27,147 Total revenue 141,886 62,715 114,229 38,335 44,681 (4,022 ) 397,824 Cost of service revenue 63,150 10,830 30,807 3,314 1,021 (1,919 ) 107,203 Government fees paid - 24,215 5,031 - - (2,099 ) 27,147 Total cost of service 63,150 35,045 35,838 3,314 1,021 (4,018 ) 134,350 Gross margin 78,736 27,670 78,391 35,021 43,660 (4 ) 263,474 Salaries and benefits 30,710 10,119 40,571 13,638 17,695 16,643 129,376 Facilities and telecommunications 4,341 1,279 5,050 1,830 1,495 2,289 16,284 Other operating expenses 12,625 3,707 19,624 5,414 5,787 (1,414 ) 45,743 Depreciation and amortization 2,752 5,031 6,374 2,798 1,623 2,044 20,622 Impairment loss - - 297 - - - 297 Income (loss) from operations $ 28,308 $ 7,534 $ 6,475 $ 11,341 $ 17,060 $ (19,566 ) $ 51,152 Operating margin percentage 20.0 % 19.6 % 5.9 % 29.6 % 38.2 % N/A 13.8 % 21 Table of Contents Credit Services Segment Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Service revenue was $67.7 million for the three months ended June 30, 2009, an increase of $0.7 million compared to service revenue of $67.0 million for the three months ended June 30, 2008. The increase is due to a $6.0 million increase in revenue related to our direct to consumer credit business and a $4.8 million increase in mortgage related credit revenue reflecting increased lending volumes as compared to the same period in 2008. These increases are partially offset by a $10.1 million decrease in revenue related to vehicle financing reflecting an overall decline in auto and truck sales. Gross margin was $37.2 million for the three months ended June 30, 2009, an increase of $0.6 million compared to gross margin of $36.6 million in the same period of 2008. The impact of the increase in transactions resulted in an overall increase in gross margin. Gross margin was 54.9% for the three months ended June 30, 2009 as compared to 54.6% for the three months ended June 30, 2008. Salaries and benefits decreased by $2.9 million. Salaries and benefits were 17.8% of service revenue for the three months ended June 30, 2009 compared to 22.3% during the same period in 2008. Salaries and benefits expense decreased primarily due to operational efficiencies. Facilities and telecommunication expenses decreased $0.5 million. Facilities and telecommunication expense were 2.4% and 3.2% of service revenue for the three months ended June 30, 2009 and 2008, respectively. The decrease is due to the consolidation of operations. Other operating expenses decreased by $1.6 million. Other operating expenses were 6.5% of service revenue in the second quarter of 2009 compared to 9.0% for the same period of 2008. The decrease in 2009 is due to a decrease in lease expense, service fees, professional service fees, marketing expense, bad debt expense and travel expense, offset by an increase in temporary labor. Depreciation and amortization was flat compared to the same period in 2008. Depreciation and amortization was 2.2% of service revenue during the second quarter of 2009 compared to 2.3% in the same period in 2008. Income from operations was $17.6 million for the three months ended June 30, 2009 compared to $12.0 million in the same period of 2008. The operating margin percentage increased from 17.9% to 26.0% primarily due operational efficiencies gained related to the segment’s cost reduction measures in 2008. Data Services Segment Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Total service revenue was $28.8 million for the three months ended June 30, 2009, an increase of $9.3 million compared to service revenue of $19.5 million in the same period of 2008. This segment has experienced a significant increase in service revenue primarily due to the lead generation business, offset by reduced volumes in the specialty credit and transportation businesses as a result of the overall economic downturn. Gross margin was $13.4 million for the three months ended June 30, 2009, a decrease of $0.4 million compared to gross margin of $13.8 million in the same period of 2008. Gross margin as a percentage of service revenue was 46.6% for the three months ended June 30, 2009 as compared to 70.8% for the three months ended June 30, 2008. The decrease in the gross margin as a percentage of service revenue is primarily due to the revenue mix. The lead generation eAdvertising business has lower margins. Salaries and benefits decreased by $0.6 million. Salaries and benefits were approximately 15.1% of service revenue in the second quarter of 2009 compared to 25.6% of service revenue in the second quarter of 2008. The decrease in expense is related to the decrease in staffing as compared to the same period in 2008. Facilities and telecommunication expenses for the second quarter of 2009 were comparable to the same period in 2008. Facilities and telecommunication expenses were approximately 2.3% of service revenue in the second quarter of 2009 compared to 3.3% of service revenue in the second quarter of 2008. Other operating expenses increased by $2.0 million. Other operating expenses were 13.3% of service revenue in the second quarter of 2009 and 9.6% in the second quarter of 2008. The expense increase is primarily due to the increase in bad debt expense at the lead generation business. Depreciation and amortization for the second quarter of 2009 was comparable to the same period in 2008. Depreciation and amortization was 8.4% of service revenue during the second quarter of 2009 compared to 13.0% in the same period in 2008. The operating margin percentage decreased from 19.3% to 7.5% in comparing the second quarter of 2008 to the second quarter of 2009. The decrease in the operating margin is primarily due to the increase in bad debt expense and the change in the revenue mix of the businesses in the second quarter of 2009 compared to the same period in 2008. 