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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From _____ to _____
---------------
Commission File Number: 1-9293
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main Street, Ada, Oklahoma 74821-0145
(Address of principal executive offices) (Zip Code)
(Registrants' telephone number, including area code): (580) 436-1234
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No [ ]
The number of shares outstanding of the registrant's common stock as of October
18, 2002 was 19,009,090.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-Q
For the Quarter Ended September 30, 2002
CONTENTS
Part I. Financial Statements
Item 1. Financial Statements of Registrant:
a) Consolidated Balance Sheets
as of September 30, 2002 (Unaudited) and
December 31, 2001
b) Consolidated Statements of Income
(Unaudited) for the three months and nine months ended
September 30, 2002 and 2001
c) Consolidated Statements of Comprehensive Income
(Unaudited) for the three months and nine months ended
September 30, 2002 and 2001
d) Consolidated Statements of Cash Flows
(Unaudited) for the nine months ended
September 30, 2002 and 2001
e) Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 4. Submission Of Matters To A Vote Of Security Holders
Item 6. Exhibits and Reports on Form 8-K
Signatures
Certifications
ITEM 1. FINANCIAL STATEMENTS OF REGISTRANT
----------------------------------
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)
ASSETS
September 30, December 31,
2002 2001
------------ ------------
Current assets: (Unaudited)
Cash and cash equivalents........................................................ $ 13,077 $ 14,290
Available-for-sale investments, at fair value.................................... 7,089 6,070
Membership income receivable..................................................... 6,209 5,472
Inventories...................................................................... 1,210 922
Income taxes receivable.......................................................... 256 -
Deferred member and associate service costs...................................... 15,153 14,228
Deferred income taxes............................................................ 4,687 3,413
------------ ------------
Total current assets......................................................... 47,681 44,395
Available-for-sale investments, at fair value...................................... 11,899 13,386
Investments pledged................................................................ 4,159 4,315
Property and equipment, net........................................................ 20,583 14,755
Deferred member and associate service costs........................................ 3,230 2,907
Other assets....................................................................... 5,191 5,962
------------ ------------
Total assets............................................................... $ 92,743 $ 85,720
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.............................................................. $ 8,584 $ 7,664
Deferred revenue and fees........................................................ 24,042 20,893
Income taxes payable............................................................. - 1,087
Accounts payable and accrued expenses............................................ 16,310 9,678
Current portion of notes payable................................................. 3,333 -
------------ ------------
Total current liabilities...................................................... 52,269 39,322
Deferred revenue and fees........................................................ 4,625 4,158
Deferred income taxes ........................................................... 886 16
Notes payable.................................................................... 5,100 -
------------ ------------
Total liabilities............................................................ 62,880 43,496
------------ ------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 23,861 and
24,806 issued at September 30, 2002 and December 31, 2001, respectively........ 239 248
Capital in excess of par value................................................... 47,702 66,223
Retained earnings................................................................ 80,594 54,240
Accumulated other comprehensive income........................................... 356 186
Treasury stock, at cost; 4,852 and 3,989 shares held at
September 30, 2002 and December 31, 2001, respectively......................... (99,028) (78,673)
------------ ------------
Total stockholders' equity................................................... 29,863 42,224
------------ ------------
Total liabilities and stockholders' equity................................. $ 92,743 $ 85,720
------------ ------------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------- ----------- ----------- -----------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues:
Membership fees.............................................. $ 79,583 $ 67,427 $ 229,062 $ 193,822
Associate services........................................... 9,363 7,706 27,499 26,827
Other........................................................ 1,213 1,082 3,573 2,699
----------- ----------- ----------- -----------
90,159 76,215 260,134 223,348
----------- ----------- ----------- -----------
Costs and expenses:
Membership benefits.......................................... 26,620 22,128 76,936 63,951
Commissions.................................................. 31,064 28,916 91,671 83,999
Associate services and direct marketing...................... 7,732 5,305 22,455 21,277
General and administrative................................... 8,529 6,966 23,869 20,841
Other, net................................................... 2,539 1,635 4,968 3,707
----------- ----------- ----------- -----------
76,484 64,950 219,899 193,775
----------- ----------- ----------- -----------
Income from continuing operations before income taxes.......... 13,675 11,265 40,235 29,573
Provision for income taxes..................................... 4,718 3,745 13,881 9,712
----------- ----------- ----------- -----------
Income from continuing operations.............................. 8,957 7,520 26,354 19,861
Loss from operations of discontinued UFL segment,
net of applicable income tax - Note 5........................ - (562) - (506)
----------- ----------- ----------- -----------
Net income..................................................... $ 8,957 $ 6,958 $ 26,354 $ 19,355
----------- ----------- ----------- -----------
Basic earnings per common share from continuing operations..... $ .46 $ .35 $ 1.32 $ .92
Basic loss per common share from
discontinued operations...................................... - (.03) - (.02)
----------- ----------- ----------- -----------
Basic earnings per common share................................ $ .46 $ .32 $ 1.32 $ .90
----------- ----------- ----------- -----------
Diluted earnings per common share from continuing operations... $ .46 $ .35 $ 1.32 $ .92
Diluted loss per common share from
discontinued operations...................................... - (.03) - (.02)
----------- ----------- ----------- -----------
Diluted earnings per common share.............................. $ .46 $ .32 $ 1.32 $ .90
----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in 000's)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------- ----------- ----------- -----------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income..................................................... $ 8,957 $ 6,958 $ 26,354 $ 19,355
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment...................... (30) (36) 69 (11)
----------- ----------- ----------- -----------
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during period.... 104 377 155 709
Reclassification adjustment for realized losses (gains)
included in net income................................... (25) - (54) (12)
----------- ----------- ----------- -----------
79 377 101 697
----------- ----------- ----------- -----------
Other comprehensive income, net of income taxes of $43 and $183
for the three months and $54 and $366 for the nine months ended
September 30, 2002 and 2001, respectively..................... 49 341 170 686
----------- ----------- ----------- -----------
Comprehensive income........................................... $ 9,006 $ 7,299 $ 26,524 $ 20,041
----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
(Unaudited)
Nine Months Ended
September 30,
-------------------------
2002 2001
----------- -----------
Cash flows from operating activities:
Net income....................................................................... $ 26,354 $ 19,355
Adjustments to reconcile net income to net cash provided
by operating activities:
Loss from discontinued operations.............................................. - 506
