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, 2001
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
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PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (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
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Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K ( ).
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 28, 2002 - $370,000,000.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of February 28,
2002 there were 20,168,524 shares of Common Stock, par value $.01 per share,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 2002 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, 2001
TABLE OF CONTENTS
PART I.
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ITEM 1. DESCRIPTION OF BUSINESS
General
Acquisition of TPN, Inc. d.b.a. The Peoples Network
Universal Fidelity Life Insurance Company
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
PART II.
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Measures of Member retention
Results of Operations:
Comparison of 2001 to 2000
Comparison of 2000 to 1999
Liquidity and Capital Resources
Forward-Looking Statements
Risk Factors
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
PART III. **
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PART IV.
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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 2002 annual meeting of
shareholders.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2001
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
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General
Pre-Paid Legal Services, Inc. (the "Company") was one of the first
companies in the United States organized solely to design, underwrite and market
legal expense plans. The Company's predecessor commenced business in 1972 and
began offering legal expense reimbursement services as a "motor service club"
under Oklahoma law. In 1976, the Company was formed and acquired its predecessor
in a stock exchange. The Company began offering Memberships independent of the
motor service club product by adding a legal consultation and advice service,
and in 1979 the Company implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. The Company's legal expense plans (referred to as
"Memberships") currently provide for a variety of legal services in a manner
similar to medical plans. In most states and provinces, standard plan benefits
include preventive legal services, motor vehicle legal defense services, trial
defense services, IRS audit services and a 25% discount off legal services not
specifically covered by the Membership for an average monthly Membership fee of
approximately $21. Additionally, in approximately 37 states, the Legal Shield
rider can be added to the standard plan for only $1 per month and provides
members with 24-hour access to a toll-free number for attorney assistance if the
member is arrested or detained.
Plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province. Members have
direct, toll-free access to their provider law firm rather than having to call
for a referral. At December 31, 2001, the Company had 1,242,908 Memberships in
force with members in all 50 states, the District of Columbia and the Canadian
provinces of Ontario, British Columbia, Alberta and Manitoba. Approximately 90%
of such Memberships were in 29 states and the Canadian province of Ontario.
Acquisition of TPN, Inc. d.b.a. The Peoples Network ("TPN")
TPN was merged into the Company effective October 2, 1998. Since its
inception in 1994, TPN had marketed personal and home care products, personal
development products and services together with PRIMESTAR(R) satellite
subscription television service to its members through a network marketing sales
force. TPN had a sales force of approximately 30,000 distributors at the time of
the acquisition of which approximately 13,000 immediately became Company sales
associates after the acquisition. Due to concentration on Membership sales and
the recruitment of new sales associates after the acquisition, product sales
dramatically declined and were eliminated entirely in 2000. The acquisition
qualified as a "pooling of interests" for financial reporting purposes.
Universal Fidelity Life Insurance Company
The Company completed its acquisition of Universal Fidelity Life Insurance
Company ("UFL") on December 30, 1998. UFL, based in Duncan, Oklahoma, was a
subsidiary of Pioneer Financial Services, Inc. ("Pioneer"), which is a member of
the Conseco group of companies. As part of the transaction, Pioneer Life
Insurance Company, a wholly owned subsidiary of Pioneer, entered into a 100%
coinsurance agreement with UFL assuming all of the assets and liabilities
relating to Medicare supplement and health care business written by UFL. UFL
retained its existing life insurance business with annual premiums of
approximately $1 million and continued to provide claims processing for the
coinsured Medicare supplement and health care policies and receive full cost
reimbursement for such services. UFL marketed primarily to individuals, age 65
and over, in New Mexico, Oklahoma and Texas. The acquisition of UFL was
accounted for using the purchase method of accounting for business combinations.
On December 31, 2001 the Company completed the sale of UFL. The Company
received a $2.8 million dividend and $1.2 million from the sale of 100% of UFL
stock. As a result of this sale, as required by discontinued operations
accounting, UFL's net assets of $4.5 million have been segregated on the
Consolidated Balance Sheet as of December 31, 2000. UFL's results of operations
of $(504,000), $649,000 and $826,000, net of tax, have also been segregated in
the Consolidated Statements of Income for the years ended December 31, 2001,
2000 and 1999, respectively.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. According to the latest estimates
developed by the National Resource Center for Consumers of Legal Services
("NRC"), there were 157 million Americans without any type of legal service
plan. The NRC estimates that 115 million Americans were entitled to service
through at least one legal service plan in 2000 although more than half are
"free" plans that generally provide limited benefits on an automatic enrollment
without any direct cost to the individual. The 115 million Americans compares 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 continuing growth in the number of
individuals covered by plans, is increasing.
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association according to NRC estimates, and
accounted for approximately 57% of covered persons in 2000. The NRC estimates
that an additional 26% are covered by employee assistance plans that are also
automatic enrollment plans without direct cost to participants designed to
provide limited telephonic access to attorneys for members of employee groups.
Free plans and employee assistance plans therefore comprise approximately 83% of
covered persons in 2000. Employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit and the
Armed Forces are each estimated by the NRC to account for approximately 5% of
covered persons in 2000.
According to the NRC, the remaining covered persons in 2000 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 7% of the market in 2000 and represent the
market segment in which the Company primarily competes. According to the NRC,
these plans typically have more comprehensive benefits, higher utilization,
involve higher costs to participants, and are offered on an individual
enrollment or voluntary basis.
Of the current work force covered by legal service plans, only 7% were
estimated by the NRC to be covered by plans having full coverage. The Company
believes these plans include benefits comparable to those provided by the
Company's Memberships. Accordingly, the Company believes that significant
opportunities exist for successful marketing of the Company's Memberships to
employee groups and other individual consumers.
According to the latest estimates of the census bureaus of the United
States and Canada, currently the two geographic areas in which the Company
operates, the number of households in the combined area exceeds 125 million.
Since the Company has always disclosed its members in terms of Memberships and
individuals covered by the Membership include the individual who purchases the
Membership together with his or her spouse and never married children living at
home up to age 21 or up to age 23 if the children are full time college
students, the Company believes that its market share should be viewed as a
percentage of households. Historically, the Company's primary market focus has
been the "middle" eighty percent of such households rather than the upper and
lower ten percent segments based on the Company's belief that the upper ten
percent may already have a relationship with an attorney or law firm and the
lower ten percent may not be able to afford the cost of a legal service plan. As
a percentage of this defined "middle" market of approximately 100 million
households, the Company currently has a 1% share of the estimated market based
on its existing 1.2 million active memberships and, over the last 29 years, an
additional 2% of households have previously purchased, but no longer own,
memberships. The Company routinely remarkets to previous members and reinstated
approximately 54,000 and 48,000 Memberships during 2001 and 2000, respectively.
Description of Memberships
The Memberships sold by the Company generally allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with the Company. Provider law firms are paid a monthly fixed fee on a
capitated basis to render services to plan members residing within the state or
province in which the provider law firm attorneys are licensed to practice.
Because the fixed fee payments by the Company to provider law firms do not vary
based on the type and amount of benefits utilized by the member, this capitated
arrangement provides significant advantages to the Company in managing claims
risk. At December 31, 2001, Memberships subject to the capitated provider law
firm arrangement comprised approximately 99% of the Company's active
Memberships. The remaining Memberships, approximately 1%, were primarily sold
prior to 1987 and allow members to locate their own lawyer ("open panel") to
provide legal services available under the Membership with the member's lawyer
being reimbursed for services rendered based on usual, reasonable and customary
fees, or are in states where there is no provider law firm in place and the
Company's referral attorney network is utilized.
Family Legal Plan
The Family Legal Plan currently marketed in most jurisdictions by the
Company consists of five basic benefit groups that provide coverage for a broad
range of preventive and litigation-related legal expenses. The Family Legal Plan
accounted for more than 90% of the Company's Membership fees in 2001 and
approximately 95% of the outstanding Memberships at December 31, 2001. In
addition to the Family Legal Plan, the Company markets other specialized legal
services products specifically related to employment in certain professions
described below.
In 12 states, the Company's plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and the Company has bilingual staff for both customer service and
marketing service functions. The Company will continue to evaluate making its
plans available in additional languages in markets where demand for such a
product is expected to be sufficient to justify this additional cost.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, the
Company has not raised rates to existing members. If new benefits become
available, existing members may choose the newer, more comprehensive plan at a
higher rate or keep their existing Memberships. Memberships are automatically
renewed at the end of each Membership period unless the member cancels prior to
the renewal date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $26.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Automobile Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. The Company has experienced increased sales of
this option during the last three years.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount. Provider law firms have agreed to provide to
members any legal services beyond those stipulated in the Membership at a fee
discounted 25% from the provider law firm's customary and usual hourly rate.
Legal Shield Benefit
In approximately 37 states, the Legal Shield plan can be added to the
standard or expanded Family Legal Plan for $1 per month and provides members
with 24-hour access to a toll-free number for provider law firm assistance if
the member is arrested or detained. The Legal Shield member, if detained, can
present their Legal Shield card to the officer that has detained them to make it
clear that they have access to legal representation and that they are requesting
to contact a lawyer immediately. The benefits of the Legal Shield plan are
subject to conditions imposed by the detaining authority, which may not allow
for the provider law firm to communicate with the member on an immediate basis.
There were approximately 591,000 Legal Shield subscribers at December 31, 2001
compared to approximately 325,000 at December 31, 2000.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. The Company began operations in
Ontario and British Columbia during 1999, Alberta in February 2001 and Manitoba
in August 2001. Benefits of the Canadian plan include expanded preventive
benefits including assistance with Canadian Government agencies, warranty
assistance and small claims court assistance as well as the preferred member
discount. Canadian Membership fees collected during 2001 were approximately $4.3
million in U.S. dollars compared to $3.8 million collected in 2000 and $1.0
million collected in 1999. The Company plans to expand operations in other
provinces and territories of Canada.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, the Company also
offers other specialty or niche legal service plans. These specialty plans
usually contain many of the Family Legal Plan benefits adjusted as necessary to
meet specific industry or prospective member requirements. In addition to those
specialty plans described below, the Company will continue to evaluate and
develop other such plans as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $75 to $125 depending on the
number of employees and provides business oriented legal service benefits for
any for-profit business with 99 or fewer employees. This plan is available in 36
states and represented approximately 3.8%, 5.5% and 3.8% of the Company's
Membership fees during 2001, 2000 and 1999, respectively.
Law Officers Legal Plan
The Law Officers Legal Plan, developed in 1991 and marketed to law
enforcement officers, provides 24-hour job-related emergency toll-free access to
a provider law firm and provides legal services associated with administrative
hearings. This plan was designed to meet the legal needs of persons in the law
enforcement profession and is currently marketed at the monthly rate of $16.00
or at a group rate of $14.95. The Company has members covered under the Law
Officers Legal Plan in 27 states. The Law Officers Legal Plan offers the basic
family legal plan benefits described above without the motor vehicle related
benefits. These motor vehicle benefits are available in the Law Officers Legal
Plan only for defense of criminal charges resulting from the operation of a
licensed motor vehicle. Additionally, at no charge to the member, a 24-hour
emergency hotline is available to access the services of the provider law firm
in situations of job-related urgency. The Law Officers Legal Plan also offers
representation at no additional charge for up to ten hours (five hours per
occurrence) for two administrative hearings or inquiries per year and one
pre-termination hearing per Membership year before a review board or arbitrator.
Preparation and/or counsel for post-termination hearings are also available to
members as a schedule of benefits, which increases with each Membership year.
The schedule of benefits is similar to that offered under the Family Legal Plan
Trial Defense, including the availability of the optional pre-trial hours
described above for an additional $9.00 per month. During the years ended
December 31, 2001, 2000 and 1999, the Law Officers Legal Plan accounted for
approximately 1.5%, 4.8% and 2.1%, respectively, of the Company's Membership
fees.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage on a closed panel plan basis for persons
who drive a commercial vehicle. This legal service plan is currently offered in
48 states. In certain states, the Commercial Driver Legal Plan is underwritten
by the Road America Motor Club, an unrelated motor service club. During the
years ended December 31, 2001, 2000 and 1999, this plan accounted for
approximately .9%, 2.5% and 1.1%, respectively, of Membership fees. The Plan
underwritten by the Road America Motor Club is available at the monthly rate of
$35.95 or at a group rate of $32.95. Plans underwritten by the Company are
available at the monthly rate of $32.95 or at a group rate of $29.95. Benefits
include the motor vehicle related benefits described above, defense of
Department of Transportation violations and the 25% discounted rate for services
beyond plan scope, such as defense of non-moving violations. The Road America
Motor Club underwritten plan includes bail and arrest bonds and services for
family vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 32 states and represented approximately 1.5%, .6% and .5% of the
Company's Membership fees during 2001, 2000 and 1999, respectively.
Comprehensive Group Legal Services Plan
The Company introduced in late 1999 the Comprehensive Group plan, designed
for the large group employee benefit market. This plan provides all the benefits
of the Family Legal Plan as well as mortgage document preparation, assistance
with uncontested legal situations such as adoptions, name changes, separations
and divorces. Additional benefits include the preparation of health care power
of attorney and living wills or directives to physicians. Although the Company
has not experienced any significant sales of this plan, the Company expects this
plan to improve its competitive position in the large group market.
Provider Law Firms
The Company's Memberships generally allow members to access legal services
through a network of independent provider law firms under contract with the
Company generally referred to as "provider law firms." Provider law firms are
paid a fixed fee on a per capita basis to render services to plan members
residing within the state or province in which the provider law firm attorneys
are licensed to practice. Because the fixed fee payments by the Company to
provider law firms in connection with the Memberships do not vary based on the
type and amount of benefits utilized by the member, this arrangement provides
significant advantages to the Company in managing its cost of benefits. Pursuant
to these provider law firm arrangements and due to the volume of revenue
directed to these firms, the Company has the ability to more effectively monitor
the customer service aspects of the legal services provided and the financial
leverage to help ensure a customer friendly emphasis by the provider law firms.
Additionally, due to the volume of revenue that may be directed to particular
provider law firms, the Company has access to larger, more diversified law
firms. The Company, through its members, is typically the largest client base of
its provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, investigation by the Company of bar association standing and client
references, evaluation of the education, experience and areas of practice of
lawyers within the firm, on-site evaluations by Company management, and
interviews with lawyers in the firm who would be responsible for providing
services. Most importantly, these candidate law firms are evaluated on the
firm's customer service philosophy. The vast majority of the provider firms are
"AV" rated by Martindale-Hubbell, the highest rating possible.
Martindale-Hubbell has maintained ratings for the legal community for over a
century. According to Martindale-Hubbell, its ratings reflect the confidential
opinions of bar members and the judiciary, and attest to the individual lawyer's
legal ability and adherence to professional standards of ethics.
The majority of provider law firms are connected to the Company via
high-speed digital links to the Company's management information systems,
thereby providing real-time monitoring capability. This online connection offers
the provider law firm access to specially designed software developed by the
Company for administration of legal services by the firm. These systems provide
statistical reports of each law firm's activity and performance and allow
approximately 96% of members to be monitored on a near real-time basis. The few
provider law firms that are not online with the Company typically have a small
Membership base and must provide various weekly reports to the Company to assist
in monitoring the firm's service level. The combination of the online
statistical reporting and weekly service reports for smaller provider law firms
allows quality control monitoring of over 15 separate service delivery
benchmarks. In addition, the Company regularly conducts extensive random surveys
of members who have used the legal services of a provider law firm. The Company
surveys each state every 60 days, compiles the results of such surveys and
provides the provider law firms with copies of each survey and the overall
summary of the results. If a member indicates on a survey the service did not
meet their expectation, the member is contacted immediately to resolve the
issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to the Company's online monitoring, member complaints, member
survey evaluations, telephone reports and other information developed in
connection with member service monitoring. If a problem is detected, immediate
remedial actions are recommended by the Company to the provider law firms to
eliminate service deficiencies. In the event the deficiencies of a provider law
firm are not eliminated through discussions and additional training with the
Company, such deficiencies may result in the termination of the provider law
firm. The Company is in constant communication with its provider law firms and
meets with them frequently for additional training, to encourage increased
communications with the Company and to share suggestions relating to the timely
and effective delivery of services to the Company's members.
Each attorney member of the provider law firm rendering services must
have at least two years of experience as a lawyer, unless the Company waives
this requirement due to special circumstances such as instances when the lawyer
demonstrates significant legal experience acquired in an academic, judicial or
similar capacity other than as a lawyer. The Company provides customer service
training to the provider law firms and their support staff through on-site
training that allows the Company to observe the individual lawyers of provider
law firms as they directly assist the members.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit the
Company to terminate the Agreement for cause immediately upon written notice,
(c) require the firm to maintain a minimum amount of malpractice insurance on
each of its attorneys, in an amount not less than $100,000, (d) preclude the
Company from interference with the lawyer-client relationship, (e) provide for
periodic review of services provided, (f) provide for protection of the
Company's proprietary information and (g) require the firm to indemnify the
Company against liabilities resulting from legal services rendered by the firm.
The Company is precluded from contracting with other law firms to provide the
same service in the same geographic area, except in situations where the
designated law firm has a conflict of interest, the Company enrolls a group of
500 or more members, or when the agreement is terminated by either party.
Provider law firms are precluded from contracting with other prepaid legal
service companies without Company approval. Provider law firms receive a fixed
monthly payment for each member who are residents in the service area and are
responsible for providing the Membership benefits without additional
remuneration. If a provider law firm delivers legal services to an open panel
member, the law firm is reimbursed for services rendered according to the open
panel Membership. Provider law firms currently average approximately 60
employees each and on average are evenly split between support staff and
lawyers.
The Company has had occasional disputes with provider law firms, some of
which have resulted in litigation. The toll-free telephone lines utilized and
paid for by the provider law firms are owned by the Company so that in the event
of a termination, the members' calls can be rerouted very quickly. Nonetheless,
the Company believes that its relations with provider law firms are generally
very good. At the end of 2001, the Company had provider law firms representing
45 states and three provinces compared to 43 states and two provinces at the end
of 2000 and 41 states at the end of 1999. During the last three years, the
Company's relationships with a total of four provider law firms were terminated
by the Company or the provider law firm. Eight provider law firms have been
under contract with the Company for more than eight years with the average
tenure of all provider law firms being approximately 5 1/2 years.
The Company has an extensive database of referral lawyers who have provided
services to its members for use by members when a designated provider law firm
is not available. Lawyers with whom members have experienced verified service
problems, or are otherwise inappropriate for the referral system, are removed
from the Company's list of referral lawyers.
Marketing
Multi-Level Marketing
The Company markets Memberships through a multi-level marketing program
that encourages individuals to sell Memberships and allows individuals to
recruit and develop their own sales organizations. Commissions are paid only
when a Membership is sold and no commissions are paid based solely on
recruitment. When a Membership is sold, commissions are paid to the associate
making the sale, and to other associates (on average, 16 others at December 31,
2001 compared to 11 others at December 31, 2000 due to additional commission
levels added during 2001) who are in the line of associates who directly or
indirectly recruited the selling associate. The Company provides training
materials, organizes area-training meetings and designates personnel at the home
office specially trained to answer questions and inquiries from associates. The
Company offers various communication avenues to its sales associates to keep
such associates informed of any changes in the marketing of its Memberships. The
primary communication vehicles utilized by the Company to keep its sales
associates informed include extensive use of email, an interactive voice-mail
service, The Connection monthly magazine, the weekly Communication Show that may
be viewed via the Company's Internet webcasts, an interactive voice response
system and the Company's website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. The Company's marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 74% of
the Company's Memberships in force at December 31, 2001 compared to 73% and 75%
at December 31, 2000 and 1999, respectively. Although other means of payment are
available, approximately 73% of fees on Memberships purchased by individuals or
families are paid on a monthly basis by means of automatic bank draft or credit
card.