22 Table of Contents Income from operations was $2.2 million for the second quarter of 2009, a decrease of $1.6 million compared to $3.8 million in the second quarter of 2008. The decrease is primarily driven by the lead generation business where cost of service and operating expenses have increased offset by an increase in revenue. Employer Services Segment Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Total service revenue was $40.2 million for the three months ended June 30, 2009, a decrease of $15.3 million compared to service revenue of $55.5 million in the same period of 2008. The decrease was a result of a decrease in hiring in the United States and abroad. The recession has caused increased unemployment, which directly affects this segment. Salaries and benefits decreased by $4.7 million. Salaries and benefits were 38.9% of service revenue in the second quarter of 2009 compared to 36.6% in the same period of 2008. The expense decrease is a direct effect of office consolidations and the reduction in staffing, offset by an increase in salary and benefit expense related to moving technology personnel from Corporate to Employer Services. Facilities and telecommunication expenses decreased by $0.4 million. Facilities and telecommunication expenses were 5.3% of service revenue in the second quarter of 2009 and 4.6% in the second quarter of 2008. The expense decrease is a direct effect of office consolidations. Other operating expenses decreased by $4.6 million. Other operating expenses were 13.2% and 17.9% of service revenue in the second quarter of 2009 and 2008, respectively. The expense decrease in other operating expenses is primarily due to moving technology personnel from Corporate to Employer Services which were previously allocated from Corporate to other expenses, a decrease in temporary labor, professional fees, bad debt expense and decreased foreign currency losses. Depreciation and amortization increased by $0.5 million. Depreciation and amortization was 9.4% of service revenue in the second quarter of 2009 compared to 5.9% in the same period of 2008. The increase is primarily due to accelerated depreciation on software related to outsourcing some services in our drug screening division in the second quarter of 2009. The operating margin percentage increased from 5.4% to 6.7% primarily due to the decline in operating expenses offset by a decline in revenue. Income from operations was $2.7 million for the three months ended June 30, 2009, a decrease of $0.3 million compared to income from operations of $3.0 million in the same period of 2008. The decrease is due to the decline in service revenue, offset by an approximately 26% decrease in operating expenses. Multifamily Services Segment Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Total service revenue was $19.7 million for the three months ended June 30, 2009, a decrease of $0.3 million compared to service revenue of $20.0 million in the same period of 2008. The decrease is primarily due to a decline in revenue at the screening business due to the current economic conditions. Salaries and benefits cost decreased $0.6 million. Salaries and benefits were 29.4% of service revenue for the second quarter of 2009 compared to 32.0% of service revenue in the same period of 2008. The expense decrease is primarily due to a reduction in employees. Facilities and telecommunication expenses decreased $0.2 million. Facilities and telecommunication expenses were 3.7% of service revenue in the second quarter of 2009 and 4.5% in the second quarter of 2008. The expense decrease is a direct effect of office consolidations. Other operating expenses decreased $0.6 million. Other operating expenses were 11.8% of service revenue in the second quarter of 2009 compared to 14.7% in the same period of 2008. The decrease is due to reduced leased equipment, marketing and travel expenses. Depreciation and amortization was flat when compared to the second quarter of 2008. Depreciation and amortization was 7.7% of service revenue in the second quarter of 2009 compared to 7.2% in the same period of 2008. Income from operations was $7.6 million in the second quarter of 2009 compared to income from operations of $6.6 million in the same period of 2008. The operating margin percentage increased from 32.9% to 38.5% primarily due to reduced operating expenses. The increase in operating margin is primarily due to management’s cost containment initiatives. 