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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(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, 2005
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Pre-Paid Way
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark if registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes [ ] No |X|
Indicate by check mark if registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes [ ] No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer [ ] Accelerated filer |X| Non-accelerated file [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No |X|
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. As of June 30, 2005 -$456,454,000
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 17, 2006 there
were 15,480,767 shares of Common Stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of our definitive proxy statement for its 2006 annual meeting of
shareholders are incorporated into Part III of this Form 10-K by reference.
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PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the Year Ended December 31, 2005
TABLE OF CONTENTS
PART I
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ITEM 1. BUSINESS
General
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Identity Theft Shield Provider
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
Availability of Information
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
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, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
Equity Compensation Plans
Issuer Purchases of Equity Securities
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Overview of our Financial Model
Measures of Member Retention
Results of Operations
Comparison of 2005 to 2004
Comparison of 2004 to 2003
Liquidity and Capital Resources
Forward Looking Statements
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III (Information required by Part III is incorporated by
-------- reference from our definitive proxy statement for its 2006
annual meeting of shareholders.)
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
SIGNATURES
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2005
PART I
ITEM 1. BUSINESS.
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General
We were one of the first companies in the United States organized solely to
design, underwrite and market legal expense plans. Our predecessor commenced
business in 1972 and began offering legal expense reimbursement services as a
"motor service club" under Oklahoma law. In 1976, we were formed and acquired
our predecessor in a stock exchange. We began offering Memberships independent
of the motor service club product by adding a legal consultation and advice
service, and in 1979 we implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. Our 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
$20. Additionally, in approximately 40 states, the Legal Shield rider can be
added to the standard plan for only $1 per month and provides members with
24-hour access to a toll-free number for attorney assistance if the member is
arrested or detained. Also, during the third quarter of 2003, we began offering
our Identity Theft Shield ("IDT") to new and existing members at $9.95 per month
if added to a legal service Membership ("add-on IDT") or it may be purchased
separately for $12.95 per month ("stand-alone IDT"). The identity theft related
benefits include a credit report and related instructional guide, a credit score
and related instructional guide, credit report monitoring with daily online and
monthly offline notification of any changes in credit information and
comprehensive identity theft restoration services.
Legal plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province and IDT plan
benefits are provided by Kroll Background America, Inc., a subsidiary of Kroll
Inc. ("Kroll"). Members have direct, toll-free access to Kroll or their provider
law firm rather than having to call for a referral. At December 31, 2005, we had
1,542,789 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 provinces.
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. The National Resource Center for
Consumers of Legal Services ("NRC") previously provided market information for
different types of legal service plans and estimates of number of users.
However, the NRC is no longer in existence and we are unaware of any current
comparable information sources. In the last NRC report in 2002, the NRC
estimated there were 164 million Americans without any type of legal service
plan. The NRC estimated that 122 million Americans were entitled to service
through at least one legal service plan in 2002 although more than half are
"free" plans that generally provide limited benefits on an automatic enrollment
without any direct cost to the individual. The 122 million Americans compares to
4 million in 1981, 58 million in 1990 and 115 million in 2000. We believe 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.
"Public Perceptions of Lawyers: Consumer Research Findings, April 2002"
prepared on behalf of the American Bar Association concluded that nearly seven
in ten households had some occasion during the past year that might have led
them to hire a lawyer. This report further suggested that "for the consumer,
legal services are among the most difficult services to buy. The prospect of
doing so is rife with uncertainty and potential risk." And further concluded
that "the challenge (and opportunity) for the legal profession is to make
lawyers more accessible and less threatening to consumers who might need them."
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 and 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. There are also employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit. Finally,
there are individual enrollment plans, other employment based plans, including
voluntary payroll deduction plans, and miscellaneous plans. These plans
typically have more comprehensive benefits, higher utilization, involve higher
costs to participants, and are offered on an individual enrollment or voluntary
basis. This is the market segment in which we compete.
According to the latest estimates of the census bureaus of the United
States and Canada, the two geographic areas in which we operate, the number of
households in the combined area exceeds 127 million. Since we have always
disclosed our 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, we believe that our
market share should be viewed as a percentage of households. Historically, our
primary market focus has been the "middle" eighty percent of such households
rather than the upper and lower ten percent segments based on our 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, we currently have an approximate 1.5% share of the
estimated market based on our existing 1.5 million active Memberships and, over
the last 30 years, an additional 5% of households have previously purchased, but
no longer own, Memberships. We routinely remarket to previous members and
reinstated approximately 79,000, 72,000 and 66,000 Memberships during 2005, 2004
and 2003, respectively.
Description of Memberships
The Memberships we sell generally allow members to access legal services
through a network of independent law firms ("provider law firms") under contract
with us. 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 us 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 us in managing claims risk. At December 31, 2005, Memberships
subject to the capitated provider law firm arrangement comprised approximately
99% of our 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 our referral attorney network described below is utilized.
Family Legal Plan
The Family Legal Plan we currently market in most jurisdictions 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 92% of our Membership fees in 2005 and 2004. In addition to the Family
Legal Plan, we market other specialized legal services products specifically
related to employment in certain professions described below.
In 12 states, certain of our plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and we have bilingual staff for customer service, attorney resources
and marketing service functions. We will continue to evaluate making our 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, we
have 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 $25.00
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.
Motor Vehicle Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. There were approximately 571,000 subscribers of
this benefit at December 31, 2005 compared to 545,000 at December 31, 2004.
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 for All Other Services. Provider law firms have
agreed to provide to members any legal services beyond those stipulated in the
Membership at a fee discounted 25% from the provider law firm's customary and
usual hourly rate. This "customary and usual hourly rate" is a fixed single
hourly rate for each provider firm that is generally an average of the firm's
various hourly rates for its attorneys which typically vary based on experience
and expertise.
Legal Shield Benefit
In approximately 41 states and four Canadian provinces, 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. The Legal Shield benefit was introduced in 1999. There were
approximately 1,015,000 Legal Shield subscribers at December 31, 2005 compared
to approximately 932,000 at December 31, 2004.
Identity Theft Shield Benefit
During the third quarter of 2003, we announced a joint marketing agreement
with Kroll Background America Inc., a subsidiary of Kroll Inc., that allows our
independent sales associates to market Kroll's identity theft benefits in 49
states and four Canadian provinces. By adding the new Identity Theft Shield to
their existing family Membership, members have toll free access to the identity
theft specialists at Kroll. This benefit can be added to a legal service
Membership for $9.95 per month or purchased separately for $12.95 per month. The
identity theft related benefits include a credit report and related
instructional guide, a credit score and related instructional guide, credit
report monitoring with daily online and monthly offline notification of any
changes in credit information and comprehensive identity theft restoration
services. There were approximately 513,000 and 311,000 subscribers at December
31, 2005 and 2004, respectively, comprised of 461,000 and 284,000 subscribers at
$9.95 per month and 52,000 and 27,000 subscribers at $12.95 per month.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. We 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 2005 were approximately $5.6 million in U.S.
dollars compared to $4.4 million collected in 2004 and $4.2 million collected in
2003.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, we also offer 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, we will continue to evaluate and develop other such plans
as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $69 to $150 ($175 in Canada)
depending on the number of employees and provides business oriented legal
service benefits for any for-profit business with 99 or fewer employees. This
plan is available in 42 states and three Canadian provinces and represented
approximately 3.4%, 4.3% and 3.7% of our Membership fees during 2005, 2004 and
2003, 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. We have 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, 2005, 2004
and 2003, the Law Officers Legal Plan accounted for approximately 1.6%, 1.4% and
..9%, respectively, of our Membership fees.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage by a provider law firm for persons who
drive a commercial vehicle. This legal service plan is currently offered in 45
states. In certain states, the Commercial Driver Legal Plan is underwritten by
the Road America Motor Club, an unrelated motor service club. During the years
ended December 31, 2005, 2004 and 2003, this plan accounted for approximately
..9%, 1.2% and .9%, respectively, of Membership fees. The Plan underwritten by
the Road America Motor Club is available at the monthly rate of $35.95 or at a
group rate of $32.95. Plans underwritten by us 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 37 states and one Canadian province and represented approximately
1.8%, 1.4% and 1.6% of our Membership fees during 2005, 2004 and 2003,
respectively.
Comprehensive Group Legal Services Plan
In late 1999 we introduced the Comprehensive Group plan, designed for the
large group employee benefit market. This plan, available in 35 states, 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 we have experienced decreased sales of this plan during the
last year (4,444 Memberships, 4,482 Memberships and 8,795 Memberships during
2005, 2004 and 2003, respectively), we still believe this plan improves our
competitive position in the large group market. We continue to emphasize group
marketing to employee groups of less than 50 rather than larger groups where
there is more competition, price negotiation and typically a longer sales cycle.
Other than additional benefits such as the Legal Shield and Identity Theft
Shield benefits described above, the basic structure and design of the
Membership benefits has not significantly changed over the last several years.
The consistency in plan design and delivery provides us consistent, accurate
data about plan utilization which enables us to manage our benefit costs through
the capitated payment structure to provider firms. We frequently evaluate and
consider other plan benefits that may include other services complimentary to
the basic legal service plan.
Provider Law Firms
Our Memberships generally allow members to access legal services through a
network of independent provider law firms under contract with us generally
referred to as "provider law firms." Provider law firms are paid a fixed fee on
a per capita basis to render services to plan members residing within the state
or province as provided by the contract. Because the fixed fee payments by us 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 us in managing our cost of benefits. Pursuant to these
provider law firm arrangements and due to the volume of revenue directed to
these firms, we have the ability to more effectively monitor the customer
service aspects of the legal services provided, the financial leverage to help
ensure a customer friendly emphasis by the provider law firms and we have has
access to larger, more diversified law firms. Through our members, we are
typically the largest client base of our 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, our investigation 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 our 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.