The Company's marketing efforts towards employee groups, principally on a
payroll deduction payment basis, are designed to permit its sales associates to
reach more potential members with each sales presentation and strive to
capitalize on, among other things, what the Company perceives to be a growing
interest among employers in the value of providing legal service plans to their
employees. Memberships sold through employee groups constituted approximately
26% of total Memberships in force at December 31, 2001 compared to 27% and 25%
at December 31, 2000 and 1999, respectively. The majority of employee group
Memberships are sold to school systems, governmental entities and businesses. No
group accounted for more than 1% of the Company's consolidated revenues from
Memberships during 2001, 1999 or 1998. Substantially all group Memberships are
paid on a monthly basis.
Sales associates are generally engaged as independent contractors and are
provided with training materials and are given the opportunity to participate in
Company training programs. Sales associates are required to complete a specified
training program prior to marketing the Company's Memberships to employee
groups. All advertising and solicitation materials used by sales associates must
be approved by the Company prior to use. At December 31, 2001, the Company had
286,488 "vested" sales associates compared to 242,085 and 204,137 "vested" sales
associates at December 31, 2000 and 1999, respectively. A sales associate is
considered to be "vested" if he or she has personally sold at least three new
Memberships per quarter or if he or she retains a personal Membership. A vested
associate is entitled to continue to receive commissions on prior sales after
all previous commission advances have been recovered. However, a substantial
number of vested associates do not continue to market the Membership, as they
are not required to do so in order to continue to be vested. During 2001, the
Company had 81,613 sales associates who personally sold at least one Membership,
of which 46,687 (57%) made first time sales. During 2000 and 1999 the Company
had 73,826 and 64,611 sales associates producing at least one Membership sale,
respectively, of which 43,169 (58%) and 41,121 (64%), respectively, made first
time sales. During 2001, the Company had 13,749 sales associates who personally
sold more than ten Memberships compared to 11,055 and 8,284 in 2000 and 1999,
respectively. A substantial number of the Company's sales associates market the
Company's Memberships on a part-time basis only.
The Company derives revenues from its multi-level marketing sales force,
principally from a one-time enrollment fee of $65 from each new sales associate
for which the Company provides initial marketing supplies and enrollment
services to the associate. In January 1997, the Company implemented a new
combination classroom and field training program, titled Fast Start to Success
("Fast Start"), aimed at increasing the level of new Membership sales per
associate. 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 Memberships and recruiting three new
sales associates or by personally selling five new Memberships within 60 days of
the associate's start date advance through the various commission levels at a
faster rate and qualify for advance commissions. Associates in states that
require the associate to become licensed will have 60 days from the issue date
on their license to complete the same requirements. The program typically
requires a fee of $184 per new associate, except for special promotions the
Company implements from time to time, that is earned by the Company upon
completion of the training program. Upon successful completion of the program,
the sponsoring associates are paid certain training bonuses. Amounts collected
from sales associates are intended primarily to offset the Company's costs
incurred in recruiting and training and providing materials to sales associates
and are not intended to generate profits from such activities. Other revenues
from sales associates represent the sale of marketing supplies and promotional
materials.
Regional Vice Presidents
The Company has a group of employees that serve as Regional Vice Presidents
("RVPs") responsible for associate activity in a given geographic region and
with the ability to appoint independent contractors as Area Coordinators within
the RVP's region. The RVPs have weekly reporting requirements as well as
quarterly sales and recruiting goals. The RVP and Area Coordinator program
provides a basis to effectively monitor current sales activity, further educate
and motivate the sales force and otherwise enhance the relationships between the
associates and the Company. New products and initiatives will continue to be
channeled through the RVPs and Area Coordinators. At December 31, 2001, the
Company had 58 RVPs in place.
Pre-Paid Legal Benefits Association
The Pre-Paid Legal Benefits Association was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this association is open to sales associates that reach a certain
level within the Company's marketing programs who also maintain an active
personal legal services Membership. The Benefits Association is a separate
association not owned or controlled by the Company and is governed by a 16
member Board of Directors, including four officer positions. None of the
officers or directors of the Benefits Association serve in any such capacity
with the Company. The Benefits Association employs a Director of Associate
Benefits as well as a third-party benefits administration company, both paid by
the Association. Affinity programs available to members of the Benefits
Association include credit cards, long-distance plans including paging, wireless
services and Internet service provider offerings, real estate planning programs
and a travel club. As determined by its Board of Directors, some of the revenue
generated by the Benefits Association through commissions from vendors of the
benefit and affinity programs or contributed to the Benefits Association by the
Company may be used to make open-market purchases of the Company's stock for use
in stock awards to Benefit Association members based on criteria established by
the Benefits Association. At December 31, 2001, approximately 21,000 shares had
been purchased by the Benefits Association for future awards to its members.
Cooperative Marketing
The Company has in the past, and may in the future, develop marketing
strategies pursuant to which the Company seeks arrangements with insurance and
service companies that have established sales forces. Under such arrangements,
the agents or sales force of the cooperative marketing partner market the
Company's Memberships along with the products already marketed by the partner's
agents or sales force. Such arrangements allow the cooperative marketing partner
to enhance its existing customer relationships and distribution channels by
adding the Company's product to the marketing partner's existing range of
products and services, while the Company is able to gain broader Membership
distribution and access to established customer bases.
The Company has a cooperative marketing agreement with Atlanta-based
Primerica Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one
of the largest financial services marketing organizations in North America with
more than 100,000 personal financial analysts across the U.S. and Canada. The
PFS cooperative marketing agreement resulted in approximately 13,000 and 12,000
Memberships during 2001 and 2000, respectively.
The Company has had limited success with cooperative marketing arrangements
in the past and is unable to predict with certainty what success it will
achieve, if any, under its existing or future cooperative marketing
arrangements.
Internet Marketing Alliances
The Company is continuing to develop an Internet marketing alliance
strategy pursuant to which the Company will seek arrangements with established
Internet companies. Under such proposed alliances, those visiting the web sites
of the alliance partner will have the opportunity to learn more about legal
service plans including the ability to immediately purchase a Membership
on-line. Such arrangements allow the alliance partner to derive an additional
revenue source from those already visiting their websites and allow the Company
to benefit from the tremendous volume of individuals visiting such sites. Such
alliances should allow the Company to gain broader Membership distribution and
access to established customer bases of an alliance partner.
Operations
The Company's corporate operations involve Membership application
processing, member-related customer service, various associate-related services
including commission payments, receipt of Membership fees, related general
ledger accounting, and managing and monitoring the provider law firm
relationships.
The Company utilizes a management information system to control operations
costs and monitor benefit utilization. Among other functions, the system
evaluates benefit claims, monitors member use of benefits, and monitors
marketing/sales data and financial reporting records. Dominant company concerns
in the architecture of private networks and web systems include security,
capacity to accommodate peak traffic, disaster recovery, and scalability. The
Company believes its management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
required. The Company believes this excess capacity will enable it to experience
a significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
The Company has built a strong Internet presence to strengthen the services
provided to both members and associates. The Company's Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors, and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
The Company's operations also include departments specifically responsible
for marketing support and regulatory and licensing compliance. The Company has
an internal production staff that is responsible for the development of new
audio and video sales materials.
Quality Control
In addition to the Company's quality control efforts for provider law firms
described above, the Company also closely monitors the performance of its home
office personnel, especially those who have telephone contact with members or
sales associates. The Company records home office employee telephone calls with
its members and sales associates to assure that Company policies are being
followed and to gather data about recurring problems that may be avoided through
modifications in policies. The Company also uses such recorded calls for
training and recognition purposes.
Competition
The Company competes in a variety of market segments in the prepaid legal
services industry, including, among others, individual enrollment plans,
employee benefit plans and certain specialty segments. According to 2000
estimates by NRC (the most recent data available), an estimated 40% of the total
estimated market in the segments in which the Company competes is served by a
large number of small companies with regional areas of emphasis or union-based
automatic enrollment plans. The remaining 60% of such market are served
primarily by the Company and five other principal competitors: Hyatt Legal Plans
(a MetLife company), ARAG Group (formerly Midwest Legal Services), LawPhone/ACS,
National Legal Plan and Legal Services Plan of America (a GE Financial Assurance
Partnership Marketing Group company, formerly the Signature Group). For
employment-based plans other than employer paid, union-based automatic
enrollment plans and employee assistance plans and for individual enrollment
plans, the Company represents approximately 44% of the market share garnered by
this group according to the NRC.
If a greater number of companies seek to enter the prepaid legal services
market, the Company will experience increased competition in the marketing of
its Memberships. However, the Company believes its competitive position is
enhanced by its actuarial database, its existing network of provider attorney
law firms and its ability to tailor products to suit various types of
distribution channels or target markets. The Company believes that no other
competitor has the ability to monitor the customer service aspect of the
delivery of legal services to the same extent the Company does. Serious
competition is most likely from companies with significant financial resources
and advanced marketing techniques.
Regulation
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, Secretaries of State, State Bar Associations and
State Attorney General offices depending on individual state opinions of
regulatory responsibility for legal expense plans. The Company is also required
to file with similar government agencies in Canada. While some states or
provinces regulate legal expense plans as insurance or specialized legal expense
products, others regulate them as services.
As of December 31, 2001, the Company or one of its subsidiaries was
marketing new Memberships in 35 states or provinces that require no special
licensing or regulatory compliance. The Company's subsidiaries serve as
operating companies in 16 states that regulate Memberships as insurance or
specialized legal expense products. The most significant of these wholly owned
subsidiaries are Pre-Paid Legal Casualty, Inc. ("PPLCI") and Pre-Paid Legal
Services, Inc. of Florida ("PPLSIF"). Of the Company's total Memberships in
force as of December 31, 2001, 36% were written in jurisdictions that subject
the Company or one of its subsidiaries to insurance or specialized legal expense
plan regulation.
The Company began selling Memberships in the Canadian provinces of Ontario
and British Columbia during 1999, Alberta during February 2001 and Manitoba
during August 2001. The Memberships currently marketed by the Company in such
provinces do not constitute an insurance product and therefore are exempt from
insurance regulation.
In states with no special licensing or regulatory requirements, the Company
commences operations only when advised by the appropriate regulatory authority
that proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
the Company or one of its subsidiaries would be required to qualify as an
insurance company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies. These agencies regulate the
Company's forms, rates, trade practices, allowable investments and licensing of
agents and sales associates. These agencies also prescribe various reports,
require regular evaluations by regulatory authorities, and set forth-minimum
capital and reserve requirements. The Company's insurance subsidiaries are
routinely evaluated and examined by representatives from the various regulatory
authorities in the normal course of business. Such examinations have not and are
not expected to adversely impact the Company's operations or financial condition
in any material way. The Company believes that all of its subsidiaries meet any
required capital and reserve requirements. Dividends paid by PPLCI are
restricted under Oklahoma law to available surplus funds derived from realized
net profits.
The Company is required to register and file reports with the Oklahoma
Insurance Commissioner as a member of a holding company system under the
Oklahoma Insurance Holding Company System Regulatory Act. Transactions between
PPLCI and the Company or any other subsidiary must be at arms-length with
consideration for the adequacy of PPLCI's surplus, and must have prior approval
of the Oklahoma Insurance Commissioner. Payment of any extraordinary dividend by
PPLCI to the Company requires approval of the Oklahoma Insurance Commissioner.
During each of 2001 and 2000, PPLCI declared a $5 million dividend payable to
the Company of which $1.5 million was paid in 2000, $3.5 million paid in 2001
and the remaining $5 million in 2002. Additionally, during 2001, the Company
received a $2.8 million dividend from UFL after receiving all necessary
regulatory approvals. On December 31, 2001 the Company completed the sale of its
wholly owned subsidiary UFL, after receiving all necessary regulatory approvals.
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, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to the
Company by such subsidiaries. PPLSIF is subject to restrictions of this type
under the laws of the State of Florida, including restrictions with respect to
payment of dividends to the Company.
As the legal plan industry matures, additional legislation may be enacted
that would affect the Company and its subsidiaries. The Company cannot predict
with any accuracy if such legislation would be adopted or its ultimate effect on
operations, but expects to continue to work closely with regulatory authorities
to minimize any undesirable impact.
The Company's operations are further impacted by the American Bar
Association Model Rules of Professional Conduct ("Model Rules") and the American
Bar Association Code of Professional Responsibility ("ABA Code") as adopted by
various states. Arrangements for payments to a lawyer by an entity providing
legal services to its members are permissible under both the Model Rules and the
ABA Code, so long as the arrangement prohibits the entity from regulating or
influencing the lawyer's professional judgment. The ABA Code prohibits lawyer
participation in closed panel legal service programs in certain circumstances.
The Company's agreements with provider law firms comply with both the Model
Rules and the ABA Code. The Company relies on the lawyers serving as the
designated provider law firms for the closed panel benefits to determine whether
their participation would violate any ethical guidelines applicable to them. The
Company and its subsidiaries comply with filing requirements of state bar
associations or other applicable regulatory authorities.
The Company also is required to comply with state, provincial and federal
laws governing the Company's multi-level marketing approach. These laws
generally relate to unfair or deceptive trade practices, lotteries, business
opportunities and securities. The Company has experienced no material problems
with marketing compliance. In jurisdictions that require associates to be
licensed, the Company receives all applications for licenses from the associates
and forwards them to the appropriate regulatory authority. The Company maintains
records of all associates licensed, including effective and expiration dates of
licenses and all states in which an associate is licensed. The Company does not
accept new Membership sale applications from any unlicensed associate in such
jurisdictions.
Employees
At December 31, 2001, after the sale of UFL, the Company and its
subsidiaries employed 586 individuals on a full-time basis, exclusive of
independent agents and sales associates who are not employees. None of the
Company's employees are represented by a union. Management considers its
employee relations to be good.
Foreign Operations
The Company began operations in the Canadian provinces of Ontario and
British Columbia during 1999, Alberta in February 2001 and Manitoba in August
2001 and derived aggregate revenues, including Membership fees and revenues from
associate services, from Canada of $4.4 million in U.S. dollars during 2001
compared to $4.9 million and $2.7 million in 2000 and 1999, respectively. Due to
the relative stability of the United States and Canadian foreign relations and
currency exchange rates, the Company believes that any risk of foreign
operations or currency valuations is minimal and would not have a material
effect on the Company's financial condition, liquidity or results of operations.
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, the Company completed construction during 1999, of a new
facility containing approximately 17,000 square feet of office and warehouse and
shipping space. The Company now has three buildings on its property located
approximately five miles from the Company's executive and administrative
offices. The Company previously completed construction of its Customer Care
facility during 1998 that contains approximately 10,000 square feet of office
and call center space. The Customer Care facility is adjacent to the material
distribution center constructed during 1997 containing 8,600 square feet that is
now used for general office space. The Company currently fully utilizes these
three existing facilities with combined square footage of more than 35,000
square feet and has begun construction of a new home office complex in Ada
located approximately five miles from its current location. The new home office
will be constructed on approximately 87 acres contributed to the Company by the
City of Ada in 2001 as part of an economic development incentive package.
Pursuant to the terms of the incentive package, the Company must construct its
new building within five years with a completed value of at least $12 million or
the acreage reverts back to the contributing entity. The Company chose the
general contractor for the new complex in August 2001 and construction began in
November 2001. Scheduled completion of the estimated $30 million complex, which
will include a sales associate Hall of Fame and six-story tower, is June 2003.
Costs incurred through December 31, 2001 of approximately $1.7 million have been
paid from existing resources and cash flow.
In addition to the property described above that is owned by the Company,
the Company opened an additional Customer Care facility in Antlers, Oklahoma
during March 2000, in building space provided by the City of Antlers at no cost
to the Company. This facility contains approximately 50 Customer Care
representatives with the option of adding another 50 to 100 representatives in
the next two years. In conjunction with a rural economic development program
coordinated by the City of Antlers, a new facility is being built at no cost to
the Company that will accommodate more than 100 customer service
representatives. The Company has agreed to lease the facilities upon completion
of the construction.
ITEM 3. LEGAL PROCEEDINGS
-------------------------------
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered judgment in favor of the defendants.
The deadline for plaintiffs to file notice of their intent to appeal, if any, is
thirty days from the date on which the judgment is entered.
In January 2001, the Company received inquiries from the Division of
Enforcement of the SEC requesting information relating primarily to the
Company's accounting policies for commission advance receivables from sales
associates. The Company has had no further contact from the Division of
Enforcement. The Division of Enforcement's inquiries were informal and did not
constitute a formal investigation or proceeding. The Company is unable to
determine the ultimate outcome of this inquiry, including whether the Division
of Enforcement will continue the inquiry subsequent to the Company's decision to
restate its financial statements. As of March 8, 2002, the Company has had no
further contact from the Division of Enforcement.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On August 14, 2001, Mr. Strykowski filed an amended
complaint, which added Deloitte & Touche, the Company's previous outside
auditors, as defendants. The complaints allege that the defendant directors
caused the Company to violate generally accepted accounting principles and
federal securities laws by improperly capitalizing commission expenses, caused
the Company to allegedly pay increased salaries and bonuses based upon financial
performance which was allegedly improperly inflated, and caused the Company to
expend significant dollars in connection with the defense of its accounting
policy, including cost incurred in connection with the defense of the securities
class actions described above, and in connection with the repurchase of its own
shares on the open market at allegedly artificially inflated prices. The
derivative actions have been consolidated and are in the preliminary pleading
stage. The Company believes that these derivative actions are related to the
putative securities class actions described above and may be intended to
circumvent the restrictions on those actions imposed by the Private Securities
Litigation Reform Act of 1995. On February 15, 2002, the defendants moved to
stay the derivative action pending a decision on the motion to dismiss the
related securities class actions. On March 8, 2002, the Pre-Paid defendants
withdrew that motion as moot in light of the March 5, 2002 order dismissing the
putative securities class actions. On March 1, 2002, plaintiffs filed a
consolidated amended derivative complaint making claims and allegations similar
to those contained in the original derivative complaints. While the outcome of
these cases is uncertain, based on the information currently available to the
Company, it appears that the complaints should be dismissed because the
plaintiffs failed to make or excuse the requisite demand that the Company pursue
the claims of alleged misconduct as well as for failure to state a claim.
In the second quarter of 2001 and through January 30, 2002, multiple
lawsuits were filed against the Company, certain sales associates and other
unnamed defendants in Alabama state courts by current or former members seeking
unspecified actual and punitive damages for alleged breach of contract and fraud
in connection with the sale of memberships. As of March 8, 2002, the Company was
aware of 21 separate lawsuits involving approximately 114 plaintiffs that have
been filed in multiple counties in Alabama, and additional suits of a similar
nature have been threatened to be filed in Alabama and elsewhere by one or more
of the counsel involved in these suits in Alabama. These cases make allegations
similar to allegations made in cases previously filed against the Company in
Alabama state courts by multiple plaintiffs which were previously settled for a
payment of $1.5 million to settle claims by 97 separate claimants. In January
2002, one of the law firms representing individual plaintiffs filed a putative
class action on behalf of all Alabama residents purchasing memberships seeking
damages and injunctive relief based on alleged failures to provide coverage
under the memberships. Based on the Company's preliminary investigation of the
new cases, the facts involved are in many respects significantly different from
the facts involved in the case the company previously settled. These cases are
all in various stages of litigation, and the ultimate outcome of any particular
case is not determinable.
