PRE PAID LEGAL SERVICES INC - 10-K Annual Report

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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, 1996

( ) 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.)

321 East Main
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)

Registrant's telephone number including area code: (405) 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 American 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 ( ).

State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within the past 60 days prior to the date of
the filing: As of March 20, 1997 - $328,167,721.

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of March 20, 1997
there were 21,864,585 shares of Common Stock, par value $.01 per share,
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 1997 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, 1996

TABLE OF CONTENTS
PART I.
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ITEM 1. DESCRIPTION OF BUSINESS
General
Industry Overview
Description of Contracts
Provider Attorneys
Marketing
Operations
Quality Control
Competition
Regulation
Employees

ITEM 2. DESCRIPTION OF PROPERTY

ITEM 3. LEGAL PROCEEDINGS

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS

PART II.
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS

ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Results of Operations:
1996 compared to 1995
1995 compared to 1994
Liquidity and Capital Resources

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

PART III. **
- --------- --

PART IV.
- --------

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K

SIGNATURES

** Information required by Part III is incorporated by reference from the
Company's definitive proxy statement for its 1997 annual meeting of
shareholders.

PRE-PAID LEGAL SERVICES, INC.
FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 1996

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 which 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
"Contracts") currently provide for or reimburse a portion of the legal fees
associated with a variety of legal services in a manner similar to medical
reimbursement plans. At December 31, 1996, the Company had 294,151 Contracts in
force with members in all 50 states, and the District of Columbia. Approximately
93% of such Contracts were in 24 states.

Industry Overview

Legal service plans, while used in Europe for many years, 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 estimates
developed by the National Resource Center for Consumers of Legal Services
("NRC"), there were 126 million Americans entitled to service through at least
one legal service plan in 1996, compared to 4 million in 1981, 15 million in
1985, 58 million in 1990 and 88.5 million in 1995. The legal service plan
industry continues to evolve and market acceptance of legal service plans, as
indicated by the recent 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. The types of plans
offered include "free" plans which generally provide limited benefits on an
automatic enrollment basis without any direct cost to the individual user. Free
plans include those sponsored by labor unions, the American Association of
Retired Persons, the National Education Association and military services and,
according to NRC estimates, accounted for approximately 52% of covered persons
in 1996. The NRC estimates that an additional 29% are covered by employee
assistance plans which are also automatic enrollment plans without direct cost
to participants designed to provide limited telephonic access to attorneys for
members of employee groups. Employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit are
estimated by the NRC to account for approximately 6% of covered persons in 1996.

According to the NRC, the remaining covered persons in 1996 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 13% of the market in 1996 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.

The NRC estimates that approximately 77% of the total U.S. work force
was not covered by a legal service plan in 1996. Of the 23% of the work force
covered by legal service plans, only 4% was estimated by the NRC to be covered
by plans having benefits comparable to those provided by the Company's
Contracts. Accordingly, the Company believes that significant opportunities
exist for successful marketing of the Company's Contracts to employee groups and
other individual consumers.

Description of Contracts

Legal services have been offered by the Company under two types of
Contracts: closed panel and open panel. Since 1987, substantially all of the
Contracts sold by the Company have been closed panel Contracts which allow
members to access legal services through a network of independent attorneys
("provider attorneys") under contract with the Company. Provider attorneys are
paid a fixed fee on a per capita basis to render services to plan members
residing within the state in which the provider attorney is licensed to
practice. Because the fixed fee payments by the Company to provider attorneys in
connection with closed panel plans do not vary based on the type and amount of
benefits utilized by the member, the closed panel plans provide significant
advantages to the Company in managing claims risk. At December 31, 1996, closed
panel Contracts comprised approximately 88% of the Company's active Contracts.
Prior to 1987, the Company sold primarily open panel Contracts which allow
members to locate their own attorney to provide legal services available under
the Contract with the member's attorney being reimbursed for services rendered
based on usual, reasonable and customary fees.

The family legal plan currently marketed by the Company consists of
four basic benefits which provide coverage for a broad range of preventive and
litigation-related legal expenses. The family plan accounted for approximately
92% of the outstanding Contracts at December 31, 1996. In addition to the family
plan, the Company markets other specialized legal services products specifically
related to employment in certain professions. 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. 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 attorney and provides legal services associated
with administrative hearings. The School Teachers Legal Plan, developed in 1993
and marketed to school employees, also provides legal services associated with
administrative hearings. The Small Business Owners plan was developed during
1995 and marketed in selected geographical areas. This plan provides business
oriented legal service benefits for small businesses with 15 or fewer employees
and $250,000 or less in net income per year. Also developed during 1995 in
conjunction with a regional CPA firm and test marketed to sales associates is
the Tax and Financial Services plan. This plan has a minimum one year enrollment
and provides unlimited toll free consultation and annual tax return preparation
for both the State and Federal income tax returns.

In several states, the Company's plans are available in the Spanish
language. For the Spanish language plans, the provider law firms have bilingual
staff and attorney resources 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. Each Contract is guaranteed renewable,
except in the case of fraud or nonpayment of Contract fees. Contracts 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 Contract is sold as a package consisting
of five separate benefits known as "Titles." Contracts range in cost from $10.00
to $25.00 per month depending in part on the schedule of benefits, which varies
from state to state in compliance with regulatory requirements, and on certain
other state regulations. Benefits for most corporate and commercial matters are
excluded from open panel Contracts. Benefits for domestic matters and drug and
alcohol related matters are limited in all Contracts.

Title I: Preventive Legal Services. This benefit offers unlimited
toll-free access to a member's provider attorney firm for any legal matter. This
Title also offers last will and testament preparation for the member and annual
will reviews at no additional cost. Document review benefits and letter writing
benefits are also Title I benefits.

Title I benefits offered on the open panel plan basis permit half-hour
consultations for personal legal matters with the attorney of choice and pay an
attorney's reasonable fee for covered consultations. This benefit, however, does
not provide for a duplication of services previously billed relating to the same
matter per membership in a 90-day period. The member is responsible for any fees
incurred as a result of legal work in addition to the half-hour consultation or
legal assistance provided under this benefit.

Title II: Automobile Legal Protection. This benefit offers legal
assistance for matters resulting from the operation of a licensed motor vehicle
or boat. 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 or boat 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 or boat
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
Title 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.

Title III: Trial Defense. This Title offers assistance to the member
and the member's spouse through an increasing schedule of benefits based on
membership year. Up to 60 hours of attorney time are available for the defense
of civil or job-related criminal charges in the first membership year. The
criminal action must be a result of the direct performance 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 Title 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 Title 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 incrementing 5
additional hours each membership year to the maximum limit of 35 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. The
Company has experienced increased sales of this option during the last three
years.

Title IV: 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 remainder of the 50 hours 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
Title.

With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
membership year under Title III (without the pre-trial option described) and 3.5
hours under Title IV, these Titles do not ensure complete pre-trial coverage. In
order to receive additional Title III or IV benefits, a matter must actually
proceed to trial. The costs of pre-trial preparation that exceed the benefits
under the Contract are the responsibility of the member. Provider attorneys
under the closed panel Contract have agreed to provide to members any legal
service beyond those stipulated in the Contract at a 25% discount from the
provider's customary and usual rate.

Title II, III and IV benefits available on an open panel plan basis
provide comparable benefits with limitations based on fees incurred rather than
hours of service.

Title V: Preferred Member Discount. Provider attorneys under the closed
panel Contract have agreed to provide to members any legal services beyond those
stipulated in the Contract at a fee discounted 25% from the provider's customary
and usual rate.

Commercial Driver's Legal Plan
The Commercial Driver's Legal Plan provides coverage on a closed panel
plan basis for persons who drive a commercial vehicle. The Company has members
covered under the Commercial Driver's Legal Plan in 45 states. The Commercial
Driver's Legal Plan is underwritten by the Road America Motor Club, an unrelated
motor service club. During the years ended December 31, 1996, 1995 and 1994,
this plan accounted for approximately 3.5%, 4.7% and 7.8%, respectively, of
Contract premiums. The Plan is available at the monthly rate of $35.95 or at a
group rate of $32.95. Benefits include Title II, defense of Department of
Transportation violations and the 25% discounted rate for services beyond plan
scope, such as defense of non-moving violations, bail and arrest bonds, and
services for family vehicles.

Law Officers Legal Plan
The Law Officers Legal Plan was designed in 1991 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 16 states. The Law Officers Legal
Plan offers the basic plan benefits of Titles I, III, IV and V. Title II is
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 attorney 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 is 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 Title III, Trial Defense. During the years ended December 31, 1996, 1995
and 1994, the Law Officers Legal Plan accounted for approximately 2.4%, 3.4% and
3.9%, respectively, of the Company's Contract premiums.

Provider Attorneys

The Company currently markets Contracts primarily on a closed panel
basis. Closed panel Contracts allow members to access legal services through a
network of independent attorneys under contract with the Company generally
referred to as "provider attorneys." Provider attorneys are paid a fixed fee on
a per capita basis to render services to plan members residing within the state
in which the provider attorney is licensed to practice. Because the fixed fee
payments by the Company to provider attorneys in connection with closed panel
Contracts do not vary based on the type and amount of benefits utilized by the
member, the closed panel Contracts provide significant advantages to the Company
in managing claims risk. Prior to 1987, the Company sold Contracts on an open
panel basis. Open panel Contracts allow members to locate their own attorney to
provide legal services available under the membership. Members' attorneys are
reimbursed for services rendered according to a payment schedule commonly termed
"usual, reasonable, and customary" relevant to the average cost of legal
services in their area. At December 31, 1996, closed panel Contracts comprised
approximately 88% of the Company's active memberships while open panel Contracts
accounted for the remainder.

Provider attorney firms are selected to serve closed panel plan members
based on a number of factors, including recommendations from provider attorneys
and other attorneys in the area in which the candidate provider attorney 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 attorneys within the firm, on-site
evaluations by Company management, and interviews with attorneys in the firm who
would be responsible for providing services. Each member of the provider
attorney firm rendering services must have at least two years of experience as
an attorney, unless the Company waives this requirement due to special
circumstances such as instances when the attorney demonstrates significant legal
experience acquired in an academic, judicial or similar capacity other than as
an attorney.

Agreements with provider attorney 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 specified minimum amount of
malpractice insurance, (d) preclude the Company from interference with the
attorney-client relationship, and (e) provide for periodic review of services
provided. 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 attorneys are precluded from contracting with other prepaid legal
service companies without Company approval. Provider attorneys receive a fixed
monthly payment for each closed plan member in the service area and are
responsible for providing the Contract benefits without additional remuneration.
If a closed panel Contract provider attorney delivers legal services to an open
panel member, the attorney is reimbursed for services rendered according to the
open panel membership Contract.

The Company has had occasional disputes with provider attorneys, some
of which have resulted in litigation. Nonetheless, the Company believes that its
relations with provider attorneys are generally good. At the end of 1996, the
Company had 30 provider attorney firms compared to 27 provider attorney firms at
the end of 1995 and 23 at the end of 1994. During the last three years, the
Company's relationships with an average of three provider attorney firms
annually were terminated by the Company or the provider attorney firm for
reasons other than the lack of a sufficient number of members in the geographic
area to support the use of the provider attorney firm.