Provision for deferred income taxes............................................ (294) 618
Depreciation and amortization.................................................. 3,844 2,953
Tax benefit on exercise of stock options....................................... 817 -
Compensation expense relating to contribution of stock to ESOP................. 207 162
Increase in income taxes receivable............................................ (256) -
Increase in Membership income receivable....................................... (737) (1,005)
(Increase) decrease in inventories............................................. (288) 329
Increase in deferred member and associate service costs........................ (1,248) (1,817)
Decrease in other assets....................................................... 771 817
Increase in accrued Membership benefits........................................ 920 579
Increase in deferred revenue and fees.......................................... 3,616 3,472
Decrease in income taxes payable............................................... (1,087) (760)
Increase in accounts payable, accrued expenses and other, net.................. 6,426 576
----------- -----------
Net cash provided by operating activities of continuing operations........... 39,045 25,785
----------- -----------
Cash flows from investing activities:
Additions to property and equipment............................................ (9,672) (6,620)
Purchases of investments - available for sale.................................. (12,890) (10,454)
Maturities and sales of investments - available for sale....................... 13,199 9,305
----------- -----------
Net cash used in investing activities of continuing operations........... (9,363) (7,769)
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of common stock options................................. 3,036 99
Debt proceeds.................................................................. 9,100 -
Repayments of debt............................................................. (667) -
Decrease in capital lease obligations.......................................... - (194)
Purchases of treasury stock.................................................... (42,364) (15,820)
----------- -----------
Net cash used in financing activities of continuing operations........... (30,895) (15,915)
----------- -----------
Net (decrease) increase in cash and cash equivalents............................. (1,213) 2,101
Cash and cash equivalents at beginning of period................................. 14,290 10,866
----------- -----------
Cash and cash equivalents at end of period....................................... $ 13,077 $ 12,967
----------- -----------
Supplemental disclosure of cash flow information:
Net cash used in discontinued operations....................................... $ - $ (593)
----------- -----------
Cash paid for interest......................................................... $ 37 $ 1
----------- -----------
Income taxes paid.............................................................. $ 14,980 $ 8,400
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands
unless otherwise indicated)
(Unaudited)
Note 1 - Basis of Presentation
The accompanying consolidated financial statements and notes thereto have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") have been omitted. The
accompanying consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's 2001 Annual Report on Form 10-K.
The consolidated financial statements include the financial statements of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying unaudited financial
statements as of September 30, 2002, and for the three months and nine months
ended September 30, 2002 and 2001, reflect adjustments (which were normal and
recurring) which, in the opinion of management, are necessary for a fair
statement of the financial position and results of operations of the interim
periods presented. Results for the three months and nine months ended September
30, 2002 are not necessarily indicative of results expected for the full year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Note 2 - Contingencies
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. Plaintiffs thereafter filed a motion requesting reconsideration of
the dismissal which was denied. The plaintiffs have appealed the judgment and
the order denying their motion to reconsider the judgment to the Tenth Circuit
Court of Appeals, and the Pre-Paid defendants will respond according to the
schedule set by the appellate court. In August 2002, the lead institutional
plaintiff withdrew from the case, leaving two individual plaintiffs as lead
plaintiffs on behalf of the putative class. The ultimate outcome of this case is
not determinable.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On March 1, 2002, plaintiffs filed a consolidated
amended derivative complaint. The amended complaint alleges that the defendant
directors caused the Company to violate generally accepted accounting principles
and federal securities laws by improperly capitalizing commission expenses,
caused the Company to allegedly pay increased salaries and bonuses based upon
financial performance which was allegedly improperly inflated, and caused the
Company to expend significant dollars in connection with the defense of its
accounting policy, including cost incurred in connection with the defense of the
securities class action described above, and in connection with the repurchase
of its own shares on the open market at allegedly artificially inflated prices.
This derivative action is related to the putative securities class action
described above, which has been dismissed with prejudice. After the defendants
moved to dismiss the consolidated amended derivative complaint, the plaintiffs
filed a voluntary dismissal of the case in August 2002 without prejudice. The
Pre-Paid defendants have objected to the voluntary dismissal. The case is in the
preliminary stages and the ultimate outcome is not determinable.
Beginning in the second quarter of 2001 and through September 30, 2002,
multiple lawsuits were filed against the Company, certain officers, employees,
sales associates and other defendants in various Alabama and Mississippi state
courts by current or former members seeking unspecified actual and punitive
damages for alleged breach of contract, fraud and various other claims in
connection with the sale of memberships. As of September 30, 2002, the Company
was aware of 21 separate lawsuits involving approximately 289 plaintiffs that
have been filed in multiple counties in Alabama, and eleven separate lawsuits
involving approximately 420 plaintiffs in multiple counties in Mississippi.
Certain of the Mississippi lawsuits also name the Company's provider attorney in
Mississippi as a defendant. A complaint was also filed on behalf of the
Mississippi plaintiffs and others with the Attorney General of Mississippi in
March 2002 and the Company responded to a request for information from the
Attorney General in May 2002. No other action has been taken by the Attorney
General since that date. Additional suits of a similar nature have been
threatened. In January 2002, one of the law firms representing individual
plaintiffs in some of those Alabama suits filed a putative class action on
behalf of all Alabama residents purchasing memberships seeking damages and
injunctive relief based on alleged failures to provide coverage under the
memberships. The class action allegations of that suit have been dismissed with
prejudice and the claims of the two individuals are all that remain in that
suit. Two Alabama member suits have been dismissed with prejudice by the
Pre-Paid members who brought the suits without any payment by Pre-paid. In
Mississippi, the Company has filed lawsuits in the United States District Court
for the Southern and Northern Districts of Mississippi in which the Company
seeks to compel arbitration of the various Mississippi claims under the Federal
Arbitration Act and the terms of the Company's membership agreements. These
cases are all in various stages of litigation, including trial settings
beginning in Alabama in December 2002 and in Mississippi in February 2003, and
seek varying amounts of actual and punitive damages. While the amount of
membership fees paid by the plaintiffs in the Mississippi cases is $500,000 or
less, certain of the cases seek damages of $90 million. The ultimate outcome of
any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against the Company and certain of its officers in the
District Court of Creek County, Oklahoma on behalf of Jeff and Jana Weller
individually and doing business as Hi-Tech Auto making similar allegations
relating to the Company's memberships and seeking unspecified damages on behalf
of a "nationwide" class. The Company's preliminary motions in this case have
been denied. The case is in the preliminary stages and the ultimate outcome is
not determinable.
