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Executives

Cindy Williams – Director Investor Relations

John Lamson – Chief Financial Officer

Anand Nallathambi – President and Chief Executive Officer

Analysts

Carter Malloy – Stevens Inc.

Mark Marcon – Robert W. Baird

Nathaniel Otis – Keefe, Bruyette & Woods

First Advantage Corporation (FADV) Q2 2009 Earnings Call July 27, 2009 5:00 PM ET

Operator

Welcome to First Advantage Corporation's second quarter 2009 earnings conference call. (Operator Instructions) This call is being recorded and will be available for replay from the company's investor relations pages on their Web site at www.fadv.com and through August 10, 2009, by dialing toll free within the United States 888-562-2796 or 203-369-3746 outside the U.S.

A copy of today's press release is also available on the company's Web site at www.fadv.com. We will now turn the call over to Miss Cindy Williams, Director of Investor Relations to make a brief introductory statement.

Cindy Williams

Good afternoon everyone. At this time we would like to remind listeners that management's commentary and responses to your questions may contain forward-looking statements including certain statements made in this presentation relating to cost reduction initiatives and impact on improved efficiencies of future quarters including headcount reductions, facilities consolidation, reduction in professional services and marketing related expenses and other statements that do not relate strictly to historical or current fact. Forward-looking statements speak only as to the date they are made and the company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date for forward-looking statements are made. Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statement. Factors that could cause the anticipated results to differ from those described in those forward-looking statements include, general volatility of the capital markets and the market prices 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 successfully integrate those acquisition acquired, 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 risks identified from time to time in the company's SEC filings. Investors are advised to consult the company's filings with the SEC including its 2008 annual report on Form 10-K and second quarter 2009 10-Q for a discussion of these and other risks.

We will now begin our conference call this afternoon with our Chief Financial Officer and Executive Vice President, John Lamson, who will provide an overview of our financial performance for the second quarter of 2009. Following John, we will hear from Anand Nallathambi, President and Chief Executive Officer, who will provide us with an overview of First Advantage's strategy and operations.

At this time it is my pleasure to turn the call over to Mr. John Lamson.

John Lamson

Good afternoon everybody. As we previously announced on June 29, 2009, First Advantage confirmed that we received a unsolicited proposal from First American to acquire all the issued and outstanding shares of First Advantage not owned by First American at a fixed exchange ratio of .5375 of a share of First American stock for each share of First Advantage common stock.

The proposal is under consideration by the special committee of the board of directors of First Advantage, which is comprised of directors who are unaffiliated with First American.

The special committee is being assisted Regal and Financial advisors. As the special committee is currently considering the proposal, we are unable to respond to questions today regarding that proposal from First American.

As to our operating results, First Advantage reported income from continuing operations of $12.6 million for the current quarter, compared to $13.4 million for the second quarter of 2008.

Net income attributable to First Advantage shareholders was $13.0 million, or $0.22 per share, in the current quarter compared to $12.4 million in the second quarter of 2008, or $0.21 per share. That included a loss on discontinued operations of $1.3 million, or $0.02 per share. The second quarter of 2008 also included restructuring charges of approximately $1.7 million that reduced earnings per share by $0.02.

Earnings from continuing operations before interest, taxes, depreciation, and amortization, EBITDA, was $33.2 million for the quarter ended June 30, 2009, compared to $35.3 million for the comparable quarter June 30, 2008. A reconciliation of EBITDA to net income is included in our earnings release.

Cash provided from continuing operations was $24.2 million for the current quarter. Capital expenditures were $5.8 million in the current quarter, resulting in free cash flow of $18.4 million. At June 30, 2009, we had positive working capital of $118.7 million.

Service revenue, which excludes reimbursed government fees, was $164.7 million in the current quarter, compared to $182.4 million in the same quarter of last year.

Operating income was $21.9 million in the current quarter, compared to $24.0 million in the second quarter of 2008.

The consolidated operating margin was 13.3% in the current quarter compared to 13.2% in the second quarter of 2008.

Credit services margins were 26% in the current quarter compared to 17.9% in the second quarter of 2008. Revenue increased slightly from $67.0 million in 2008 to $67.7 million in the current quarter.

Credit services revenue related to vehicle financing decreased by $10.1 million, or approximately 40%, reflecting overall decline in auto and truck sales. This decline was offset by a $6.1 million increase in revenue related to our direct-to-consumer business, a 72% increase, and a $4.8 million increase, or 14.2%, in mortgage-related credit revenue reflecting increased lending volumes relative to Q2 of 2008.

The increase in operating margin in this segment is due to maintaining margins in the dealer services business, despite the revenue decline, and direct-to-consumer businesses and increased margins in the mortgage-related business.

Organic growth increased by 1% quarter-over-quarter and by 5% sequentially.

