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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, 1997
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
______________________________________________________________
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
Common Stock, $0.01 Par Value 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 February 3, 1998 - $843,262,424.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of February 3,
1998 there were 22,404,853 shares of Common Stock, par value $.01 per share,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 1998 annual
meeting of shareholders are incorporated into Part III of this Form 10-K by
reference.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the year ended December 31, 1997
TABLE OF CONTENTS
PART I.
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.
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:
1997 compared to 1996
1996 compared to 1995
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 1998 annual meeting of
shareholders.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
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, 1997 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.
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, 1997, the Company had 425,381 Contracts in
force with members in all 50 states, and the District of Columbia. Approximately
94% of such Contracts were in 27 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 105 million Americans entitled to service through at least
one legal service plan in 1997, compared to 4 million in 1981, 15 million in
1985, 58 million in 1990 and 98 million in 1996. 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 50% of covered persons
in 1997. 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 1997.
According to the NRC, the remaining covered persons in 1997 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 15% of the market in 1997 and
represent the market segment in which the Company primarily competes. According
to the NRC, these plans typically have more comprehensive benefits, higher
utilization, involve higher costs to participants, and are offered on an
individual enrollment or voluntary basis.
Of the current work force covered by legal service plans, only 10% 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, 1997, closed
panel Contracts comprised approximately 91% 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
five basic benefits which provide coverage for a broad range of preventive and
litigation-related legal expenses. The family plan accounted for approximately
93% of the outstanding Contracts at December 31, 1997. 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 20 or fewer employees
and $2 million or less in gross income per year.
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, other than the Small
Business Legal Defense Plan, 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, bankruptcy
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 or no valid operators license.
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 within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this 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 remaining 46.5 hours of actual trial time if
settlement is not achieved prior to litigation. Coverage is limited to audit
notification received regarding the tax return for years during which the
membership is effective. Representation for charges of fraud or income tax
evasion, business and corporate tax returns and certain other matters are
excluded from this 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 hourly 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 hourly 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 44 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, 1997, 1996 and 1995,
this plan accounted for approximately 2.2%, 3.5% and 4.7%, 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 21 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, including the availability of the optional
pre-trial hours described above for an additional $9.00 per month. During the
years ended December 31, 1997, 1996 and 1995, the Law Officers Legal Plan
accounted for approximately 2.2%, 2.4% and 3.4%, respectively, of the Company's
Contract premiums.
Small Business Legal Defense Plan
The Small Business Legal Defense plan was developed during 1995 and
test marketed in selected geographical areas and more widely marketed beginning
in 1996. During 1997, the coverage offered pursuant to this plan was expanded to
include trial defense benefits and membership in the Fran Tarkenton Small
Business NETwork(TM) ("FTSBN"). Through the FTSBN, members may receive products,
services and information from a group of affinity partners, including
certificates valued at over $2,000 in free and discounted services from such
affinity partners. This expanded plan is currently marketed at the monthly rate
of $69.00 and provides business oriented legal service benefits for any
for-profit business with 20 or fewer employees and $2 million or less in gross
annual income. This plan is available in 28 states and represented approximately
2.1% and 2.4% of the Company's Contract premiums during 1997 and 1996,
respectively.
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, 1997, closed panel Contracts comprised
approximately 91% 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 who are residents 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 1997, the
Company had 35 provider attorney firms compared to 30 provider attorney firms at
the end of 1996 and 27 at the end of 1995. During the last three years, the
Company's relationships with a total of three provider attorney firms 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 11 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, 1997,
compared to 76% and 78% at December 31, 1996 and 1995, respectively. Although
other means of payment are available, approximately 57% 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, 1997 sold through employee groups
constituted approximately 24% of total Contracts in force compared to 24% and
22% at December 31, 1996 and 1995, respectively. The majority of employee group
Contracts are sold to school systems, governmental entities and businesses. No
group accounted for more than 1% of the Company's consolidated revenues from
Contracts during 1997, 1996 or 1995.
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, 1997,
the Company had 123,470 "active" sales associates compared to 110,350 and 78,281
"active" sales associates at December 31, 1996 and 1995, respectively. 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 1997, the Company had 37,404 sales associates who sold at least one
Contract, of which 25,909 (69%) made first time sales, compared to 32,290 and
21,116 sales associates producing at least one Contract sale in 1996 and 1995,
respectively, of which 24,715 (77%) and 18,313 (87%), 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 $65 from
each new sales associate and the sale of marketing supplies and promotional
materials to associates. Effective January 4, 1997, the Company implemented a
new self funded combination classroom and field training program, titled Fast
Start to Success ("Fast Start"), aimed at increasing the level of new membership
sales per associate. The positive impact of the program is reflected in the
increase in new memberships written and new sales associates recruited per
successful Fast Start associate. Associates successfully completing Fast Start
during 1997 produced 6.1 times more new Contracts and recruited 4.0 times more
new sales associates than non-Fast Start qualified associates. The Fast Start
program provides a direct economic incentive to existing associates to help
train new recruits. Associates who successfully complete the program by writing
three new Contracts and recruiting one new sales associate within 15 days of the
associate's Fast Start training advance through the various commission levels at
a faster rate. The program requires a one-time training fee of $184 per new
associate, or a total of $249 including the one time enrollment fee of $65
described above, and upon successful completion of the program provides for the
payment of certain training bonuses and covers the additional training materials
used in the 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 field leaders to the
position of Regional Vice President ("RVP") and has since removed and added RVPs
based on their performance. At December 31, 1997, there were 18 RVPs in place.
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. The RVPs
have weekly reporting requirements as well as quarterly sales and recruiting
goals. 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 Fast Start
program, will be channeled through the RVPs and Area Coordinators.
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.
During the fourth quarter of 1997, the Company announced cooperative
marketing agreements with the Chicago-based insurance company, CNA, one of the
10 largest U.S. insurance groups, and Atlanta-based Primerica Financial Services
("PFS"), a subsidiary of the Travelers Group Inc. PFS is one of the largest
financial services marketing organizations in North America with more than
100,000 personal financial analysts across the U.S. and Canada. Neither of these
arrangements resulted in membership sales during 1997.