The Company's agreements with provider attorney firms require the
provider attorney firms to indemnify the Company against liabilities resulting
from legal services rendered by the provider attorney firm.

Marketing

Multi-Level Marketing
The Company markets Contracts through a multi-level marketing program
which encourages individuals to sell Contracts and allows individuals to recruit
and develop their own sales organizations. Commissions are paid only when a
Contract is sold and are not based solely on recruitment. When a Contract is
sold, commissions are paid to the associate making the sale, and to other
associates (often as many as nine others) who are in the line of associates who
directly or indirectly recruited the selling associate. Each sales associate is
responsible for monitoring the progress and sales practices of the associates
recruited by him or her. 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.

Multi-level marketing is primarily used for product marketing based on
personal sales since it encourages individual or group face-to-face meetings
with prospective purchasers of the product 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.
Contracts with individuals or families sold by the multi-level sales force
constituted 76% of the Company's Contracts in force at December 31, 1996,
compared to 78% and 75% at December 31, 1995 and 1994, respectively. Although
other means of payment are available, approximately 59% of premiums on Contracts
purchased by individuals or families are paid on a monthly basis by means of
automatic bank draft.

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. Contracts in force at December 31, 1996 sold through employee groups
constituted approximately 24% of total Contracts in force compared to 22% and
25% at December 31, 1995, and 1994, respectively. The majority of employee group
Contracts are sold to school systems, governmental entities and businesses. No
group accounted for more than 10% of the Company's consolidated revenues
from Contracts during 1996, 1995 or 1994.

Sales associates under the Company's multi-level marketing system are
generally engaged as independent contractors and are provided with training
guides 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 Contracts to employee groups. All advertising
and solicitation materials used by sales associates must be approved by the
Company prior to use. A substantial number of the Company's sales associates
market the Company's Contracts on a part-time basis only. At December 31, 1996,
the Company had 110,350 "active" sales associates compared to 78,281 "active"
sales associates at December 31, 1995. A sales associate is considered to be
"active" if he or she has originated at least three new Contracts per quarter or
if he or she retains a personal Contract. During 1996, the Company had 32,290
sales associates who sold at least one Contract, of which 24,715 (77%) made
first time sales, compared to 21,116 and 7,048 sales associates producing at
least one Contract sale in 1995 and 1994, respectively, of which 18,313 (87%)
and 5,089 (72%), respectively, made first time sales.

The Company derives revenues from services provided to its multi-level
marketing sales force, principally from a one-time enrollment fee of
approximately $65 ($49 prior to February 1, 1996 and $55 prior to July 1, 1996)
from each new sales associate and the sale of marketing supplies and promotional
materials to associates. Effective January 4, 1997, the Company implemented a
training program which allows an associate who successfully completes the
program to advance through the various commission levels at a faster rate.
Associates participating in this program pay a one-time fee of $249 instead of
the $65 fee. The increased fee covers the additional training and materials used
in the training program. Amounts collected from sales associates are intended
primarily to offset the Company's direct and indirect costs incurred in
recruiting, monitoring and providing materials to sales associates and are not
intended to generate material profits from such activities.

During July, 1996 the Company promoted 14 of its top producers to the
position of Regional Vice President ("RVP"). Each RVP is responsible for
associate activity in a given geographic region and has the ability to appoint
Area Coordinators within the RVP's region. This 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, such as the Company's
recently implemented training program will be channeled through the RVPs.

Cooperative Marketing
The Company is continuing to develop a cooperative marketing strategy
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
Contracts 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 Contract distribution and
access to established customer bases.

The premium and commission structures in connection with Contracts sold
under cooperative marketing arrangements are generally similar to the structure
found in the Company's multi-level marketing system, although the specific terms
of each cooperative marketing arrangement may vary depending on the strength of
and the specific marketing, training and administrative responsibilities assumed
by the cooperative marketing partner.

The Company has had mixed success with cooperative marketing
arrangements in the past and is unable to predict with certainty what success it
will achieve, if any, under its current 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 premiums, related general ledger
accounting, and managing and processing benefit claims.

The Company employs a computerized management information system to
control operations costs and monitor benefit utilization. Among other functions,
the system evaluates benefit claims, monitors member use of attorneys,
calculates average amount of claims incurred, processed and paid by benefit
category, and monitors marketing/sales data and financial reporting records. The
Company believes its management information system has substantial capacity to
accommodate increases in data flow before substantial upgrades will be required.
The Company believes this excess capacity may enable it to make significant
increases in the volume of its business and the number of members serviced with
less than commensurate increases in administrative costs.

The Company's operations also include departments specifically
responsible for marketing support and regulatory and licensing compliance.

Quality Control

The Company systematically monitors the services provided by provider
attorneys to members through periodic member surveys and review of member
complaints. Additionally, the majority of members are represented by provider
attorneys who are connected via high speed digital links to the Company's
management information systems, providing additional real time monitoring
capability. Problems discovered in connection with member surveys or complaints
are evaluated to determine remedial actions which the Company might recommend to
provider attorneys and in the most extreme cases may result in the termination
of a provider attorney. The Company meets with provider attorneys frequently to
encourage dialogue and information sharing relating to the timely and effective
delivery of services to members and requires provider attorneys to provide
various reports to the Company to enable the Company to monitor Contract usage.

The Company has an extensive data base of attorneys who have provided
services to its members. Attorneys with whom members have experienced service
problems are not listed on the Company's referral list for use by members when a
designated provider attorney is not available.

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
provider attorneys and members to assure that Company policies are being
followed and to gather data about recurring problems which may be avoided
through modifications in policies.

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. An estimated 50% 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. The
remaining 50% of such market is served primarily by the Company and five other
principal competitors: Hyatt Legal Services, Midwest Legal Services, LawPhone,
National Legal Plan and Montgomery Ward's Signature Group.

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 Contracts. However, the Company believes its competitive
position is enhanced by its actuarial data base and the ability to tailor
products to suit any type of distribution channel or target market. 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. While some states regulate
legal expense plans as insurance or specialized legal expense products, others
regulate them as services.

As of December 31, 1996, the Company or one of its subsidiaries was
marketing new Contracts in 34 states which require no special licensing or
regulatory compliance. The Company's subsidiaries serve as operating companies
in 11 states which regulate Contracts 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 Contracts in force as of December 31, 1996,
34% were written in jurisdictions which subject the Company or one of its
subsidiaries to insurance or specialized legal expense 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 Contracts will be exempt from insurance
regulation even in states 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 Contracts
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. 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. 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 dividend by PPLCI to the
Company from its statutory surplus or net gain from operations requires approval
of the Oklahoma Insurance Commissioner. 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, such as Texas, 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, Contracts 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 and other jurisdictions in which it
conducts business, including restrictions with respect to payment of dividends
to the Company.

As the legal plan industry matures, the Company anticipates enactment
of additional legislation which 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 attempt 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 an attorney 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 attorney's professional judgment. The ABA Code prohibits
attorney participation in closed panel legal service programs in certain
circumstances. The Company's agreements with provider attorney firms comply with
both the Model Rules and the ABA Code. The Company relies on the attorneys
serving as the designated attorneys 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 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 which 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 Contract sale applications from any unlicensed associate in such
jurisdictions.

Employees

At December 31, 1996, the Company and its subsidiaries employed 142
individuals on a full-time basis, exclusive of independent agents and sales
associates. None of the Company's employees are represented by a union.
Management considers its employee relations to be good.

ITEM 2. DESCRIPTION OF PROPERTY
- ------------------------------------

The executive and administrative offices of the Company and its
subsidiaries are located at 321 East Main Street, Ada, Oklahoma. These offices,
containing approximately 40,000 square feet of office space, are owned by the
Company. While the Company currently fully utilizes these existing facilities,
management believes that it will have no difficulty in securing additional
facilities in close proximity to its office building if necessary for future
expansion.

ITEM 3. LEGAL PROCEEDINGS
- ------------------------------

The Company is a named defendant in certain lawsuits arising in the
ordinary course of the Company's business. While the outcome of these lawsuits
cannot be predicted with certainty, the Company does not expect these matters to
have a material adverse effect on the Company's financial condition, liquidity
or results of operations.

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
- -------

At March 20, 1997, there were approximately 6,100 holders of record
(including brokerage firms and other nominees) of the Company's Common Stock.
The Common Stock is listed on the American 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 American
Stock Exchange.
High Low
1997:
1st Quarter (through March 20)....................... $ 18.63 $ 15.75

1996:
4th Quarter.......................................... $ 18.38 $ 10.88
3rd Quarter.......................................... 19.38 10.00
2nd Quarter.......................................... 23.13 13.88
1st Quarter.......................................... 15.25 9.13

1995:
4th Quarter.......................................... $ 10.88 $ 6.75
3rd Quarter.......................................... 8.88 5.56
2nd Quarter.......................................... 7.06 3.19
1st Quarter.......................................... 3.69 1.69

The Company has never declared a cash dividend on its Common Stock. For
the foreseeable future, it is anticipated that any earnings which may be
generated from the operations of the Company will be used to finance the
Company's growth and that cash dividends will not be paid to holders of the
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 and capital requirements. 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. At December 31, 1996, PPLCI did not have funds available for
payment of dividends without the prior approval of the Oklahoma Insurance
Commissioner. Additionally, the Company is restricted pursuant to a bank credit
agreement from paying any dividends on its common stock as long as any debt
remains outstanding pursuant to such agreement. To date, the Company has not
borrowed under the bank credit agreement.

Recent Sales of Unregistered Securities
Between January 19, 1996 and December 19, 1996, the Company issued to
current non-employee directors, in connection with the attendance of such
persons at meetings of the Board of Directors of the Company, a total of 51,500
shares of Common Stock upon exercise of outstanding warrants to purchase Common
Stock at a weighted average exercise price of $1.35 per share.

Between March 12, 1996 and December 18, 1996, the Company issued to
Roger T. Staubach and his assigns a total of 243,281 shares of Common Stock upon
exercise of outstanding warrants to purchase Common Stock at an exercise price
of $.50 per share. Such warrants were issued by the Company during 1993 in
connection with a marketing services agreement entered into between the Company
and Mr. Staubach.

Between December 10, 1996 and December 12, 1996, the Company issued to
a sales associate of the Company a total of 2,500 shares of Common Stock upon
exercise of outstanding warrants to purchase Common Stock at an exercise price
of $8.25 per share in connection with the achievement of certain sales levels
within the Company.

Such shares of Common Stock were issued without registration under the
Securities Act of 1933 in reliance on the exemption under Section 4(2) thereof.

ITEM 6. SELECTED FINANCIAL DATA
- ------------------------------------

The following table sets forth selected historical 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 included elsewhere
herein.

