UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2003
( )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
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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.)
One Pre-Paid Way
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
------------------- ----------------
Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K ( ).
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes |X| No [ ]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked prices of such common equity,
as of the last business day of the registrant's most recently completed second
fiscal quarter. As of June 30, 2003 -$291,000,000
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of February 29,
2004 there were 16,791,225 shares of Common Stock, par value $.01 per share,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 2004 annual
meeting of shareholders are incorporated into Part III of this Form 10-K by
reference.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the year ended December 31, 2003
TABLE OF CONTENTS
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Identity Theft Shield Provider
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
Availability of Information
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
Equity Compensation Plans
Issuer Purchases of Equity Securities
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview of the Company's Financial Model
Measures of Member retention
Results of Operations:
Comparison of 2003 to 2002
Comparison of 2002 to 2001
Liquidity and Capital Resources
Forward-Looking Statements
Risk Factors
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
PART III. (Information required by Part III is incorporated by reference
from the Company's definitive proxy statement for its 2004 annual
meeting of shareholders.)
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
SIGNATURES
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Pre-Paid Legal Services, Inc. (the "Company") was one of the first
companies in the United States organized solely to design, underwrite and market
legal expense plans. The Company's predecessor commenced business in 1972 and
began offering legal expense reimbursement services as a "motor service club"
under Oklahoma law. In 1976, the Company was formed and acquired its predecessor
in a stock exchange. The Company began offering Memberships independent of the
motor service club product by adding a legal consultation and advice service,
and in 1979 the Company implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. The Company's legal expense plans (referred to as
"Memberships") currently provide for a variety of legal services in a manner
similar to medical plans. In most states and provinces, standard plan benefits
include preventive legal services, motor vehicle legal defense services, trial
defense services, IRS audit services and a 25% discount off legal services not
specifically covered by the Membership for an average monthly Membership fee of
approximately $22. Additionally, in approximately 40 states, the Legal Shield
rider can be added to the standard plan for only $1 per month and provides
members with 24-hour access to a toll-free number for attorney assistance if the
member is arrested or detained. Also, during the third quarter of 2003, the
Company began offering its Identity Theft Shield ("IDT") to new and existing
members at $9.95 per month if added to a legal service Membership or it may be
purchased separately for $12.95 per month. The identity theft related benefits
include a credit report and related instructional guide, a credit score and
related instructional guide, credit report monitoring with daily online and
monthly offline notification of any changes in credit information, up to $25,000
in credit restoration expense reimbursement and comprehensive identity theft
restoration services.
Legal plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province and IDT plan
benefits are provided by Kroll Background America, Inc., a subsidiary of Kroll
Inc. ("Kroll"). Members have direct, toll-free access to Kroll or their provider
law firm rather than having to call for a referral. At December 31, 2003, the
Company had 1,418,997 Memberships in force with members in all 50 states, the
District of Columbia and the Canadian provinces of Ontario, British Columbia,
Alberta and Manitoba. Approximately 90% of such Memberships were in 29 states.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. According to the latest estimates
developed by the National Resource Center for Consumers of Legal Services
("NRC") for 2002, there were 164 million Americans without any type of legal
service plan. The NRC estimates that 122 million Americans were entitled to
service through at least one legal service plan in 2002 although more than half
are "free" plans that generally provide limited benefits on an automatic
enrollment without any direct cost to the individual. The 122 million Americans
compares to 4 million in 1981, 58 million in 1990 and 115 million in 2000. The
legal service plan industry continues to evolve and market acceptance of legal
service plans, as indicated by the continuing growth in the number of
individuals covered by plans, is increasing.
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association according to NRC estimates, and
accounted for approximately 56% of covered persons in 2002. The NRC estimates
that an additional 27% are covered by employee assistance plans that are also
automatic enrollment plans without direct cost to participants designed to
provide limited telephonic access to attorneys for members of employee groups.
Free plans and employee assistance plans therefore comprise approximately 83% of
covered persons in 2002. Employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit and the
Armed Forces are each estimated by the NRC to account for approximately 5% of
covered persons in 2002.
According to the NRC, the remaining covered persons in 2002 were covered by
individual enrollment plans, other employment based plans, including voluntary
payroll deduction plans, and miscellaneous plans. These plans were estimated by
the NRC to account for approximately 8% of the market in 2002 and represent the
market segment in which the Company primarily competes. According to the NRC,
these plans typically have more comprehensive benefits, higher utilization,
involve higher costs to participants, and are offered on an individual
enrollment or voluntary basis.
Of the current work force covered by legal service plans, only 7% were
estimated by the NRC to be covered by plans having full coverage. The Company
believes these plans include benefits comparable to those provided by the
Company's Memberships. Accordingly, the Company believes that significant
opportunities exist for successful marketing of the Company's Memberships to
employee groups and other individual consumers.
According to the latest estimates of the census bureaus of the United
States and Canada, currently the two geographic areas in which the Company
operates, the number of households in the combined area exceeds 127 million.
Since the Company has always disclosed its members in terms of Memberships and
individuals covered by the Membership include the individual who purchases the
Membership together with his or her spouse and never married children living at
home up to age 21 or up to age 23 if the children are full time college
students, the Company believes that its market share should be viewed as a
percentage of households. Historically, the Company's primary market focus has
been the "middle" eighty percent of such households rather than the upper and
lower ten percent segments based on the Company's belief that the upper ten
percent may already have a relationship with an attorney or law firm and the
lower ten percent may not be able to afford the cost of a legal service plan. As
a percentage of this defined "middle" market of approximately 100 million
households, the Company currently has an approximate 1.4% share of the estimated
market based on its existing 1.4 million active Memberships and, over the last
30 years, an additional 4% of households have previously purchased, but no
longer own, Memberships. The Company routinely remarkets to previous members and
reinstated approximately 66,000, 57,000 and 54,000 Memberships during 2003, 2002
and 2001, respectively.
Description of Memberships
The Memberships sold by the Company generally allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with the Company. Provider law firms are paid a monthly fixed fee on a
capitated basis to render services to plan members residing within the state or
province in which the provider law firm attorneys are licensed to practice.
Because the fixed fee payments by the Company to provider law firms do not vary
based on the type and amount of benefits utilized by the member, this capitated
arrangement provides significant advantages to the Company in managing claims
risk. At December 31, 2003, Memberships subject to the capitated provider law
firm arrangement comprised approximately 99% of the Company's active
Memberships. The remaining Memberships, approximately 1%, were primarily sold
prior to 1987 and allow members to locate their own lawyer ("open panel") to
provide legal services available under the Membership with the member's lawyer
being reimbursed for services rendered based on usual, reasonable and customary
fees, or are in states where there is no provider law firm in place and the
Company's referral attorney network is utilized.
Family Legal Plan
The Family Legal Plan currently marketed in most jurisdictions by the
Company consists of five basic benefit groups that provide coverage for a broad
range of preventive and litigation-related legal expenses. The Family Legal Plan
accounted for more than 93% of the Company's Membership fees in 2003 and
approximately 95% of the outstanding Memberships at December 31, 2003. In
addition to the Family Legal Plan, the Company markets other specialized legal
services products specifically related to employment in certain professions
described below.
In 12 states, certain of the Company's plans are available in the Spanish
language. For the Spanish language plans, the provider law firms have both
bilingual staff and lawyers and the Company has bilingual staff for both
customer service and marketing service functions. The Company will continue to
evaluate making its plans available in additional languages in markets where
demand for such a product is expected to be sufficient to justify this
additional cost.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, the
Company has not raised rates to existing members. If new benefits become
available, existing members may choose the newer, more comprehensive plan at a
higher rate or keep their existing Memberships. Memberships are automatically
renewed at the end of each Membership period unless the member cancels prior to
the renewal date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $26.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Automobile Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. There were approximately 598,000 subscribers of
this benefit at December 31, 2003 compared to 614,000 at December 31, 2002.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount. Provider law firms have agreed to provide to
members any legal services beyond those stipulated in the Membership at a fee
discounted 25% from the provider law firm's customary and usual hourly rate.
This "customary and usual hourly rate" is a fixed single hourly rate for each
provider firm that is generally an average of the firm's various hourly rates
for its attorneys which typically vary based on experience and expertise.
Legal Shield Benefit
In approximately 40 states, the Legal Shield plan can be added to the
standard or expanded Family Legal Plan for $1 per month and provides members
with 24-hour access to a toll-free number for provider law firm assistance if
the member is arrested or detained. The Legal Shield member, if detained, can
present their Legal Shield card to the officer that has detained them to make it
clear that they have access to legal representation and that they are requesting
to contact a lawyer immediately. The benefits of the Legal Shield plan are
subject to conditions imposed by the detaining authority, which may not allow
for the provider law firm to communicate with the member on an immediate basis.
There were approximately 881,000 Legal Shield subscribers at December 31, 2003
compared to approximately 613,000 at December 31, 2002.
Identity Theft Shield Benefit
During the third quarter of 2003, the Company and Kroll Background America
Inc., a subsidiary of Kroll Inc., announced a joint marketing agreement that
allows the Company's independent sales associates to market Kroll's identity
theft benefits. By adding the new Identity Theft Shield to their existing family
Membership, members have toll free access to the identity theft specialists at
Kroll. This benefit can be added to a legal service Membership for $9.95 per
month or purchased separately for $12.95 per month. The identity theft related
benefits include a credit report and related instructional guide, a credit score
and related instructional guide, credit report monitoring with daily online and
monthly offline notification of any changes in credit information, up to $25,000
in credit restoration expense reimbursement and comprehensive identity theft
restoration services. There were approximately 91,000 subscribers at December
31, 2003 comprised of 87,000 subscribers at $9.95 per month and 4,000
subscribers at $12.95 per month.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. The Company began operations in
Ontario and British Columbia during 1999, Alberta in February 2001 and Manitoba
in August 2001. Benefits of the Canadian plan include expanded preventive
benefits including assistance with Canadian Government agencies, warranty
assistance and small claims court assistance as well as the preferred member
discount. Canadian Membership fees collected during 2003 were approximately $4.2
million in U.S. dollars compared to $3.7 million collected in 2002 and $4.3
million collected in 2001. The Company plans to expand operations in other
provinces and territories of Canada.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, the Company also
offers other specialty or niche legal service plans. These specialty plans
usually contain many of the Family Legal Plan benefits adjusted as necessary to
meet specific industry or prospective member requirements. In addition to those
specialty plans described below, the Company will continue to evaluate and
develop other such plans as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $69 to $150 ($175 in Canada)
depending on the number of employees and provides business oriented legal
service benefits for any for-profit business with 99 or fewer employees. This
plan is available in 42 states and provinces and represented approximately 3.7%,
4.0% and 3.8% of the Company's Membership fees during 2003, 2002 and 2001,
respectively.
Law Officers Legal Plan
The Law Officers Legal Plan, developed in 1991 and marketed to law
enforcement officers, provides 24-hour job-related emergency toll-free access to
a provider law firm and provides legal services associated with administrative
hearings. This plan was designed to meet the legal needs of persons in the law
enforcement profession and is currently marketed at the monthly rate of $16.00
or at a group rate of $14.95. The Company has members covered under the Law
Officers Legal Plan in 27 states. The Law Officers Legal Plan offers the basic
family legal plan benefits described above without the motor vehicle related
benefits. These motor vehicle benefits are available in the Law Officers Legal
Plan only for defense of criminal charges resulting from the operation of a
licensed motor vehicle. Additionally, at no charge to the member, a 24-hour
emergency hotline is available to access the services of the provider law firm
in situations of job-related urgency. The Law Officers Legal Plan also offers
representation at no additional charge for up to ten hours (five hours per
occurrence) for two administrative hearings or inquiries per year and one
pre-termination hearing per Membership year before a review board or arbitrator.
Preparation and/or counsel for post-termination hearings are also available to
members as a schedule of benefits, which increases with each Membership year.
The schedule of benefits is similar to that offered under the Family Legal Plan
Trial Defense, including the availability of the optional pre-trial hours
described above for an additional $9.00 per month. During the years ended
December 31, 2003, 2002 and 2001, the Law Officers Legal Plan accounted for
approximately .9%, 1.4% and 1.5%, respectively, of the Company's Membership
fees.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage by a provider law firm for persons who
drive a commercial vehicle. This legal service plan is currently offered in 45
states. In certain states, the Commercial Driver Legal Plan is underwritten by
the Road America Motor Club, an unrelated motor service club. During the years
ended December 31, 2003, 2002 and 2001, this plan accounted for approximately
..9%, 1.3% and .9%, respectively, of Membership fees. The Plan underwritten by
the Road America Motor Club is available at the monthly rate of $35.95 or at a
group rate of $32.95. Plans underwritten by the Company are available at the
monthly rate of $32.95 or at a group rate of $29.95. Benefits include the motor
vehicle related benefits described above, defense of Department of
Transportation violations and the 25% discounted rate for services beyond plan
scope, such as defense of non-moving violations. The Road America Motor Club
underwritten plan includes bail and arrest bonds and services for family
vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 35 states and represented approximately 1.6%, 1.7% and 1.5% of the
Company's Membership fees during 2003, 2002 and 2001, respectively.
Comprehensive Group Legal Services Plan
The Company introduced in late 1999 the Comprehensive Group plan, designed
for the large group employee benefit market. This plan provides all the benefits
of the Family Legal Plan as well as mortgage document preparation, assistance
with uncontested legal situations such as adoptions, name changes, separations
and divorces. Additional benefits include the preparation of health care power
of attorney and living wills or directives to physicians. Although the Company
has experienced increased sales of this plan during the last three years (8,795
Memberships, 7,051 Memberships and 3,462 Memberships during 2003, 2002 and 2001,
respectively) and believes this plan improves its competitive position in the
large group market, the Company continues to emphasize group marketing to
employee groups of less than 50 rather than larger groups where there is more
competition, price negotiation and typically a longer sales cycle.
Other than additional benefits such as the Legal Shield benefit described
above, the basic structure and design of the Membership benefits has not
significantly changed over the last several years. The consistency in plan
design and delivery provides the Company consistent, accurate data about plan
utilization which enables the Company to manage its benefit costs through the
capitated payment structure to provider firms.
Provider Law Firms
The Company's Memberships generally allow members to access legal services
through a network of independent provider law firms under contract with the
Company generally referred to as "provider law firms." Provider law firms are
paid a fixed fee on a per capita basis to render services to plan members
residing within the state or province as provided by the contract. Because the
fixed fee payments by the Company to provider law firms in connection with the
Memberships do not vary based on the type and amount of benefits utilized by the
member, this arrangement provides significant advantages to the Company in
managing its cost of benefits. Pursuant to these provider law firm arrangements
and due to the volume of revenue directed to these firms, the Company has the
ability to more effectively monitor the customer service aspects of the legal
services provided and the financial leverage to help ensure a customer friendly
emphasis by the provider law firms. Generally, due to the volume of revenue that
may be directed to particular provider law firms, the Company has access to
larger, more diversified law firms. The Company, through its members, is
typically the largest client base of its provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, investigation by the Company of bar association standing and client
references, evaluation of the education, experience and areas of practice of
lawyers within the firm, on-site evaluations by Company management, and
interviews with lawyers in the firm who would be responsible for providing
services. Most importantly, these candidate law firms are evaluated on the
firm's customer service philosophy.
The majority of provider law firms are connected to the Company via
high-speed digital links to the Company's management information systems,
thereby providing real-time monitoring capability. This online connection offers
the provider law firm access to specially designed software developed by the
Company for administration of legal services by the firm. These systems provide
statistical reports of each law firm's activity and performance and allow
approximately 97% of members served by provider law firms to be monitored on a
near real-time basis. The few provider law firms that are not online with the
Company typically have a small Membership base and must provide various weekly
reports to the Company to assist in monitoring the firm's service level. The
combination of the online statistical reporting and weekly service reports for
smaller provider law firms allows quality control monitoring of over 15 separate
service delivery benchmarks. In addition, the Company regularly conducts
extensive random surveys of members who have used the legal services of a
provider law firm. The Company surveys members in each state every 60 days,
compiles the results of such surveys and provides the provider law firms with
copies of each survey and the overall summary of the results. If a member
indicates on a survey the service did not meet their expectation, the member is
contacted as soon as possible to resolve the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to the Company's online monitoring, member complaints, member
survey evaluations, telephone reports and other information developed in
connection with member service monitoring. If a problem is detected, immediate
remedial actions are recommended by the Company to the provider law firms to
eliminate service deficiencies. In the event the deficiencies of a provider law
firm are not eliminated through discussions and additional training with the
Company, such deficiencies may result in the termination of the provider law
firm. The Company is in constant communication with its provider law firms and
meets with them frequently for additional training, to encourage increased
communications with the Company and to share suggestions relating to the timely
and effective delivery of services to the Company's members.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless the Company waives this
requirement due to special circumstances such as instances when the lawyer
demonstrates significant legal experience acquired in an academic, judicial or
similar capacity other than as a lawyer. The Company provides customer service
training to the provider law firms and their support staff through on-site
training that allows the Company to observe the individual lawyers of provider
law firms as they directly assist the members.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit the
Company to terminate the Agreement for cause immediately upon written notice,
(c) require the firm to maintain a minimum amount of malpractice insurance on
each of its attorneys, in an amount not less than $100,000, (d) preclude the
Company from interference with the lawyer-client relationship, (e) provide for
periodic review of services provided, (f) provide for protection of the
Company's proprietary information and (g) require the firm to indemnify the
Company against liabilities resulting from legal services rendered by the firm.
The Company is precluded from contracting with other law firms to provide the
same service in the same geographic area, except in situations where the
designated law firm has a conflict of interest, the Company enrolls a group of
500 or more members, or when the agreement is terminated by either party.
Provider law firms are precluded from contracting with other prepaid legal
service companies without Company approval. Provider law firms receive a fixed
monthly payment for each member who are residents in the service area and are
responsible for providing the Membership benefits without additional
remuneration. If a provider law firm delivers legal services to an open panel
member, the law firm is reimbursed for services rendered according to the open
panel Membership. As of December 31, 2003, provider law firms averaged
approximately 59 employees each and on average are evenly split between support
staff and lawyers.
The Company has had occasional disputes with provider law firms, some of
which have resulted in litigation. The toll-free telephone lines utilized and
paid for by the provider law firms are owned by the Company so that in the event
of a termination, the members' calls can be rerouted very quickly. Nonetheless,
the Company believes that its relations with provider law firms are generally
very good. At the end of 2003, the Company had provider law firms representing
46 states and four provinces compared to 45 states and three provinces at the
end of 2002 and 2001. During the last three calendar years, the Company's
relationships with a total of four provider law firms were terminated by the
Company or the provider law firm. As of December 31, 2003, 26 provider law firms
have been under contract with the Company for more than eight years with the
average tenure of all provider law firms being approximately 7 1/2 years.
The Company has an extensive database of referral lawyers who have provided
services to its members for use by members when a designated provider law firm
is not available. Lawyers with whom members have experienced verified service
problems, or are otherwise inappropriate for the referral system, are removed
from the Company's list of referral lawyers.
Identity Theft Shield Benefits Provider
Kroll is one of the world's leading independent risk consulting companies.
Kroll provides a broad range of investigative, intelligence, financial,
security, and technology services to help clients reduce risks, solve problems,
and capitalize on opportunities. Headquartered in New York with more than 60
offices on six continents, Kroll has a multidisciplinary corps of more than
2,200 employees and serves a global clientele of law firms, financial
institutions, corporations, nonprofit institutions, government agencies, and
individuals. Over the last three years, Kroll has developed a unique solution
for victims of identity theft. This new service is now available to Pre-Paid
Legal members through the Identity Theft Shield benefit. Similar to the provider
law firms, Kroll is paid a fixed fee on a monthly per capita basis to render
services to IDT members
Marketing
Multi-Level Marketing
The Company markets Memberships through a multi-level marketing program
that encourages individuals to sell Memberships and allows individuals to
recruit and develop their own sales organizations. Commissions are paid only
when a Membership is sold or an associate subscribes to the Company's eService
package (described below). No commissions are paid based solely on recruitment.
When a Membership is sold, commissions are paid to the associate making the
sale, and to other associates (on average, 13 others at December 31, 2003
compared to 17 others at December 31, 2002) who are in the line of associates
who directly or indirectly recruited the selling associate. The Company provides
training materials, organizes area-training meetings and designates personnel at
the home office specially trained to answer questions and inquiries from
associates. The Company offers various communication avenues to its sales
associates to keep such associates informed of any changes in the marketing of
its Memberships. The primary communication vehicles utilized by the Company to
keep its sales associates informed include extensive use of e-mail, an
interactive voice-mail service, The Connection monthly magazine, the weekly
Communication Show that may be heard via the Company's Internet webcasts, an
interactive voice response system, a monthly DVD (digital video disc) program
and the Company's website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. The Company's marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 75% of
the Company's Memberships in force at December 31, 2003 compared to 73% at
December 31, 2002 and 2001. Although other means of payment are available,
approximately 73% of fees on Memberships purchased by individuals or families
are paid on a monthly basis by means of automatic bank draft or credit card.
The Company's marketing efforts towards employee groups, principally on a
payroll deduction payment basis, are designed to permit its sales associates to
reach more potential members with each sales presentation and strive to
capitalize on, among other things, what the Company perceives to be a growing
interest among employers in the value of providing legal service plans to their
employees. Memberships sold through employee groups constituted approximately
25% of total Memberships in force at December 31, 2003 compared to 27% at
December 31, 2002 and 2001. Adverse publicity about the Company is responsible,
to some extent, for the decline in group memberships on a percentage basis. The
majority of employee group Memberships are sold to school systems, governmental
entities and businesses. The Company emphasizes group marketing to employee
groups of less than 50 rather than larger groups where there is more
competition, price negotiation and typically a longer sales cycle. No group
accounted for more than 1% of the Company's consolidated revenues from
Memberships during 2003, 2002 or 2001. Substantially all group Memberships are
paid on a monthly basis. The Company is active in legislative lobbying efforts
to enhance the ability of the Company to market to public employee groups and to
encourage Congress to reenact legislation to permit legal service plans to
qualify for pre-tax payments under tax qualified employee cafeteria plans.
Sales associates are generally engaged as independent contractors and are
provided with training materials and are given the opportunity to participate in
Company training programs. Sales associates are required to complete a specified
training program prior to marketing the Company's Memberships to employee
groups. All advertising and solicitation materials used by sales associates must
be approved by the Company prior to use. At December 31, 2003, the Company had
329,600 "vested" sales associates compared to 341,116 and 286,488 "vested" sales
associates at December 31, 2002 and 2001, respectively. A sales associate is
considered to be "vested" if he or she has personally sold at least three new
Memberships per quarter or if he or she retains a personal Membership. A vested
associate is entitled to continue to receive commissions on prior sales after
all previous commission advances have been recovered. However, a substantial
number of vested associates do not continue to market the Membership, as they
are not required to do so in order to continue to be vested. During 2003, the
Company had 84,207 sales associates who personally sold at least one Membership,
of which 45,920 (55%) made first time sales. During 2002 and 2001 the Company
had 103,112 and 81,613 sales associates producing at least one Membership sale,
respectively, of which 65,383 (63%) and 46,687 (57%), respectively, made first
time sales. During 2003, the Company had 10,685 sales associates who personally
sold more than ten Memberships compared to 12,738 and 13,749 in 2002 and 2001,
respectively. A substantial number of the Company's sales associates market the
Company's Memberships on a part-time basis only. The decline in total vested
sales associates, those making at least one membership sale in 2003, those
making first time sales in 2003 and those that sold more than ten Memberships
during 2003 are all attributable to the decline in new sales associates added
during 2003. For the year 2003, new sales associates enrolled decreased 30% to
108,557 from the 155,663 enrolled in 2002.