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 delivery of 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
that are not connected to the Company's management information systems to
provide various statistical 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
members and sales associates 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 21% 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 79% 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 the 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, its existing network of
provider attorney firms and its ability to tailor products to suit various types
of distribution channels or target markets. 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, 1997, the Company or one of its subsidiaries was
marketing new Contracts in 30 states which require no special licensing or
regulatory compliance. The Company's subsidiaries serve as operating companies
in 15 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, 1997,
39% were written in jurisdictions which subject the Company or one of its
subsidiaries to insurance or specialized legal expense plan 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, 1997, the Company and its subsidiaries employed 216
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. Additionally, during 1997, the Company completed construction of its
material distribution center located approximately 5 miles from its
administrative offices. This new structure contains approximately 8,600 square
feet of inventory, package assembly and shipping space. 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 February 3, 1998, there were approximately 5,406 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
1998:
1st Quarter (through February 3).................... $ 41.06 $ 28.50
1997:
4th Quarter......................................... $ 34.63 $ 25.50
3rd Quarter......................................... 30.31 21.13
2nd Quarter......................................... 24.63 14.00
1st Quarter......................................... 19.13 14.50
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
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, 1997, PPLCI did not have funds available for
payment of dividends without the prior approval of the Oklahoma Insurance
Commissioner.
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.
Certain reclassifications have been made to conform to current year
presentation. 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,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Income Statement Data: (In thousands, except ratio, per share and Contract amounts)
Revenues:
Contract premiums............................................ $76,688 $50,582 $31,290 $22,852 $19,182
Associate services........................................... 12,143 5,646 3,183 912 462
Interest income.............................................. 1,636 1,302 1,308 466 195
Other........................................................ 2,001 1,678 1,255 379 329
------- ------- ------- ------- -------
Total revenues............................................. 92,468 59,208 37,036 24,609 20,168
------- ------- ------- ------- -------
Costs and expenses:
Contract benefits............................................ 25,132 16,871 10,477 7,990 7,480
Commissions.................................................. 16,717 11,476 7,708 6,788 6,117
General and administrative expenses.......................... 8,711 6,201 4,305 3,940 3,530
Associate services and direct marketing...................... 11,431 4,544 2,573 1,539 1,139
Depreciation................................................. 704 533 477 410 538
Depreciation...................................................
Interest..................................................... - 26 10 320 518
Other expenses............................................... 866 372 242 226 709
------- ------- ------- ------- -------
Total costs and expenses................................... 63,561 40,023 25,792 21,213 20,031
------- ------- ------- ------- -------
Income before income taxes..................................... 28,907 19,185 11,244 3,396 137
Provision (benefit) for income taxes........................... 10,117 6,715 3,932 (319) 29
------- ------- ------- ------- -------
Net income..................................................... 18,790 12,470 7,312 3,715 108
Less dividends on preferred shares............................. 13 15 125 465 15
------- ------- ------- ------- -------
Net income applicable to common shares......................... $18,777 $12,455 $ 7,187 $ 3,250 $ 93
======= ======= ======= ======= =======
Net income per common share - basic (1)........................ $ .85 $ .58 $ .38 $ .28 $ .01
Net income per common share - diluted (1)...................... .83 .56 .34 .24 .01
Weighted average number of common shares outstanding-basic(1).. 22,127 21,332 18,947 11,603 10,662
Weighted average number of common shares outstanding-diluted(1) 22,575 22,319 21,408 15,566 12,407
Contract Benefit Cost and Statistical Data:
Loss ratio (2)................................................. 32.8% 33.4% 33.5% 35.0% 39.0%
Expense ratio (2).............................................. 34.3% 35.7% 39.2% 47.9% 54.0%
Combined loss and expense ratio................................ 67.1% 69.1% 72.7% 82.9% 93.0%
New Contracts sold............................................. 283,723 194,483 109,922 45,893 34,294
Period end Contracts in force.................................. 425,381 294,151 203,535 144,438 133,121
Cash Flow Data:
Net cash provided by operating activities...................... $ 7,733 $ 942 $ 624 $ 3,040 $ 1,100
Net cash provided by (used in) investing activities............ (3,978) (2,549) (2,192) 254 (611)
Net cash provided by (used in) financing activities............ 3,217 1,949 6,545 3,802 (1,307)
Balance Sheet Data:
Total assets................................................... $91,912 $57,532 $ 35,629 $ 18,154 $ 11,109
Notes payable, financing transactions and
subordinated debentures....................................... - - - - 3,837
Total liabilities.............................................. 21,401 12,058 5,889 2,347 6,656
Stockholders' equity ......................................... 70,511 45,474 29,740 15,807 4,453
(1) All share and per share information has been restated to reflect the
adoption of Statement of Financial Accounting Standards 128, Earnings Per
Share. See Note 9 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, general and
administrative expenses and premium taxes as a percentage of Contract
premiums. The Company has revised the expense ratio definition for 1997 to
provide data it believes more accurately reflects trends in the
Company's growth. All prior periods have been conformed to current year
presentation. 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 access to larger, more diversified law firms. At December 31, 1997,
approximately 91% of the Company's Contracts were closed panel plans compared to
88% at December 31, 1996.
Contract benefit costs relating to open panel Contracts, which
constituted approximately 9% of Contracts in force at December 31, 1997, 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
reviewed annually 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. Prior to March 1, 1995, 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 advanced commissions at the time
of sale of all new Contracts. Effective January 4, 1997, the Company implemented
a policy whereby the associate receives only earned commissions on the first
three sales unless the associate has successfully completed the 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 12, 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. During 1997, 24%
of all associates submitting new memberships accounted for 76% of all such new
memberships produced thereby further enhancing the recovery of commissions
advances.
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 Contract persistency. The Company closely monitors such commission
advances to ensure maximum recoverability and maintains a recoverability reserve
which at December 31, 1997 and 1996, was $3.7 million and $3.4 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 on January 4, 1997.
In order to successfully qualify, the new associate going through the training
program must produce 3 new Contracts and recruit 1 new associate within 15 days
of receiving the training.
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 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, 1997, the
Company's annual Contract persistency rates, using the foregoing method, have
averaged approximately 76%. The annual Contract persistency rates were 73.6%,
73.9% and 80.0% for 1997, 1996 and 1995, 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
determined by the formula described above, but does not necessarily indicate
that the new Contracts written are less persistent, only that the ratio of new
Contracts to total Contracts is higher than it was during 1997 and 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, general and administrative
expenses and premium taxes as a percentage of Contract premiums. The Company has
revised the expense ratio definition for 1997 to provide data it believes
more accurately reflects trends in the Company's growth. All prior periods have
been conformed to current year presentation. 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 generally advances significant commissions at the time a
Contract is sold. Since approximately 93% 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 in relation to the existing active base of
Contracts and the composition of new or existing sales associates producing such
Contracts.