Our Data Services margins were 7.5% in the current quarter compared to 19.3% in the second quarter of 2008. Revenue increased from $19.5 million in the second quarter of 2008 to $28.8 million in the current quarter. A substantial portion of the revenue increase was in our regeneration business. The margin decline is due primarily to lower margin e-advertising revenue in our regeneration business.

Organic growth was 47% quarter-over-quarter and declined 51% on a sequential basis, with regeneration revenue the primary factor in both periods.

Our Employer Services segment revenue was $40.2 million in the second quarter of 2009 compared to $55.5 million in the second quarter of 2008, a decline of 27.6%. The decline in revenue reflects the increased unemployment rates in the U.S. and overall recessionary environment domestically and in our foreign operations.

Pre-tax income decreased from $3.0 million in 2008 to $2.7 million in 2009.

Restructuring costs were $1.1 million in 2008 and $300,000 in 2009.

Margins, adjusted for the restructuring charges were 7.4% in both 2008 and 2009 quarters. Constant margins, despite the 27% decline in revenue, reflect the impact of cost containment initiatives developed in 2008 and an improved revenue mix in higher margin tax and higher in solutions services-type revenues.

Sequentially revenue increased by $2.7 million, or 7.3%, and earnings increased by $3.2 million, reflecting operating efficiencies and a higher mix of tax and high-end solutions revenue.

Sequential growth from the first quarter of 2008 to the second quarter of 2008 was only 3.4% compared to the 7.3% growth we saw from the first quarter of 2009 to the second quarter of 2009.

Our Multi-Family Services segment margins increased from 33% in the second quarter of 2008 to 38.5% in the current quarter on essentially flat revenue due to cost reductions initiated during 2008.

Revenue in or Investigative and Lit Support segment declined from $21.2 million in 2008 to $8.7 million in 2009. The decline is the result of fewer projects in our e-discovery business in 2009.

Margins were 3.1% in the current quarter compared to 35.6% in 2008 due to the revenue decline.

Our corporate expenses decreased by $500,000 as we continued to emphasize cost reductions in all of our corporate departments.

The cost reductions we have discussed in the past are evidenced in the current quarter. Comparing the current quarter to the quarter ended June 30, 2008, we have reduced salaries and benefits by $14.8 million, or 24%, and total operating expenses from $104.9 million to $84.5 million, a reduction of $20.4 million, or 19.4%.

At June 30, 2009, First Advantage had total debt outstanding of $38.2 million, including fixed rate debt of $3.5 million with an average interest rate of 5.1% and variable rate debt of $34.7 million with an average interest rate of 1.9%. Our available and unused line of credit was $199.3 million and we had $60.5 million of cash on hand at the end of the quarter. Our debt to capital was only 3.8%.

With that, I'll turn it over to Anand.

Anand Nallathambi

Good afternoon everyone. We're pleased with the results of our second quarter which were in line with expectations. Though we are still in the midst of a recessionary environment, the improvements in the mortgage and consumer credit, employer and multi-family services are evident and encouraging.

In general, these businesses are now more efficient and built to deliver improved margins as overall market strength returns.

In the Credit Services segment, mortgage credit continued its strong performance in the second quarter, aided by the continuing refinance wave we experienced in the first quarter.

Compared to the first quarter of 2008, revenues were up 14% while earnings were up 109%. The big story here is the resurgence in margins. With rehabilitation of strict cost control initiatives the capability of this business has improved.

We expect a continued flight to quality over the next few quarters as lending guidelines and regulations are implemented to address fraud and loan quality concerns. The return to conservative underwriting standards bodes well for traditional market leaders like us.

In the automotive sector car sales remained weak as current estimates on new car sales were reduced from 12.5 million units to 9.5 million units in 2009.

Revenues in this segment were 40% lower than last year. Fortunately, our team has been able to maintain margins in the high teens, however, this will become more difficult the longer the downturn exists.

Federal government stimulus programs, including warranty guarantees and rebates for trade-ins, should stimulate consumer interest in newer, more fuel-efficient vehicles. We remain focused on increasing our share in a declining market and pushing additional ancillary products through our distribution channels.

The financial performance of the membership services division was driven by growth in third-party administrative services and consumer ID protection. Compared to last year's second quarter, revenues were 73% higher and earnings were up almost 80%.

Service revenues in the Data Services segment increased 40% over the second quarter of 2008. On a sequential basis, service revenue in this segment declined 51% as we made flights to diversity this business into a more predictable product mix and continued to decrease our exposure to lower-margin, non-traditional lead generation products.

In the specialty finance business the economic downturn has hurt our usual growth trajectory, however, compared to the second quarter of 2008, year-over-year revenues were stable at 90% and pre-tax income at 99%.

