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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From _____ to _____
---------------
Commission File Number: 1-9293
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Pre-Paid Way, Ada, Oklahoma 74821-5813
(Address of principal executive offices) (Zip Code)
(Registrants' telephone number, including area code): (580) 436-1234
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |X| No [ ]
The number of shares outstanding of the registrant's common stock as of
April 2, 2004 was 16,464,982.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-Q
For the Quarter Ended March 31, 2004
CONTENTS
Part I. Financial Information
Item 1. Financial Statements:
a) Consolidated Balance Sheets
as of March 31, 2004 (Unaudited) and
December 31, 2003
b) Consolidated Statements of Income
(Unaudited) for the three months ended
March 31, 2004 and 2003
c) Consolidated Statements of Comprehensive Income
(Unaudited) for the three months ended
March 31, 2004 and 2003
d) Consolidated Statements of Cash Flows
(Unaudited) for the three months ended
March 31, 2004 and 2003
e) Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial
Condition And Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities
Item 6. Exhibits and Reports on Form 8-K
Signatures
ITEM 1. FINANCIAL STATEMENTS
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)
ASSETS
March 31, December 31,
2004 2003
------------ ------------
Current assets: (Unaudited)
Cash and cash equivalents........................................................ $ 20,251 $ 21,459
Available-for-sale investments, at fair value.................................... 10,299 10,203
Membership fees receivable....................................................... 4,489 4,575
Inventories...................................................................... 1,254 857
Refundable income taxes.......................................................... - 331
Deferred member and associate service costs...................................... 14,310 14,215
Deferred income taxes............................................................ 4,615 4,894
------------ ------------
Total current assets......................................................... 55,218 56,534
Available-for-sale investments, at fair value...................................... 17,214 15,711
Investments pledged................................................................ 4,376 4,253
Property and equipment, net........................................................ 48,378 47,004
Deferred member and associate service costs........................................ 2,434 2,375
Other assets....................................................................... 7,012 5,135
------------ ------------
Total assets............................................................... $ 134,632 $ 131,012
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.............................................................. $ 9,706 $ 9,289
Deferred revenue and fees........................................................ 23,370 23,763
Current portion of capital leases payable........................................ 810 19
Current portion of notes payable................................................. 18,953 18,953
Income taxes payable............................................................. 4,874 -
Accounts payable and accrued expenses............................................ 17,194 16,380
------------ ------------
Total current liabilities...................................................... 74,907 68,404
Capital leases payable........................................................... 1,009 1,687
Notes payable.................................................................... 19,730 24,468
Deferred revenue and fees........................................................ 3,332 3,330
Deferred income taxes ........................................................... 2,205 2,104
Other non-current liabilities.................................................... 1,770 1,445
------------ ------------
Total liabilities............................................................ 102,953 101,438
------------ ------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 21,317 and
21,674 issued at March 31, 2004 and December 31, 2003, respectively............ 213 217
Retained earnings................................................................ 129,525 127,576
Accumulated other comprehensive income........................................... 969 809
Treasury stock, at cost; 4,852 shares held at
March 31, 2004 and December 31, 2003........................................... (99,028) (99,028)
------------ ------------
Total stockholders' equity................................................... 31,679 29,574
------------ ------------
Total liabilities and stockholders' equity................................. $ 134,632 $ 131,012
------------ ------------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
-----------------------
2004 2003
----------- -----------
Revenues:
Membership fees.............................................. $ 86,750 $ 81,547
Associate services........................................... 6,557 7,537
Other........................................................ 1,302 1,236
----------- -----------
94,609 90,320
----------- -----------
Costs and expenses:
Membership benefits.......................................... 29,286 26,725
Commissions.................................................. 29,272 28,178
Associate services and direct marketing...................... 7,603 7,059
General and administrative................................... 10,046 7,993
Other, net................................................... 2,185 1,993
----------- -----------
78,392 71,948
----------- -----------
Income before income taxes..................................... 16,217 18,372
Provision for income taxes..................................... 5,595 6,338
----------- -----------
Net income..................................................... $ 10,622 $ 12,034
----------- -----------
Basic earnings per common share................................ $ .63 $ .67
----------- -----------
Diluted earnings per common share.............................. $ .63 $ .67
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in 000's)
(Unaudited)
Three Months Ended
March 31,
-----------------------
2004 2003
----------- -----------
Net income..................................................... $ 10,622 $ 12,034
----------- -----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment...................... (20) 68
----------- -----------
Unrealized gains on investments:
Unrealized holding gains arising during period............. 222 88
Reclassification adjustment for realized losses (gains)
included in net income................................... (42) -
180 88
Other comprehensive income, net of income taxes
of $97 and $47 for the three months ended March 31, 2004 and ----------- ------------
2003, respectively........................................... 160 156
----------- -----------
Comprehensive income........................................... $ 10,782 $ 12,190