23 Table of Contents Investigative and Litigation Services Segment Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Total service revenue was $8.7 million for the three months ended June 30, 2009, a decrease of $12.5 million compared to service revenue of $21.2 million in the same period of 2008. The decrease is primarily due to the case activity level in the Litigation Support Services division. Salaries and benefits decreased by $3.4 million. Salaries and benefits were 58.1% of service revenue in the second quarter of 2009 compared to 39.9% in the same period of 2008. The expense decrease is mainly due to the decline of compensation related to revenue and profitability. Facilities and telecommunication expenses were flat compared to the same period in 2008. Facilities and telecommunication expenses were 8.3% of service revenue in the second quarter of 2009 and 3.4% in the second quarter of 2008. Other operating expenses decreased by $1.8 million. Other operating expenses were 16.1% of service revenue in the second quarter of 2009 and 15.1% for the same period of 2008. The decrease in expense is primarily due to a reduction in bad debt expense, travel expenses and professional fees. Depreciation and amortization was flat when compared to the second quarter of 2008. Depreciation and amortization was 8.4% of service revenue in the second quarter of 2009 compared to 4.1% in the same period of 2008. The operating margin percentage decreased from 35.6% to 3.1%. The decrease in margin is primarily due to the revenue decline on the higher margin electronic discovery business. Income from operations was $0.3 million for the second quarter of 2009 compared to $7.5 million for the same period of 2008. The decrease is primarily due to the revenue decrease on the higher margin electronic discovery business. Corporate Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Corporate costs and expenses represent primarily compensation and benefits for senior management, administrative staff, and their related expenses in addition to an administrative fee paid to First American. The corporate expenses were $8.3 million in the second quarter of 2009 compared to expenses of $8.8 million in the same period of 2008. The expense decrease is due to moving technology personnel from Corporate to Employer Services, decreases in compensation and benefit expenses, and travel expenses. 24 Table of Contents Consolidated Results Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008 Consolidated service revenue for the three months ended June 30, 2009 was $164.7 million, a decrease of $17.7 million compared to service revenue of $182.4 million in the same period in 2008. The decrease in service revenue compared to the second quarter of 2008 is directly related to the downturn in domestic and international hiring, weakness in the credit markets, and overall economic slowdown, offset by the increase in the Data Services segment. Salaries and benefits decreased $14.8 million. Salaries and benefits were 29.2% of service revenue for the three months ended June 30, 2009 and 34.5% for the same period in 2008. The decrease is primarily due to strategic reductions in employees, a decline of compensation related to revenue and profitability, and a reduction in the 401(k) match expense. Facilities and telecommunication decreased by $1.2 million compared to the same period in 2008. Facilities and telecommunication expenses were 4.2% of service revenue in the second quarter of 2009 and 4.4% in the second quarter of 2008. The decrease is primarily due to savings related to office consolidations. Other operating expenses decreased by $4.3 million compared to the same period in 2008. Other operating expenses were 11.3% and 12.6% of service revenue for the three months ended June 30, 2009 and 2008, respectively. The decrease in expense is due to office consolidations and cost reduction measures. This is offset by an increase in bad debt expense at the Data Services segment. Depreciation and amortization increased by $0.2 million due to fixed asset additions and the roll out of internally developed software, offset by certain fixed assets and intangibles becoming fully depreciated. The consolidated operating margin was 13.3% for the three months ended June 30, 2009, compared to 13.2% for the same period in 2008. Income from operations was $21.9 million for the three months ended June 30, 2009 compared to $24.0 million for the same period in 2008. The decrease of $2.1 million is comprised of a decrease in operating income of $7.3 million in Investigative and Litigation Support Services, $1.6 million in Data Services, and $0.3 million at Employer Services offset by increases in operating income of $5.6 million in Credit Services, $1.0 million in Multifamily Services and a decrease of corporate expenses of $0.5 million. Credit Services Segment Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Service revenue was $132.1 million for the