The Company derives revenues from its multi-level marketing sales force,
principally from a one-time enrollment fee of $65 from each new sales associate
for which the Company provides initial marketing supplies and enrollment
services to the associate. In January 1997, the Company implemented a new
combination classroom and field training program, titled Fast Start to Success
("Fast Start"), aimed at increasing the level of new Membership sales per
associate. During most of 2003, the Fast Start program provided a direct
economic incentive to existing associates to help train new recruits in the form
of a qualification, or training, bonus. Associates successfully completed the
program by writing three new Memberships and recruiting a new sales associate or
by personally selling five new Memberships within 60 days of the associate's
start date. Associates in states that require the associate to become licensed
had 60 days from the issue date on their license to complete the same
requirements. Beginning January 1, 2004, new Fast Start associates must qualify
within the first 45 days of their start date. The program typically requires a
fee ranging from $34 to $184 per new associate, depending on special promotions
the Company implements from time to time, that is earned by the Company upon
completion of the training program. Amounts collected from sales associates are
intended primarily to offset the Company's costs incurred in recruiting and
training and providing materials to sales associates and are not intended to
generate profits from such activities. Other revenues from sales associates
represent the sale of marketing supplies and promotional materials and includes
fees related to the Company's eService program for associates. The eService
program provides subscribers Internet based back office support such as reports,
on-line documents, tools, a personal e-mail account and multiple personalized
web sites with "flash" movie presentations.
The Company's compensation plan for the multi-level marketing force is
under continuous review by the Company to assure that the various financial
incentives in the plan encourage the Company's desired goals. The Company offers
various incentive programs from time to time and frequently adjusts the program
to maintain appropriate incentives and to improve Membership production and
retention.
The Company holds its International Convention once a year, typically in
the spring, and a Leadership Summit, typically in the fall, and routinely hosts
more than 10,000 of its sales associates at these events. These events are
intended to provide additional training, corporate updates, new announcements,
motivation and associate recognition. Additionally, the Company offers the
Player's Club incentive program providing additional incentives to its
associates as a reward for consistent, quality business. Associates can earn the
right to attend an annual incentive trip by meeting monthly qualification
requirements for the entire calendar year and maintaining certain personal
retention rates for the Memberships sold during the calendar year. Associates
can also earn the right to receive additional monthly bonuses by meeting the
monthly qualification requirements for twelve consecutive months and maintaining
certain personal retention rates for the Memberships sold during that twelve
month period.
Regional Vice Presidents
The Company has a group of employees that serve as Regional Vice Presidents
("RVPs") responsible for associate activity in a given geographic region and
with the ability to appoint independent contractors as Area Coordinators within
the RVP's region. The RVPs have weekly reporting requirements as well as
quarterly sales and recruiting goals. The RVP and Area Coordinator program
provides a basis to effectively monitor current sales activity, further educate
and motivate the sales force and otherwise enhance the relationships between the
associates and the Company. New products and initiatives will continue to be
channeled through the RVPs and Area Coordinators. At December 31, 2003, the
Company had 80 RVPs in place.
Pre-Paid Legal Benefits Association
The PPL Benefits Association (PPLBA) was founded in 1999 with the intent of
providing sales associates the opportunity to have access, at their own expense,
to health insurance and life insurance benefits. Membership in the Association
allows a sales associate to become eligible to enroll in numerous benefit
programs, as well as take advantage of attractive affinity agreements.
Membership in this association is open to sales associates that reach a certain
level within the Company's marketing programs who also maintain an active
personal legal services Membership. The PPLBA is a separate association not
owned or controlled by the Company and is governed by a 9 member Board of
Directors, including four officer positions. None of the officers or directors
of the PPLBA serve in any such capacity with the Company. The PPLBA employs a
Director of Associate Benefits paid by the Association. Affinity programs
available to members of the PPLBA include credit cards, long-distance, wireless
services, safety trip plan, mortgage and real estate assistance and a travel
club. As determined by its Board of Directors, some of the revenue generated by
the PPLBA through commissions from vendors of the benefits and affinity programs
or contributed to the Association by the Company may be used to make open-market
purchases of the Company's stock for use in stock bonus awards to Association
members based on criteria established from time to time by the Board of
Directors of the PPLBA. Since inception and through December 31, 2003,
approximately 31,000 shares were purchased by the PPLBA for awards to its
members. In 2002, the PPLBA offered cash in lieu of stock awards and
approximately 21,000 shares purchased by the Association were sold to the
Company on January 2, 2003 at the stock's closing price to fund the awards. For
the 2003 stock bonus award program the PPLBA awarded approximately 10,000 shares
of stock to Association members.
Cooperative Marketing
The Company has in the past, and may in the future, develop marketing
strategies pursuant to which the Company seeks arrangements with insurance and
service companies that have established sales forces. Under such arrangements,
the agents or sales force of the cooperative marketing partner market the
Company's Memberships along with the products already marketed by the partner's
agents or sales force. Such arrangements allow the cooperative marketing partner
to enhance its existing customer relationships and distribution channels by
adding the Company's product to the marketing partner's existing range of
products and services, while the Company is able to gain broader Membership
distribution and access to established customer bases.
The Company has a cooperative marketing agreement with Atlanta-based
Primerica Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one
of the largest financial services marketing organizations in North America with
more than 100,000 personal financial analysts across the U.S. and Canada. The
PFS cooperative marketing agreement resulted in approximately 15,000 Memberships
during each of 2003 and 2002.
The Company has had limited success with cooperative marketing arrangements
in the past and is unable to predict with certainty what success it will
achieve, if any, under its existing or future cooperative marketing
arrangements.
Operations
The Company's corporate operations involve Membership application
processing, member-related customer service, various associate-related services
including commission payments, receipt of Membership fees, related general
ledger accounting, and managing and monitoring the provider law firm
relationships.
The Company utilizes a management information system to control operations
costs and monitor benefit utilization. Among other functions, the system
evaluates benefit claims, monitors member use of benefits and monitors
marketing/sales data and financial reporting records. Dominant company concerns
in the architecture of private networks and web systems include security,
scalability, capacity to accommodate peak traffic and business continuity in the
event of a disaster. The Company believes its management information system has
substantial capacity to accommodate increases in business data before
substantial upgrades will be required. The Company believes this excess capacity
will enable it to experience a significant increase in the number of members
serviced with less than a commensurate increase of administrative costs.
The Company has built a strong Internet presence to strengthen the services
provided to both members and associates. The Company's Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
The Company's operations also include departments specifically responsible
for marketing support and regulatory and licensing compliance. The Company has
an internal production staff that is responsible for the development of new
audio and video sales materials.
Quality Control
In addition to the Company's quality control efforts for provider law firms
described above, the Company also closely monitors the performance of its home
office personnel, especially those who have telephone contact with members or
sales associates. The Company records home office employee telephone calls with
its members and sales associates to assure that Company policies are being
followed and to gather data about recurring problems that may be avoided through
modifications in policies. The Company also uses such recorded calls for
training and recognition purposes.
Competition
The Company competes in a variety of market segments in the prepaid legal
services industry, including, among others, individual enrollment plans,
employee benefit plans and certain specialty segments. According to the latest
(2002) estimates by NRC, an estimated 35% of the total estimated market in the
segments in which the Company competes is served by a large number of small
companies with regional areas of emphasis or union-based automatic enrollment
plans. The remaining 65% of such market are served primarily by the Company and
five other principal competitors: Hyatt Legal Plans (a MetLife company), ARAG
Group (formerly Midwest Legal Services), LawPhone/ACS, National Legal Plan and
Legal Services Plan of America (a GE Financial Assurance Partnership Marketing
Group company, formerly the Signature Group). For employment-based plans other
than employer paid, union-based automatic enrollment plans and employee
assistance plans and for individual enrollment plans, the Company represents
approximately 51% of the market share garnered by this group according to the
NRC.
If a greater number of companies seek to enter the prepaid legal services
market, the Company will experience increased competition in the marketing of
its Memberships. However, the Company believes its competitive position is
enhanced by its actuarial database, its existing network of provider attorney
law firms and its ability to tailor products to suit various types of
distribution channels or target markets. The Company believes that no other
competitor has the ability to monitor the customer service aspect of the
delivery of legal services to the same extent the Company does. Serious
competition is most likely from companies with significant financial resources
and advanced marketing techniques.
Regulation
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, Secretaries of State, State Bar Associations and
State Attorney General offices depending on individual state opinions of
regulatory responsibility for legal expense plans. The Company is also required
to file with similar government agencies in Canada. While some states or
provinces regulate legal expense plans as insurance or specialized legal expense
products, others regulate them as services.
As of December 31, 2003, the Company or one of its subsidiaries was
marketing new Memberships in 38 states or provinces that require no special
licensing. The Company's subsidiaries serve as operating companies in 16 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"). Of the Company's total Memberships in force as of December 31, 2003,
38% were written in jurisdictions that subject the Company or one of its
subsidiaries to insurance or specialized legal expense plan regulation.
The Company began selling Memberships in the Canadian provinces of Ontario
and British Columbia during 1999, Alberta during February 2001 and Manitoba
during August 2001. The Memberships currently marketed by the Company in such
provinces do not constitute an insurance product and therefore are exempt from
insurance regulation.
In states with no special licensing or regulatory requirements, the Company
commences operations only when advised by the appropriate regulatory authority
that proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
the Company or one of its subsidiaries would be required to qualify as an
insurance company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate the Company's forms, rates, trade practices, allowable
investments and licensing of agents and sales associates. These agencies also
prescribe various reports, require regular evaluations by regulatory
authorities, and set forth-minimum capital and reserve requirements. The
Company's insurance subsidiaries are routinely evaluated and examined by
representatives from the various regulatory authorities in the normal course of
business. Such examinations have not and are not expected to adversely impact
the Company's operations or financial condition in any material way. The Company
believes that all of its subsidiaries meet any required capital and reserve
requirements. Dividends paid by PPLCI are restricted under Oklahoma law to
available surplus funds derived from realized net profits.
The Company is required to register and file reports with the Oklahoma
Insurance Commissioner as a member of a holding company system under the
Oklahoma Insurance Holding Company System Regulatory Act. Transactions between
PPLCI and the Company or any other subsidiary must be at arms-length with
consideration for the adequacy of PPLCI's surplus, and must have prior approval
of the Oklahoma Insurance Commissioner. Payment of any extraordinary dividend by
PPLCI to the Company requires approval of the Oklahoma Insurance Commissioner.
During 2001, PPLCI declared a $5 million dividend payable to the Company which
was paid in 2002. During 2002, PPLCI declared a $6 million dividend which was
paid in December of 2002. While PPLCI had approximately $3.5 million in surplus
funds available for payment of an ordinary dividend in December 2002, no such
dividend was declared or paid during 2003. At December 31, 2003 PPLCI had
approximately $750,000 available for payment of an ordinary dividend. Any change
in control of the Company, defined as acquisition by any method of more than 10%
of the Company's outstanding voting stock, including rights to acquire such
stock by conversion of preferred stock, exercise of warrants or otherwise,
requires approval of the Oklahoma Insurance Commissioner. Holding company laws
in some states in which PPLCI operates provide for comparable registration and
regulation of the Company.
Certain states have enacted special licensing or regulatory requirements
designed to apply only to companies offering legal service products. These
states most often follow regulations similar to those regulating casualty
insurance providers. Thus, the operating company may be expected to comply with
specific minimum capitalization and unimpaired surplus requirements; seek
approval of forms, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to the
Company by such subsidiaries. PPLSIF is subject to restrictions of this type
under the laws of the State of Florida, including restrictions with respect to
payment of dividends to the Company. At December 31, 2003, PPLSIF did not have
funds available for payment of substantial dividends without the prior approval
of the insurance commissioner.
As the legal plan industry matures, additional legislation may be enacted
that would affect the Company and its subsidiaries. The Company cannot predict
with any accuracy if such legislation would be adopted or its ultimate effect on
operations, but expects to continue to work closely with regulatory authorities
to minimize any undesirable impact.
The Company's operations are further impacted by the American Bar
Association Model Rules of Professional Conduct ("Model Rules") and the American
Bar Association Code of Professional Responsibility ("ABA Code") as adopted by
various states. Arrangements for payments to a lawyer by an entity providing
legal services to its members are permissible under both the Model Rules and the
ABA Code, so long as the arrangement prohibits the entity from regulating or
influencing the lawyer's professional judgment. The ABA Code prohibits lawyer
participation in closed panel legal service programs in certain circumstances.
The Company's agreements with provider law firms comply with both the Model
Rules and the ABA Code. The Company relies on the lawyers serving as the
designated provider law firms for the closed panel benefits to determine whether
their participation would violate any ethical guidelines applicable to them. The
Company and its subsidiaries comply with filing requirements of state bar
associations or other applicable regulatory authorities.
The Company also is required to comply with state, provincial and federal
laws governing the Company's multi-level marketing approach. These laws
generally relate to unfair or deceptive trade practices, lotteries, business
opportunities and securities. The Company has experienced no material problems
with marketing compliance. In jurisdictions that require associates to be
licensed, the Company receives all applications for licenses from the associates
and forwards them to the appropriate regulatory authority. The Company maintains
records of all associates licensed, including effective and expiration dates of
licenses and all states in which an associate is licensed. The Company does not
accept new Membership sale applications from any unlicensed associate in such
jurisdictions.
Employees
At December 31, 2003, the Company and its subsidiaries employed 742
individuals on a full-time basis, exclusive of independent agents and sales
associates who are not employees. None of the Company's employees are
represented by a union. Management considers its employee relations to be good.
Foreign Operations
The Company began operations in the Canadian provinces of Ontario and
British Columbia during 1999, Alberta in February 2001 and Manitoba in August
2001 and derived aggregate revenues, including Membership fees and revenues from
associate services, from Canada of $4.5 million in U.S. dollars during 2003
compared to $4.0 million and $4.4 million in 2002 and 2001, respectively. Due to
the relative stability of the United States and Canadian foreign relations and
currency exchange rates, the Company believes that any risk of foreign
operations or currency valuations is minimal and would not have a material
effect on the Company's financial condition, liquidity or results of operations.
Availability of Information
The Company files periodic reports and proxy statements with the Securities
and Exchange Commission. The public may read and copy any materials the Company
files with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company
files its reports with the SEC electronically. The SEC maintains an Internet
site that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC. The address
of this site is http://www.sec.gov.
The Company's Internet address is www.prepaidlegal.com. The Company makes
available on its website free of charge copies of its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) of the Exchange
Act as soon as reasonably possible after the Company electronically files such
material with, or furnishes it to, the SEC.
ITEM 2. DESCRIPTION OF PROPERTY
The executive and administrative offices of the Company and its
subsidiaries are located at One Pre-Paid Way, Ada, Oklahoma. The newly completed
office complex, containing approximately 170,000 square feet of office space, is
owned by the Company and constructed on approximately 87 acres contributed to
the Company by the City of Ada in 2001 as part of an economic development
incentive package. Costs incurred through December 31, 2003 of approximately
$30.7 million, including $706,000 in capitalized interest costs, have been paid
from existing resources and proceeds from a $20 million line of credit for the
new office construction. The Company has entered into construction contracts in
the amount of $28.9 million with the general contractor pertaining to the new
office complex. Total remaining costs of completion pursuant to these contracts
from January 1, 2004 are estimated at approximately $3.1 million.
Continued growth over the past 11 years required the Company to lease and
purchase several ancillary sites to accommodate its expanding workforce. In
December over 600 employees departed their various worksites and moved to the
newly constructed headquarters. The new headquarters contains two long bars of
open office area designed to serve as podiums, which stretch east from the
northern and southern edges of the tower. Two and three stories high
respectively, the podiums house the call centers and Information Technology
departments. Only 60 feet across, they are designed to ensure that employees are
never more that thirty feet from a source of daylight. Shared corporate services
- -- including a 650-seat auditorium, dining hall, exercise facility, and a
connecting corridor containing a company history gallery -- are located at the
east end of the bars, creating a central courtyard. The courtyard features a
reflecting pool and a 12-foot bronze sculpture of the Company's logo, the Lady
of Justice, a universal symbol of justice. The building's main entrance welcomes
its frequent visitors, celebrates the history of the Company, and is designed to
convey the tradition of civic judicial buildings. The building is designed to
expand over time without negatively impacting the site layout or the building
concept and the Company emphasized the use of modular furnishings to provide
enhanced flexibility. The Company placed importance on the goal of providing
each employee with an excellent work environment.
Additionally, the Company fully utilizes another distribution facility
located about two miles from its new offices and containing approximately 17,000
square feet of office and warehouse and shipping space. The Company's previous
headquarters of approximately 40,000 square feet and two other buildings
containing approximately 18,600 combined square feet located adjacent to the
distribution facility are now used as disaster recovery, or business continuity,
sites.
In addition to the property described above that is owned by the Company,
the Company opened an additional Customer Care facility in Antlers, Oklahoma
during March 2000, in building space provided by the City of Antlers at no cost
to the Company. In conjunction with a rural economic development program
coordinated by the City of Antlers, a new facility was built at no cost to the
Company that can accommodate approximately 100 customer service representatives.
The Company leased the facilities from the City of Antlers upon completion of
the construction in November 2002.
ITEM 3. LEGAL PROCEEDINGS
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. In August 2002 the lead institutional plaintiff withdrew from
the case, leaving two individual plaintiffs as lead plaintiffs on behalf of the
putative class. As of December 31, 2003, the briefing in the appeal had been
completed. On January 14, 2004 oral argument was held in the appeal. The Company
is unable to predict when a decision will be made on this appeal, and the
ultimate outcome of the case is not determinable.
Beginning in the second quarter of 2001 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 actual and punitive damages for alleged breach of contract,
fraud and various other claims in connection with the sale of Memberships.
During 2003, there were at one time as many as 30 separate lawsuits involving
approximately 285 plaintiffs in Alabama. As of December 31, 2003, as a result of
dismissals or settlements for nominal amounts, the Company was aware of
approximately 25 separate lawsuits involving approximately 98 plaintiffs that
have been filed in multiple counties in Alabama. As of February 27, 2004, there
were approximately 80 named plaintiffs in approximately 25 cases pending in
Alabama. In February 2004, the claims of several additional plaintiffs in one of
the cases were dismissed on summary judgment in the Company's favor. As of
December 31, 2003, the Company was aware of 18 separate lawsuits involving
approximately 432 plaintiffs in multiple counties in Mississippi. Certain of the
Mississippi lawsuits also name the Company's provider attorney in Mississippi as
a defendant. Proceedings in several of the eleven cases which name the Company's
provider attorney as a defendant have been stayed pending the Mississippi
Supreme Court's ruling on the Pre-Paid defendants' appeal of a trial court's
granting of a partial summary judgment that the action is not required to be
submitted to arbitration. At least three complaints have been filed by the law
firm representing plaintiffs in eleven of the cases on behalf of certain of the
Mississippi plaintiffs and others with the Attorney General of Mississippi in
March 2002, December 2002 and August 2003. The Company has responded to the
Attorney General's requests for information with respect to these complaints,
and as of December 31, 2003, the Company was not aware of any further actions
being taken by the Attorney General. 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, and has appealed the state court rulings in
favor of certain of the plaintiffs on the arbitration issue to the Mississippi
Supreme Court. One of the federal courts has ordered arbitration of a case
involving 8 plaintiffs. These cases are all in various stages of litigation,
including trial settings beginning in Alabama in April 2004, and in Mississippi
in May 2004, 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. Additional
suits of a similar nature have been threatened. 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 Pre-Paid defendants' preliminary motions in this
case were denied, and on June 17, 2003, the Oklahoma Court of Civil Appeals
reversed the trial court's denial of the Pre-Paid defendants' motion to compel
arbitration, finding that the trial court erred when it denied Pre-Paid's motion
to compel arbitration pursuant to the terms of the valid Membership contracts,
and remanded the case to the trial court for further proceedings consistent with
that opinion. There have been no material developments in this case since the
June 17, 2003 Court of Appeals decision. The ultimate outcome of this case 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
was originally a putative class action brought by Gina Kotwitz, later adding,
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, including a request stated in June 2003 for the imposition of
a constructive trust as to earned commissions applied to the reduction of debit
balances and disgorgement of all earned renewal commissions applied to the
reduction of debit balances. On September 23, 2003 the court entered an order
dismissing the class action allegations upon the motion of the plaintiffs. The
order provides that the action will proceed only on an individual basis, and
that the hearing on plaintiffs' motion for class certification previously set
for February 2004 was cancelled. The Company has filed a motion for summary
judgment, which was pending as of December 31, 2003. The ultimate outcome of
this case 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 a 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 Pre-Paid defendants filed motions to dismiss the complaint and
to strike the class action allegations on September 19, 2002, and discovery in
the action was stayed pending a ruling on the motion to dismiss. On July 24,
2003, the Court granted in part and denied in part the Pre-Paid defendants'
motion to dismiss. The claims asserted under the Securities Exchange Act of 1934
and the Oklahoma Securities Act were dismissed without prejudice. The motion was
denied as to the remaining claims. On July 23, 2003, the Court denied the motion
to strike class action allegations at that time. The case is in the process of
completion of class certification briefing currently scheduled to be concluded
May 5, 2004, after which time the Court will make a determination as to whether
the case may proceed as a class action. The ultimate outcome of this case is not
determinable.
In December 2002, the West Virginia Supreme Court reversed a summary
judgment which had been granted by the Circuit Court of Monangalia County, West
Virginia in favor of the Company in connection with the claims of a former
member, Georgia Poling and her daughters against the Company and a referral
lawyer with respect to a 1995 referral. That action was originally filed in
March 2000, and alleges breach of contract and fraud against the Company in
connection with the referral. Plaintiffs seek actual and punitive damages in
unspecified amounts. The case is set for trial in April 2004. The ultimate
outcome of this case is not determinable.
On January 30, 2003, the Company announced that it had received a subpoena
from the office of the United States Attorney for the Southern District of New
York requesting information relating to trading activities in the Company's
stock in advance of the January 2003 announcement of recruiting and Membership
production results for the fourth quarter of 2002. The Company also received
notice from the Securities and Exchange Commission that it is conducting an
informal inquiry into the same subject and requesting that the Company
voluntarily provide certain information. The Company has and will continue to
respond to any such requests, the last of which occurred in July 2003. As of
February 27, 2004, the Company was not aware of any further inquiries in either
of these matters. The ultimate outcome of these matters 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 costs of the defense
of these various matters are reflected as a part of general and administrative
expense in the consolidated statements of income. The Company has established an
accrued liability it believes will be sufficient to cover estimated damages in
connection with various cases (exclusive of ongoing defense costs which are
expensed as incurred), which at December 31, 2003 was $3.3 million. The Company
believes it has meritorious defenses in all pending cases and will vigorously
defend against the plaintiffs' claims. However, it is possible that an adverse
outcome in certain cases or increased litigation costs could have an adverse
effect upon the Company's financial condition, operating results or cash flows
in particular quarterly or annual periods.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Price of and Dividends on the Common Stock
At February 29, 2004, there were 5,772 holders of record (including
brokerage firms and other nominees) of the Company's common stock, which is
listed on the New York Stock Exchange under the symbol "PPD." The following
table sets forth, for the periods indicated, the range of high and low sales
prices for the common stock, as reported by the New York Stock Exchange.
High Low
------- -------
2004:
1st Quarter (through February 29)............................................ $ 26.33 $ 21.57
2003:
4th Quarter ................................................................. $ 28.30 $ 23.24
3rd Quarter.................................................................. 25.21 20.60
2nd Quarter.................................................................. 27.40 17.22
1st Quarter.................................................................. 26.80 15.80
2002:
4th Quarter.................................................................. $ 30.49 $ 17.04
3rd Quarter.................................................................. 24.29 16.68
2nd Quarter.................................................................. 30.45 18.50
1st Quarter.................................................................. 31.75 18.76
The Company has never declared a cash dividend on its common stock.
However, due to recent changes in the Federal tax laws providing for certain
preferential treatment of dividends in certain instances, the Company may
reconsider its dividend policy.