Income Tax Matters-Net Operating Losses
At December 31, 1997, the Company had net operating loss carryforwards
("NOLs") for Federal regular and alternative minimum tax purposes of
approximately $14.6 million and $14.2 million, respectively, expiring in 2001
through 2012. 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 ("AMT") 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, 1997 of $2.6 million. The Company believes it will realize
the approximate $926,000 tax benefit from this tax loss and the approximate
$997,000 of tax benefits from the 1996 tax loss of $2.8 million and has
appropriately not provided a valuation allowance against these amounts. The
Company accrued tax expense for 1997 and 1996 at the applicable statutory rates
and expects to continue such accrual for 1998 since it does not expect to be
able to utilize available tax benefits from its existing pre-1996 carryforwards.
However, if the level of tax deductions for commissions is less than expected in
1998 (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 1998 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 58,121 new sales
associates during 1997 compared to 69,789 during 1996 and 50,464 during 1995,
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.
Year 2000 Issues
The Company has conducted a comprehensive review of its computer
systems to identify the systems that could be affected by the "Year 2000" issue
and has developed a plan to resolve the issue. The Year 2000 issue is the result
of computer programs being written using two digits rather than four to define
the applicable year. Any of the Company's affected programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a major system failure or
miscalculations. The Company presently believes that, with modifications to
existing software and conversion to new software, the Year 2000 issue will not
pose significant operational problems for the Company's computer systems as so
modified and converted. Testing and conversion of system applications commenced
during 1993 and is expected to be completed during 1998. Costs incurred in prior
periods have not been material. The remaining total cost of the Company's
remediation efforts is expected to be approximately $240,000, substantially all
of which will be incurred during 1998. This amount is not expected to have a
material effect on results of operations, liquidity or capital resources during
1998 or future periods. A significant portion of the Company's Year 2000
remediation plan will be accomplished by the Company's internal programming
staff and while such efforts will result in the concentration on Year 2000
programming, these costs are not likely to be incremental costs to the
Corporation, but rather will represent the redeployment of existing information
technology resources. However, if such modifications and conversions are not
completed in a timely fashion, the Year 2000 issue may have a material adverse
impact on the operations of the Company.
Accounting Standards to be Adopted
Statement of Financial Accounting Standards 130, "Reporting
Comprehensive Income," ("SFAS 130") was issued in June, 1997. This Statement
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. This Statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. SFAS 130, effective for fiscal years beginning after December 15,
1997, requires reclassification of financial statements for earlier periods
provided for comparative purposes. The Company currently does not expect
adoption of this Statement to have a material effect on financial statement
presentation.
Statement of Financial Accounting Standards 131, "Disclosures about
Segments of an Enterprise and Related Information," ("SFAS 131") was issued in
June, 1997. This Statement establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. SFAS 131,
effective for fiscal years beginning after December 15, 1997, requires
comparative information for previous years to be restated to comply with SFAS
131's reporting requirements. The Company currently does not expect adoption of
this Statement to have a material effect on financial statement presentation or
related footnote disclosures.
Results of Operations
Comparison of 1997 to 1996
The Company reported net income applicable to common shares of $18.8
million, or $.83 per diluted common share, for 1997, up 51% from net income
applicable to common shares of $12.5 million, or $.56 per diluted common share,
for 1996. The increase in the net income applicable to common shares for 1997 is
primarily the result of increases in every revenue category for 1997 as compared
to 1996.
Contract premiums totaled $76.7 million during 1997 compared to $50.6
million for 1996, an increase of 52%. Contract premiums and their impact on
total revenues in any period are determined directly by the number of active
Contracts in force during any such period. The active Contracts in force are
determined by both the number of new Contracts sold in any period together with
the persistency, or renewal rate, of existing Contracts. New Contract sales
increased 46% during 1997 to 283,723 from 194,483 during 1996. At December 31,
1997, there were 425,381 active Contracts in force compared to 294,151 at
December 31, 1996. Additionally, the average annual premium per Contract has
increased from $216 for all Contracts in force at December 31, 1996 to $225 for
all Contracts in force at December 31, 1997, a 4.0% increase, as a result of a
higher portion of active Contracts containing the additional pre-trial hours
benefit at an additional cost to the member together with increased sales of the
Small Business Legal Defense plan.
Associate services revenue increased 115% from $5.6 million for 1996 to
$12.1 million during 1997 primarily as a result of Fast Start which resulted in
the Company receiving training fees of approximately $5.7 million during 1997.
The new combination classroom and field training program, titled Fast Start to
Success ("Fast Start"), is aimed at increasing the level of new membership sales
per associate. The positive impact of the program is reflected in the increase
in new memberships written and new sales associates recruited per Fast Start
associate. Fast Start requires a training fee of $184 per new associate and upon
successful completion of the program provides for the payment of certain
training bonuses. In order to be deemed successful for Fast Start purposes, the
new associate must write three new memberships and recruit one new sales
associate within 15 days of the associate's Fast Start training. The $5.7
million in training fees was comprised of $184 from each of approximately 28,900
new sales associates who elected to participate in Fast Start and training fees
of $25 from each of approximately 14,500 existing associates who participated in
the program. New associates enrolled during 1997 were 58,121 compared to 69,789
for 1996, a decrease of 17%. The Company believes that the decline in new
associate enrollment during 1997 is primarily attributable to the increased
costs associated with the Fast Start program. However, while the number of new
associates decreased during 1997, the number of new Contracts sold, at least
partially as a result of the Fast Start program, increased significantly. Future
revenues from associate services will depend primarily on the number of new
associates enrolled and the number who choose to participate in the Company's
training program, but the Company expects that such revenues will continue to be
largely offset by the direct and indirect cost to the Company of training
bonuses paid, providing associate services and other direct marketing expenses.
Interest income for 1997 increased 26% to $1.6 million from $1.3
million for 1996. Interest income increased as a result of increases in the
average investments outstanding. At December 31, 1997 the Company reported $29.5
million in cash and investments compared to $19.9 million at December 31, 1996.
Primarily as a result of the increase in Contract premiums, total
revenues increased to $92.5 million for 1997 from $59.2 million during 1996, an
increase of 56%.
Contract benefits totaled $25.1 million for 1997 compared to $16.9
million for 1996, and represented 33% of Contract premiums for both 1997 and
1996. This loss ratio (Contract benefits as a percentage of Contract premiums)
should remain near 35% as the portion of active Contracts which provide for a
capitated benefit continues to increase.