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
(Unaudited)
Three Months Ended
March 31,
-------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net income....................................................................... $ 10,622 $ 12,034
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for deferred income taxes............................................ 283 167
Depreciation and amortization.................................................. 1,948 1,693
Tax benefit on exercise of stock options....................................... 107 -
Decrease (increase) in Membership income receivable............................ 86 (53)
(Increase) decrease in inventories............................................. (397) 145
Decrease in income tax receivable.............................................. 331 -
Increase in deferred member and associate service costs........................ (154) (684)
Increase in other assets....................................................... (1,877) (1,333)
Increase in accrued Membership benefits........................................ 417 43
(Decrease) increase in deferred revenue and fees............................... (391) 542
Increase in income taxes payable............................................... 4,874 5,896
Increase in accounts payable and accrued expenses and other.................... 1,119 1,822
----------- -----------
Net cash provided by operating activities.................................... 16,968 20,272
----------- -----------
Cash flows from investing activities:
Additions to property and equipment............................................ (3,205) (5,846)
Purchases of investments - available for sale.................................. (3,030) (155)
Maturities and sales of investments - available for sale....................... 1,585 -
----------- -----------
Net cash used in investing activities.................................... (4,650) (6,001)
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of stock options........................................ 411 55
Decrease in capital lease obligations.......................................... (4) (797)
Proceeds from issuance of debt................................................. - 3,600
Repayments of debt............................................................. (4,738) (1,000)
Purchases of treasury stock.................................................... (9,195) (19,920)
----------- -----------
Net cash used in financing activities ................................... (13,526) (18,062)
----------- -----------
Net decrease in cash and cash equivalents........................................ (1,208) (3,791)
Cash and cash equivalents at beginning of period................................. 21,459 20,858
----------- -----------
Cash and cash equivalents at end of period....................................... $ 20,251 $ 17,067
----------- -----------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized.............................. $ 461 $ 106
----------- -----------
Cash paid for income taxes..................................................... $ - $ -
----------- -----------
Non-cash activities - capital lease obligations incurred....................... $ 117 $ -
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands
unless otherwise indicated)
(Unaudited)
Note 1 - Basis of Presentation
The accompanying consolidated financial statements and notes thereto have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") have been omitted. The
accompanying consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's 2003 Annual Report on Form 10-K.
The consolidated financial statements include the financial statements of
the Company and its wholly owned subsidiaries, as well as those of PPL Agency,
Inc. All significant intercompany balances and transactions have been eliminated
in consolidation.
In the opinion of management, the accompanying unaudited financial
statements as of March 31, 2004, and for the three month periods ended March 31,
2004 and 2003, reflect adjustments (which were normal and recurring) which, in
the opinion of management, are necessary for a fair statement of the financial
position and results of operations of the interim periods presented. Results for
the three month period ended March 31, 2004 are not necessarily indicative of
results expected for the full year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Stock-Based Compensation
The Company has a stock-based employee compensation plan. The Company
accounts for this plan under the recognition and measurement principles of
Accounting Principles Board ("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 under those plans 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 Financial Accounting Standards Board Statement ("FASB") No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three Months Ended
March 31,
-----------------------
2004 2003
--------- ---------
Net income, as reported................................................................ $ 10,622 $ 12,034
Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards, net of related tax effects................................ (441) (296)
--------- ---------
Pro forma net income................................................................... $ 10,181 $ 11,738
--------- ---------
Earnings per share:
Basic - as reported................................................................ $ .63 $ .67
Basic - pro forma.................................................................. $ .61 $ .65
Diluted - as reported.............................................................. $ .63 $ .67
Diluted - pro forma................................................................ $ .61 $ .65
Note 2 - Contingencies
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. Plaintiffs thereafter filed a motion requesting reconsideration of
the dismissal which was denied. The plaintiffs have appealed the judgment and
the order denying their motion to reconsider the judgment to the Tenth Circuit
Court of Appeals. 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 April 21, 2004, as a result of
dismissals or settlements for nominal amounts, the Company was aware of
approximately 24 separate lawsuits involving approximately 77 plaintiffs that
have been filed in multiple counties in Alabama. As of April 21, 2004, 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 had 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. On
April 1, 2004, the Mississippi Supreme Court affirmed the trial court's partial
summary judgment that arbitration should not be had in one of the cases on
appeal. Pre-Paid has asked the Mississippi Supreme Court to rehear that issue.
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
April 21, 2004, 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. 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 June
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 March 31, 2004. 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 was set for trial in April 2004 but was settled
prior to trial for an amount not deemed material by the Company.