It is anticipated that earnings generated from the operations of the
Company will be used to finance the Company's growth, to continue to purchase
shares of its stock, to retire existing debt and possibly to pay a cash
dividend. The Company has lines of credit as described in "Management's
Discussion and Analysis - Liquidity and Capital Resources," which prohibit
payment of cash dividends in excess of $1.8 million per quarter on its common
stock. Any decision by the Board of Directors of the Company to pay cash
dividends in the future will depend upon, among other factors, the Company's
earnings, financial condition, capital requirements and approval from its lender
for any dividends in excess of $1.8 million per quarter. In addition, the
Company's ability to pay dividends is dependent in part on its ability to derive
dividends from its subsidiaries. The payment of dividends by PPLCI is restricted
under the Oklahoma Insurance Code to available surplus funds derived from
realized net profits and requires the approval of the Oklahoma Insurance
Commissioner for any dividend representing more than 10% of such accumulated
available surplus or an amount representing more than the previous years' net
profits. During 2002 and 2001, PPLCI declared a $6 million and a $5 million
dividend payable to the Company. Both the 2001 and 2002 dividends were paid
during 2002. PPLSIF is similarly restricted pursuant to the insurance laws of
Florida. At December 31, 2003, PPLSIF did not have funds available for payment
of substantial dividends without the prior approval of the insurance
commissioner. While PPLCI had approximately $3.5 million in surplus funds
available for payment of an ordinary dividend in December 2002, no such dividend
was declared or paid during 2003. At December 31, 2003 PPLCI had approximately
$750,000 available for payment of an ordinary dividend. At December 31, 2003 the
amount of restricted net assets of consolidated subsidiaries was $16.7 million.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plans
The following table provides information with respect to the Company's
equity compensation plans as of December 31, 2003, (other than its tax qualified
Employee Stock Ownership Plan designed to provide retirement benefits).
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
- --------------------------------------- ----------------------- --------------------- -------------------------
Equity compensation plans approved by
security holders (1)................. 1,020,252 $24.75 1,162,250
Equity compensation plans not approved
by security holders (2).............. 255,247 21.31 -
- --------------------------------------- ----------------------- --------------------- -------------------------
Total.................................. 1,275,499 $24.06 1,162,250
- --------------------------------------- ----------------------- --------------------- -------------------------
(1) These stock options have been issued pursuant to the Company's Stock Option
Plan which has been approved by security holders.
(2) These stock options have been issued to the Company's Regional Vice
Presidents ("RVPs") (described above) in order to encourage stock ownership
by its RVPs and to increase the proprietary interest of such persons in its
growth and financial success. These options have been granted periodically
to RVPs since 1996. Options are granted at fair market value at the date of
the grant and are generally immediately exercisable for a period of three
years or within 90 days of termination, whichever occurs first. There were
106,002, 244,679 and 131,288 total options granted to RVPs in the years
ended December 31, 2003, 2002 and 2001, respectively. The Company has
decided to discontinue the RVP stock option grants immediately after the
2003 fourth quarter stock options are awarded in the first quarter of 2004.
Issuer Purchases of Equity Securities
The following table provides information about the Company's purchases of stock
in the open market during the fourth quarter of 2003.
Total Number of Maximum Number
Total Number of Shares that May Yet
Shares Purchased as of Shares that May
Total Number of Average Price Paid Part of Publicly Yet Be Purchased
Period Shares Purchased per Share Announced Plans or Under the Plans or
Programs Programs (1)
- ----------------------- --------------------- --------------------- --------------------- ---------------------
October 2003........... 65,000 $ 27.44 65,000 848,900
November 2003.......... 95,400 26.85 95,400 753,500
December 2003.......... 378,000 25.97 378,000 375,500
--------------------- --------------------- ---------------------
Total.................. 538,400 $ 22.70 538,400
--------------------- --------------------- ---------------------
1) 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 subsequently from time to time
increased such authorization from 500,000 shares to 8,000,000 shares. The
most recent authorization was for 1,000,000 additional shares May 23, 3003
and there has been no time limit set for completion of the repurchase
program.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data for
the Company as of the dates and for the periods indicated. This information is
not necessarily indicative of the Company's future performance. The following
information should be read in conjunction with the Company's Consolidated
Financial Statements and Notes thereto and Management's Discussion and Analysis
of Financial Condition and Results of Operation included elsewhere herein.
Year Ended December 31,
------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees...................................... $ 330,322 $ 308,401 $ 263,514 $ 211,763 $ 153,918
Associate services................................... 25,704 37,418 36,485 30,372 22,816
Product sales (2).................................... - - 60 1,016 5,888
Other................................................ 5,287 4,804 3,602 3,232 3,809
---------- ---------- ---------- ---------- ----------
Total revenues..................................... 361,313 350,623 303,661 246,383 186,431
---------- ---------- ---------- ---------- ----------
Costs and expenses:
Membership benefits.................................. 111,165 103,761 87,429 69,513 51,089
Commissions.......................................... 115,386 119,371 111,060 96,614 74,333
Associate services and direct marketing.............. 28,929 32,566 29,879 23,251 15,815
General and administrative expenses.................. 36,711 33,256 28,243 21,524 19,280
Product costs (2).................................... - - 33 675 4,174
Other, net........................................... 8,546 6,685 5,884 4,403 3,226
---------- ---------- ---------- ---------- ----------
Total costs and expenses........................... 300,737 295,639 262,528 215,980 167,917
---------- ---------- ---------- ---------- ----------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle.... 60,576 54,984 41,133 30,403 18,514
Provision for income taxes............................. 20,669 18,970 13,519 9,550 6,480
---------- ---------- ---------- ---------- ----------
Income from continuing operations before cumulative
effect 39,907 36,014 27,614 20,853 12,034
of change in accounting principle....................
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit (expense) of
$0, $387 and ($444) for years 2001, 2000 and 1999,
respectectively)........................................ - - (504) 649 826
---------- ---------- ---------- ---------- ----------
Income before cumulative effect of change in accounting
principle............................................ 39,907 36,014 27,110 21,502 12,860
Cumulative effect of adoption of SAB 101 (net of
applicable income tax benefit of $546)............... - - - (1,013) -
---------- ---------- ---------- ---------- ----------
Net income............................................... 39,907 36,014 27,110 20,489 12,860
Less dividends on preferred shares..................... - - - 4 10
---------- ---------- ---------- ---------- ----------
Net income applicable to common stockholders............. $ 39,907 $ 36,014 $ 27,110 $ 20,485 $ 12,850
---------- ---------- ---------- ---------- ----------
Basic earnings per common share from continuing
operations before cumulative effect of accounting change $ 2.28 $ 1.83 $ 1.28 $ .93 $ .52
Basic earnings per common share from discontinued
operations........................................... - - (.02) .03 .04
---------- ---------- ---------- ---------- ----------
Basic earnings per common share before cumulative effect
of change in accounting principle.................... 2.28 1.83 1.26 .96 .56
Cumulative effect of adoption of SAB 101................. - - - (.05) -
---------- ---------- ---------- ---------- ----------
Basic earnings per common share.......................... $ 2.28 $ 1.83 $ 1.26 $ .91 $ .56
---------- ---------- ---------- ---------- ----------
Selected Financial Data, continued
Year Ended December 31,
------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(In thousands, except ratio, per share and Membership amounts)
Diluted earnings per common share from continuing
operations before cumulative effect of accounting change $ 2.27 $ 1.82 $ 1.28 $ .92 $ .51
Diluted earnings per common share from discontinued
operations........................................... - - (.02) .03 .04
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share before cumulative
effect of accounting change.......................... 2.27 1.82 1.26 .95 .55
Cumulative effect of adoption of SAB 101................. - - - (.05) -
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share........................ $ 2.27 $ 1.82 $ 1.26 $ .90 $ .55
---------- ---------- ---------- ---------- ----------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net income.................................................................................. $ 21,502 $ 12,786
Basic earnings per common share.......................................................... $ .96 $ .55
Diluted earnings per common share........................................................ $ .95 $ .55
Weighted average number of common shares
outstanding - basic.................................. 17,530 19,674 21,504 22,504 23,099
Weighted average number of common shares
outstanding - diluted................................ 17,599 19,764 21,544 22,679 23,374
Membership Benefits Cost and Statistical Data:
Membership benefits ratio (1).......................... 33.7% 33.6% 33.2% 32.8% 33.2%
Commissions ratio (1).................................. 34.9% 38.7% 42.1% 45.6% 48.3%
General & administrative expense ratio (1)............. 11.1% 10.8% 10.7% 10.2% 12.5%
Product cost ratio (1) (2)............................. - - 55.0% 66.4% 70.9%
Commission cost per new Membership sold................ $ 172 $ 154 $ 152 $ 144 $ 141
New Memberships sold................................... 671,857 773,767 728,295 670,118 525,352
Period end Memberships in force........................ 1,418,997 1,382,306 1,242,908 1,064,805 827,979
Cash Flow Data:
Net cash provided by operating activities................ $ 51,693 $ 52,073 $ 37,801 $ 23,201 $ 17,031
Net cash (used in) provided by investing activities...... (36,901) (11,074) (6,963) (7,965) 12,070
Net cash (used in) financing activities................. (14,191) (34,431) (27,414) (13,714) (26,687)
Balance Sheet Data:
Total assets........................................... $ 131,012 $ 96,836 $ 85,720 $ 77,766 $ 58,156
Total liabilities...................................... 101,438 61,864 43,496 35,999 25,518
Stockholders' equity .................................. 29,574 34,972 42,224 41,767 32,638
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. The product cost ratio represents product costs as a
percentage of product sales for those years in which the Company sold
products. These ratios do not measure total profitability because they do
not take into account all revenues and expenses.
(2) During the fourth quarter of 1998, the Company completed the acquisition of
TPN. Since its inception in late 1994, TPN had marketed personal and home
care products, personal development products and services together with
PRIMESTAR(R) satellite subscription television service to its members
through a network marketing sales force. Product sales declined and were
eventually eliminated following the TPN acquisition due to the
concentration on Membership sales as opposed to the sale of goods and
services.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview of the Company's Financial Model
The Company is in one line of business - the marketing of legal expense and
other complimentary plans primarily through a multi-level marketing force to
individuals. The Company's principal revenues are derived from membership fees,
and to a much lesser extent, revenues from marketing associates. The Company's
principal expenses are commissions, Membership benefits, associates services and
direct marketing costs and general and administrative expense. The following
table reflects the changes in these categories of revenues and expenses in the
last 3 years (dollar amounts in 000's):
% % %
Change Change Change
% of from % of from % of from
Total Prior Total Prior Total Prior
2003 Revenue Year 2002 Revenue Year 2001 Revenue Year
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
Revenues:
Membership fees........ $ 330,322 91.4 7.1 $ 308,401 88.0 17.0 $ 263,514 86.8 24.4
Associate services..... 25,704 7.1 (31.3) 37,418 10.6 2.6 36,485 12.0 20.1
Other.................. 5,287 1.5 10.1 4,804 1.4 31.2 3,662 1.2 (13.8)
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
361,313 100.0 3.0 350,623 100.0 15.5 303,661 100.0 23.2
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
Costs and expenses:
Commissions............ 115,386 31.9 (3.3) 119,371 34.0 7.5 111,060 36.6 15.0
Membership benefits.... 111,165 30.8 7.1 103,761 29.6 18.7 87,429 28.8 25.8
Associate services and
direct marketing..... 28,929 8.0 (11.2) 32,566 9.3 9.0 29,879 9.8 28.5
General and administrative 36,711 10.2 10.4 33,256 9.5 17.7 28,243 9.3 31.2
Other, net............. 8,546 2.4 27.8 6,685 1.9 13.0 5,917 1.9 16.5
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
300,737 83.2 1.7 295,639 84.3 12.6 262,528 86.4 21.6
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
Provision for income taxes 20,669 5.7 9.0 18,970 5.4 40.3 13,519 4.4 41.6
Loss from operations of
discontinued UFL segment - - - - - (504) - -
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
Net income.................. $ 39,907 11.0 10.8 $ 36,014 10.3 32.8 $ 27,110 8.9 32.3
----------- ------- ------ ---------- ------- ------ ----------- ------- --------
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees and their impact on total revenues during any
period. The two most important variables impacting the number of active
Memberships during a period are the number of new Memberships written during the
period combined with the retention characteristics of both new and existing
Memberships. See "Measures of Member Retention" below for a discussion of the
Company's Membership retention. Associate services revenues are a function of
the number of new sales associates enrolled and the price of entry during the
period, the number of associates subscribing to the Company's eService offering
and the amount of sales tools purchased by the sales force.
Membership benefits expense is primarily determined by the number of active
Memberships and the per capita contractual rate that exists between the Company
and its benefits providers and during the last five years has been and is
expected to continue to be a relatively fixed percentage of Membership revenues
of approximately 33%-34%. Commissions paid to associates are primarily dependent
on the number and price of new Memberships sold during a period and any special
incentives that may be in place during the period. The Company expenses advance
commissions ratably over the first month of the related Membership. The level of
commission expense in relation to Membership revenues varies depending on the
level of new Memberships written and is expected to be higher when the Company
experiences increases in new Membership sales. During the last five years this
percentage has ranged from approximately 35% to 48% of Membership revenues.
Associate services and direct marketing expenses are directly impacted by the
number of new associates enrolled during a period due to the cost of materials
provided to such new associates, the number of associates subscribing to the
Company's eService offering, the amount of sales tools purchased by the sales
force as well as the number of those associates who successfully meet the Fast
Start to Success training and incentive award program qualifications. Generally,
these costs are more than offset by associate services revenue, although this
did not occur in 2003 due to the lower entry fees charged during most of the
year. General and administrative expenses are expected to trend up in terms of
dollars, but remain relatively constant as a percent of revenues. During the
past five years, general and administrative expenses have ranged from 8.7% to
10.2% of total revenues.
The primary benchmarks monitored by the Company throughout the various
periods include the number of active Memberships and their related retention
characteristics, the number of new Memberships written, the number of new
associates enrolled and the percentage of new associates that successfully meet
the Fast Start to Success qualification requirements.
The Company experienced decreases in both the number of new Memberships
written and the number of new associates enrolled during 2003 compared to the
prior year, the first year such a decrease has occurred in more than ten years.
During the 2002 fourth quarter, the Company eliminated the commission advances
to certain associates that had below average retention and due to below average
retention rates of Internet submitted Memberships, the Company placed
restrictions on those associates who are able to submit new memberships via the
Internet. These actions naturally reduced the number of new memberships written
and new associates enrolled during the 2002 fourth quarter and during 2003 but
demonstrate the Company's commitment to improve Membership retention. The
Company also attributes such decline, in part, to negative publicity (see Risk
Factors). Such adverse publicity may affect the Company's ability to write new
Memberships (especially in large employee groups), recruit new associates and
may have a detrimental effect on the persistency of the Company's Memberships.
However depending on the average monthly Membership fee and the entry price for
new associates, the Company may experience declines in both areas in terms of
numbers but may experience increases in both Membership fees and associate
services revenue and vice versa
Although the Company has grown its active Membership base and related
Membership fees in each of the past 11 years, the rate of growth has slowed to
an unacceptable rate. The Company believes however, that its current product
design, pricing parameters and business model are generally appropriate and it
has no immediate plans to change these fundamental sectors. The Company's focus
during 2004 will be on improved training of its associates, enhancing the
quality and quantity of sales tools provided to new and existing associates,
providing incentives for associates to write consistent, quality business and
continued emphasis on improving the basic retention characteristics of its
Memberships.
During the first part of 2004, the Company has updated its Fast Start to
Success training program materials and hosted more than 600 Fast Start trainers
at its new corporate headquarters in order to "train the trainers" on the
updated training materials. Also, beginning in 2004, the Company has increased
the amount of sales tools that are included in the new associate kit and
provided a supplemental package of sale tools if the new associate qualifies
pursuant to the Fast Start rules. The Company has also increased the number of
"points" needed to qualify for its Player's Club incentive award program to
encourage more productivity from both its new and existing associates.
Critical Accounting Policies
The Company's financial statements and accompanying notes are prepared in
accordance with accounting principles generally accepted in the United States of
America. Preparing financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. These estimates and assumptions are affected by
management's application of accounting policies. If these estimates or
assumptions are incorrect, there could be a material change in the Company's
financial condition or operating results. Many of these "critical accounting
policies" are common in the insurance and financial services industries; others
are specific to the Company's business and operations. The Company's critical
accounting policies include estimates relating to revenue recognition related to
Membership and associate fees, deferral of Membership and associate related
costs, expense recognition related to commissions to associates, accrual of
incentive awards payable and accounting for legal contingencies.
Revenue recognition - Membership and Associate Fees
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis, of which approximately 73% are paid in advance and, therefore,
are deferred and recognized over the following month. At December 31, 2003 the
deferred revenue associated with the Membership fees was $17.8 million which is
classified as a current liability.
The Company also charges new members, who are not part of an employee
group, a $10 enrollment fee. This enrollment fee and related incremental direct
and origination costs are deferred and recognized in income over the estimated
life of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101"). At December 31, 2003
the deferred revenue associated with the Membership enrollment fees was $7.9
million, of which $4.6 million was classified as a current liability. The
Company computes the expected Membership life using over 20 years of actuarial
data as explained in more detail in the Measures of Membership Retention section
of MD&A. At December 31, 2003, management computed the expected Membership life
to be approximately 3 years, which is unchanged from year end 2002. If the
expected Membership life were to change significantly, which management does not
expect in the short term, the deferred Membership enrollment fee and related
costs would be recognized over a longer or shorter period.
The Company derives revenues from services provided to its marketing sales
force from a one-time non-refundable enrollment fee of $65 from each new sales
associate for which the Company provides initial sales and marketing supplies
and enrollment services to the associate. Revenue from, and costs of, the
initial sales and marketing supplies (approximately $11) are recognized when the
materials are delivered to the associates. The remaining $54 of revenues and
related incremental direct and origination costs are deferred and recognized
over the estimated average active service period of associates which at December
31, 2003 is estimated to be approximately six months, unchanged from year end
2002. At December 31, 2003, the deferred revenue associated with sales associate
enrollment fees was $1.4 million, which is classified as a current liability.
Management estimates the active service period of an associate periodically
based on the average number of months an associate produces new Memberships
including those associates that fail to write any Memberships. If the active
service period of associates changes significantly, which management does not
expect in the short term, the deferred revenue and related costs would be
recognized over the new estimated active service period.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs the
Company incurs in enrolling new Members and new associates related to the
deferred revenue discussed above, and that portion of payments made to provider
law firms ($5.2 million deferred at December 31, 2003 which is classified as a
current asset) and associates related to deferred Membership revenue. Deferred
costs for enrolling new members include the cost of the Membership kit and
salary and benefit costs for employees who process Membership enrollments, and
were $5.6 million at December 31, 2003, of which $3.2 million is classified in
current assets. Deferred costs for enrolling new associates include training and
success bonuses paid to individuals involved in recruiting the associate and
salary and benefit costs of employees who process associate enrollments, and
were $1.2 million at December 31, 2003, and is classified as a current asset.
Such costs are deferred to the extent of the lesser of actual costs incurred or
the amount of the related fee charged for such services. Deferred costs are
amortized to expense over the same period as the related deferred revenue as
discussed above. Deferred costs that will be recognized within one year of the
balance sheet date are classified as current and all remaining deferred costs
are considered noncurrent. Associate related costs are reflected as associate
services and direct marketing, and are expensed as incurred if not related to
the deferred revenue discussed above. These costs include providing materials
and services to associates, Fast Start bonuses, associate introduction kits,
associate incentive programs, group marketing and marketing services departments
(including costs of related travel, marketing events, leadership summits and
international sales convention).
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, the Company
implemented a level commission schedule (approximately 27% per annum at December
31, 2001) with up to a three-year advance commission payment. Prior to March 1,
1995, the Company's commission program provided for advance commission payments
to associates of approximately 70% of first year Membership premiums on new
Membership sales and commissions were earned by the associate at a rate of
approximately 16% in all subsequent years. 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 rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from five to 25% per annum based
on the first 12 month Membership retention rate of the associate's personal
sales and those of his organization. Beginning in August 2003, the Company
allowed the associate to choose between the level commission structure and up to
three year commission advance or the differential commission structure with a
one year commission advance.
Prior to January 1997 the Company advanced commissions at the time of sale
of all new Memberships. In January 1997, the Company implemented a policy
whereby the associate receives only earned commissions on the first three sales
unless the associate has successfully completed the Fast Start training program.
For all sales beginning with the fourth Membership or all sales made by an
associate successfully completing the Fast Start training program, the Company
currently advances commission payments at the time of sale of a new Membership.
The amount of cash potentially advanced upon the sale of a new Membership, prior
to the recoupment of any charge-backs (described below), represents an amount
equal to up to one-year commission earnings. Although the average number of
marketing associates receiving an advance commission payment on a new Membership
is 14, the overall initial advance may be paid to approximately 30 different
individuals, each at a different level within the overall commission structure.
The commission advance immediately increases an associate's unearned advance
commission balance to the Company.
Although the Company, prior to March 1, 2002, advanced its sales associates
up to three years commission when a Membership is sold and subsequent to March
1, 2002, up to one year commission, the average commission advance paid to its
sales associates as a group is actually less than the maximum amount possible
because some associates choose to receive less than a full advance and the
Company pays less than a full advance on some of its specialty products. In
addition, the Company may from time to time place associates on a less than full
advance basis if there are problems with the quality of the business being
submitted or other performance problems with an associate. Additionally, the
Company does not advance commissions on certain categories of group business
which have historically demonstrated below average retention characteristics.
Also, any residual commissions due an associate (defined as commission on an
individual Membership after the advance has been earned) are retained to reduce
any remaining unearned commission advance balances prior to being paid to that
sales associate. For those associates that have made at least 10 personal sales,
opened at least one group and personally write 15% or more of their
organizational business, 15% of their commissions are set aside in individual
reserve balance accounts, further reducing the amount of advance commissions.
The average commission advance paid as a percentage of the maximum advance
possible pursuant to the Company's commission structures was approximately 80%,
76% and 73% during 2003, 2002 and 2001, respectively. The commission cost per
new Membership sold has increased over each of the last three years by 12%, 1%
and 6% for 2003, 2002 and 2001, respectively, and 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. Should the Company add
additional products, such as the Identity Theft Shield described above or add
additional commissions to its compensation plan or reduce the amount of
chargebacks collected from its associates, the commission cost per new
Membership will increase accordingly.
The Company expenses advance commissions ratably over the first month of
the related Membership. At December 31, 2003, advance commissions deferred were
$4.7 million and included as a current asset. As a result of this accounting
policy, the Company's commission expenses are all recognized over the first
month of a Membership and there is no commission expense recognized for the same
Membership during the remainder of the advance period. The Company tracks its
unearned advance commission balances outstanding in order to ensure the advance
commissions are recovered before any renewal commissions are paid and for
internal purposes of analyzing its commission advance program. While not
recorded as an asset, unearned advance commission balances from associates for
the following years ended December 31 were:
2003 2002 2001
---- ---- ----
(Amounts in 000's)
Beginning unearned advance commission balances (1)..................$ 227,084 $ 211,609 $ 167,193
Advance commissions, net of chargebacks and other................... 113,030 118,917 110,211
Earned commissions applied.......................................... (145,371) (101,030) (63,870)
Advance commission write-offs....................................... (2,849) (2,412) (1,925)
--------- ----------- -----------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)........................................ 191,894 227,084 211,609
Estimated unrecoverable advance commission balances (1)(2).......... (24,862) (25,156) (15,868)
--------- ----------- -----------
Ending unearned advance commission balances, net (1)............... $ 167,032 $ 201,928 $ 195,741
--------- ----------- -----------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2) Estimated unrecoverable advances increased as a percentage of ending
advances from 7% at December 31, 2001 to 13% at December 31, 2003
primarily due to the change in the compensation structure described
above from a 36-month possible advance to a 12-month possible advance.
This change allows the advances to be earned more quickly by the
associate so the increase in advances before estimated unrecoverable
balances increased 7% from 2001 to 2002 compared to a decrease of 15%
from 2002 to 2003.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $30 million,
$26 million and $20 million at December 31, 2003, 2002 and 2001, respectively.
As such, at December 31, 2003 future commissions and related expense will be
reduced as unearned advance commission balances of $137 million are recovered.