six months ended June 30, 2009, a decrease of $9.8 million compared to service revenue of $141.9 million for the six months ended June 30, 2008. A decrease in revenue at the dealer services division resulted in an overall decrease in service revenue, which is partially offset by an increase in revenue from the mortgage credit and consumer credit divisions. The challenging credit markets and overall economy continues to affect our credit reporting businesses compared to the first half of 2008. Gross margin was $72.5 million for the six months ended June 30, 2009, a decrease of $6.2 million compared to gross margin of $78.7 million in the same period of 2008. The decline in gross margin is primarily due to the overall decrease in revenue and the revenue mix compared to prior year. Gross margin was 54.9% for the six months ended June 30, 2009 as compared to 55.5% for the six months ended June 30, 2008. Salaries and benefits decreased by $6.5 million. Salaries and benefits were 18.3% of service revenue in the first six months of 2009 compared to 21.6% during the same period in 2008. Salaries and benefits expense decreased due to operational efficiencies and reduced staffing. Facilities and telecommunication expenses decreased $1.0 million. Facilities and telecommunication expense were 2.6% of service revenue in the first six months of 2009 compared to 3.1% in the same period of 2008. The decrease is due to the consolidation of offices. Other operating expenses decreased by $3.0 million. Other operating expenses were 7.3% of service revenue in the six months ended June 30, 2009 compared to 8.9% for the same period of 2008. The decrease in 2009 is due to a decrease in service fees, lease expense, marketing expense, bad debt expense and travel expense, offset by an increase in temporary labor and professional service fees. Depreciation and amortization increased by $0.2 million. Depreciation and amortization was 2.2% of service revenue during the first six months of 2009 compared to 1.9% in the same period in 2008. The increase is primarily due to the rollout of new software projects. Income from operations was $32.3 million for the six months ended June 30, 2009 compared to $28.3 million in the same period of 2008. The operating margin percentage increased from 20.0% to 24.5% primarily due operational efficiencies gained related to the segment’s cost reduction measures in 2008. 25 Table of Contents Data Services Segment Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Total service revenue was $87.9 million for the six months ended June 30, 2009, an increase of $49.4 million compared to service revenue of $38.5 million in the same period of 2008. This segment has experienced a significant increase in service revenue primarily due to the lead generation business, offset by reduced volumes in the specialty credit and transportation businesses as a result of the overall economic downturn. Gross margin was $31.6 million for the six months ended June 30, 2009, an increase of $3.9 million compared to gross margin of $27.7 million in the same period of 2008. Gross margin as a percentage of service revenue was 35.9% for the six months ended June 30, 2009 as compared to 71.9% for the six months ended June 30, 2008. The decrease in the gross margin as a percentage of service revenue is primarily due to the revenue mix. The lead generation eAdvertising business has lower margins. Salaries and benefits decreased by $0.4 million. Salaries and benefits were approximately 11.1% of service revenue in the first six months of 2009 compared to 26.3% of service revenue in the same period of 2008. The decrease in expense is related to the decrease in staffing as compared to the same period in 2008. Facilities and telecommunication expenses for the six months ended June 30, 2009 were comparable to the same period in 2008. Facilities and telecommunication expenses were approximately 1.4% of service revenue in the first six months of 2009 compared to 3.3% of service revenue in the same period of 2008. Other operating expenses increased by $4.2 million. Other operating expenses were 9.0% of service revenue for the six months ended June 30, 2009 and 9.6% in the same period of 2008. The expense increase is primarily due to the increase in bad debt expense at the lead generation business. Depreciation and amortization for the six months ended June 30, 2009 was comparable to the same period in 2008. The operating margin percentage decreased from 19.6% to 8.9% in comparing the six months ended June 30, 2008 to same period of 2009. The decrease in the operating margin is primarily due to the revenue mix of the businesses in the first half of 2009 compared to the same period in 2008. Income from operations was $7.8 million for the six months ended June 30, 2009, an increase of $0.3 million compared to $7.5 million in the first six months of 2008. The increase is primarily driven by the lead generation business where revenue has increased, offset by increased cost of service and operating expenses. Employer Services