On June 29, 2001, an action was filed in the District Court of Canadian
County, Oklahoma by Gina Cotwitz against the Company. This action is a putative
class action on behalf of all sales associates of the Company and alleges
violations of the Oklahoma Consumer Protection Act, the Oklahoma Uniform
Consumer Credit Code and breach of contract in connection with certain of the
Company's practices relating to advancing commissions to sales associates. The
Company has filed an answer denying the plaintiff's claims and raising
affirmative defenses and intends to vigorously defend this case. The case is in
the preliminary stages and the ultimate outcome is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is putative class action filed on behalf of all
sales associates of the Company and alleges that the marketing plan offered by
the Company constitutes a security under the Securities Act of 1933 and seeks
remedies for failure to register the marketing plan as a security and for
violations of the anti-fraud provisions of the Securities Act of 1933 and the
Securities Exchange Act of 1934 in connection with representations alleged to
have been made in connection with the marketing plan. The Complaint also alleges
violations of the Oklahoma Securities Act, the Oklahoma Business Opportunities
Sales Act, breach of contract, breach of duty of good faith and fair dealing and
unjust enrichment and violation of the Oklahoma Consumer Protection Act and
negligent supervision. The Company intends to vigorously defend this case. The
case is in the preliminary stages and the ultimate outcome is not determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in these proceedings. While the ultimate outcome of these proceedings
is not determinable, the Company does not currently anticipate that these
contingencies will result in any material adverse effect to its financial
condition or results of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
--------------------------------------------------------------------------------
Market Price of and Dividends on the Common Stock
At February 28, 2002, there were 5,510 holders of record (including
brokerage firms and other nominees) of the Company's common stock which is
listed on the New York Stock Exchange under the symbol "PPD." The following
table sets forth, for the periods indicated, the range of high and low sales
prices for the common stock, as reported by the New York Stock Exchange.
High Low
2002:
1st Quarter (through February 28)............................................ $ 27.45 $ 18.85
2001:
4th Quarter ................................................................. $ 22.25 $ 15.05
3rd Quarter.................................................................. 22.48 15.80
2nd Quarter.................................................................. 24.75 10.04
1st Quarter.................................................................. 28.63 10.05
2000:
4th Quarter.................................................................. $ 48.75 $ 23.56
3rd Quarter.................................................................. 34.44 29.38
2nd Quarter.................................................................. 34.75 26.00
1st Quarter.................................................................. 32.44 19.88
The Company has never declared a cash dividend on its common stock. For the
foreseeable future, it is anticipated that earnings generated from the
operations of the Company will be used to finance the Company's growth and to
purchase shares of its stock 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 for any dividend representing more than 10% of such accumulated
available surplus or an amount representing more than the previous years' net
profits. During each of 2001 and 2000, PPLCI declared a $5 million dividend
payable to the Company of which $1.5 million was paid in 2000, $3.5 million paid
in 2001 and the remaining $5 million in 2002. Additionally, during 2001, the
Company received a $2.8 million dividend from UFL after receiving all necessary
regulatory approvals. PPLSIF is similarly restricted pursuant to the insurance
laws of Florida. At December 31, 2001, PPLSIF did not have funds available for
payment of substantial dividends without the prior approval of the insurance
commissioner while PPLCI had approximately $5.6 million in surplus funds
available for payment of an ordinary dividend.
The Company has a line of credit with Bank of Oklahoma, N.A. as described
in "Management's Discussion and Analysis - Liquidity and Capital Resources,"
which prohibits payment of cash dividends on its common stock.
Recent Sales of Unregistered Securities
None.
ITEM 6. SELECTED FINANCIAL DATA
-------------------------------------
The following table sets forth selected financial and statistical data for
the Company as of the dates and for the periods indicated. As a result of the
1998 fourth quarter acquisition of TPN, Inc. ("TPN") that was accounted for as a
pooling of interests, the 1997 and 1998 periods have been restated to include
the operating results of TPN. This information is not necessarily indicative of
the Company's future performance. The following information should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto included elsewhere herein.
Year Ended December 31,
-------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- -------- -------- ---------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees.........................................$ 263,514 $ 211,763 $153,918 $107,393 $ 74,555
Associate services...................................... 36,485 30,372 22,816 17,255 12,143
Product sales........................................... 60 1,016 5,888 27,779 41,070
Other................................................... 3,602 3,232 3,809 2,901 1,867
--------- ---------- --------- --------- ---------
Total revenues........................................ 303,661 246,383 186,431 155,328 129,635
--------- ---------- --------- --------- ---------
Costs and expenses:
Membership benefits..................................... 87,429 69,513 51,089 35,465 24,684
Commissions............................................. 111,060 96,614 74,333 50,652 38,717
Associate services and direct marketing................. 29,879 23,251 15,815 14,738 11,431
General and administrative expenses..................... 28,243 21,524 19,280 21,902 20,311
Product costs........................................... 33 675 4,174 17,967 27,017
Other, net.............................................. 5,884 4,403 3,226 2,152 1,626
--------- ---------- --------- --------- ---------
Total costs and expenses.............................. 262,528 215,980 167,917 142,876 123,786
--------- ---------- --------- --------- ---------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle....... 41,133 30,403 18,514 12,452 5,849
Provision for income taxes................................ 13,519 9,550 6,480 1,013 3,962
--------- ---------- --------- --------- ---------
Income from continuing operations before cumulative
effect of change in accounting principle................ 27,614 20,853 12,034 11,439 1,887
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit (expense) of
$0, $387 and ($444) for years 2001, 2000 and 1999,
respectively)........................................... (504) 649 826 - -
--------- ---------- --------- --------- ---------
Income before cumulative effect of change in accounting
principle............................................... 27,110 21,502 12,860 11,439 1,887
Cumulative effect of adoption of SAB 101 (net of
applicable income tax benefit of $546).................. - (1,013) - - -
--------- ---------- --------- --------- ---------
Net income.................................................. 27,110 20,489 12,860 11,439 1,887
Less dividends on preferred shares........................ - 4 10 10 13
--------- ---------- --------- --------- ---------
Net income applicable to common stockholders................$ 27,110 $ 20,485 $ 12,850 $ 11,429 $ 1,874
--------- ---------- --------- --------- ---------
Basic earnings per common share from continuing
operations before cumulative effect of accounting change.. $ 1.28 $ .93 $ .52 $ .49 $ .08
Basic earnings per common share from discontinued
operations.............................................. (.02) .03 .04 - -
--------- ---------- --------- --------- ---------
Basic earnings per common share before cumulative effect
of change in accounting principle....................... 1.26 .96 .56 .49 .08
Cumulative effect of adoption of SAB 101.................... - (.05) - - -
--------- ---------- --------- --------- ---------
Basic earnings per common share............................. $ 1.26 $ .91 $ .56 $ .49 $ .08
--------- ---------- --------- --------- ---------
Diluted earnings per common share from continuing
operations before cumulative effect of accounting change.. $ 1.28 $ .92 $ .51 $ .48 $ .08
Diluted earnings per common share from discontinued
operations.............................................. (.02) .03 .04 - -
--------- ---------- --------- --------- ---------
Diluted earnings per common share before cumulative
effect of accounting change............................. 1.26 .95 .55 .48 .08
Cumulative effect of adoption of SAB 101.................... - (.05) - - -
--------- ---------- --------- --------- ---------
Diluted earnings per common share........................... $ 1.26 $ .90 $ .55 $ .48 $ .08
--------- ---------- --------- --------- ---------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net income................................................ $ 21,502 $ 12,786 $ 11,155 $ 1,726
Basic earnings per common share........................... $ .96 $ .55 $ .48 $ .07
Diluted earnings per common share......................... $ .95 $ .55 $ .47 $ .07
Weighted average number of common shares
outstanding - basic..................................... 21,504 22,504 23,099 23,456 23,127
Weighted average number of common shares
outstanding - diluted................................... 21,544 22,679 23,374 23,906 23,575
Membership Benefit Cost and Statistical Data:
Membership benefits ratio (1)............................. 33.2% 32.8% 33.2% 33.0% 33.1%
Commissions ratio (1)..................................... 42.1% 45.6% 48.3% 47.2% 51.9%
General & administrative expense ratio (1)................ 10.7% 10.2% 12.5% 20.4% 27.2%
Product cost ratio (1).................................... 55.0% 66.4% 70.9% 64.7% 65.8%
New Memberships sold...................................... 728,295 670,118 525,352 391,827 283,723
Period end Memberships in force...........................1,242,908 1,064,805 827,979 603,017 425,381
Cash Flow Data:
Net cash provided by continuing operating activities........$ 37,801 $ 23,201 $ 17,031 $ 11,295 $ 14,472
Net cash (used in) provided by continuing investing
activities............................................... (6,963) (7,965) 12,070 (33,531) (6,254)
Net cash (used in) provided by continuing financing
activities............................................... (27,414) (13,714) (26,687) 1,444 3,464
Balance Sheet Data:
Total assets..............................................$ 85,720 $ 77,766 $ 58,156 $ 68,789 $ 57,745
Total liabilities......................................... 43,496 35,999 25,518 23,218 25,237
Stockholders' equity 42,224 41,767 32,638 45,571 32,508
-----------
(1) The Membership benefits ratio, the Commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. The product cost ratio represents product costs as a
percentage of product sales. These ratios do not measure total
profitability because they do not take into account all revenues and
expenses.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
-----------------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
General
Membership Fees and Membership Benefit Costs
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis. The Company also charges new members, who are not part of an
employee group, a $10 enrollment fee. This enrollment fee and related direct
incremental costs are deferred and recognized in income over the estimated life
of a Membership.
Approximately 99% of active Memberships at December 31, 2001 have benefits
delivered by a designated provider law firm with whom the Company has arranged
for the services to be provided in a particular geographic area, typically a
state or province. Provider law firms receive a fixed monthly payment for each
member in their service area and are responsible for providing the Membership
benefits without additional remuneration. The fixed cost aspect of this
arrangement provides significant advantages to the Company in managing its
claims risk. Pursuant to these provider law firm arrangements, 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 law
firms, has access to larger, more diversified law firms.
Membership benefit costs relating to non-provider Memberships ("open panel"
Memberships or Memberships in states where a provider law firm is not in place),
which constituted approximately 1% of Memberships in force at December 31, 2001,
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 Membership 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 Memberships are managed primarily through contractual benefit
limitations and, as a result, underwriting decisions are not necessarily based
on individual Membership purchases.
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, the Company
implemented a level commission schedule (approximately 27% per annum at December
31, 2001) with up to a three-year advance commission payment. Prior to March 1,
1995, the Company's commission program provided for advance commission payments
to associates of approximately 70% of first year Membership premiums on new
Membership sales and commissions were earned by the associate at a rate of
approximately 16% in all subsequent years. Effective March 1, 2002, and in order
to offer additional incentives for increased Membership retention rates, the
Company returned to a differential commission structure with rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from zero to 25% per annum based
on the first 12 month Membership retention rate of the associate's sales
organization.
Prior to January 1997 the Company advanced commissions at the time of sale
of all new Memberships. In January 1997, the Company implemented a policy
whereby the associate receives only earned commissions on the first three sales
unless the associate has successfully completed the Fast Start training program
that was implemented in 1997. For all sales beginning with the fourth Membership
or all sales made by an associate successfully completing the Fast Start
training program, the Company currently advances commission payments at the time
of sale of a new Membership. The amount of cash potentially advanced upon the
sale of a new Membership, prior to the recoupment of any charge-backs (described
below), represents an amount equal to up to three years commission earnings
before March 1, 2002, and an amount equal to up to one year commission earnings
thereafter. Although the average number of marketing associates receiving an
advance commission payment on a new Membership is 17, the overall initial
advance may be paid to more than thirty different individuals, each at a
different level within the overall commission structure. The commission advance
immediately increases an associate's unearned advance commission balance to the
Company.
Although the Company, prior to March 1, 2002, advanced its sales associates
up to three years commission when a membership is sold, the average commission
advance paid to its sales associates as a group is actually less than 3 years
because some associates choose to receive less than a 3-year advance and the
Company pays less than a 3-year advance on some of its specialty products. Also,
any residual commissions due an associate (defined as commission on an
individual membership after the advance has been earned) are retained to reduce
any remaining unearned commission advance balances prior to being paid to that
sales associate. The average commission advance in 2001, 2000 and 1999 was
approximately 2.18 years, 2.31 years and 2.43 years, respectively.
The Company expenses advance commissions ratably over the first month of
the related membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates for the following years
ended December 31 were:
2001 2000 1999
---- ---- ----
(Amounts in 000's)
Beginning unearned advance commission balances (1)..................$ 167,193 $ 125,257 $ 87,263
Advance commissions, net............................................ 110,211 97,500 74,800
Earned commissions applied.......................................... (63,870) (48,255) (36,806)
Advance commission write-offs (2)................................... (1,925) (7,309) -
---------- ----------- -----------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)........................................ 211,609 167,193 125,257
Estimated unrecoverable advance commission balances (1) (3)......... (15,868) (11,055) (4,544)
---------- ------------ ------------
Ending unearned advance commission balances, net (1)................$ 195,741 $ 156,138 $ 120,713
----------- ------------ ------------
(1)These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2)In 2000, the Company began writing off unearned advanced commission
balances rather than increasing the estimated unrecoverable balance
when the associate had no remaining active memberships since the
associate would no longer have any future commission earnings.
(3)Increase in estimated unrecoverable balances in 2000 due to change
in evaluation methodology such that the Company now evaluates the
recoverability of non-vested associate commission advance balances on
an individual associate basis as it does the advances to its active
associates. Previously, the Company "pooled" the activity of
non-vested associates and evaluated the recoverability of commissions
as if the group of non-vested associates were a single associate.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $20.0 million,
$14.2 million and $9.9 million at December 31, 2001, 2000 and 1999,
respectively. As such, at December 31, 2001 future commissions and related
expense will be reduced as unearned advance commission balances of $175.7
million are recovered. Commissions are earned by the associate as Membership
premiums are earned by the Company, usually on a monthly basis. The Company
reduces unearned advance commission balances or remits payment to an associate,
as appropriate, when commissions are earned. Should a Membership lapse before
the advances have been recovered for each commission level, the Company
generates an immediate "charge-back" to the applicable sales associate to
recapture up to 50% of any unearned advance on Memberships written prior to
March 1, 2002, and 100% on any Memberships written thereafter. This charge-back
is deducted from any future advances that would otherwise be payable to the
associate for additional new Memberships. Any remaining unearned advance
commission balance may be recovered by withholding future residual earned
commissions due to an active associate on active Memberships. Additionally, even
though a commission advance may have been fully recovered on a particular
Membership, no additional commission earnings from any Membership are paid to an
associate until all previous advances on all Memberships, both active and
lapsed, have been recovered.
Prior to March 1, 2002, the Company charged associates a fee on unearned
advance commission balances relating to lapsed Memberships ("Membership lapse
fee"). The fee that is recorded on the associates unearned commission balance is
determined by applying the prime interest rate to the unearned advance
commission balance pertaining to lapsed Memberships. The Company realizes and
recognizes this fee only when the amount of the calculated fee is collected by
withholding from cash commission payments due the associate. The fees collected
reduce commission expense. The Company's ability to recover these fees is
primarily dependant on the associate selling new Memberships, which qualify for
commission advances. The Company eliminated the Membership lapse fee for
Memberships sold after March 1, 2002 in conjunction with the change in the
commission structure described above.
The Company has the contractual right to require associates to repay
unearned advance commission balances from sources other than earned commissions
including cash (a) from all associates either (i) upon termination of the
associate relationship, which includes but is not limited to when an associate
becomes non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, the Company has not demanded repayments of the
unearned advance commission balances from associates, including terminated
associates, because collection efforts would likely increase costs and have the
potential to disrupt the Company's relationships with its sales associates. This
business decision by the Company has a significant effect on the Company's cash
flow by electing to defer collection of advance payments of which approximately
$15.9 million were not expected to be collected from future commissions at
December 31, 2001. However, the Company regularly reviews the unearned advance
commission balance status of associates and will exercise its right to require
associates to repay advances when management believes that such action is
appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet the Company's established vesting requirements by selling at least
three new Memberships per quarter or retaining a personal Membership. Non-vested
associates lose their right to any further commissions earned on Memberships
previously sold at the time they become non-vested. As a result the Company has
no continuing obligation to individually account to these associates as it does
to active associates and is entitled to retain all commission earnings that
would be otherwise payable to these terminated associates. The Company does
continue to reduce the unearned advance commission balances for commissions
earned on active Memberships previously sold by those associates. Substantially
all individual non-vested associate unearned advance commission balances were
less than $1,000 and the average balance was $920 at December 31, 2001.
Although the advance commissions are expensed ratably over the first month
of the related Membership, the Company assesses, at the end of each quarter, on
an associate-by-associate basis, the recoverability of each associate's unearned
advanced commission balance by estimating the associate's future commissions to
be earned on active Memberships. Each active Membership is assumed to lapse in
accordance with the Company's estimated future lapse rate, which is based on the
Company's actual historical Membership retention experience as applied to each
active Membership's year of origin. The lapse rate is based on a 20-year history
of Membership retention rates, which is updated quarterly to reflect actual
experience. The Company also closely reviews current data for any trends that
would affect the historical lapse rate. The sum of all expected future
commissions to be earned for each associate is then compared to that associate's
unearned advance commission balance. The Company estimates unrecoverable advance
commission balances when expected future commissions to be earned on active
Memberships (aggregated on an associate-by-associate basis) are less than the
unearned advance commission balance. If an associate with an outstanding
unearned advance commission balance has no active Memberships, the unearned
advance commission balance is written off. Refer to "Measures of Member
Retention - Expected Membership Life, Expected Remaining Membership Life" for a
description of the method used by the Company to estimate future commission
earnings.
Further, the Company's analysis of the recoverability of unearned advance
commission balances is also based on the assumption that the associate does not
write any new Memberships. The Company believes that this assessment methodology
is highly conservative since its actual experience is that some associates do
continue to sell new Memberships and the Company, through its chargeback rights,
gains an additional source to recover unearned advance commission balances.
Operating Ratios
Three principal operating measures monitored by the Company in addition to
measures of Membership retention are the Membership benefit ratio, commission
ratio and the general and administrative expense ratio. The Membership benefits
ratio, the Commissions ratio and the general and administrative expense ratio
represent those costs as a percentage of Membership fees. The Company strives to
maintain these ratios as low as possible while at the same time providing
adequate incentive compensation to its sales associates and provider law firms.
These ratios do not measure total profitability because they do not take into
account all revenues and expenses.
Cash Flow Considerations Relating to Sales of Memberships
The Company generally advances significant commissions at the time a
Membership is sold. Since approximately 95% of Membership fees are collected on
a monthly basis, a significant cash flow deficit is created at the time a
Membership is sold. This deficit is reduced as monthly Membership fees are
remitted and no additional commissions are paid on the Membership until all
previous unearned advance commission balances have been fully recovered. Since
the cash advanced at the time of sale of a new Membership may be recovered over
a multi-year period, cash flow from operations may be adversely affected
depending on the number of new Memberships written in relation to the existing
active base of Memberships and the composition of new or existing sales
associates producing such Memberships.
Income Tax Matters-Net Operating Losses
The Company has a net operating loss carryforward ("NOL") in the amount of
$1.8 million as of December 31, 2001 representing the remaining NOLs of TPN. The
ability of the Company to utilize NOLs and tax credit carryforwards to reduce
future federal income taxes is 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 that result in an
aggregate change of more than 50% in the beneficial ownership of the stock of
the Company. 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. The acquisition of TPN by the Company
constituted an Ownership Change of TPN. As a result, the ability of the Company
to utilize TPN's remaining $1.8 million in NOLs is limited to approximately
$954,000 per year. Although the Company did not utilize any of the TPN NOL
during 1998, it did fully utilize the available amount during 1999 and 2000.