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
April 21, 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 March 31, 2004 was $3.0 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 that it occupied in
December 2003 and incurred further finishing costs during the first quarter of
2004. Costs incurred through March 31, 2004 of approximately $32.5 million,
including approximately $706,000 of capitalized interest costs, have been paid
from existing resources and a real estate line of credit. Total remaining costs
from April 1, 2004 are estimated at approximately $1.5 million.
Note 3 - Treasury Stock Purchases
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 8 million shares during subsequent board meetings. At March 31, 2004,
the Company had purchased 8 million treasury shares under these authorizations
for a total consideration of $182.6 million, an average price of $22.83 per
share. The Company purchased and formally retired 375,500 shares of its common
stock during the 2004 first quarter for $9.2 million, or an average price of
$24.49, reducing its common stock by $3,755 and its retained earnings by $9.2
million, and is currently working with its lenders for additional financing or
modifications to existing loan covenants pertaining to restrictions on the
amount of treasury stock that may be purchased. See Note 6 below. 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 and may seek alternative sources of financing
to continue or accelerate the program. Any additional 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.
Note 4 - Earnings Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding during the 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.
Three Months
Ended
March 31,
-------------------
Basic Earnings Per Share: 2004 2003
--------- ---------
Earnings:
Net income........................................................... $ 10,622 $ 12,034
--------- ---------
Shares:
Weighted average shares outstanding.................................. 16,751 18,039
--------- ---------
Diluted Earnings Per Share:
Earnings:
Net income........................................................... $ 10,622 $ 12,034
--------- ---------
Shares:
Weighted average shares outstanding.................................. 16,751 18,039
Assumed exercise of options.......................................... 74 16
--------- ---------
Weighted average number of shares, as adjusted....................... 16,825 18,055
--------- ---------
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 777,000 shares and
1.2 million shares for the three months ended March 31, 2004 and 2003,
respectively, with an average exercise price of $27.24 and $27.73, respectively,
were excluded from the calculation of diluted earnings per share for the
respective periods.
Note 5 - Recent Issued Accounting Pronouncements
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
addition, the interpretation became applicable on December 31, 2003 for special
purpose entities (SPEs) created prior to February 1, 2003. As of March 31, 2004,
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 postponed the date on which the interpretation is
applicable to March 31, 2004. The Company has determined the adoption of the
provisions of FIN 46 did 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.
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 6 - Notes Payable and Capital Leases
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 repayments began in
December 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 March 31, 2004 was 3.35% 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 March 31,
2004 was 4.10% 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 March 31,
2004 follows:
Real estate line of credit......................... $ 19,238
Stock purchase line of credit...................... 19,445
----------------
Total notes payable................................ 38,683
Less: Current portion of notes payable............. (18,953)
Long term portion.................................. ----------------
$ 19,730
----------------
Repayment Schedule commencing April 2004:
Year 1............................................. $ 18,953
Year 2............................................. 5,063
Year 3............................................. 2,286
Year 4............................................. 2,286
Year 5............................................. 10,095
Total notes payable................................ ----------------
$ 38,683
----------------
During 2003, the Company entered into a capital lease in the amount of $2.4
million to acquire significant new computer hardware to supplement its current
information technology platform and provide redundancy for its critical business
systems. The capital lease requires the Company to make annual payments of
$792,000 beginning January 2003 through January 2005. Pursuant to this lease,
the Company received a $1 million vendor rebate during April 2003, which was
recorded as a reduction in property and equipment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operation in the Company's Form 10-K for the year ended December 31, 2003, which
describes, among other things, the Company's basic business model, critical
accounting policies, measures of Membership retention, and basic cash flow
characteristics of the Company's business. The following tables set forth
changes in the principal categories of revenues and expenses and Membership and
recruiting activity for the first quarter of 2004 compared to the first quarter
of 2003 and the fourth quarter of 2003 (Amounts in 000's):
Three % % Three
Months Change Change Months Three Months
Ended % of from from Ended % of Ended % of
March 31, Total Prior Sequential March 31, Total December 31, Total
2004 Revenue Year Period 2003 Revenue 2003 Revenue
--------- ------- ------ ---------- -------- ------- ------------ -------
Revenues:
Membership fees.................... $ 86,750 91.7 6.4 3.0 $ 81,547 90.3 $ 84,199 92.2
Associate services................. 6,557 6.9 (13.0) 13.0 7,537 8.3 5,804 6.4
Other.............................. 1,302 1.4 5.3 (1.7) 1,236 1.4 1,324 1.4
--------- ------- ------ ---------- -------- ------- ------------ -------
94,609 100.0 4.7 3.6 90,320 100.0 91,327 100.0
--------- ------- ------ ---------- -------- ------- ------------ -------
Costs and expenses:
Commissions........................ 29,286 31.0 9.6 1.4 26,725 29.6 28,894 31.6
Membership benefits................ 29,272 30.9 3.9 (3.7) 28,178 31.2 30,412 33.3
Associate services and direct 7,603 8.0 7.7 6.9 7,059 7.8 7,109 7.8
marketing........................