Segment Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Total service revenue was $77.6 million for the six months ended June 30, 2009, a decrease of $31.6 million compared to service revenue of $109.2 million in the same period of 2008. The decrease was a result of a decrease in hiring in the United States and abroad. The recession has caused increased unemployment, which directly affects this segment. Salaries and benefits decreased by $7.8 million. Salaries and benefits were 42.2% of service revenue in the first six months of 2009 compared to 37.2% in the same period of 2008. The decrease in expense is a direct effect of office consolidations and the reduction in staffing, offset by an increase in expense related to moving technology personnel from Corporate to Employer Services. Facilities and telecommunication expenses decreased by $0.8 million. Facilities and telecommunication expenses were 5.4% of service revenue in the six months ended June 30, 2009 and 4.6% in the same period of 2008. The expense decrease is a direct effect of office consolidations. Other operating expenses decreased by $9.1 million. Other operating expenses were 13.5% and 18.0% of service revenue in the six months ended June 30, 2009 and 2008, respectively. The expense decrease in other operating expenses is primarily due to moving technology personnel from Corporate to Employer Services which increased costs allocated out of Employer services, a decrease in temporary labor, bad debt expense and decreased foreign currency losses. Depreciation and amortization increased by $0.9 million primarily. Depreciation and amortization was 9.4% of service revenue in the second quarter of 2009 compared to 5.8% in the same period of 2008. The increase is primarily due to the rollout of internally developed software and the accelerated depreciation on software related to outsourcing some services in our drug screening division. The operating margin percentage decreased from 5.9% to 2.8% primarily due to the decline in service revenue. Income from operations was $2.2 million for the six months ended June 30, 2009, a decrease of $4.3 million compared to income from operations of $6.5 million in the same period of 2008. The decrease is due to the decline in service revenue, offset by an approximately 24% decrease in operating expenses. 26 Table of Contents Multifamily Services Segment Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Total service revenue was $37.6 million for the six months ended June 30, 2009, a decrease of $0.7 million compared to service revenue of $38.3 million in the same period of 2009. The decrease is primarily due to a decline in revenue due to the current economic conditions. Salaries and benefits cost decreased $1.5 million. Salaries and benefits were 32.2% of service revenue for the six months ended June 30, 2009 compared to 35.6% of service revenue in the same period of 2008. The expense decrease is primarily due to a reduction in employees. Facilities and telecommunication expenses decreased $0.3 million. Facilities and telecommunication expenses were 4.0% of service revenue in the first six months of 2009 and 4.8% in the same period of 2008. The expense decrease is a direct effect of office consolidations. Other operating expenses decreased $0.9 million. Other operating expenses were 11.9% of service revenue in the first six months of 2009 compared to 14.1% in the same period of 2008. The decrease is due to reduced leased equipment, marketing and travel expenses. Depreciation and amortization increased $0.2 million. Depreciation and amortization was 8.0% of service revenue in the first quarter of 2009 compared to 7.3% in the same period of 2008. The operating margin percentage increased from 29.6% to 35.3% due to reduced operating expenses. Income from operations was $13.3 million in the first six months of 2009 compared to income from operations of $11.3 million in the same period of 2008. Investigative and Litigation Services Segment Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Total service revenue was $20.4 million for the six months ended June 30, 2009, a decrease of $24.3 million compared to service revenue of $44.7 million in the same period of 2008. The decrease is primarily due to the case activity level in the Litigation Support Services division. Salaries and benefits decreased by $6.0 million. Salaries and benefits were 57.3% of service revenue in the first six months of 2009 compared to 39.6% in the same period of 2008. The expense decrease is mainly due to the decline of compensation related to revenue and profitability. Facilities and telecommunication expenses decreased $0.2 million. Facilities and telecommunication expenses were 6.4% of service revenue in the six months ended June 30, 2009 and 3.3% in the first quarter of 2008. Other operating expenses decreased by $2.1 million. Other operating expenses were 18.0% of service revenue in the first six months of 2009 and 13.0% for the same period of 2008. The decrease in expense is primarily due to a reduction in bad debt expense, travel expenses and professional