Approximately 87% of provider law firms, representing 98% of our legal
service members, are connected to us via high-speed digital links to our
management information systems, thereby providing real-time monitoring
capability. This online connection offers the provider law firm access to
specially designed software developed by us for administration of legal services
by the firm. These systems provide statistical reports of each law firm's
activity and performance and allow virtually all of the members served by
provider law firms to be monitored on a near real-time basis. The few provider
law firms that are not online with us typically have a small Membership base and
must provide various weekly reports to us 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, we regularly
conduct extensive random surveys of members who have used the legal services of
a provider law firm. We survey members in each state every 60 days, compile the
results of such surveys and provide the provider law firms with copies of each
survey and the overall summary of the results. If a member indicates on a survey
the service did not meet their expectation, the member is contacted as soon as
possible to resolve the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to our online monitoring, member complaints, member survey
evaluations, telephone reports and other information developed in connection
with member service monitoring. If a problem is detected, we recommend immediate
remedial actions 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 us, such deficiencies may result in the
termination of the provider law firm. We are in constant communication with our
provider law firms and meet with them frequently for additional training, to
encourage increased communications with us and to share suggestions relating to
the timely and effective delivery of services to our members. We have recently
empanelled a provider committee consisting of four specific provider law firm
members to meet with us on a quarterly basis in order to improve the flow of
communications between our provider law firms and our management.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless we waive 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. We provide customer service training to the
provider law firms and their support staff through on-site training that allows
us 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 us 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 us from
interference with the lawyer-client relationship, (e) provide for periodic
review of services provided, (f) provide for protection of our proprietary
information and (g) require the firm to indemnify us against liabilities
resulting from legal services rendered by the firm. We are 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, we enroll 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 our approval.
Provider law firms receive a fixed monthly payment for each member who are
residents in the service area and are responsible for providing the Membership
benefits without additional remuneration. If a provider law firm delivers legal
services to an open panel member, the law firm is reimbursed for services
rendered according to the open panel Membership. As of December 31, 2005,
provider law firms averaged approximately 54 employees each and on average are
evenly split between support staff and lawyers.
We have 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 us so that in the event of a termination,
the members' calls can be rerouted very quickly. Nonetheless, we believe that
our relations with provider law firms are generally very good. At the end of
2005, we had provider law firms representing 48 states and four provinces
compared to 46 states and four provinces at the end of 2004 and 2003. During the
last three calendar years, our relationships with a total of eight provider law
firms were terminated by us or the provider law firm. As of December 31, 2005,
28 provider law firms have been under contract with us for more than eight years
with the average tenure of all provider law firms being approximately 7.7 years.
We have an extensive database of referral lawyers who have provided
services to our 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 our list of referral lawyers.
Identity Theft Shield Benefits Provider
Kroll is one of the world's leading risk consulting companies. For more
than 30 years, Kroll has helped companies, government agencies and individuals
reduce their exposure to risk and capitalize on business opportunities. Kroll is
an operating unit of Marsh & McLennan Companies, Inc., the global professional
services firm. With offices in more than 60 cities in the U.S. and abroad, Kroll
can operate and restructure businesses; scrutinize accounting practices and
financial documents; gather and filter electronic evidence for attorneys;
recover lost or damaged data from computers and servers; conduct in-depth
investigations; screen domestic and foreign-born job candidates; protect
individuals, and enhance security systems and procedures. Kroll's clients
include many of the world's largest and most prestigious corporations, law
firms, academic institutions, non-profit organizations, sovereign governments
and high net-worth individuals, entertainers and celebrities. Kroll's seasoned
professionals were handpicked and recruited from leading management consulting
companies, top law firms, international auditing companies, multinational
corporations, special operations forces, law enforcement and intelligence
agencies. Kroll also maintains a network of highly trained specialists in cities
throughout the world who can respond to global needs 24 hours a day, seven days
a week. Over the last three years, Kroll has developed a unique solution for
victims of identity theft and this service is now available to our members
through the Identity Theft Shield benefit. Similar to the provider law firms,
Kroll is paid a fixed fee on a monthly per capita basis to render services to
IDT members.
Marketing
Multi-Level Marketing
We market 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. 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, 9 others at December 31, 2005 compared to 13
others at December 31, 2004 and 2003) who are in the line of associates who
directly or indirectly recruited the selling associate. We provide training
materials, organize area-training meetings and designate personnel at the home
office specially trained to answer questions and inquiries from associates. We
offer various communication avenues to our sales associates to keep such
associates informed of any changes in the marketing of our Memberships. The
primary communication vehicles we utilize to keep our sales associates informed
include extensive use of conference calls and e-mail, an interactive voice-mail
service, The Connection monthly magazine, an interactive voice response system,
a monthly DVD (digital video disc) program and our 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. Our 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 80% of
our Memberships in force at December 31, 2005, compared to 75% at December 31,
2004 and 2003. Although other means of payment are available, approximately 74%
of fees on Memberships purchased by individuals or families are paid on a
monthly basis by means of automatic bank draft or credit card.
Group marketing
Our marketing efforts towards employee groups, principally on a payroll
deduction payment basis, are designed to permit our sales associates to reach
more potential members with each sales presentation and strive to capitalize on,
among other things, what we perceive to be a growing interest among employers in
the value of providing legal and identity theft service plans to their
employees. Memberships sold through employee groups constituted approximately
20% of total Memberships in force at December 31, 2005, compared to 25% at
December 31, 2004 and 2003. Adverse publicity from certain news publications
about us is responsible, to some extent, for the decline in group Memberships on
a percentage basis. We believe such adverse publicity makes opening new employee
groups more difficult and negatively impacts the retention rates of existing
employee group Memberships. The majority of employee group Memberships are sold
to school systems, governmental entities and businesses. We emphasize group
marketing to employee groups of less than 50 rather than larger groups where
there is more competition, price negotiation and typically a longer sales cycle.
No group accounted for more than 1% of our consolidated revenues from
Memberships during 2005, 2004 or 2003. Substantially all group Memberships are
paid on a monthly basis. We are active in legislative lobbying efforts to
enhance our ability to market to public employee groups and to encourage
Congress to reenact legislation to permit legal service plans to qualify for
pre-tax payments under tax qualified employee cafeteria plans.
General
Sales associates are generally engaged as independent contractors and are
provided with training materials and are given the opportunity to participate in
our training programs. Sales associates are required to complete a specified
training program prior to marketing our Memberships to employee groups. All
advertising and solicitation materials used by sales associates must be approved
by us prior to use. At December 31, 2005, we had 468,365 "vested" sales
associates compared to 343,696 and 329,600 "vested" sales associates at December
31, 2004 and 2003, 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 2005, we had 103,248 sales associates who
personally sold at least one Membership, of which 61,238 (59%) made first time
sales. During 2004 and 2003 we had 79,716 and 84,207 sales associates producing
at least one Membership sale, respectively, of which 41,699 (52%) and 45,920
(55%), respectively, made first time sales. During 2005, we had 11,221 sales
associates who personally sold more than ten Memberships compared to 9,895 and
10,685 in 2004 and 2003, respectively. A substantial number of our sales
associates market our Memberships on a part-time basis only. For the year 2005,
new sales associates enrolled increased 125% to 242,223 with an average
enrollment fee of $57 from the 107,552 enrolled in 2004 with an average
enrollment fee of $142.
We derive revenues from our multi-level marketing sales force, principally
from a one-time enrollment fee from each new sales associate for which we
provide initial marketing supplies and enrollment services to the associate.
Average enrollment fees paid by new sales associates were $57, $142 and $136 for
2005, 2004 and 2003, respectively. We have a combination classroom and field
training program, titled Fast Start to Success ("Fast Start"), aimed at
increasing the level of new Membership sales per associate. Associates
successfully complete the program by writing three new Memberships and
recruiting a new sales associate or by personally selling five new Memberships
within 45 days of the associate's start date. Associates in states that require
the associate to become licensed have 45 days from the issue date on their
license to complete the same requirements. Amounts collected from sales
associates are intended primarily to offset our costs incurred in recruiting and
training and providing materials to sales associates and are not intended to
generate profits from such activities. Other revenues from sales associates
represent the sale of marketing supplies and promotional materials and include
fees related to our eService program for associates. The eService program
provides subscribers Internet based back office support such as reports, on-line
documents, tools, a personal e-mail account and multiple personalized web sites
with "flash" movie presentations.
We continually review our compensation plan for the multi-level marketing
force to assure that the various financial incentives in the plan encourage our
desired goals. We offer various incentive programs from time to time and
frequently adjust the program to maintain appropriate incentives and to improve
Membership production and retention.
We hold our International Convention once a year, typically in the spring,
and a Leadership Summit, typically in the fall, and routinely host more than
10,000 of our sales associates at these events. These events are intended to
provide additional training, corporate updates, new announcements, motivation
and associate recognition. Additionally, we offer the Player's Club incentive
program providing additional incentives to our associates as a reward for
consistent, quality business. Associates can earn the right to attend an annual
incentive trip by meeting monthly qualification requirements for the entire
calendar year and maintaining certain personal retention rates for the
Memberships sold during the calendar year. Associates can also earn the right to
receive additional monthly bonuses by meeting the monthly qualification
requirements for twelve consecutive months and maintaining certain personal
retention rates for the Memberships sold during that twelve month period.
Regional Vice Presidents
We have 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 us. New products and initiatives will continue to be channeled
through the RVPs and Area Coordinators. At December 31, 2005, we had 106 RVPs in
place.
Pre-Paid Legal Benefits Association
The PPL Benefits Association ("PPLBA") was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this Association is open to sales associates that reach a certain
level within our marketing programs who also maintain an active personal legal
services Membership. The PPLBA is a separate association not owned or controlled
by us and is governed by an 8 member Board of Directors, including four officer
positions. None of the officers or directors of the PPLBA serve in any such
capacity with us. The PPLBA employs a Director of Associate Benefits paid by the
Association. Affinity programs available to members of the PPLBA include credit
cards, long-distance, wireless services, safety trip plan, mortgage and real
estate assistance and a travel club. As determined by its Board of Directors,
some of the revenue generated by the PPLBA through commissions from vendors of
the benefits and affinity programs or contributed to the Association by us may
be used to make open-market purchases of our stock for use in stock bonus awards
to Association members based on criteria established from time to time by the
Board of Directors of the PPLBA. Since inception and through December 31, 2005,
approximately 39,000 shares were purchased by the PPLBA for awards to its
members. In 2002, the PPLBA offered cash in lieu of stock awards and
approximately 21,000 shares purchased by the Association were sold to us on
January 2, 2003 at the stock's closing price to fund the awards. The PPLBA
awarded approximately 3,300, 5,000 and 10,000 shares of stock to Association
members representing the 2005, 2004 and 2003 stock bonus awards, respectively.