Commission expense was $16.7 million for 1997 compared to $11.5 million
for 1996, and represented 22% and 23% of Contract premiums for 1997 and 1996,
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 1997 and 1996 were $8.7
million and $6.2 million, respectively, and represented 11% and 12% of Contract
premiums for such years. Although the total amount of general and administrative
expenses increased approximately $2.5 million during 1997, these expenses, as a
percent of Contract premiums, decreased 1%. 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 expenses increased to $11.4
million for 1997 from $4.5 million for 1996 primarily as a result of
approximately $4.4 million in Fast Start training bonuses paid, additional costs
of supplies due to increased purchases by associates and higher staffing
requirements. These expenses also include the costs of providing associate
services and marketing costs other than commissions which are directly
associated with new membership sales.
Due to property and equipment additions during 1997 of $1.3 million,
depreciation increased from $533,000 for 1996 to $704,000 for 1997.
The Company's expense ratio, which represents commissions, general and
administrative expenses and premium taxes as a percentage of membership
premiums, was 34% for 1997 compared to 36% for 1996 resulting in a combined loss
and expense ratio of 67% for 1997 compared to 69% for 1996. The combined ratio
does not measure total profitability because it does not take into account all
revenues and expenses.
Provision for income taxes increased significantly during 1997 to $10.1
million compared to $6.7 million for 1996, 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 future
tax deductions attributable to expected levels of commissions to be paid on new
Contract sales.
Dividends paid on outstanding preferred stock decreased to $13,000 for
1997 from $15,000 during 1996 and is attributable to the conversion of shares of
$3.00 Cumulative Convertible Preferred Stock into common stock.
Comparison of 1996 to 1995
The Company reported net income applicable to common shares of $12.5
million, or $.56 per diluted common share, for 1996, up 74% from net income
applicable to common shares of $7.2 million, or $.35 per diluted 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 $200 for all Contracts in
force at December 31, 1995 to $216 for all Contracts in force at December 31,
1996, a 8.0% 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 $59.2 million for 1996 from $37.0 million during 1995, an
increase of 60%.
Contract benefits totaled $16.9 million for 1996 compared to $10.5
million for 1995, an increase of 61%. However, the loss ratio for the 1996
period of 33% was the same for 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 for 1996 was 36% compared to 39% for 1995.
These factors resulted in a combined loss and expense ratio of 69% and 73% 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.
Liquidity and Capital Resources
General
Consolidated net cash provided by operating activities was $7.7
million, $942,000 and $624,000 for 1997, 1996 and 1995, respectively. Cash
provided by operating activities increased significantly during 1997 compared to
1996 and 1995 due to the $6.3 million increase in net income, an increase of
$3.4 million in deferred income taxes and an increase of $1.2 million in
accounts payable and accrued expenses, all of which more than offset the $4.5
million increase in commission advances.
During 1997, the Company had net cash provided by financing activities
of $3.2 million as a result of the exercise proceeds of options to purchase
common stock, an increase of $1.3 million from such proceeds in 1996. In 1995,
the Company had net cash provided by financing activities of $6.5 million, after
dividends of $125,000, as a result of the exercise proceeds of warrants to
purchase common stock during May, 1995.
The Company had a consolidated working capital surplus of $39.2 million
at December 31, 1997 compared to $23.4 million at December 31, 1996. The $15.8
million increase in working capital during 1997 was primarily the result of
increases in the current portion of commission advances of $6.6 million and
increases in cash and investments of $10.7 million.
The Company generally advances significant commissions at the time a
membership is sold. During 1997, the Company advanced commissions of $38.1
million on new membership sales compared to $28.5 million for 1996. Since
approximately 93% of membership premiums are collected on a monthly basis, a
significant cash flow deficit is created at the time a membership is sold. This
deficit is reduced as monthly premiums are remitted and no additional
commissions are paid on the membership until all previous commission advances
have been fully recovered. Commission advances were subsequently reduced by
commission earnings of $14.9 million and $9.3 million for 1997 and 1996,
respectively. The Company has recorded an allowance of $3.7 million to provide
for estimated uncollectible balances which includes an increase in the allowance
of $300,000 during 1997.
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
unpledged cash and investments at December 31, 1997 of $26.7 million.
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, 1997 and 1996
Consolidated Statements of Income - For the years ended December 31, 1997, 1996
and 1995
Consolidated Statements of Cash Flows - For the years ended December 31, 1997,
1996 and 1995
Consolidated Statements of Changes in Stockholders' Equity - For the years ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
Consolidated Financial Statement Schedule
- -----------------------------------------
Schedule II. Consolidated Valuation and Qualifying Accounts - For the years
ended December 31, 1997, 1996 and 1995
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, 1997 and 1996, and the
related statements of income, changes in stockholders' equity, and cash flows
each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 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 12, 1998
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)
ASSETS
December 31,
-----------------
1997 1996
------ ------
Current assets:
Cash and cash equivalents............................... $21,803 $14,831
Held-to-maturity investments - current portion.......... 4,242 500
Accrued Contract income................................. 2,399 1,710
Commission advances - current portion................... 15,705 9,108
------- -------
Total current assets.................................. 44,149 26,149
Held-to-maturity investments.............................. 650 1,757
Investments pledged....................................... 2,772 2,772
Commission advances, net.................................. 38,038 21,744
Property and equipment, net............................... 3,594 2,955
Other..................................................... 2,709 2,155
------- -------
Total assets......................................... $91,912 $57,532
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Contract benefits........................................ $ 2,649 $ 1,862
Accounts payable and accrued expenses.................... 2,281 912
------- -------
Total current liabilities.............................. 4,930 2,774
Deferred income taxes...................................... 16,471 9,284
------- -------
Total liabilities...................................... 21,401 12,058
------- -------
Stockholders' equity:
Preferred stock, $1 par value; authorized 400 shares; 5
issued and outstanding as follows:
$3.00 Cumulative Convertible Preferred Stock, 3 and 5
shares authorized, issued and outstanding at
December 31, 1997 and 1996, respectively;
liquidation value of $55 and $84 at December 31, 1997
and 1996, respectively................................. 3 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, 23 and
32 shares authorized, issued and outstanding at
December 31, 1997 and 1996, respectively; liquidation
value of $304 and $430 at December 31,1997 and 1996,
respectively.......................................... 23 32