fees. Depreciation and amortization decreased $0.2 million. Depreciation and amortization was 7.1% of service revenue in the six months ended June 30, 2009 compared to 3.6% in the same period of 2008. The operating margin percentage decreased from 38.2% to 6.9%. The decrease in margin is primarily due to the revenue decline on the higher margin electronic discovery business. Income from operations was $1.4 million for the six months ended June 30, 2009 compared to $17.1 million for the same period of 2008. The decrease is primarily due to the revenue decrease on the higher margin electronic discovery business. Corporate Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Corporate costs and expenses represent primarily compensation and benefits for senior management, administrative staff, and their related expenses in addition to an administrative fee paid to First American. The corporate expenses were $16.2 million in the six months ended June 30, 2009 compared to expenses of $19.6 million in the same period of 2008. The expense decrease is due to moving technology personnel from Corporate to Employer Services, decreases in compensation and benefit expenses, and travel expenses. 27 Table of Contents Consolidated Results Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Consolidated service revenue for the six months ended June 30, 2009 was $354.7 million, a decrease of $16.0 million compared to service revenue of $370.7 million in the same period in 2008. The decrease in service revenue is directly related to the downturn in domestic and international hiring, the decline in the mortgage industry, weakness in the credit markets, and overall economic slowdown, partially offset by an increase in the Data Services segment. Salaries and benefits decreased $28.1 million. Salaries and benefits were 28.6% of service revenue for the six months ended June 30, 2009 and 34.9% for the same period in 2008. The decrease is primarily due to strategic reductions in employees, a decline of compensation related to revenue and profitability, and a reduction in the 401(k) match expense. Facilities and telecommunication decreased by $2.8 million compared to the same period in 2008. Facilities and telecommunication expenses were 3.8% of service revenue in the first six months of 2009 and 4.4% in the first quarter of 2008. The decrease is primarily due to savings related to office consolidations. Other operating expenses decreased by $7.8 million compared to the same period in 2008. Other operating expenses were 10.7% and 12.3% of service revenue for the six months ended June 30, 2009 and 2008, respectively. The decrease in expense is due to office consolidations and cost reduction measures. This is offset by an increase in bad debt expense at the Data Services segment. Depreciation and amortization increased by $1.0 million due to fixed asset additions and the roll out of internally developed software, offset by certain fixed assets and intangibles becoming fully depreciated. The consolidated operating margin was 11.5% for the six months ended June 30, 2009, compared to 13.8% for the same period in 2008. Income from operations was $40.8 million for the six months ended June 30, 2009 compared to $51.2 million for the same period in 2008. The decrease of $10.4 million is comprised of a decrease in operating income of $15.6 million in Investigative and Litigation Support Services, and $4.3 million at Employer Services offset by increases in operating income of $4.0 million in Credit Services, $1.9 million in Multifamily Services, $0.3 million in Data Services, and a decrease of corporate expenses of $3.3 million. Critical Accounting Estimates Critical accounting policies are those policies used in the preparation of the Company’s financial statements that require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosure of contingencies. A summary of these policies can be found in Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for year ended December 31, 2008. Liquidity and Capital Resources Overview The Company’s principal sources of capital include, but are not limited to, existing cash balances, operating cash flows and borrowing under its Secured Credit Facility (see Note 6 to the Consolidated Financial Statements). The Company’s short-term and long-term liquidity depends primarily upon its level of net income, working capital management (accounts receivable, accounts payable and accrued expenses), capital expenditures and bank borrowings. The Company believes that, based on current forecasts and anticipated market conditions, sufficient operating cash flow will be generated to meet all operating needs, to make planned capital expenditures, scheduled debt payments, and tax obligations for the next twelve months. Any material variance of operating results could require us to seek other funding alternatives including raising additional capital, which may be difficult in the current economic conditions. In previous years, First Advantage sought to acquire other businesses as part of its growth strategy. The Company