Teletrack has successfully maintained its margins in a tough environment and as of late, we are starting to see a modest uptick in volumes as consumer credit quality deteriorates and direct competitors experience service problems.

Additionally, our expansion efforts in both the credit card industry as well as the international arena, are both progressing well.

Service revenues declined in our Employer Services segment 28% from the second quarter of 2008 as unemployment figures reached a 25-year high. In June the Department of Labor released updated unemployment figures of 9.4%. Although the unemployment forecasts for the near term still seem a bit gloomy, there are positive trends that are on the rise, which opens up opportunities for us.

There has been a marked increase in the use of social networks in job search and candidate recruiting. This online media placement and sourcing of candidates is a trend that will only increase over time.

Additionally, in the international arena, we are seeing an uptick in activity in skills assessments and consumer driven employment profiles, especially in Asia.

During the second quarter we had ten significant customer wins representing over $10.0 million in annual revenue potential. These customer wins are across a broad representation of our product lines and reinforce the integrated product strategy at First Advantage.

Our multi-family segment remains a consistent performer, despite the highest rental vacancy rates in the past 22 years. Service revenue declined marginally by 2% in the second quarter compared to a year ago but operating margins were 38.5%, a 17% increase over the second quarter of 2008. The operating margins were achieved in large part due to focused, consistent roll out of residency analytics, strict cost control, and facilities consolidations.

In our investigative and litigation support segment, we experienced continued project delays for e-discovery services during the second quarter. Service revenue declined 59% compared to the second quarter of 2008 and declined 26% on a sequential quarterly basis.

Industry insiders have stated that the industry was down as much as 50% during the first half of the year but it is now slowing commencing a recovery.

Industry experts also point out that the weak economy has created pent up demand for litigations with some estimated 500,000 cases requiring discovery services over the next year.

On the investigative side, we have seen a resurgence in client activity, with a 49% increase in revenues from the last quarter. Though it's a small portion of the segment, the fact there is a renewal of hedge fund activity is a good sign for most of our businesses.

In closing, the scalability of our business is more evident now than ever as we are more streamlined and well structured as a company. Our focus on cost control has resulted in an annualized cost pick up totaling $48.0 million, with the bulk of that coming from credit and employer services.

For the last 18 months, we have reduced our global workforce by 26%, consolidating platforms, closed out facilities, and divested of underperforming, non-strategic businesses. As evidenced by new client sign ups, we are now positioned to have better sustainable, organic growth across our business segments.

The key take away is that our corporate-wide focus is to not just wait for market improvements or a return to normalcy in the overall macroeconomic environment but to constantly seek opportunities to drive revenue growth and maintain expense levels. We are starting to see the results of that operating model.

I would now like to open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Carter Malloy – Stevens Inc.

Carter Malloy – Stevens Inc.

I realize your, and understand your reluctance to speak about the yield situation but can you talk about your relationship with First American and your comfort with them around their offer.

John Lamson

Our relationship with First American is essentially the same as it's always been. We've always had a good relationship with First American. And we're not going to make any comments on the offer.

Anand Nallathambi

Our relationship remains the same and we are very closely connected from the mortgage/credit perspective because we provide credit at the starting point of a lot of mortgage-related services that First American offers.

So it's a pretty good relationship, I would say.

Carter Malloy – Stevens Inc.

On your credit services, can you talk about the drivers behind the big jump in the direct-to-consumer.

Anand Nallathambi

We have had just a lot of good client sign ups and with our significant clients that we have third-party administrative services, we have had a lot of new projects, most of it centered on consumer ID protection and fraud management.

Carter Malloy – Stevens Inc.

You gave the growth rate. I'm not sure if I heard it on the mortgage-related. Volumes were up $4.8 million.

Anand Nallathambi

Obviously the first 6 months of the year has been a very good, it reflects what the high refinance activity and currently I think it's continuing, or it's basically essentially flat from where we were in June. So we are yet to see the resurgence because we are seeing the same reports that you are seeing about the surge in new home sales.

So the near term looks very good. Long term, we just don't know.

Carter Malloy – Stevens Inc.

But one could expect credit services to at least hold the line sequential.

Anand Nallathambi

Yes.

Carter Malloy – Stevens Inc.

Within your Data Services can you just talk about how big Legion is now that it has come back down significantly off the very high. And how much of that business that is significant can expect a sequential stabilization there.

John Lamson

I think we have seen stabilization in the business over the last couple of months, so I think what some of the run rates you see now and the whole regeneration business is about 65% of the data segment's revenue. And I think that's probably a fairly consistent rate, what we're seeing now.

Operator

Your next question comes from Mark Marcon – Robert W. Baird.