Cooperative Marketing
We have in the past, and may in the future, develop marketing strategies
pursuant to which we seek 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 our 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 our product to the
marketing partner's existing range of products and services, while we are able
to gain broader Membership distribution and access to established customer
bases.
We have 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 23,000 new Membership
sales during 2005 compared to 19,000 and 15,000, respectively for 2004 and 2003.
We have had limited success with cooperative marketing arrangements in the
past and are unable to predict with certainty what success we will achieve, if
any, under our existing or future cooperative marketing arrangements.
Operations
Our 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, human resources, internal audit and managing and monitoring the
provider law firm relationships.
We utilize 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. Our dominant concerns in the architecture of
private networks and web systems include security, scalability, capacity to
accommodate peak traffic and business continuity in the event of a disaster. We
believe our management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
required. We believe this excess capacity will enable us to experience a
significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
We have built a strong Internet presence to strengthen the services
provided to both members and associates. Our 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.
Our operations also include departments specifically responsible for
marketing support and regulatory and licensing compliance. We have an internal
production staff that is responsible for the development of new audio and video
sales materials.
Quality Control
In addition to our quality control efforts for provider law firms described
above, we also closely monitor the performance of our home office personnel,
especially those who have telephone contact with members or sales associates. We
record home office employee telephone calls with our members and sales
associates to assure that our policies are being followed and to gather data
about recurring problems that may be avoided through modifications in policies.
We also use such recorded calls for training and recognition purposes.
Competition
We compete in a variety of market segments in the legal service plan
industry, including, among others, individual enrollment plans, employee benefit
plans and certain specialty segments. Our principal competitors are Hyatt Legal
Plans (a MetLife company), ARAG(R) North America, National Legal Plan and Legal
Services Plan of America (a GE Financial company, formerly the Signature Group).
Most of these concentrate their marketing to larger employer groups and offer
open panel plans.
If a greater number of companies seek to enter the legal service plan
market, we will experience increased competition in the marketing of our
Memberships. However, we believe our competitive position is enhanced by our
actuarial database, our existing network of provider attorney law firms and our
ability to tailor products to suit various types of distribution channels or
target markets. We believe that no other competitor has the ability to monitor
the customer service aspect of the delivery of legal services to the same extent
we do. Finally, we have intentionally concentrated our group marketing to small
employer groups. Serious competition is most likely from companies with
significant financial resources and advanced marketing techniques.
Regulation
We are 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. We are 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, 2005, we or one of our subsidiaries were marketing new
Memberships in 37 states or provinces that require no special licensing. Our
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"),
Pre-Paid Legal Services, Inc. of Florida ("PPLSIF") and Legal Service Plans of
Virginia, Inc. ("LSPV"). Of our total Memberships in force as of December 31,
2005, 26% were written in jurisdictions that subject us or one of our
subsidiaries to insurance or specialized legal expense plan regulation. We are
actively working with regulators in the various states in which our subsidiaries
are regulated as insurance to explore other regulatory alternatives to eliminate
some of the agent licensing or financial and marketing regulation that is
prevalent in the insurance industry.
We 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 we currently market 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, we commence
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,
we or one of our subsidiaries would be required to qualify as an insurance
company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate PPLCI'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. Our 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 our operations or financial condition in any
material way. We believe that all of our 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.
We are 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
us or any other subsidiary must be at arms-length with consideration for the
adequacy of PPLCI's surplus, and may require prior approval of the Oklahoma
Insurance Commissioner. Payment of any extraordinary dividend by PPLCI to us
requires approval of the Oklahoma Insurance Commissioner. 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 the
greater of 10% of such accumulated available surplus or the previous years' net
profits. During 2005, PPLCI declared and paid a $4.1 million dividend to us. No
dividends were declared or paid by PPLCI during 2004 or 2003. At January 1,
2006, PPLCI had approximately $6.1 million available for payment of an ordinary
dividend. Any change in our control, defined as acquisition by any method of
more than 10% of our outstanding voting stock, including rights to acquire such
stock by conversion of preferred stock, exercise of warrants or otherwise,
requires approval of the Oklahoma Insurance Commissioner. Holding company laws
in some states in which PPLCI operates provide for comparable registration and
regulation of us.
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 us 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 us. At January 1, 2006, neither PPLSIF nor LSPV had funds available
for payment of substantial dividends without the prior approval of the insurance
commissioner. LSPV declared and paid us a $3.7 million dividend during 2005.
As the legal plan industry continues to mature, additional legislation may
be enacted that would affect us and our subsidiaries. We cannot predict with any
accuracy if such legislation would be adopted or its ultimate effect on
operations, but expect to continue to work closely with regulatory authorities
to minimize any undesirable impact and, as noted above, to reduce regulatory
cost and burden where possible.
Our 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. Our agreements
with provider law firms comply with both the Model Rules and the ABA Code. We
rely 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. We and our subsidiaries comply with
filing requirements of state bar associations or other applicable regulatory
authorities.
We are also required to comply with state, provincial and federal laws
governing our multi-level marketing approach. These laws generally relate to
unfair or deceptive trade practices, lotteries, business opportunities and
securities. We have experienced no material problems with marketing compliance.
In jurisdictions that require associates to be licensed, we receive all
applications for licenses from the associates and forward them to the
appropriate regulatory authority. We maintain records of all associates
licensed, including effective and expiration dates of licenses and all states in
which an associate is licensed. We do not accept new Membership sale
applications from any unlicensed associate in such jurisdictions.
Employees
At December 31, 2005, we employed 815 individuals on a full-time basis,
exclusive of independent agents and sales associates who are not employees, and
excluding RVPs described above. None of our employees are represented by a
union. We consider our employee relations to be good.
Foreign Operations
We 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 $6.0 million in U.S. dollars during 2005
compared to $4.7 million and $4.5 million in 2004 and 2003, respectively. In
addition, we incur expenses in Canada in relation to these revenues. Due to the
relative stability of the United States and Canadian foreign relations and
currency exchange rates, we believe that any risk of foreign operations or
currency valuations is minimal and would not have a material effect on our
financial condition, liquidity or results of operations.
Availability of Information
We file periodic reports and proxy statements with the Securities and
Exchange Commission ("SEC"). The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our Internet address is www.prepaidlegal.com. We make available on our
website free of charge copies of our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably possible after we electronically file such material with, or
furnish it to, the SEC.
ITEM 1A. RISK FACTORS
--------------------------
Our financial position, results of operations and cash flows are subject to
various risks, many of which are not exclusively within our control that may
cause actual performance to differ materially from historical or projected
future performance. Information contained within this Form 10-K should be
carefully considered by investors in light of the risk factors described below.
In addition to factors discussed elsewhere in this report, the following are
some of the important factors that 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.
We have 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, our ability to provide
administrative services to members or other factors. If our Membership
persistency or renewal rates are less than we have historically experienced, our
cash flow, earnings and growth rates could be adversely affected.
We may not be able to grow Memberships and revenues at the same rate as we
have historically experienced and have recently experienced declines in new
Membership sales and associate recruitment.
Our year end active Memberships have increased 6%, 2% and 3% in the years
ended December 31, 2005, 2004 and 2003, respectively. Changes in net income for
the same three years were (12%), 2% and 11%, respectively. Our ability to grow
Memberships and revenues is substantially dependent upon our ability to expand
or enhance the productivity of our sales force, develop additional legal expense
products, develop alternative marketing methods or expand geographically. There
is no assurance that we will be able to achieve increases in Membership and
revenue growth comparable to our historical growth rates.
We are dependent upon the continued active participation of our principal
executive officer.
Our success depends substantially on the continued active participation of
our principal executive officer, Harland C. Stonecipher. Although our management
includes other individuals with significant experience in our business, the loss
of the services of Mr. Stonecipher could have a material adverse effect on our
financial condition and results of operations.
There is litigation pending that may have a material adverse effect on us
if adversely determined.
See "Item 3. Legal Proceedings."
We are in a regulated industry and regulations could have an adverse effect
on our ability to conduct our business.
We are 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 legal service plans. Regulation of our activities is
inconsistent among the various states in which we do business with some states
regulating legal service plans as insurance or specialized legal service
products and others regulating such plans as services. Such disparate regulation
requires us to structure our Memberships and operations differently in certain
states in accordance with the applicable laws and regulations. Our 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 our business could increase the compliance costs we
incur in order to conduct our business or limit the jurisdictions in which we
are able to conduct business.
The business in which we operate is competitive.
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect our ability to
grow. In addition, we 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 our financial condition and results of operations. See "Description of
Business - Competition."
We are dependent upon the success of our marketing force.
Our principal method of product distribution is through multi-level
marketing. The success of a multi-level marketing force is highly dependent upon
our 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 we must compete with these organizations to recruit, maintain and
grow our multi-level marketing force. In order to do so, we may be required to
increase our marketing costs through increases in commissions, sales incentives
or other features, all of which could adversely affect our future earnings. In
addition, the level of confidence of the sales associates in our ability to
perform is an important factor in maintaining and growing a multi-level
marketing force. Adverse financial developments concerning us, including
negative publicity or common stock price declines, could adversely affect our
ability to maintain the confidence of our sales force.
Our stock price may be affected by the significant level of short sellers
of our stock.
As of January 13, 2006, the New York Stock Exchange reported that
approximately 4.7 million shares of our stock were sold short, which constitutes
approximately 30% of our outstanding shares and 45% of our public float,
representing one of the largest short interest percentages of any New York Stock
Exchange listed company. Short sellers expect to make a profit if our shares
decline in value. We have been the subject of a negative publicity campaign from
several known sources of information who support short sellers. The existence of
this short interest position may contribute to volatility in our stock price and
may adversely affect the ability of our stock price to rise if market conditions
or our performance would otherwise justify a price increase.
We have not been able to increase our employee group Membership sales.
Our success in growing Membership sales is dependent in part on our ability
to market to employee groups. At December 31, 2005, group memberships
represented 20% of total Memberships compared to 25% at December 31, 2004 and
2003. Adverse publicity about us may affect our ability to market successfully
to employee groups, particularly larger groups. There is no assurance that we
will be able to increase our group business.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
----------------------------------------
None.
ITEM 2. PROPERTIES.