NOLs of $954,000, $954,000 and $888,000 are expected to be utilized in the
income tax returns for 2001, 2002 and 2003, respectively, and therefore the
previously provided valuation allowance was reversed in the fourth quarter of
2001.
Associate Services
The Company derives revenues from services provided to its marketing sales
force from an enrollment fee of approximately $65 from each new sales associate
for which the Company provides initial sales and marketing supplies and
enrollment services to the associate. In January 1997, the Company implemented a
training program ("Fast Start") that allows an associate who successfully
completes the program to advance through the various commission levels at a
faster rate. Associates participating in this program typically pay a fee of
$184, except for special promotions the Company implements from time to time, in
addition to the $65. The fee covers the additional training and materials used
in the training program and is recognized in income upon completion of the
training. The Company enrolled 122,192 new sales associates during 2001 compared
to 97,617 during 2000 and 92,644 during 1999, resulting in significant increases
in associate services revenues and costs. Associate services also includes
revenue recognized on the sale of marketing supplies and promotional material to
associates. The Company's 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 costs incurred in recruiting, training, monitoring and providing
materials to sales associates and are not intended to generate significant
profits from such activities.
TPN's revenues were primarily comprised of receipts for goods and services
provided by TPN to its distributors and other customers. Distributors were
required to purchase a distributor kit that included training materials and
business support literature. TPN distributors were required to meet certain
sales production levels to be eligible to receive commissions and many
distributors elected to purchase products through an automatic monthly bank or
credit card draft. These practices, which resulted in enhanced product sales,
were discontinued in February 1999.
Insurance operations
UFL retained its existing life insurance business as a part of the
Company's 1998 acquisition of UFL. The life insurance operations of UFL
generated approximately $1 million in life insurance premiums and continued to
provide claims processing for the coinsured Medicare supplement and health care
policies and receive full cost reimbursement for such services from the
coinsurer. UFL marketed primarily to individuals, age 65 and over, in New
Mexico, Oklahoma and Texas. On December 31, 2001 the Company completed the sale
of UFL (See Note 2 to the Consolidated Financial Statements).
Investment Policy
The Company's investment policy is to some degree controlled by certain
insurance regulations, which, coupled with management's own investment
philosophy, results in a conservative investment portfolio that is not risk
oriented. The Company's investments consist of common stocks, investment grade
(rated Baa or higher) preferred stocks and investment grade bonds primarily
issued by corporations, the United States Treasury, federal agencies, federally
sponsored agencies and enterprises, as well as mortgage-backed securities and
state and municipal tax-exempt bonds. The Company is required to pledge
investments to various state insurance departments as a condition to obtaining
authority to do business in certain states.
Disclosures About Market Risk
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to the
Company's significant investment in fixed-maturity investments, interest rate
risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in fair values of those
instruments. Additionally, fair values of interest rate sensitive instruments
may be affected by the creditworthiness of the issuer, prepayment options,
relative values of alternative investments, liquidity of the instrument and
other general market conditions.
As of December 31, 2001, substantially all of the Company's investments
were in investment grade (rated Baa or higher) fixed-maturity investments and
interest-bearing money market accounts including certificates of deposit. The
Company does not hold any investments classified as trading account assets or
derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on the Company's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly, with
no effect given to any steps that management might take to counteract that
change.
The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table:
Hypothetical change Estimated fair value
in interest rate after hypothetical
Fair Value (bp = basis points) change in interest rate
---------- ------------------- ------------------------
(Dollars in thousands)
Fixed-maturity investments at December 31, 2001 (1).... $ 18,983 100 bp increase $ 17,635
200 bp increase 16,437
50 bp decrease 19,575
100 bp decrease 20,167
Fixed-maturity investments at December 31, 2000 (1).... $ 16,391 100 bp increase $ 15,772
200 bp increase 15,145
50 bp decrease 16,674
100 bp decrease 16,948
--------------------
(1) Excluding short-term investments with a fair value of $3.3 million and $3.9
million at December 31, 2001 and 2000, respectively. Excludes UFL
investments with a fair value of $9.1 million at December 31, 2000.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2001 would reduce
the estimated fair value of the Company's fixed-maturity investments by
approximately $2.5 million at that date. At December 31, 2000, and based on
the fair value of fixed-maturity investments of $16.4 million, an
instantaneous 200 basis point increase in market interest rates would have
reduced the estimated fair value of the Company's fixed-maturity
investments by approximately $1.2 million at that date. The Company's
increased sensitivity to rising interest rates is due to the increase in
investments with maturities over ten years from $5.2 million at December
31, 2000 to $9.9 million at December 31, 2001. The definitive extent of the
interest rate risk is not quantifiable or predictable due to the
variability of future interest rates, but the Company does not believe such
risk is material.
The Company primarily manages its exposure to interest rate risk by
purchasing investments that can be readily liquidated should the interest rate
environment begin to significantly change.
Accounting Standards to be Adopted
In July 2001, the Financial Accounting Standards Board issued new
pronouncements: SFAS 141, "Business Combinations"; SFAS 142, "Goodwill and Other
Intangible Assets"; and SFAS 143, "Accounting for Asset Retirement Obligations."
SFAS 141, which requires the purchase method of accounting for all business
combinations, applies to all business combinations initiated after June 30, 2001
and to all business combinations accounted for by the purchase method that are
completed after June 30, 2001. SFAS 141 will not apply to the Company unless it
enters into a future business combination. SFAS 142 requires that goodwill as
well as certain other intangible assets be tested annually for impairment. In
addition, the Statement eliminates the current requirement to amortize goodwill
or intangible assets with indefinite lives, and is effective for fiscal years
beginning after December 15, 2001. SFAS 143 requires entities to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred and a corresponding increase in the carrying amount of the
related long-lived asset. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The Company does not expect SFAS 142 or 143 to materially impact
its reported results.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", ("SFAS 144") is effective for the Company for the fiscal year beginning
January 1, 2002, and addresses accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business." SFAS 144 retains the
fundamental provisions of SFAS No. 121 and expands the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. The Company
estimates that the new standard will not have a material impact on its financial
statements but is still in the process of evaluating the impact on its financial
statements.
Measures of Member Retention
One of the major factors affecting the Company's profitability and cash
flow is the ability of the Company to retain a Membership, and therefore
continue to receive fees, once it has been sold. The Company monitors its
overall Membership persistency rate, as well as the retention rates with respect
to Memberships sold by individual associates and agents and retention rates with
respect to Memberships by year of issue, geographic region, utilization
characteristics and payment method, and other sub groupings.
Terminology
The following terms are used in describing the various measures of
retention:
o Membership life is a period that commences on the day of initial
enrollment of a member and continues until the individual's Membership
eventually terminates or lapses (the terms terminate or lapse may be used
interchangeably here).
o Membership age means the time since the Membership has been in effect.
o Lapse rate means the percentage of Memberships of a specified group of
Memberships that lapse in a specified time period.
o Retention rate is the complement of a lapse rate, and means the
percentage of Memberships of a specified group that remain in force at the
end of a specified time period.
o Persistency and retention are used in a general context to mean the
tendency for Memberships to continue to remain in force, while the term
persistency rate is a specific measure that is defined below.
o Lapse rates, retention rates, persistency rates, and expected Membership
life may be referred to as measures of Membership retention.
o Expected Membership life means the average number of years a new
Membership is expected to remain in force.
o Blended rate when used in reference to any measure of member retention
means a rate computed across a mix of Memberships of various Membership
ages.
o Expected remaining Membership life means the number of additional years
that an existing member is expected to continue to renew from a specific
point in time based on the Membership life.
Variations in Membership Retention by Sub-Groups, Impact on Aggregate
Numbers
Company wide measures of Membership retention include data relating to
members who can potentially be further sorted by identifiable sub-groupings. For
example, Memberships may be subdivided into those owned by members who are or
are not sales associates, to those who are or are not members of group plans,
etc.
Measures of Membership retention of different sub-groups may vary. For
example, the Company's experience indicates that first year retention rate of
Memberships owned by members who also are sales associates is approximately 10%
better than retention of Memberships owned by non-associate members. While this
correlation can be identified, the cause and effect relationship here cannot be
isolated. These sales associate members may have a financial incentive to retain
the Membership in order to continue to receive commissions. They also likely
have a better understanding and appreciation of the benefits of the Membership,
which may have contributed in fact to their decision to also become a sales
associate. Additionally, members who have accessed the services of the provider
law firms historically have higher retention rates than those who have not.
All aggregate measures of Membership retention or expected life may be
impacted by shifts in the underlying enrollment mix of sub-groups that have
different retention rates. For example Memberships owned by non-associate new
members have comprised an increasing percentage of new Memberships enrolled each
year over the past five years. Since non-associate members have a known lower
first year retention rate, a shift in mix alone will cause a reduction in
reported aggregate retention measures and expected member life, even if the
retention rates within each sub-group do not change. It is important to note
that all blended rates discussed here may reflect the impact of such shifts in
enrollment mixes. At December 31, 2001, 249,799 of the active 1,242,908
memberships were also vested associates which represents 20% of the total active
memberships. The following table shows total new memberships sold during each
year and the number and percentage of Memberships sold to persons who are
associates.
Total New Associate
Year Memberships Memberships Ratio
---- ----------- ----------- -------
1997 283,723 54,144 19.1%
1998 391,827 69,890 17.8%
1999 525,352 85,219 16.2%
2000 670,118 90,684 13.5%
2001 728,295 103,515 14.2%
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, the Company has observed that Memberships in their first year have
a significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 47.3% of all new Memberships lapse during the first year, leaving 52.7%
still in force at the end of the first year. More tenured Memberships have
significantly lower lapse rates. For example, by year seven lapse rates are
under 10% and annual retention exceeds 90%. The following table shows as of
December 31, 2001 the Company's blended retention rate and lapse rates based on
its historical experience for the last 20 years. The blended retention and lapse
rates as of the end of 2001 did not differ materially from those previously
reported at the end of 2000.
Membership Retention versus Membership Age
-----------------------------------------------------------
Membership Yearly Lapse Yearly End of Year
Year Rate Retention Memberships
---------- ------------ --------- ------------
0 - 100.00% 100.0
1 47.3% 52.7% 52.7
2 29.9% 70.1% 36.9
3 22.3% 77.7% 28.7
4 18.3% 81.7% 23.5
5 14.0% 86.0% 20.2
6 11.1% 88.9% 17.9
7 9.9% 90.1% 16.2
Membership Persistency
The Company's Membership persistency rate is a specific computation that
measures the number of Memberships in force at the end of a year as a percentage
of the total of (i) Memberships in force at the beginning of such year, plus
(ii) new Memberships sold during such year. From 1981 through the year ended
December 31, 2001, the Company's annual Membership persistency rates, using the
foregoing method, have averaged approximately 73.3%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
-------- ----------- ---------------- --------- ----------- -----------
1997 294,151 283,723 577,874 425,381 73.6%
1998 425,381 391,827 817,208 603,017 73.8%
1999 603,017 525,352 1,128,369 827,979 73.4%
2000 827,979 670,118 1,498,097 1,064,805 71.1%
2001 1,064,805 728,295 1,793,100 1,242,908 69.3%
The Company's overall Membership persistency rate varies based on, among
other factors, the relative age of total Memberships in force, and shifts in the
mix of members enrolled. The Company's overall Membership persistency rate could
become lower when the Memberships in force include a higher proportion of newer
Memberships, as will happen following periods of rapid growth. The Company's
overall Membership persistency rate could also become lower when the new
enrollments include a higher proportion of non-associate members, a trend that
has been observed over the past five years.
Unless offset by other factors, these factors could result in a decline in
the Company's overall Membership persistency rate as determined by the formula
described above, but does not necessarily indicate that the new Memberships
written are less persistent.
Expected Membership Life, Expected Remaining Membership Life
Using historical data through 2001 for all past Members enrolled, the
expected Membership life can be computed to be approximately three years. This
number represents the average number of years a new Membership can be expected
to remain in force. Although about half of all new Memberships may lapse in the
first year, the expected Membership life is much longer due to the contribution
of higher annual retention rates in subsequent years.
Since the Company's experience is that the retention rate of a given
generation of new Memberships improves with Membership age, the expected
remaining Membership life of a Membership also increases with Membership age.
For example, while a new Membership may have an expected Membership life of
three years, the expected remaining Membership life of a Membership that reaches
its first year anniversary is approximately five years.
Since the actual population of Memberships in force at any time is a
distribution of ages from zero to more than 20 years, the expected remaining
Membership life of the entire population at large greatly exceeds three years
per Membership. As of December 31, 2001, based on the historical data described
above, the current expected remaining Membership life of the actual population
is over six years per Membership. This measure is used by the Company to
estimate the future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 20 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
Actions that May Impact Retention in the Future
The potential impact on the Company's future profitability and cash flow
due to future changes in Membership retention can be significant. While blended
retention rates have not changed significantly over the past five years, the
Company has recently taken actions that may impact retention rates in the
future. Since December 31, 2001, the Company has implemented several new
initiatives aimed at improving the retention rate of both new and existing
Memberships. Such initiatives include a revised compensation structure,
effective March 1, 2002, featuring variable renewal commission rates ranging
from zero to 25% per annum based on the 12 month Membership retention rate of
the associate's sales organization; implementation of a "non-taken"
administrative fee to sales associates of $35 for any Membership application
that is processed by the Company after March 1, 2002, but for which a payment is
never received; and, an increase in the amount of the commission "charge-back"
(described above) for Memberships written after March 1, 2002 from 50% of the
unearned Membership commission advance balance to 100% of the unearned
Membership commission advance balance. The Company is also in the process of
designing and implementing an enhanced member "life cycle" communication process
aimed at both increasing the overall amount of communication from the Company to
the members as well as more specific target messaging to members based on the
length of their Membership as well as utilization characteristics. The Company
believes that such efforts may increase the utilization by members and therefore
lead to higher retention rates.
Results of Operations
Comparison of 2001 to 2000
The Company reported net income applicable to common shares of $27.1
million, or $1.26 per diluted common share, for 2001. The net income per diluted
share was up 40% from net income applicable to common shares of $20.5 million,
or $.90 per diluted common share, for 2000. The increase in the net income
applicable to common shares for 2001 is primarily the result of increases in
Membership fees for 2001 as compared to 2000.
Membership fees totaled $263.5 million during 2001 compared to $211.8
million for 2000, an increase of 24%. Membership fees and their impact on total
revenues in any period are determined directly by the number of active
Memberships in force during any such period. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales increased 9%
during 2001 to 728,295 from 670,118 during 2000. At December 31, 2001, there
were 1,242,908 active Memberships in force compared to 1,064,805 at December 31,
2000, an increase of 17%. Additionally, the average annual fee per Membership
has increased from $244 for all Memberships in force at December 31, 2000 to
$251 for all Memberships in force at December 31, 2001, a 3% increase, as a
result of a higher portion of active Memberships containing the additional
pre-trial hours benefit at an additional cost to the member.
Associate services revenue increased 20% from $30.4 million for 2000 to
$36.5 million during 2001 as a result of more new associates recruited and as a
result of Fast Start which resulted in the Company receiving training fees of
approximately $17.5 million during 2001 compared to $16.8 million during 2000.
The field-training program, titled Fast Start to Success ("Fast Start") is aimed
at increasing the level of new Membership sales per associate. Fast Start
typically requires a training fee of $184 per new associate, except for special
promotions the Company implements from time to time, and upon successful
completion of the program provides for the payment of certain training bonuses.
In order to be deemed successful for Fast Start purposes, the new associate must
write three new Memberships and recruit three new sales associates or personally
sell five Memberships within 60 days of becoming an associate. The $17.5 million
and $16.8 million for 2001 and 2000, respectively, in training fees was
collected from approximately 117,698 new sales associates who elected to
participate in Fast Start in 2001 compared to 91,432 during 2000. New associates
electing to participate in Fast Start increased to 96% of new associates during
2001 from 94% for 2000. Total new associates enrolled during 2001 were 122,192
compared to 97,617 for 2000, an increase of 25%. 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 (including training bonuses
paid), providing associate services and other direct marketing expenses.
Product sales declined 94% during 2001 to $60,000 from $1.0 million in 2000
primarily due to the concentration on Membership sales as opposed to the sale of
goods and services following the TPN acquisition. Product sales are expected to
cease in future periods as the Company no longer allows product sales.
Other income increased 11%, from $3.2 million to $3.6 million primarily due
to the increase in Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $303.7 million for 2001 from $246.4 million during 2000, an
increase of 23%.
Membership benefits totaled $87.4 million for 2001 compared to $69.5
million for 2000, and represented 33% of Membership fees for both years. This
Membership benefit ratio (Membership benefits as a percentage of Membership
fees) should remain near current levels as substantially all active Memberships
provide for a capitated benefit.
Commissions to associates increased 15% to $111.1 million for 2001 compared
to $96.6 million for 2000, and represented 42% and 46% of Membership fees for
such years. These amounts were reduced by $2.2 million and $1.8 million,
respectively, representing Membership lapse fees. These fees are determined by
applying the prime interest rate to the unearned advance commission balance
pertaining to lapsed Memberships. The Company realizes and recognizes this fee
only when the amount of the calculated fee is collected by withholding from cash
commissions due the associate, because the Company's ability to recover fees in
excess of current payments is primarily dependent on the associate selling new
Memberships which qualify for advance commission payments. These fees will no
longer be applicable after March 1, 2002. Commissions to associates are
primarily dependent on the number of new memberships sold during a period. New
memberships sold during 2001 totaled 728,295, a 9% increase from the 670,118
sold during 2000.
Associate services and direct marketing expenses increased to $29.9 million
for 2001 from $23.3 million for 2000 primarily as a result of Fast Start
training bonuses paid of approximately $9.0 million during 2001 compared to $8.9
million in 2000. Additional costs of supplies due to increased enrollment of new
associates, purchases by associates and higher staffing requirements for
associate related service departments also contributed to the increase. These
expenses also include the costs of providing associate services and marketing
costs other than commissions that are directly associated with new Membership
sales.
General and administrative expenses during 2001 and 2000 were $28.2 million
and $21.5 million, respectively, and represented 11% and 10% of Membership fees
for such years. Management expects gradual decreases in general and
administrative expenses when expressed as a percentage of Membership fees as a
result of certain economies of scale.
Product costs declined more than $642,000, or 95%, during 2001 to $33,000
from $675,000 for 2000 in conjunction with the 94% decline in product sales.
Product costs as a percentage of product sales were 55% for 2001 compared to 66%
during 2000. Product costs are expected to cease in future periods as the
Company no longer allows product sales.
Other expenses, which includes depreciation and amortization and premium
taxes reduced by interest income, increased 34% to $5.9 million for 2001 from
$4.4 million for 2000. Depreciation and amortization increased to $4.1 million
for 2001 from $2.8 million for 2000. Premium taxes increased from $1.7 million
for 2000 to $2.5 million for 2001. Interest income increased to $1.9 million for
2001 from $1.8 million for 2000. At December 31, 2001 the Company reported $38
million in cash and investments (after utilizing $27.9 million to purchase
approximately 1.5 million treasury shares of its common stock during 2001)
compared to $32 million at December 31, 2000.
The provision for income taxes increased during 2001 to $13.5 million
compared to $9.6 million for 2000, representing 32.9% and 31.4% of income from
continuing operations before income taxes for 2001 and 2000, respectively.
Dividends paid on outstanding preferred stock decreased from $4,000 for
2000 to zero during 2001 due to all shares of preferred stock being converted
into shares of common stock or redeemed by the Company during the second quarter
of 2000.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Income (loss) from discontinued operations, net of income tax, is $(504,000),
net of tax of $0 and $649,000 net of tax benefit of $387,000 for the years ended
December 31, 2001 and 2000, respectively.