Year Ended December 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
Income Statement Data: (In thousands, except ratio, per share and Contract amounts)

Revenues:
Contract premiums ..................... $ 50,582 $ 31,290 $ 22,852 $ 19,182 $ 19,026
Associate services .................... 5,646 3,183 912 462 41
Interest income ....................... 1,302 1,308 466 195 292
Other ................................. 2,416 1,352 379 329 298
--------- --------- --------- --------- ---------
Total revenues ....................... 59,946 37,133 24,609 20,168 19,657
========= ========= ========= ========= =========
Costs and expenses:
Contract benefits ..................... 17,609 10,574 7,990 7,480 7,011
Commissions ........................... 11,476 7,708 6,788 6,117 3,629
General and administrative expenses ... 6,201 4,305 3,940 3,530 3,674
Associate services and direct marketing 4,544 2,573 1,539 1,139 772
Depreciation .......................... 533 477 410 538 573
Interest .............................. 26 10 320 518 792
Other expenses ........................ 372 242 226 709 218
--------- --------- --------- --------- ---------
Total costs and expenses ............. 40,761 25,889 21,213 20,031 16,669
--------- --------- --------- --------- ---------
Income before income taxes ............. 19,185 11,244 3,396 137 2,988
Provision (benefit) for income taxes ... 6,715 3,932 (319) 29 47
--------- --------- --------- --------- ---------
Net income ............................. 12,470 7,312 3,715 108 2,941
Less dividends on preferred shares ..... 15 125 465 15 15
--------- --------- --------- --------- ---------
Net income applicable to common shares . $ 12,455 $ 7,187 $ 3,250 $ 93 $ 2,926
========= ========= ========= ========= =========
Net income per common and common ....... $ .56 $ .35 $ .26 $ .01 $ .23
equivalent share
Net income per common share - assuming
full dilution .......................... .56 .34 .24 .01 .22
Weighted average number of common ...... 22,398 21,778 15,772 12,643 13,806
shares outstanding(1)
Contract Benefit Cost and Statistical
Data:
Loss ratio(2) .......................... 34.8% 34.1% 35.0% 39.0% 36.8%
Expense ratio(2) ....................... 45.8% 45.3% 55.9% 64.1% 50.4%
Combined loss and expense ratio ........ 80.6% 79.4% 90.9% 103.1% 87.2%
New Contracts sold ..................... 194,483 109,922 45,893 34,294 14,439
Period end Contracts in force .......... 294,151 203,535 144,438 133,121 123,123
Cash Flow Data:
Net cash provided by operating ......... $ 942 $ 624 $ 3,040 $ 1,100 $ 2,437
activities
Net cash provided by (used in) ......... (2,549) (2,192) 254 (611) 320
investing activities
Net cash provided by (used in) ......... 1,949 6,545 3,802 (1,307) (2,889)
financing activities
Balance Sheet Data:
Total assets ........................... $ 57,532 $ 35,629 $ 18,154 $ 11,109 $ 11,547
Notes payable, financing transactions
and subordinated debentures ............ - - - 3,837 5,449
Total liabilities ...................... 12,058 5,889 2,347 6,656 7,267
Stockholders' equity ................... 45,474 29,740 15,807 4,453 4,280

- ----------
(1) Weighted average shares outstanding gives effect to dilutive effect of
outstanding common stock equivalents and other potentially dilutive
securities. See Note 1 of Notes to Consolidated Financial Statements of the
Company.
(2) The loss ratio represents Contract benefit costs as a percentage of Contract
premiums. The expense ratio represents the total of commissions, direct
marketing expenses, general and administrative expenses, premium taxes,
interest and certain other normal operating expenses as a percentage of
Contract premiums. The combined ratio does not measure total profitability
because it does not take into account all revenues and expenses.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ----------------------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------

General

Contract Premiums and Contract Benefit Costs
The Company's principal revenues are derived from Contract premiums,
most of which are collected on a monthly basis. Contracts are generally
guaranteed renewable and non-cancelable except for fraud, non-payment of
Contract premiums or upon written request by the member.

Contract benefit costs vary depending on the type of Contract. Closed
panel plans provide the Contract benefits only through a designated provider
attorney with whom the Company has arranged for the services to be provided in a
particular geographic area. Provider attorneys receive a fixed monthly payment
for each member in their service area and are responsible for providing the
Contract benefits without additional remuneration. The fixed cost aspect of
closed panel plans provides significant advantages to the Company in managing
its claims risk. Under closed panel plans, the Company has the ability to more
effectively monitor the quality of legal services provided and, due to the
volume of claims that may be directed to particular provider attorney law firms,
has potential access to larger, more diversified law firms. At December 31,
1996, approximately 88% of the Company's Contracts were closed panel plans.

Contract benefit costs relating to open panel Contracts, which
constituted approximately 12% of Contracts in force at December 31, 1996, are
based on the usual, reasonable and customary fee for providing the required
services. Such costs are generally paid on a current basis as most costs are
certain in amount and require only limited investigation. The Company maintains
a reserve for estimated incurred but not reported open panel Contract benefit
costs as well as costs which are in the payment process. These reserves are
periodically reviewed by an independent actuary as necessary in conjunction with
the preparation and filing of financial statements and other reports with
various state insurance regulatory authorities. Underwriting risks associated
with the open panel Contracts are managed primarily through contractual benefit
limitations and, as a result, underwriting decisions are not necessarily based
on individual Contract purchases.

Commissions
Beginning with new membership Contracts written after March 1, 1995,
the Company implemented a level commission schedule which results in the Company
incurring commission expense related to the sale of its legal expense plans on a
basis more consistent with the collection of the premiums generated by the sale
of such Contracts. Historically, the Company had incurred much higher
commissions (approximately 70%) during the first year of the membership with
substantially lower commissions (approximately 16%) in all subsequent years. The
level commission structure results in the Company incurring commissions at the
rate of approximately 25% per year for all membership years.

Prior to January 4, 1997, the Company's advanced commissions at the
time of sale of all new Contracts. Effective January 4, 1997, the Company
implemented a policy whereby the associate receives earned commissions on the
first three sales unless the associate has successfully completed the new
training program which was implemented at the same time. For all sales beginning
with the fourth membership or all sales made by an associate successfully
completing the new training program the Company currently advances commissions
at the time of sale of a new membership Contract. 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 three years
commission earnings. Although the average number of marketing associates
receiving an advance commission payment on a new membership is ten, the overall
initial advance may be paid to more than twenty different individuals, each at a
different level within the overall commission structure. This commission advance
immediately increases an associate's account with the Company and represents
prepaid commissions on active memberships.

Should a membership lapse before the advances have been recovered for
each commission level, the Company immediately generates a "charge-back" to the
applicable sales associate to recapture 50% of any unearned advance. This
charge-back is immediately deducted from any future advances that would
otherwise be payable to the associate for additional new memberships. The
Company historically has been able to immediately recover the majority of such
charge-backs. Any remaining unrecovered advance on a membership that has lapsed
represents a receivable from the associate and is reflected as commission
advances and is categorized as current or non-current based on the expected
recovery period. Additionally, even though a commission advance may have been
fully recovered on a particular membership, no additional commission earnings
from any membership will be paid to an associate until all previous advances on
all memberships, both active and lapsed, have been recovered.

The Company's commission advance policy exposes the Company to the risk
of uncollectible commission advances particularly for associates who do not
receive commissions on a large number of memberships or who experience below
average persistency. The Company closely monitors such commission advances to
ensure maximum recoverability and maintains a recoverability reserve which at
December 31, 1996 and 1995, was $3.4 million and $2.7 million, respectively.

Associates also receive compensation when associates sponsored by them
or other associates that they have sponsored in their organization successfully
complete the new training program implemented by the Company January 4, 1997.

Contract Persistency
One of the major factors affecting the Company's profitability and cash
flow is Contract persistency, which represents the ability of the Company to
retain a Contract, and therefore receive premiums, once it has been written. The
Company periodically monitors its overall Contract persistency rate, as well as
the persistency rates with respect to Contracts sold by individual associates
and agents and persistency rates with respect to Contract sales by geographic
region and payment method. The Company's Contract persistency rate measures the
number of Contracts in force at the end of a year as a percentage of the total
of (i) Contracts in force at the beginning of such year, plus (ii) new Contracts
sold during such year. From 1981 through the year ended December 31, 1996, the
Company's annual Contract persistency rates, using the foregoing method, have
averaged approximately 76%. The annual Contract persistency rates were 74.0%,
80.0% and 80.7% for 1996, 1995 and 1994, respectively. The Company's overall
Contract persistency rate varies based on, among other factors, the relative age
of total Contracts in force. The Company's overall Contract persistency rate
could be lower when the Contracts in force include a higher proportion of newer
Contracts. The Company has recently experienced significant increases in new
Contract sales and, as a result, the percentage of newer Contracts in its total
Contracts in force has increased. Unless offset by other factors, this increase
could result in a decline in the Company's overall Contract persistency rate as
it did during 1996. The Company's financial condition and results of operations
may be materially adversely affected if the persistency rates of existing and
new Contracts are materially lower than the Company's historical experience.

Operating Ratios
Two principal operating measures monitored by the Company in addition
to Contract persistency are the loss ratio and the expense ratio. The loss ratio
represents Contract benefit costs as a percentage of Contract premiums. The
expense ratio represents the total of commissions, direct marketing expenses,
general and administrative expenses, premium taxes, interest and certain other
normal operating expenses as a percentage of Contract premiums. The Company
strives to maintain a combined loss and expense ratio as low as possible. The
combined ratio does not measure total profitability because it does not take
into account all revenues and expenses.

Cash Flow Considerations Relating to Sales of Contracts
The Company advances significant commissions at the time a Contract is
sold. Since approximately 92% of Contract premiums are collected on a monthly
basis, a significant cash flow deficit is created at the time a Contract is
sold. This deficit is reduced as monthly premiums are remitted and no additional
commissions are paid on the Contract until all previous commission advances have
been fully recovered. Since the cash advanced at the time of sale of a new
membership Contract will be recovered over a three year period, cash flow from
operations may be adversely affected depending on the number of new membership
Contracts written and the composition of new or existing sales associates
producing such Contracts.

Income Tax Matters-Net Operating Losses
At December 31, 1996, the Company had net operating loss carryforwards
("NOLs") for Federal regular and alternative minimum tax purposes of
approximately $11.9 million and $11.5 million, respectively, expiring in 2012
and 2013, respectively. In addition, the Company had general business and
rehabilitation tax credit carryforwards of approximately $325,000 expiring
primarily in 1998 to 2001, and an alternative minimum tax credit carryforward of
$366,000 which does not expire. A valuation allowance has been established for
deferred tax assets representing pre-1996 carryforwards except as related to the
AMT Credit carryforward (which is considered to be fully realizable) as the
Company does not believe it is more likely than not that the tax benefits of
such carryforwards will be realized. The Company generated a tax loss for the
year ended December 31, 1996 of $2.8 million. The Company believes it will
realize the approximate $1.0 million tax benefits from this tax loss and has
appropriately not provided a valuation allowance against this amount. The
Company accrued tax expense for 1996 and 1995 at the applicable statutory rates
and expects to continue such accrual for 1997 since it does not expect to be
able to utilize available tax benefits from its existing carryforwards. However,
if the level of tax deductions for commissions is less than expected in 1997 (as
a result of new Contract sales being less than expected or for any other
reason), the Company may have taxable income. In such case, the Company's tax
expense for 1997 would be reduced to reflect any actual or anticipated future
utilization of deferred tax benefits through reduction in the current valuation
allowance.