Mark Marcon – Robert W. Baird

I'm wondering if you could talk a little more about employer services. You did see a little bit of a sequential uptick and noted that there's some positive signs. You also mentioned that you might be well positioned to benefit from the growth in social networks. So I was wondering if you could just give a little bit more color around all of those comments.

First, are you seeing any sort of monthly improvements and then secondly, how are you going to take advantage of the social networks.

Anand Nallathambi

Let me talk to the importance of the clients sign ups that we have seen. We are seeing a really big uptick in a lot of the new client sign ups and I think it's just a question of focused sales efforts from our staff, and I also think there is some consolidation that you're seeing in the marketplace amongst traditional vendors. I can't attribute it to anything else other than we're just winning more than our fair share of the RFP that are coming out there. So that's the first question.

The second question that you were talking about is what are the trends that we are talking about that we feel like we have a good chance of capitalizing on. We are really seeing a lot and I think you guys are pretty well clued into it. But the social networks are playing a really major role in candidate sourcing out there and our hiring solutions business is one of our high margins divisions within the Employer Services segment.

So we feel like being close to the point of sale of sourcing candidates and trying to go after passive candidates, of where they congregate and social networks playing a big role in it, it seems to bode well for us because we gravitate more towards that. And I think in a general industry trend you would see that the job boards are somewhat dissipating or giving way to more the franglish between where people congregate and where people have an affinity to be present in social networks.

Mark Marcon – Robert W. Baird

So you're talking specially about your hiring solutions, not necessarily the—it wouldn't necessarily change what you would see in terms of the screening side, but more in terms of some of your more network solutions and being able to automate the process.

Anand Nallathambi

Yes, automate the process, try to get into the conversations with employers early enough in the process. I also think that the I&I verifications and the biometrics, those are all things that are helping us. And I think that speaks to the diversified set of screening services that we bring to the table.

Mark Marcon – Robert W. Baird

Could you talk a bit more about ILS. I'm starting to hear some signs from some other players that maybe they're starting to see a pick up. Are you seeing an pick-ups at all on the month?

Anand Nallathambi

We're seeing a lot of pick up on the investigator side. On the ILS side, the pipeline still looks good and we have been saying this for a long time, but the conversations and the discussions on the RFPs that we are responding to, there has been no let up there. It's just an almost substandard animation of delayed projects on hold. Or people trying to tranche up smaller bites of discovery services while they spend a longer engagement as before.

So it's not anything that's changing. It's more like people trying to delay the spend.

Mark Marcon – Robert W. Baird

So they're delaying the spend, so those delays continue, you're not seeing any abatement of that are you?

Anand Nallathambi

It's starting to open up but it's nothing material to kind of say we see a resurgence in this market back to like 30% higher or anything like that.

We are seeing the pressures dissipate a little bit but not to a material extent yet. But all industry insiders and all the client discussion that we are having seem to point that over the next 9 to 12 months you would see a lot more of this activity come through.

Mark Marcon – Robert W. Baird

I understand you're not able to speak about First American currently, but at what point do you anticipate being able to talk about that and under what format or circumstances.

Anand Nallathambi

I think we will have to wait and see. We are just at this point clearly focused on running the business and we're leaving the proposal of this analysis and discussion or any negotiations to be carried on by the special committee of our board.

Mark Marcon – Robert W. Baird

And do anticipate that at some point you would be able to disclose how those discussions are going?

Anand Nallathambi

Just like you, we're eager to get involved in it but I think at this point we've just got to sit and wait.

Operator

Your next question comes from Nathaniel Otis – Keefe, Bruyette & Woods.

Nathaniel Otis – Keefe, Bruyette & Woods

You touched on it a little bit, but in that investigative and litigation support, have you made any cuts there and just a little color on how are you going about maintaining certain levels of expenses, given that you have this extending pipeline and you're trying to match that against certainly profitability in that space. Just any type of color on what your thoughts are, if the pipeline continues to stretch out longer and will you make some strategic cuts there, or how are you looking about just maintaining expenses there?

Anand Nallathambi

I think we have made some cuts. I don't know the exact percentages, but I think to the tune of close to about $2.0 million worth of cost savings is what I've been told so far.

In addition to that, what we're trying to do is we're moving some of these functions of data services or software development kind of things offshore. We're also kind of focused on new products to kind of extend the product line because now is the time for us to kind of focus on what additional ways that we can drive revenue growth and to that extent we have opened up operations in Bangalore to provide attorney legal reviews, coming out of India.

So we're kind of exploring a lot of different models, defending our product line, streamlining expenses, and staying as tight as we can and try to make a go of it as soon as the market opens up.

Operator

There are no further questions in the queue.

Anand Nallathambi

Thanks everyone.

Operator

This concludes today’s conference call.

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Source: First Advantage Corporation Q2 2009 Earnings Call Transcript
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