Comparison of 2000 to 1999
The Company reported net income applicable to common shares of $20.5
million, or $.90 per diluted common share, for 2000. The net income per diluted
share was up 59% from net income applicable to common shares of $12.9 million,
or $.55 per diluted common share, for 1999. The increase in the net income
applicable to common shares for 2000 is primarily the result of increases in
Membership fees for 2000 as compared to 1999.
Membership fees totaled $211.8 million during 2000 compared to $153.9
million for 1999, an increase of 38%. Membership fees and their impact on total
revenues in any period are determined directly by the number of active
Memberships in force during any such period. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales increased
28% during 2000 to 670,118 from 525,352 during 1999. At December 31, 2000, there
were 1,064,805 active Memberships in force compared to 827,979 at December 31,
1999, an increase of 29%. Additionally, the average annual fee per Membership
has increased from $238 for all Memberships in force at December 31, 1999 to
$244 for all Memberships in force at December 31, 2000, a 3% increase, as a
result of a higher portion of active Memberships containing the additional
pre-trial hours benefit at an additional cost to the member together with
increased sales of the Business Owners' Legal Solutions plan.
Associate services revenue increased 33% from $22.8 million for 1999 to
$30.4 million during 2000 as a result of more new associates recruited and as a
result of Fast Start which resulted in the Company receiving training fees of
approximately $16.8 million during 2000 compared to $12.6 million during 1999.
The field-training program, titled Fast Start to Success ("Fast Start") is aimed
at increasing the level of new Membership sales per 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 three new sales associates or personally sell five
Memberships within 60 days of becoming an associate. The $16.8 million and $12.6
million for 2000 and 1999, respectively, in training fees was comprised of $184
from each of approximately 91,432 new sales associates who elected to
participate in Fast Start in 2000 compared to 68,535 that paid the $184 during
1999. New associates electing to participate in Fast Start increased to 94% of
new associates during 2000 from 74% for 1999. Total new associates enrolled
during 2000 were 97,617 compared to 92,644 for 1999, an increase of 5%. While
the number of new associates increased during 2000, the number of new
Memberships sold, at least partially as a result of the Fast Start program,
increased even more 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 (including training bonuses paid), providing
associate services and other direct marketing expenses.
Product sales declined 83% during 2000 to $1.0 million from $5.9 million in
1999 primarily due to the concentration on Membership sales as opposed to the
sale of goods and services following the TPN acquisition. Product sales are
expected to be immaterial in 2001 and future periods as the Company no longer
encourages product sales.
Other income decreased $600,000, or 15%, from $3.8 million to $3.2 million
primarily due to the change in accounting principle relating to the adoption of
SAB 101.
Primarily as a result of the increase in Membership fees, total revenues
increased to $246.4 million for 2000 from $186.4 million during 1999, an
increase of 32%.
Membership benefits totaled $69.5 million for 2000 compared to $51.1
million for 1999, and represented 32.8% and 33.2% of Membership fees for 2000
and 1999, respectively. This Membership benefit ratio (Membership benefits as a
percentage of Membership fees) should remain near 35% as substantially all
active Memberships provide for a capitated benefit.
Commissions to associates increased 30% to $96.6 million for 2000 compared
to $74.3 million for 1999, and represented 45.6% and 48.3% of Membership fees
for such years. Commissions to associates are primarily dependent on the number
of new memberships sold during a period. New memberships sold during 2000
totaled 670,118, a 28% increase from the 525,352 sold during 1999.
Associate services and direct marketing expenses increased to $23.3 million
for 2000 from $15.8 million for 1999 primarily as a result of Fast Start
training bonuses paid of approximately $8.9 million during 2000 compared to $7.5
million in 1999. Additional costs of supplies due to increased enrollment of new
associates, purchases by associates and higher staffing requirements for
associate related service departments also contributed to the increase. These
expenses also include the costs of providing associate services and marketing
costs other than commissions that are directly associated with new Membership
sales.
General and administrative expenses during 2000 and 1999 were $21.5 million
and $19.3 million, respectively, and represented 10.2% and 12.5% of Membership
fees for such years. Management expects further gradual decreases in general and
administrative expenses when expressed as a percentage of Membership fees as a
result of certain economies of scale.
Product costs declined more than $3.4 million, or 84%, during 2000 to
$675,000 from $4.2 million for 1999 in conjunction with the 83% decline in
product sales. Product costs as a percentage of product sales were 66% for 2000
compared to 71% during 1999. Product costs are expected to be immaterial in 2001
and future periods as the Company no longer encourages product sales.
Other expenses increased 36% from $3.2 million to $4.4 million for 2000
primarily due to $1.7 million litigation settlements during the 4th quarter of
2000 offset by an increase in interest income for 2000 of 21% to $2.9 million
from $2.4 million for 1999. At December 31, 2000 the Company reported $31.5
million in cash and investments (after utilizing more than $17.3 million to
repurchase approximately 520,000 shares of its common stock) compared to $22.8
million at December 31, 1999. Depreciation and amortization decreased from $3.1
million for 1999 to $2.8 million for 2000. This decrease was primarily due to
increased amortization of production costs of $425,000 during the 1999 period.
The provision for income taxes increased during 2000 to $9.6 million
compared to $6.5 million for 1999, representing 31.4% and 35.0% of income from
continuing operations before income taxes for 2000 and 1999, respectively.
Dividends paid on outstanding preferred stock decreased to $4,000 for 2000
from $9,700 during 1999. During the second quarter of 2000, all shares of
preferred stock were converted into shares of common stock or redeemed by the
Company.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Income from discontinued operations, net of income tax, are $649,000, net of tax
benefit of $387,000 and $826,000 net of tax expense of $444,000 for the years
ended December 31, 2000 and 1999, respectively.
Liquidity and Capital Resources
General
Consolidated net cash provided by operating activities of continuing
operations was $37.8 million, $23.2 million and $17.0 million for 2001, 2000 and
1999, respectively. Cash provided by operating activities increased $14.7
million during 2001 compared to 2000 primarily due to the $6.6 million increase
in net income, a $5.5 million decrease in the change in deferred member and
associate service costs, a $7.2 million decrease in the change in accounts
payable and accrued expenses offset by a $6.5 million decrease in the change in
deferred revenues.
Net cash (used in) provided by investing activities of continuing
operations was $(7.0) million, $(8.0) million and $12.1 million for 2001, 2000
and 1999, respectively. During 2001, 2000 and 1999 the Company received
dividends of $2.8 million, $5.0 million and $12.5 million, respectively from
UFL. Additionally, the Company received $1.2 million in proceeds from the sale
of UFL. In addition to capital expenditures of $8.3 million, $5.6 million and
$2.6 million during 2001, 2000 and 1999, respectively, the Company's purchases
of available-for-sale investments exceeded the maturities and sales of such
investments by $2.6 million and $7.4 million in 2001 and 2000, respectively, but
maturities and sales exceeded purchases by $2.1 million during 1999.
Net cash used in financing activities of continuing operations was $27.4
million, $13.7 million and $26.7 million for 2001, 2000 and 1999, respectively.
This $13.7 million change during 2001 was mainly comprised of the $10.9 million
increase in purchases of treasury stock.
The Company had consolidated working capital of $5.1 million at December
31, 2001 compared to working capital of $7.3 million at December 31, 2000. The
$2.2 million decrease in working capital during 2001 was primarily the result of
an increase in accounts payable and accrued expenses of $3.9 million and a
decrease in net assets of discontinued operations of $4.5 million partially
offset by an increase in cash and cash equivalents and available-for-sale
investments of $7.5 million.
The Company generally advances significant commissions to associates at the
time a Membership is sold. The Company expenses these advances ratably over the
first month of the related Membership. During 2001, the Company paid advance
commissions to associates of $110.2 million on new Membership sales compared to
$97.5 million for 2000. Since approximately 95% of Membership fees are collected
on a monthly basis, a significant cash flow deficit is created on a per
Membership basis at the time a Membership is sold. Since there are no further
commissions paid on a Membership during the advance period, the Company
typically derives significant positive cash flow from the Membership over its
remaining life. See Commissions to Associates above for additional information
on advance commissions.
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 4,500,000 shares during subsequent board meetings. At December 31,
2001, the Company had purchased 3.2 million shares under these authorizations
for a total consideration of $74.6 million, an average price of $23.48 per
share. Treasury stock purchases will be made at prices that are considered
attractive by management and at such times that management believes will not
unduly impact the Company's liquidity. No time limit has been set for completion
of the treasury stock purchase program.
The Company believes that it has significant ability to finance expected
future growth in Membership sales based on its existing amount of cash and cash
equivalents and unpledged investments at December 31, 2001 of $33.7 million. The
Company expects to maintain cash and cash equivalents and investment balances on
an on-going basis of approximately $25 million to $35 million in order to meet
expected working capital needs and regulatory capital requirements. Balances in
excess of this amount would be used for discretionary purposes such as treasury
stock purchases.
As more fully discussed in Item-2 - Description of Property, the Company is
constructing a new corporate office complex. Costs incurred through December 31,
2001 of approximately $1.7 million have been paid from existing resources and
cash flow. The Company continues to consider incurring indebtedness in order to
finance the remaining costs of its new corporate headquarters in order to allow
cash flow from operations to continue to be used to purchase treasury stock.
Since December 31, 2001, the Company has entered into a construction contract in
the amount of $2.9 million with the general contractor pertaining to site work
for the new office complex. The Company expects to enter into similar types of
construction contracts for various phases of construction during the remainder
of the construction period. Total remaining costs of construction are estimated
at approximately $28 million during the 18-month period beginning January 1,
2002.
On November 6, 2001, the Company entered into a $17.5 million line of
credit with Bank of Oklahoma, N.A. in order to fund additional treasury stock
purchases. The line of credit provides for immediate funding of up to $17.5
million with repayments originally scheduled to begin February 15, 2002 and end
November 15, 2002 with interest at the Libor rate plus 2% per annum or the prime
rate minus 1/2 percent per annum as selected by the Company. Since the Company
did not access this line of credit prior to February 15, 2002, the Company has
asked the bank to amend the terms of the loan to allow for advances subsequent
to February 15, 2002 without extending the repayment time frame. The bank has
indicated their willingness to make such amendment and submitted formal
amendment documentation to the Company, but those documents have not been
finalized. The loan is secured by the Company's rights to receive membership
fees on a portion of its memberships. The terms of this loan have various
covenants customary for similar transactions. The Company had not drawn on this
available credit line as of March 8, 2002.
Parent Company Funding and Dividends
Although the Company is the operating entity in many jurisdictions, the
Company's subsidiaries serve as operating companies in various states that
regulate Memberships as insurance or specialized legal expense products. The
most significant of these wholly owned subsidiaries are PPLCI and PPLSIF. The
ability of PPLCI and PPLSIF to provide funds to the Company is subject to a
number of restrictions under various insurance laws in the jurisdictions in
which PPLCI and PPLSIF conduct business, including limitations on the amount of
dividends and management fees that may be paid and requirements to maintain
specified levels of capital and reserves. In addition PPLCI will be required to
maintain its stockholders' equity at levels sufficient to satisfy various state
or provincial regulatory requirements, the most restrictive of which is
currently $3 million. Additional capital requirements of PPLCI or PPLSIF will be
funded by the Company in the form of capital contributions or surplus
debentures. At December 31, 2001, PPLSIF did not have funds available for
payment of substantial dividends without the prior approval of the insurance
commissioner. PPLCI had approximately $5.6 million in surplus funds available
for payment of an ordinary dividend.
Forward-Looking Statements
All statements in this report concerning Pre-Paid Legal Services, Inc. (the
"Company") other than purely historical information, including but not limited
to, statements relating to the Company's future plans and objectives,
discussions with the staff of the SEC, expected operating results, and the
assumptions on which such forward-looking statements are based, constitute
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are based
on the Company's historical operating trends and financial condition as of
December 31, 2001 and other information currently available to management. The
Company cautions that the Forward-Looking Statements are subject to all the
risks and uncertainties incident to its business, including but not limited to
risks described below. Moreover, the Company may make acquisitions or
dispositions of assets or businesses, enter into new marketing arrangements or
enter into financing transactions. None of these can be predicted with certainty
and, accordingly, are not taken into consideration in any of the Forward-Looking
Statements made herein. For all of the foregoing reasons, actual results may
vary materially from the Forward-Looking Statements. The Company assumes no
obligation to update the Forward-Looking Statements to reflect events or
circumstances occurring after the date of the statement.
Risk Factors
There are a number of risk factors which could affect our financial
condition or results of operations.
Our future results may be adversely affected if membership persistency or
renewal rates are lower than our historical experience.
The Company has over 20 years of actual historical experience to measure
the expected retention of new members. These retention rates could be adversely
affected by the quality of services delivered by provider law firms, the
existence of competitive products or services, the Company's ability to provide
administrative services to members or other factors. If the Company's membership
persistency or renewal rates are less than the Company has historically
experienced, the Company's cash flow, earnings and growth rates could be
adversely affected.
The Company may not be able to grow memberships and earnings at the same
rate as it has historically experienced.
The Company's year end active memberships have increased 17%, 29% and 37%
in the years ended December 31, 2001, 2000 and 1999, respectively. Net income
applicable to common stockholders for the same three years has increased 32%,
59% and 12%, respectively. The Company's ability to grow memberships and
earnings is substantially dependent upon its ability to expand or enhance the
productivity of its sales force, develop additional legal expense products,
develop alternative marketing methods or expand geographically. There is no
assurance that the Company will be able to achieve increases in membership and
earnings growth comparable to its historical growth rates.
The Company is dependent upon the continued active participation of its
principal executive officer.
The success of the Company depends substantially on the continued active
participation of its principal executive officer, Harland C. Stonecipher.
Although the Company's management includes other individuals with significant
experience in the business of the Company, the loss of the services of Mr.
Stonecipher could have a material adverse effect on the Company's financial
condition and results of operations.
There is litigation pending that may have a material adverse effect on the
Company if adversely determined.
There was a putative class action pending against the Company in the United
Stated District Court for the Western District of Oklahoma primarily alleging
violations of the federal securities laws in connection with the Company's prior
accounting policy with respect to commission advances. On March 5, 2002, the
Court granted the Company's motion to dismiss, with prejudice, and entered
judgment in favor of the defendants. It is possible that the Plaintiffs will
appeal this decision. There are also other lawsuits pending against the Company,
including putative class action by sales associates, which if adversely
determined could have a material adverse effect on the Company. See "Item 3.
Legal Proceedings".
The Company is in a regulated industry and regulations could have an
adverse effect on the Company's ability to conduct its business.
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, State Bar Associations and State Attorney General's
Offices, depending on individual state positions regarding regulatory
responsibility for prepaid legal expense plans. Regulation of the Company's
activities is inconsistent among the various states in which the Company does
business with some states regulating legal expense plans as insurance or
specialized legal expense products and others regulating such plans as services.
Such disparate regulation requires the Company to structure its memberships and
operations differently in certain states in accordance with the applicable laws
and regulations. The Company's multi-level marketing strategy is also subject to
U.S. federal, Canadian provincial and U.S. state regulation under laws relating
to consumer protection, pyramid sales, business opportunity, lotteries and
multi-level marketing. Changes in the regulatory environment for the Company's
business could increase the compliance costs the Company incurs in order to
conduct its business or limit the jurisdictions in which the Company is able to
conduct business.
The business in which the Company operates is competitive.
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect the Company's
ability to grow. In addition, the Company may face competition from a growing
number of Internet based legal sites with the potential to offer legal and
related services at competitive prices. Increased competition could have a
material adverse effect on the Company's financial condition and results of
operations. See "Description of Business - Competition".
The Company is dependent upon the success of its marketing force.
The Company's principal method of product distribution is through
multi-level marketing. The success of a multi-level marketing force is highly
dependent upon the Company's ability to offer a commission and organizational
structure and sales training and incentive program that enable sales associates
to recruit and develop other sales associates to create an organization. There
are a number of other products and services that use multi-level marketing as a
distribution method and the Company must compete with these organizations to
recruit, maintain and grow its multi-level marketing force. In order to do so,
the Company may be required to increase its marketing costs through increases in
commissions, sales incentives or other features, all of which could adversely
affect the Company's future earnings. In addition, the level of confidence of
the sales associates in the Company's ability to perform is an important factor
in maintaining and growing a multi-level marketing force. Adverse financial
developments concerning the Company, including negative publicity or common
stock price declines, could adversely affect the ability of the Company to
maintain the confidence of its sales force.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-----------------------------------------------------------------------
Included in Item 7 on page 23.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants
Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2001 and 2000
Consolidated Statements of Income - For the years ended December 31, 2001, 2000
and 1999
Consolidated Statements of Cash Flows - For the years ended December 31, 2001,
2000 and 1999
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements
(All schedules have been omitted since the required information is not
applicable or because the information is included in the consolidated
financial statements or the notes thereon.)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. and subsidiaries (the "Company") as of December 31, 2001 and
2000, and the related consolidated statements of income, cash flows and changes
in stockholders' equity for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 1, during 2000 the Company changed certain of its revenue
recognition policies as a result of the adoption of Staff Accounting Bulletin
No. 101 "Revenue Recognition in Financial Statements."
GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 8, 2002
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
---------- ----------
2001 2000
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 14,290 $ 10,866
Available-for-sale investments, at fair value........................................ 6,070 1,953
Membership income receivable......................................................... 5,472 4,563
Inventories.......................................................................... 922 1,542
Net assets of discontinued operations................................................ - 4,504
Deferred member and associate service costs.......................................... 14,228 11,606
Deferred income taxes................................................................ 3,413 4,361
---------- ----------
Total current assets............................................................. 44,395 39,395
Available-for-sale investments, at fair value.......................................... 13,386 14,412
Investments pledged.................................................................... 4,315 4,306
Property and equipment, net............................................................ 14,755 10,501
Deferred member and associate service costs............................................ 2,907 2,513
Other assets........................................................................... 5,962 6,639
---------- ----------
Total assets................................................................... $ 85,720 $ 77,766
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 7,664 $ 6,831
Deferred revenue and fees............................................................ 20,893 18,130
Current portion of capital lease obligation.......................................... - 223
Accounts payable and accrued expenses................................................ 10,765 6,865
---------- ----------
Total current liabilities.......................................................... 39,322 32,049
Deferred revenue and fees............................................................ 4,158 3,083
Deferred income taxes ............................................................... 16 867
---------- ----------
Total liabilities................................................................ 43,496 35,999
---------- ----------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 24,806 and
24,740 issued at December 31, 2001 and 2000, respectively.......................... 248 247
Capital in excess of par value....................................................... 66,223 64,958
Retained earnings.................................................................... 54,240 27,130
Accumulated other comprehensive income (loss)........................................ 186 (108)
Treasury stock, at cost; 3,989 and 2,480 shares held at
December 31, 2001 and 2000, respectively........................................... (78,673) (50,460)
---------- ----------
Total stockholders' equity....................................................... 42,224 41,767
---------- ----------
Total liabilities and stockholders' equity..................................... $ 85,720 $ 77,766
---------- ----------
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,
------------------------------------------
2001 2000 1999
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 263,514 $ 211,763 $ 153,918
Associate services................................................... 36,485 30,372 22,816
Product sales........................................................ 60 1,016 5,888
Other................................................................ 3,602 3,232 3,809
------------- ------------- -------------
303,661 246,383 186,431
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 87,429 69,513 51,089
Commissions.......................................................... 111,060 96,614 74,333
Associate services and direct marketing.............................. 29,879 23,251 15,815
General and administrative........................................... 28,243 21,524 19,280
Product costs........................................................ 33 675 4,174
Other, net........................................................... 5,884 4,403 3,226
------------- ------------- -------------
262,528 215,980 167,917
------------- ------------- -------------
Income from continuing operations before income taxes and cumulative
effect of change in accounting principle............................. 41,133 30,403 18,514
Provision for income taxes............................................. 13,519 9,550 6,480
------------- ------------- -------------
Income from continuing operations before cumulative effect of change in
accounting principle................................................. 27,614 20,853 12,034
Income (loss) from operations of discontinued UFL segment (net of
applicable income tax benefit (expense) of $0, $387 and ($444) for
years 2001, 2000 and 1999, respectively)............................. (504) 649 826
------------- ------------- -------------
Income before cumulative effect of change in accounting principle...... 27,110 21,502 12,860
Cumulative effect of adoption of SAB 101 (net of applicable income
tax benefit of $546)................................................. - (1,013) -
Net income............................................................. 27,110 20,489 12,860
Less dividends on preferred shares..................................... - 4 10
------------- ------------- -------------
Net income applicable to common stockholders........................... $ 27,110 $ 20,485 $ 12,850
------------- ------------- -------------
Basic earnings per common share from continuing operations before
cumulative effect of accounting change............................... $ 1.28 $ .93 $ .52
Basic earnings per common share from discontinued operations........... (.02) .03 .04
------------- ------------- -------------
Basic earnings per common share before cumulative effect of accounting
change............................................................... 1.26 .96 .56
------------- ------------- -------------
Cumulative effect of adoption of SAB 101............................... - (.05) -
Basic earnings per common share........................................ $ 1.26 $ .91 $ .56
------------- ------------- -------------
Diluted earnings per common share from continuing operations before
cumulative effect of accounting change............................... $ 1.28 $ .92 $ .51
Diluted earnings per common share from discontinued operations......... (.02) .03 .04
------------- ------------- -------------
Diluted earnings per common share before cumulative effect of
accounting change.................................................... 1.26 .95 .55
Cumulative effect of adoption of SAB 101............................... - (.05) -
------------- ------------- -------------
Diluted earnings per common share...................................... $ 1.26 $ .90 $ .55
------------- ------------- -------------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net Income........................................................... $ 21,502 $ 12,786
------------- -------------
Basic earnings per common share...................................... $ .96 $ .55
------------- -------------
Diluted earnings per common share.................................... $ .95 $ .55
------------- -------------
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,
-----------------------------------------
2001 2000 1999
------------ ------------ ------------
Cash flows from operating activities:
Net income................................................................$ 27,110 $ 20,489 $ 12,860
Cumulative change in accounting principle................................. - 1,013 -
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss (income) from UFL's discontinued operations........................ 504 (649) (826)
Provision (benefit) for deferred income taxes........................... (1,314) (550) 518
Depreciation and amortization........................................... 4,135 2,770 3,076
Tax benefit on exercise of stock options................................ 82 1,044 1,149
Compensation expense relating to contribution of stock to ESOP.......... 162 130 86
Increase in accrued Membership income................................... (909) (1,409) (782)
Decrease (increase) in inventories...................................... 620 (100) 1,146
Decrease in prepaid product commissions................................. - 125 1,259
Increase in deferred member and associate service costs................. (3,016) (8,521) (1,552)
Decrease (increase) in other assets..................................... 614 (1,059) (2,259)
Increase in accrued Membership benefits................................. 833 1,579 1,444
Increase (decrease) in deferred revenues................................ 3,838 10,370 (785)
Increase (decrease) in accounts payable and accrued expenses and other.. 5,142 (2,031) 1,697
------------ ------------ ------------
Net cash provided by operating activities of continuing operations.... 37,801 23,201 17,031
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sale of UFL............................................... 1,200 - -
Dividends received from UFL............................................. 2,800 5,000 12,500
Additions to property and equipment..................................... (8,326) (5,577) (2,577)
Purchases of investments - available for sale........................... (12,642) (8,501) (11,077)
Maturities and sales of investments - available for sale................ 10,005 1,113 13,224
------------ ------------ ------------
Net cash (used in) provided by investing activities
of continuing operations............................................ (6,963) (7,965) 12,070
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from sale of common stock...................................... 1,022 4,110 3,348
Decrease in capital lease obligations................................... (223) (330) (593)
Purchases of treasury stock............................................. (28,213) (17,323) (29,432)
Redemption of preferred stock........................................... - (167) -
Dividends paid on preferred stock....................................... - (4) (10)
------------ ------------ ------------
Net cash used in financing activities of continuing operations........ (27,414) (13,714) (26,687)
------------ ------------ ------------
Net increase in cash and cash equivalents................................. 3,424 1,522 2,414
Cash and cash equivalents at beginning of year............................ 10,866 9,344 6,930
------------ ------------ ------------
Cash and cash equivalents at end of year..................................$ 14,290 $ 10,866 $ 9,344
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Net cash used in discontinued operations................................$ (704) $ (143) $ (827)
Cash paid for interest..................................................$ 2 $ 10 $ 23
------------ ------------ ------------
Income taxes paid.......................................................$ 12,700 $ 9,102 $ 3,060
------------ ------------ ------------
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)
Special Preferred
$3 Preferred Stock Stock Common Stock
------------------ ----------------- ----------------
Shares Amount Shares Amount Shares Amount
------- -------- ------- -------- ------- --------
January 1, 1999 3 $ 3 18 $ 18 24,321 $ 243
---------------
Conversion of Preferred Stock into Common Stock.................. - - - - 2 -
Contributed to Company's ESOP plan............................... - - - - 3 -
Exercise of stock options and other.............................. - - - - 181 2
Income tax benefit related to exercise of stock options.......... - - - - - -
Net income....................................................... - - - - - -
Cash dividends on preferred shares............................... - - - - - -
Other comprehensive income (loss)................................ - - - - - -
Treasury shares purchased........................................ - - - - - -
------- -------- ------- -------- ------- --------
December 31, 1999 3 3 18 18 24,507 245
-----------------
Redemption or conversion of Preferred Stock...................... (3) (3) (18) (18) 30 -
Contributed to Company's ESOP plan............................... - - - - 6 -
Exercise of stock options and other.............................. - - - - 214 2
Income tax benefit related to exercise of stock options.......... - - - - (17) -
Net income....................................................... - - - - - -
Cash dividends on preferred shares............................... - - - - - -
Other comprehensive income (loss)................................ - - - - - -
Treasury shares purchased........................................ - - - - - -
------- -------- ------- -------- ------- --------
December 31, 2000 - - - - 24,507 247
-----------------
Contributed to Company's ESOP plan............................... - - - - 6 -
Exercise of stock options and other.............................. - - - - 60 1
Income tax benefit related to exercise of stock options.......... - - - - - -
Net income....................................................... - - - - - -
Other comprehensive income (loss)................................ - - - - - -
Treasury shares purchased........................................ - - - - - -
------- -------- ------- -------- ------- --------
December 31, 2001.................................................. - $ - - $ - 24,806 $ 248
------- -------- ------- -------- ------- --------
(1) Accumulated Other Comprehensive Income (Loss) Year Ended December 31,
-------------------------------
2001 2000 1999
--------- ---------- ----------
Net income........................................................... $ 27,110 $ 20,489 $ 12,860
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment............................ (7) (12) -
--------- ---------- ----------
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during period,......... 299 893 (580)
Less: reclassification adjustment for (gains) losses included
in net income.................................................. 2 (31) (354)
--------- ---------- ----------
301 862 (934)
--------- ---------- ----------
Other comprehensive income (loss), net of income taxes
of $110, $464 and $503 in 2001, 2000 and 1999, respectively........ 294 850 (934)
--------- ---------- ----------
Comprehensive income................................................. $ 27,404 $ 21,339 $ 11,926
--------- ---------- ----------
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)
Retained Accumulated
Capital in Earnings Other Treasury Stock
Excess of (Accumulated Comprehensive ------------------
Par Value Deficit) Income (Loss) Shares Amount Total
----------- ------------- --------------- ------------------ --------
January 1, 1999 $ 55,241 $ (6,205) $ (24) 797 $ (3,705) $ 45,571
---------------
Conversion of Preferred Stock into Common Stock 1 - - - - 1
Contributed to Company's ESOP plan............. 86 - - - - 86
Exercise of stock options and other............ 3,345 - - - - 3,347
Income tax benefit related to exercise of stock
options....................................... 1,149 - - - - 1,149
Net income..................................... - 12,860 - - - 12,860
Cash dividends on preferred shares............. - (10) - - - (10)
Other comprehensive income (loss).............. - - (934) - - (934)
Treasury shares purchased...................... - - - 1,163 (29,432) (29,432)
----------- ------------ ------------- ------- -------- ---------
December 31, 1999 59,822 6,645 (958) 1,960 (33,137) 32,638
-----------------
Redemption or conversion of Preferred stock.... (146) - - - - (167)
Contributed to Company's ESOP plan............. 130 - - - - 130
Exercise of stock options and other............ 4,108 - - - - 4,110
Income tax benefit related to exercise of stock
options....................................... 1,044 - - - - 1,044
Net income..................................... - 20,489 - - - 20,489
Cash dividends on preferred shares............. - (4) - - - (4)
Other comprehensive income (loss).............. - - 850 - - 850
Treasury shares purchased...................... - - - 520 (17,323) (17,323)
----------- ------------ ------------- ------- -------- ---------
December 31, 2000................................ 64,958 27,130 (108) 2,480 (50,460) 41,767
Contributed to Company's ESOP plan............. 162 - - - - 162
Exercise of stock options and other............ 1,021 - - - - 1,022
Income tax benefit related to exercise of stock
options....................................... 82 - - - - 82
Net income..................................... - 27,110 - - - 27,110
Other comprehensive income (loss).............. - - 294 - - 294
Treasury shares purchased...................... - - - 1,509 (28,213) (28,213)
----------- ------------ ------------- ------- -------- ---------
December 31, 2001................................$ 66,223 $ 54,240 $ 186 3,989 $ (78,673) $ 42,224
----------- ------------ ------------- ------- -------- ---------
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands
unless otherwise indicated)
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Pre-Paid Legal Services, Inc. (the "Company") develops and markets legal
service plans (referred to as "Memberships"). The Memberships sold by the
Company allow members to access legal services through a network of independent
law firms ("provider law firms") under contract with the Company. Provider law
firms are paid a fixed fee on a capitated basis to render services to plan
members residing within the state or province in which the provider law firm is
licensed to practice. Because the fixed fee payments by the Company to provider
law firms do not vary based on the type and amount of benefits utilized by the
member, this capitated arrangement provides significant advantages to the
Company in managing claims risk. At December 31, 2001, Memberships subject to
the provider law firm arrangement comprised approximately 99% of the Company's
active Memberships. The remaining Memberships, approximately 1%, were primarily
sold prior to 1987 and allow members to locate their own lawyer to provide legal
services available under the Membership with the member's lawyer being
reimbursed for services rendered based on usual, reasonable and customary fees.
Memberships are generally guaranteed renewable and Membership fees are
principally collected on a monthly basis, although approximately 5% of Members
have elected to pay their fees in advance on an annual or semi-annual basis. At
December 31, 2001, the Company had 1,242,908 Memberships in force with members
in all 50 states, the District of Columbia and the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. Approximately 90% of the
Memberships were in 29 states and the provinces of Ontario and British Columbia.
The Memberships are marketed by an independent sales force referred to as
"associates".
During the fourth quarter of 1998, the Company completed the acquisition of
TPN, Inc. d.b.a. The People's Network ("TPN") and Universal Fidelity Life
Insurance Company ("UFL"). Since its inception in late 1994, TPN had marketed
personal and home care products, personal development products and services
together with PRIMESTAR(R) satellite subscription television service to its
members through a network marketing sales force. UFL is an Oklahoma domiciled
life and accident and health insurer which was sold in 2001. (See Note 2)
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, as well as those of PPL Agency, Inc. (See
Note 9 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.
Foreign Currency Translation
The financial results of the Company's Canadian operations are measured in
its local currency and then translated into U.S. dollars. All balance sheet
accounts have been translated using the current rate of exchange at the balance
sheet date. Results of operations have been translated using the average rates
prevailing throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Commissions to Associates
Prior to March 1, 2002, the Company had a level Membership commission
schedule of approximately 27% of Membership fees. The Company, prior to March 1,
2002 advanced the equivalent of up to three years of commissions on new
Membership sales. In January 1997, the Company implemented a new policy whereby
associates do not receive advance commissions on the first three Memberships
submitted unless the associate successfully completes a Company training
program, produces three Memberships and recruits three associates within 60 days
from becoming an associate.
Effective March 1, 2002, and in order to offer additional incentives for
increased Membership retention rates, the Company returned to a differential
commission structure with rates of approximately 80% of first year Membership
premiums on new Memberships written and variable renewal commission rates
ranging from zero to 25% per annum based on the 12 month Membership retention
rate of the associate's sales organization.
The Company expenses advance commissions ratably over the first month of
the related Membership. As a result of this accounting policy, the Company's
commission expenses are recorded in the first month of a Membership and there is
no commission expense recognized for the same Membership during the remainder of
the advance period.
Prior to February 1999, TPN distributors received commissions from the sale
of personal and home care products, personal development products, communication
services and satellite subscription sales. These commissions were paid to the
distributor actually making the sale as well as other distributors in his
organization. Commissions on goods and services were not advanced and averaged
approximately 32% of the product sales price. These commissions were paid and
expensed at the time of sale and were subject to recovery only in the event of
returned goods or refunds.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash, certificates
of deposit, short-term investments, debt and equity securities, 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, 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.
Investments
The Company classifies its investments held as available for sale and
accounts for them at fair value with unrealized gains and losses, net of taxes,
excluded from earnings and reported as other comprehensive income. The Company
classifies available-for-sale securities as current if the Company expects to
sell the securities within one year, or if the Company intends to utilize the
securities for current operations. All other available-for-sale securities are
classified as non-current.
All investment securities are adjusted for amortization of premiums and
accretion of discounts. Amortization of premiums and accretion of discounts are
recorded to income over the contractual maturity or estimated life of the
individual investment on the level yield method. Gain or loss on sale of
investments is based upon the specific identification method. Income earned on
the Company's investments in certain state and political subdivision debt
instruments is not generally taxable for federal income tax purposes.
Inventories
Inventories include the cost of materials and packaging and are stated at
the lower of cost or market. Cost is determined using the first-in, first-out
("FIFO") method for the personal, home care and personal development inventory
and the average cost method for sales and promotional materials. Cost of jewelry
is determined using the retail-inventory method.
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.
Deferred Member and Associate Costs
Deferred costs represent the direct incremental expenses the Company incurs
in enrolling new members and new associates and that portion of payments made to
provider law firms and Associates related to deferred Membership revenue.
Deferred costs for enrolling new members include the cost of the Membership kit
and salary and benefit costs for employees who process Membership enrollments.
Deferred costs for enrolling new associates include bonuses paid to individuals
involved in recruiting the associate and salary and benefit costs of employees
who process associate enrollments. Such costs are deferred to the extent of the
lesser of actual costs incurred or the amount of the related fee charged for
such services. Deferred costs are amortized to expense over the same period as
the related deferred revenue.
Revenue Recognition
Membership fees are recognized in income ratably over the related service
period in accordance with Membership terms, which generally require the holder
of the Membership to remit fees on at least a monthly basis. Approximately 95%
of the Company's members remit their Membership fees on a monthly basis.
Membership fees received in advance for Membership periods beyond the balance
sheet date are included in Deferred revenue and fees.
Associate services revenue includes one-time non-refundable enrollment fees
of $65 from each new sales associate and typically fees of $184 paid by
associates participating in the Company's training program, except for special
promotions the Company implements from time to time. The fee for the training
program is recognized upon completion of the training. The enrollment fee is for
sales and promotional materials, bonuses paid to individuals who recruit and
sponsor the associates and enrollment services provided to the associate.
Revenue from and costs of the sales and promotional materials (approximately
$18) is recognized when the materials are delivered to the associates. The
remaining $47 of revenues and related direct incremental costs are deferred and
recognized over the estimated average active service period of associates which
at December 31, 2001 is estimated to be one year.
The Company charges a $10 enrollment fee to new members who are not part of
an employee group. This fee and related direct incremental costs are deferred
and amortized to income over the estimated life of the Membership which at
December 31, 2001 is 3.6 years.
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due
provider law firms on approximately 99% of the Memberships and claims reported
but not paid and actuarially estimated claims incurred but not reported on the
remaining non-provider Memberships which represent approximately 1%. The Company
calculates the benefit liability on the non-provider Memberships based on
completion factors that consider historical claims experience based on the dates
that claims are incurred, reported to the Company and subsequently paid.
Processing costs related to these claims are accrued based on an estimate of
expenses to process such claims.
Income Taxes
The Company accounts for income taxes using the asset and liability
approach that requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that are recognized in
different periods in the Company's financial statements and tax returns. In
estimating future tax consequences, the Company generally considers all future
events other than the enactment of changes in the tax law or rates.
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
The Company records deferred tax assets related to the recognition of future tax
benefits of temporary differences and net operating loss and tax credit
carryforwards. To the extent that realization of such benefits is not considered
more likely than not, the Company establishes a valuation allowance to reduce
such assets to the estimated realizable amount.
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 reviews long-lived assets to be held and used in operations
when events or changes in circumstances indicate that the assets might be
impaired. The carrying value of long-lived assets is considered impaired when
the identifiable undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair value of the
long-lived asset. Fair value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. Losses on
long-lived assets to be disposed of are determined in a similar manner, except
that fair values are reduced by disposal costs.
Stock-Based Compensation
Compensation expense is recorded with respect to stock option grants and
restricted stock awards to employees and board members 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. For employee and board member
stock options, the Company follows the disclosure requirements of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") in preparing its financial statement disclosures.
Stock options granted to associates and other non-employees are accounted
for at fair value in accordance with SFAS 123.
Segment Information
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosures about products and services, geographic areas
and major customers are presented in Note 15.
New Accounting Standards Issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," ("SFAS 133") was issued in June 1998. This Statement, as amended,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in the fair value of a derivative
(that is, gains and losses) depends on the intended use of the derivative and
the resulting designation. SFAS 133, as amended, applies to all entities and is
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
The Company adopted SFAS 133, as amended, on January 1, 2001 as required. The
Company did not hold any derivative instruments at January 1, 2001 and there was
no effect on the consolidated financial statements upon the adoption of SFAS
133.
In July 2001, the Financial Accounting Standards Board issued new
pronouncements: SFAS 141, "Business Combinations"; SFAS 142, "Goodwill and Other
Intangible Assets"; and SFAS 143, "Accounting for Asset Retirement Obligations."
SFAS 141, which requires the purchase method of accounting for all business
combinations, applies to all business combinations initiated after June 30, 2001
and to all business combinations accounted for by the purchase method that are
completed after June 30, 2001. SFAS 141 will not apply to the Company unless it
enters into a future business combination. SFAS 142 requires that goodwill as
well as certain other intangible assets be tested annually for impairment. In
addition, the Statement eliminates the current requirement to amortize goodwill
or intangible assets with indefinite lives, and is effective for fiscal years
beginning after December 15, 2001. SFAS 143 requires entities to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred and a corresponding increase in the carrying amount of the
related long-lived asset. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The Company does not expect SFAS 142 or143 to materially impact
its reported results.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", (SFAS 144") is effective for the Company for the fiscal year beginning
January 1, 2002, and addresses accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business." SFAS 144 retains the
fundamental provisions of SFAS No. 121 and expands the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. The Company
estimates that the new standard will not have a material impact on its financial
statements but is still in the process of evaluating the impact on its financial
statements.