The ability of the Company to utilize NOLs and tax credit carryforwards
to reduce future federal income taxes of the Company is also subject to various
limitations under the Internal Revenue Code of 1986, as amended (the "Code").
One such limitation is contained in Section 382 of the Code which imposes an
annual limitation on the amount of a corporation's taxable income that can be
offset by those carryforwards in the event of a substantial change in ownership
as defined in Section 382 ("Ownership Change"). In general, an Ownership Change
occurs if during a specified three-year period there are capital stock
transactions which result in an aggregate change of more than 50% in the
beneficial ownership of the stock of the Company. The Company is not aware of
any pending or contemplated transactions that would result in an Ownership
Change under Section 382. However, the Company does not have control over all
possible variables which can affect the Ownership Change calculation and,
accordingly, it is possible that an Ownership Change could occur in the future.
The effect of any such Ownership Change on the Company's financial condition or
results of operations cannot be determined because it is dependent upon unknown
future facts and circumstances at the time of any such change, including, among
others, the amount of the Company's NOLs, the fair market value of the Company's
stock and the Company's other tax attributes.

Associate Services
The Company derives revenues from services provided to its marketing
sales force, principally from a one-time enrollment fee of approximately $65
($49 prior to February 1, 1996 and $55 prior to July 1996) from each new sales
associate and the sale of marketing supplies and promotional materials to
associates on an ongoing basis. Effective January 4, 1997, the Company
implemented a training program which allows an associate who successfully
completes the program to advance through the various commission levels at a
faster rate. Associates participating in this program pay a one-time fee of $249
instead of the $65 fee. The increased fee covers the additional training and
materials used in the training program. The Company enrolled 69,789 new sales
associates during 1996 compared to 50,464 during 1995 and 14,129 during 1994,
resulting in significant increases in associate services revenues and costs. The
Company's direct costs of providing materials and services to associates are
reflected as costs of associate services and direct marketing. Amounts collected
from sales associates are intended primarily to offset the Company's direct and
indirect costs incurred in recruiting, monitoring and providing materials to
sales associates and are not intended to generate material profits from such
activities.

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 principally of short term
instruments issued by the United States Treasury, insured bank certificates of
deposit, high grade government bonds and similar investments. The Company is
required to pledge investments to various state insurance departments as a
condition to obtaining authority to do business in certain states.

Accounting Standards to be Adopted
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
128"). SFAS 128 establishes standards for computing and presenting earnings per
share ("EPS"), and is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods. This Statement
simplifies the standards for computing earnings per share previously found in
APB Opinion No. 15, Earnings per Share, and makes them comparable to
international EPS standards. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement for all entities with complex
capital structures. Management has not yet evaluated the effect of this
pronouncement on the Company's consolidated financial statements.

Forward Looking Statements
All statements in this report concerning the Company other than purely
historical information, including, but not limited to, statements relating to
the Company's future plans and objectives, expected operating results and
assumptions relating to future performance constitute "Forward-Looking
Statements" within the meaning of 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, 1996 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 relating to the marketing of its Contracts, Contract
persistency, regulation and competition risks and the risk relating to the
continued active participation of its principal executive officer, Harland C.
Stonecipher. 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.

Results of Operations

Comparison of 1996 to 1995
The Company reported net income applicable to common shares of $12.5
million, or $.56 per common share, for 1996, up 74% from net income applicable
to common shares of $7.2 million, or $.35 per common share, for 1995. The
increase in the net income applicable to common shares for 1996 is primarily the
result of increases in every revenue category except for interest income for
1996 as compared to 1995.

Contract premiums totaled $50.6 million during 1996 compared to $31.3
million for 1995, an increase of 62%. The increase in Contract premiums was
primarily the result of increased new Contract sales resulting in a higher
number of active Contracts in force. New Contract sales during 1996 were 194,483
compared to 109,922 during 1995. At December 31, 1996, there were 294,151 active
Contracts in force compared to 203,535 at December 31, 1995. Additionally, the
average annual premium per Contract has increased from $239 for those Contracts
written in 1995 to $244 for Contracts written during 1996, a 2.0% increase, as a
result of a higher portion of Contracts written during 1996 including the
additional pre-trial hours benefit at an additional cost to the member.

Associate services revenue increased from $3.2 million for 1995 to $5.6
million during 1996 as a result of higher new associate enrollments and the
increase in the fee paid for associate enrollment. New associates enrolled
during 1996 were 69,789 compared to 50,464 for 1995, an increase of 38%.
Associate services revenue also increased as a result of increases in sales of
marketing materials used by the associates in sales presentations of the
Company's Contracts. Associate services revenue for 1996 was comprised of $4.1
million in enrollment fees and $1.5 million in sales of marketing materials.
Future revenues from associate services will depend primarily on the number of
new associates enrolled, but the Company expects that such revenues will
continue to be largely offset by the direct and indirect cost to the Company of
providing associate services.

Interest income for 1996 equaled interest income for 1995 of $1.3
million. Included in 1995 interest income was $187,000 for prior years interest
pertaining to outstanding notes receivable. Such amounts were previously not
considered recoverable but were subsequently collected. Interest income would
have otherwise increased as a result of increases in the average investments
outstanding and higher interest rates on investments. At December 31, 1996 the
Company reported $19.9 million in cash and investments compared to $18.3 million
at December 31, 1995.

Primarily as a result of the increase in Contract premiums, total
revenues increased to $59.9 million for 1996 from $37.1 million during 1995, an
increase of 61%.

Contract benefits totaled $17.6 million for 1996 compared to $10.6
million for 1995, an increase of 66%. However, the loss ratio for the 1996
period of 35% was approximately the same as the 34% for the comparable period of
1995 and should remain near 35% as the portion of active Contracts which provide
for a capitated benefit continues to increase.

Commission expense was $11.5 million for 1996 compared to $7.7 million
for 1995, and represented 23% and 24% of Contract premiums for 1996 and 1995,
respectively. Commission expense, as a percentage of Contract premiums, should
remain at or near 25% of Contract premiums in future years.

General and administrative expenses during 1996 and 1995 were $6.2
million and $4.3 million, respectively, and represented 12% and 14% of Contract
premiums for such years. Although the total amount of general and administrative
expenses increased approximately $1.9 million during 1996, these expenses, as a
percent of Contract premiums, decreased 2%. This trend of gradual increases in
the total dollar amount of these expenses but decreases when expressed as a
percentage of Contract premiums should continue as a result of certain economies
of scale pertaining to the Company's operating leverage.

Associate services and direct marketing costs increased to $4.5 million
for 1996 from $2.6 million for 1995 but were generally consistent as a percent
of total revenues, 8% for 1996 and 7% for 1995. These costs include the costs of
providing associate services and marketing costs other than commissions, which
are directly associated with new Contract sales.

Due to property and equipment additions during the later part of 1995
and the year ended December 31, 1996, depreciation increased from $477,000 for
1995 to $533,000 for 1996.

The Company's expense ratio remained at 45% for both 1996 and 1995.
These factors resulted in a combined loss and expense ratio of 81% and 80% for
1996 and 1995, respectively.

Provision for income taxes increased significantly during 1996 to $6.7
million compared to $3.9 million for 1995, but remained at 35% of income before
income taxes. The Company has established a valuation allowance for the portion
of its deferred tax asset that the Company believes more likely than not will
not be realized. The Company believes it is unlikely that it will generate
sufficient taxable income to realize the benefits from its pre-1996 NOLs and
certain other carryforwards before they expire, primarily as a result of tax
deductions attributable to expected levels of commission to be paid on new
Contract sales.

Dividends paid on outstanding preferred stock decreased to $15,000 for
1996 from $125,000 during 1995. This $110,000 decrease is attributable to the
automatic conversion of preferred stock to common stock pursuant to its terms
during February 1995.

Comparison of 1995 to 1994
The Company reported net income applicable to common shares of $7.2
million, or $.35 per common share, for 1995 up 35% from net income applicable to
common shares of $3.3 million, or $.26 per common share, for 1994. This 35%
increase in net income applicable to common shares was achieved despite a 67%
increase in the weighted average number of shares used in computing earnings per
share from 12.5 million shares in 1994 to 20.8 million shares for 1995. The
increase in the net income applicable to common shares for 1995 is primarily the
result of increases in every revenue category for 1995 as compared to 1994.

Contract premiums totaled $31.3 million during 1995 compared to $22.9
million for 1994, an increase of 37%. The increase in Contract premiums was
primarily the result of increased new Contract sales resulting in a higher
number of active Contracts in force. New Contract sales during 1995 were 109,922
compared to 45,893 during 1994. At December 31, 1995, there were 203,535 active
Contracts in force compared to 144,438 at December 31, 1994. Additionally, the
average annual premium per Contract has increased from $229 for those Contracts
written in 1994 to $239 for Contracts written during 1995, a 4.0% increase, as a
result of a higher portion of Contracts written during 1995 including the
additional pre-trial hours benefit at an additional cost to the member.

Associate services revenue increased from $912,000 for 1994 to $3.2
million during 1995 as a result of higher new associate enrollments. New
associates enrolled during 1995 were 50,464 compared to 14,129 for 1994, an
increase of 257%. Associate services revenue also increased as a result of
increases in sales of marketing materials used by the associates in sales
presentations of the Company's Contracts. Associate services revenue for 1995
was comprised of $2.5 million in enrollment fees and $677,000 in sales of
marketing materials. Future revenues from associate services will depend
primarily on the number of new associates enrolled, but the Company expects that
such revenues will continue to be largely offset by the direct and indirect cost
to the Company of providing associate services.

Interest income for 1995 increased to $1.3 million compared to $466,000
for 1994. Interest income increased primarily as a result of increases in the
average investments outstanding. At December 31, 1995 the Company reported $18.3
million in cash and investments compared to $11.7 million at December 31, 1994.

Primarily as a result of the increase in Contract premiums, total
revenues increased to $37.1 million for 1995 from $24.6 million during 1994, an
increase of 51%.

Contract benefits totaled $10.6 million for 1995 compared to $8.0
million for 1994, an increase of 33%. However, the loss ratio for 1995 decreased
to 34% from 35% for 1994.

Commission expense was $7.7 million for 1995 compared to $6.8 million
for 1994, and represented 24% and 30% of Contract premiums for 1995 and 1994,
respectively. Commission expense, as a percentage of Contract premiums, declined
as a result of changes in the commission structure for Contracts sold after
March 1, 1995.

General and administrative expenses during 1995 and 1994 were $4.3
million and $4.3 million, respectively, and represented 14% and 19% of Contract
premiums for such years. Although the total amount of general and administrative
expenses increased approximately $55,000 during 1995, these expenses, as a
percent of Contract premiums, decreased 5%. This trend of gradual increases in
the total dollar amount of these expenses but decreases when expressed as a
percentage of Contract premiums should continue as a result of certain economies
of scale pertaining to the Company's operating leverage.