Common stock, $.01 par value; 100,000 shares authorized;
23,151 and 22,459 issued at December 31, 1997 and 1996,
respectively............................................ 232 225
Capital in excess of par value........................... 47,303 41,039
Retained earnings........................................ 25,127 6,350
Less: Treasury stock at cost; 747 shares................. (2,177) (2,177)
------- -------
Total stockholders' equity.............................. 70,511 45,474
------- -------
Total liabilities and stockholders' equity............. $91,912 $57,532
======= =======
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,
-------------------------
1997 1996 1995
------ ------ ------
Revenues:
Contract premiums............................ $76,688 $50,582 $31,290
Associate services........................... 12,143 5,646 3,183
Interest income.............................. 1,636 1,302 1,308
Other........................................ 2,001 1,678 1,255
------- ------- -------
92,468 59,208 37,036
------- ------- -------
Costs and expenses:
Contract benefits............................ 25,132 16,871 10,477
Commissions.................................. 16,717 11,476 7,708
General and administrative................... 8,711 6,227 4,315
Associate services and direct marketing...... 11,431 4,544 2,573
Depreciation................................. 704 533 477
Premium taxes................................ 866 372 242
------- ------- -------
63,561 40,023 25,792
------- ------- -------
Income before income taxes..................... 28,907 19,185 11,244
Provision for income taxes..................... 10,117 6,715 3,932
------- ------- -------
Net income..................................... 18,790 12,470 7,312
Less dividends on preferred shares............. 13 15 125
------- ------- -------
Net income applicable to common stockholders... $18,777 $12,455 $ 7,187
======= ======= =======
Basic earnings per common share................ $ .85 $ .58 $ .38
======= ======= =======
Diluted earnings per common share.............. $ .83 $ .56 $ .34
======= ======= =======
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,
--------------------------
1997 1996 1995
------ ------ ------
Cash flows from operating activities:
Net income..................................... $18,790 $12,470 $ 7,312
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for associate stock options........ 100 318 76
Provision for deferred income taxes.......... 10,117 6,715 3,932
Depreciation and amortization................ 704 533 477
Increase in accrued Contract income.......... (689) (672) (475)
Increase in commission advances.............. (22,891) (18,381) (9,938)
Increase in other assets..................... (554) (492) (736)
Increase in Contract benefits................ 787 315 138
Increase (decrease) in accounts payable and
accrued expenses............................ 1,369 136 (162)
------- ------- -------
Net cash provided by operating activities.. 7,733 942 624
------- ------- -------
Cash flows from investing activities:
Additions to property and equipment.......... (1,343) (1,286) (608)
Purchases of investments..................... (2,951) (1,663) (1,695)
Maturities of investments.................... 316 400 111
------- ------- -------
Net cash used in investing activities...... (3,978) (2,549) (2,192)
------- ------- -------
Cash flows from financing activities:
Proceeds from sale of common and preferred
stock........................................ 3,230 1,964 6,670
Dividends paid on preferred stock............ (13) (15) (125)
------- ------ -------
Net cash provided by financing activities.. 3,217 1,949 6,545
------- ------ -------
Net increase in cash and unpledged cash
equivalents.................................. 6,972 342 4,977
Cash and cash equivalents at beginning of year. 14,831 14,489 9,512
------- ------- -------
Cash and cash equivalents at end of year....... $21,803 $14,831 $14,489
======= ======= =======
Supplemental disclosure of cash flow information:
Cash paid for interest....................... $ 6 $ 26 $ 10
======= ======= =======
Cash paid for income taxes................... $ - $ - $ 18
======= ======= =======
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,
-----------------------
1997 1996 1995
------ ------ ------
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 exchanged for Common Stock (299 in 1995)..... - - (299)
----- ----- -----
Shares issued and outstanding at end of year........ - - -
----- ----- -----
$3.00 Cumulative Convertible Preferred Stock,
authorized 5 shares; 5 shares issued and
outstanding at beginning of year, liquidation
value of $84....................................... 5 5 5
Shares exchanged for Common Stock (2 in 1997)....... (2) - -
----- ----- -----
Shares issued and outstanding at end of year (3 in
1997, 5 in 1996 and 1995), liquidation value of
$55 at December 31, 1997........................... 3 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 (32 in 1997, 45 in
1996, and 60 in 1995)............................... 32 45 60
Shares exchanged for Common Stock (9 in 1997, 13 in
1996, and 15 in 1995)............................... (9) (13) (15)
----- ----- -----
Shares issued and outstanding at end of year (23 in
1997, 32 in 1996, and 45 in 1995), liquidation
value of $304 at December 31, 1997.................. 23 32 45
----- ----- -----
Common Stock - $.01 par value, shares authorized
100,000; shares issued and outstanding at beginning
of year (22,459 in 1997, 21,513 in 1996, and 14,216
in 1995)............................................ 225 215 142
Shares issued during year:
Conversion of Preferred Stock (38 in 1997, 46 in
1996, and 4,245 in 1995)............................ - 1 42
Contributed to Company's employee stock ownership
plan (3 in 1997,
5 in 1996, and 20 in 1995)......................... - - -
Exercise of stock options and warrants (651 in
1997, 895 in 1996, and 3,032 in 1995) .............. 7 9 31
----- ----- -----
Shares issued and outstanding at end of year (23,151
in 1997, 22,459 in 1996, and 21,513 in 1995)........ 232 225 215
----- ----- -----
Capital in Excess of Par Value
Balance at beginning of year.......................... 41,039 37,757 30,770
Exercise of stock options and warrants.............. 3,267 2,225 6,567
Income tax benefit related to exercise of stock
options............................................. 2,930 997 -
Conversion of preferred stock and convertible
debentures.......................................... 11 14 272
Stock contribution to employee stock ownership plan. 56 46 39
Other............................................... - - 109
------ ------ ------
Balance at end of year................................ 47,303 41,039 37,757
------ ------ ------
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,
-------------------------
1997 1996 1995
------ ------ ------
Retained Earnings (Deficit)
Balance at beginning of year...................... $ 6,350 $(6,105) $(13,292)
Net Income........................................ 18,790 12,470 7,312
Cash dividends.................................... (13) (15) (125)
------- ------- -------
Balance at end of year............................ 25,127 6,350 (6,105)
------- ------- -------
Treasury stock
Balance at beginning and end of year (747 shares). (2,177) (2,177) (2,177)
------- ------- -------
Total Stockholders' Equity........................ $70,511 $45,474 $29,740
======= ======= =======
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 and are marketed primarily in 27
states by an independent sales force referred to as "Associates". Contract
premiums are principally collected on a monthly basis.
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 6 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.
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 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 basis consistent
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 a training
program which includes an intensive one-day training seminar, produces three
memberships and recruits 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.