General and administrative......... 10,046 10.6 25.7 1.5 7,993 8.8 9,894 10.8
Other, net......................... 2,185 2.3 9.6 (4.6) 1,993 2.2 2,290 2.5
--------- ------- ------ ---------- -------- ------- ------------ -------
78,392 82.9 9.0 (.3) 71,948 79.7 78,599 86.1
--------- ------- ------ ---------- -------- ------- ------------ -------
Income before income taxes........... 16,217 17.1 (11.7) 27.4 18,372 20.3 12,728 13.9
Provision for income taxes........... 5,595 5.9 (11.7) 29.0 6,338 7.0 4,336 4.7
Net income........................... ---------- ------- ------ ---------- --------- -------- ------------- -------
$ 10,622 11.2 (11.7) 26.6 $ 12,034 13.3 $ 8,392 9.2
--------- ------- ------ ---------- -------- ------- ------------ -------
Three Months Ended
-----------------------------------
New Memberships: 3/31/2004 3/31/2003 12/31/2003
--------- --------- ----------
New legal service membership sales.......................... 156,135 178,820 149,124
New "stand-alone" IDT membership sales...................... 6,697 - 4,377
--------- --------- ----------
Total new membership sales......................... 162,832 178,820 153,501
--------- --------- ----------
162,832
New "add-on" IDT membership sales........................... 84,774 - 89,928
Active Memberships:
Active legal service memberships at end of period........... 1,417,553 1,394,569 1,414,746
Active "stand-alone" IDT memberships at end of period
(see note below)............................................ 12,071 - 4,251
--------- --------- ----------
Total active memberships at end of period.......... 1,429,624 1,394,569 1,418,997
--------- ---------- ----------
1,429,624
Active "add-on" IDT memberships at end of period (see note
below)..................................................... 154,774 - 86.602
New sales associates recruited.............................. 14,774 29,755 33,068
(Note - reflects 2,748 transfers from "add-on" status to "stand-alone" status during the quarter)
Identity Theft Shield ("IDT") memberships sold in conjunction with new
legal plan memberships or "added-on" to existing legal plan memberships sell for
$9.95 per month and are not counted as "new" memberships but do increase the
average premium of the Company's membership base, while "stand alone" Identity
Theft Shield memberships are not attached to a legal plan membership and sell
for $12.95 per month.
Effective January 1, 2004, and continuing throughout the quarter, the
Company, in order to provide additional tools and enhance the classroom training
to the new sales associate, increased the cost to become a Fast Start sales
associate to $249 from $99 which was in effect for December 2003 and $149 which
was in effect for October and November 2003. The cost to become a Fast Start
associate during the entire previous year's comparable quarter was $149. Despite
the higher Fast Start fee, which caused a significant decline in the number of
new sales associates recruited, the number of new legal memberships sold
actually increased sequentially. The Company attributes this to a combination of
a solid core base of active associates and more productive newly recruited sales
associates.
Results of Operations - First quarter of 2004 compared to first quarter of 2003
Net income for the first quarter of 2004 decreased 12 percent to $10.6
million from $12.0 million for the prior year's first quarter primarily due to
after-tax losses of $3.2 million related to the sale of more than 91,000
Identity Theft Shield memberships in the 2004 first quarter period compared to
none in the 2003 comparable period. These after-tax losses are created since the
Company advances significant commissions at the time a membership is sold and
are expensed during the first month of the membership. Since approximately 95%
of membership fees are collected on a monthly basis, a significant cash flow
deficit and after-tax loss is created at the time a membership is sold. This
deficit and loss are 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. Diluted earnings per
share decreased 6 percent to 63 cents per share from 67 cents per share for the
prior year's comparable quarter due to decreased net income of 12 percent and an
approximate 7 percent decrease in the weighted average number of outstanding
shares.net income of $10.6 million, or $.63 per diluted common share, for the
three months ended March 31, 2004, down 12% from net income of $12.0 million, or
$.67 per diluted common share, for the comparable period of the prior year.
Diluted earnings per share decreased 6% due to decreased net income of 12%
partially offset by an approximate 7% decrease in the weighted average number of
outstanding shares.
Membership fees totaled $86.8 million during the 2004 first quarter
compared to $81.5 million for 2003, an increase of 6%. 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 9% during the three months ended March 31, 2004 to 162,832 from
178,820 during the comparable period of 2003. At March 31, 2004, there were
1,429,624 active Memberships in force compared to 1,394,569 at March 31, 2003,
an increase of 3%. Additionally, the average annual fee per Membership has
increased from $256 for all Memberships in force at March 31, 2003 to $266 for
all Memberships in force at March 31, 20004, 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 during the fourth
quarter of 2003.