Commissions are earned by the associate as Membership premiums are earned by the
Company, usually on a monthly basis. The Company reduces unearned advance
commission balances or remits payment to an associate, as appropriate, when
commissions are earned. Should a Membership lapse before the advances have been
recovered for each commission level, the Company, except as described below,
generates an immediate "charge-back" to the applicable sales associate to
recapture up to 50% of any unearned advance on Memberships written prior to
March 1, 2002, and 100% on any Memberships written thereafter. Beginning in
August 2003, the Company allowed the associate to choose between the level
commission structure and up to three year commission advance and up to 50%
chargebacks or the differential commission structure with a one year commission
advance and up to 100% chargebacks. This charge-back is deducted from any future
advances that would otherwise be payable to the associate for additional new
Memberships. In order to encourage additional Membership sales, the Company
waived chargebacks for associates that met certain criteria in December 2002 and
March 2003, which effectively increases the Company's commission expense. Any
remaining unearned advance commission balance may be recovered by withholding
future residual earned commissions due to an active associate on active
Memberships. Additionally, even though a commission advance may have been fully
recovered on a particular Membership, no additional commission earnings from any
Membership are paid to an associate until all previous advances on all
Memberships, both active and lapsed, have been recovered. The Company also has
reduced chargebacks from 100% to 50% for certain senior marketing associates who
have demonstrated the ability to maintain certain levels of sales over specified
periods and maintain certain Membership retention levels. The Company may adjust
chargebacks from time to time in the future in order to encourage certain
production incentives.
Prior to March 1, 2002, the Company charged associates a fee on unearned
advance commission balances relating to lapsed Memberships ("Membership lapse
fee"). The fee that was recorded on the associates unearned commission balance
was determined by applying the prime interest rate to the unearned advance
commission balance pertaining to lapsed Memberships. The Company realized and
recognized this fee only when the amount of the calculated fee was collected by
withholding from cash commission payments due the associate. The fees collected
reduced commission expense. The Company's ability to recover these fees was
primarily dependant on the associate selling new Memberships, which qualify for
commission advances. The Company eliminated the Membership lapse fee for
Memberships sold after March 1, 2002 in conjunction with the change in the
commission structure described above.
The Company has the contractual right to require associates to repay
unearned advance commission balances from sources other than earned commissions
including cash (a) from all associates either (i) upon termination of the
associate relationship, which includes but is not limited to when an associate
becomes non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, the Company has not demanded repayments of the
unearned advance commission balances from associates, including terminated
associates, because collection efforts would likely increase costs and have the
potential to disrupt the Company's relationships with its sales associates. This
business decision by the Company has a significant effect on the Company's cash
flow by electing to defer collection of advance payments of which approximately
$24.9 million were not expected to be collected from future commissions at
December 31, 2003. However, the Company regularly reviews the unearned advance
commission balance status of associates and will exercise its right to require
associates to repay advances when management believes that such action is
appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet the Company's established vesting requirements by selling at least
three new Memberships per quarter or retaining a personal Membership. Non-vested
associates lose their right to any further commissions earned on Memberships
previously sold at the time they become non-vested. As a result the Company has
no continuing obligation to individually account to these associates as it does
to active associates and is entitled to retain all commission earnings that
would be otherwise payable to these terminated associates. The Company does
continue to reduce the unearned advance commission balances for commissions
earned on active Memberships previously sold by those associates. Substantially
all individual non-vested associate unearned advance commission balances were
less than $1,000 and the average balance was $416 at December 31, 2003.
Although the advance commissions are expensed ratably over the first month
of the related Membership, the Company assesses, at the end of each quarter, on
an associate-by-associate basis, the recoverability of each associate's unearned
advanced commission balance by estimating the associate's future commissions to
be earned on active Memberships. Each active Membership is assumed to lapse in
accordance with the Company's estimated future lapse rate, which is based on the
Company's actual historical Membership retention experience as applied to each
active Membership's year of origin. The lapse rate is based on the Company's
more than 20-year history of Membership retention rates, which is updated
quarterly to reflect actual experience. The Company also closely reviews current
data for any trends that would affect the historical lapse rate. The sum of all
expected future commissions to be earned for each associate is then compared to
that associate's unearned advance commission balance. The Company estimates
unrecoverable advance commission balances when expected future commissions to be
earned on active Memberships (aggregated on an associate-by-associate basis) are
less than the unearned advance commission balance. If an associate with an
outstanding unearned advance commission balance has no active Memberships, the
unearned advance commission balance is written off but has no financial
statement impact as advance commissions are expensed ratably over the first
month of the related Memberships. Refer to "Measures of Member Retention -
Expected Membership Life, Expected Remaining Membership Life" for a description
of the method used by the Company to estimate future commission earnings.
Further, the Company's analysis of the recoverability of unearned advance
commission balances is also based on the assumption that the associate does not
write any new Memberships. The Company believes that this assessment methodology
is highly conservative since its actual experience is that many associates do
continue to sell new Memberships and the Company, through its chargeback rights,
gains an additional source to recover unearned advance commission balances.
Changes in the Company's estimates with respect to recoverability of
unearned commissions could occur if the underlying Membership persistency
changes from historical levels. Should Membership persistency decrease, the
unearned commissions would be recovered over a longer period and the amount not
recovered would most likely increase, although any increase in uncollectible
unearned commissions would not have any immediate expense impact since the
commission advances are expensed in the month they incurred. Holding all other
factors constant, the decline in persistency would also lead to lower Membership
fees, less net income and less cash flow from operations. Conversely, should
persistency increase, the unearned commissions would be recovered more quickly,
the amount unrecovered would decrease and, holding all other factors constant,
the Company would enjoy higher Membership fees, more net income and more cash
flow from operations.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. At December 31, 2003, the accrued
amount payable was $4.5 million. Changes to any of these assumptions would
directly affect the amount accrued but the Company does not expect any of the
significant trends impacting this account to change significantly in the near
term.
Legal Contingencies
The Company is subject to various legal proceedings and claims, the
outcomes of which are subject to significant uncertainty. Given the inherent
unpredictability of litigation, it is difficult to estimate the impact of
litigation on the Company's financial condition or results of operation. SFAS 5,
Accounting for Contingencies, requires that an estimated loss from a loss
contingency should be accrued by a charge to income if it is probable that an
asset has been impaired or a liability has been incurred and the amount of the
loss can be reasonably estimated. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been incurred. The
Company evaluates, among other factors, the degree of probability of an
unfavorable outcome and the ability to make a reasonable estimate of the amount
of loss. The Company has established an accrued liability it believes will be
sufficient to cover estimated damages in connection with various cases, which at
December 31, 2003 was $3.3 million. This process requires subjective judgment
about the likely outcomes of litigation. Liabilities related to most of the
Company's lawsuits are especially difficult to estimate due to the nature of the
claims, limitation of available data and uncertainty concerning the numerous
variables used to determine likely outcomes or the amounts recorded. Litigation
expenses are recorded as incurred and the Company does not accrue for future
legal fees. It is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon the Company's financial
condition, operating results or cash flows in particular quarterly or annual
periods. See "Legal Proceedings."
Other General Matters
Operating Ratios
Three principal operating measures monitored by the Company in addition to
measures of Membership retention are the Membership benefits ratio, commission
ratio and the general and administrative expense ratio. The Membership benefits
ratio, the commissions ratio and the general and administrative expense ratio
represent those costs as a percentage of Membership fees. The Company strives to
maintain these ratios as low as possible while at the same time providing
adequate incentive compensation to its sales associates and provider law firms.
These ratios do not measure total profitability because they do not take into
account all revenues and expenses.
Cash Flow Considerations Relating to Sales of Memberships
The Company generally advances significant commissions at the time a
Membership is sold. Since approximately 95% of Membership fees 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 Membership fees are
remitted and no additional commissions are paid on the Membership until all
previous unearned advance commission balances have been fully recovered. Since
the cash advanced at the time of sale of a new Membership may be recovered over
a multi-year period, cash flow from operations may be adversely affected
depending on the number of new Memberships written in relation to the existing
active base of Memberships and the composition of new or existing sales
associates producing such Memberships.
Investment Policy
The Company's investment policy is to some degree controlled by certain
insurance regulations, which, coupled with management's own investment
philosophy, results in a conservative investment portfolio that is not risk
oriented. 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 is required to pledge
investments to various state insurance departments as a condition to obtaining
authority to do business in certain states.
New Accounting Standards Issued
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity" ("SFAS 150"). SFAS No. 150 changes the accounting
for certain financial instruments that, under previous guidance, could be
classified as equity or "mezzanine" equity, by now requiring those instruments
to be classified as liabilities (or assets in some circumstances) in the
consolidated balance sheets. Further, SFAS No. 150 requires disclosure regarding
the terms of those instruments and settlement alternatives. The guidance in SFAS
No. 150 generally is effective for all financial instruments entered into or
modified after May 31, 2003, and was otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The Company has evaluated
SFAS No. 150 and determined that it does not have an impact on its financial
reporting and disclosures.
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46 (R), addresses
the application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities and results of the activity of a VIE be consolidated into the
financial statements of the enterprise that is considered the primary
beneficiary. This interpretation applies immediately to VIEs created after
January 31, 2003, and to VIEs in which a company obtains an interest after that
date. The Company has not created or obtained an interest in any VIEs in 2003.
In addition, the interpretation becomes applicable on December 31, 2003 for
special purpose entities (SPEs) created prior to February 1, 2003. As of
December 31, 2003, the company had no SPEs for which it was considered the
primary beneficiary. For non-SPEs in which a company holds a variable interest
that it acquired before February 1, 2003, the FASB has postponed the date on
which the interpretation will become applicable to March 31, 2004. The Company
has determined the adoption of the provisions of FIN 46 will not have a material
effect on its financial condition or results of operations.
In November 2003, the Emerging Issues Task Force or EITF of the FASB
reached a consensus on one issue with respect to EITF Issue 03-1, "The Meaning
of Other-Than-Temporary Impairment and its Application to Certain Investments,"
thereby requiring certain quantitative and qualitative disclosures for
securities accounted for under SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," that are impaired at the balance sheet date but
for which an other-than-temporary impairment has not been recognized. Adoption
of EITF Issue 03-1, which was effective for us on December 31, 2003, did not
have a material impact on the Company's financial position, results of
operations or cash flows. The required disclosures have been included in Note 3
to the consolidated financial statements.
In December 2003, the Staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which
supersedes SAB No. 101. The primary purpose of SAB No. 104 is to rescind
accounting guidance contained in SAB No. 101 and the SEC's "Revenue Recognition
in Financial Statements Frequently Asked Questions and Answers" (the FAQ)
related to multiple element revenue arrangements in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The Company does not expect the
issuance of SAB No. 104 to significantly impact its current revenue recognition
policies.
Measures of Member Retention
One of the major factors affecting the Company's profitability and cash
flow is the ability of the Company to retain a Membership, and therefore
continue to receive fees, once it has been sold. The Company monitors its
overall Membership persistency rate, as well as the retention rates with respect
to Memberships sold by individual associates and agents and retention rates with
respect to Memberships by year of issue, geographic region, utilization
characteristics and payment method, and other sub groupings.
Terminology
The following terms are used in describing the various measures of
retention:
o Membership life is a period that commences on the day of initial
enrollment of a member and continues until the individual's Membership
eventually terminates or lapses (the terms terminate or lapse may be used
interchangeably here).
o Membership age means the time since the Membership has been in effect.
o Lapse rate means the percentage of Memberships of a specified group of
Memberships that lapse in a specified time period.
o Retention rate is the complement of a lapse rate, and means the
percentage of Memberships of a specified group that remain in force at the
end of a specified time period.
o Persistency and retention are used in a general context to mean the
tendency for Memberships to continue to remain in force, while the term
persistency rate is a specific measure that is defined below.
o Lapse rates, retention rates, persistency rates, and expected Membership
life may be referred to as measures of Membership retention.
o Expected Membership life means the average number of years a new
Membership is expected to remain in force.
o Blended rate when used in reference to any measure of member retention
means a rate computed across a mix of Memberships of various Membership
ages.
o Expected remaining Membership life means the number of additional years
that an existing member is expected to continue to renew from a specific
point in time based on the Membership life.
Variations in Membership Retention by Sub-Groups, Impact on Aggregate
Numbers
Company wide measures of Membership retention include data relating to
members who can potentially be further sorted by identifiable sub-groupings. For
example, Memberships may be subdivided into those owned by members who are or
are not sales associates, to those who are or are not members of group plans,
etc.
Measures of Membership retention of different sub-groups may vary. For
example, the Company's experience indicates that first year retention rate of
Memberships owned by members who also are sales associates is approximately 10%
better than retention of Memberships owned by non-associate members. While this
correlation can be identified, the cause and effect relationship here cannot be
isolated. These sales associate members may have a financial incentive to retain
the Membership in order to continue to receive commissions. They also likely
have a better understanding and appreciation of the benefits of the Membership,
which may have contributed in fact to their decision to also become a sales
associate. Additionally, members who have accessed the services of the provider
law firms historically have higher retention rates than those who have not.
All aggregate measures of Membership retention or expected life may be
impacted by shifts in the underlying enrollment mix of sub-groups that have
different retention rates. For example Memberships owned by non-associate new
members have comprised an increasing percentage of new Memberships enrolled each
year over the past five years. Since non-associate members have a known lower
first year retention rate, a shift in mix alone will cause a reduction in
reported aggregate retention measures and expected member life, even if the
retention rates within each sub-group do not change. It is important to note
that all blended rates discussed here may reflect the impact of such shifts in
enrollment mixes. At December 31, 2003, 295,716 of the active 1,418,997
Memberships were also vested associates which represents 21% of the total active
Memberships. The following table shows total new Memberships sold during each
year and the number and percentage of Memberships sold to persons who are
associates.
Total New Associate
Year Memberships Memberships Ratio
---- ----------- ----------- -----
1999 525,352 85,219 16.2%
2000 670,118 90,684 13.5%
2001 728,295 103,515 14.2%
2002 773,767 119,326 15.4%
2003 671,857 86,406 12.9%
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, the Company has observed that Memberships in their first year have
a significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 49.0% of all new Memberships lapse during the first year, leaving 51.0%
still in force at the end of the first year. More tenured Memberships have
significantly lower lapse rates. For example, by year seven lapse rates are
under 10% and annual retention exceeds 90%. The following table shows as of
December 31, 2003 the Company's blended retention rate and lapse rates based on
its historical experience for the last 22 years. The blended retention and lapse
rates as of the end of 2003 did not differ materially from those previously
reported at the end of 2002.
Membership Retention versus Membership Age
- -----------------------------------------------------------
Membership Yearly Yearly End of Year
Year Lapse Rate Retention Memberships
- ---------- ---------- ---------- -------------
0 100.0
1 49.0% 51.0% 51.0
2 28.7% 71.3% 36.4
3 21.1% 78.9% 28.7
4 17.0% 83.0% 23.8
5 15.2% 84.8% 20.2
6 11.9% 88.1% 17.8
7 9.4% 90.6% 16.1
Membership Persistency
The Company's Membership persistency rate is a specific computation that
measures the number of Memberships in force at the end of a year as a percentage
of the total of (i) Memberships in force at the beginning of such year, plus
(ii) new Memberships sold during such year. From 1981 through the year ended
December 31, 2003, the Company's annual Membership persistency rates, using the
foregoing method, have averaged approximately 71.9%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
---- ----------- --------------- --------- ----------- -----------
1999 603,017 525,352 1,128,369 827,979 73.4%
2000 827,979 670,118 1,498,097 1,064,805 71.1%
2001 1,064,805 728,295 1,793,100 1,242,908 69.3%
2002 1,242,908 773,767 2,016,675 1,382,306 68.5%
2003 1,382,306 671,857 2,054,163 1,418,997 69.1%
The Company's overall Membership persistency rate varies based on, among
other factors, the relative age of total Memberships in force, and shifts in the
mix of members enrolled. The Company's overall Membership persistency rate could
become lower when the Memberships in force include a higher proportion of newer
Memberships, as will happen following periods of rapid growth. The Company's
overall Membership persistency rate could also become lower when the new
enrollments include a higher proportion of non-associate members, a trend that
has been observed over the past five years.
Unless offset by other factors, these factors could result in a decline in
the Company's overall Membership persistency rate as determined by the formula
described above, but does not necessarily indicate that the new Memberships
written are less persistent.
Expected Membership Life, Expected Remaining Membership Life
Using historical data through 2003 for all past Members enrolled, the
expected Membership life can be computed to be approximately three years. This
number represents the average number of years a new Membership can be expected
to remain in force. Although about half of all new Memberships may lapse in the
first year, the expected Membership life is much longer due to the contribution
of higher annual retention rates in subsequent years.
Since the Company's experience is that the retention rate of a given
generation of new Memberships improves with Membership age, the expected
remaining Membership life of a Membership also increases with Membership age.
For example, while a new Membership may have an expected Membership life of
three years, the expected remaining Membership life of a Membership that reaches
its first year anniversary is approximately four years.
Since the actual population of Memberships in force at any time is a
distribution of ages from zero to more than 20 years, the expected remaining
Membership life of the entire population at large greatly exceeds three years
per Membership. As of December 31, 2003, based on the historical data described
above, the current expected remaining Membership life of the actual population
is over six years per Membership. This measure is used by the Company to
estimate the future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 20 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
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 implemented several initiatives aimed at improving the retention
rate of both new and existing Memberships. Such initiatives include an optional
revised compensation structure featuring variable renewal commission rates
ranging from five to 25% per annum based on the 12 month Membership retention
rate of the associate's personal sales and those of his organization and
implementation of a "non-taken" administrative fee to sales associates of $35
for any Membership application that is processed but for which a payment is
never received. The Company has designed and implemented an enhanced member
"life cycle" 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. The Company believes that such efforts may
ultimately increase the utilization by members and therefore lead to higher
retention rates. The Company's 2003 retention rates did not differ materially
from 2002 and the Company intends to continue to develop programs and
initiatives designed to improve retention.
Results of Operations
Comparison of 2003 to 2002
Net income for 2003 increased 11 percent to $39.9 million from $36.0
million for 2002. Diluted earnings per share for 2003 increased 25 percent to
$2.27 per share from $1.82 per share for the prior year due to increased net
income of 11 percent and an approximate 11 percent decrease in the weighted
average number of outstanding shares. Membership revenues for 2003 were up 7
percent to $330.3 million from $308.4 million for the prior year marking the
eleventh consecutive year of increased membership revenue.
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 decreased 13% during 2003 to 671,857 from
773,767 during 2002. At December 31, 2003, there were 1,418,997 active
Memberships in force compared to 1,382,306 at December 31, 2002, an increase of
3%. Additionally, the average annual fee per Membership has increased from $256
for all Memberships in force at December 31, 2002 to $262 for all Memberships in
force at December 31, 2003, a 2% increase, as a result of a larger number of
Legal Shield subscribers, increased sales of the Company's business oriented
Memberships, and the introduction of the Identity Theft Shield Membership during
the last quarter of 2003.
Associate services revenue decreased 31% from $37.4 million for 2002 to
$25.7 million during 2003 primarily as a result of a decline in new enrollments
of sales associates and fewer associates enrolling in the eService program
offered by the Company. The eService fees totaled $8.4 million during 2003
compared to $11.2 million for 2002, a decrease of 25%. The Company also had a
decline in fees for the Fast Start program for 2003. The Company received
training fees of approximately $7.7 million during 2003 compared to $13.1
million during 2002, primarily as a result of special training promotions during
2003 that reduced the net amount of training fees received by the Company. The
field-training program, titled Fast Start to Success ("Fast Start") is aimed at
increasing the level of new Membership sales per associate. In addition to the
$65 associate fee, associates participating in this program typically pay a fee
ranging from $34 to $184, depending on special promotions the Company implements
from time to time. In order to be deemed successful for Fast Start purposes, the
new associate must write three new Memberships and recruit one new sales
associate or personally sell five Memberships within 60 days of becoming an
associate. The $7.7 million and $13.1 million for 2003 and 2002, respectively,
in training fees was collected from approximately 107,490 new sales associates
who elected to participate in Fast Start in 2003 compared to 150,247 during
2002. New associates electing to participate in Fast Start increased to 99% of
new associates during 2003 from 97% for 2002. Total new associates enrolled
during 2003 were 108,557 compared to 155,663 for 2002, a decrease of 30%. Future
revenues from associate services will depend primarily on the number of new
associates enrolled, the price charged for the Fast Start program and the number
who choose to participate in the Company's eService program, but the Company
expects that such revenues will continue to be largely offset by the direct and
indirect cost to the Company of training (including training bonuses paid),
providing associate services and other direct marketing expenses.
Other revenue increased 10%, from $4.8 million to $5.3 million primarily
due to the increase in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $361.3 million for 2003 from $350.6 million during 2002, an
increase of 3%.
Membership benefits, which represent payments to provider law firms,
totaled $111.2 million for 2003 compared to $103.8 million for 2002, and
represented 34% of Membership fees for both years. This Membership benefits
ratio (Membership benefits as a percentage of Membership fees) should remain
near current levels as substantially all active Memberships provide for a
capitated benefit in the absence of any changes in the capitated benefit level,
which has not changed significantly since 1993.
Commissions to associates decreased 3% from $119.4 million for 2002
compared to $115.4 million for 2003, and represented 39% and 35% of Membership
fees for such years. These amounts were reduced by $705,000 and $196,000,
respectively, representing Membership lapse fees. These fees were determined by
applying the prime interest rate to the unearned 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 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 commission payments. These fees were
eliminated for Memberships sold after March 1, 2002. Commissions to associates
are primarily dependent on the number of new Memberships sold during a period.
New Memberships sold during 2003 totaled 671,857, a 13% decrease from the
773,767 sold during 2002.
Associate services and direct marketing expenses decreased to $28.9 million
for 2003 from $32.6 million for 2002. Fast Start training bonuses incurred were
approximately $2.9 million during 2003 compared to $6.8 million in 2002. This
$3.9 million decline in bonuses, a $521,000 decrease in cost of marketing
materials sent to new associates, and a $1.6 million decrease in the
amortization of deferred associate costs were offset by a $1.3 million increase
in Fast Start attendance bonuses incurred and a $1.4 million increase in the
cost of associate incentive program costs. The Fast Start training bonuses are
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 the costs of providing associate services and
marketing expenses as discussed under Member and Associate Costs.
General and administrative expenses during 2003 and 2002 were $36.7 million
and $33.3 million, respectively, and represented 11% of Membership fees for both
years. Management expects general and administrative expenses, when expressed as
a percentage of Membership fees, to increase slightly due to additional overhead
of the home office complex. The Company should experience cost efficiencies as a
result of certain economies of scale in some areas but expects such cost savings
in 2004 to be largely offset by higher levels of expenses related to legal fees.
Other expenses, which includes depreciation and amortization, litigation
accruals and premium taxes reduced by interest income, increased 28% to $8.5
million for 2003 from $6.7 million for 2002. Depreciation and amortization
increased to $7.1 million for 2003 from $5.3 million for 2002. Premium taxes
increased from $2.2 million for 2002 to $2.7 million for 2003 due to increased
revenues in the states in which the Company pays premium taxes. Interest income
decreased to $1.4 million for 2003 from $2.1 million for 2002. At December 31,
2003 the Company reported $51.6 million in cash and investments (after utilizing
$48.3 million to purchase approximately 2.1 million treasury shares of its
common stock during 2003) compared to $41 million at December 31, 2002.
The provision for income taxes increased during 2003 to $20.7 million
compared to $19.0 million for 2002, representing 34.1% and 34.5% of income from
continuing operations before income taxes for 2003 and 2002, respectively.
Comparison of 2002 to 2001
The Company reported net income of $36.0 million, or $1.82 per diluted
common share, for 2002. The net income per diluted share was up 44% from net
income of $27.1 million, or $1.26 per diluted common share, for 2001. The
increase in the net income for 2002 is primarily the result of increases in
Membership fees for 2002 as compared to 2001 as well as a decrease in the
weighted average number of shares outstanding of 8%.