-------------------------
Our executive and administrative offices and our subsidiaries are located
at One Pre-Paid Way, Ada, Oklahoma. The office complex, owned by us, contains
approximately 170,000 square feet of office space and was constructed on
approximately 87 acres contributed to us by the City of Ada in 2001 as part of
an economic development incentive package. Construction was completed in 2004 at
a cost of approximately $34.1 million, including $706,000 in capitalized
interest costs, and was funded from existing resources and proceeds from a $20
million line of credit.
Continued growth over the past 12 years required us to lease and purchase
several ancillary sites to accommodate our expanding workforce before
constructing our new headquarters. The new headquarters contains two long bars
of open office area designed to serve as podiums, which stretch east from the
northern and southern edges of the tower. Two and three stories high
respectively, the podiums house the call centers and Information Technology
departments. Only 60 feet across, they are designed to ensure that employees are
never more that thirty feet from a source of daylight. Shared corporate services
-- including a 650-seat auditorium, dining hall, exercise facility, and a
connecting corridor containing a company history gallery -- are located at the
east end of the bars, creating a central courtyard. The courtyard features a
reflecting pool and a 12-foot bronze sculpture of our logo, the Lady of Justice,
a universal symbol of justice. The building's main entrance welcomes its
frequent visitors, celebrates our history, and is designed to convey the
tradition of civic judicial buildings. The building is designed to expand over
time without negatively impacting the site layout or the building concept and we
emphasized the use of modular furnishings to provide enhanced flexibility. We
placed importance on the goal of providing each employee with an excellent work
environment.
Additionally, we fully utilize another distribution facility located about
two miles from our new offices and containing approximately 17,000 square feet
of office and warehouse and shipping space. Our previous headquarters of
approximately 40,000 square feet and two other buildings containing
approximately 18,600 combined square feet located adjacent to the distribution
facility are now used as disaster recovery, or business continuity, sites.
In addition to the property described above that we own, we 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 us. In conjunction
with a rural economic development program coordinated by the City of Antlers, a
new facility was built at no cost to us that can accommodate approximately 100
customer service representatives. We leased the facilities from the City of
Antlers upon completion of the construction in November 2002. During 2005, in
conjunction with economic development incentives, we leased additional office
space in Duncan, Oklahoma which currently is occupied by approximately 90 of our
customer service representatives and during January 2006, we acquired an
additional 40,000 square foot building in Duncan that can hold 350 customer
service representatives when remodeling is completed later in 2006. We are
considering similar arrangements with other cities within Oklahoma to help
diversify our access to competent labor pools.
ITEM 3. LEGAL PROCEEDINGS.
--------------------------------
We and various 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 we issued false and misleading
financial information, primarily related to the method we used to account for
commission advance receivables from sales associates. On March 5, 2002, the
Court granted our motion to dismiss the complaint, with prejudice, and entered a
judgment in favor of the defendants. Plaintiffs thereafter filed a motion
requesting reconsideration of the dismissal which was denied. The plaintiffs
have appealed the judgment and the order denying their motion to reconsider the
judgment to the Tenth Circuit Court of Appeals. In August 2002 the lead
institutional plaintiff withdrew from the case, leaving two individual
plaintiffs as lead plaintiffs on behalf of the putative class. As of December
31, 2003, the briefing in the appeal had been completed. On January 14, 2004
oral argument was held in the appeal and as of February 17, 2006, a decision was
pending. We are unable to predict when a decision will be made on this appeal,
and the ultimate outcome of the case is not determinable.
Beginning in the second quarter of 2001 multiple lawsuits were filed
against us, certain officers, employees, sales associates and other defendants
in various Alabama and Mississippi state courts by current or former members
seeking actual and punitive damages for alleged breach of contract, fraud and
various other claims in connection with the sale of Memberships. During 2004,
there were at one time as many as 30 separate lawsuits involving approximately
285 plaintiffs in Alabama. As of February 17, 2006, as a result of dismissals,
summary judgments, or settlements for nominal amounts, there were no lawsuits
remaining in Alabama. As of February 17, 2006, we were aware of 7 separate
lawsuits involving approximately 406 plaintiffs in multiple counties in
Mississippi. Certain of the Mississippi lawsuits also name our former provider
attorney in Mississippi as a defendant. In Mississippi, we filed lawsuits in the
United States District Court for the Southern and Northern Districts of
Mississippi in which we seek to compel arbitration of the various Mississippi
claims under the Federal Arbitration Act and the terms of our Membership
agreements. One of the federal courts has ordered arbitration of a case
involving 8 plaintiffs. These cases are all in various stages of litigation,
including trial settings in Mississippi in May, 2006, and seek varying amounts
of actual and punitive damages. We have tried three separate lawsuits in
Mississippi. The first trial in Mississippi on these cases resulted in a
unanimous jury verdict in our favor, including other named defendants, on all
claims on October 19, 2004, while the second and third trials in Mississippi
resulted in insubstantial plaintiffs' verdicts on February 15, 2005 and May 9,
2005, respectively. On August 16, 2005 the Circuit Judge in the February 15,
2005 trial overturned the jury's finding of fraud and fraudulent
misrepresentation on the grounds that the evidence was insufficient to support
those claims and reduced the damages awarded by the jury to a total of $525 for
four plaintiffs. On July 18, 2005 the Circuit Judge in the May 9, 2005 trial
entered an order granting plaintiff's motion to reconsider the submission of the
issue of punitive damages to the jury, and trial on that issue was held in
November 2005. The trial on that issue resulted in punitive damage verdicts
against us and against our chief executive officer in the collective total
amount of $9.9 million. Pre-Paid will seek post judgment and appellate relief in
that case. Although the amount of Membership fees paid by the plaintiffs in the
Mississippi cases is $500,000 or less, certain of the cases seek damages of $90
million. The ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against us and certain officers in the District Court
of Creek County, Oklahoma on behalf of Jeff and Jana Weller individually and
doing business as Hi-Tech Auto making similar allegations relating to our
Memberships and seeking unspecified damages on behalf of a "nationwide" class.
The Pre-Paid defendants' preliminary motions in this case were denied, and on
June 17, 2003, the Oklahoma Court of Civil Appeals reversed the trial court's
denial of the Pre-Paid defendants' motion to compel arbitration, finding that
the trial court erred when it denied Pre-Paid's motion to compel arbitration
pursuant to the terms of the valid Membership contracts, and remanded the case
to the trial court for further proceedings consistent with that opinion. On
December 3, 2004, the District Court ordered the plaintiffs to proceed with the
arbitration. On October 16, 2005 plaintiff Jana Weller died, and on December 20,
2005 we filed a Suggestion of Death Upon the Record with respect thereto. The
ultimate outcome of this case is not determinable.
On October 3, 2005 we received a Civil Investigative Demand from the
Commissioner of Consumer Protection of the State of Connecticut requesting
information relating to our memberships and commissions to associates in
Connecticut. As of February 17, 2006, we were in the process of responding to
the request. The ultimate outcome of this matter is not determinable.
We are a defendant in various other legal proceedings that are routine and
incidental to our business. We will vigorously defend our interests in all
proceedings in which it is named as a defendant. We also receive periodic
complaints or requests for information from various state and federal agencies
relating to our business or the activities of our marketing force. We promptly
respond to any such matters and provide any information requested.
While the ultimate outcome of these proceedings is not determinable, we do
not currently anticipate that these contingencies will result in any material
adverse effect to our financial condition or results of operation, unless an
unexpected result occurs in one of the cases. The costs of the defense of these
various matters are reflected as a part of general and administrative expense,
or Membership benefits if fees relate to Membership issues, in the consolidated
statements of income. We have established an accrued liability we believe will
be sufficient to cover estimated damages in connection with various cases
(exclusive of ongoing defense costs which are expensed as incurred), which at
December 31, 2005 was $2.5 million. We believe that we have meritorious defenses
in all pending cases and will vigorously defend against the plaintiffs' claims.
However, it is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments which aggregate $5.7 million. The Canadian taxing authorities
contend commission deductions should be matched with the membership revenue as
received, we contend these commissions are deductible when paid. Under Canadian
tax laws, our commission payments are treated as a prepaid expense. We base our
deduction of commission on the fact that all the services (the sale of the
membership) have been performed by the sales associate at the time of sale
therefore this prepaid expense (the commission payments) is deductible when
paid. Also, the commission payment is taxable to the sales associate when paid
and each year we issue a T4 (Canadian 1099 equivalent) to sales associates for
the total commission payments made during that year. In addition, Canadian
taxing authorities have challenged our allocation of general and administrative
expenses to Canadian operations. We contend the allocation of general and
administrative expenses, based on the percentage of Canadian new memberships
written and the Canadian percentage memberships in force, is reasonable. At
December 31, 2005 we have accrued $472,000 for this assessment.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
--------------------------------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES.