Direct marketing costs increased to $2.6 million for 1995 from $1.5
million for 1994 but were fairly consistent as a percent of Contract premiums
and include those costs other than commissions, which are directly associated
with new Contract sales.

The Company's expense ratio decreased from 56% for 1994 to 45% for
1995. These factors resulted in a combined loss and expense ratio of 79% and 91%
for 1995 and 1994, respectively.

Provision for income taxes increased significantly during 1995 to $3.9
million, or 35% of net income before taxes, from a 1994 benefit of $319,000.
This $4.2 million change is attributable to the 1994 expense which reflected the
benefit of net operating loss carryforwards, general business and rehabilitation
tax credit carryforwards and alternative minimum tax credit carryforward. The
Company has established a valuation allowance for the portion of its deferred
tax asset that the Company does not believe it is more likely than not that the
tax benefits from its NOLs and other carryforwards will be realized. The Company
believes it is unlikely that it will generate sufficient taxable income to
realize these benefits before they expire, primarily as a result of tax
deductions attributable to expected levels of commissions to be paid on new
Contract sales.

Dividends paid on outstanding preferred stock decreased to $125,000 for
1995 from $465,000 during 1994. This $340,000 decrease is attributable to the
automatic conversion of preferred stock to common stock pursuant to its terms on
February 27, 1995.

Liquidity and Capital Resources

General
Consolidated net cash provided by operating activities was $942,000,
$624,000 and $3.0 million for 1996, 1995 and 1994, respectively. Cash provided
by operating activities remained relatively equal when comparing 1996 to 1995
due to the $5.2 million increase in net income, after an increase of $2.8
million in the impact of deferred income taxes, that helped to offset the $8.4
million increase in commission advances. The decrease of $2.4 million from 1995
to 1994 was primarily the result of increases in commission advances of $9.2
million which was partially offset by an increase in net income of $3.6 million
and an increase in provision for deferred income taxes of $4.3 million.

During 1996, the Company had net cash provided by financing activities
of $1.9 million as a result of the exercise proceeds of options to purchase
common stock. In 1995, the Company had net cash provided by financing activities
of $6.7 million as a result of the exercise proceeds of warrants to purchase
common stock during May, 1995. The Company used $3.9 million for debt retirement
during 1994. However, the cash used to retire debt during 1994 was more than
offset by the $8.1 million of proceeds received as a result of new issuances of
common and preferred stock primarily from the public offering completed in June,
1994 together with the exercise of other outstanding common stock warrants.
Dividends on preferred stock of $465,000 together with the debt retirement,
offset by the stock issuance proceeds, resulted in net cash provided by
financing activities of $3.8 million for 1994.

The Company had a consolidated working capital surplus of $23.4 million
at December 31, 1996 compared to a consolidated working capital surplus of $17.6
million at December 31, 1995. The $5.8 million increase in working capital
during 1996 was primarily the result of the current portion of commission
advances of $5.2 million.

The Company has an unsecured revolving credit agreement with Bank One,
Texas under which the Company may borrow up to $5 million, as determined by the
borrowing base defined by the agreement, through July, 1997. The borrowing base
is determined by a formula based on 80% of the net cash flow from certain of the
Company's Contracts that have been in existence for 18 months or more. At
December 31, 1996, the borrowing base was approximately $5 million. Under the
agreement, the interest rate, at the option of the Company is at the bank's base
lending rate or an adjusted London interbank rate and is determined at the time
of borrowing. Interest is to be paid monthly and any outstanding principal,
unless converted to an 18 month term loan upon the occurrence of certain events,
comes due in its entirety on July 1, 1997. The agreement contains restrictions
which, among other things, require maintenance of certain financial ratios,
restrict encumbrance of assets and creation of indebtedness, and limit the
payment of dividends. To date, the Company has not borrowed under the bank
credit agreement. The Company expects to renew or replace the credit agreement
at its expiration in July 1997.

As a result of the retirement of all outstanding debt during 1994, the
Company has no outstanding material financial commitments.

The Company believes that it has significant ability to finance
expected future growth in Contract sales based on its existing amount of cash
and cash equivalents and investments at December 31, 1996 ($17.1 million) and
the unused revolving credit agreement availability of $5 million.

Public unit offering
During the second quarter of 1994 the Company completed the sale of
346,500 units consisting of a total of 346,500 shares of $2.40 Cumulative
Convertible Preferred Stock and 2,425,500 common stock purchase warrants in a
public offering. Each unit, sold at a price of $24.00 per unit, consisted of one
share of preferred stock and seven warrants. Each share of preferred stock had a
cumulative dividend of $2.40 per year, a liquidation preference of $24.00 per
share and was convertible at any time at the option of the holder into 14 shares
of common stock. Each share of preferred stock was also automatically
convertible into common stock if the closing price of the preferred stock
exceeded $33.60 for ten consecutive trading days. The closing price of preferred
stock exceeded such price level for the 10 consecutive trading days ending
February 24, 1995, and, as a result, the then outstanding 277,700 shares of
preferred stock were converted into common stock. The remaining shares of
preferred stock had been previously voluntarily converted. The automatic
conversion of the preferred stock together with earlier voluntary conversions
resulted in savings of $831,600 per year in dividends.

Each warrant entitled the holder to purchase one share of common stock
at an exercise price of $2.50 per share at any time until September 8, 1999. The
warrants were redeemable at the option of the Company at a price of $.25 per
warrant following the date upon which the last reported sale price of the common
stock of the Company exceeds $3.75 per share (150% of the warrant exercise
price) for five consecutive trading days. The closing price of the common stock
exceeded that price level for the five consecutive trading days ended April 20,
1995.

The Company exercised its right to call the warrants for redemption and
all of the 2.4 million warrants with an exercise price of $2.50 per warrant were
exercised and resulted in net cash proceeds to the Company of more than $6
million. As a result of the exercise, the number of outstanding shares of the
Company's common stock increased to 20,545,661 shares from 18,120,171. The
proceeds from the exercise of the warrants have been invested in short term
obligations of the U.S. Treasury and other government agencies and will be used
primarily for the payment of commission advances upon the sale of new Contracts.

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 which
regulate Contracts 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
regulatory requirements, the most restrictive of which is currently $3 million.
Additional capital requirements of either PPLCI or PPLSIF will be funded by the
Company in the form of capital contributions or surplus debentures.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
- -------------------------------------------------------

PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE

Independent Auditors' Report

Consolidated Financial Statements
- ---------------------------------
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Income - For the years ended December 31, 1996, 1995
and 1994
Consolidated Statements of Cash Flows - For the years ended December 31, 1996,
1995 and 1994
Consolidated Statements of Changes in Stockholders' Equity - For the years ended
December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements

Consolidated Financial Statement Schedule
- -----------------------------------------
Schedule II. Consolidated Valuation and Qualifying Accounts - For the years
ended December 31, 1996, 1995 and 1994

INDEPENDENT AUDITORS' REPORT
----------------------------

To the Board of Directors and Stockholders of
Pre-Paid Legal Services, Inc.

We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related statements of income, changes in stockholders' equity, and cash flows
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedule listed at Item 8 herein. These
financial statements and the financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and the financial statement schedule based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Pre-Paid Legal Services, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

Deloitte & Touche LLP
Tulsa, Oklahoma
February 13, 1997

PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)

ASSETS

December 31,
-------------------
1996 1995
--------- --------
Current assets:
Cash.................................................. $14,831 $14,489
Held-to-maturity investments - current portion........ 500 500
Accrued Contract income................................ 1,710 1,038
Commission advances - current portion.................. 9,108 3,923
------- -------
Total current assets................................ 26,149 19,950
Held-to-maturity investments............................. 1,757 500
Investments pledged..................................... 2,772 2,766
Commission advances, net............................... 21,744 8,548
Property and equipment, net............................. 2,955 2,202
Other................................................... 2,155 1,663
------- -------
Total assets........................................ $57,532 $35,629
======= =======

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Contract benefits...................................... $ 1,862 $ 1,547
Accounts payable and accrued expenses.................. 912 646
Contingency reserves on trust preparation services..... - 130
------ ------
Total current liabilities......................... 2,774 2,323
Deferred income taxes.................................... 9,284 3,566
------ ------
Total liabilities.................................... 12,058 5,889
====== ======

Stockholders' equity:
Preferred stock, $1 par value; authorized 400 shares;
5 issued and outstanding as follows:
$3.00 Cumulative Convertible Preferred Stock,
authorized 5shares; 5 shares outstanding;
liquidation value of $84 ......................... 5 5
Special preferred stock, $1 par value; authorized 500 shares,
issued and outstanding in one series designated as follows:
$1.00 Non-Cumulative Special Preferred Stock, 32 and 45
shares authorized, issued and outstanding at
December 31, 1996 and 1995, respectively; liquidation
value of $430 and $605 at December 31, 1996
and 1995 respectively............................. 32 45
Common stock, $.01 par value; 100,000 shares authorized;
22,459 and 21,513 issued at December 31, 1996 and 1995,
respectively ......................................... 225 215
Capital in excess of par value ......................... 41,039 37,757
Retained earnings (deficit)............................. 6,350 (6,105)
Less: Treasury stock at cost; 747 shares................ (2,177) (2,177)
------- -------
Total stockholders' equity............................. 45,474 29,740
------- -------
Total liabilities and stockholders' equity............ $57,532 $35,629
------- -------

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,
-----------------------------------
1996 1995 1994
-------- -------- --------
Revenues:
Contract premiums.................... $ 50,582 $ 31,290 $ 22,852
Associate services................... 5,646 3,183 912
Interest income...................... 1,302 1,308 466
Other................................ 2,416 1,352 379
-------- -------- --------
59,946 37,133 24,609
-------- -------- --------
Costs and expenses:
Contract benefits..................... 17,609 10,574 7,990
Commissions........................... 11,476 7,708 6,788
General and administrative............ 6,227 4,315 4,260
Associate services and direct marketing 4,544 2,573 1,539
Depreciation........................... 533 477 410
Premium taxes.......................... 372 242 226
-------- -------- --------
40,761 25,889 21,213
-------- -------- --------

Income before income taxes............... 19,185 11,244 3,396
Provision (benefit) for income taxes..... 6,715 3,932 (319)
-------- -------- --------
Net income............................... 12,470 7,312 3,715
Less dividends on preferred shares....... 15 125 465
-------- -------- --------
Net income applicable to common shares... $ 12,455 $ 7,187 $ 3,250
======== ======== ========

Earnings per common and common equivalent
share................................... $ .56 $ .35 $ .26
======== ======= ========
Earnings per common share - assuming full
dilution................................ $ .56 $ .34 $ .24
======== ======= ========

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,
---------------------------------------