Membership fees totaled $308.4 million during 2002 compared to $263.5
million for 2001, an increase of 17%. 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 6%
during 2002 to 773,767 from 728,295 during 2001. At December 31, 2002, there
were 1,382,306 active Memberships in force compared to 1,242,908 at December 31,
2001, an increase of 11%. Additionally, the average annual fee per Membership
has increased from $251 for all Memberships in force at December 31, 2001 to
$256 for all Memberships in force at December 31, 2002, a 2% increase, as a
result of a higher portion of active Memberships containing the additional
pre-trial hours benefit at an additional cost to the member, a larger number of
Legal Shield subscribers and increased sales of the Company's business oriented
Memberships.
Associate services revenue increased 3% from $36.5 million for 2001 to
$37.4 million during 2002 primarily as a result of more new associates enrolling
in the eService program offered by the Company. The eService fees totaled $11.2
million during 2002 compared to $7.3 million for 2001, an increase of 53%. This
increase was offset by the reduced fees for the Fast Start program for 2002. The
Company received training fees of approximately $13.1 million during 2002
compared to $17.5 million during 2001, primarily as a result of special training
promotions during 2002 that reduced the net amount of training fees received by
the Company. The $13.1 million and $17.5 million for 2002 and 2001,
respectively, in training fees was collected from approximately 150,247 new
sales associates who elected to participate in Fast Start in 2002 compared to
117,698 during 2001. New associates electing to participate in Fast Start
increased to 97% of new associates during 2002 from 96% for 2001. Total new
associates enrolled during 2002 were 155,663 compared to 122,192 for 2001, an
increase of 27%.
Other revenue increased 31%, from $3.7 million to $4.8 million primarily
due to the increase in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $350.6 million for 2002 from $303.7 million during 2001, an
increase of 15%.
Membership benefits, which represent payments to provider law firms,
totaled $103.8 million for 2002 compared to $87.4 million for 2001, and
represented 34% and 33%, respectively of Membership fees.
Commissions to associates increased 8% to $119.4 million for 2002 compared
to $111.1 million for 2001, and represented 39% and 42% of Membership fees for
such years. These amounts were reduced by $705,000 and $2.2 million,
respectively, representing Membership lapse fees. New Memberships sold during
2002 totaled 773,767, a 6% increase from the 728,295 sold during 2001.
Associate services and direct marketing expenses increased to $32.6 million
for 2002 from $29.9 million for 2001 primarily due to a $1.8 million increase in
the associate incentive program from $3.0 million to $4.8 million. Additional
costs of supplies due to increased enrollment of new associates, purchases by
associates and higher staffing requirements for associate related service
departments also contributed to the increase. These expenses also include the
costs of providing associate services and marketing expenses as discussed under
Member and Associate Costs.
General and administrative expenses during 2002 and 2001 were $33.3 million
and $28.2 million, respectively, and represented 11% of Membership fees for both
years.
Other expenses, which includes depreciation and amortization, litigation
accruals and premium taxes reduced by interest income, increased 14% to $6.7
million for 2002 from $5.9 million for 2001. Depreciation and amortization
increased to $5.3 million for 2002 from $4.1 million for 2001. Due to the
increased amount of litigation during 2002, the Company increased the accrual by
$1.3 million to $3.3 million at December 31, 2002. Premium taxes decreased from
$2.5 million for 2001 to $2.2 million for 2002 due to a change in the tax
structure of one of the states in which the Company pays premium taxes. Interest
income increased to $2.1 million for 2002 from $1.9 million for 2001. At
December 31, 2002 the Company reported $41 million in cash and investments
(after utilizing $50.2 million to purchase approximately 2.3 million treasury
shares of its common stock during 2002) compared to $38 million at December 31,
2001.
The provision for income taxes increased during 2002 to $19.0 million
compared to $13.5 million for 2001, representing 34.5% and 32.9% of income from
continuing operations before income taxes for 2002 and 2001, respectively.
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, is $(504,000), net of tax
of $0 for the year ended December 31, 2001.
Liquidity and Capital Resources
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees collected and their contribution to cash flow
from operations during any period. Cash receipts from associate services are
directly impacted by the number of new sales associates enrolled and the price
of entry during the period, the number of associates subscribing to the
Company's eService offering and the amount of sales tools purchased by the sales
force.
The cash outlay related to Membership benefits is directly impacted by the
number of active Memberships and the contractual rate that exists between the
Company and its benefits providers. Commissions paid to associates are primarily
dependent on the number and price of new Memberships sold during a period and
any special incentives that may be in place during the period. Cash requirements
related to associate services and direct marketing activities are directly
impacted by the number of new associates enrolled during a period due to the
cost of materials provided to such new associates, the number of associates
subscribing to the Company's eService offering, the amount of sales tools
purchased by the sales force as well as the number of those associates who
successfully meet the Fast Start to Success training and incentive award program
qualifications.
Membership revenues are more than sufficient to fund the cash requirements
for membership benefits (at approximately 33%-34% of Membership revenues),
commissions (ranging from 34% to 48% of Membership revenues) and general and
administrative expense (at approximately 11% of Membership revenues). Likewise,
as a general rule, associate services revenue is sufficient to fund associate
services and direct marketing cash costs. The Company has generated significant
cash flow from operations of approximately $52 million in 2003 and 2002 and $38
million in 2001. As discussed below, the Company has used a significant portion
of its cash flow to repurchase shares of its stock in the open market. Cash flow
from operations could be reduced if the Company experienced significant growth
in new members because of the negative cash flow characteristics of its
commission advance policies discussed above.
As a result of the Company's ability to generate cash flow from operations,
including in periods of Membership growth, it has not historically been
dependent on, and does not expect to need in the future, external sources of
financing from the sale of securities or from bank borrowings to fund its basic
business operations. However, as described below, in 2002 and 2003, the Company
incurred debt for limited and specific purposes to permit it to construct a new
corporate headquarters and to accelerate its treasury stock purchase program.
General
Consolidated net cash provided by operating activities was $51.7 million,
$52.1 million and $37.8 million for 2003, 2002 and 2001, respectively. Cash
provided by operating activities decreased $380,000 during 2003 compared to 2002
primarily due to the $5.6 million increase in the change in other assets, a $1.6
million decrease in the change in deferred revenues and a $1.3 million decrease
in the change in accounts payable and accrued expenses partially offset by a
$3.9 million increase in net income, $1.8 million increase in depreciation, $1.4
million increase in the change in other non-current liabilities and a $1.1
million increase in the change in taxes payable.
Net cash used in investing activities was $36.9 million, $11.1 million and
$7.0 million for 2003, 2002 and 2001, respectively. During 2001 the Company
received dividends of $2.8 million from UFL and received $1.2 million in
proceeds from the sale of UFL during 2001. In addition to capital expenditures
of $27.0 million, $15.2 million and $8.3 million during 2003, 2002 and 2001,
respectively, the Company's purchases of available-for-sale investments exceeded
the maturities and sales of such investments by $9.9 million and $7.4 million in
2003 and 2001, respectively, but maturities and sales exceeded purchases by $4.1
million during 2002.
Net cash used in financing activities was $14.2 million, $34.4 million and
$27.4 million for 2003, 2002 and 2001, respectively. This $20.2 million change
during 2003 was primarily comprised of a $30.4 million increase in proceeds from
issuance of debt, a $1.9 million decrease in purchases of treasury stock, a $1
million vendor rebate and offset by a $9.9 million increase in repayment of debt
and capital lease obligations and a $3.1 million decrease in proceeds from sale
of common stock on exercise of options.
The Company had a consolidated working capital deficit of $11.9 million at
December 31, 2003, a decrease of $14.6 million compared to a consolidated
working capital surplus of $2.7 million at December 31, 2002. The decrease was
primarily due to the $17.3 million increase in the current portion of long-term
debt. Additional expenses for furniture, fixtures and equipment and related cost
to move into the new office complex increased accounts payable and related
expenses by $2.9 million. An increase in cash and equivalents as well as
investments available for sale reduced the deficit by $6.8 million. The $11.9
million working capital deficit at December 31, 2003 would have been a $2.3
million working capital deficit excluding the current portion of deferred
revenue and fees in excess of the current portion 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 ($51.7 million during 2003) and the Company's contractual
commitment to refrain from discretionary treasury stock purchases until the
purchase line of credit is repaid, the Company does not expect any difficulty in
meeting its financial obligations in the short term or the long term.
The Company generally advances significant commissions to associates at the
time a Membership is sold. The Company expenses these advances ratably over the
first month of the related Membership. During 2003, the Company paid advance
commissions to associates of $113.0 million on new Membership sales compared to
$118.9 million for 2002. Since approximately 95% of Membership fees are
collected on a monthly basis, a significant cash flow deficit is created on a
per Membership basis at the time a Membership is sold. Since there are no
further commissions paid on a Membership during the advance period, the Company
typically derives significant positive cash flow from the Membership over its
remaining life. See Commissions to Associates above for additional information
on advance commissions.
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 8,000,000 shares during subsequent board meetings. At December 31,
2003, the Company had purchased 7.6 million treasury shares under these
authorizations for $173.4 million, an average price of $22.74 per share.
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, however, due to restrictions contained in the Company's
debt agreements with lenders, the Company is prohibited from purchasing treasury
stock with any funds other than the $25 million loan proceeds until the loan is
repaid. At December 31, 2003, the Company had approximately $10.8 million
available to purchase additional treasury shares. No time limit has been set for
completion of the treasury stock purchase program. Given the current interest
rate environment, the nature of other investments available and the Company's
expected cash flows, management believes that purchasing treasury shares
enhances shareholder value. The Company expects to continue its treasury stock
program and may seek alternative sources of financing to continue or accelerate
the program.
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 December 31, 2003 of $47.4 million. The
Company expects to maintain cash and cash equivalents and investment balances on
an on-going basis of approximately $20 million to $30 million in order to meet
expected working capital needs and regulatory capital requirements. Balances in
excess of this amount would be used for discretionary purposes such as treasury
stock purchases, after repayment of the stock purchase line of credit.
As more fully discussed in Item-2 - Description of Property, the Company
just completed a new office complex, containing approximately 170,000 square
feet of office space, and constructed on approximately 87 acres contributed to
the Company by the City of Ada in 2001 as part of an economic development
incentive package. Costs incurred through December 31, 2003 of approximately
$30.7 million, including $706,000 in capitalized interest costs, have been paid
from existing resources and proceeds from a $20 million line of credit for the
new office construction. The Company has entered into construction contracts in
the amount of $28.9 million with the general contractor pertaining to the new
office complex. Total remaining costs of completion pursuant to these contracts
from January 1, 2004 are estimated at approximately $3.1 million and will be
funded from existing resources and cash flow from operations.
On June 11, 2002, the Company entered into two line of credit agreements
totaling $30 million with a commercial lender providing for a treasury stock
purchase line and a real estate line for funding of the Company's new corporate
office complex. The treasury stock line of credit provided for funding of up to
$10 million to finance treasury stock purchases and has been repaid. The real
estate line of $20 million was fully funded in December 2003 with interest at
the 30 day LIBOR Rate plus 2.25%, adjusted monthly, and is repayable beginning
December 31, 2003 in monthly principal payments of $191,000 plus interest with a
balloon payment on September 30, 2008. The loan is primarily collateralized by a
first mortgage on the 87 acre construction site, the 170,000 square foot home
office complex, the Company's rights to receive Membership fees on a portion of
its Memberships and by a security interest covering all equipment. The interest
rate at December 31, 2003 was 3.42% for the real estate loan and the real estate
loan agreement provides for the same financial covenants described below for the
2003 $25 million credit facility.
During the 2003 third quarter, the Company arranged $25 million in
additional financing from a group of banks, consisting of Bank of Oklahoma,
Comerica Bank and First United Bank and Trust. The $25 million was fully funded
on November 30, 2003. The financing provided up to $25 million for treasury
stock purchases with scheduled monthly principal payments of $1,389,000
beginning December 31, 2003 through May 31, 2005 with interest at the 30 day
LIBOR Rate plus three percent, adjusted monthly. The interest rate at December
31, 2003 was 4.17% for the treasury stock loan. The loan is primarily
collateralized by the Company's rights to receive Membership fees on a portion
of its Memberships and a pledge of the stock of its subsidiaries. The definitive
agreement contains covenants similar to those in the Company's previous line of
credit, including provisions prohibiting the Company from pledging assets,
incurring additional indebtedness and selling assets. The loan agreement also
prohibits the Company from purchasing treasury stock with any funds other than
the $25 million loan proceeds until the loan is repaid. In addition to customary
events of default, an additional event of default occurs if Harland C.
Stonecipher ceases to be the chairman and Chief Executive Officer of the Company
for 90 days. Pre-payment of the loan is permitted.
The loan agreements contain the following financial covenants: (a) the
Company's quarterly Debt Coverage Ratio (as defined in the loan agreements)
shall not be less than 125%; (b) the Company's cancellation rate on contracts
less than or equal to twelve months old shall not exceed 45% on a trailing 12
month basis, calculated on a monthly basis, (c) the Company shall maintain a
rolling twelve month average retention rate of Membership contracts in place for
greater than eighteen months of not less than 70%, calculated on a monthly
basis, (d) commencing December 31, 2003 and for each quarter thereafter Net
Worth shall increase by the amount as of September 30, 2003 minus the amount of
stock repurchased since the date of the loan plus 50% of quarterly net income
and shall never fall below zero, and (e) the Company's dividends to
shareholders, if declared, are limited to $1.8 million per quarter.
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 PPLCI and 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, or any
of the Company's regulated subsidiaries, will be funded by the Company in the
form of capital contributions or surplus debentures. During February 2004, the
Company made a capital contribution to a wholly-owned subsidiary of PPLCI,
Pre-Paid Legal Services of Tennessee, Inc. in the amount of $600,000. At
December 31, 2003, PPLSIF did not have funds available for payment of
substantial dividends without the prior approval of the insurance commissioner.
While PPLCI had approximately $3.5 million in surplus funds available for
payment of an ordinary dividend in December 2002, no such dividend was declared
or paid during 2003. At December 31, 2003 PPLCI had approximately $750,000
available for payment of an ordinary dividend. At December 31, 2003 the amount
of restricted net assets of consolidated subsidiaries was $16.7 million.
Contractual Obligations
The following table reflects the Company's contractual obligations as of
December 31, 2003.
Payments Due by Period (In Thousands)
-----------------------------------------------------------
More
Less than than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
--------- --------- --------- --------- ---------
Long-term debt.................................... $ 43,421 $ 18,953 $ 11,516 $ 12,952 $ -
Purchase obligations (1).......................... 9,486 4,721 4,765 - -
Contractual obligations related to construction in
progress (2).................................... 4,770 4,770 - - -
Capital leases.................................... 2,621 67 933 142 1,479
Deferred compensation plan........................ 1,445 - - - 1,445
Operating leases.................................. 311 67 134 110 -
--------- --------- --------- --------- ---------
Total (3)......................................... $ 62,054 $ 28,578 $ 17,348 $ 13,204 $ 2,924
--------- --------- --------- --------- ---------
(1) Includes contractual commitments pursuant to executory contracts for
products and services such as voice and data services and contractual
obligations related to future Company events such as hotel room blocks,
meeting space and food and beverage guarantees. The Company expects to
receive proceeds from such future events and reimbursement from provider
law firms for certain voice and data services that will partially offset
these obligations.
(2) Primarily related to remaining amounts pursuant to contracts entered into
with the general contractor pertaining to the new corporate headquarters as
well as other ancillary vendors.
(3) Does not include commitments for attorney provider payments, commissions,
etc. which are expected to remain in existence for several years but as to
which the Company's obligations vary directly either based on Membership
revenues or new Memberships sold and are not readily estimable.
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,
discussions with the staff of the SEC, 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
December 31, 2003 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 which could affect our financial
condition or results of operations.
Our future results may be adversely affected if Membership persistency or
renewal rates are lower than our historical experience.
The Company has over 20 years of actual historical experience to measure
the expected retention of new members. These retention rates could be adversely
affected by the quality of services delivered by provider law firms, the
existence of competitive products or services, the Company's ability to provide
administrative services to members or other factors. If the Company's Membership
persistency or renewal rates are less than the Company has historically
experienced, the Company's cash flow, earnings and growth rates could be
adversely affected.
The Company may not be able to grow Memberships and earnings at the same
rate as it has historically experienced and has recently experienced declines in
new membership sales and associate recruitment.
The Company's year end active Memberships have increased 3%, 11% and 17% in
the years ended December 31, 2003, 2002 and 2001, respectively. Net income for
the same three years has increased 11%, 33% and 32%, respectively. However,
beginning in the fourth quarter of 2002 and continuing in each quarter of 2003,
the Company experienced declines in new Memberships sold and during four of
these five quarters also had a decline in the number of associates recruited
compared to the comparable quarter of the prior year. The Company's ability to
grow Memberships and earnings is substantially dependent upon its ability to
expand or enhance the productivity of its sales force, develop additional legal
expense products, develop alternative marketing methods or expand
geographically. There is no assurance that the Company will be able to achieve
increases in Membership and earnings growth comparable to its historical growth
rates.
The Company is dependent upon the continued active participation of its
principal executive officer.
The success of the Company depends substantially on the continued active
participation of its principal executive officer, Harland C. Stonecipher.
Although the Company's management includes other individuals with significant
experience in the business of the Company, the loss of the services of Mr.
Stonecipher could have a material adverse effect on the Company's financial
condition and results of operations.
There is litigation pending that may have a material adverse effect on the
Company if adversely determined.
See "Item 3. Legal Proceedings".
The Company is in a regulated industry and regulations could have an
adverse effect on the Company's ability to conduct its business.
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, State Bar Associations and State Attorney General's
Offices, depending on individual state positions regarding regulatory
responsibility for prepaid legal expense plans. Regulation of the Company's
activities is inconsistent among the various states in which the Company does
business with some states regulating legal expense plans as insurance or
specialized legal expense products and others regulating such plans as services.
Such disparate regulation requires the Company to structure its Memberships and
operations differently in certain states in accordance with the applicable laws
and regulations. The Company's multi-level marketing strategy is also subject to
U.S. federal, Canadian provincial and U.S. state regulation under laws relating
to consumer protection, pyramid sales, business opportunity, lotteries and
multi-level marketing. Changes in the regulatory environment for the Company's
business could increase the compliance costs the Company incurs in order to
conduct its business or limit the jurisdictions in which the Company is able to
conduct business.
The business in which the Company operates is competitive.
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect the Company's
ability to grow. In addition, the Company may face competition from a growing
number of Internet based legal sites with the potential to offer legal and
related services at competitive prices. Increased competition could have a
material adverse effect on the Company's financial condition and results of
operations. See "Description of Business - Competition".
The Company is dependent upon the success of its marketing force.
The Company's principal method of product distribution is through
multi-level marketing. The success of a multi-level marketing force is highly
dependent upon the Company's ability to offer a commission and organizational
structure and sales training and incentive program that enable sales associates
to recruit and develop other sales associates to create an organization. There
are a number of other products and services that use multi-level marketing as a
distribution method and the Company must compete with these organizations to
recruit, maintain and grow its multi-level marketing force. In order to do so,
the Company may be required to increase its marketing costs through increases in
commissions, sales incentives or other features, all of which could adversely
affect the Company's future earnings. In addition, the level of confidence of
the sales associates in the Company's ability to perform is an important factor
in maintaining and growing a multi-level marketing force. Adverse financial
developments concerning the Company, including negative publicity or common
stock price declines, could adversely affect the ability of the Company to
maintain the confidence of its sales force.
The Company's stock price may be affected by the significant level of short
sellers of the Company's stock.
As of February 10, 2004, the New York Stock Exchange reported that
approximately 8.2 million shares of the Company's stock were sold short, which
constitutes approximately 49% of the Company's outstanding shares and 73% of its
public float, representing one of the largest short interest percentages of any
New York Stock Exchange listed company. Short sellers expect to make a profit if
the Company's shares decline in value. The Company has been the subject of a
negative publicity campaign from several known sources of information who
support short sellers. The existence of this short interest position may
contribute to volatility in the Company's stock price and may adversely affect
the ability of the Company's stock price to rise if market conditions or the
Company's performance would otherwise justify a price increase.
The Company has not been able to increase significantly its employee group
membership sales.
The Company's success in growing membership sales is dependent in part on
its ability to market to employee groups. In 2003, group memberships declined to
25% of total memberships at year end compared to 27% at December 31, 2002.
Adverse publicity about the Company may affect the Company's ability to market
successfully to employee groups, particularly larger groups. There is no
assurance that the Company will be able to increase its group business. ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 December 31, 2003, substantially all of the Company's investments
were in investment grade (rated Baa or higher) fixed-maturity investments and
interest-bearing money market accounts including certificates of deposit. 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:
Hypothetical change Estimated fair value
in interest rate after hypothetical
Fair value (bp = basis points) change in interest rate
---------- ------------------- -----------------------
(Dollars in thousands)
Fixed-maturity investments at December 31, 2003 (1).... $ 27,052 100 bp increase $ 26,009
200 bp increase 24,977
50 bp decrease 27,451
100 bp decrease 27,904
Fixed-maturity investments at December 31, 2002 (1).... $ 16,111 100 bp increase $ 14,740
200 bp increase 13,806
50 bp decrease 16,310
100 bp decrease 16,794
(1) Excluding short-term investments with a fair value of $2.4 million and $2.7
million at December 31, 2003 and 2002, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2003 would reduce
the estimated fair value of the Company's fixed-maturity investments by
approximately $2.1 million at that date. At December 31, 2002, and based on
the fair value of fixed-maturity investments of $16.1 million, 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 $2.3 million at that date. The Company's $11
million increase in fixed-maturity investments from $16.1 million at
December 31, 2002 to $27.1 million at December 31, 2003 was primarily from
the $10 million increase in daily variable interest rate municipal bonds.
The Company's decreased sensitivity to rising interest rates is due to the
$1.0 million decrease in long term fixed-maturity corporate obligation
investments and a $1 million increase in mid-term U.S. Government
investments. 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.
Interest Rate Risk
The Company is exposed to market risk related to changes in interest rates.
As of December 31, 2003, the Company had $43.4 million in notes payable
outstanding at interest rates indexed to the 30 day LIBOR rate that exposes it
to the risk of increased interest costs if interest rates rise. Assuming a 100
basis point increase in interest rates on the floating rate debt, interest
expense would increase by approximately $400,000. Additionally, the Company had
$10.0 million invested in floating rate municipal bonds at year end. Assuming a
100 basis point decrease in interest rates on the bonds, interest income would
be reduced by approximately $100,000. As of December 31, 2003, the Company had
not entered into any interest rate swap agreements with respect to the term
loans or the floating rate municipal bonds.