On June 29, 2001, an action was filed against the Company in the District
Court of Canadian County, Oklahoma. In 2002, the petition was amended to add
five additional named plaintiffs and to add and drop certain claims. This action
is a putative class action brought by Gina Kotwitz, George Kotwitz, Rick Coker,
Richard Starke, Jeff Turnipseed and Aaron Bouren on behalf of all sales
associates of the Company. The amended petition seeks injunctive and declaratory
relief, with such other damages as the court deems appropriate, for alleged
violations of the Oklahoma Uniform Consumer Credit Code in connection with the
Company's commission advances, and seeks injunctive and declaratory relief
regarding the enforcement of certain contract provisions with sales associates.
The damages alleged on the Consumer Credit Code claim are in excess of $315
million. The plaintiffs' request for class certification is set for hearing on
March 28, 2003. The case is in the preliminary stages and the ultimate outcome
is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is putative class action seeking unspecified
damages filed on behalf of all sales associates of the Company and alleges that
the marketing plan offered by the Company constitutes a security under the
Securities Act of 1933 and seeks remedies for failure to register the marketing
plan as a security and for violations of the anti-fraud provisions of the
Securities Act of 1933 and the Securities Exchange Act of 1934 in connection
with representations alleged to have been made in connection with the marketing
plan. The complaint also alleges violations of the Oklahoma Securities Act, the
Oklahoma Business Opportunities Sales Act, breach of contract, breach of duty of
good faith and fair dealing and unjust enrichment and violation of the Oklahoma
Consumer Protection Act and negligent supervision. This case is subject to the
Private Litigation Securities Reform Act. Pursuant to the Act, the Court has
approved the named plaintiffs and counsel and an amended complaint was filed in
August 2002. The Company filed motions to dismiss the complaint and to strike
the class action allegations on September 19, 2002. All discovery in the action
is stayed pending a ruling on the motion to dismiss, which the Company expects
will occur no earlier than January 2003. The case is in the preliminary stages
and the ultimate outcome is not determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in all proceedings in which it is named as a defendant. The Company
also receives periodic complaints or requests for information from various state
and federal agencies relating to its business or the activities of its marketing
force. The Company promptly responds to any such matters and provides any
information requested.
While the ultimate outcome of these proceedings is not determinable, the
Company does not currently anticipate that these contingencies will result in
any material adverse effect to its financial condition or results of operation,
unless an unexpected result occurs in one of the cases. The Company has
established an accrued liability it believes will be sufficient to cover
estimated damages in connection with various cases, which at September 30, 2002
was $3.3 million. If an unexpected result were to occur in one or more of the
pending cases, the amount of damages awarded could differ significantly from
management's estimates. The Company believes it has meritorious defenses in all
pending cases and will vigorously defend against the plaintiffs' claims.
The Company is constructing a new corporate office complex with an
estimated completion during the third quarter of 2003 at an estimated cost of
approximately $30 million. Costs incurred through September 30, 2002 of
approximately $8.2 million have been paid from existing resources and the real
estate line of credit. The Company expects to incur additional indebtedness in
order to finance the remaining costs of its new corporate headquarters in order
to allow cash flow from operations to continue to be used to purchase treasury
stock. The Company has entered into construction contracts in the amount of
$28.2 million with the general contractor pertaining to the new office complex.
Total remaining costs of construction from October 1, 2002 are estimated at
approximately $21.8 million.
Note 3 - Treasury Stock Purchases
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 6.0 million shares during subsequent board meetings. At September 30,
2002, the Company had purchased 5.2 million shares under these authorizations
for a total consideration of $117.3 million, an average price of $22.50 per
share. As of September 30, 2002, 1.1 million shares with a cost of $22.0 million
were formally retired and removed from the shares outstanding and from the
shares of treasury stock. This transaction reduced common stock by $11,601 and
reduced capital in excess of par value by $22.0 million.
Treasury stock purchases will be made at prices that are considered
attractive by management and at such times that management believes will not
unduly impact the Company's liquidity. No time limit has been set for completion
of the purchase program. The Company has obtained a $10 million line of credit
facility to be used for additional stock purchases. As of September 30, 2002,
the Company had drawn $4 million on this available credit line and repaid
$667,000 resulting in availability of $6.7 million. The Company may make
additional draws in the future.
Note 4 - Earnings Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
respective periods.
Diluted earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock and common stock
equivalents outstanding during the respective periods. The weighted average
number of common shares is increased by the number of shares issuable on the
exercise of options less the number of common shares assumed to have been
purchased with the proceeds from the exercise of the options pursuant to the
treasury stock method; those purchases are assumed to have been made at the
average price of the common stock during the respective period.
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- ---------------------
Basic Earnings Per Share: 2002 2001 2002 2001
---------- ---------- ---------- ----------
Earnings:
Income from continuing operations applicable to common shares........ $ 8,957 $ 7,520 $ 26,354 $ 19,861
---------- ---------- ---------- ----------
Shares:
Weighted average shares outstanding.................................. 19,312 21,351 19,909 21,586
---------- ---------- ---------- ----------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations available to common
stockholders after assumed conversions............................. $ 8,957 $ 7,520 $ 26,354 $ 19,861
---------- ---------- ---------- ----------
Shares:
Weighted average shares outstanding.................................. 19,312 21,351 19,909 21,585
Assumed exercise of options.......................................... 37 63 119 39
---------- ---------- ---------- ----------
Weighted average number of shares, as adjusted....................... 19,349 21,414 20,028 21,624
---------- ---------- ---------- ----------
Note 5 - Discontinued Operations
On December 31, 2001 the Company completed the sale of its wholly owned
subsidiary Universal Fidelity Life Insurance Company ("UFL"). The Company
received a $2.8 million dividend and $1.2 million from the sale of 100% of UFL
stock. The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income for
the three months and nine months ended September 30, 2001. Cash flow impacts of
discontinued operations have been segregated in the Consolidated Statements of
Cash Flows for the nine months ended September 30, 2001. Details of income from
discontinued operations are as follows:
Three Months
Ended
September 30, Nine Months Ended
2001 September 30, 2001
------------- ------------------
Revenues................................................................ $ 309 $ 861
------------- ------------------
Loss from discontinued operations, net of tax expense of $0............. $ (562) $ (506)
------------- ------------------
Note 6 - Recent Issued Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued new
pronouncements: SFAS 142, "Goodwill and Other Intangible Assets"; and SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 142 requires that goodwill
as well as other intangible assets be tested annually for impairment. In
addition, the Statement eliminates the previous requirement to amortize goodwill
or intangible assets with indefinite lives, and is effective for fiscal years
beginning after December 15, 2001. SFAS 142 was adopted effective January 1,
2002 and did not have a material impact on the Company's financial position or
results of operations. SFAS 143 requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred and a corresponding increase in the carrying amount of the related
long-lived asset. SFAS 143 is effective for fiscal years beginning after June
15, 2002. The Company does not expect SFAS 143 to materially impact its reported
results.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", (SFAS 144") is effective for the Company for the fiscal year beginning
January 1, 2002, and addresses accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business." SFAS 144 retains the
fundamental provisions of SFAS No. 121 and expands the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. The Company adopted
SFAS 144 effective January 1, 2002. The new standard did not have a material
impact on the Company's financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", (SFAS 146"). SFAS No. 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred, rather than at the date of the
entity's commitment to an exit plan. This statement is effective for exit and
disposal activities that are initiated after December 31, 2002. Since adoption
of this SFAS is prospective, the Company does not believe that the
implementation of this SFAS will have a material impact on its financial
statements.