1996 1995 1994
----------- ----------- -----------
Cash flows from operating activities:
Net income ..................................................................... $ 12,470 $ 7,312 $ 3,715
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for associate stock options ........................................ 318 76 --
Provision (benefit) for deferred income taxes ................................ 6,715 3,932 (362)
Depreciation and amortization ................................................ 533 477 410
(Increase) decrease in accrued Contract income ............................... (672) (475) 22
Increase in commission advances .............................................. (18,381) (9,938) (709)
(Increase) decrease in other assets .......................................... (492) (736) 436
Increase (decrease) in Contract benefits ..................................... 315 138 (515)
Increase (decrease) in accounts payable and accrued expenses and
contingency reserves ....................................................... 136 (162) 43
-------- -------- --------

Net cash provided by operating activities ................................ 942 624 3,040
-------- -------- --------

Cash flows from investing activities:
Additions to property and equipment .......................................... (1,286) (608) (528)
Purchases of investments ..................................................... (1,663) (1,695) (51)
Maturities of investments .................................................... 400 111 833
-------- -------- --------
Net cash provided by (used in) investing activities ...................... (2,549) (2,192) 254
-------- -------- --------

Cash flows from financing activities:
Reduction in notes payable ................................................... -- -- (2,669)
Payment of debentures ........................................................ -- -- (1,243)
Proceeds from issuance of promissory note .................................... -- -- 75
Proceeds from sale of common and preferred stock ............................. 1,964 6,670 8,104
Dividends paid on preferred stock ............................................ (15) (125) (465)
-------- -------- --------
Net cash provided by financing activities ................................ 1,949 6,545 3,802
-------- -------- --------
Net increase in cash and
unpledged cash equivalents ................................................... 342 4,977 7,096

Cash and cash equivalents at beginning of year ................................. 14,489 9,512 2,416
-------- -------- --------
Cash and cash equivalents at end of year ....................................... $ 14,831 $ 14,489 $ 9,512
======== ======== ========

Supplemental disclosure of cash flow information:
Cash paid for interest ....................................................... $ 26 $ 10 $ 334
======== ======== ========
Cash paid for income taxes ................................................... $ -- $ 18 $ 30
======== ======== ========
Supplemental schedule of non-cash investing and financing activities:
Conversion of subordinated debentures to common stock ........................ $ -- $ -- $ 529
======== ======== ========

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)

Year Ended December 31,
--------------------------
1996 1995 1994
-------- -------- --------
Preferred Stock - $1 par value, 400 shares
- ---------------
authorized; issued and outstanding in two series
designated as follows:
$2.40 Cumulative Convertible Preferred Stock,
---------------------------------------------
authorized 391 shares; shares issued and
outstanding at beginning of year (299 in 1995)..... $ - $ 299 $ -
Shares issued during year (346 in 1994)............. - - 346
Shares exchanged for Common Stock (299 in 1995 and
47 in 1994)........................................ - (299) (47)
------ ------ ------
Shares issued and outstanding at end of year (299
in 1994), liquidation value of $7,188 at December
31, 1994........................................... - - 299
------ ------ ------
$3.00 Cumulative Convertible Preferred Stock,
---------------------------------------------
authorized 5 shares; 5 shares issued and
outstanding at beginning and end of year,
liquidation value of $84.......................... 5 5 5
------ ------ ------

Special Preferred Stock - $1 par value, 500 shares
- -----------------------
authorized; series of fixed annual dividends $1,
non-cumulative, convertible, shares issued and
outstanding at beginning of year (45 in 1996, 60 in
1995, and 62 in 1994)............................... 45 60 62
Shares exchanged for Common Stock (13 in 1996, 15 in
1995, and 2 in 1994)................................ (13) (15) (2)
------ ------ ------
Shares issued and outstanding at end of year (32 in
1996, 45 in 1995, and 60 in 1994), liquidation
value of $430 at December 31, 1996.................. 32 45 60
------ ------ ------

Common Stock - $.01 par value, shares authorized
- ------------
100,000; shares issued and outstanding at beginning
of year (21,513 in 1996, 14,216 in 1995, and 11,542
in 1994)............................................ 215 142 115
Shares issued during year:
Conversion of Preferred Stock and convertible
debentures (456 in 1996, 4,245 in 1995, and 1,191
in 1994)............................................ 1 42 12
Contributed to Company's employee stock ownership
plan (51 in 1996, 20 in 1995, and 20 in 1994)....... - - -
Exercise of warrants (891 in 1996, 3,032 in 1995,
and 1,463 in 1994) ................................. 9 31 15
------ ------ ------
Shares issued and outstanding at end of year (22,459
in 1996, 21,513 in 1995, and 14,216 in 1994)........ 225 215 142
------ ------ ------

Capital in Excess of Par Value
- ------------------------------
Balance at beginning of year.......................... 37,757 30,770 22,990
Preferred stock offering............................ - - 6,486
Exercise of warrants................................ 2,225 6,567 790
Deferred income taxes related to exercise of stock
options............................................. 997 - -
Conversion of preferred stock and convertible
debentures.......................................... 14 272 566
Stock contribution to employee stock ownership plan. 46 39 34
Other............................................... - 109 (96)
------ ------ ------
Balance at end of year ............................... 41,039 37,757 30,770
------ ------ ------

PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
(Amounts and shares in 000's, except dividend rates and par values)

Year Ended December 31,
-----------------------------
1996 1995 1994
--------- -------- --------
Retained Earnings (Deficit)
- ---------------------------
Balance at beginning of year...................... $(6,105) $(13,292) $(16,542)
Net Income........................................ 12,470 7,312 3,715
Cash dividends.................................... (15) (125) (465)
------- -------- --------
Balance at end of year............................ 6,350 (6,105) (13,292)
------- -------- --------

Treasury stock
- --------------
Balance at beginning and end of year (747 shares). (2,177) (2,177) (2,177)
------- ------- -------

Total Stockholders' Equity........................ $45,474 $29,740 $15,807
======= ======= =======

The accompanying notes are an integral part of these financial statements.

PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 "Company") underwrites and markets
legal service plans (referred to as "Contracts") which provide for or reimburse
a portion of legal fees incurred by members in connection with specified
matters. Contracts are guaranteed renewable, are principally collected on a
monthly basis and are marketed primarily in 24 states by an independent sales
force referred to as "Associates".

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.

Commissions
Effective March 1, 1995 the Company implemented a level commission
schedule of approximately 25% of annual premium revenue per year for all
membership years. This commission schedule results in the Company incurring
commission expense related to the sale of its legal expense plans on a
consistent basis with the collection of the premiums generated by the sale of
such Contracts. The Company currently advances the equivalent of three years of
commissions on new Contract sales. Effective January 4, 1997, the Company
implemented a new policy whereby associates receive only earned commissions on
the first three memberships submitted unless the associate successfully
completes the training program implemented by the Company at the same time,
which includes an intensive one-day training seminar and the production of three
memberships and the recruitment of one associate within 15 business days from
their training date. Prior to March 1, 1995 first year commissions payable on
the sale of a Contract, and earned in the first Contract year, were
approximately 70% of annual Contract premiums while renewal commissions (payable
as earned after the first Contract year) were approximately 16% of annual
premiums.

Basis of Presentation
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities. Certain reclassifications have been made to conform to
current year presentation.

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 7 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.

Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash,
certificates of deposit, other short-term investments, receivables and trade
payables. 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, other short-term investments,
net receivables and trade payables are considered to be representative of their
respective fair value, due to the short term nature of these instruments.

Investment Securities
The Company accounts for its investments in debt and equity securities
in accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115").
Investments classified as trading are accounted for at fair value, available for
sale investments are accounted for at fair value with unrealized gains and
losses, net of taxes, excluded from earnings and reported as a separate
component of stockholders' equity, and held to maturity investments are
accounted for at amortized cost.

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. The Company has the ability and
intent to hold to maturity its investment securities classified as held to
maturity; accordingly, no adjustment has been made for the excess, if any of
amortized cost over market. In determining the investment category
classifications, management considers its asset/liability strategy, changes in
interest rates and prepayment risk, the need to increase capital and other
factors. Under certain circumstances (including the deterioration of the
issuer's creditworthiness, a change in tax law, or statutory or regulatory
requirements), the Company may change the investment security classification.
Gain or loss on sale of investments is based upon the specific identification
method. Income earned on the Company's investments in state and political
subdivisions is not taxable.

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.

Revenue Recognition
Contract premiums are recognized in income when due in accordance with
Contract terms which generally require the holder of the Contract to remit
premiums on a monthly basis. Contracts are canceled for nonpayment of premium
after ninety days. Premiums due but not collected at the end of an accounting
period are recorded as accrued Contract income; a provision for uncollectible
premiums, if any, is recorded currently. Sales of marketing kits to Associates
are recognized as revenue when cash is received.

Commission Advances
Commission advances represent the unearned portion of commissions
advanced to Associates on sales of memberships. Commissions are earned as
premiums are collected, usually on a monthly basis. The Company reduces
Commission Advances as premiums are paid and commissions earned. Unearned
commission advances on lapsed memberships must subsequently be recovered through
an associate's active memberships. At December 31, 1996, the Company maintains
an allowance of $3.4 million to provide for estimated uncollectible balances.
Effective November 1, 1993, the Company imposed a charge of 1.5% per month on
unearned commission advances made between November 1, 1993 and March 1, 1995.
Effective March 1, 1995, and in conjunction with other commission structure
changes, the Company reduced the charge from 1.5% to .17% per month for
commission advances made after such date. Effective January 4, 1997, the Company
implemented a change to the method used in calculating the charge on unearned
commission advances to only calculate a charge against unearned commission
advances on memberships which canceled subsequent to the advance being made. The
charge was also changed to equal the prime rate.

Contract Benefit Costs
Contract benefit costs represent claims reported but not paid and
actuarially estimated claims incurred but not reported. The Company calculates
Contract benefit costs based on completion factors which 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 in accordance with SFAS 109,
which is an 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, SFAS 109
generally considers all future events other than enactment's of changes in the
tax law or rates

Deferred 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 estimated realizable value.

Earnings Per Share
Earnings per common and common equivalent share are computed by
dividing net income applicable to common shares by the weighted average number
of shares of common stock and common stock equivalents outstanding during the
year. The $3.00 Cumulative Convertible Preferred stock is not included in the
weighted average number of common shares outstanding since it is not considered
to be common stock equivalent. Special Preferred stock is considered to be a
common stock equivalent and the number of shares issuable on conversion of the
special preferred stock is added to the number of common shares. The number of
common shares is also increased by the number of shares issuable on the exercise
of warrants and options less the number of common shares assumed to have been
purchased with the proceeds from the exercise of the options and warrants
pursuant to the modified treasury stock method; those purchases are assumed to
have been made at the average price of the common stock during the respective
periods. Weighted average number of shares used in computing earnings per common
and common equivalent share are 22,325,000, 20,762,000, and 12,460,000 for 1996,
1995 and 1994 respectively.