Foreign Currency Exchange Rate Risk
Although the Company is exposed to foreign currency exchange rate risk
inherent in revenues, net income and assets and liabilities denominated in
Canadian dollars, the potential change in foreign currency exchange rates is not
a substantial risk, as approximately 1% of the Company's revenues are derived
outside of the United States.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants
Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2003 and 2002
Consolidated Statements of Income - For the years ended December 31, 2003, 2002
and 2001
Consolidated Statements of Cash Flows - For the years ended December 31, 2003,
2002 and 2001
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
Financial Statement Schedules
Schedule I - Condensed Financial Information of the Registrant
(All other schedules have been omitted since the required information is
not applicable or because the information is included in the
consolidated financial statements or the notes thereon.)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. and subsidiaries (the "Company") as of December 31, 2003 and
2002, and the related consolidated statements of income, cash flows and changes
in stockholders' equity for each of the three years in the period ended December
31, 2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2003 and 2002 and for each of
the three years in the period ended December 31, 2003. In our opinion, this
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information therein.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2004
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
------------------------
2003 2002
------------ ----------
Current assets:
Cash and cash equivalents............................................................ $ 21,459 $ 20,858
Available-for-sale investments, at fair value........................................ 10,203 3,970
Membership fees receivable........................................................... 4,575 5,247
Inventories.......................................................................... 857 1,212
Refundable income taxes.............................................................. 331 275
Deferred member and associate service costs.......................................... 14,215 13,639
Deferred income taxes................................................................ 4,894 4,603
------------ ----------
Total current assets............................................................. 56,534 49,804
Available-for-sale investments, at fair value.......................................... 15,711 11,560
Investments pledged.................................................................... 4,253 4,160
Property and equipment, net............................................................ 47,004 25,593
Deferred member and associate service costs............................................ 2,375 2,991
Other assets........................................................................... 5,135 2,728
------------ ----------
Total assets................................................................... $ 131,012 $ 96,836
------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 9,289 $ 8,610
Deferred revenue and fees............................................................ 23,763 22,612
Current portion of capital leases payable............................................ 19 14
Current portion of notes payable..................................................... 18,953 2,412
Accounts payable and accrued expenses................................................ 16,380 13,498
------------ ----------
Total current liabilities.......................................................... 68,404 47,146
Capital leases payable............................................................... 1,687 912
Notes payable........................................................................ 24,468 8,221
Deferred revenue and fees............................................................ 3,330 4,266
Deferred income taxes................................................................ 2,104 1,319
Other non-current liabilities........................................................ 1,445 -
------------ ----------
Total liabilities................................................................ 101,438 61,864
------------ ----------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 21,674 and
23,688 issued at December 31, 2003 and 2002, respectively.......................... 217 237
Capital in excess of par value....................................................... - 43,219
Retained earnings.................................................................... 127,576 90,254
Accumulated other comprehensive income............................................... 809 290
Treasury stock, at cost; 4,852 and 4,852 shares held at
December 31, 2003 and 2002, respectively........................................... (99,028) (99,028)
------------ ----------
Total stockholders' equity....................................................... 29,574 34,972
------------ ----------
Total liabilities and stockholders' equity..................................... $ 131,012 $ 96,836
------------ ----------
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)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 330,322 $ 308,401 $ 263,514
Associate services................................................... 25,704 37,418 36,485
Other................................................................ 5,287 4,804 3,662
------------- ------------- -------------
361,313 350,623 303,661
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 111,165 103,761 87,429
Commissions.......................................................... 115,386 119,371 111,060
Associate services and direct marketing.............................. 28,929 32,566 29,879
General and administrative........................................... 36,711 33,256 28,243
Other, net........................................................... 8,546 6,685 5,917
------------- ------------- -------------
300,737 295,639 262,528
------------- ------------- -------------
Income from continuing operations before income taxes.................. 60,576 54,984 41,133
Provision for income taxes............................................. 20,669 18,970 13,519
------------- ------------- -------------
Income from continuing operations...................................... 39,907 36,014 27,614
Loss from operations of discontinued UFL segment (net of
applicable income tax benefit of $0)................................. - - (504)
------------- ------------- -------------
Net income............................................................. $ 39,907 $ 36,014 $ 27,110
------------- ------------- -------------
Basic earnings per common share from continuing operations............. $ 2.28 $ 1.83 $ 1.28
Basic earnings per common share from discontinued operations........... - - (.02)
------------- ------------- -------------
Basic earnings per common share........................................ $ 2.28 $ 1.83 $ 1.26
------------- ------------- -------------
Diluted earnings per common share from continuing operations........... $ 2.27 $ 1.82 $ 1.28
Diluted earnings per common share from discontinued operations......... - - (.02)
------------- ------------- -------------
Diluted earnings per common share...................................... $ 2.27 $ 1.82 $ 1.26
------------- ------------- -------------
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)
Year Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Net income.................................................................. $ 39,907 $ 36,014 $ 27,110
Adjustments to reconcile net income to net cash provided by operating
activities:
Loss from UFL's discontinued operations................................... - - 504
Provision (benefit) for deferred income taxes............................. 288 102 (1,314)
Depreciation and amortization............................................. 7,082 5,272 4,135
Tax benefit on exercise of stock options.................................. 234 1,104 82
Compensation expense relating to contribution of stock to ESOP............ 220 207 162
Decrease (increase) in accrued Membership income.......................... 672 225 (909)
Decrease (increase) in inventories........................................ 355 (290) 620
(Increase) in refundable income taxes..................................... (56) (275) -
Decrease (increase) in deferred member and associate service costs........ 40 505 (3,016)
(Increase) decrease in other assets....................................... (2,407) 3,234 614
Increase in accrued Membership benefits................................... 679 946 833
Increase in deferred revenue and fees..................................... 215 1,827 3,838
Increase in other non-current liabilities................................. 1,445 - -
(Decrease) increase in income taxes payable............................... - (1,087) 327
Increase in accounts payable and accrued expenses and other............... 3,019 4,289 4,815
--------- --------- ---------
Net cash provided by operating activities............................... 51,693 52,073 37,801
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of UFL................................................. - - 1,200
Dividends received from UFL............................................... - - 2,800
Additions to property and equipment....................................... (27,012) (15,184) (8,326)
Purchases of investments - available for sale............................. (15,695) (12,280) (12,642)
Maturities and sales of investments - available for sale.................. 5,806 16,390 10,005
--------- --------- ---------
Net cash used in investing activities................................... (36,901) (11,074) (6,963)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of debt............................................ 42,700 12,300 -
Repayments of debt........................................................ (9,912) (1,667) -
Proceeds from exercise of stock options................................... 2,014 5,088 1,022
Purchases of treasury stock............................................... (48,292) (50,152) (28,213)
Proceeds from other financing............................................. 1,000 - -
Decrease in capital lease obligations..................................... (1,701) - (223)
--------- --------- ---------
Net cash used in financing activities................................... (14,191) (34,431) (27,414)
--------- --------- ---------
Net increase in cash and cash equivalents................................... 601 6,568 3,424
Cash and cash equivalents at beginning of year.............................. 20,858 14,290 10,866
--------- --------- ---------
Cash and cash equivalents at end of year.................................... $ 21,459 $ 20,858 $ 14,290
--------- --------- ---------
Supplemental disclosure of cash flow information:
Net cash used in discontinued operations.................................. $ - $ - $ (704)
--------- --------- ---------
Cash paid for interest, net of amount capitalized......................... $ 78 $ - $ 2
--------- --------- ---------
Cash paid for income taxes................................................ $ 20,200 $ 19,116 $ 12,700
--------- --------- ---------
Non-cash activities - capital lease obligations incurred.................. $ 2,481 $ 926 $ -
--------- --------- ---------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts and shares in 000's, except dividend rates and par values)
Accumulated
Capital in Other
Common Stock Excess of Retained Comprehensive Treasury Stock
Shares Amount Par Value Earnings Income (Loss)1 Shares Amount Total
------- ------- -------- -------- --------------- ----- --------- -------
January 1, 2001 24,740 $ 247 $ 64,958 $ 27,130 $ (108) 2,480 $(50,460) $41,767
Contributed to Company's ESOP plan. 6 - 162 - - - - 162
Exercise of stock options and other 60 1 1,021 - - - - 1,022
Income tax benefit related to exercise
of stock options................. - - 82 - - - - 82
Net income......................... - - - 27,110 - - - 27,110
Other comprehensive income......... - - - - 294 - - 294
Treasury shares purchased.......... - - - - - 1,509 (28,213) (28,213)
------- ------- -------- -------- --------------- ----- --------- -------
December 31, 2001 24,806 248 66,223 54,240 186 3,989 (78,673) 42,224
Contributed to Company's ESOP plan. 10 - 207 - - - - 207
Exercise of stock options and other 314 3 5,085 - - - - 5,088
Income tax benefit related to exercise
of stock options................. - - 1,104 - - - - 1,104
Subscriptions receivable retired (net
of additional advances of $489 and
interest recognized of $85)...... - - 383 - - - - 383
Net income......................... - - - 36,014 - - - 36,014
Other comprehensive income......... - - - - 104 - - 104
Treasury shares purchased.......... - - - - - 2,305 (50,152) (50,152)
Treasury shares retired............ (1,442) (14) (29,783) - - (1,442) 29,797 -
------- ------- -------- -------- --------------- ----- --------- -------
December 31, 2002 23,688 237 43,219 90,254 290 4,852 (99,028) 34,972
Contributed to Company's ESOP plan. 8 - 220 - - - - 220
Exercise of stock options and other 105 - 2,014 - - - - 2,014
Income tax benefit related to exercise -
of stock options................. - - 234 - - - 234
Net income......................... - - - 39,907 - - - 39,907
Other comprehensive income......... - - - - 519 - - 519
Treasury shares purchased.......... - - - - - 2,127 (48,292) (48,292)
Treasury shares retired............ (2,127) (20) (45,687) (2,585) - (2,127) 48,292 -
------- ------- -------- -------- --------------- ----- --------- -------
December 31, 2003.................... 21,674 $ 217 $ - $127,576 $ 809 4,852 $(99,028) $29,574
------- ------- -------- -------- --------------- ----- --------- -------
(1) Other Comprehensive Income Year Ended December 31,
------------------------------
2003 2002 2001
--------- --------- ---------
Net income.................................................................... $ 39,907 $ 36,014 $ 27,110
--------- --------- ---------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment..................................... 137 85 (7)
--------- --------- ---------
Unrealized gains on investments:
Unrealized holding gains arising during period,........................... 469 75 299
Less: reclassification adjustment for (gains) losses included in net (87) (56) 2
--------- --------- ---------
income......................................................................
382 19 301
--------- --------- ---------
Other comprehensive income, net of income taxes of $206, $11 and $162 in 2003,
2002 and 2001, respectively................................................. 519 104 294
--------- --------- ---------
Comprehensive income.......................................................... $ 40,426 $ 36,118 $ 27,404
--------- --------- ---------
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)
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Pre-Paid Legal Services, Inc. (the "Parent") and subsidiaries
(collectively, the "Company") develops and markets legal service plans (referred
to as "Memberships"). The Memberships sold by the Company allow members to
access legal services through a network of independent law firms ("provider law
firms") under contract with the Company. During the third quarter of 2003, the
Company began offering its Identity Theft Shield to new and existing members at
$9.95 per month if added to a legal service Membership or it may be purchased
separately for $12.95 per month. The nationwide provider of the Identity Theft
Shield benefits and the Provider law firms are paid a fixed fee on a capitated
basis to render services to plan members residing within the state or province
in which the provider law firm is licensed to practice. Because the fixed fee
payments by the Company to benefit providers do not vary based on the type and
amount of benefits utilized by the member, this capitated arrangement provides
significant advantages to the Company in managing claims risk. At December 31,
2003, Memberships subject to the provider law firm arrangement comprised
approximately 99% of the Company's active Memberships. The remaining
Memberships, approximately 1%, were primarily sold prior to 1987 and allow
members to locate their own lawyer to provide legal services available under the
Membership with the member's lawyer being reimbursed for services rendered based
on usual, reasonable and customary fees. Memberships are generally guaranteed
renewable and Membership fees are principally collected on a monthly basis,
although approximately 5% of Members have elected to pay their fees in advance
on an annual or semi-annual basis. At December 31, 2003, the Company had
1,418,997 Memberships in force with members in all 50 states, the District of
Columbia and the Canadian provinces of Ontario, British Columbia, Alberta and
Manitoba. Approximately 90% of the Memberships were in 29 states. The
Memberships are marketed by an independent sales force referred to as
"associates".
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, as well as those of PPL Agency, Inc. (See
Note 10 for additional information regarding PPL Agency, Inc.). The primary
subsidiaries of the Company include Pre-Paid Legal Casualty, Inc. ("PPLCI") and
Pre-Paid Legal Services, Inc. of Florida ("PPLSIF"). All significant
intercompany accounts and transactions have been eliminated.
Notes 6 and 12 and the first two paragraphs of Note 10 to these
consolidated financial statements relate to the Parent.
Foreign Currency Translation
The financial results of the Company's Canadian operations are measured in
its local currency and then translated into U.S. dollars. All balance sheet
accounts have been translated using the current rate of exchange at the balance
sheet date. Results of operations have been translated using the average rates
prevailing throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash, certificates
of deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by the Company,
using available market information and appropriate valuation methodologies. The
carrying value of cash, certificates of deposit, Membership fees receivable,
Membership benefits payable and accounts payable and accrued expenses are
considered to be representative of their respective fair value, due to the short
term nature of these instruments. The carrying value of notes payable is
considered to be representative of their respective fair value, due to the
variable interest rate feature of such notes. The fair value disclosures
relating to debt and equity securities are presented in Note 3.
Cash and Cash Equivalents
The Company considers all highly liquid unpledged investments with
maturities of three months or less at time of acquisition to be cash
equivalents. The Company maintains its cash balances in financial institutions,
which at times, may exceed federally insured limits. The Company has not
experienced any losses in such accounts and believes it is not exposed to any
significant credit risk on cash and cash equivalents.
Investments
The Company classifies its investments held as available for sale and
accounts for them at fair value with unrealized gains and losses, net of taxes,
excluded from earnings and reported as other comprehensive income. The Company
classifies available-for-sale securities as current if the Company expects to
sell the securities within one year, or if the Company intends to utilize the
securities for current operations. All other available-for-sale securities are
classified as non-current.
All investment securities are adjusted for amortization of premiums and
accretion of discounts. Amortization of premiums and accretion of discounts are
recorded to income over the contractual maturity or estimated life of the
individual investment on the level yield method. Gain or loss on sale of
investments is based upon the specific identification method. Income earned on
the Company's investments in certain state and political subdivision debt
instruments is not generally taxable for federal income tax purposes.
Membership fees receivable
The Company's Membership fees receivable consists of amounts due from
members for services provided pursuant to their Membership contract. Membership
fees are principally collected on a monthly basis. Membership fees receivable is
a result of a portion of members, mostly group members, who pay their Membership
fees in arrears and are recorded at amounts due under the terms of the
Membership agreement. An allowance for doubtful accounts is not necessary as the
recorded amount is adjusted to net realizable value at period-end based on the
Company's historical experience and the short period of time after period-end in
which the accounts will be collected.
Inventories
Inventories include the cost of materials and packaging and are stated at
the lower of cost or market.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and
amortization. Depreciation of property and equipment is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the estimated useful lives of the related assets
or the period of the lease, whichever is shorter. Maintenance and repairs are
expensed as incurred and renewals and betterments are capitalized. Interest cost
incurred during the construction period of major facilities is capitalized. The
capitalized interest is recognized as part of the asset to which it relates and
is amortized over the asset's estimated useful life.
Revenue recognition - Membership and Associate Fees
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis, of which approximately 73% are paid in advance and, therefore,
are deferred and recognized over the following month.
The Company also charges new members, who are not part of an employee
group, a $10 enrollment fee. This enrollment fee and related incremental direct
and origination costs are deferred and recognized in income over the estimated
life of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101"). The Company computes
the expected Membership life using more than 20 years of actuarial data. At
December 31, 2003, management computed the expected Membership life to be
approximately 3 years. If the expected Membership life were to change
significantly, which management does not expect in the short term, the deferred
Membership enrollment fee and related costs would be recognized over a longer or
shorter period.
The Company derives revenues from services provided to its marketing sales
force from a one-time non-refundable enrollment fee of $65 from each new sales
associate for which the Company provides initial sales and marketing supplies
and enrollment services to the associate. Revenue from, and costs of, the
initial sales and marketing supplies (approximately $11) are recognized when the
materials are delivered to the associates. The remaining $54 of revenues and
related incremental direct and origination costs are deferred and recognized
over the estimated average active service period of associates which at December
31, 2003 is estimated to be approximately six months. Management estimates the
active service period of an associate periodically based on the average number
of months an associate produces new Memberships including those associates that
fail to write any Memberships. If the active service period of associates
changes significantly, the deferred revenue and related costs will be recognized
over the new estimated active service period.
The Company also encourages participation in a training program ("Fast
Start") that allows an associate who successfully completes the program to
advance through the various commission levels at a faster rate. Associates
participating in this training program typically pay a fee ranging from $34 to
$184, depending on special promotions the Company implements from time to time.
The fee covers the additional training and materials used in the training
program, and is recognized in income upon completion of the training. Associate
services revenue also includes revenue recognized on the sale of marketing
supplies and promotional material to associates and includes fees related to the
Company's eService program for associates. The eService program provides
subscribers Internet based back office support such as reports, on-line
documents, tools, a personal e-mail account and multiple personalized web sites
with "flash" movie presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs the
Company incurs in enrolling new Members and new associates related to the
deferred revenue discussed above, and that portion of payments made to provider
law firms and associates related to deferred Membership revenue. Deferred costs
for enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments. Deferred costs
for enrolling new associates include training and success bonuses paid to
individuals involved in recruiting the associate and salary and benefit costs of
employees who process associate enrollments. Such costs are deferred to the
extent of the lesser of actual costs incurred or the amount of the related fee
charged for such services. Deferred costs are amortized to expense over the same
period as the related deferred revenue. Deferred costs that will be recognized
within one year of the balance sheet date are classified as current and all
remaining deferred costs are considered noncurrent. Associate related costs are
reflected as associate services and direct marketing, and are expensed as
incurred if not related to the deferred revenue discussed above. These costs
include providing materials and services to associates, Fast Start bonuses,
associate introduction kits, the associate incentive program, group marketing
and marketing services departments (including costs of related travel, marketing
events, leadership summits and international sales convention).
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due the
provider of Identity Theft Shield benefits and provider law firms on
approximately 99% of the Memberships and claims reported but not paid and
actuarially estimated claims incurred but not reported on the remaining
non-provider Memberships which represent approximately 1%. The Company
calculates the benefit liability on the non-provider Memberships based on
completion factors that consider historical claims experience based on the dates
that claims are incurred, reported to the Company and subsequently paid.
Processing costs related to these claims are accrued based on an estimate of
expenses to process such claims.
Income Taxes
The Company accounts for income taxes using the asset and liability
approach that requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that are recognized in
different periods in the Company's financial statements and tax returns. In
estimating future tax consequences, the Company generally considers all future
events other than future changes in the tax law or rates that have not been
enacted.
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
The Company records deferred tax assets related to the recognition of future tax
benefits of temporary differences and net operating loss and tax credit
carryforwards. To the extent that realization of such benefits is not considered
more likely than not, the Company establishes a valuation allowance to reduce
such assets to the estimated realizable amount.
Commissions to Associates
Prior to March 1, 2002, the Company had a level Membership commission
schedule of approximately 27% of Membership fees and advanced the equivalent of
up to three years of commissions on new Membership sales. 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 rates of approximately 80% of first year Membership premiums on new
Memberships written and variable renewal commission rates ranging from five to
25% per annum based on the 12 month Membership retention rate of the associate's
sales organization. Beginning in August 2003, the Company allowed the associate
to choose between the level commission structure and up to three year commission
advance or the differential commission structure with a one year commission
advance.
The Company expenses advance commissions ratably over the first month of
the related Membership. As a result of this accounting policy, the Company's
advance commission expenses are recorded in the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. Associates must qualify for advance commissions
by writing at least three Memberships.
Long-Lived Assets
The Company reviews long-lived assets to be held and used in operations
when events or changes in circumstances indicate that the assets might be
impaired. The carrying value of long-lived assets is considered impaired when
the identifiable undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair value of the
long-lived asset. Fair value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. Losses on
long-lived assets to be disposed of are determined in a similar manner, except
that fair values are reduced by disposal costs.
Stock-Based Compensation
The Company has a stock-based employee compensation plan, which is
described more fully in Note 13. The Company accounts for this plan under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related Interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
2003 2002 2001
--------- --------- ---------
Net income, as reported................................................... $ 39,907 $ 36,014 $ 27,110
Deduct: Total stock-based employee compensation expense determined under
fair value based method for all awards, net of related tax effects........ (860) (3,201) (2,471)
--------- --------- ---------
Pro forma net income...................................................... $ 39,047 $ 32,813 $ 24,639
--------- --------- ---------
Earnings per share:
Basic - as reported................................................... $ 2.28 $ 1.83 $ 1.26
Basic - pro forma..................................................... $ 2.23 $ 1.67 $ 1.15
Diluted - as reported................................................. $ 2.27 $ 1.82 $ 1.26
Diluted - pro forma................................................... $ 2.22 $ 1.66 $ 1.14
The estimated fair value of options granted to employees was estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions used: no dividend yield; risk-free
interest rate of 2.38% for 2003, 3.06% for 2002 and 4.09% for 2001; expected
life of 3-5 years; and expected volatility for the years ending December 31,
2003, 2002 and 2001 were 55.9%, 59.3% and 63.1%, respectively. Using these
assumptions, the weighted average fair values at date of grant for options
granted during 2003, 2002 and 2001 were $8.63, $9.86 and $8.58, respectively.
The exercise of certain stock options which have been granted gives rise to
compensation which is includable in the taxable income of the option grantee and
deductible by the Company for federal and state income tax purposes. Such
compensation results from increases in the fair market value of the Company's
common stock subsequent to the date of grant of the applicable exercised stock
options, and in accordance with Accounting Principles Board Opinion No. 25, such
compensation is not recognized as an expense for financial accounting purposes
and the related tax benefits are recorded in capital in excess of par value.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. Changes to any of these
assumptions would directly affect the amount accrued but the Company does not
expect any of the significant trends impacting this account to change
significantly in the near term.
Legal Contingencies
The Company accounts for legal contingencies in accordance with SFAS 5,
Accounting for Contingencies, which requires that a loss contingency should be
accrued by a charge to income if it is probable that an asset has been impaired
or a liability has been incurred and the amount of the loss can be reasonably
estimated. Disclosure of a contingency is required if there is at least a
reasonable possibility that a loss has been incurred. The Company evaluates,
among other factors, the degree of probability of an unfavorable outcome and the
ability to make a reasonable estimate of the amount of loss. This process
requires subjective judgment about the likely outcomes of litigation.
Liabilities related to most of the Company's lawsuits are especially difficult
to estimate due to the nature of the claims, limitation of available data and
uncertainty concerning the numerous variables used to determine likely outcomes
or the amounts recorded. Litigation expenses are recorded as incurred and the
Company does not accrue for future legal fees. It is possible that an adverse
outcome in certain cases or increased litigation costs could have an adverse
effect upon the Company's financial condition, operating results or cash flows
in particular quarterly or annual periods.
Segment Information
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosures about products and services and geographic
areas are presented in Note 16.
New Accounting Standards Issued
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, "Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity" ("SFAS 150"). SFAS No. 150 changes the accounting
for certain financial instruments that, under previous guidance, could be
classified as equity or "mezzanine" equity, by now requiring those instruments
to be classified as liabilities (or assets in some circumstances) in the
consolidated balance sheets. Further, SFAS No. 150 requires disclosure regarding
the terms of those instruments and settlement alternatives. The guidance in SFAS
No. 150 generally is effective for all financial instruments entered into or
modified after May 31, 2003, and was otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The Company has evaluated
SFAS No. 150 and determined that it does not have an impact on its financial
reporting and disclosures.
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46 (R), addresses
the application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities and results of the activity of a VIE be consolidated into the
financial statements of the enterprise that is considered the primary
beneficiary. This interpretation applies immediately to VIEs created after
January 31, 2003, and to VIEs in which a company obtains an interest after that
date. The Company has not created or obtained an interest in any VIEs in 2003.
In addition, the interpretation becomes applicable on December 31, 2003 for
special purpose entities (SPEs) created prior to February 1, 2003. As of
December 31, 2003, the company had no SPEs for which it was considered the
primary beneficiary. For non-SPEs in which a company holds a variable interest
that it acquired before February 1, 2003, the FASB has postponed the date on
which the interpretation will become applicable to March 31, 2004. The Company
has determined the adoption of the provisions of FIN 46 will not have a material
effect on its financial condition or results of operations.
In November 2003, the Emerging Issues Task Force or EITF of the FASB
reached a consensus on one issue with respect to EITF Issue 03-1, "The Meaning
of Other-Than-Temporary Impairment and its Application to Certain Investments,"
thereby requiring certain quantitative and qualitative disclosures for
securities accounted for under SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," that are impaired at the balance sheet date but
for which an other-than-temporary impairment has not been recognized. Adoption
of EITF Issue 03-1, which was effective for us on December 31, 2003, did not
have a material impact on the Company's financial position, results of
operations or cash flows. The required disclosures have been included in Note 3
to the consolidated financial statements.