Associate services revenue decreased 13% from $7.5 million for the first
three months of 2003 to $6.6 million during the comparable period of 2004
primarily as a result of approximately 50% fewer new associates recruited. Total
new associates enrolled during the first quarter of 2004 were 14,774 compared to
29,755 for the same period of 2003. As a result of the 50% lower overall
recruiting, associate fees decreased 16% from $4.5 million for the first three
months of 2003 to $3.8 million during the comparable period of 2004. 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 providing associate services and other
direct marketing expenses.
Other revenue increased 5%, to $1.3 million for the three months ended
March 31, 2004 from $1.2 million for the comparable period of 2003 primarily due
to an increase in enrollment fees of $120,000. Enrollment fee revenue recognized
increased for the three months ended March 31, 2004 despite a lower number of
Memberships being written during the period compared to the 2003 period due to
the amortization of previously deferred revenue.
Primarily as a result of the increase in Membership fees, total revenues
increased to $94.6 million for the three months ended March 31, 2004 from $90.3
million during the comparable period of 2003, an increase of 5%.
Membership benefits totaled $29.3 million for the three months ended March
31, 2004 compared to $26.7 million for the comparable period of 2003, and
represented 34% and 33% of Membership fees for the 2004 and 2003 periods,
respectively. This Membership benefit ratio (Membership benefits as a percentage
of Membership fees) pertaining to legal service plans should remain near current
levels as substantially all active Memberships provide for a capitated cost in
the absence of any changes in the capitated benefit level, which has not changed
significantly since 1993. However, the higher benefit ratio of the Identity
Theft Shield Membership may increase the blended benefit ratio if the Company
continues to sell significant numbers of Identity Theft Shield Memberships.
Commissions to associates increased 4% to $29.3 million for the three
months ended March 31, 2004 compared to $28.2 million for the comparable period
of 2003, and represented 34% and 35% of Membership fees for such periods.
Commissions to associates are primarily dependent on the number of new
memberships sold, including add-on membership sales, during a period. New
memberships sold during the three months ended March 31, 2004 totaled 162,832, a
9% decrease from the 178,820 sold during the comparable period of 2003.
Commissions to associates per new membership sold were $180 per membership for
the three months ended March 31, 2004 compared to $158 for the comparable period
of 2003. The average commission per new membership sold varies depending on the
compensation structure that is in place at the time a new membership is sold and
the amount of any charge-backs (recoupment of previous commission advances) that
are deducted from amounts that would otherwise be paid to the various sales
associates that are compensated for the membership sale. Should the Company add
additional commissions to its compensation plan or reduce the amount of
chargebacks collected from its associates as it has from time to time, the
commission cost per new Membership will increase accordingly.
Associate services and direct marketing expenses increased to $7.6 million
for the three months ended March 31, 2004 from $7.1 million for the comparable
period of 2003, primarily due to a $1.2 million increase in Player's Club
related expenses due to more associates qualifying for this incentive program,
partially offset by a $656,000 decline in Fast Start training attendance checks
since that program, which was in effect during the 2003 first quarter, was
eliminated prior to 2004. The increased number of qualifiers is primarily due to
increased retention rates of the Memberships written by Player's Club
qualifiers. The Company offers the Player's Club incentive program to provide
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. Other Fast Start training related costs 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.
General and administrative expenses during the three months ended March 31,
2004 and 2003 were $10.0 million and $8.0 million, respectively, and represented
12% and 10%, respectively, of Membership fees for each period. The 2004 first
quarter reflects increased legal fees for litigation costs and increased
expenses related to employees, voice and data services, and bank service charges
due to the increases in legal plans and Identity Theft Shield Memberships.
Management expects general and administrative expenses when expressed as a
percentage of Membership fees to remain relatively consistent over the near
term. The Company should experience cost efficiencies as a result of certain
economies of scale in some areas but expects any such cost savings for the
remainder of 2004 to be largely offset by higher levels of expenses related to
legal fees, expenses related to its new corporate headquarters and increased
compliance costs as a result of new requirements of the Sarbanes-Oxley Act of
2002.
Other expenses, net, which include depreciation and amortization, interest
expense and premium taxes reduced by interest income, was $2.2 million for the
period ended March 31, 2004 compared to $2.0 million for the 2003 comparable
period. Depreciation increased to $1.9 million for the first quarter of 2004
from $1.7 million for the comparable period of 2003 primarily due to capital
expenditures during the last 12 months and interest expense increased to
$462,000 during the 2004 period from $2,000 during the comparable period of
2003. Premium taxes decreased from $655,000 for the three months ended March 31,
2003 to $370,000 for the comparable period of 2004 primarily due to one of the
states changing the type of taxes that the Company is required to pay instead of
premium taxes. Due to an increase in the average balance of investments,
interest income increased by approximately $75,000 for the first quarter of 2004
to $432,000 from $357,000 for the 2003 period.