Earnings per common share - assuming full dilution are determined on
the assumptions described above except that the purchases assumed to have been
made upon the exercise of warrants and options are assumed to have been made at
the market price at the close of the respective periods if that market price is
higher than the average market price for such periods. Additionally, the $2.40
cumulative convertible preferred stock and certain convertible subordinated
debentures are assumed to have been converted and the respective dividends and
interest are included in determining net income applicable to common shares.
Weighted average number of shares used in computing earnings per common
share-assuming full dilution are 22,398,000, 21,778,000, and 15,772,000 for
1996, 1995 and 1994, respectively.

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.

Long-Lived Assets
The Company records impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. Long-lived assets
that are held for disposal are valued at the lower of the carrying amount or
fair value less cost to sell, except for assets that constitute a discontinued
operation. Assets of discontinued operations are valued at estimated net
realizable value.

Stock-Based Compensation
Compensation expense is recorded with respect to stock option grants
and restricted stock awards to employees using the intrinsic value method
prescribed by Accounting Principles ("APB") Opinion No. 25. This method
calculates compensation expense on the measurement date as the excess of the
current market price of the underlying Company stock over the amount the
employee is required to pay for the shares, if any. The expense is recognized
over the vesting period of the grant or award. The Company has elected not to
adopt the fair value method of accounting for stock-based compensation which is
encouraged, but not required, by Statement of Financial Accounting Standards No
123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has
adopted the disclosure requirements of SFAS 123 in preparing its 1996 financial
statement disclosures (see Note 9).

Accounting Standards to be Adopted
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
128"). SFAS 128 establishes standards for computing and presenting earnings per
share ("EPS"), and is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods. This Statement
simplifies the standards for computing earnings per share previously found in
APB Opinion No. 15, Earnings per Share, and makes them comparable to
international EPS standards. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement for all entities with complex
capital structures. Management has not yet evaluated the effect of this
pronouncement on the Company's consolidated financial statements.

Note 2 - Investment Securities

A summary of the amortized cost, unrealized gains and losses and fair
values of held to maturity investment securities at December 31, 1996 and 1995
follows:
December 31, 1996
-------------------------------------
Amortized Gross Unrealized Fair
Cost Gains Losses Value
--------- ------- ---------- ------
U.S. Government obligations.. $2,025 $ - $ 3 $2,022
Obligations of state and
political subdivisions..... 414 1 2 413
------ ----- ----- ------
Total........................ $2,439 $ 1 $ 5 $2,435
====== ===== ===== ======

December 31, 1995
-------------------------------------
Amortized Gross Unrealized Fair
Cost Gains Losses Value
--------- ------- ------- -------

U.S. Government obligations.. $1,143 $ - $ - $1,143
Obligations of state and
political subdivisions..... 412 - 9 403
------ ----- ----- ------
Total........................ $1,555 $ - $ 9 $1,546
====== ===== ===== ======

A comparison of the amortized cost and fair value of the Company's held
to maturity investment securities at December 31, 1996 by maturity date
follows:
Amortized
Cost Fair Value
--------- ----------

One year or less............ $ 764 $ 765
Two years through five years 1,675 1,670
------ ------
Total....................... $2,439 $2,435
====== ======

The Company's investment securities are included in the accompanying
consolidated balance sheets at December 31, 1996 and 1995 as follows.
Remaining amounts included in these balance sheet captions represent
certificates of deposit.
December 31,
----------------
1996 1995
------- -------

Held-to-maturity investments-
current portion.............. $ 500 $ 500
Held-to-maturity investments..... 989 112
Investments pledged.............. 950 943
------ ------
Total............................ $2,439 $1,555
====== ======

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 Company has investments pledged to state regulatory agencies
as follows:
December 31,
-----------------
1996 1995
-------- -------
Certificates of deposit................$1,822 $1,822
Obligation of state and political
subdivisions......................... 300 300
U. S. Government obligations........... 650 644
------ ------
Total $2,772 $2,766
====== ======

Note 3 - Property and Equipment

Property and equipment is comprised of the following:
December 31,
Estimated ----------------
Useful Life 1996 1995
----------- ------- ------
Equipment, furniture and fixtures...3-10 years $5,283 $4,338
Computer software................... 5 years 2,087 1,822
Building and improvements...........20 years 1,653 1,621
Automotive.......................... 3 years 213 163
Land................................ 110 110
------ ------
9,346 8,054
Accumulated depreciation............ (6,391) (5,852)
------ ------
Property and equipment, net......... $2,955 $2,202
====== ======

Note 4 - Revolving Credit Agreement

The Company has an unsecured revolving credit agreement with Bank One,
Texas under which the Company may borrow up to $5 million, as determined by the
borrowing base defined by the agreement, through July, 1997. The borrowing base
is determined by a formula based on 80% of the net cash flow from certain of the
Company's Contracts that have been in existence for 18 months or more. At
December 31, 1996, the borrowing base was approximately $5 million. Under the
agreement, the interest rate, at the option of the Company is at the bank's base
lending rate or an adjusted London interbank rate and is determined at the time
of borrowing. Interest is to be paid monthly and any outstanding principal,
unless converted to an 18 month term loan upon the occurrence of certain events,
comes due in its entirety on July 1, 1997. The agreement contains restrictions
which, among other things, require maintenance of certain financial ratios,
restrict encumbrance of assets and creation of indebtedness, and limit the
payment of dividends. To date, the Company has not borrowed under the bank
credit agreement.

Note 5 - Income Taxes

The provision (benefit) for income taxes consists of the following:

Year Ended December 31,
--------------------------
1996 1995 1994
------- ------- --------
Current............................. $ - $ - $ 43
Deferred............................ 6,715 3,932 (362)
------ ------ ------
Total provision (benefit) for
income taxes....................... $6,715 $3,932 $ (319)
====== ====== ======

A reconciliation of the statutory Federal income tax rate to the
effective income tax rate is as follows:

Year Ended December 31,
------------------------
1996 1995 1994
------ ------ ------
Statutory Federal income tax rate..... 34.0% 34.0% 34.0%
Tax exempt interest................... (.2) (.2) (.3)
Benefit of operating loss
carryforwards....................... - - (32.5)
Benefit of AMT credit carryforward.... - - (10.6)
State income taxes and other.......... 1.2 1.2 -
----- ----- -----
Effective income tax rate............. 35.0% 35.0% (9.4)%
===== ===== =====

Deferred tax liabilities and assets at December 31, 1996 and 1995 are
comprised of the following:

December 31,
----------------
1996 1995
------- -------
Deferred tax liabilities:
Commissions advanced........................ $10,772 $4,408
Depreciation................................ 175 179
------- -------
Total deferred tax liabilities........... 10,947 4,587
------- -------
Deferred tax assets:
Litigation accruals......................... - 135
Contract benefit reserve.................... 139 226
Receivables allowance....................... 201 201
Net operating loss carryforward............. 4,198 3,188
Capital loss carryforward................... 654 653
General Business Credit carryforward........ 325 325
AMT Credit carryforward.................... 366 366
------- -------
Total deferred tax assets................. 5,883 5,094
Valuation allowance for deferred tax assets. (4,220) (4,073)
------- -------
Total net deferred tax assets............. 1,663 1,021
------- -------
Net deferred liability...................... $(9,284) $(3,566)
======= =======

A valuation allowance has been established for deferred tax assets
representing pre-1996 carryforwards except as related to the AMT Credit
carryforward (which is considered to be fully realizable) as the Company does
not believe it is more likely than not that the tax benefits of such
carryforwards will be realized. During the years ended December 31, 1996 and
1995, the valuation allowance increased by $147,000 and decreased by $239,000,
respectively.

The Company generated a tax loss for the year ended December 31, 1996
of $2.8 million. The Company believes it will realize the approximate $1.0
million tax benefits from this tax loss and has appropriately not provided a
valuation allowance against this amount. Because this 1996 taxable loss resulted
primarily from reductions in taxable income generated by the exercise of stock
options, the offsetting credit has been recorded in capital in excess of par
value.

At December 31, 1996, the Company has net operating loss carryforwards
(NOLs) for Federal regular tax and alternative minimum tax purposes of
approximately $11.9 million and $11.5 million, respectively, expiring in 2012
and 2013. In addition, the Company has general business and rehabilitation tax
credit carryforwards of approximately $325,000, expiring primarily in 1998 to
2001, and an alternative minimum tax credit carryforward of $366,000 which does
not expire. The Company also has a capital loss carryforward of $1,800,000 which
expires in 1997.

The ability of the Company to utilize NOLs and tax credit carryforwards
to reduce future Federal income taxes of the Company is subject to various
limitations under the Internal Revenue Code of 1986, as amended (the "Code").
The utilization of such carryforwards may be further limited upon the occurrence
of certain capital stock transactions, including the issuance or exercise of
rights to acquire stock, the purchase or sale of stock by 5% stockholders, as
defined in Temporary Treasury Regulations, and the offering of stock by the
Company during any three-year period resulting in an aggregate change of more
than 50% ("Ownership Change") in the beneficial ownership of the Company. In the
event of an Ownership Change, Section 382 of the Code imposes an annual
limitation on the amount of a corporation's taxable income that can be offset by
those carryforwards.

Note 6 - Stockholders' Equity

On February 27, 1995, all of the Company's remaining outstanding $2.40
Cumulative Convertible Preferred Stock automatically converted into common stock
pursuant to its terms. Approximately 3.9 million shares of common stock were
issued as a result of this conversion.

Each share of $3.00 Cumulative Convertible Preferred Stock is entitled
to receive cumulative cash dividends at the annual rate of $3 per share, payable
quarterly, is convertible into 2.5 shares of Common Stock and is redeemable at
the option of the Company at $25 per share. The $3.00 Cumulative Convertible
Preferred Stock had a liquidation value of $84,000 at December 31, 1996.

Each share of the Special Preferred Stock is entitled to a
non-cumulative annual dividend of $1.00 per share, is convertible into 3.5
shares of Common Stock and is redeemable at the option of the Company at $13.34
per share, plus all accumulated and unpaid dividends. The Special Preferred
Stock had a liquidation value of $430,000 at December 31, 1996. During 1996,
1995 and 1994, Special Preferred Stock consisting of approximately 13,000,
15,000 and 2,000 shares, respectively, were converted into 105,000 shares of
Common Stock.

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. At December 31, 1996, PPLCI did not have
funds available for payment of dividends without the approval of the Oklahoma
Insurance Commissioner. The Company's ability to pay dividends is also
restricted under a line of credit agreement which precludes payments of
dividends on Common Stock as long as any amounts are outstanding pursuant to
such credit agreement. To date, the Company has not borrowed under the bank
credit agreement.

At December 31, 1996, the Company had outstanding warrants and options
to purchase a total of approximately 988,000 shares of the Company's Common
Stock at an average price of $6.47 per share expiring at various periods through
December, 2005.

Note 7 - Related Party Transactions

The Company's Chairman 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 during 1996, 1995 and 1994 of $130,000, $413,000 and $401,000,
respectively, through its sales of insurance products of an unaffiliated
company. Agency had net income for the year ended December 31, 1996 and 1995 of
$56,000 and $599, respectively and a net loss for the year ended December 31,
1994 of $170,000, after incurring commissions earned by the Chairman of $18,000,
$45,000 and $229,000, respectively, and annual management fees of $72,000 paid
to the Company.