In December 2003, the Staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which
supersedes SAB No. 101. The primary purpose of SAB No. 104 is to rescind
accounting guidance contained in SAB No. 101 and the SEC's "Revenue Recognition
in Financial Statements Frequently Asked Questions and Answers" (the FAQ)
related to multiple element revenue arrangements in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The Company does not expect the
issuance of SAB No. 104 to significantly impact its current revenue recognition
policies.
Note 2 - 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 resulting in no gain or loss on the sale. The results of operations of the
UFL segment have been segregated and reported as discontinued operations in the
consolidated statements of income. Details of income from discontinued
operations, net of income tax, are as follows:
Year Ended
December 31,
2001
------------
Revenues............................................................... $ 1,703
------------
Loss from discontinued operations, net of tax benefit of $0............ $ (504)
------------
Note 3 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of the Company's investments at December 31, 2003 and 2002 follows:
December 31, 2003
--------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
----------- -------- -------- ----------
U.S. Government obligations........................ $ 7,086 $ 155 $ (45) $ 7,196
Corporate obligations.............................. 4,388 337 (14) 4,711
Equity securities.................................. 417 322 - 739
Obligations of state and political subdivisions.... 14,968 203 (25) 15,146
Certificates of deposit............................ 2,375 - - 2,375
----------- -------- -------- ----------
Total.............................................. $ 29,234 $ 1,017 $ (84) $ 30,167
----------- -------- -------- ----------
December 31, 2002
--------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
----------- -------- -------- ----------
U.S. Government obligations........................ $ 5,915 $ 276 $ - $ 6,191
Corporate obligations.............................. 5,540 88 (83) 5,545
Equity securities.................................. 917 5 (56) 866
Obligations of state and political subdivisions.... 4,260 120 (5) 4,375
Certificates of deposit............................ 2,713 - - 2,713
----------- -------- -------- ----------
Total.............................................. $ 19,345 $ 489 $ (144) $ 19,690
----------- -------- -------- ----------
In determining whether declines in the fair value of available-for-sale
securities below their cost are other than temporary, management considers the
financial condition of the issuer, causes for the decline in fair value (i.e.,
interest rate fluctuations or declines in creditworthiness) and severity and
duration of the decline, among other things. The following table presents gross
unrealized losses and fair value, aggregated by investment category for
investments with unrealized losses that have not been recognized as other than
temporary. All individual securities have been in a continuous unrealized loss
position less than 12 months at December 31, 2003:
Gross
Unrealized
Fair Value Losses
---------- -----------
U. S. Government obligations....................... $ 3,534 $ (45)
Corporate obligations.............................. 1,013 (14)
Obligations of state and political subdivisions.... 763 (25)
---------- -----------
Total.............................................. $ 5,310 $ (84)
---------- -----------
The contractual maturities of the Company's available-for-sale investments
in debt securities and certificates of deposit at December 31, 2003 by maturity
date follows:
Amortized
Cost Fair Value
---------- ----------
One year or less................................... $ 2,559 $ 2,567
Two years through five years....................... 2,361 2,530
Six years through ten years........................ 6,603 6,680
More than ten years................................ 17,294 17,650
---------- ----------
Total.............................................. $ 28,817 $ 29,427
---------- ----------
The Company's investment securities are included in the accompanying
consolidated balance sheets at December 31, 2003 and 2002 as follows:
December 31,
-----------------------
2003 2002
--------- ---------
Available-for-sale investments (current)........... $ 10,203 $ 3,970
Available-for-sale investments (non-current)....... 15,711 11,560
Investments pledged................................ 4,253 4,160
--------- ---------
Total.............................................. $ 30,167 $ 19,690
--------- ---------
The Company is required to pledge investments to various state insurance
departments as a condition to obtaining authority to do business in certain
states. The fair value of investments pledged to state regulatory agencies is as
follows:
December 31,
-----------------------
2003 2002
--------- ---------
Certificates of deposit............................ $ 2,375 $ 2,243
Obligation of state and political subdivisions..... 136 139
U. S. Government obligations....................... 1,742 1,778
--------- ---------
Total.............................................. $ 4,253 $ 4,160
--------- ---------
Proceeds from sales of investments during 2003 and 2002 were $4.7 million
and $7.6 million and resulted in gross realized gains of $154,000 and $95,000
and gross realized losses of $19,000 and $9,000. Sales of investments during
2001 were not significant.
Note 4 - Property and Equipment
Property and equipment is comprised of the following:
Estimated December 31,
Useful Life 2003 2002
------------ ---------- ----------
Equipment, furniture and fixtures.......... 3-10 years $ 26,109 $ 17,696
Computer software.......................... 3 years 8,370 6,585
Building and improvements.................. 20-40 years 31,107 3,185
Automotive................................. 3 years 188 171
Construction in progress................... N/A 3,002 12,649
Land....................................... N/A 170 170
------------ ---------- ----------
68,946 40,456
Accumulated depreciation................................. (21,942) (14,863)
---------- ----------
Property and equipment, net.............................. $ 47,004 $ 25,593
---------- ----------
Construction in progress includes all construction costs, including
capitalized interest on funds borrowed, associated with the portion of the
Company's new corporate headquarters not placed in service prior to December 31,
2003. Capitalized interest on funds borrowed was $586,000 during 2003 and
$120,000 during 2002. No interest was capitalized in 2001.
Note 5 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
-----------------------
2003 2002
--------- ---------
Accounts payable................................... $ 4,875 $ 3,340
Marketing bonuses payable.......................... 1,049 1,201
Incentive awards payable........................... 4,453 3,345
Litigation accrual................................. 3,263 3,290
Other.............................................. 2,740 2,322
--------- ---------
Total.............................................. $ 16,380 $ 13,498
--------- ---------
The Company's litigation accrual increased from $1.7 million at December
31, 2000 to $2.0 million at December 31, 2001 reflecting an additional accrual
of $1.7 million and a settlement payment of $1.4 million during 2001. Due to
increased litigation during 2002 (See Note 12), the Company increased the
accrual by $1.3 million to $3.3 million at December 31, 2002 and only
insignificant changes occurred during 2003.
Note 6 - Notes Payable
On June 11, 2002, the Company entered into two line of credit agreements
totaling $30 million with a commercial lender providing for a treasury stock
purchase line and a real estate line for funding of the Company's new corporate
office complex. The treasury stock line of credit provided for funding of up to
$10 million to finance treasury stock purchases and has been repaid. The real
estate line of $20 million was fully funded in December 2003 with interest at
the 30 day LIBOR Rate plus 2.25%, adjusted monthly, and is repayable beginning
December 31, 2003 in monthly principal payments of $191,000 plus interest with a
balloon payment on September 30, 2008. The loan is primarily collateralized by a
first mortgage on the 87 acre construction site, the 170,000 square foot home
office complex, the Company's rights to receive Membership fees on a portion of
its Memberships and by a security interest covering all equipment. The interest
rate at December 31, 2003 was 3.42% for the real estate loan and the real estate
loan agreement provides for the same financial covenants described below for the
2003 $25 million credit facility.
During the 2003 third quarter, the Company arranged $25 million in
additional financing from a group of banks, consisting of Bank of Oklahoma,
Comerica Bank and First United Bank and Trust. The $25 million was fully funded
on November 30, 2003. The financing provided up to $25 million for treasury
stock purchases with scheduled monthly principal payments of $1.4 million
beginning December 31, 2003 through May 31, 2005 with interest at the 30 day
LIBOR Rate plus three percent, adjusted monthly. The interest rate at December
31, 2003 was 4.17% for the treasury stock loan. The loan is primarily
collateralized by the Company's rights to receive Membership fees on a portion
of its Memberships and a pledge of the stock of its subsidiaries. The definitive
agreement contains covenants similar to those in the Company's previous line of
credit, including provisions prohibiting the Company from pledging assets,
incurring additional indebtedness and selling assets. The loan agreement also
prohibits the Company from purchasing treasury stock with any funds other than
the $25 million loan proceeds until the loan is repaid. In addition to customary
events of default, an additional event of default occurs if Harland C.
Stonecipher ceases to be the chairman and Chief Executive Officer of the Company
for 90 days. Pre-payment of the loan is permitted.
The loan agreements contain the following financial covenants: (a) the
Company's quarterly Debt Coverage Ratio (as defined in the loan agreements)
shall not be less than 125%; (b) the Company's cancellation rate on contracts
less than or equal to twelve months old shall not exceed 45% on a trailing 12
month basis, calculated on a monthly basis, (c) the Company shall maintain a
rolling twelve month average retention rate of Membership contracts in place for
greater than eighteen months of not less than 70%, calculated on a monthly
basis, (d) commencing December 31, 2003 and for each quarter thereafter Net
Worth shall increase by the amount as of September 30, 2003 minus the amount of
stock repurchased since the date of the loan plus 50% of quarterly net income
and shall not fall below zero, and (e) the Company's dividends to shareholders,
if declared, are limited to $1.8 million per quarter.
A schedule of outstanding balances and future maturities as of December
31, 2003 follows:
Real estate line of credit................. $ 19,810
Stock purchase line of credit.............. 23,611
----------------
Total notes payable........................ 43,421
Less: Current portion of notes payable..... (18,953)
Long term portion.......................... ----------------
$ 24,468
----------------
Repayment Schedule commencing January 2004:
Year 1..................................... $ 18,953
Year 2..................................... 9,230
Year 3..................................... 2,286
Year 4..................................... 2,286
Year 5..................................... 10,666
Total notes payable........................ ----------------
$ 43,421
----------------
Note 7 - Income Taxes
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
----------------------------------
2003 2002 2001
--------- --------- --------
Current.................................... 20,381 18,868 14,833
Deferred................................... 288 102 (1,314)
--------- --------- --------
Total provision for income taxes......... $ 20,669 $ 18,970 $ 13,519
--------- --------- --------
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
2003 2002 2001
--------- --------- --------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Change in valuation allowance.............. - - (.8)
Tax exempt interest........................ (.1) (.1) (.1)
Wage tax credits........................... (.5) (.4) (.5)
Other...................................... (.3) - (.7)
--------- --------- --------
Effective income tax rate.................. 34.1% 34.5% 32.9%
--------- --------- --------
Deferred tax liabilities and assets at December 31, 2003 and 2002 are
comprised of the following:
December 31,
-----------------------
2003 2002
----------- -----------
Deferred tax liabilities:
Unrealized investment gains, net................. $ 326 $ 121
Deferred member and associate service costs...... 6,337 5,821
Depreciation..................................... 2,695 1,735
----------- -----------
Total deferred tax liabilities................ 9,358 7,677
----------- -----------
Deferred tax assets:
Expenses not yet deducted for tax purposes....... 1,798 1,152
Deferred revenue and fees........................ 10,350 9,407
Net operating loss carryforward.................. - 402
----------- -----------
Total deferred tax assets..................... 12,148 10,961
----------- -----------
Net deferred tax asset........................... $ 2,790 $ 3,284
----------- -----------
The Company's deferred tax assets and liabilities are included in the
accompanying consolidated balance sheets at December 31, 2003 and 2002 as
follows.
December 31,
-----------------------
2003 2002
----------- -----------
Deferred income taxes (current asset).............. $ 4,894 $ 4,603
Deferred income taxes (non-current liability)...... (2,104) (1,319)
----------- -----------
Net deferred tax asset............................. $ 2,790 $ 3,284
----------- -----------
Note 8 - Stockholders' Equity
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 8,000,000 shares during subsequent board meetings. At December 31,
2003, the Company had purchased 7.6 million treasury shares under these
authorizations for $173.4 million, an average price of $22.74 per share.
The Company has lines of credit (see Note 6) which prohibit payment of cash
dividends on its common stock in excess of $1.8 million per quarter. Any
decision by the Board of Directors of the Company to pay cash dividends in the
future will depend upon, among other factors, the Company's earnings, financial
condition, capital requirements and approval from its lender for any dividends
in excess of $1.8 million per quarter. In addition, the Company's ability to pay
dividends is dependent in part on its ability to derive dividends from its
subsidiaries. The payment of dividends by PPLCI is restricted under the Oklahoma
Insurance Code to available surplus funds derived from realized net profits and
requires the approval of the Oklahoma Insurance Commissioner for any dividend
representing more than 10% of such accumulated available surplus or an amount
representing more than the previous years' net profits. During 2002, PPLCI
declared and paid a $6 million dividend to the Company. PPLSIF is similarly
restricted pursuant to the insurance laws of Florida. At December 31, 2003,
PPLSIF did not have funds available for payment of substantial dividends without
the prior approval of the insurance commissioner. While PPLCI had approximately
$3.5 million in surplus funds available for payment of an ordinary dividend in
December 2002, no such dividend was declared or paid during 2003. At December
31, 2003 PPLCI had approximately $750,000 available for payment of an ordinary
dividend. At December 31, 2003 the amount of restricted net assets of
consolidated subsidiaries was $16.7 million.
Note 9 - Comprehensive Income
Comprehensive income is comprised of two subsets - net income and other
comprehensive income. Included in other comprehensive income for the Company are
foreign currency translation adjustments and unrealized gains on investments.
These items are accumulated within the Statements of Changes in Stockholders'
Equity under the caption "Accumulated Other Comprehensive Income". As of
December 31, accumulated other comprehensive income, as reflected in the
Consolidated Statements of Changes in Stockholders' Equity, was comprised of the
following:
2003 2002
-------- --------
Foreign currency translation adjustments.................................. $ 203 $ 66
Unrealized gains on investments, net of income taxes of $326 and $121..... 606 224
-------- --------
Accumulated other comprehensive income.................................. $ 809 $ 290
-------- --------
Note 10 - Related Party Transactions
The Company's Chairman, Harland C. Stonecipher, is the owner of PPL Agency,
Inc. ("Agency"). The Company has agreed to indemnify and hold harmless the
Chairman for any personal losses incurred as a result of his ownership of this
corporation and any income earned by Agency accrues to the Company. The Company
provides management and administrative services for Agency, for which it
receives specified management fees and expense reimbursements.
Agency's financial position and results of operations are included in the
Company's financial statements on a combined basis. Agency earned commissions,
net of amounts paid directly to its agents by the underwriter, during 2003, 2002
and 2001 of $119,000, $138,000 and $121,000, respectively, through its sales of
insurance products of an unaffiliated company. Agency had net income of $20,000,
$33,000 and $16,000 for the years ended December 31, 2003, 2002 and 2001,
respectively after incurring commissions earned by the Chairman of $57,000,
$58,000 and $57,000, respectively, and annual management fees paid to the
Company of $36,000 for 2003, 2002 and 2001.
Mr. Stonecipher and his wife, Shirley A. Stonecipher, own Stonecipher
Aviation LLC ("SA") and Mr. and Mrs. Stonecipher together with Wilburn L. Smith,
National Marketing Director and formerly President and a director of the
Company, own S & S Aviation LLC ("S&SA"). The Company has agreed to reimburse SA
and S&SA for certain expenses pertaining to trips made by Company personnel for
Company business purposes using aircraft owned by SA and S&SA. Such
reimbursement represents the pro rata portion of direct operating expenses, such
as fuel, maintenance, pilot fees and landing fees, incurred in connection with
such aircraft based on the relative number of flights taken for Company business
purposes versus the number of other flights during the applicable period. No
reimbursement is made for depreciation, capital expenditures or improvements
relating to such aircraft. During 2003, 2002 and 2001, the Company paid
$307,000, $397,000 and $214,000, respectively, to SA and paid $592,000, $436,000
and $355,000 to S&SA during 2003, 2002 and 2001, respectively, as reimbursement
for such transportation expenses.
Mr. Smith had loans from the Company made in December 1992, December 1996
and October 1998. The largest aggregate balance of the loans during the year
ended December 31, 2002 was $521,000. These loans were fully repaid during 2002
including interest of $24,100. Mr. Smith also owns corporations or partnerships
not affiliated with the Company but engaged in the marketing of the Company's
legal service Memberships and which earn commissions from sales of Memberships.
These entities earned commissions of $15,000, $15,000 and $18,000 during 2003,
2002 and 2001, respectively, of which $6,000, $9,000 and $10,000, respectively,
was passed through as commissions to their sales agents.
Randy Harp, Chief Operating Officer and a director of the Company, had
loans from the Company made in 2000 and 2002, including an advance of $489,000
during 2002. These loans were fully repaid during 2002 including interest of
$105,200.
John W. Hail, a director of the Company, served as Executive Vice
President, Director and Agency Director of the Company from July 1986 through
May 1988 and also served as Chairman of the Board of Directors of TVC Marketing,
Inc., which was the exclusive marketing agent of the Company from April 1984
through September 1985. Pursuant to agreements between Mr. Hail and the Company
entered into during the period in which Mr. Hail was an executive officer of the
Company, Mr. Hail receives override commissions from renewals of certain
Memberships initially sold by the Company during such period. During 2003, 2002
and 2001, such override commissions on renewals totaled $81,000, $87,000 and
$92,000, respectively. Mr. Hail also owns interests ranging from 12% to 100% in
corporations not currently affiliated with the Company, including TVC Marketing,
Inc., but which were engaged in the marketing of the Company's legal service
Memberships and which earn renewal commissions from Memberships previously sold.
These entities earned renewal commissions of $552,000, $526,000 and $543,000
during 2003, 2002 and 2001, respectively, of which $300,000, $266,000 and
$294,000, respectively, was passed through as commissions to their sales agents.
During the 2003 third quarter, the Company terminated a marketing services
agreement with Eric Worre, a senior marketing associate, and commenced an action
in the District Court of Pontotoc County, Oklahoma alleging breach of contract
and seeking to collect $1.4 million in outstanding notes receivable arising from
loans made by the Company at various times between 1998 and 2001. Due to
uncertainties about the full recoverability of these notes, the Company recorded
bad debt expense of $515,000 in 2003 to write down the notes to the Company's
current estimate of their recoverable value. Depending on future developments in
the litigation, it is possible that a write off of all or a portion of the
remaining $867,000 of notes receivable may be necessary.
Note 11 - Leases
At December 31, 2003, the Company was committed under noncancelable
operating and capital leases, principally for buildings and equipment. Aggregate
rental expense under all operating leases was $93,000, $174,000 and $142,000 in
2003, 2002 and 2001, respectively.
Future commitments commencing January 2004 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2004............................................... $ 67
2005............................................... 67
2006............................................... 67
2007............................................... 66
2008............................................... 44
Total operating lease commitments.................. ------------
$ 311
------------
Future minimum lease payments commencing in January 2004 related to capital
leases are as follows:
Year Ended December 31,
2004............................................... $ 67
2005............................................... 862
2006............................................... 71
2007............................................... 71
2008............................................... 71
Thereafter......................................... 1,479
----------
Total minimum lease payments....................... 2,621
Less: Imputed interest............................. (915)
----------
Present value of net minimum lease payments........ 1,706
Less: Current portion.............................. (19)
----------
Non current portion of capital leases payable...... $ 1,687
----------
The Company entered into two capital leases near the end of 2002 and one
early in 2003 to acquire equipment and buildings. These capital leases expire at
various dates through 2032. The capital lease assets are included in property
and equipment as follows at December 31, 2003.
Equipment, furniture and fixtures.................. $ 2,094
Buildings and improvements......................... 314
2,408
Less: accumulated amortization..................... (519)
-------------
Net capital lease assets........................... $ 1,889
--------------
Note 12 - Commitments and 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. In August 2002 the lead institutional plaintiff withdrew from
the case, leaving two individual plaintiffs as lead plaintiffs on behalf of the
putative class. As of December 31, 2003, the briefing in the appeal had been
completed. On January 14, 2004 oral argument was held in the appeal. The Company
is unable to predict when a decision will be made on this appeal, and the
ultimate outcome of the case is not determinable.
Beginning in the second quarter of 2001 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 actual and punitive damages for alleged breach of contract,
fraud and various other claims in connection with the sale of Memberships.
During 2003, there were at one time as many as 30 separate lawsuits involving
approximately 285 plaintiffs in Alabama. As of December 31, 2003, as a result of
dismissals or settlements for nominal amounts, the Company was aware of
approximately 25 separate lawsuits involving approximately 98 plaintiffs that
have been filed in multiple counties in Alabama. As of February 27, 2004, there
were approximately 80 named plaintiffs in approximately 25 cases pending in
Alabama. In February 2004, the claims of several additional plaintiffs in one of
the cases were dismissed on summary judgment in the Company's favor. As of
December 31, 2003, the Company was aware of 18 separate lawsuits involving
approximately 432 plaintiffs in multiple counties in Mississippi. Certain of the
Mississippi lawsuits also name the Company's provider attorney in Mississippi as
a defendant. Proceedings in several of the eleven cases which name the Company's
provider attorney as a defendant have been stayed pending the Mississippi
Supreme Court's ruling on the Pre-Paid defendants' appeal of a trial court's
granting of a partial summary judgment that the action is not required to be
submitted to arbitration. At least three complaints have been filed by the law
firm representing plaintiffs in eleven of the cases on behalf of certain of the
Mississippi plaintiffs and others with the Attorney General of Mississippi in
March 2002, December 2002 and August 2003. The Company has responded to the
Attorney General's requests for information with respect to these complaints,
and as of December 31, 2003, the Company was not aware of any further actions
being taken by the Attorney General. 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, and has appealed the state court rulings in
favor of certain of the plaintiffs on the arbitration issue to the Mississippi
Supreme Court. One of the federal courts has ordered arbitration of a case
involving 8 plaintiffs. These cases are all in various stages of litigation,
including trial settings beginning in Alabama in April 2004, and in Mississippi
in May 2004, 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. Additional
suits of a similar nature have been threatened. 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 Pre-Paid defendants' preliminary motions in this
case were denied, and on June 17, 2003, the Oklahoma Court of Civil Appeals
reversed the trial court's denial of the Pre-Paid defendants' motion to compel
arbitration, finding that the trial court erred when it denied Pre-Paid's motion
to compel arbitration pursuant to the terms of the valid Membership contracts,
and remanded the case to the trial court for further proceedings consistent with
that opinion. There have been no material developments in this case since the
June 17, 2003 Court of Appeals decision. The ultimate outcome of this case 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
was originally a putative class action brought by Gina Kotwitz, later adding,
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, including a request stated in June 2003 for the imposition of
a constructive trust as to earned commissions applied to the reduction of debit
balances and disgorgement of all earned renewal commissions applied to the
reduction of debit balances. On September 23, 2003 the court entered an order
dismissing the class action allegations upon the motion of the plaintiffs. The
order provides that the action will proceed only on an individual basis, and
that the hearing on plaintiffs' motion for class certification previously set
for February 2004 was cancelled. The Company has filed a motion for summary
judgment, which was pending as of December 31, 2003. The ultimate outcome of
this case 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 a 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 Pre-Paid defendants filed motions to dismiss the complaint and
to strike the class action allegations on September 19, 2002, and discovery in
the action was stayed pending a ruling on the motion to dismiss. On July 24,
2003, the Court granted in part and denied in part the Pre-Paid defendants'
motion to dismiss. The claims asserted under the Securities Exchange Act of 1934
and the Oklahoma Securities Act were dismissed without prejudice. The motion was
denied as to the remaining claims. On July 23, 2003, the Court denied the motion
to strike class action allegations at that time. The case is in the process of
completion of class certification briefing currently scheduled to be concluded
May 5, 2004, after which time the Court will make a determination as to whether
the case may proceed as a class action. The ultimate outcome of this case is not
determinable.
In December 2002, the West Virginia Supreme Court reversed a summary
judgment which had been granted by the Circuit Court of Monangalia County, West
Virginia in favor of the Company in connection with the claims of a former
member, Georgia Poling and her daughters against the Company and a referral
lawyer with respect to a 1995 referral. That action was originally filed in
March 2000, and alleges breach of contract and fraud against the Company in
connection with the referral. Plaintiffs seek actual and punitive damages in
unspecified amounts. The case is set for trial in April 2004. The ultimate
outcome of this case is not determinable.