Codification of Statutory Accounting Principles
In March 1998, the National Association of Insurance Commissioners adopted
the Codification of Statutory Accounting Principles (the "Codification"). The
Codification, which is intended to standardize regulatory accounting and
reporting to state insurance departments, was effective January 1, 2001.
However, statutory accounting principles will continue to be established by
individual state laws and permitted practices. The State of Oklahoma required
adoption of the Codification for the preparation of statutory financial
statements effective January 1, 2001. The Company's adoption of the Codification
increased the statutory capital and surplus of its regulated subsidiaries as of
January 1, 2001 by $798,000.
Accounting Change
SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," ("SAB 101") was issued December 1999. This Staff Bulletin
summarizes certain of the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101
was effective no later than the fourth fiscal quarter of fiscal years, beginning
after December 15, 1999. The Company implemented SAB 101 in the fourth quarter
of 2000, but effective January 1, 2000, and has deferred the non-refundable $10
Membership and $47 of the associate enrollment fees and the related direct
incremental costs associated with services provided members and associates in
return for such fees. These deferred revenues and related costs will be
amortized to income over the estimated life of the Membership or the estimated
average active service period of associates which at December 31, 2001 were 3.6
years and one year, respectively. The implementation of SAB 101 resulted in a
cumulative effect type adjustment of $1.0 million, net of tax, which decreased
net income for the year ended December 31, 2000.
Note 2 - Discontinued Operations
On December 31, 2001 the Company completed the sale of its wholly owned
subsidiary UFL. The Company received a $2.8 million dividend and $1.2 million
from the sale of 100% of UFL stock resulting in no gain or loss on the sale. Net
assets of $4.5 million have been segregated on the December 31, 2000
Consolidated Balance Sheet. Assets and liabilities of UFL's discontinued
operations were as follows:
December 31,
2000
-------------
Cash............................................... $ 704
Available-for-sale investments, current............ 495
Amount due from coinsurer.......................... 12,242
Available-for-sale investments, non-current........ 6,795
Investment pledged................................. 1,799
Property and equipment, net........................ 699
Goodwill, net...................................... 616
Other assets....................................... 2,082
------------
Total assets....................................... 25,432
------------
Accident and health reserves....................... 12,242
Life insurance reserves, current................... 976
Accounts payable and accrued expenses.............. 54
Life insurance reserves, non-current............... 7,656
------------
Total Liabilities.................................. 20,928
------------
Net assets of UFL's discontinued operations... $ 4,504
------------
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Cash flow impacts of discontinued operations have been segregated in the
Consolidated Statements of Cash Flows. Details of income from discontinued
operations, net of income tax, are as follows:
Year Ended December 31,
2001 2000 1999
-------- -------- --------
Revenues............................................................... $ 1,703 $ 2,590 $ 3,130
-------- -------- --------
Income (loss) from discontinued operations, net of tax benefit (expense)
of $0, $387 and ($444) for years 2001, 2000 and 1999, respectively... $ (504) $ 649 $ 826
-------- -------- --------
Note 3 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of the Company's investments at December 31, 2001 and 2000 follows:
December 31, 2001
--------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ----------- --------- --------- ----------
U.S. Government obligations........................ $ 7,773 $ 246 $ - $ 8,019
Corporate obligations.............................. 7,172 73 (104) 7,141
Equity securities.................................. 1,418 63 1,481
Obligations of state and political subdivisions.... 3,785 52 (14) 3,823
Certificates of deposit............................ 3,307 - - 3,307
---------- -------- -------- ----------
Total.............................................. $ 23,455 $ 434 $ (118) $ 23,771
---------- -------- -------- ----------
December 31, 2001
--------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ----------- --------- --------- ----------
U.S. Government obligations........................ $ 9,636 $ 116 $ (219) $ 9,533
Corporate obligations.............................. 3,842 10 (90) 3,762
Equity securities.................................. 417 12 - 429
Obligations of state and political subdivisions.... 3,095 26 (25) 3,096
Certificates of deposit............................ 3,851 - - 3,851
---------- -------- -------- ----------
Total.............................................. $ 20,841 $ 164 $ (334) $ 20,671
---------- -------- -------- ----------
The contractual maturities of the Company's available-for-sale investments
in debt securities and certificates of deposit at December 31, 2001 by maturity
date follows:
Amortized
Cost Fair Value
---------- ----------
One year or less................................... $ 3,540 $ 3,552
Two years through five years....................... 4,112 4,186
Six years through ten years........................ 4,492 4,568
More than ten years................................ 9,893 9,984
---------- ----------
Total.............................................. $ 22,037 $ 22,290
---------- ----------
The Company's investment securities are included in the accompanying
consolidated balance sheets at December 31, 2001 and 2000 as follows.
December 31,
------------------------
2001 2000
---------- ----------
Available-for-sale investments (current)........... $ 6,070 $ 1,953
Available-for-sale investments (non-current)....... 13,386 14,412
Investments pledged................................ 4,315 4,306
---------- ----------
Total.............................................. $ 23,771 $ 20,671
---------- ----------
The Company is required to pledge investments to various state
insurance departments as a condition to obtaining authority to do business in
certain states. The fair value of investments pledged to state regulatory
agencies is as follows:
December 31,
---------- ---------
2001 2000
---------- ----------
Certificates of deposit............................ $ 2,407 $ 2,451
Obligation of state and political subdivisions..... 138 132
U. S. Government obligations....................... 1,770 1,723
---------- ----------
Total.............................................. $ 4,315 $ 4,306
---------- ----------
Sales of investments during 2001, 2000 and 1999 were not significant.
Note 4 - Inventories
Inventories consist of the following:
December 31,
----------------------
2001 2000
-------- --------
Personal and home care, and personal development inventory...... $ - $ 198
Jewelry inventory............................................... 35 613
Sales and promotional materials................................. 887 1,160
Less: Inventory reserve......................................... - (429)
-------- --------
Total........................................................... $ 922 $ 1,542
-------- --------
The Company previously established an inventory reserve of $812 during 1999
and subsequently wrote-off inventory relating to such reserve in the amount of
$383 and $429 during 2000 and 2001, respectively.
Note 5 - Property and Equipment
Property and equipment is comprised of the following:
December 31,
Estimated -----------------------
Useful Life 2001 2000
------------ ---------- ----------
Equipment, furniture and fixtures.......... 3-10 years $ 12,910 $ 11,112
Computer software.......................... 3 years 6,478 4,224
Building and improvements.................. 20 years 4,617 2,898
Automotive................................. 3 years 171 138
Land....................................... 170 170
---------- ----------
24,346 18,542
Accumulated depreciation................................. (9,591) (8,041)
---------- ----------
Property and equipment, net.............................. $ 14,755 $ 10,501
---------- ----------
The net carrying value of capitalized leased assets was $0 and $560,000 at
December 31, 2001 and 2000, respectively.
Note 6 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
---------- ----------
2001 2000
---------- ----------
Accounts payable................................... $ 1,518 $ 2,154
Fast Start training bonuses payable................ 577 845
Incentive awards payable........................... 3,000 -
Current income tax liability....................... 1,087 760
Other.............................................. 4,583 3,106
---------- ----------
Total.............................................. $ 10,765 $ 6,865
---------- ----------
Note 7 - Income Taxes
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
--------- --------- ---------
2001 2000 1999
--------- --------- ---------
Current income taxes:
Federal.................................. $ 14,210 $ 9,463 $ 4,895
State.................................... 623 637 1,067
--------- --------- ---------
14,833 10,100 5,962
Deferred................................... (1,314) (550) 518
--------- --------- ---------
Total provision for income taxes......... $ 13,519 $ 9,550 $ 6,480
--------- --------- --------
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
-------------------------------
2001 2000 1999
------ ------ ------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Change in valuation allowance.............. (.8) (3.4) -
Tax exempt interest........................ (.1) (.2) -
State income taxes......................... 1.5 2.6 1.5
Other...................................... (2.7) (2.6) (1.5)
------ ------ ------
Effective income tax rate.................. 32.9% 31.4% 35.0%
------ ------ ------
Deferred tax liabilities and assets at December 31, 2001 and 2000 are
comprised of the following:
December 31,
------------------------
2001 2000
----------- ------------
Deferred tax liabilities:
Unrealized investment gains (net)............ $ 110 $ -
Deferred member and associate service costs.. 5,997 4,942
Depreciation................................. 655 683
----------- -----------
Total deferred tax liabilities............ 6,762 5,625
----------- -----------
Deferred tax assets:
Expenses not yet deducted for tax purposes... 746 1,636
Unrealized loss on investments............... - 58
Deferred revenue and fees.................... 8,768 7,425
Pre-merger net operating loss carryforward... 645 979
----------- -----------
Total deferred tax assets................. 10,159 10,098
Valuation allowance for deferred tax assets.. - (979)
----------- -----------
Total net deferred tax assets............. 10,159 9,119
----------- -----------
Net deferred tax asset....................... $ 3,397 $ 3,494
----------- -----------
The Company's deferred tax assets and liabilities are included in the
accompanying consolidated balance sheets at December 31, 2001 and 2000 as
follows.
December 31,
------------------------
2001 2000
---------- ----------
Deferred tax asset (current)....................... $ 3,413 $ 4,361
Deferred tax liability (non-current)............... (16) (867)
---------- ----------
Net deferred tax asset............................. $ 3,397 $ 3,494
---------- ----------
At December 31, 2001, the Company has net operating loss carryforwards
(NOLs) in the amount of $1.8 million that expire in 2015 through 2018
representing remaining NOLs of TPN generated prior to the merger date. At
December 31, 2000, the Company had established a valuation allowance for the TPN
NOLS. NOLs of $954,000 and general business credits of $261,000 were utilized in
the 2000 income tax return and accordingly, were also realized for financial
reporting purposes. NOLs of $954,000, $954,000 and $888,000 are expected to be
utilized in the income tax returns for 2001, 2002 and 2003, respectively, and
therefore the previously provided valuation allowance of $979,000 was reversed
in the fourth quarter of 2001. During 2000 and 1999, the valuation allowance was
reduced by $919,000 and $82,000, respectively, due to the utilization of
pre-merger NOLs and general business credit carryforwards.
The exercise of certain 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 are recorded in capital in excess of par value.
Note 8 - Stockholders' Equity
During 2000 and 1999, the Company's $3.00 Cumulative Convertible Preferred
Stock, consisting of 2,133 shares and 111 shares, respectively, were converted
into 5,609 shares of Common Stock and during 2000, 1,027 shares were redeemed
for a value of $26,000. Each share of $3.00 Cumulative Convertible Preferred
Stock was previously entitled to receive cumulative cash dividends at the annual
rate of $3 per share, payable quarterly, was convertible into 2.5 shares of
Common Stock and was redeemable at the option of the Company at $25 per share.
At December 31, 2000 all such shares had been converted or redeemed.
During 2000 and 1999, the Company's Special Preferred Stock, consisting of
7,032 shares and 391 shares, respectively, were converted into 42,661 shares of
Common Stock and during 2000, 10,585 shares were redeemed for a value of
$141,000. Each share of the Special Preferred Stock was previously entitled to a
non-cumulative annual dividend of $1.00 per share, was convertible into 3.5
shares of Common Stock and was redeemable at the option of the Company at $13.34
per share, plus all accumulated and unpaid dividends. At December 31, 2000 all
such shares had been converted or redeemed.
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 4,500,000 shares during subsequent board meetings. At December 31,
2001, the Company had purchased 3.2 million treasury shares under these
authorizations for a total consideration of $74.6 million, an average price of
$23.48 per share.
On November 6, 2001, the Company entered into a $17.5 million line of
credit with Bank of Oklahoma, N.A. in order to fund additional treasury stock
purchases. The line of credit provides for immediate funding of up to $17.5
million with repayments originally scheduled to begin February 15, 2002 and end
November 15, 2002 with interest at the Libor rate plus 2% per annum or the prime
rate minus 1/2 percent per annum as selected by the Company. Since the Company
did not access this line of credit prior to February 15, 2002, the Company has
asked the bank to amend the terms of the loan to allow for advances subsequent
to February 15, 2002 without extending the repayment time frame. The bank has
indicated their willingness to make such amendment and submitted formal
amendment documentation to the Company, but those documents have not been
finalized. The loan is secured by the Company's rights to receive membership
fees on a portion of its memberships. The terms of this loan have various
covenants customary for similar transactions. The Company had not drawn on this
available credit line as of March 8, 2002.
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 PPLSIF is
restricted under various insurance laws to available surplus funds derived from
realized net profits. At December 31, 2001, PPLSIF did not have funds available
for payment of significant dividends without the approval of the insurance
commissioner. PPLCI had approximately $5.6 million in surplus funds available
for payment of an ordinary dividend. The Company has a line of credit with Bank
of Oklahoma, N.A. as described above that prohibits payment of cash dividends on
its common stock.
Note 9 - Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of two subsets - net income (loss)
and other comprehensive income (loss). Included in other comprehensive income
(loss) for the Company are foreign currency translation adjustments and
unrealized gains (losses) on investments. These items are accumulated within the
Statements of Changes in Stockholders' Equity under the caption "Accumulated
Other Comprehensive Income (Loss)". As of December 31, accumulated other
comprehensive income (loss), as reflected in the Consolidated Statements of
Changes in Stockholders' Equity, was comprised of the following:
2001 2000
-------- --------
Foreign currency translation adjustments............................. $ (19) $ (12)
Unrealized gains (losses) on investments............................. 205 (96)
-------- --------
Accumulated Other Comprehensive income (loss)...................... $ 186 $ (108)
-------- --------
Note 10 - Related Party Transactions
The Company's Chairman, Harland C. Stonecipher, is the owner of PPL Agency,
Inc. ("Agency"). The Company has agreed to indemnify and hold harmless the
Chairman for any personal losses incurred as a result of his ownership of this
corporation and any income earned by Agency accrues to the Company. The Company
provides management and administrative services for Agency, for which it
receives specified management fees and expense reimbursements.
Agency's financial position and results of operations are included in the
Company's financial statements on a combined basis. Agency earned commissions,
net of amounts paid directly to its agents by the underwriter, during 2001, 2000
and 1999 of $121,000, $122,000 and $121,000, respectively, through its sales of
insurance products of an unaffiliated company. Agency had net income of $16,000
and $12,000 for the years ended December 31, 2001 and 2000, respectively and a
net loss for the year ended December 31, 1999 of $18,000 after incurring
commissions earned by the Chairman of $57,000, $50,000 and $49,000,
respectively, and annual management fees paid to the Company of $36,000 for
2001, 2000 and 1999.
Mr. Stonecipher and Shirley A. Stonecipher own Stonecipher Aviation LLC
("SA") and Mr. and Mrs. Stonecipher together with Wilburn L. Smith, President
and a director of the Company, own S & S Aviation LLC ("S&SA"). The Company has
agreed to reimburse SA and S&SA for certain expenses pertaining to trips made by
Company personnel for Company business purposes using aircraft owned by SA and
S&SA. Such reimbursement represents the pro rata portion of direct operating
expenses, such as fuel, maintenance, pilot fees and landing fees, incurred in
connection with such aircraft based on the relative number of flights taken for
Company business purposes versus the number of other flights during the
applicable period. No reimbursement is made for depreciation, capital
expenditures or improvements relating to such aircraft. During 2001, 2000 and
1999, the Company paid $214,000, $264,000 and $276,000, respectively, to SA as
reimbursement for such transportation expenses. S&SA was organized during 2000,
and the Company paid $355,000 and $372,000 to S&SA during 2001 and 2000,
respectively, as reimbursement for such transportation expenses.
The Company indemnified Mr. Stonecipher for litigation expenses and
settlement costs in connection with a lawsuit filed by Frank Jaques, a former
director of the Company, in 1999 against Mr. Stonecipher in the District Court
of Pontotoc County, Oklahoma. Mr. Jaques claimed damages relating to an
agreement between Mr. Jaques and Mr. Stonecipher relating to a stock
subscription agreement with the Company that Mr. Stonecipher entered into in
order to obtain the approval of the Oklahoma Securities Department for the
Company's original intrastate public offering in 1977. The stock subscription
agreement was executed by Mr. Stonecipher for the benefit of the Company in his
capacity as the Chairman and founder. The Board of Directors determined that the
requirements for indemnification under the Company's Bylaws had been satisfied
and that Mr. Stonecipher was entitled to such indemnification. In 2000, the
Company reimbursed Mr. Stonecipher $130,000 for litigation expenses, and in
2001, the Company reimbursed him for $1,000 in litigation expenses and $275,000
for settlement of the case which was accrued as of December 31, 2000.
Wilburn L. Smith, President and a director of the Company, has loans from
the Company made in December 1992, December 1996 and October 1998. The largest
aggregate balance of the loans during the year ended December 31, 2001 was
$526,000. The outstanding balance of the loans as of December 31, 2001 was
$511,000. The 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 Mr. Smith's
commissions from the Company. Mr. Smith also owns corporations or partnerships
not affiliated with the Company but engaged in the marketing of the Company's
legal service memberships and which earn commissions from sales of memberships.
These entities earned commissions, net of amounts passed through as commissions
to their sales agents, during 2001, 2000 and 1999 of $18,000, $13,000 and
$14,000, respectively.
Randy Harp, Chief Operating Officer and a director of the Company, has
loans from the Company made in December 2000. The largest aggregate balance of
these loans during the year ended December 31, 2001 was $441,000. The
outstanding balance of these loans as of December 31, 2001 was $441,000. These
loans bear annual interest at the rate of 3% in excess of the prime rate,
adjusted on January 1 of each year.
John W. Hail, a director of the Company, served as Executive Vice
President, Director and Agency Director of the Company from July 1986 through
May 1988 and also served as Chairman of the Board of Directors of TVC Marketing,
Inc., which was the exclusive marketing agent of the Company from April 1984
through September 1985. Pursuant to agreements between Mr. Hail and the Company
entered into during the period in which Mr. Hail was an executive officer of the
Company, Mr. Hail receives override commissions from renewals of certain
memberships initially sold by the Company during such period. During 2001, 2000
and 1999, such override commissions on renewals totaled $92,000, $90,000 and
$91,000, respectively. Mr. Hail also owns interests ranging from 12% to 100% in
corporations not currently affiliated with the Company, including TVC Marketing,
Inc., but which were engaged in the marketing of the Company's legal service
memberships and which earn renewal commissions from memberships previously sold.
These entities earned renewal commissions, net of amounts passed through as
commissions to their sales agents, during 2001, 2000 and 1999 of $294,000,
$313,000 and $301,000, respectively.
David A. Savula, a director of the Company, is actively engaged as an
independent contractor in the marketing of the Company's legal service
memberships. During 2001, 2000 and 1999, Mr. Savula received from the Company
$1.1 million, $936,000 and $815,000 respectively, pursuant to a previous
agreement with the Company providing for the payment to Mr. Savula of override
commissions and other fees with respect to commissions earned by, and new sales
associate sponsorships within, the Company's multilevel marketing sales force,
as well as amounts received pursuant to his individual associate agreement.
The Company also has notes receivable from certain marketing consultants
who provide significant marketing-related services to the Company. Such notes
aggregated approximately $2.7 million and $2.6 million at December 31, 2001 and
2000, respectively, and bear interest at the rate of 10%.
Note 11 - Leases
At December 31, 2001, the Company was committed under noncancelable
operating and capital leases, principally for buildings and equipment. Aggregate
rental expense under all operating leases was $142,000, $50,000 and $113,000 in
2001, 2000 and 1999, respectively. At December 31, 2001, the Company had no
minimum rentals for capital leases.
Note 12 - Commitments and Contingencies
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered judgment in favor of the defendants.