--------------------------------------
Market Price of and Dividends on the Common Stock
At February 17, 2006, there were 5,486 holders of record (including
brokerage firms and other nominees) of our 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
-------- -------
2006:
1st Quarter (through February 17)............... $ 39.90 $ 35.35
2005:
4th Quarter..................................... $ 48.40 $ 37.20
3rd Quarter..................................... 52.77 36.35
2nd Quarter..................................... 47.00 33.51
1st Quarter..................................... 38.37 30.69
2004:
4th Quarter..................................... $ 40.39 $ 25.45
3rd Quarter..................................... 26.10 22.25
2nd Quarter..................................... 25.50 22.27
1st Quarter..................................... 26.33 21.57
On December 6, 2004, we declared our first cash dividend of $0.50 per share
on our outstanding shares of common stock. The following table sets forth, for
2005 and 2004, the declaration date, the per share dividend amount, the
aggregate dividend amount, the record date and the payable date of cash
dividends that we have declared on our outstanding shares of common stock:
Declared Per Share Aggregate Amount Record Date Payment Date
------------------ --------- ---------------- ----------------- ----------------
December 6, 2004 $0.50 $7.8 million December 20, 2004 January 14, 2005
April 4, 2005 0.30 4.6 million April 25, 2005 May 16, 2005
December 19, 2005 0.30 4.6 million December 30, 2005 January 13, 2006
It is anticipated that earnings generated from our operations will be used
to finance our growth, to continue to purchase shares of our stock, to retire
existing debt and possibly pay cash dividends. We have loans as described in
"Management's Discussion and Analysis - Liquidity and Capital Resources," which
currently prohibit payment of cash dividends in excess of 65% of net income. Any
decision by our Board of Directors to pay additional cash dividends in the
future will depend upon, among other factors, our earnings, financial condition,
capital requirements and approval from our lender for any dividends in excess of
65% of net income. In addition, our ability to pay dividends is dependent in
part on our ability to derive dividends from our 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 the
greater of 10% of such accumulated available surplus or the previous years' net
profits. PPLSIF and LSPV are similarly restricted pursuant to their respective
insurance laws. The following table reflects subsidiary dividends during the
last three years:
Dividends Paid
-------------------------------------------- Dividends Available
Regulated Subsidiary 2005 2004 2003 1/1/2006
--------------------------------- ------------- ------------- -------------- -------------------
Pre-Paid Legal Casualty, Inc. $ 4.1 million - - $ 6.1 million
Legal Service Plans of Virginia 3.7 million - - -
At December 31, 2005 the amount of restricted net assets of consolidated
subsidiaries was $25.3 million, representing amounts that may not be paid to us
as dividends either under the applicable regulations or without regulatory
approval. At January 1, 2006 PPLCI had approximately $6.1 million available for
payment to us of an ordinary dividend.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plans
The following table provides information with respect to our equity
compensation plans as of December 31, 2005, (other than our tax qualified
Employee Stock Ownership Plan designed to provide retirement benefits).
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
-------------------------------------- --------------------- -------------------- --------------------------
Equity compensation plans approved by
security holders (1)................. 474,500 $20.82 1,346,252
Equity compensation plans not approved
by security holders (2).............. 32,667 22.70 -
--------------------- -------------------- --------------------------
Total.................................. 507,167 $20.94 1,346,252
--------------------- -------------------- --------------------------
--------------
(1) These stock options have been issued pursuant to our Stock Option Plan
which has been approved by security holders. We do not expect to grant any
additional options under this plan.
(2) These stock options have been issued to our Regional Vice Presidents
("RVPs") (described above) in order to encourage stock ownership by our
RVPs and to increase the proprietary interest of such persons in our growth
and financial success. These options have been granted periodically to RVPs
since 1996. Options are granted at fair market value at the date of the
grant and are generally immediately exercisable for a period of three years
or within 90 days of termination, whichever occurs first. There were 36,751
and 106,002 total options granted to RVPs in the years ended December 31,
2004 and 2003, respectively. We discontinued the RVP stock option grants
immediately after the 2003 fourth quarter stock options were awarded in the
first quarter of 2004.
Issuer Purchases of Equity Securities
The following table provides information about our purchases of stock in the
open market during the fourth quarter of 2005.
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Part of Publicly Be Purchased Under
Total Number of Average Price Paid Announced Plans or the Plans or
Period Shares Purchased per Share Programs Programs (1)
----------------------- --------------------- ------------------ ------------------- --------------------
October 2005........... - - - 586,082
November 2005.......... - - - 586,082
December 2005.......... - - - 586,082
--------------------- ------------------ ------------------- --------------------
Total.................. - - -
--------------------- ------------------ -------------------
---------
(1) We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock.
The Board of Directors has subsequently from time to time increased such
authorization from 500,000 shares to 10,000,000 shares. The most recent
authorization was for 1,000,000 additional shares August 9, 2004 and there
has been no time limit set for completion of the repurchase program. In
addition, we purchased 980,518 shares for $26.00 per share in a tender
offer completed on September 28, 2004.
ITEM 6. SELECTED FINANCIAL DATA.
--------------------------------------
The following table sets forth selected financial and statistical data for
us as of the dates and for the periods indicated. This information is not
necessarily indicative of our future performance. The following information
should be read in conjunction with our Consolidated Financial Statements and
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operation included elsewhere herein.
Year Ended December 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ---------- ----------- ----------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees............................................ $ 389,255 $ 355,461 $ 330,322 $ 308,401 $ 263,514
Associate services......................................... 28,963 24,901 25,704 37,418 36,485
Other...................................................... 5,162 5,575 5,287 4,804 3,662
----------- ----------- ---------- ----------- ----------
Total revenues........................................... 423,380 385,937 361,313 350,623 303,661
----------- ----------- ---------- ----------- ----------
Costs and expenses:
Membership benefits......................................... 137,150 122,280 111,165 103,761 87,429
Commissions................................................. 141,631 118,757 115,386 119,371 111,060
Associate services and direct marketing..................... 30,453 29,325 28,929 32,566 29,879
General and administrative expenses......................... 49,015 43,742 36,711 33,256 28,243
Other, net.................................................. 10,456 9,578 8,546 6,685 5,917
----------- ----------- ---------- ----------- ----------
Total costs and expenses.................................. 368,705 323,682 300,737 295,639 262,528
----------- ----------- ---------- ----------- ----------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle........... 54,675 62,255 60,576 54,984 41,133
Provision for income taxes...................................... 18,863 21,478 20,669 18,970 13,519
----------- ----------- ---------- ----------- ----------
Income from continuing operations............................... 35,812 40,777 39,907 36,014 27,614
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit of $0 for 2001)...... - - - - (504)
----------- ----------- ---------- ----------- ----------
Net income applicable to common stockholders.................... $ 35,812 $ 40,777 $ 39,907 $ 36,014 $ 27,110
----------- ----------- ---------- ----------- ----------
Basic earnings per common share from continuing operations..... $ 2.31 $ 2.50 $ 2.28 $ 1.83 $ 1.28
Basic earnings per common share from discontinued
operations................................................... - - - - (.02)
----------- ----------- ---------- ----------- ----------
Basic earnings per common share................................ $ 2.31 $ 2.50 $ 2.28 $ 1.83 $ 1.26
----------- ----------- ---------- ----------- ----------
Diluted earnings per common share from continuing
operations................................................... $ 2.29 $ 2.48 $ 2.27 $ 1.82 $ 1.28
Diluted earnings per common share from discontinued
operations................................................... - - - - (.02)
----------- ----------- ---------- ----------- ----------
Diluted earnings per common share.............................. $ 2.29 $ 2.48 $ 2.27 $ 1.82 $ 1.26
----------- ----------- ---------- ----------- ----------
Dividends declared per common share............................ $ .60 $ .50 $ - $ - $ -
----------- ----------- ---------- ----------- ----------
Weighted average number of common shares
outstanding - basic........................................ 15,470 16,313 17,530 19,674 21,504
Weighted average number of common shares
outstanding - diluted...................................... 15,652 16,458 17,599 19,764 21,544
Selected Financial Data, continued
----------------------------------
Year Ended December 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ---------- ----------- ----------
Membership Benefits Cost and Statistical Data: (In thousands, except ratio, per share and Membership amounts)
Membership benefits ratio (1)................................ 35.2% 34.4% 33.7% 33.6% 33.2%
Commissions ratio (1)........................................ 36.4% 33.4% 34.9% 38.7% 42.1%
General and administrative expense ratio (1)................. 12.6% 12.3% 11.1% 10.8% 10.7%
Commission cost per new Membership sold...................... $ 202 $ 190 $ 172 $ 154 $ 152
New Memberships and stand-alone IDT plans sold............... 700,727 624,525 671,857 773,767 728,295
Period end Memberships and stand-alone IDT plans in
force....................................................... 1,542,789 1,451,700 1,418,997 1,382,306 1,242,908
New add-on IDT memberships sold.............................. 441,108 335,792 89,928 - -
Period end add-on IDT memberships in force................... 461,094 283,889 86,602 - -
Average annual Membership fee................................ $ 287 $ 274 $ 262 $ 256 $ 251
Cash Flow Data:
Net cash provided before changes in assets and liabilities..... $ 45,443 $ 51,689 $ 47,731 $ 42,699 $ 30,679
Net cash provided by operating activities...................... 50,131 47,263 51,693 52,073 37,801
Net cash used in investing activities.......................... (15,545) (11,322) (36,901) (11,074) (6,963)
Net cash used in financing activities......................... (26,601) (31,428) (14,191) (34,431) (27,414)
Balance Sheet Data:
Total assets................................................. $ 164,865 $ 146,064 $ 131,012 $ 96,836 $ 85,720
Total liabilities............................................ 113,471 114,617 101,438 61,864 43,496
Stockholders' equity ........................................ 51,394 31,447 29,574 34,972 42,224
-----------
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. 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.