The Company has recorded a provision for income taxes of $5.6 million
(34.5% of pretax income) for the first quarter of 2004 compared to $6.3 million
(34.5% of pretax income) for the same period of 2003.
Results of Operations - First Quarter of 2004 compared to the
Fourth Quarter of 2003
First quarter 2004 membership fees increased from the 2003 fourth quarter
to $86.8 million vs. $84.2 million. Associate services revenue increased during
the 2004 first quarter from the 2003 fourth quarter by approximately $753,000.
Associate services and direct marketing expenses also increased by $494,000 from
the 2003 fourth quarter. Membership benefits totaled $29.3 million in the first
quarter of 2004 compared to $28.9 million for the 2003 fourth quarter and
represented 34% of membership fees for both periods. Due to increased
commissions related to the sale of Identity Theft Shield memberships which began
during the 2003 fourth quarter, total commissions to associates per new
membership sold during the respective quarters were $180 per membership for the
2004 first quarter compared to $198 for the 2003 fourth quarter. General and
administrative expenses during the 2004 first quarter were $10.0 million
compared to $9.9 million for the 2003 fourth quarter and represented 12% of
membership fees for both periods.
Liquidity and Capital Resources
General
Consolidated net cash provided from operating activities for the first
quarter of 2004 decreased 16 percent to $17.0 million from $20.3 million for the
2003 quarter. Approximate $5.6 million negative cash flow resulted from sales of
Identity Theft Shield memberships during the 2004 first quarter. This negative
cash flow is created since the Company 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 loss 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. The
decrease of $3.3 million resulted primarily from the decrease in net income of
$1.4 million, a net increase in the change in income taxes payable of $1.0
million and a net decrease in the change in accounts payable and accrued
expenses of $1.1 million.
Consolidated net cash used in investing activities was $4.7 million for the
first quarter of 2004 compared to $6.0 million for the comparable period of
2003. This $1.3 million decrease in cash used in investing activities resulted
from the $2.6 million decrease in additions to property and equipment, primarily
additional costs of the Company's new corporate office complex and a $1.6
million increase in maturities and sales of investments offset by a $2.9 million
net increase in purchases of available-for-sale investments.
Net cash used in financing activities during the first quarter of 2004 was
$13.5 million compared to $18.1 million for the comparable period of 2003, in
each case primarily for treasury stock purchases. This $4.5 million change was
primarily comprised of the $10.7 million decrease in treasury stock purchases
partially offset by a decrease of $3.6 million in net proceeds from issuance of
debt and a net $2.9 million increase in payments on debt and capital lease
obligations.
During the three months ended March 31, 2004, the Company purchased and
formally retired 375,500 million shares of treasury stock reducing its common
stock accounts by $3,755 and retained earnings by $9.2 million. Primarily due to
the large amount of treasury stock purchases in the first quarter of 2004 of
approximately $9.2 million, the Company had a consolidated working capital
deficit of $19.7 million at March 31, 2004, an increase of $7.8 million compared
to a consolidated working capital deficit of $11.9 million at December 31, 2003.
The increase was primarily due to the $4.9 million increase in income taxes
payable, the $1.2 million decrease in cash and cash equivalents and the $791,000
increase in the current portion of capital leases payable. The $19.7 million
working capital deficit at March 31, 2004 would have been a $10.6 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 ($17.0 million during the 2004 first quarter) 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.
At March 31, 2004 the Company reported $47.8 million in cash and cash
equivalents and unpledged investments compared to $47.4 million at December 31,
2003. The Company's investments consist of common stocks, investment grade
(rated Baa or higher) bonds primarily issued by corporations, the United States
Treasury, federal agencies, federally sponsored agencies and enterprises as well
as mortgage-backed securities and state and municipal tax-exempt bonds.
The Company generally advances significant commissions at the time a
Membership is sold. During the three months ended March 31, 2004, the Company
advanced commissions, net of chargebacks, of $25.7 million on new Membership
sales compared to $27.7 million for the same period of 2003. 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.
The Company expenses advance commissions ratably over the first month of
the related Membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates as of March 31, 2004, and
related activity for the three month period then ended, were:
(Amounts in 000's)
Beginning unearned advance commission payments (1)............................... $ 191,894
Advance commission payments, net................................................. 25,708
Earned commissions applied....................................................... (29,016)
Advance commission payment write-offs............................................ (688)
-------------
Ending unearned advance commission payments before
estimated unrecoverable payments (1)........................................... 187,898
Estimated unrecoverable advance commission payments (1).......................... (25,632)
Ending unearned advance commission payments, net (1)............................. -------------
$ 162,266
-------------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
The ending unearned advance commission payments, net, above includes net
unearned advance commission payments to non-vested associates of $31.0 million.