will continue to evaluate acquisitions in order to achieve economies of scale, expand market share and enter new markets. While uncertainties within the Company’s industry exist, management is not aware of any trends or events likely to have a material adverse effect on liquidity or the accompanying financial statements. Management expects continued weakness in the real estate and mortgage markets to continue impacting the Company’s Credit Services segment and the transportation and specialty credit businesses in the Data Services segment. In addition, the effect of the issues in the real estate and related credit markets and other macroeconomic matters has resulted in higher unemployment rates negatively impacting the volumes in the Employer Services segment. Given this outlook, management is focusing on expense reductions, operating efficiencies, and increasing market share throughout the Company. 28 Table of Contents Statements of Cash Flows The Company’s primary source of liquidity is cash flow from operations and amounts available under credit lines the Company has established with a bank. As of June 30, 2009, cash and cash equivalents were $60.5 million. Net cash provided by operating activities of continuing operations was $37.2 million in the six months ended June 30, 2009 compared to cash used in operating activities of continuing operations was $2.5 million for same period in 2008. Cash provided by operating activities of continuing operations increased by $39.7 million when comparing the six months ended June 30, 2009 and the same period in 2008. Income from continuing operations was $23.4 million in the first half of 2009 and $29.6 million for the same period in 2008. The increase in cash provided by operating activities was primarily due to the income tax payments of $56.9 million in 2008 related to the sale of DealerTrack shares. Cash used in investing activities of continuing operations was $30.4 million and $70.4 million for the six months ended June 30, 2009 and 2008, respectively. In the six months ended June 30, 2009, net cash in the amount of $19.5 million was used for acquisitions compared to $51.2 million in the same period of 2008. Purchases of property and equipment were $9.8 million in the first half of 2009 compared to $17.5 million in the same period of 2008. Cash provided by financing activities of continuing operations was $0.5 million for the six months ended June 30, 2009, compared to $35.6 million for the six months ended June 30, 2008. In the six months ended June 30, 2009, proceeds from existing credit facilities were $50.4 million compared to $90.0 million in the same period of 2008. Repayment of debt was $45.1 million in the first half of 2009 and $52.0 million in the same period of 2008. Cash used to acquire noncontrolling interest in a consolidated subsidiary was $5.1 million and $8.0 million for the six months ended June 30, 2009 and 2008, respectively. Debt and Capital In 2005, the Company executed a revolving credit agreement with a bank syndication (the “Credit Agreement”). Borrowings available under the Credit Agreement total up to $225 million. The Credit Agreement includes a $10 million sub-facility for the issuance of letters of credit and up to a $5 million swing loan facility. The credit facility maturity date is September 28, 2010. The Credit Agreement is collateralized by the stock and accounts receivable of the Company’s subsidiaries. At June 30, 2009, the Company had available lines of credit of $195.1 million. At June 30, 2009, the Company was in compliance with the financial covenants of its loan agreements. First Advantage filed a Registration Statement with the Securities and Exchange Commission for the issuance of up to 5.0 million shares of our Class A common stock, par value $.001 per share, from time to time as full or partial consideration for the acquisition of businesses, assets or securities of other business entities. The Registration Statement was declared effective on January 9, 2006. A total of 1,338,631 shares were issued for acquisitions as of June 30, 2009. Contractual Obligations and Commercial Commitments The following is a schedule of long-term contractual commitments, as of June 30, 2009, over the periods in which they are expected to be paid. (In thousands) 2009 2010 2011 2012 2013 Thereafter Total Minimum contract purchase commitments $ 2,042 $ 2,618 $ 902 $ 41 $ 41 $ 26 $ 5,670 Advertising commitments 167 - - - - - 167 Operating leases 7,161 12,222 8,849 7,029 6,963 13,402 55,626 Debt and capital leases 4,548 32,921 492 72 78 53 38,164 Interest payments related to debt (1) 768 549 4 - - - 1,321 Total (2) $ 14,686 $ 48,310 $ 10,247 $ 7,142 $ 7,082 $ 13,481 $ 100,948 (1) Estimated interest payments are calculated assuming current interest rates over minimum maturity periods specified in debt agreements. (2) Excludes FIN 48 tax liability of $4.9 million due to uncertainty of payment period. 29 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in the Company’s risk since filing its Form 10-K for the year ended December 31, 2008.