Note 7 - Notes Payable
On June 11, 2002, the Company entered into two line of credit agreements
totaling $30 million with commercial lenders providing for a treasury stock
purchase line and a real estate line for funding of the Company's new corporate
office complex. These lines of credit provide for funding of up to $10 million
to finance treasury stock purchases through March 31, 2003 with scheduled
monthly repayments beginning after the initial advance and ending no later than
March 31, 2004 with interest at the 30 day LIBOR Rate plus two percent, adjusted
monthly. The real estate line of up to $20 million may be funded over the period
ending December 31, 2003 with interest at the 30 day LIBOR Rate plus 2.25%,
adjusted monthly, and will be repayable beginning after the advance period in
105 equal monthly principal payments plus interest with a balloon payment on
September 30, 2008.
As of September 30, 2002, the Company had accessed $3.3 million of the $10
million treasury stock purchase line, net of repayments of $667,000, and $5.1
million of the $20 million real estate line. The interest rates as of September
30, 2002 are 3.82% and 4.07% for the treasury stock loan and the real estate
loan, respectively. The $3.3 million used to purchase treasury stock is
scheduled to be paid off by July 30, 2003 and therefore has been classified as
short term. Monthly principal payments are $333,333. The Company is scheduled to
begin payments on the real estate line on December 31, 2003. As of September 30,
2002, interest capitalized pursuant to the real estate line was $42,000. A
schedule of outstanding balances and future maturities as of September 30, 2002
follows:
Real estate line of credit................. $ 5,100
Stock purchase line of credit.............. 3,333
--------------
Total notes payable........................ 8,433
Less: Current portion of notes payable..... (3,333)
--------------
Long term portion.......................... $ 5,100
--------------
Repayment Schedule commencing October 2002:
Year 1..................................... $ 3,333
Year 2..................................... 486
Year 3..................................... 583
Year 4..................................... 583
Year 5..................................... 583
Thereafter................................. 2,865
--------------
Total notes payable........................ $ 8,433
--------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Results of Operations
- ---------------------
First Nine Months of 2002 Compared to First Nine Months of 2001
---------------------------------------------------------------
The Company reported net income of $26.4 million, or $1.32 per diluted
common share, for the nine months ended September 30, 2002, up 36% from net
income of $19.4 million, or $.90 per diluted common share, for the comparable
period of the prior year. Diluted earnings per share increased 47 percent due to
increased net income of 36 percent and an approximate seven percent decrease in
the weighted average number of outstanding shares.
Membership fees totaled $229.1 million during 2002 compared to $193.8
million for 2001, an increase of 18%. Membership fees and their impact on total
revenues in any period are determined directly by the number of active
Memberships in force during any such period. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales increased
10% during the nine months ended September 30, 2002 to 604,417 from 548,967
during the comparable period of 2001. At September 30, 2002, there were
1,389,467 active Memberships in force compared to 1,216,889 at September 30,
2001, an increase of 14%. Additionally, the average annual fee per Membership
has increased from $251 for all Memberships in force at September 30, 2001 to
$256 for all Memberships in force at September 30, 2002, a 2% increase. This
increase is a result of a higher portion of active Memberships containing
additional benefits at an additional cost.
Associate services revenue increased 3% from $26.8 million for the first
nine months of 2001 to $27.5 million during the same period of 2002 primarily as
a result of increased associate recruiting offset by the reduced associate entry
fee during the months of March through September of 2002. The associate entry
fee ranged from $99 to $199 during these months compared to the typical
associate fee of $249. The associate entry fee has been reduced periodically in
the past and may continue to be reduced at certain times in future periods.
Although the reduction in price may lead to lower associate services revenues
overall, the reduced price typically increases the number of new associates that
join and to a great extent offsets the overall reduction in revenue. As a result
of this lower fee for part of the 2002 period, the Fast Start program generated
training fees of approximately $8.2 million during the first nine months of 2002
compared to $14.6 million for the comparable period of 2001. The
classroom-training program, titled Fast Start to Success ("Fast Start") is aimed
at increasing the level of new Membership sales per associate. Fast Start
typically requires a training fee of $184 per new associate, except for special
promotions the Company implements from time to time, and upon successful
completion of the program, which includes a specified number of Membership
sales, provides for the payment of certain training bonuses. The $8.2 million
and $14.6 million for the nine month periods ending September 30, 2002 and 2001,
respectively, in training fees was collected from approximately 120,896 new
sales associates who elected to participate in Fast Start during the first nine
months of 2002 compared to 79,584 that participated during the comparable period
of 2001. Total new associates enrolled during the first nine months of 2002 were
126,108 compared to 83,193 for the same period of 2001, an increase of 52%.
Other income increased 32%, to $3.6 million for the nine months ended
September 30, 2002 from $2.7 million for the comparable period of 2001 primarily
due to an increase in Membership enrollment fees of $800,000.
Primarily as a result of the increase in Membership fees, total revenues
increased to $260.1 million for the nine months ended September 30, 2002 from
$223.3 million during the comparable period of 2001, an increase of 16%.
Membership benefits totaled $76.9 million for the nine months ended
September 30, 2002 compared to $64.0 million for the comparable period of 2001,
and represented 34% and 33%, respectively of Membership fees for the 2002 and
2001 periods. This Membership benefit ratio (Membership benefits as a percentage
of Membership fees) should remain near current levels as substantially all
active Memberships provide for a capitated cost.