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. Revenues from Associates' training
program fees and sales of marketing supplies are recognized as income 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 are recovered through collection of
premiums on an associate's active memberships. At December 31, 1997, the Company
maintains an allowance of $3.7 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 Liability
The Contract benefit liability represents claims reported but not paid
and actuarially estimated claims incurred but not reported on open panel
Contracts and per capita amounts due provider attorneys on closed panel
Contracts. The Company calculates the benefit liability costs on open panel
Contracts 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 the enactment 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.
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 or changes in 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.
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 Board Opinion No. 25 ("APB 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 financial
statement disclosures.
Accounting Standards to be Adopted
Statement of Financial Accounting Standards 130, "Reporting
Comprehensive Income," ("SFAS 130") was issued in June, 1997. This Statement
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. This Statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. SFAS 130, effective for fiscal years beginning after December 15,
1997, requires reclassification of financial statements for earlier periods
provided for comparative purposes. The Company currently does not expect
adoption of this Statement to have a material effect on financial statement
presentation.
Statement of Financial Accounting Standards 131, "Disclosures about
Segments of an Enterprise and Related Information," ("SFAS 131") was issued in
June, 1997. This Statement establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. SFAS 131,
effective for fiscal years beginning after December 15, 1997, requires
comparative information for previous years to be restated to comply with SFAS
131's reporting requirements. The Company currently does not expect adoption of
this Statement to have a material effect on financial statement presentation or
related footnote disclosures.
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, 1997 and
1996 follows:
December 31, 1997
------------------------------------
Amortized Gross Unrealized Fair
Cost Gains Losses Value
--------- ------- ----------- ------
U.S. Government obligations.. $3,200 $ 3 $ - $3,203
Obligations of state and
political subdivisions..... 300 - - 300
------ ------ ------ ------
Total................... $3,500 $ 3 $ - $3,503
====== ====== ====== ======
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
====== ====== ====== ======
A comparison of the amortized cost and fair value of the Company's held
to maturity investment securities at December 31, 1997 by maturity date
follows:
Amortized
Cost Fair Value
--------- ----------
One year or less............... $2,850 $2,853
Two years through five years... 650 650
------ ------
Total.......................... $3,500 $3,503
====== ======
The Company's investment securities are included in the accompanying
consolidated balance sheets at December 31, 1997 and 1996 as follows.
December 31,
---------------
1997 1996
------ ------
Held-to-maturity investments
-current portion................ $1,875 $ 500
Held-to-maturity investments.... 650 989
Investments pledged............... 975 950
------ ------
Total........................... $3,500 $2,439
====== ======
Remaining amounts included in these balance sheet captions represent
certificates of deposit.
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,
----------------
1997 1996
------ ------
Certificates of deposit.......... $1,797 $1,822
Obligation of state and
political subdivisions.......... 300 300
U. S. Government obligations.... 675 650
------ ------
Total $2,772 $2,772
====== ======
Note 3 - Property and Equipment
Property and equipment is comprised of the following:
December 31,
Estimated ----------------
Useful Life 1997 1996
------------ ------ ------
Equipment, furniture and
fixtures................... 3-10 years $6,186 $5,283
Computer software.............. 5 years 2,324 2,087
Building and improvements...... 20 years 1,834 1,653
Automotive..................... 3 years 231 213
Land........................... 110 110
------ ------
10,685 9,346
Accumulated depreciation...... (7,091) (6,391)
------ ------
Property and equipment, net... $3,594 $2,955
====== ======
Note 4 - Income Taxes
The provision for income taxes consists of the following:
Year Ended December 31,
-------------------------
1997 1996 1995
------- ------- -------
Current........................... $ - $ - $ -
Deferred.......................... 10,117 6,715 3,932
------- ------- -------
Total provision for income taxes.. $10,117 $ 6,715 $ 3,932
======= ======= =======
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
-----------------------
1997 1996 1995
------ ------ ------
Statutory Federal income tax
rate............................ 34.0% 34.0% 34.0%
Tax exempt interest.............. (.2) (.2) (.2)
State income taxes and other..... 1.2 1.2 1.2
---- ---- ----
Effective income tax rate........ 35.0% 35.0% 35.0%
==== ==== ====
Deferred tax liabilities and assets at December 31, 1997 and 1996 are
comprised of the following:
December 31,
---------------------
1997 1996
-------- --------
Deferred tax liabilities:
Commissions advanced .............................. $ 18,784 $ 10,772
Depreciation ...................................... - 175
-------- --------
Total deferred tax liabilities.................... 18,784 10,947
-------- --------
Deferred tax assets:
Expenses not yet deducted for tax purposes........ 445 340
Depreciation ..................................... 14 -
Net operating loss carryforward................... 5,099 4,198
Capital loss carryforward ........................ - 654
General Business Credit carryforward.............. 325 325
AMT Credit carryforward .......................... 366 366
------- ------
Total deferred tax assets ........................ 6,249 5,883
Valuation allowance for deferred tax assets....... (3,936) (4,220)
------- ------
Total net deferred tax assets..................... 2,313 1,663
------- ------
Net deferred liability ........................... $(16,471) $(9,284)
======== =======
A valuation allowance has been established for deferred tax assets
representing the estimated tax benefit of the General Business Credit
carryforward and pre-1996 net operating loss carryforwards as the Company does
not believe it is more likely than not that the tax benefits of such
carryforwards will be realized. The valuation allowance decreased $284,000
during the year ended December 31, 1997 and increased $147,000 for the year
ended December 31, 1996.
The Company generated tax losses of $2.6 million and $2.8 million for
the years ended December 31, 1997 and 1996, respectively. The Company believes
it will realize the approximate $1.9 million future tax benefits from these tax
losses and has appropriately not provided a valuation allowance against this
amount.
The exercise of stock options which have been granted under the
Company's various stock option plans give rise to compensation which is
includable in the taxable income of the option grantee and deductible by the
Company for federal and state income tax purposes. Such compensation results
from increases in the fair market value of the Company's common stock subsequent
to the date of grant of the applicable exercised stock options, and in
accordance with Accounting Principles Board Opinion No. 25, such compensation is
not recognized as an expense for financial accounting purposes and the related
tax benefits, including the $1.9 million of future tax benefits of net operating
loss carryforwards, are recorded in capital in excess of par value.