On January 30, 2003, the Company announced that it had received a subpoena
from the office of the United States Attorney for the Southern District of New
York requesting information relating to trading activities in the Company's
stock in advance of the January 2003 announcement of recruiting and Membership
production results for the fourth quarter of 2002. The Company also received
notice from the Securities and Exchange Commission that it is conducting an
informal inquiry into the same subject and requesting that the Company
voluntarily provide certain information. The Company has and will continue to
respond to any such requests, the last of which occurred in July 2003. As of
February 27, 2004, the Company was not aware of any further inquiries in either
of these matters. The ultimate outcome of these matters 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 costs of the defense
of these various matters are reflected as a part of general and administrative
expense in the consolidated statements of income. The Company has established an
accrued liability it believes will be sufficient to cover estimated damages in
connection with various cases (exclusive of ongoing defense costs which are
expensed as incurred), which at December 31, 2003 was $3.3 million. The Company
believes it has meritorious defenses in all pending cases and will vigorously
defend against the plaintiffs' claims. However, it is possible that an adverse
outcome in certain cases or increased litigation costs could have an adverse
effect upon the Company's financial condition, operating results or cash flows
in particular quarterly or annual periods.
The Company constructed a new corporate office complex which was
substantially completed near the end of 2003. Costs incurred through December
31, 2003 of approximately $30.7 million, including approximately $706,000 of
capitalized interest costs, have been paid from existing resources and the real
estate line of credit. The Company entered into construction contracts in the
amount of $28.9 million with the general contractor pertaining to the new office
complex and expected remaining costs related to these contracts from January 1,
2004 are estimated at approximately $3.1 million and will be funded from
existing resources and cash flow from operations.
Near the end of 2002, the Company committed to acquire significant new
computer hardware to supplement its current information technology platform and
provide redundancy for its critical business systems. The Company paid
approximately $1.6 million in 2003 and received a $1 million vendor rebate
during 2003 as a result of this commitment. The commitment calls for the Company
to expend approximately $800,000 in 2005.
Note 13 - Stock Options, Stock Ownership Plan and Benefit Plan
The Company has a stock option plan (the "Plan") under which the Board of
Directors (the "Board") or its Stock Option Committee (the "Committee") may
grant options to purchase shares of the Company's common stock. The Plan permits
the granting of options to directors, officers and employees of the Company to
purchase the Company's common stock at not less than the fair value at the time
the options are granted. The Plan provides for option grants to acquire up to
3,000,000 shares and permits the granting of incentive stock options as defined
under Section 422 of the Internal Revenue Code at an exercise price for each
option equal to the market price of the Company's common stock on the date of
the grant and a maximum term of 10 years. Options not qualifying as incentive
stock options under the Plan have a maximum term of 15 years. The Board or
Committee determines vesting of options granted under the Plan. No options may
be granted under the Plan after December 12, 2005.
The Plan provides for automatic grants of options to non-employee directors
of the Company. Under the Plan, each incumbent non-employee director and any new
non-employee director receives options to purchase 10,000 shares of common stock
on March 1 of each year. The options granted each year are immediately
exercisable as to 2,500 shares and vest in additional increments of 2,500 shares
on the following June 1st, September 1st, and December 1st in the year of grant,
subject to continued service by the non-employee director during such periods.
Options granted to non-employee directors under the Plan have an exercise price
equal to the closing price of the common stock on the date of grant.
Also included below are stock options that have been issued to the
Company's Regional Vice Presidents ("RVPs") in order to encourage stock
ownership by its RVPs and to increase the proprietary interest of such persons
in its growth and financial success. These options have been granted
periodically to RVPs since 1996. Options are granted at fair market value at the
date of the grant and are generally immediately exercisable for a period of
three years or within 90 days of termination, whichever occurs first. There were
106,002, 244,679 and 131,288 total options granted to RVPs in the years ended
December 31, 2003, 2002 and 2001, respectively. The Company has not adopted any
limit for the number of options that may be granted to RVPs.
A summary of the status of the Company's total stock option activity as of
December 31, 2003, 2002 and 2001, and for the years ended on those dates is
presented below:
2003 2002 2001
--------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- --------- ----------- -------- ----------- ---------
Outstanding at beginning of year..... 1,498,392 $ 26.09 1,336,636 $ 25.09 1,199,086 $ 29.06
Granted.............................. 153,502 20.99 499,679 22.54 443,288 17.64
Exercised............................ (105,514) 25.42 (329,229) 16.73 (43,175) 20.77
Terminated........................... (270,881) 35.45 (8,694) 23.31 (262,563) 32.51
----------- --------- ----------- -------- ----------- ---------
Outstanding at end of year........... 1,275,499 $ 24.06 1,498,392 $ 26.09 1,336,636 $ 25.09
----------- --------- ----------- -------- ----------- ---------
Options exercisable at year end...... 1,206,124 $ 24.18 1,378,392 $ 26.54 1,199,644 $ 25.56
----------- --------- ----------- -------- ----------- ---------
The following table summarizes information about stock options outstanding
at December 31, 2003:
Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
------------------------ ------------------ ---------------- ----------------
$15.65 - $20.16 409,424 2.8 $ 17.84
$20.24 - $25.65 394,735 2.8 23.88
$26.11 - $38.31 471,340 0.9 29.63
------------------ ---------------- ----------------
1,275,499 2.1 $ 24.06
------------------ ---------------- ----------------
The following table summarizes information about stock options exercisable
at December 31, 2003:
Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
------------------------ ------------------ ---------------- ----------------
$15.65 - $20.16 379,424 2.4 $ 17.73
$20.24 - $25.65 360,360 2.8 23.87
$26.11 - $38.31 466,340 0.8 29.67
------------------ ---------------- ----------------
1,206,124 1.9 $ 24.18
------------------ ---------------- ----------------
During 1988, the Company adopted an employee stock ownership plan. Under
the plan, employees may elect to defer a portion of their compensation by making
contributions to the plan. Up to seventy-five percent of the contributions made
by employees may be used to purchase Company common stock. The Company, at its
option, may make matching contributions to the plan, and recorded expense during
2003, 2002 and 2001 of $220,000, $207,000 and $162,000, based on annual
contributions of Company stock of 8,220 shares, 10,000 shares and 6,100 shares,
respectively.
In November 2002, the Company adopted a deferred compensation plan, which
permits executive officers and key employees to defer receipt of a portion of
their compensation. Deferred amounts accrue hypothetical returns based upon
investment options selected by the participant. Deferred amounts are paid in
cash based on the value of the investment option and are generally payable
following termination of employment in a lump sum or in installments as elected
by the participant, but the plan permits on demand distributions, which are
subject to a 10% penalty, and provides for financial hardship distributions,
distributions in the event of total disability or death and distributions upon a
change in control. The plan also provides for a death benefit of $500,000 for
each participant. Although the plan is unfunded and represents an unsecured
liability of the Company to the participants, during 2003, the Company purchased
company-owned variable life insurance policies to insure the lives of the group
of participants and to finance its obligations under the plan. As of December
31, 2003 and 2002, the Company had an aggregate deferred compensation liability
of $1.4 million and $307,000, respectively, which is included in other
non-current liabilities. At December 31, 2003, the cash value of the underlying
company-owned insurance policies was $1.3 million and included in other assets.
Note 14 - 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 year.
Diluted earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock and dilutive potential
common shares outstanding during the year. The weighted average number of common
shares is also increased by the number of dilutive potential common 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.
Year Ended December 31,
-------------------------------
Basic Earnings Per Share: 2003 2002 2001
--------- --------- ---------
Earnings:
Income from continuing operations............... $ 39,907 $ 36,014 $ 27,614
--------- --------- ---------
Shares:
Weighted average shares outstanding............. 17,530 19,674 21,504
--------- --------- ---------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations
after assumed conversions................... $ 39,907 $ 36,014 $ 27,614
--------- --------- ---------
Shares:
Weighted average shares outstanding............ 17,530 19,674 21,504
Assumed exercise of options.................... 69 90 40
--------- --------- ---------
Weighted average number of shares, as adjusted. 17,599 19,764 21,544
--------- --------- ---------
Options to purchase shares of common stock are excluded from the
calculation of diluted earnings per share when their inclusion would have an
anti-dilutive effect on the calculation. Options to purchase 799,000 shares,
921,000 shares and 903,000 shares with an average exercise price of $27.48,
$29.76 and $29.57, were excluded from the calculation of diluted earnings per
share for the years ended December 31, 2003, 2002 and 2001, respectively.
Note 15 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations
for the years ended December 31, 2003 and 2002.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2003 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---- ----------- ----------- ----------- -----------
Revenues........................................... $ 90,320 $ 89,642 $ 90,024 $ 91,327
Net income......................................... 12,034 10,043 9,438 8,392
Basic income per common share (1):
Net Income....................................... $ .67 $ .57 $ .54 $ .49
Diluted income per common share (1):
Net Income....................................... $ .67 $ .57 $ .54 $ .49
2002
Revenues........................................... $ 82,031 $ 87,944 $ 90,159 $ 90,489
Net income......................................... 8,870 8,527 8,957 9,660
Basic income per common share (1):
Net Income....................................... $ .44 $ .42 $ .46 $ .51
Diluted income per common share (1):
Net Income....................................... $ .43 $ .42 $ .46 $ .51
(1) The sum of EPS for the four quarters may differ from the annual EPS due to
rounding and the required method of computing weighted average number of
shares in the respective periods.
Note 16 - Segment Information
The Company previously reported UFL as a segment. On December 31, 2001 the
Company completed the sale of UFL and as a result has made the disclosures
required by discontinued operations accounting - see Note 2 to consolidated
financial statements.
Substantially all of the Company's business is currently conducted in the
United States. Revenues from the Company's Canadian operations for 2003, 2002
and 2001 were $4.5 million, $4.0 million and $4.4 million, respectively. The
Company has no significant long-lived assets located in Canada.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. 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
the end of the period covered by this 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 to
ensure that information required to be disclosed by the Company in reports it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10 through 14 of Form 10-K are incorporated herein by
reference to the Company's Proxy Statement for the Annual Meeting of
Shareholders to be filed prior to April 30, 2003.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements: See Index to Consolidated Financial Statements
and Consolidated Financial Statement Schedule set forth on page 42 of
this report.
(2) Exhibits: For a list of the documents filed as exhibits to this
report, see the Exhibit Index following the signatures to this report.
(b) Reports on Form 8-K:
The Company filed Form 8-K dated October 2, 2003 providing under Item 7
- Financial Statements and Exhibits the Company's press release dated
October 2, 2003 announcing its Membership and recruiting information
for the three months ended September 30, 2003.
The Company filed Form 8-K dated October 27, 2003 providing under Item
7 - Financial Statements and Exhibits the Company's press release dated
October 27, 2003, announcing its earnings and operating results for the
three months ended September 30, 2003.
Both of these Form 8-K's were filed pursuant to the instructions to
Form 8-K requiring the information to be "furnished" to the SEC. They
are not deemed to be filed for any other purpose.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 12, 2004 By: /s/ Randy Harp
-------------------------------------------
Randy Harp
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
/s/ Harland C. Stonecipher Chairman of the Board of Directors March 12, 2004
- ----------------------------------------------------
Harland C. Stonecipher (Principal Executive Officer)
/s/ Randy Harp Chief Operating Officer and March 12, 2004
- ----------------------------------------------------
Randy Harp Director
/s/ Steve Williamson Chief Financial Officer March 12, 2004
- ----------------------------------------------------
Steve Williamson (Principal Financial and
Accounting Officer)
/s/ Peter K. Grunebaum Director March 12, 2004
- ----------------------------------------------------
Peter K. Grunebaum
/s/ John W. Hail Director March 12, 2004
- ----------------------------------------------------
John W. Hail
/s/ Martin H. Belsky Director March 12, 2004
- ----------------------------------------------------
Martin H. Belsky
/s/ Steven R. Hague Director March 12, 2004
- ----------------------------------------------------
Steven R. Hague
PRE-PAID LEGAL SERVICES, INC AND SUBSIDIARIES
Schedule I - Condensed Financial Information of the Registrant
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
(Amounts in 000's)
ASSETS
December 31,
-----------------------
2003 2002
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 17,981 $ 18,828
Available-for-sale investments, at fair value........................................ 9,895 -
Membership income receivable......................................................... 2,637 3,201
Inventories.......................................................................... 857 1,212
Refundable income taxes.............................................................. 331 -
Deferred member and associate service costs.......................................... 12,372 11,873
Deferred income taxes................................................................ 2,837 3,187
---------- ----------
Total current assets............................................................. 46,910 38,301
Available-for-sale investments, at fair value.......................................... 792 450
Investments pledged.................................................................... 273 274
Property and equipment, net............................................................ 46,615 25,124
Investments in and amounts due to/from subsidiaries, net............................... 18,140 21,561
Deferred member and associate service costs............................................ 2,375 2,991
Other assets........................................................................... 5,184 2,415
---------- ----------
Total assets................................................................... $ 120,289 $ 91,116
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 9,008 $ 8,329
Deferred revenue and fees............................................................ 17,740 16,796
Current portion of capital leases payable............................................ 19 14
Current portion of notes payable..................................................... 18,953 2,412
Income taxes payable................................................................. - 1,234
Accounts payable and accrued expenses................................................ 14,065 12,550
---------- ----------
Total current liabilities.......................................................... 59,785 41,335
Capital leases payable............................................................... 1,687 912
Notes payable........................................................................ 24,468 8,221
Deferred revenue and fees............................................................ 3,330 4,266
Other non-current liabilities........................................................ 1,445 1,410
---------- ----------
Total liabilities................................................................ 90,715 56,144
---------- ----------
Stockholders' equity:
Common stock......................................................................... 217 237
Capital in excess of par value....................................................... - 43,219
Retained earnings.................................................................... 127,576 90,254
Accumulated other comprehensive income............................................... 809 290
Treasury stock, at cost.............................................................. (99,028) (99,028)
---------- ----------
Total stockholders' equity....................................................... 29,574 34,972
---------- ----------
Total liabilities and stockholders' equity..................................... $ 120,289 $ 91,116
---------- ----------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 211,824 $ 199,849 $ 169,036
Associate services................................................... 25,499 37,195 36,019
Other................................................................ 3,796 3,004 2,065
------------- ------------- -------------
241,119 240,048 207,120
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 66,524 63,515 52,017
Commissions.......................................................... 68,353 83,097 88,040
Associate services and direct marketing.............................. 28,823 32,516 29,829
General and administrative........................................... 14,711 13,773 12,307
Other, net........................................................... 6,792 5,829 4,553
------------- ------------- -------------
185,203 198,730 186,746
------------- ------------- -------------
Income from continuing operations before income taxes and
equity in net income of subsidiaries................................. 55,916 41,318 20,374
Provision for income taxes............................................. 19,080 14,271 6,593
------------- ------------- -------------
Income from continuing operations before equity in net
income of subsidiaries............................................... 36,836 27,047 13,781
Equity in net income of subsidiaries................................... 3,071 8,967 13,833
------------- ------------- -------------
Income from continuing operations...................................... 39,907 36,014 27,614
Loss from operations of discontinued UFL segment (net of
applicable income tax benefit of $0)................................. - - (504)
------------- ------------- -------------
Net income............................................................. $ 39,907 $ 36,014 $ 27,110
------------- ------------- -------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2003 2002 2001
------------ ------------ ------------
Net cash provided by operating activities.............................. $ 50,271 $ 55,380 $ 39,673
Cash flows from investing activities:
Proceeds from sale of UFL............................................ - - 1,200
Additions to property and equipment.................................. (27,012) (15,184) (8,326)
Purchases of investments - available for sale........................ (9,915) - -
Maturities and sales of investments - available for sale............. - 64 -
------------ ------------ ------------
Net cash used in investing activities.............................. (36,927) (15,120) (7,126)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 2,014 5,088 1,022
Decrease in capital lease obligations................................ (1,701) - (223)
Purchases of treasury stock.......................................... (48,292) (50,152) (28,213)
Proceeds from issuance of debt....................................... 42,700 12,300 -
Repayments of debt................................................... (9,912) (1,667) -
Proceeds from other financing........................................ 1,000 - -
------------ ------------ ------------
Net cash used in financing activities.............................. (14,191) (34,431) (27,414)
------------ ------------ ------------
Net increase in cash and cash equivalents.............................. (847) 5,829 5,133
Cash and cash equivalents at beginning of year......................... 18,828 12,999 7,866
------------ ------------ ------------
Cash and cash equivalents at end of year............................... $ 17,981 $ 18,828 $ 12,999
------------ ------------ ------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
Notes to Condensed Financial Statements
Basis of Presentation
In the parent-company-only financial statements, Pre-Paid Legal Services, Inc.'s
("Parent Company") investment in subsidiaries is stated at cost plus equity in
undistributed earnings of subsidiaries since the date of acquisition. The
parent-company-only financial statements should be read in conjunction with the
Parent Company's consolidated financial statements.
Notes 6 and 12 and the first two paragraphs of Note 10 to the consolidated
financial statements of Pre-Paid Legal Services, Inc. relate to the Parent
Company and therefore have not been repeated in these notes to condensed
financial statements.
Expense Advances and Reimbursements
Pursuant to management agreements with certain subsidiaries, which have been
approved by insurance regulators, commission advances are paid and expensed by
the Parent Company and the Parent Company is compensated for a portion its
general and administrative expenses determined in accordance with the
agreements.
Dividends from Subsidiaries
Dividends paid to the Parent Company from its subsidiaries accounted for by the
equity method are summarized as follows:
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------- ------------ -------------
(Amounts in 000's)
Pre-Paid Legal Casualty, Inc........................................... $ - $ 11,000 $ 3,500
Universal Fidelity Life Insurance Company.............................. - - 2,800
------------- ------------ -------------
$ - $ 11,000 $ 6,300
------------- ------------ -------------
INDEX TO EXHIBITS
Exhibit No. Description
3.1 Amended and Restated Certificate of Incorporation of the Company, as
amended (Incorporated by reference to Exhibit 4.1 of the Company's
Report on Form 8-K dated January 10, 1997)
3.2 Amended and Restated Bylaws of the Company (Incorporated by reference
to Exhibit 3.1 of the Company's Report on Form 10-Q for the period
ended June 30, 2003)
*10.1Employment Agreement effective January 1, 1993 between the Company
and Harland C. Stonecipher (Incorporated by reference to Exhibit 10.1
of the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1992)
*10.2Agreements between Shirley Stonecipher, New York Life Insurance
Company and the Company regarding life insurance policy covering
Harland C. Stonecipher (Incorporated by reference to Exhibit 10.21 of
the Company's Annual Report on Form 10-K for the year ended December
31, 1985)
*10.3Amendment dated January 1, 1993 to Split Dollar Agreement between
Shirley Stonecipher and the Company regarding life insurance policy
covering Harland C. Stonecipher (Incorporated by reference to Exhibit
10.3 of the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1992)
*10.4Form of New Business Generation Agreement Between the Company and
Harland C. Stonecipher (Incorporated by reference to Exhibit 10.22 of
the Company's Annual Report on Form 10-K for the year ended December
31, 1986)
*10.5Amendment to New Business Generation Agreement between the Company
and Harland C. Stonecipher effective January, 1990 (Incorporated by
reference to Exhibit 10.12 of the Company's Annual Report on Form
10-KSB for the year ended December 31, 1992)
*10.6Amendment No. 2 to New Business Generation Agreement between the
Company and Harland C. Stonecipher effective January, 1990
(Incorporated by reference to Exhibit 10.13 of the Company's Annual
Report on Form 10-K for the year ended December 31, 2002)
*10.7Stock Option Plan, as amended effective May 2000 (Incorporated by
reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K
for the year ended December 31, 2000)
10.8 Loan agreement dated June 11, 2002 between Bank of Oklahoma, N.A. and
the Company (Incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the six-months ended June
30, 2002)
10.9 Security agreement dated June 11, 2002 between Bank of Oklahoma, N.A.
and the Company (Incorporated by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-Q for the six months ended June
30, 2002)
10.10Form of Mortgage dated July 23, 2002 between Bank of Oklahoma, N.A.
and the Company (Incorporated by reference to Exhibit 10.3 of the
Company's Quarterly Report on Form 10-Q for the six months ended June
30, 2002)
*10.11 Deferred compensation plan effective November 6, 2002 (Incorporated
by reference to Exhibit 10.14 of the Company's Annual Report on Form
10-K for the year ended December 31, 2002)
10.12Loan agreement dated September 19, 2003 between Registrant and Bank
of Oklahoma, N.A., Comerica Bank and First United Bank & Trust
(Incorporated by reference to Exhibit 10.1 of the Company's Report on
Form 10-Q for the period ended September 30, 2003)
21.1 List of Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP
31.1 Certification of Harland C. Stonecipher, Chairman and Chief Executive
Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934
31.2 Certification of Steve Williamson, Chief Financial Officer, pursuant
to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1 Certification of Harland C. Stonecipher, Chairman and Chief Executive
Officer, pursuant to 18 U.S.C. Section 1350
32.2 Certification of Steve Williamson, Chief Financial Officer, pursuant
to 18 U.S.C. Section 1350
* Constitutes a management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report.
EXHIBIT 21.1
PRE-PAID LEGAL SERVICES, INC.
Subsidiaries of Registrant
State or Percentage of
Province Ownership by
Name of Subsidiary Incorporation Registrant
Pre-Paid Legal Casualty, Inc. Oklahoma 100%
American Legal Services, Inc. Oklahoma 100%
Pre-Paid Legal Services, Inc. of Florida Florida 100%
Legal Service Plans of Virginia, Inc. Virginia 100%
Ada Travel Service, Inc. Oklahoma 100%
Pre-Paid Canadian Holdings, L.L.C. Oklahoma 100%
National Pre-Paid Legal Services of Mississippi, Inc. Georgia 100% owned by
Pre-Paid Legal
Services, Inc. of
Florida
Pre-Paid Legal Services of Tennessee, Inc. Tennessee 100% owned by
Pre-Paid Legal
Casualty, Inc.
PPL Legal Care of Canada Corporation Nova Scotia, 100% owned by
Canada Pre-Paid Canadian
Holdings, L.L.C.
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated February 27, 2004, accompanying the consolidated
financial statements included in the Annual Report of Pre-Paid Legal Services,
Inc. on Form 10-K for the year ended December 31, 2003. We hereby consent to the
incorporation by reference of said report in the Registration Statements of
Pre-Paid Legal Services, Inc. on Forms S-8 (File No. 33-82144, effective July
28, 1994, File No. 33-62663, effective September 14, 1995, File No. 333-53183,
effective May 20, 1998 and File No. 333-38386, effective June 1, 2000).
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2004
Exhibit 31.1
CERTIFICATION
I, Harland C. Stonecipher, Chief Executive Officer, certify that:
(1) I have reviewed this annual report on Form 10-K of Pre-Paid Legal Services,
Inc.;
(2) Based on my knowledge, this 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
report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
(4) The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Omitted pursuant to Exchange Act Release 34-47986
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
(5) The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 12, 2004 /s/ Harland C. Stonecipher
---------------------------------------------------
Harland C. Stonecipher
Chairman and Chief Executive Officer
Exhibit 31.2
CERTIFICATION
I, Steve Williamson, Chief Financial Officer, certify that:
(1) I have reviewed this annual report on Form 10-K of Pre-Paid Legal Services,
Inc.;
(2) Based on my knowledge, this 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
report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
(4) The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Omitted pursuant to Exchange Act Release 34-47986
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
(5) The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 12, 2004 /s/ Steve Williamson
---------------------------------------------------
Steve Williamson
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
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 Annual
Report on Form 10-K for the year ended December 31, 2003 (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: March 12, 2004 /s/ Harland C. Stonecipher
---------------------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer and
President
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
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 Annual
Report on Form 10-K for the year ended December 31, 2003 (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: March 12, 2004 /s/ Steve Williamson
---------------------------------------------------
Steve Williamson
Chief Financial Officer