Commissions to associates increased 9% to $91.7 million for the nine months
ended September 30, 2002 compared to $84.0 million for the comparable period of
2001, and represented 40% and 43% of Membership fees for such periods. These
amounts were reduced by $635,000 and $1.8 million, respectively, representing
Membership lapse fees. Prior to March 1, 2002, these fees were determined by
applying the prime interest rate to the advance commission balance pertaining to
lapsed Memberships. The Company realizes and recognizes this fee only when the
amount of the calculated fee is collected by withholding from cash commissions
payments due the associate, because the Company's ability to recover fees in
excess of current payments is primarily dependent on the associate selling new
Memberships which qualify for advance commissions. The Company eliminated these
fees for Memberships sold after March 1, 2002 in conjunction with the change in
the commission structure as discussed in "Liquidity and Capital Resources".
Commissions to associates are primarily dependent on the number of new
memberships sold during a period. New memberships sold during the nine months
ended September 30, 2002 totaled 604,417, a 10% increase from the 548,967 sold
during the comparable period of 2001. Commissions to associates per new
membership sold were $152 per membership for the nine months ended September 30,
2002 compared to $153 for the comparable period of 2001. The average commission
per new membership sold varies depending on the compensation structure that is
in place at the time a new membership is sold and the amount of any charge-backs
(recoupment of previous commission advances) that are deducted from amounts that
would otherwise be paid to the various sales associates that are compensated for
the membership sale.
Associate services and direct marketing expenses increased to $22.5 million
for the nine months ended September 30, 2002 from $21.3 million for the
comparable period of 2001. Fast Start bonuses incurred were approximately $4.3
million during the first nine months of 2002 compared to $7.0 million in the
same period of 2001. Fast Start bonuses are typically eliminated or reduced
during those times the Company reduces the sales associate entry fee as it did
from March to September of 2002. These Fast Start training bonuses are also
affected by the number of new sales associates that successfully meet the
qualification criteria established by the Company, i.e. more training bonuses
will be paid when a higher number of new sales associates meet such criteria.
These expenses also include marketing costs, other than commissions, that are
directly associated with Membership sales.
General and administrative expenses during the nine months ended September
30, 2002 and 2001 were $23.9 million and $20.8 million, respectively, and
represented 10% and 11%, respectively, of Membership fees for each period.
Management expects general and administrative expenses as a percentage of
Membership fees to remain near current levels in the near term but to gradually
decrease as a percentage of Membership fees as a result of certain economies of
scale.
Other expenses, net, which include depreciation and amortization,
litigation accruals and premium taxes reduced by interest income, were
approximately $5.0 million and $3.7 million, respectively for the nine months
ended September 30, 2002 and September 30,2001. Depreciation and amortization
increased to $3.8 million for the first nine months of 2002 from $3.0 million
for the comparable period of 2001 but premium taxes decreased to $1.5 million
from $1.7 million for the nine months ended September 30, 2001 due to a change
in the tax structure of one of the states in which the Company pays premium
taxes. During the nine months ended September 30, 2002, the Company increased
its litigation accrual by $1.3 million compared to $250,000 for the comparable
period of 2001. The litigation accrual covers estimated potential damages from
pending litigation and was $3.3 million at September 30, 2002. Defense costs are
expensed as incurred and included in general and administrative expenses or
membership benefits. Interest income increased by approximately $300,000 for the
first nine months of 2002 to $1.7 million from $1.4 million for the 2001 period.
The Company has recorded a provision for income taxes of $13.9 million
(34.5% of pretax income) for the first nine months of 2002 compared to $9.7
million (32.8% of pretax income) for the same period of 2001. The lower
effective tax rate for the 2001 period was primarily attributable to the
utilization of net operating loss carryforwards and tax credits.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Loss from discontinued operations, net of income tax of $0, was $506,000 for the
nine months ended September 30, 2001. UFL was sold on December 31, 2001.
Third Quarter of 2002 compared to the Third Quarter of 2001
-----------------------------------------------------------
The results of operations in the third quarter of 2002, compared to the
third quarter of 2001, reflect increases in revenues and expenses primarily as a
result of the same factors discussed in the comparison of the first nine months
of 2002 to the first nine months of 2001.
Total revenues increased 18% or approximately $14.0 million to $90.2
million in the third quarter of 2002 compared to $76.2 million in the third
quarter of 2001, primarily as a result of increases in membership premiums. The
membership premium increase of 18% primarily resulted from an increase in the
number of average active memberships during the third quarter of 2002 compared
to the similar period in 2001.
Membership benefits totaled $26.6 million in the 2002-third quarter
compared to $22.1 million in the 2001-third quarter and resulted in a loss ratio
of 33% for both periods.
Associate services revenue increased 22% from $7.7 million for the third
quarter of 2001 to $9.4 million during the same period of 2002 primarily as a
result of more new associates enrolled during the third quarter of 2002 of
46,653 compared to 22,002 enrolled during the comparable period of 2001,
partially offset by a reduced associate entry fee of $99 and $149 during the
third quarter 2002 compared to the typical associate fee of $249 which was in
effect during the 2001 period. The associate entry fee has been reduced
periodically in the past and may continue to be reduced at certain times in
future periods. As a result of this lower fee for part of the 2002 quarter, the
Fast Start program generated training fees of approximately $2.1 million during
the third quarter of 2002 compared to $3.5 million for the comparable period of
2001. The classroom-training program, titled Fast Start to Success ("Fast
Start") is aimed at increasing the level of new Membership sales per associate.
Fast Start typically requires a training fee of $184 per new associate, except
for special promotions the Company implements from time to time, and upon
successful completion of the program provides for the payment of certain
training bonuses. The $2.1 million and $3.5 million for the third quarter 2002
and 2001, respectively, in training fees was collected from approximately 46,474
new sales associates who elected to participate in Fast Start during the
2002-third quarter compared to 21,221 that participated during the comparable
quarter of 2001. Total new associates enrolled during the third quarter of 2002
were 46,653 compared to 22,002 for the same period of 2001, an increase of 112%.
The number of new associates recruited in the third quarter of 2002 represents
the highest recruiting quarter in the Company's history.
Other income increased 12%, to $1.2 million for the three months ended
September 30, 2002 from $1.1 million for the comparable period of 2001 primarily
due to an increase in enrollment fees of $100,000.
Commissions to associates increased 8% to $31.1 million for the three
months ended September 30, 2002 compared to $28.9 million for the comparable
period of 2001, and represented 39% and 43% of Membership fees for such periods.