As such, at March 31, 2004 future commission payments and related expense should
be reduced as unearned advance commission payments of $131 million are
recovered. Commissions are earned by the associate as Membership premiums are
earned by the Company, usually on a monthly basis. For additional information
concerning these commission advances, see the Company's Annual report on Form
10-K under the heading Commissions to Associates in Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations.
The Company believes that it has significant ability to finance expected
future growth in Membership sales based on its recurring cash flow and existing
amount of cash and cash equivalents and unpledged investments at March 31, 2004
of $47.8 million. The Company expects to maintain cash and investment balances,
including pledged investments, on an on-going basis of approximately $20 to $30
million in order to meet expected working capital needs and regulatory capital
requirements. Cash balances in excess of this amount would be used for
discretionary purposes such as treasury stock purchases, after repayment of the
stock purchase line of credit.
The Company constructed a new corporate office complex that it occupied in
December 2003 and incurred further finishing costs during the first quarter of
2004. Costs incurred through March 31, 2004 of approximately $32.5 million,
including approximately $706,000 of capitalized interest costs, have been paid
from existing resources and a real estate line of credit. Total remaining costs
from April 1, 2004 are estimated at approximately $1.5 million.
On June 11, 2002, the Company entered into a real estate line of credit
agreement totaling $20 million with a commercial lender providing for funding of
the Company's new corporate office complex. The real estate line was fully
funded in December 2003 with interest at the 30 day LIBOR Rate plus 2.25%,
adjusted monthly, and repayments began in December 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 March 31, 2004
was 3.35% 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 March 31,
2004 was 4.10% 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.
Parent Company Funding and Dividends
Although the Company is the operating entity in many jurisdictions, the
Company's subsidiaries serve as operating companies in various states that
regulate Memberships as insurance or specialized legal expense products. The
most significant of these wholly owned subsidiaries are Pre-Paid Legal Casualty,
Inc. ("PPLCI") and Pre-Paid Legal Services Inc. of Florida ("PPLSIF"). The
ability of PPLCI and PPLSIF to provide funds to the Company is subject to a
number of restrictions under various insurance laws in the jurisdictions in
which PPLCI and PPLSIF conduct business, including limitations on the amount of
dividends and management fees that may be paid and requirements to maintain
specified levels of capital and reserves. In addition PPLCI will be required to
maintain its stockholders' equity at levels sufficient to satisfy various state
or provincial regulatory requirements, the most restrictive of which is
currently $3 million. Additional capital requirements of PPLCI or PPLSIF, 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 March
31, 2004, PPLSIF did not have funds available for payment of substantial
dividends without the prior approval of the insurance commissioner. At March 31,
2004 PPLCI had approximately $750,000 available for payment of an ordinary
dividend.
Contractual Obligations
There have been no material changes outside of the ordinary course of
business in the Company's contractual obligations from those disclosed in the
Company's annual report on Form 10-K for the year ended December 31, 2003.
Critical Accounting Policies
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. Each of these accounting
policies and the application of critical accounting policies and estimates was
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 2003. There were no significant changes in the application of
critical accounting policies or estimates during the first quarter of 2004. The
Company is not aware of any reasonably likely events or circumstances which
would result in different amounts being reported that would materially affect
its financial condition or results of operations.
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 March
31, 2004 and other information currently available to management. The Company
cautions that the Forward-Looking Statements are subject to all the risks and
uncertainties incident to its business, including but not limited to risks
described below. Moreover, the Company may make acquisitions or dispositions of
assets or businesses, enter into new marketing arrangements or enter into
financing transactions. None of these can be predicted with certainty and,
accordingly, are not taken into consideration in any of the Forward-Looking
Statements made herein. For all of the foregoing reasons, actual results may
vary materially from the Forward-Looking Statements. The Company assumes no
obligation to update the Forward-Looking Statements to reflect events or
circumstances occurring after the date of the statement.
Risk Factors
There are a number of risk factors that could affect our financial
condition or results of operations. See Note 2 - Contingencies and Part II, Item
1 - Legal Proceedings. Please refer to page 39 and 40 of the Company's 2003
Annual Report on Form 10-K for a description of other risk factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to the
Company's significant investment in fixed-maturity investments, interest rate
risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in fair values of those
instruments. Additionally, fair values of interest rate sensitive instruments
may be affected by the creditworthiness of the issuer, prepayment options,
relative values of alternative investments, liquidity of the instrument and
other general market conditions.