A former executive officer and director of the Company has a loan from
the Company which was made prior to the time he became a director. The largest
balance of this loan during the year ended December 31, 1996 was $281,000. The
outstanding balance of this loan as of December 31, 1996 was $281,000. The loan
bears annual interest at the rate of 3% in excess of the prime rate, adjusted on
January 1 of each year, and is secured by commissions due from the Company.

The former executive officer and director owns interests ranging from
10% to 67% in corporations or partnerships not affiliated with the Company but
engaged in the marketing of the Company's Contracts and which earn commissions
from sales of Contracts. These entities earned commissions, net of amounts
passed through as commissions to their sales agents, during 1996, 1995 and 1994
of $54,000, $55,000 and $71,000, respectively.

Note 8 - Commitments and Contingencies

Aggregate rental expense under all operating leases was $27,000,
$28,000 and $42,000 in 1996, 1995 and 1994, respectively. There are no
significant operating lease commitments in effect at December 31, 1996.

The Company is a named defendant in certain lawsuits arising in the
ordinary course of the Company's business. While the outcome of these lawsuits
cannot be predicted with certainty, the Company does not expect these matters to
have a material adverse effect on the Company's financial condition, liquidity
or results of operations.

Note 9 - Stock Options and Purchase Plan

The Company has a stock option plan ("Plan") under which the Board of
Directors ("Board") or its Stock Option Committee ("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
1,000,000 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 will have a maximum term of 15 years. Vesting of
options granted under the Plan is determined by the Board or Committee. 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 will receive options to purchase 10,000 shares
of common stock on March 1 of each year commencing March 1, 1996. The options to
be granted on March 1 of each year will be immediately exercisable as to 2,500
shares and will 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.

A summary of the status of the Company's Plan as of December 31, 1996,
1995 and 1994 and changes during the years ending on those dates is presented
below:

1996 1995 1994
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ----------- ------------ ---------- ---------- ----------

Outstanding at beginning of year..... 405,000 $ 5.40 150,000 $ .58 150,000 $ .58
Granted.............................. 45,000 13.50 315,000 6.84 - -
Exercised............................ (40,000) .38 (60,000) .90 - -
Terminated........................... - - - - - -
------- -------- ------- -------- ------- --------
Outstanding at end of year........... 410,000 $ 6.78 405,000 $ 5.40 150,000 $ .58
======= ======== ======= ======== ======= ========
Options exercisable at year end...... 385,000 $ 6.18 405,000 $ 5.40 150,000 $ .58
======= ======== ======= ======== ======= ========

The following table summarizes information about stock options
outstanding at December 31, 1996 issued pursuant to the Plan:

Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
------------------------- --------------------- -------------------- ------------------

$.38 - $1.82 150,000 1.67 $ 1.33
$8.13 - $10.38 235,000 1.77 9.27
$16.00 25,000 4.92 16.00
------- ---- ---------
410,000 1.93 $ 6.78
======= ==== =========

The Company, effective July 3, 1995 and pursuant to a registration
statement on Form S-3, initiated a stock option plan for its marketing
associates whereby the associates could earn stock options based upon their
production and recruiting efforts. These options were issued to qualifying
associates at each month end from July, 1995 through March 31, 1996 based on
that month's production and recruiting results. The exercise price is equal to
the closing stock price on the last trading day of each respective month.
Additional grants pursuant to the plan ceased March 31, 1996. Activity related
to this plan was as follows during 1996 and 1995:

1996 1995
------------------ ----------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-------- -------- -------- ---------
Outstanding at beginning
of year.................... 298,225 $ 8.02 - $ -
Granted....................... 177,133 12.50 299,785 8.02
Exercised..................... (70,516) 8.95 (1,560) 7.03
Terminated.................... (54,750) 8.63 - -
------- ------ ------- ------
Outstanding at end of year... 350,092 $10.00 298,225 $ 8.02
======= ====== ======= ======
Options exercisable at
year end................... 350,092 $10.00 298,225 $ 8.02
======= ====== ======= ======

The following table summarizes information about stock options
outstanding at December 31, 1996 issued to marketing associates:

Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
------------------------- ----------------------- ----------------------- ---------------------

$5.81 - $7.94 123,771 .58 $ 7.38
$8.50 - $10.38 130,379 .58 9.60
$12.00 - $14.88 95,942 .58 13.93
------- --- -----
350,092 .58 $ 10.00
======= === ===========

In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation" ("SFAS 123") , the Company recorded
compensation expense related to the issuance of stock options to marketing
associates of $318,000 and $76,000 during 1996 and 1995, respectively. The
weighted average fair value of options granted that met the minimum exercise
criteria during 1996 was $2.79 per share. The fair value of each stock option
grant to marketing associates was measured on the date of the grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used: no dividend yield; risk-free interest rate of 6.00%; expected
life of 1.5 years; and expected volatility of 48.62%.

SFAS 123 establishes a fair value method and disclosure standards for
stock-based employee compensation arrangements, such as stock purchase plans and
stock options. It also applies to transactions in which an entity issues its
equity instruments to acquire goods or services from nonemployees, requiring
that such transactions be accounted for based on fair value. As allowed by SFAS
123, the Company will continue to follow the provisions of Accounting Principles
Board Opinion No. 25 and related interpretations for its employee compensation
arrangements, and disclose the pro forma effects of applying SFAS 123. Had
compensation cost for the Company's employee related stock option plans been
determined based on the fair value at the grant dates for awards under the Plan
consistent with the method of SFAS 123, the Company's net income and earnings
per share for 1996 and 1995 would have been reduced to the pro forma amounts
indicated below:
1996 1995
------- -------
Net income applicable to common shares:
As reported............................. $12,455 $ 7,187
Pro forma............................... $12,227 $ 6,428

Earnings per common and common equivalent share:
As reported............................. $ .56 $ .35
Pro forma............................... $ .55 $ .31

Earnings per common share - assuming full dilution:
As reported............................. $ .56 $ .34
Pro forma............................... $ .55 $ .30

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 6.00%; expected life of 5 years; and expected volatility
ranging from 53.74% to 63.75%.

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 1996, 1995 and 1994 of $46,176, $39,150 and $34,027
based on contributions of Company stock of 51,000 shares, 20,000 shares and
20,000 shares, respectively.

Note 10 - Selected Quarterly Financial Data (Unaudited)

Following is a summary of the unaudited interim results of operations
for the year ended December 31, 1996 and 1995.

Selected Quarterly Data
(In thousands except per share amounts)
Earnings per common Earnings per common
Income before Net and common share - assuming full
Revenues income taxes Income equivalent share dilution
---------- -------------- -------- ----------------- ---------------------
1996
----

First quarter......... $12,354 $3,954 $2,566 $.12 $.12
Second quarter........ 14,796 4,862 3,156 .14 .14
Third quarter......... 15,760 5,006 3,251 .15 .15
Fourth quarter........ 17,036 5,363 3,482 .16 .16

1995
----
First quarter......... $7,548 $2,103 $1,274 $.08 $.07
Second quarter........ 8,898 2,760 1,818 .09 .09
Third quarter......... 9,740 2,944 1,940 .09 .09
Fourth quarter........ 10,947 3,437 2,155 .10 .10

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
- ----------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
- ------------------------

None.

PART III

In accordance with the provisions of General Instruction G(3), information
required by Items 10, 11, 12 and 13 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, 1997.

PART IV

ITEM 14. 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 19 of this report.
(2) Financial Statement Schedule: See Index to Consolidated Financial
Statements and Consolidated Financial Statement Schedule set forth
on page 19 of this report.
(3) Exhibits: For a list of the documents files as exhibits to this
report, see the Exhibit Index following the signatures to this
report.

(b) Reports on Form 8-K: The Company filed no reports on Form 8-K during the
quarter ended December 31, 1996.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

PRE-PAID LEGAL SERVICES, INC.

Date: March 28, 1997 By: /s/ RANDY HARP
------------------------------
Randy Harp
Chief Financial Officer

In accordance with the Exchange Act, 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 March 28, 1997
- ------------------------------ Directors
Harland C. Stonecipher (Principal Executive Officer)

/s/ KATHLEEN S. PINSON Vice President, Controller and March 28, 1997
- ------------------------------ Director,
Kathleen S. Pinson (Principal Accounting Officer)

/s/ RANDY HARP Chief Operating Officer, Chief March 28, 1997
- ------------------------------ Financial Officer and Director
Randy Harp (Principal Financial Officer)

/s/ PETER K. GRUNEBAUM Director March 28, 1997
- ------------------------------
Peter K. Grunebaum

/s/ CHARLES H. WALLS Director March 28, 1997
- ------------------------------
Charles H. Walls

SCHEDULE II
PRE-PAID LEGAL SERVICES, INC.
Consolidated Valuation And Qualifying Accounts
Years ended December 31, 1996
(Amounts in 000's)

Additions
Balance at Charged to Balance at
Beginning Cost and End of
Description of Year Expenses Deductions Year
- -----------------------------------------------------------------------------------------------------
Allowance for unrecoverable commission advances
- (non-current):

December 31, 1996 $2,669 $775 - $3,444

December 31, 1995 $2,469 $200 - $2,669

December 31, 1994 $2,525 - $56 $2,469

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 September 30, 1996)

*10.1 Employment 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)

*10.2 Agreements 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)

*10.3 Amendment 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)

*10.4 Form 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)

*10.5 Amendment 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.)

*10.6 Stock Option Plan, as amended and restated effective December
12, 1995 (Incorporated by reference to Exhibit 10.6 of the
Company's Annual Report on Form 10-KSB for the year ended
December 31, 1995)

*10.7 Demand Note of Wilburn L. Smith and Carol Smith dated December
11, 1992 in favor of the Company (Incorporated by reference to
Exhibit 10.15 of the Company's Form SB-2 filed February 8, 1994)

*10.8 Security Agreement between the Company, Wilburn L. Smith and
Carol Smith dated December 11, 1992 ((Incorporated by reference
to Exhibit 10.16 of the Company's Form SB-2 filed February 8,
1994)

*10.9 Letter Agreements dated July 8, 1993 and March 7, 1994 between
the Company and Wilburn L. Smith (Incorporated by reference to
Exhibit 10.17 of the Company's Form 10-KSB filed for the year
ending December 31, 1993)

*10.10 Employment agreement effective March 26, 1996 between the
Company and Jack Mildren (Incorporated by reference to Exhibit
10.10 of the Company's Form 10-KSB filed for the year ending
December 31, 1995)

INDEX TO EXHIBITS, (Continued)

Exhibit No. Description
- ----------- -----------

10.11 Revolving Credit Agreement between Company and Bank One, Texas,
National Association dated January 27, 1995 (Incorporated by
reference to Exhibit 10.14 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1994)

11.1 Statement of Computation of Per Share Earnings

21.1 List of Subsidiaries of the Company

23.1 Consent of Deloitte & Touche LLP

27.1 Financial Data Schedule

- --------------------
* Constitutes a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this report.