At December 31, 1997, the Company has net operating loss carryforwards
for Federal regular tax and alternative minimum tax purposes of approximately
$14.6 million and $14.2 million, respectively, expiring in 2001 through 2012. 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 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 5 - 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 $55,000 at December 31, 1997. During
1997 and 1996, $3.00 Cumulative Convertible Preferred Stock consisting of 1,714
and 40 shares, respectively, were converted into 4,385 shares of Common Stock.
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 $304,000 at December 31, 1997. During 1997,
1996 and 1995, Special Preferred Stock consisting of 9,767, 12,812 and 14,841
shares, respectively, were converted into 130,970 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, 1997, PPLCI did not have
funds available for payment of dividends without the approval of the Oklahoma
Insurance Commissioner.
At December 31, 1997, the Company had outstanding options to purchase a
total of 560,100 shares of the Company's Common Stock at an average price of
$15.89 per share expiring at various periods through July, 2003.
Note 6 - 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, net of amounts paid directly to its agents by the underwriter,
during 1997, 1996 and 1995 of $110,000, $130,000 and $120,000, respectively,
through its sales of insurance products of an unaffiliated company. Agency had a
net loss for the year ended December 31, 1997 of $12,500 and net income for the
year ended December 31, 1996 and 1995 of $6,700 and $599, respectively, after
incurring commissions earned by the Chairman of $50,000, $49,000 and $45,000
respectively, and annual management fees of $72,000 paid to the Company.
The Chairman and his wife own Stonecipher Aviation LLC ("SA"). The
Company has agreed to reimburse SA for certain expenses pertaining to trips made
by Company personnel for Company business purposes using aircraft owned by SA.
Such reimbursement represents the pro rata portion of direct operating expenses,
such as fuel, maintenance, pilot fees and landing fees, incurred in connection
with such aircraft based on the relative number of flights taken for Company
business purposes versus the number of other flights during the applicable
period. No reimbursement is made for depreciation, capital expenditures or
improvements relating to such aircraft. During 1997, the Company paid $192,000
to SA as reimbursement for such transportation expenses.
An executive officer (President) and director of the Company has loans
from the Company made in December 1992 and December 1996. The largest aggregate
balance of these loans during the year ended December 31, 1997 was $296,000. The
outstanding balance of these loans as of December 31, 1997 was $296,000. These
loans bear annual interest at the rate of 3% in excess of the prime rate,
adjusted on January 1 of each year, and are secured by commissions due from the
Company. This individual also 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 1997, 1996 and 1995 of $49,000,
$54,000 and $55,000, respectively.
Note 7 - Commitments and Contingencies
Aggregate rental expense under all operating leases was $17,000,
$27,000 and $28,000 in 1997, 1996 and 1995, respectively. There are no
significant operating lease commitments in effect at December 31, 1997.
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 8 - 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, 1997,
1996 and 1995 and changes during the years ending on those dates is presented
below:
1997 1996 1995
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Outstanding at beginning of year..... 410,000 $ 6.78 405,000 $ 5.40 150,000 $ .58
Granted.............................. 185,000 14.49 45,000 13.50 315,000 6.84
Exercised............................ (285,000) 5.55 (40,000) .38 (60,000) .90
Terminated........................... (10,000) 16.00 - - - -
------- -------- ------- ------- ------- -------
Outstanding at end of year........... 300,000 $ 12.39 410,000 $ 6.78 405,000 $ 5.40
======= ======== ======= ======= ======= =======
Options exercisable at year end...... 290,000 $ 12.27 385,000 $ 6.18 405,000 $ 5.40
======= ======== ======= ======= ======= =======
The following table summarizes information about stock options
outstanding at December 31, 1997 issued pursuant to the Plan:
Weighted Average
Range of Exercise Number Remaining Weighted Average
Prices Outstanding Contractual Life Exercise Price
- -------------------------------------------------------------------------------
$.38 15,000 2.72 $ .38
$8.13 - $10.38 85,000 3.02 9.32
$14.25 -$16.00 200,000 4.25 14.60
------- ---- ------
300,000 3.82 $12.39
======= ==== ======
The Company, effective July 3, 1995 and July 22, 1997, adopted stock
option plans 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 1996 and for the month of July 1997 based on the 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 for all grants from July 1995
through March 1996 and the exercise price for the July 1997 grants was $27.00
(which exceeded market). The options granted from July 1995 through March 1996
expired pursuant to their terms on July 31, 1997 and the options granted for
production during July 1997 expire on July 31, 1998. Activity related to these
plans is as follows:
1997 1996 1995
--------------------- --------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ---------- ---------------------- ---------- ----------
Outstanding at beginning of year........ 350,092 $ 10.00 298,225 $ 8.02 - $ -
Granted................................. 100,000 27.00 177,133 12.50 299,785 8.02
Exercised............................... (135,125) 10.26 (70,516) 8.95 (1,560) 7.03
Terminated.............................. (213,617) 10.01 (54,750) 8.63 - -
-------- -------- ------- -------- ------- -------
Outstanding at end of year.............. 101,350 $ 26.54 350,092 $ 10.00 298,225 $ 8.02
======== ======== ======= ======== ======= =======
Options exercisable at year end......... 101,350 $ 26.54 350,092 $ 10.00 298,225 $ 8.02
======== ======== ======= ======== ======= =======
Weighted Average
Range of Exercise Number Remaining Weighted Average
Prices Outstanding Contractual Life Exercise Price
----------------- -------------- -------------------- -------------------
$8.25 2,500 2.96 $ 8.25
$27.00 98,850 .58 27.00
------- ----- ------
101,350 .64 $26.54
======= ===== ======
In addition to those options issued pursuant to the Plan and those
options issued to marketing associates in the two preceding tables, the Company
has other options outstanding. A summary of the status of such options as of
December 31, 1997, 1996 and 1995 and changes during the years ending on those
dates is presented below:
1997 1996 1995
-------------------- ----------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ---------- --------- ---------- ----------- ----------
Outstanding at beginning of year..... 245,050 $ 1.00 1,029,656 $ 1.47 3,995,781 $ 2.01
Granted.............................. 144,000 17.12 - - 5,000 2.69
Exercised............................ (230,300) .96 (784,606) 1.62 (2,971,125) 2.20
Terminated........................... - - - - - -
------- -------- --------- ------- --------- -------
Outstanding at end of year........... 158,750 $ 15.69 245,050 $ 1.00 1,029,656 $ 1.47
======= ======== ======== ======= ========= =======
Options exercisable at year end...... 158,750 $ 15.69 245,050 $ 1.00 1,029,656 $ 1.47
======= ======== ========= ======= ========= =======
The following table summarizes information about stock options other than
those included in the Plan or issued to marketing associates outstanding at
December 31, 1997:
Weighted Average
Range of Exercise Number Remaining Weighted Average
Prices Outstanding Contractual Life Exercise Price
$.50 - $2.69 14,750 1.55 $ 1.73
$16.75 - $19.00 144,000 4.55 17.13
------- ----- -------
158,750 4.28 $ 15.69
======= ===== =======
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock Based Compensation" ("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 1997 and 1996 would
have been reduced to the pro forma amounts indicated below:
1997 1996
------ ------
Net income applicable to common
stockholders:
As reported.................. $18,790 $12,455
Pro forma.................... $17,667 $12,227
Basic earnings per common share:
As reported.................. $ .85 $ .58
Pro forma.................... $ .80 $ .57
Diluted earnings per common
share:
As reported.................. $ .83 $ .56
Pro forma.................... $ .78 $ .55
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 5.00%; expected life of 5 years; and expected volatility of
30%.