----------------------
Overview of the Our Financial Model
We are in one line of business - the marketing of legal expense and other
complimentary plans primarily through a multi-level marketing force to
individuals. Our principal revenues are derived from Membership fees, and to a
much lesser extent, revenues from marketing associates. Our principal expenses
are commissions, Membership benefits, associates services and direct marketing
costs and general and administrative expense. The following table reflects the
changes in these categories of revenues and expenses in the last 3 years (dollar
amounts in 000's):
% % %
Change Change Change
% of from % of from % of from
Total Prior Total Prior Total Prior
Revenues: 2005 Revenue Year 2004 Revenue Year 2003 Revenue Year
-------- -------- ------- -------- -------- ------- --------- --------- --------
Membership fees........... $389,255 91.9 9.5 $355,461 92.1 7.6 $ 330,322 91.4 7.1
Associate services........ 28,963 6.8 16.3 24,901 6.5 (3.1) 25,704 7.1 (31.3)
Other..................... 5,162 1.2 (7.4) 5,575 1.4 5.4 5,287 1.5 10.1
-------- -------- ------- -------- -------- ------- --------- --------- --------
423,380 100.0 9.7 385,937 100.0 6.8 361,313 100.0 3.0
-------- -------- ------- -------- -------- ------- --------- --------- --------
Costs and expenses:
Commissions............... 141,631 33.5 19.3 118,757 30.8 2.9 115,386 31.9 (3.3)
Membership benefits....... 137,150 32.4 12.2 122,280 31.7 10.0 111,165 30.8 7.1
Associate services and
direct marketing........ 30,453 7.2 3.9 29,325 7.6 1.4 28,929 8.0 (11.2)
General and administrative 49,015 11.6 12.1 43,742 11.3 19.2 36,711 10.2 10.4
Other, net................ 10,456 2.5 9.2 9,578 2.5 12.1 8,546 2.4 27.8
-------- -------- ------- -------- -------- ------- --------- --------- --------
368,705 87.1 13.9 323,682 83.9 7.6 300,737 83.2 1.7
-------- -------- ------- -------- -------- ------- --------- --------- --------
Provision for income taxes.. 18,863 4.5 (12.2) 21,478 5.6 3.9 20,669 5.7 9.0
-------- -------- ------- -------- -------- ------- --------- --------- --------
Net income.................. $ 35,812 8.5 (12.2) $ 40,777 10.6 2.2 $ 39,907 11.0 10.8
-------- -------- ------- -------- -------- ------- --------- --------- --------
The following table reflects certain data concerning our Membership sales and
associate recruiting:
% Change % Change
from from
New Memberships: 12/31/2005 Prior Year 12/31/2004 Prior Year 12/31/2003
---------------- ---------- ---------- ---------- ---------- ----------
New legal service Membership sales...................... 666,595 11.1 599,929 (10.1) 667,480
New "stand-alone" IDT Membership sales.................. 34,132 38.7 24,596 461.9 4,377
---------- ---------- ---------- ---------- ----------
Total new Membership sales..................... 700,727 12.2 624,525 (7.0) 671,857
New "add-on" IDT Membership sales....................... 441,108 31.4 335,792 273.4 89,928
Average Annual Membership fee........................... $322.04 6.2 $303.36 10.2 $275.22
Active Memberships:
-------------------
Active legal service memberships at end of period....... 1,490,847 4.6 1,424,707 .7 1,414,746
Active "stand-alone" IDT memberships at end of period... 51,942 92.4 26,993 535.0 4,251
---------- ---------- ---------- ---------- ----------
Total active memberships at end of period...... 1,542,789 6.3 1,451,700 2.3 1,418,997
---------- ---------- ---------- ---------- ----------
Active "add-on" IDT memberships at end of period........ 461,094 62.4 283,889 227.8 86,602
New Sales Associates:
---------------------
New sales associates recruited.......................... 242,223 125.2 107,552 (.9) 108,557
Average enrollment fee paid by new sales associates..... $56.61 (60.3) $142.49 (4.4) $136.45
Average Membership fee in force:
--------------------------------
Average Annual Membership fee........................... $286.60 4.6 $274.02 4.4 $262.36
During the third quarter of 2003, we began offering our Identity Theft
Shield ("IDT") to new and existing members at $9.95 per month if added to a
legal service Membership or $12.95 per month if purchased separately.
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees and their impact on total revenues during any
period. The two most important variables impacting the number of active
Memberships during a period are the number of new Memberships written during the
period combined with the retention characteristics of both new and existing
Memberships. See "Measures of Member Retention" below for a discussion of our
Membership retention. Associate services revenues are a function of the number
of new sales associates enrolled and the price of entry during the period, the
number of associates subscribing to our eService offering and the amount of
sales tools purchased by the sales force.
Membership benefits expense is primarily determined by the number of active
Memberships and the per capita contractual rate that exists between us and our
benefits providers and during the last five years has been and is expected to
continue to be a relatively fixed percentage of Membership revenues of
approximately 33%-35% but could increase should the number of IDT memberships
increase at a faster pace than the legal Memberships.. Commissions paid to
associates are primarily dependent on the number and price of new Memberships
sold during a period and any special incentives that may be in place during the
period. We expense advance commissions ratably over the first month of the
related Membership. The level of commission expense in relation to Membership
revenues varies depending on the level of new Memberships written and is
expected to be higher when we experience increases in new Membership sales.
During the last five years this percentage has ranged from approximately 33% to
42% of Membership revenues. Associate services and direct marketing expenses are
directly impacted by the number of new associates enrolled during a period due
to the cost of materials provided to such new associates, the number of
associates subscribing to our eService offering, the amount of sales tools
purchased by the sales force as well as the number of those associates who
successfully meet the Fast Start to Success training and incentive award program
qualifications. Prior to 2003 these costs were more than offset by associate
services revenue, however this did not occur in 2005, 2004 or 2003 primarily due
to the lower entry fees charged during most of the periods. General and
administrative expenses are expected to trend up in terms of dollars, but remain
relatively constant as a percent of Membership fees. During the past five years,
general and administrative expenses have ranged from 11% to 13% of Membership
fees.
The primary benchmarks monitored by us throughout the various periods
include the number of active Memberships and their related retention
characteristics, the number of new Memberships written, the number of new
associates enrolled and the percentage of new associates that successfully meet
the Fast Start to Success qualification requirements.
Although we have grown our active Membership base and related Membership
fees in each of the past 13 years, the rate of growth has not been one we find
acceptable. We believe however, that our current product design, pricing
parameters and business model are generally appropriate and we have no immediate
plans to change these fundamental sectors. Our focus during 2006 will continue
to be on improved training of our associates, enhancing the quality of sales
tools provided to new and existing associates, providing incentives for
associates to write consistent, quality business and continued emphasis on
improving the basic retention characteristics of our Memberships.
Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance
with accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. If these estimates or assumptions are
incorrect, there could be a material change in our financial condition or
operating results. Many of these "critical accounting policies" are common in
the insurance and financial services industries; others are specific to our
business and operations. Our critical accounting policies include estimates
relating to revenue recognition related to Membership and associate fees,
deferral of Membership and associate related costs, expense recognition related
to commissions to associates, accrual of incentive awards payable and accounting
for legal contingencies.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
basis. Approximately 95% of members remit their Membership fees on a monthly
basis, of which approximately 73% are paid in advance and, therefore, are
deferred and recognized over the following month. At December 31, 2005 the
deferred revenue associated with the Membership fees was $20.8 million which is
classified as a current liability.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs are deferred and recognized in income over the estimated life
of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101") as revised by SEC
Staff Accounting Bulletin No. 104. At December 31, 2005 the deferred revenue
associated with the Membership enrollment fees was $6.9 million, of which $3.9
million was classified as a current liability. We compute the expected
Membership life using more than 20 years of actuarial data as explained in more
detail in "Measures of Membership Retention" below. At December 31, 2005,
management computed the expected Membership life to be approximately 3 years,
which is unchanged from year end 2004. If the expected Membership life were to
change significantly, which management does not expect in the short term, the
deferred Membership enrollment fee and related costs would be recognized over a
longer or shorter period.
We derive revenues from services provided to our marketing sales force
primarily from a one-time non-refundable enrollment fee from each new sales
associate for which we provide initial sales and marketing supplies and
enrollment services to the associate. Average enrollment fees paid by new sales
associates were $57, $142 and $136 for 2005, 2004 and 2003, respectively.
Revenue from, and costs of, the initial sales and marketing supplies
(approximately $14) are recognized when the materials are delivered to the
associates. The remaining revenues and related incremental direct and
origination costs are deferred and recognized over the estimated average active
service period of associates which at December 31, 2005 is estimated to be
approximately six months, unchanged from year end 2004. At December 31, 2005,
the deferred revenue associated with sales associate enrollment fees was $1.6
million, which is classified as a current liability. Management estimates the
active service period of an associate periodically based on the average number
of months an associate produces new Memberships including those associates that
fail to write any Memberships. If the active service period of associates
changes significantly, which management does not expect in the short term, the
deferred revenue and related costs would be recognized over the new estimated
active service period.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
($6.5 million deferred at December 31, 2005 which is classified as a current
asset) and associates related to deferred Membership revenue. Deferred costs for
enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments, and were $6.6
million at December 31, 2005, of which $3.6 million is classified in current
assets. Deferred costs for enrolling new associates include training and success
bonuses paid to individuals involved in recruiting the associate and salary and
benefit costs of employees who process associate enrollments, and were $800,000
at December 31, 2005, and are classified as a current asset. Such costs are
deferred to the extent of the lesser of actual costs incurred or the amount of
the related fee charged for such services. Deferred costs are amortized to
expense over the same period as the related deferred revenue as discussed above.
Deferred costs that will be recognized within one year of the balance sheet date
are classified as current and all remaining deferred costs are considered
noncurrent. Associate related costs are reflected as associate services and
direct marketing, and are expensed as incurred if not related to the deferred
revenue discussed above. These costs include providing materials and services to
associates, Fast Start bonuses, associate introduction kits, associate incentive
programs, group marketing and marketing services departments (including costs of
related travel, marketing events, leadership summits and international sales
convention).
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, we 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, our
commission program provided for advance commission payments to associates of
approximately 70% of first year Membership fees 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, we returned to a
differential commission structure with rates of approximately 80% of first year
Membership fees on new Memberships written and variable renewal commission rates
ranging from five to 25% per annum based on the first 12 month Membership
retention rate of the associate's personal sales and those of his organization.
Beginning in August 2003, we allowed the associate to choose between the level
commission structure and up to three year commission advance or the differential
commission structure with a one year commission advance.
Prior to January 1997 we advanced commissions at the time of sale of all
new Memberships. In January 1997, we implemented a policy whereby the associate
receives only earned commissions on the first three sales unless the associate
has successfully completed the Fast Start training program. For all sales
beginning with the fourth Membership or all sales made by an associate
successfully completing the Fast Start training program, we currently advance
commission payments at the time of sale of a new Membership. The amount of cash
potentially advanced upon the sale of a new Membership, prior to the recoupment
of any charge-backs (described below), represents an amount equal to up to
one-year commission earnings. Although the average number of marketing
associates receiving an advance commission payment on a new Membership is 10,
the overall initial advance may be paid to approximately 30 different
individuals, each at a different level within the overall commission structure.
The commission advance immediately increases an associate's unearned advance
commission balance to us.