These amounts were reduced by $85,000 and $576,000, respectively, representing
Membership lapse fees. Commissions to associates per new membership sold were
$157 per membership for the three months ended September 30, 2002 compared to
$163 for the comparable period of 2001.
Associate services and direct marketing expenses increased to $7.7 million
for the three months ended September 30, 2002 from $5.3 million for the
comparable period of 2001. Fast Start bonuses incurred were approximately $1.7
million during the third quarter of 2002 compared to $1.3 million in the same
period of 2001. Fast Start bonuses are typically eliminated or reduced during
those times the Company reduces the sales associate entry fee as it did in the
2002-third quarter. These Fast Start training bonuses are also affected by the
number of new sales associates that successfully meet the qualification criteria
established by the Company, i.e. more training bonuses will be paid when a
higher number of new sales associates meet such criteria. These expenses also
include marketing costs, other than commissions, that are directly associated
with Membership sales.
General and administrative expenses during the three months ended September
30, 2002 and 2001 were $8.5 million and $7.0 million, respectively, and
represented 11% and 10% of Membership fees, respectively, for each period.
Management expects general and administrative expenses as a percentage of
Membership fees to remain near current levels in the near term but to gradually
decrease as a percentage of Membership fees as a result of certain economies of
scale.
Other expenses, net, which include depreciation and amortization,
litigation accruals and premium taxes reduced by interest income, were
approximately $2.5 million and $1.6 million for the three-month periods ended
September 30, 2002 and 2001, respectively. Depreciation and amortization
increased to $1.3 million for the three months ended September 30, 2002 from
$1.0 million for the comparable period of 2001 and premium taxes decreased from
$727,000 for the three months ended September 30, 2001 to $625,000 for the
comparable period of 2002. During the three months ended September 30, 2002, the
Company increased its litigation accrual by $1.3 million compared to $250,000
for the comparable period of 2001. Interest income increased for the three
months ended September 30, 2002 to $724,000 from $431,000 for the 2001
comparable period.
The above factors resulted in a 2002 third quarter net income of $9.0
million, or $.46 per share, diluted, compared to $7.0 million, or $.32 per
share, for the third quarter of 2001.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Loss from discontinued operations, net of income tax of $0, was $(562,000) for
the three months ended September 30, 2001.
Liquidity and Capital Resources
-------------------------------
General
Consolidated net cash provided by operating activities of continuing
operations was $39.0 million for the first nine months of 2002 compared to $25.8
million for the 2001 period. The increase of $13.2 million resulted primarily
from the increase in net income of $7.0 million and a net increase in the change
in accounts payable and accrued expenses of $5.9 million.
Consolidated net cash used in investing activities of continuing operations
was $9.4 million for the first nine months of 2002 compared to $7.8 million for
the comparable period of 2001. This $1.6 million increase in cash used in
investing activities resulted primarily from the increase in property and
equipment additions of $3.1 million and the $2.4 million increase in the
purchases of investments partially offset by the $3.9 million increase in
maturities and sales of investments.
Net cash used in financing activities of continuing operations during the
first nine months of 2002 was $30.9 million compared to $15.9 million for the
comparable period of 2001. This $15.0 million change was primarily comprised of
the $26.5 million increase in treasury stock purchases offset by a $2.9 million
increase in proceeds from the exercise of stock options and net debt proceeds of
$8.4 million during the 2002 period when compared to the comparable period of
2001.
Primarily due to the large amount of treasury stock purchases in the first
nine months of 2002 of approximately $42.4 million, the Company had a
consolidated working capital deficit of $4.6 million at September 30, 2002, a
decrease of $9.6 million compared to a consolidated working capital surplus of
$5.1 million at December 31, 2001. The $4.6 million working capital deficit at
September 30, 2002 would have been a $4.3 million working capital surplus
excluding the deferred revenue and fees in excess of deferred member and
associate service costs. These amounts will be eliminated by the passage of time
without the utilization of other current assets or the Company incurring other
current liabilities. Additionally, at the current rate of cash flow provided by
continuing operations ($39.0 million during the first nine months of 2002), the
Company's ability to control the timing of its discretionary treasury stock
purchases and the availability pursuant to its lines of credit, the Company does
not expect any difficulty in meeting its financial obligations in the short term
or the long term.
At September 30, 2002 the Company reported $32.1 million in cash and cash
equivalents and unpledged investments (after utilizing more than $42 million to
purchase approximately 2 million shares of its common stock during the nine
months ended September 30, 2002) compared to $33.7 million at December 31, 2001.
The Company's investments consist of common stocks, investment grade (rated Baa
or higher) preferred stocks and investment grade bonds primarily issued by
corporations, the United States Treasury, federal agencies, federally sponsored
agencies and enterprises as well as mortgage-backed securities and state and
municipal tax-exempt bonds.
The Company generally advances significant commissions at the time a
Membership is sold. During the nine months ended September 30, 2002, the Company
advanced commissions of $92.4 million on new Membership sales compared to $83.9
million for the same period of 2001. Since approximately 95% of Membership
premiums are collected on a monthly basis, a significant cash flow deficit is
created at the time a Membership is sold. This deficit is reduced as monthly
premiums are remitted and commissions payable on those Memberships are withheld
to recover the advance. Effective March 1, 2002, and in order to offer
additional incentives for increased Membership retention rates, the Company
returned to a differential commission structure with advance rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from zero to 25% per annum based
on the first year Membership retention rate of the associate's sales
organization. This current compensation structure replaces the prior
compensation structure utilized by the Company that included up to a 3-year
commission advance based on an average commission rate of approximately 27% for
all membership years.
The Company expenses advance commissions ratably over the first month of
the related membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates as of September 30, 2002
and for the nine months ended September 30, 2002 were:
(Amounts in 000's)
------------------
Beginning unearned advance commission payments (1)............................... $ 211,609
Advance commission payments, net................................................. 92,406
Earned commissions applied....................................................... (71,491)
Advance commission payment write-offs............................................ (1,708)
-----------
Ending unearned advance commission payments before
estimated unrecoverable payments (1)........................................... 230,816
Estimated unrecoverable advance commission payments (1).......................... (21,587)
Ending unearned advance commission payments, net (1)............................. -----------
$ 209,229
-----------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
The ending unearned advance commission payments, net, above includes net
unearned advance commission payments to non-vested associates of $24.4 million.