In accordance with SFAS 123, the Company recorded compensation expense
related to the issuance of stock options to marketing associates of $100,000,
$318,000 and $76,000 during 1997, 1996 and 1995, respectively. The weighted
average fair value of options granted that met the minimum exercise criteria
during 1997 was $1.07 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 5.00%; expected
life of 1 year; and expected volatility of 30%.
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 1997, 1996 and 1995 of $55,785, $46,176 and $39,150
based on contributions of Company stock of 3,000 shares, 5,100 shares and 20,000
shares, respectively.
Note 9 - Earnings Per Share
The Company has adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share," and has restated earnings per share for all periods
presented in accordance with that Statement.
Basic earnings per common share are computed by dividing net income
applicable to common stockholders by the weighted average number of shares of
Common Stock outstanding during the year.
Diluted earnings per common share are computed by dividing net income
applicable to common stockholders 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 such shares are considered
antidilutive and therefore ignored in the computation of diluted earnings per
share. Special Preferred Stock is considered to be a dilutive common stock
equivalent and the number of shares issuable on conversion of the Special
Preferred Stock is added to the weighted average number of common shares. The
weighted average 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 treasury stock method; those
purchases are assumed to have been made at the average price of the common stock
during the respective period. Additionally, the $2.40 Cumulative Convertible
Preferred Stock, which was actually converted during 1995, is assumed to have
been converted at the beginning of 1995 and the respective dividends are
included in determining net income applicable to common stockholders.
Year Ended December 31,
-------------------------
1997 1996 1995
------ ------ -------
Basic Earnings Per Share:
Earnings:
- ---------
Net income applicable to common stockholders......... $18,777 $12,455 $ 7,187
======= ======= =======
Shares:
- -------
Weighted average shares outstanding.................. 22,127 21,332 18,947
======= ======= =======
Basic earnings per common share...................... $ .85 $ .58 $ .38
======= ======= =======
Diluted Earnings Per Share:
Earnings:
- ---------
Net income applicable to common stockholders......... $18,777 $12,455 $7,187
Add: Dividends on assumed conversion of preferred
stock.............................................. - - 110
------- ------- ------
Income available to common stockholders and assumed
conversions........................................ $18,777 $12,455 $7,297
======= ======= ======
Shares:
- -------
Weighted average shares outstanding.................. 22,127 21,332 18,947
Assumed conversion of preferred stock................ 109 142 827
Assumed exercise of options and warrants............. 339 845 1,634
------- ------- -------
Weighted average number of shares, as adjusted....... 22,575 22,319 21,408
======= ======= =======
Diluted earnings per common share.................... $ .83 $ .56 $ .34
======= ======= =======
Note 10 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations
for the years ended December 31, 1997 and 1996.
Selected Quarterly Data
(In thousands except per share amounts)
Income
before Basic earnings Diluted
income Net per common earnings per
Revenues taxes Income share common share
-------- -------- -------- ------------- ------------
1997
----
First quarter.... $19,725 $6,124 $3,981 $.18 $.18
Second quarter... 22,199 6,700 4,355 .20 .19
Third quarter.... 24,199 7,667 4,983 .22 .22
Fourth quarter... 26,345 8,416 5,471 .24 .24
1996
----
First quarter.... $12,354 $3,954 $2,566 $.12 $.12
Second quarter... 14,796 4,862 3,156 .15 .14
Third quarter.... 15,760 5,006 3,251 .15 .15
Fourth quarter... 17,036 5,363 3,482 .16 .16
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, 1998.
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 20 of this report.
(2) Financial Statement Schedule: See Index to Consolidated Financial
Statements and Consolidated Financial Statement Schedule set forth
on page 20 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, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: February 13, 1998 By: /s/ Randy Harp
------------------------------------
Randy Harp
Chief Financial Officer and
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
/s/ Harland C. Stonecipher Chairman of the Board of February 13, 1998
- ----------------------------- Directors (Principal
Harland C. Stonecipher Executive Officer)
/s/ Wilburn L. Smith President and Director February 13, 1998
- -----------------------------
Wilburn L. Smith
/s/ Kathleen S. Pinson Vice President, Controller February 13, 1998
- ----------------------------- and Director, (Principal
Kathleen S. Pinson Accounting Officer)
/s/ Randy Harp Chief Operating Officer, February 13, 1998
- ----------------------------- Chief Financial Officer
Randy Harp and Director (Principal
Financial Officer)
/s/ Peter K. Grunebaum Director February 13, 1998
- -----------------------------
Peter K. Grunebaum
/s/ Francis A. Tarkenton Director February 13, 1998
- -----------------------------
Francis A. Tarkenton
SCHEDULE II
PRE-PAID LEGAL SERVICES, INC.
Consolidated Valuation And Qualifying Accounts
Years ended December 31, 1997
(Amounts in 000's)
Additions
Balance Charged
at to Cost Balance
Beginning and at End
Description of Year Expenses Deductions of Year
-------------------------------------------------------------------------------
Allowance for unrecoverable
commission advances -
(non-current):
December 31, 1997 $3,444 $ 300 - $3,744
====== ===== ===== ======
December 31, 1996 $2,669 $ 775 - $3,444
====== ===== ===== ======
December 31, 1995 $2,469 $ 200 - $2,669
====== ===== ===== ======
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 Demand Note of Wilburn L. Smith and Carol Smith dated December 31,
1996 in favor of the Company
*10.9 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)
*10.10 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)
*10.11 Stock Option Agreement dated May 13, 1997 between the Company and
Francis A. Tarkenton (Incorporated by reference to Exhibit 10.1 of
the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997)
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.