Although prior to March 1, 2002, we advanced our sales associates up to
three years commission when a Membership was sold and subsequent to March 1,
2002, up to one year commission, the average commission advance paid to our
sales associates as a group is actually less than the maximum amount possible
because some associates choose to receive less than a full advance and we pay
less than a full advance on some of our specialty products. In addition, we may
from time to time place associates on a less than full advance basis if there
are problems with the quality of the business being submitted or other
performance problems with an associate. Additionally, we do not advance
commissions on certain categories of group business which have historically
demonstrated below average retention characteristics. Also, any residual
commissions due an associate (defined as commission on an individual Membership
after the advance has been earned) are retained to reduce any remaining unearned
commission advance balances prior to being paid to that sales associate. For
those associates that have made at least 10 personal sales, opened at least one
group and personally write 15% or more of their organizational business, 15% of
their commissions are set aside in individual reserve balance accounts, further
reducing the amount of advance commissions. The average commission advance paid
as a percentage of the maximum advance possible pursuant to our commission
structures was approximately 75%, 78% and 80% during 2005, 2004 and 2003,
respectively. The commission cost per new Membership sold has increased over the
prior year by 6%, 10% and 12% for 2005, 2004 and 2003, respectively, and varies
depending on the compensation structure that is in place at the time a new
Membership is sold, the monthly Membership fee of the Membership sold and the
amount of any charge-backs (recoupment of previous commission advances) that are
deducted from amounts that would otherwise be paid to the various sales
associates that are compensated for the Membership sale. Should we add
additional products, such as the Identity Theft Shield described above or add
additional commissions to our compensation plan or reduce the amount of
chargebacks collected from our associates, the commission cost per new
Membership will increase accordingly.
We expense advance commissions ratably over the first month of the related
Membership. At December 31, 2005, advance commissions deferred were $5.3 million
and included as a current asset. As a result of this accounting policy, our
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. We track our unearned advance commission
balances outstanding in order to ensure the advance commissions are recovered
before any renewal commissions are paid and for internal purposes of analyzing
our commission advance program. While not recorded as an asset, unearned advance
commission balances from associates for the following years ended December 31
were:
2005 2004 2003
---- ---- ----
(Amounts in 000's)
Beginning unearned advance commission balances (1)..................$ 183,060 $ 191,894 $ 227,084
Advance commissions, net of chargebacks and other.................... 142,535 115,942 113,030
Earned commissions applied........................................... (127,084) (122,393) (145,371)
Advance commission write-offs........................................ (2,719) (2,383) (2,849)
----------- ----------- -----------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)......................................... 195,792 183,060 191,894
Estimated unrecoverable advance commission balances (1)(2)........... (33,879) (28,554) (24,862)
----------- ----------- -----------
Ending unearned advance commission balances, net (1)............... $ 161,913 $ 154,506 $ 167,032
----------- ----------- -----------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2) Estimated unrecoverable advances increased as a percentage of ending
advances from 13% at December 31, 2003 to 17% at December 31, 2005
primarily due to the change in the compensation structure described above
from a 36-month possible advance to a 12-month possible advance and fewer
new Memberships written during 2003 and 2004. The commission structure
change allows the advances to be earned more quickly by the associate and
the reduction in new Memberships written creates fewer new advances.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $40 million,
$27 million and $30 million at December 31, 2005, 2004 and 2003, respectively.
As such, at December 31, 2005 future commissions and related expense will be
reduced as unearned advance commission balances of $122 million are recovered.
Commissions are earned by the associate as Membership fees are earned by us,
usually on a monthly basis. We reduce unearned advance commission balances or
remit payments to associates, as appropriate, when commissions are earned.
Should a Membership lapse before the advances have been recovered for each
commission level, we, except as described below, generate an immediate
"charge-back" to the applicable sales associate to recapture up to 50% of any
unearned advance on Memberships written prior to March 1, 2002, and 100% on any
Memberships written thereafter. Beginning in August 2003, we allowed the
associate to choose between the level commission structure and up to three year
commission advance and up to 50% chargebacks or the differential commission
structure with a one year commission advance and up to 100% chargebacks. This
charge-back is deducted from any future advances that would otherwise be payable
to the associate for additional new Memberships. In order to encourage
additional Membership sales, we waived chargebacks for associates that met
certain criteria in December 2002 and March 2003, which effectively increases
our commission expense. Any remaining unearned advance commission balance may be
recovered by withholding future residual earned commissions due to an active
associate on active Memberships. Additionally, even though a commission advance
may have been fully recovered on a particular Membership, no additional
commission earnings from any Membership are paid to an associate until all
previous advances on all Memberships, both active and lapsed, have been
recovered. We also have reduced chargebacks from 100% to 50% for certain senior
marketing associates who have demonstrated the ability to maintain certain
levels of sales over specified periods and maintain certain Membership retention
levels. We may adjust chargebacks from time to time in the future in order to
encourage certain production incentives.
We have 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, we have 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 our relationships with our sales associates. This business decision by
us has a significant effect on our cash flow by electing to defer collection of
advance payments of which approximately $33.9 million were not expected to be
collected from future commissions at December 31, 2005. However, we regularly
review the unearned advance commission balance status of associates and will
exercise our 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 our 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 we have no
continuing obligation to individually account to these associates as we do to
active associates and are entitled to retain all commission earnings that would
be otherwise payable to these terminated associates. We do 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 $407 at December 31, 2005.
Although the advance commissions are expensed ratably over the first month
of the related Membership, we assess, 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 our estimated future lapse rate, which is based on our actual
historical Membership retention experience as applied to each active
Membership's year of origin. The lapse rate is based on our more than 20-year
history of Membership retention rates, which is updated quarterly to reflect
actual experience. We also closely review 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. We estimate unrecoverable advance commission
balances when expected future commissions to be earned on active Memberships
(aggregated on an associate-by-associate basis) are less than the unearned
advance commission balance. If an associate with an outstanding unearned advance
commission balance has no active Memberships, the unearned advance commission
balance is written off but has no financial statement impact as advance
commissions are expensed ratably over the first month of the related
Memberships. Refer to "Measures of Member Retention - Expected Membership Life,
Expected Remaining Membership Life" for a description of the method used by us
to estimate future commission earnings.
Further, our analysis of the recoverability of unearned advance commission
balances is also based on the assumption that the associate does not write any
new Memberships. We believe that this assessment methodology is highly
conservative since our actual experience is that many associates do continue to
sell new Memberships and we, through our chargeback rights, gain an additional
source to recover unearned advance commission balances.
Changes in our estimates with respect to recoverability of unearned
commissions could occur if the underlying Membership persistency changes from
historical levels. Should Membership persistency decrease, the unearned
commissions would be recovered over a longer period and the amount not recovered
would most likely increase, although any increase in uncollectible unearned
commissions would not have any immediate expense impact since the commission
advances are expensed in the month they incurred. Holding all other factors
constant, the decline in persistency would also lead to lower Membership fees,
less net income and less cash flow from operations. Conversely, should
persistency increase, the unearned commissions would be recovered more quickly,
the amount unrecovered would decrease and, holding all other factors constant,
we would enjoy higher Membership fees, more net income and more cash flow from
operations.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. At December 31, 2005, the accrued
amount payable was $3.1 million. Changes to any of these assumptions would
directly affect the amount accrued but we do not expect any of the significant
trends impacting this account to change significantly in the near term.
Legal Contingencies
We are subject to various legal proceedings and claims, the outcomes of
which are subject to significant uncertainty. Given the inherent
unpredictability of litigation, it is difficult to estimate the impact of
litigation on our financial condition or results of operation. SFAS 5,
Accounting for Contingencies, requires that an estimated loss from a loss
contingency should be accrued by a charge to income if it is probable that an
asset has been impaired or a liability has been incurred and the amount of the
loss can be reasonably estimated. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been incurred. We
evaluate, among other factors, the degree of probability of an unfavorable
outcome and the ability to make a reasonable estimate of the amount of loss. We
have established an accrued liability we believe will be sufficient to cover
estimated damages in connection with various cases, which at December 31, 2005
was $2.5 million. This process requires subjective judgment about the likely
outcomes of litigation. Liabilities related to most of our lawsuits are
especially difficult to estimate due to the nature of the claims, limitation of
available data and uncertainty concerning the numerous variables used to
determine likely outcomes or the amounts recorded. Litigation expenses are
recorded as incurred and we do not accrue for future legal fees. It is possible
that an adverse outcome in certain cases or increased litigation costs could
have an adverse effect upon our financial condition, operating results or cash
flows in particular quarterly or annual periods. See "Legal Proceedings."
Other General Matters
Operating Ratios
Three principal operating measures monitored by us in addition to measures
of Membership retention are the Membership benefits ratio, commission ratio and
the general and administrative expense ratio. The Membership benefits ratio, the
commissions ratio and the general and administrative expense ratio represent
those costs as a percentage of Membership fees. We strive to maintain these
ratios as low as possible while at the same time providing adequate incentive
compensation to our 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
We generally advance significant commissions at the time a Membership is
sold. Since approximately 95% of Membership fees are collected on a monthly
basis, a significant cash flow deficit is created at the time a Membership is
sold. This deficit is reduced as monthly Membership fees are remitted and no
additional commissions are paid on the Membership until all previous unearned
advance commission balances have been fully recovered. Since the cash advanced
at the time of sale of a new Membership may be recovered over a multi-year
period, cash flow from operations may be adversely affected depending on the
number of new Memberships written in relation to the existing active base of
Memberships and the composition of new or existing sales associates producing
such Memberships.
Investment Policy
Our 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. Our
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. We are required to pledge investments to various state
insurance departments as a condition to obtaining authority to do business in
certain states.
New Accounting Standards Issued
In November 2005, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position ("FSP") FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
This FSP addresses the determination as to when an investment is considered
impaired, whether that impairment is other than temporary, and the measurement
of an impairment loss. This FSP also includes accounting considerations
subsequent to the recognition of an other-than-temporary impairment and requires
certain disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance in this FSP is applicable to
reporting periods beginning after December 15, 2005. Management does not expect
the adoption of this FSP to have a material effect on our consolidated financial
position and results of operations.
In December 2004, the FASB issued SFAS No. 123(R) "Share-Based Payment,"
which replaces SFAS No. 123 "Accounting for Stock-Based Compensation," and
supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees." In
March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 107 "Share-Based Payment," which provides interpretive guidance
related to SFAS No. 123(R). SFAS No. 123(R) requires compensation costs related
to share-based payment transactions to be recognized in the financial
statements. With limited exceptions, the amount of compensation cost is measured
based on the grant-date fair value of the equity or liability instruments
issued. SFAS No. 123(R) requires liability awards to be remeasured each
reporting period and compensation costs to be recognized over the period that an
employee provides service in exchange for the award. Management plans to adopt
this statement on the modified prospective basis beginning January 1, 2006, and
does not expect adoption of this statement to have a material effect on our
consolidated financial position and results of operations. Subsequent to
adoption of this statement, share-based benefits will be valued at fair value
using the Black-Scholes option pricing model for option grants and the grant
date fair market value for stock awards. Compensation amounts so determined will
be expensed over the applicable vesting period.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20, and FASB Statement No. 3"
("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, "Accounting Changes," and
FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements," and changes the requirements for the accounting for and reporting
of a change in accounting principle. This statement applies to all voluntary
changes in accounting principle. It also applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 31, 2005.