As of March 31, 2004, substantially all of the Company's investments were
in investment grade (rated Baa or higher) fixed-maturity investments,
interest-bearing money market accounts and a collateralized repurchase
agreement. The Company does not hold any investments classified as trading
account assets or derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on the Company's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly, with
no effect given to any steps that management might take to counteract that
change. The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table (dollars in 000's):
Hypothetical change in Estimated fair value
interest rate after bypothetical
Fair Value (bp=basis points) change in interest rate
---------- ---------------------- -----------------------
Fixed-maturity investments at March 31, 2004 (1)............ $ 28,497 100 bp increase $ 27,523
200 bp increase 26,560
50 bp decrease 28,843
100 bp decrease 29,243
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
(1) Excluding short-term investments with a fair value of $2.5 and $2.4 million
at March 31, 2004 and December 31, 2003, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at March 31, 2004 would reduce the
estimated fair value of the Company's fixed-maturity investments by
approximately $1.9 million at that date. At December 31, 2003, 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 $2.1 million at that date. The definitive
extent of the interest rate risk is not quantifiable or predictable due to
the variability of future interest rates, but the Company does not believe
such risk is material.
The Company primarily manages its exposure to interest rate risk by
purchasing investments that can be readily liquidated should the interest rate
environment begin to significantly change.
Interest Rate Risk
The Company is exposed to market risk related to changes in interest rates.
As of March 31, 2004, the Company had $38.7 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 March 31, 2004, 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 4. 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 the reports
that 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 II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
See Note 2 of the Notes to Consolidated Financial Statements included in
Part I, Item 1 of this report for information with respect to legal proceedings.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
Issuer Purchases of Equity Securities
The following table provides information about the Company's purchases of
stock in the open market during the first quarter of 2004.
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Total Number Part of Publicly Be Purchased Under
of Shares Average Price Announced Plans or the Plans or
Period Purchased Paid per Share Programs Programs (1)
January 2004.......... - $ - - 375,500
February 2004......... 35,600 23.41 35,600 339,900
March 2004............ 339,900 24.60 339,900 -
--------------- ---------------- --------------------
Total................. 375,500 $ 24.49 375,500
--------------- ---------------- --------------------
(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. As of the date of this report, there has not been a further
authorization for additional purchases because additional purchase may not
be made until the Company repays the balance of its stock purchase line of
credit or obtains a waiver of such restriction. See Part I, Item 2 for a
description of the terms of this line of credit.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit No. Description
----------- -----------
31.1 Certification of Harland C. Stonecipher, Chairman, Chief Executive Officer
and President, Pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934, filed under Exhibit 31 of Item 601 of Regulation S-K
31.2 Certification of Steve Williamson, Chief Financial Officer, Pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934, filed under
Exhibit 31 of Item 601 of Regulation S-K.
32.1 Certification of Harland C. Stonecipher, Chairman, Chief Executive Officer
and President, Pursuant to 18 U.S.C. Section 1350, filed under Exhibit 32
of Item 601 of Regulation S-K.
32.2 Certification of Steve Williamson, Chief Financial Officer, Pursuant to 18
U.S.C. Section 1350, filed under Exhibit 32 of Item 601 of Regulation S-K.
(b) Reports on Form 8-K:
The Company filed a Form 8-K dated January 5, 2004 providing under Item 7 -
Financial Statements and Exhibits and Item 12 - Results of Operations and
Financial Condition the Company's press release dated January 5, 2004
announcing its Membership and recruiting information for the three months
ended December 31, 2003.
The Company filed a Form 8-K dated February 23, 2004 providing under Item 7
- Financial Statements and Exhibits and Item 12 - Results of Operations and
Financial Condition the Company's press release dated February 23, 2004,
announcing its earnings and operating results for the three months and year
ended December 31, 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 the Securities and 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: April 26, 2004 /s/ Harland C. Stonecipher
-----------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive
Officer and President
(Principal Executive Officer)
Date: April 26, 2004 /s/ Randy Harp
-----------------------------------------
Randy Harp
Chief Operating Officer
(Duly Authorized Officer)
Date: April 26, 2004 /s/ Steve Williamson
-----------------------------------------
Steve Williamson
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Exhibit 31.1
CERTIFICATION
I, Harland C. Stonecipher, Chief Executive Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of Pre-Paid Legal
Services, Inc.;
(2) Based on my knowledge, this 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: April 26, 2004 /s/ Harland C. Stonecipher
-----------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive
Officer and President
Exhibit 31.2
CERTIFICATION
I, Steve Williamson, Chief Financial Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of Pre-Paid Legal
Services, Inc.;
(2) Based on my knowledge, this 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: April 26, 2004 /s/ Steve Williamson
-----------------------------------------
Steve Williamson
Chief Financial Officer
Exhibit 32.1
Certification Pursuant to 18 U.S.C. Section 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 Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004 (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: April 26, 2004 /s/ Harland C. Stonecipher
-----------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive
Officer and President
Exhibit 32.2
Certification Pursuant to 18 U.S.C. Section 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 Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004 (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: April 26, 2004 /s/ Steve Williamson
-----------------------------------------
Steve Williamson
Chief Financial Officer