The deadline for plaintiffs to file notice of their intent to appeal, if any, is
thirty days from the date on which the judgment is entered.
In January 2001, the Company received inquiries from the Division of
Enforcement of the SEC requesting information relating primarily to the
Company's accounting policies for commission advance receivables from sales
associates. The Company has had no further contact from the Division of
Enforcement. The Division of Enforcement's inquiries were informal and did not
constitute a formal investigation or proceeding. The Company is unable to
determine the ultimate outcome of this inquiry, including whether the Division
of Enforcement will continue the inquiry subsequent to the Company's decision to
restate its financial statements. As of March 8, 2002, the Company has had no
further contact from the Division of Enforcement.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On August 14, 2001, Mr. Strykowski filed an amended
complaint, which added Deloitte & Touche, the Company's previous outside
auditors, as defendants. The complaints allege that the defendant directors
caused the Company to violate generally accepted accounting principles and
federal securities laws by improperly capitalizing commission expenses, caused
the Company to allegedly pay increased salaries and bonuses based upon financial
performance which was allegedly improperly inflated, and caused the Company to
expend significant dollars in connection with the defense of its accounting
policy, including cost incurred in connection with the defense of the securities
class actions described above, and in connection with the repurchase of its own
shares on the open market at allegedly artificially inflated prices. The
derivative actions have been consolidated and are in the preliminary pleading
stage. The Company believes that these derivative actions are related to the
putative securities class actions described above and may be intended to
circumvent the restrictions on those actions imposed by the Private Securities
Litigation Reform Act of 1995. On February 15, 2002, the defendants moved to
stay the derivative action pending a decision on the motion to dismiss the
related securities class actions. On March 8, 2002, the Pre-Paid defendants
withdrew that motion as moot in light of the March 5, 2002 order dismissing the
putative securities class actions. On March 1, 2002, plaintiffs filed a
consolidated amended derivative complaint making claims and allegations similar
to those contained in the original derivative complaints. While the outcome of
these cases is uncertain, based on the information currently available to the
Company, it appears that the complaints should be dismissed because the
plaintiffs failed to make or excuse the requisite demand that the Company pursue
the claims of alleged misconduct as well as for failure to state a claim.
In the second quarter of 2001 and through January 30, 2002, multiple
lawsuits were filed against the Company, certain sales associates and other
unnamed defendants in Alabama state courts by current or former members seeking
unspecified actual and punitive damages for alleged breach of contract and fraud
in connection with the sale of memberships. As of March 8, 2002, the Company was
aware of 21 separate lawsuits involving approximately 114 plaintiffs that have
been filed in multiple counties in Alabama, and additional suits of a similar
nature have been threatened to be filed in Alabama and elsewhere by one or more
of the counsel involved in these suits in Alabama. These cases make allegations
similar to allegations made in cases previously filed against the Company in
Alabama state courts by multiple plaintiffs which were previously settled for a
payment of $1.5 million to settle claims by 97 separate claimants. In January
2002, one of the law firms representing individual plaintiffs filed a putative
class action on behalf of all Alabama residents purchasing memberships seeking
damages and injunctive relief based on alleged failures to provide coverage
under the memberships. Based on the Company's preliminary investigation of the
new cases, the facts involved are in many respects significantly different from
the facts involved in the case the company previously settled. These cases are
all in various stages of litigation, and the ultimate outcome of any particular
case is not determinable.
On June 29, 2001, an action was filed in the District Court of Canadian
County, Oklahoma by Gina Cotwitz against the Company. This action is a putative
class action on behalf of all sales associates of the Company and alleges
violations of the Oklahoma Consumer Protection Act, the Oklahoma Uniform
Consumer Credit Code and breach of contract in connection with certain of the
Company's practices relating to advancing commissions to sales associates. The
Company has filed an answer denying the plaintiff's claims and raising
affirmative defenses and intends to vigorously defend this case. The case is in
the preliminary stages and the ultimate outcome is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is putative class action filed on behalf of all
sales associates of the Company and alleges that the marketing plan offered by
the Company constitutes a security under the Securities Act of 1933 and seeks
remedies for failure to register the marketing plan as a security and for
violations of the anti-fraud provisions of the Securities Act of 1933 and the
Securities Exchange Act of 1934 in connection with representations alleged to
have been made in connection with the marketing plan. The Complaint also alleges
violations of the Oklahoma Securities Act, the Oklahoma Business Opportunities
Sales Act, breach of contract, breach of duty of good faith and fair dealing and
unjust enrichment and violation of the Oklahoma Consumer Protection Act and
negligent supervision. The Company intends to vigorously defend this case. The
case is in the preliminary stages and the ultimate outcome is not determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in these proceedings. While the ultimate outcome of these proceedings
is not determinable, the Company does not currently anticipate that these
contingencies will result in any material adverse effect to its financial
condition or results of operation.
The Company is constructing a new corporate office complex with an
estimated completion date of June 2003 at an estimated cost of approximately $30
million. Costs incurred through December 31, 2001 of approximately $1.7 million
have been paid from existing resources and cash flow. The Company continues to
consider incurring indebtedness in order to finance the remaining costs of its
new corporate headquarters in order to allow cash flow from operations to
continue to be used to purchase treasury stock. Since December 31, 2001, the
Company has entered into a construction contract in the amount of $2.9 million
with the general contractor pertaining to site work for the new office complex.
The Company expects to enter into similar types of construction contracts for
various phases of construction during the remainder of the construction period.
Total remaining costs of construction are estimated at approximately $28 million
during the 18-month period beginning January 1, 2002.
Note 13 - Stock Options and Purchase Plan
The Company has a stock option plan (the "Plan") under which the Board of
Directors (the "Board") or its Stock Option Committee (the "Committee") may
grant options to purchase shares of the Company's common stock. The Plan permits
the granting of options to directors, officers and employees of the Company to
purchase the Company's common stock at not less than the fair value at the time
the options are granted. The Plan provides for option grants to acquire up to
2,000,000 shares and permits the granting of incentive stock options as defined
under Section 422 of the Internal Revenue Code at an exercise price for each
option equal to the market price of the Company's common stock on the date of
the grant and a maximum term of 10 years. Options not qualifying as incentive
stock options under the Plan have a maximum term of 15 years. The Board or
Committee determines vesting of options granted under the Plan. No options may
be granted under the Plan after December 12, 2005.
The Plan provides for automatic grants of options to non-employee directors
of the Company. Under the Plan, each incumbent non-employee director and any new
non-employee director receives options to purchase 10,000 shares of common stock
on March 1 of each year. The options granted each year are immediately
exercisable as to 2,500 shares and vest in additional increments of 2,500 shares
on the following June 1st, September 1st, and December 1st in the year of grant,
subject to continued service by the non-employee director during such periods.
Options granted to non-employee directors under the Plan have an exercise price
equal to the closing price of the common stock on the date of grant.
A summary of the status of the Company's total stock option activity as of
December 31, 2001, 2000 and 1999 for the years ended on those dates is presented
below:
2001 2000 1999
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- ---------- --------- ---------- ---------
Outstanding at beginning of year..... 1,199,086 $ 29.06 1,083,019 $ 26.38 1,306,700 $ 24.85
Granted.............................. 443,288 17.64 355,892 32.06 720,000 29.45
Exercised............................ (43,175) 20.77 (226,937) 21.09 (183,349) 18.46
Terminated........................... (262,563) 32.51 (12,888) 28.17 (760,332) 28.56
---------- --------- ---------- --------- ---------- ---------
Outstanding at end of year........... 1,336,636 $ 25.09 1,199,086 $ 29.06 1,083,019 $ 26.38
---------- --------- ---------- --------- ---------- ---------
Options exercisable at year end...... 1,199,644 $ 25.56 1,117,086 $ 28.96 1,030,519 $ 26.31
---------- --------- ---------- --------- ---------- ---------
The following table summarizes information about stock options
outstanding at December 31, 2001:
Range of Exercise Prices Weighted Average
------------------------- Remaining Weighted Average
Number Outstanding Contractual Life Exercise Price
------------------ ---------------- -----------------
$14.25 - $19.20 575,540 3.28 $ 16.61
$20.50 - $29.63 256,553 2.45 26.27
$30.00 - $42.13 504,543 2.23 34.16
------------------ ---------------- -----------------
1,336,636 2.73 $ 25.09
------------------ ---------------- -----------------
The following table summarizes information about stock options exercisable
at December 31, 2001:
Range of Exercise Prices Weighted Average
------------------------- Remaining Weighted Average
Number Outstanding Contractual Life Exercise Price
------------------ ---------------- -----------------
$14.25 - $19.20 469,540 2.53 $ 16.32
$20.50 - $29.63 250,553 2.44 26.20
$30.00 - $42.13 479,551 2.17 34.26
------------------ ---------------- -----------------
1,199,644 2.37 $ 25.56
------------------ ---------------- -----------------
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 continues to follow the provisions of
Accounting Principles Board Opinion No. 25 and related interpretations for its
employee compensation arrangements, and discloses 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 2001, 2000 and 1999 would have been
reduced to the pro forma amounts indicated below:
2001 2000 1999
---------- ---------- ----------
Net income applicable to common stockholders:
As reported................................ $ 27,110 $ 20,485 $ 12,850
Pro forma.................................. 24,639 16,468 9,793
Basic earnings per common share:
As reported................................ $ 1.26 $ .91 $ .56
Pro forma.................................. 1.15 .73 .42
Diluted earnings per common share:
As reported................................ $ 1.26 $ .90 $ .55
Pro forma.................................. 1.15 .73 .42
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 4.09% for 2001, 5.15% for 2000 and 6.09% for 1999; expected
life of 3-5 years; and expected volatility for the years ending December 31,
2001, 2000 and 1999 were 63.1%, 63.4% and 64.1%, respectively. Using these
assumptions, the weighted average fair values at date of grant for options
granted during 2001, 2000 and 1999 were $8.58, $17.36 and $6.53, respectively.
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
2001, 2000 and 1999 of $162,000, $130,000 and $86,000, based on annual
contributions of Company stock of 6,100 shares, 5,500 shares and 2,800 shares,
respectively.
Note 14 - Earnings Per Share
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 and the Special Preferred stock are
considered to be dilutive common stock equivalents for all periods through the
conversion/redemption date and the number of shares issuable on conversion of
the $3.00 Cumulative Convertible Preferred stock and the Special Preferred Stock
were added to the weighted average number of common shares. At December 31, 2000
all such shares had been converted or redeemed. The weighted average number of
common shares is also increased by the number of shares issuable on the exercise
of options less the number of common shares assumed to have been purchased with
the proceeds from the exercise of the options pursuant to the treasury stock
method; those purchases are assumed to have been made at the average price of
the common stock during the respective period.
Year Ended December 31,
-------------------------------
Basic Earnings Per Share: 2001 2000 1999
--------- --------- ---------
Earnings:
Income from continuing operations before cumulative effect of change in
accounting principle........................................................ $ 27,110 $ 20,853 $ 12,034
Less dividends on preferred shares............................................ - 4 10
--------- ---------- ---------
Income from continuing operations before cumulative effect of change in
accounting principle applicable to common stockholders...................... $ 27,110 $ 20,849 $ 12,024
--------- ---------- ---------
Shares:
Weighted average shares outstanding........................................... 21,504 22,504 23,099
--------- ---------- ---------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations before cumulative effect of change in
accounting principle available to common stockholders after assumed
conversions................................................................. $ 27,110 $ 20,853 $ 12,034
--------- ---------- ---------
Shares:
Weighted average shares outstanding........................................... 21,504 22,504 23,099
Assumed conversion of preferred stock......................................... - 35 70
Assumed exercise of options................................................... 40 140 205
--------- ---------- ---------
Weighted average number of shares, as adjusted................................ 21,544 22,679 23,374
--------- ---------- ---------
Note 15 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations for
the years ended December 31, 2001 and 2000.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2001 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---- ----------- ----------- ----------- -----------
Revenues........................................... $ 70,325 $ 76,808 $ 76,215 $ 80,313
Income from continuing operations.................. 7,518 4,823 7,520 7,753
Income (loss) from discontinued operations, net of 158 (102) (562) 2
tax
Net income......................................... 7,676 4,721 6,958 7,755
Basic income per common share (1):
Income from continuing operations................ $ .34 $ .22 $ .35 $ .36
Income (loss) from discontinued operations....... .01 - (.03) -
Net Income....................................... .35 .22 .32 .36
Diluted income per common share (1):
Income from continuing operations................ $ .34 $ .22 $ .35 $ .36
Income (loss) from discontinued operations....... .01 - (.03) -
Net Income....................................... .35 .22 .32 .36
2000
----
Revenues........................................... $ 55,865 $ 59,555 $ 65,686 $ 65,277
Income from continuing operations before cumulative
effect of accounting change...................... 5,681 3,190 6,786 5,196
Income (loss) from discontinued operations, net of 143 229 227 50
tax..............................................
Net income......................................... 4,811 3,419 7,013 5,246
Basic income per common share (1):
Income from continuing operations before
cumulative effect of accounting change......... $ .25 $ .13 $ .31 $ .24
Income (loss) from discontinued operations....... .01 .01 .01 -
Net Income....................................... .22 .14 .32 .24
Diluted income per common share (1):
Income from continuing operations before
cumulative effect of accounting change......... $ .25 $ .14 $ .30 $ .23
Income (loss) from discontinued operations....... .01 .01 .01 -
Net Income....................................... .21 .15 .31 .23
(1) The sum of EPS for the four quarters may differ from the annual EPS due to
rounding and the required method of computing weighted average number of
shares in the respective periods.
Note 16 - Segment Information
The Company previously reported UFL as a segment. On December 31, 2001 the
Company completed the sale of UFL and as a result has made the disclosures
required by discontinued operations accounting, see Note 2 to Consolidated
Financial Statements.
Substantially all of the Company's business is currently conducted in the
United States. Revenues from the Company's Canadian operations for 2001 and 2000
were $4.4 million and $4.9 million, respectively. The Company has no significant
long-lived assets located in Canada.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
------------------------
Not applicable.
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, 2002.
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 35
of this report.
(2) Exhibits: For a list of the documents filed as exhibits to this
report, see the Exhibit Index following the signatures to this
report.
(b) Reports on Form 8-K: None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: March 15, 2002 By: /s/ Randy Harp
--------------------------------
Randy Harp
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
---- -------- ----
/s/ Harland C. Stonecipher Chairman of the Board of Directors March 15, 2002
----------------------------------------------------
Harland C. Stonecipher (Principal Executive Officer)
/s/ Wilburn L. Smith President and Director March 15, 2002
----------------------------------------------------
Wilburn L. Smith
/s/ Kathleen S. Pinson Vice President, Controller March 15, 2002
---------------------------------------------------- and
Kathleen S. Pinson Director
/s/ Randy Harp Chief Operating Officer March 15, 2002
---------------------------------------------------- and
Randy Harp Director
(Principal Financial Officer)
/s/ Steve Williamson Chief Financial Officer March 15, 2002
---------------------------------------------------- and
Steve Williamson (Principal Accounting Officer)
/s/ Peter K. Grunebaum Director March 15, 2002
----------------------------------------------------
Peter K. Grunebaum
/s/Shirley A. Stonecipher Director March 15, 2002
----------------------------------------------------
Shirley A. Stonecipher
/s/ John W. Hail Director March 15, 2002
----------------------------------------------------
John W. Hail
/s/ David A. Savula Director March 15, 2002
----------------------------------------------------
David A. Savula
/s/ Martin H. Belsky Director March 15, 2002
----------------------------------------------------
Martin H. Belsky
/s/ John Addison Director March 15, 2002
----------------------------------------------------
John Addison
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 Amendment No. 1 to Stock Option Plan, as amended effective May 2000
(Incorporated by reference to Exhibit 10.6 of the Company's Annual Report
on Form 10-K for the year ended December 31, 2000)
*10.7 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 (Incorporated by reference to Exhibit 10.8 of
the Company's Form 10-K filed for the year ending December 31, 1997)
*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 Agreement and Plan of Reorganization dated as of September 23, 1998
between the Company and TPN, Inc. (Incorporated by reference to Exhibit
2.1 of the Company's Current Report on Form 8-K dated October 2, 1998)
10.12 Stock Purchase Agreement dated as of October 5, 1998 between the Company
and Pioneer Financial Services, Inc.(Incorporated by reference to Exhibit
2.1 of the Company's Current Report on Form 8-K dated December 30, 1998)
*10.13 Demand Note of Wilburn L. Smith dated October 8, 1998 in favor of the
Company (Incorporated by reference to Exhibit 10.13 of the Company's Form
10-K filed for the year ended December 31, 1998)
*10.14 Stock option agreement with David A. Savula dated February 6, 1998
(Incorporated by reference to Exhibit 10.14 of the Company's Form 10-K
filed for the year ended December 31, 1998)
*10.15 Stock option agreement with David A. Savula dated July 2, 1998
(Incorporated by reference to Exhibit 10.15 of the Company's Form 10-K
filed for the year ended December 31, 1998)
*10.16 Stock option agreement with David A. Savula dated July 2, 1998
(Incorporated by reference to Exhibit 10.16 of the Company's Form 10-K
filed for the year ended December 31, 1998)
10.17 Demand Note of Randy Harp dated December 22, 2000 in favor of the Company
(Incorporated by reference to Exhibit 10.17 of the Company's Annual
Report on Form 10-K for the year ended December 31, 2000)
10.18 Loan agreement dated November 6, 2001 between Bank of Oklahoma, N.A. and
the Company (Incorporated by reference to Exhibit 10.18 of the Company's
Annual Report on Form 10-K for the year ended December 31, 2000)
10.19 Security agreement dated November 6, 2001 between Bank of Oklahoma, N.A.
and the Company (Incorporated by reference to Exhibit 10.19 of the
Company's Annual Report on Form 10-K for the year ended December 31,
2000)
21.1 List of Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP
--------------------
* Constitutes a management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report.
EXHIBIT 21.1
PRE-PAID LEGAL SERVICES, INC.
Subsidiaries of Registrant
State or Percentage of
Province Ownership by
Name of Subsidiary Incorporation Registrant
------------------ ------------- --------------
Pre-Paid Legal Casualty, Inc. Oklahoma 100%
American Legal Services, Inc. Oklahoma 100%
Pre-Paid Legal Services, Inc. of Florida Oklahoma 100%
C & A Investments, Inc. Oklahoma 100%
Pre-Paid Legal Administrators, Inc. Oklahoma 100%
Justice 900, Inc. Oklahoma 100%
Legal Service Plans of Virginia, Inc. Virginia 100%
Ada Travel Service, Inc. Oklahoma 100%
Pre-Paid Canadian Holdings, L.L.C. Oklahoma 100%
National Pre-Paid Legal Services of Mississippi, Inc. Georgia 100% owned by
Pre-Paid Legal
Services, Inc. of
Florida
Pre-Paid Legal Services of Tennessee, Inc. Tennessee 100% owned by
Pre-Paid Legal
Casualty, Inc.
PPL Legal Care of Canada Corporation Nova Scotia, 100% owned by
Canada Pre-Paid Canadian
Holdings, L.L.C.
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated March 8, 2002, accompanying the consolidated
financial statements included in the Annual Report of Pre-Paid Legal Services,
Inc. on Form 10-K for the year ended December 31, 2001. We hereby consent to the
incorporation by reference of said report in the Registration Statements of
Pre-Paid Legal Services, Inc. on Forms S-8 (File No. 33-82144, effective July
28, 1994, File No. 33-62663, effective September 14, 1995, File No. 333-53183,
effective May 20, 1998 and File No. 333-38386, effective June 1, 2000).
GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 8, 2002