As such, at September 30, 2002 future commission payments and related expense
should be reduced as unearned advance commission payments of $185 million are
recovered. Commissions are earned by the associate as Membership premiums are
earned by the Company, usually on a monthly basis. For additional information
concerning these commission advances, see the Company's Annual Report on Form
10-K under the heading Commissions to Associates in Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations.
The Company believes that it has significant ability to finance expected
future growth in Membership sales based on its existing amount of cash and cash
equivalents and unpledged investments at September 30, 2002 of $32.1 million.
The Company expects to maintain cash and investment balances, including pledged
investments, on an on-going basis of approximately $25 to $35 million in order
to meet expected working capital needs and regulatory capital requirements. Cash
balances in excess of this amount would be used for discretionary purposes such
as treasury stock purchases.
In June 2002, the Company entered into line of credit agreements totaling
$30 million with commercial lenders providing for a treasury stock purchase line
and a real estate line for funding of the Company's new corporate office
complex. These arrangements provide for funding of up to $10 million to finance
treasury stock purchases over the period ending March 31, 2003 with scheduled
monthly repayments beginning after the initial advance and ending no later than
March 31, 2004 with interest at the 30 day LIBOR Rate plus two percent, adjusted
monthly. The real estate term loan portion of up to $20 million may be funded
over the period ending December 31, 2003, will be at the 30 day LIBOR Rate plus
2.25%, adjusted monthly, and will be repayable beginning after the advance
period based on a 10 year monthly amortization schedule with a balloon payment
on September 30, 2008. These agreements contain normal reporting covenants and
the loans will be secured by the Company's rights to receive membership fees on
a portion of its memberships and a mortgage on the new headquarters. As of
September 30, the Company had accessed $3.3 million of the $10 million treasury
stock purchase line, net of repayments of $667,000, and $5.1 million of the $20
million real estate line and expects to access additional amounts pursuant to
both lines in the future. A schedule of contractual obligations as of September
30, 2002 follows:
Year 1..................................... $ 3,333
Year 2..................................... 486
Year 3..................................... 583
Year 4..................................... 583
Year 5..................................... 583
Thereafter................................. 2,865
--------------
Total notes payable........................ $ 8,433
--------------
The Company is constructing a new corporate office complex with an
estimated completion during the third quarter of 2003 at an estimated cost of
approximately $30 million. Costs incurred through September 30, 2002 of
approximately $8.2 million have been paid from existing resources and the real
estate line of credit. The Company expects to incur additional indebtedness in
order to finance the remaining costs of its new corporate headquarters in order
to allow cash flow from operations to continue to be used to purchase treasury
stock. The Company has entered into construction contracts in the amount of
$28.2 million with the general contractor pertaining to the new office complex.
Total remaining costs of construction from October 1, 2002 are estimated at
approximately $21.8 million.
Actions that May Impact Retention in the Future
The potential impact on the Company's future profitability and cash flow
due to future changes in Membership retention can be significant. While blended
retention rates have not changed significantly over the past five years, the
Company has recently taken actions that may impact retention rates in the
future. Since December 31, 2001, the Company has implemented several new
initiatives aimed at improving the retention rate of both new and existing
Memberships. Such initiatives include a revised compensation structure,
effective March 1, 2002, featuring variable renewal commission rates ranging
from zero to 25% per annum based on the first year Membership retention rate of
the associate's sales organization; implementation of a "non-taken"
administrative fee to sales associates of $35 for any Membership application
that is processed by the Company after March 1, 2002, but for which a payment is
never received; and, an increase in the amount of the commission "charge-back"
for Memberships written after March 1, 2002 which are subsequently terminated
from 50% of the unearned Membership commission advance balance to 100% of the
unearned Membership commission advance balance. During August 2002, the Company
implemented an enhanced member "life cycle" electronic communication process
aimed at both increasing the overall amount of communication from the Company to
the members as well as more specific target messaging to members based on the
length of their Membership as well as utilization characteristics. Also in
August 2002, the Company implemented a new letter to the member from the
member's Provider law firm intended to provide direct contact information for
the Provider law firm and encourage the new member to have their will prepared
within the first 60 days of their membership and offering a free spousal will
should the new member comply. The Company believes that such efforts may
increase the utilization by members and therefore lead to higher retention
rates. Since several of these initiatives were only put in place during the 2002
third quarter, not enough time has elapsed to draw any meaningful conclusions or
to effectively measure the possible effect of these efforts.
Parent Company Funding and Dividends
Although the Company is the operating entity in many jurisdictions, the
Company's subsidiaries serve as operating companies in various states that
regulate Memberships as insurance or specialized legal expense products. The
most significant of these wholly owned subsidiaries are Pre-Paid Legal Casualty,
Inc. ("PPLCI") and Pre-Paid Legal Services, Inc. of Florida ("PPLSIF"). The
ability of PPLCI and PPLSIF to provide funds to the Company is subject to a
number of restrictions under various insurance laws in the jurisdictions in
which PPLCI and PPLSIF conduct business, including limitations on the amount of
dividends and management fees that may be paid and requirements to maintain
specified levels of capital and reserves. In addition PPLCI will be required to
maintain its stockholders' equity at levels sufficient to satisfy various state
or provincial regulatory requirements, the most restrictive of which is
currently $3 million. Additional capital requirements of PPLCI or PPLSIF will be
funded by the Company in the form of capital contributions or surplus
debentures. At September 30, 2002, PPLSIF did not have funds available for
payment of substantial dividends without the prior approval of the respective
insurance commissioner. PPLCI had approximately $6 million in surplus funds
available for payment of an ordinary dividend.
Forward-Looking Statements
All statements in this report concerning Pre-Paid Legal Services, Inc. (the
"Company") other than purely historical information, including but not limited
to, statements relating to the Company's future plans and objectives, expected
operating results, and the assumptions on which such forward-looking statements
are based, constitute "Forward-Looking Statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934 and are based on the Company's historical operating trends and financial
condition as of September 30, 2002 and other information currently available to
management. The Company cautions that the Forward-Looking Statements are subject
to all the risks and uncertainties incident to its business, including but not
limited to risks described below. Moreover, the Company may make acquisitions or
dispositions of assets or businesses, enter into new marketing arrangements or
enter into financing transactions. None of these can be predicted with certainty
and, accordingly, are not taken into consideration in any of the Forward-Looking
Statements made herein. For all of the foregoing reasons, actual results may
vary materially from the Forward-Looking Statements. The Company assumes no
obligation to update the Forward-Looking Statements to reflect events or
circumstances occurring after the date of the statement.
Risk Factors
There are a number of risk factors that could affect our financial
condition or results of operations, including the risks that the Company's
membership persistency or renewal rates may decline, that the Company may not be
able to continue to grow its memberships and earnings, that the Company is
dependent on the continued active participation of its principal executive
officer, that pending litigation may have a material adverse effect on the
Company if resolved unfavorably to the Company, that the Company could be
adversely affected by regulatory developments, that competition could adversely
affect the Company and that the Company is substantially dependent on its
marketing force. See Note 2 - Contingencies and Item 1 - Legal Proceedings.
Please refer to pages 33 and 34 of the Company's 2001 Annual Report on Form 10-K
for a complete description of these risk factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to the
Company's significant investment in fixed-maturity investments, interest rate
risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in fair values of those
instruments. Additionally, fair values of interest rate sensitive instruments
may be affected by the creditworthiness of the issuer, prepayment options,
relative values of alternative investments, liquidity of the instrument and
other general market conditions.
As of September 30, 2002, substantially all of the Company's investments
were in investment grade (rated Baa or higher) fixed-maturity investments,
interest-bearing money market accounts and a collateralized repurchase
agreement. The Company does not hold any investments classified as trading
account assets or derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on the Company's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly, with
no effect given to any steps that management might take to counteract that
change. The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table (dollars in 000's):
Estimated fair value
Hypothetical change after hypothetical
in interest rate change in interest
Fair Value (bp=basis points) rate
---------- ------------------- --------------------
Fixed-maturity investments at September 30, 2002 (1)........ $ 19,957 100 bp increase $ 17,751
200 bp increase 16,569
50 bp decrease 20,015
100 bp decrease 20,225
Fixed-maturity investments at December 31, 2001 (1)......... $ 18,983 100 bp increase $ 17,635
200 bp increase 16,437
50 bp decrease 19,575
100 bp decrease 20,167
- --------------------
(1) Excluding short-term investments with a fair value of $2.9 million and $3.3
million at September 30, 2002 and December 31, 2001, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at September 30, 2002 would reduce
the estimated fair value of the Company's fixed-maturity investments by
approximately $3.4 million at that date. At December 31, 2001, an
instantaneous 200 basis point increase in market interest rates would have
reduced the estimated fair value of the Company's fixed-maturity
investments by approximately $2.5 million at that date. The definitive
extent of the interest rate risk is not quantifiable or predictable due to
the variability of future interest rates, but the Company does not believe
such risk is material.
The Company primarily manages its exposure to interest rate risk by
purchasing investments that can be readily liquidated should the interest rate
environment begin to significantly change.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
(a) Evaluation of disclosure controls and procedures. The Company's
Principal Executive Officer and Principal Financial Officer have reviewed
and evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rule 240.13a-14(c)) as of a date
within ninety days before the filing date of this quarterly report. Based
on that evaluation, the Principal Executive Officer and the Principal
Financial Officer have concluded that the Company's current disclosure
controls and procedures are effective, providing them with material
information relating to the Company as required to be disclosed in the
reports the Company files or submits under the Exchange Act on a timely
basis.
(b) Changes in internal controls. There were no significant changes in
the Company's internal controls or in other factors that could
significantly affect those controls subsequent to the date of their
evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
------------------
See Note 2 of the Notes to Consolidated Financial Statements included in
Part I, Item 1 of this report for information with respect to legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
The 2002 Annual Meeting of Shareholders of the Company (the "Annual
Meeting") was held on May 31, 2002. The following matters were submitted to a
vote of the Company's shareholders at the Annual Meeting.
Election of Three Directors.
- ----------------------------
The results of the election for each of the Company's three directors whose
terms expired as of the Annual Meeting were as follows:
Abstentions and
Votes For Votes Withheld
---------- ---------------
Harland C. Stonecipher 17,363,671 825,929
Wilburn L. Smith 17,380,392 809,208
Martin H. Belsky 18,026,569 163,031
Although Wilburn L. Smith was re-elected for a three-year term, he resigned
from the Board effective August 1, 2002 together with three other inside Board
members that did not meet the new independent director definition expected to be
adopted in the future by the New York Stock Exchange. The Board of Directors of
the Company now consists of six members and is divided into three classes equal
in size, with the term of office of one class expiring each year. The new terms
of service of Messrs. Stonecipher and Belsky will expire in 2005. The terms of
the other four directors of the Company did not expire at the Annual Meeting.
The names of such other directors and the year of expiration of their respective
terms are as follows: John W. Hail - 2003; John A. Addison - 2003; Peter K.
Grunebaum - 2004 and Randy Harp - 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
---------------------------------
(a) Exhibits:
Exhibit No. Description
----------- -----------
99.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K: none
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: October 22, 2002 /s/ Harland C. Stonecipher
------------------------------------------
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: October 22, 2002 /s/ Randy Harp
------------------------------------------
Randy Harp
Chief Operating Officer
(Duly Authorized Officer)
Date: October 22, 2002 /s/ Steve Williamson
------------------------------------------
Steve Williamson
Chief Financial Officer
(Principal Accounting Officer)
CERTIFICATIONS
--------------
I, Harland C. Stonecipher, Chief Executive Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of Pre-Paid Legal
Services, Inc.;
(2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: October 22, 2002 /s/ Harland C. Stonecipher
------------------------------------------
Harland C. Stonecipher
Chairman and Chief Executive Officer
CERTIFICATIONS, continued
-------------------------
I, Steve Williamson, Chief Financial Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of Pre-Paid Legal
Services, Inc.;
(2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: October 22, 2002 /s/ Steve Williamson
-----------------------------------------
Steve Williamson
Chief Financial Officer
Exhibit 99.1
CERTIFICATION
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002 (the "Report")
fully complies with the requirements of Section 13(a) or 15(d), as applicable,
of the Securities Exchange Act of 1934 and that the information contained in the
Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
Date: October 22, 2002 /s/ Harland C. Stonecipher
----------------------------------------
Harland C. Stonecipher
Chairman and Chief Executive Officer
The foregoing certification is being furnished solely pursuant to
18 U.S.C.ss.1350.
Exhibit 99.2
CERTIFICATION
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002 (the "Report")
fully complies with the requirements of Section 13(a) or 15(d), as applicable,
of the Securities Exchange Act of 1934 and that the information contained in the
Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
Date: October 22, 2002 /s/ Steve Williamson
----------------------------------------
Steve Williamson
Chief Financial Officer
The foregoing certification is being furnished solely pursuant to
18 U.S.C.ss.1350.