Measures of Member Retention
----------------------------
One of the major factors affecting our profitability and cash flow is our
ability to retain a Membership, and therefore continue to receive fees, once it
has been sold. We monitor our 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, our experience indicates that first year retention rate of Memberships
owned by members who also are sales associates is approximately 8% 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 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 new members who
also are sales associates increased during 2005 for the first time in the past
five years, primarily due to the 125% increase in new sales associates enrolled
during 2005 compared to 2004. Since associate members have a known higher first
year retention rate, a shift in mix alone could, over time, cause an increase in
reported aggregate retention measures and expected member life, even if the
retention rates within each sub-group do not change. Despite this increase in
associate owned Memberships, our blended first year retention rate and lapse
rate remain unchanged from the previous year. It is important to note that all
blended rates discussed here may reflect the impact of such shifts in enrollment
mixes. At December 31, 2005, 410,493 of the active 1,542,789 Memberships were
also vested associates which represent 27% of the total active Memberships
compared to 21% at December 31, 2004 and 2003. 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
---- ----------- ----------- -----
2001 728,295 103,515 14.2%
2002 773,767 119,326 15.4%
2003 671,857 86,406 12.9%
2004 624,525 89,230 14.3%
2005 700,727 220,290 31.4%
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, we have observed that Memberships in their first year have a
significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 49.1% of all new Memberships lapse during the first year, leaving 50.9%
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, 2005 and 2004 our blended retention rate and lapse rates based on
our historical experience for the last 25 years.
Membership Retention versus Membership Age
----------------------------------------------------------------------------------------
As of December 31, 2004 As of December 31, 2005
----------------------------------- ----------------------------------
Yearly Yearly
Lapse Yearly End of Year Membership Lapse Yearly End of Year
Rate Retention Memberships Year Rate Retention Memberships
--------- --------- ----------- --------------- --------- --------- -----------
100.0 0 100.0
49.1% 50.9% 50.9 1 49.1% 50.9% 50.9
28.2% 71.8% 36.5 2 31.8% 68.2% 34.7
21.1% 78.9% 28.8 3 23.3% 76.7% 26.6
17.1% 82.9% 23.9 4 16.5% 83.5% 22.2
15.3% 84.7% 20.2 5 12.2% 87.8% 19.5
11.9% 88.1% 17.8 6 10.3% 89.7% 17.5
9.5% 90.5% 16.1 7 9.1% 90.9% 15.9
Membership Persistency
Our 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,
2005, our annual Membership persistency rates, using the foregoing method, have
averaged approximately 71.8%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
---- ----------- ----------- --------- ----------- -----------
2001 1,064,805 728,295 1,793,100 1,242,908 69.3%
2002 1,242,908 773,767 2,016,675 1,382,306 68.5%
2003 1,382,306 671,857 2,054,163 1,418,997 69.1%
2004 1,418,997 624,525 2,043,522 1,451,700 71.0%
2005 1,451,700 700,727 2,152,427 1,542,789 71.7%
Our 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. Our 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. Our overall Membership
persistency rate could also become lower when the new enrollments include a
higher proportion of non-associate members.
Unless offset by other factors, these factors could result in a decline in
our 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
Using historical data through 2005 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 our 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 4.7 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, 2005, 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 us 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 our future profitability and cash flow due to
future changes in Membership retention can be significant. While blended
retention rates have not changed dramatically over the past five years, we have
implemented several initiatives beginning in 2002 aimed at improving the
retention rate of both new and existing Memberships. Such initiatives include an
optional revised compensation structure featuring variable renewal commission
rates ranging from five to 25% per annum based on the 12 month Membership
retention rate of the associate's personal sales and those of his organization
and implementation of a "non-taken" administrative fee to sales associates of
$35 for any Membership application that is processed but for which a payment is
never received. We have designed and implemented an enhanced member "life cycle"
communication process aimed at both increasing the overall amount of
communication from us to the members as well as more specific target messaging
to members based on the length of their Membership as well as utilization
characteristics. We believe that such efforts may ultimately increase the
utilization by members and therefore lead to higher retention rates. However,
the effects of these efforts through 2005 on improving retention have not been
meaningful. We intend to continue to develop programs and initiatives designed
to improve retention.
Results of Operations
Comparison of 2005 to 2004
Net income for 2005 decreased 12% to $35.8 million from $40.8 million for
2004. Diluted earnings per share for 2005 decreased 8% to $2.29 per share from
$2.48 per share for the prior year due to decreased net income of 12% and an
approximate 5% decrease in the weighted average number of outstanding shares.
Membership revenues for 2005 were up 10% to $389.3 million from $355.5 million
for the prior year marking the thirteenth consecutive year of increased
Membership revenue.
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period. The active Memberships in force are determined by both the number of new
Memberships sold in any period together with the renewal rate of existing
Memberships. New Membership sales increased 12% during 2005 to 700,727 from
624,525 during 2004. At December 31, 2005, there were 1,542,789 active
Memberships in force compared to 1,451,700 at December 31, 2004, an increase of
6%. Additionally, the average annual fee per Membership has increased from $274
for all Memberships in force at December 31, 2004 to $287 for all Memberships in
force at December 31, 2005, a 5% increase, primarily as a result of increased
sales of our Identity Theft Shield Membership during year 2005.
Associate services revenue increased 16% from $24.9 million for 2004 to
$29.0 million during 2005 primarily as a result of more associates enrolling in
the eService program. The eService fees totaled $10.8 million during 2005
compared to $7.6 million for 2004, an increase of 42%. We recognized revenue
from associate fees of approximately $13.9 million during 2005 compared to $14.6
million during 2004, a decrease of 5%. New associates typically pay a fee
ranging from $49 to $249, depending on special promotions we implement from time
to time. Although the new enrollments of sales associates increased 125% during
2005 to 242,223 from 107,552 for 2004, the average associate fee paid during
2005 was $56.61 compared to $142.49 for 2004, a decrease of 60%. Future revenues
from associate services will depend primarily on the number of new associates
enrolled, the price charged for new associates and the number who choose to
participate in our eService program, but we expect that such revenues will
continue to be largely offset by the direct and indirect cost to us of training,
providing associate services and other direct marketing expenses.
Other revenue decreased 7%, from $5.6 million to $5.2 million primarily due
to the decrease in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $423.4 million for 2005 from $385.9 million during 2004, an
increase of 10%.
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $137.2 million for 2005 compared to $122.3 million for
2004, and represented 35% of Membership fees for 2005 and 34% for 2004. This
Membership benefits ratio (Membership benefits as a percentage of Membership
fees) should remain near current levels as substantially all active Memberships
provide for a capitated benefit in the absence of any changes in the capitated
benefit level, which has not changed significantly since 1993. However, since
the benefit ratio of the IDT Memberships is higher than the legal Memberships,
we expect the benefits ratio to increase above 35% if we continue to increase
the IDT Membership base and revenues.
Commissions to associates increased 19% from $118.8 million for 2004 to
$141.6 million for 2005, and represented 33% and 36% of Membership fees for such
years. Commissions to associates are primarily dependent on the number of new
Memberships sold during a period and the average fee of those Memberships. New
Memberships sold during 2005 totaled 700,727, a 12% increase from the 624,525
sold during 2003, but the "add-on" IDT Membership sales are not included in
these totals and have increased 31% to 441,108 for 2005 from 335,792 for 2004
which increased our average Annual Membership fee 6% to $322.04 for 2005 from
$303.36 for 2004. The increase in the number of new Memberships sold with an
increase in the average Annual Membership fee resulted in a 19% increase in the
Membership Fees written.
Associate services and direct marketing expenses increased to $30.5 million
for 2005 from $29.3 million for 2004. Fast Start training fees and bonuses
incurred were approximately $4.8 million during 2005 compared to $3.7 million in
2004. This $1.1 million increase in Fast Start training fees and bonuses, a $1.5
million increase in the cost of new Associate kits, a $1.4 million increase in
direct marketing and marketing services costs, and a $150,000 increase in
Players Club and supply costs was partially offset by a $1.0 million decrease in
promotional bonuses and management team overrides and a $2.0 million decrease in
amortization of deferred associate cost and other costs. The Fast Start training
fees and bonuses are affected by the number of new sales associates that attend
Fast Start class and successfully meet the qualification criteria established by
us, i.e. more training bonuses will be paid when a higher number of new sales
associates meet such criteria. These expenses include the costs of providing
associate services and marketing expenses as discussed under Member and
Associate Costs.
General and administrative expenses during 2005 and 2004 were $49.0 million
and $43.7 million, respectively, and represented 12.6% and 12.3%, respectively,
of Membership fees for such years. Increases in the 2005 period were
attributable primarily to increases in printing and fulfillment costs associated
with our new Membership kit, higher employee costs, bank services charges and
Sarbanes Oxley compliance costs.
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, increased 9% to $10.5 million for 2005 from $9.6 million for 2004.
Depreciation and amortization decreased to $7.5 million for 2005 from $7.7
million for 2004. Litigation accruals have been reduced $303,000 and $121,000
during 2005 and 2004, respectively. Premium taxes increased from $1.7 million
for 2004 to $2.1 million for 2005 due to increased revenues in the states in
which we pay premium taxes. Interest expense increased to $2.7 million for 2005
compared to $2.0 million for the prior year. Interest income decreased to $1.5
million for 2005 from $1.7 million for 2004.
The provision for income taxes decreased during 2005 to $18.9 million
compared to $21.5 million for 2004, representing 34.5% of income before income
taxes for both years.
Comparison of 2004 to 2003
Net income for 2004 increased 2% to $40.8 million from $39.9 million for
2003. Diluted earnings per share for 2004 increased 9% to $2.48 per share from
$2.27 per share for the prior year due to increased net income of 2% and an
approximate 9% decrease in the weighted average number of outstanding shares.
Membership revenues for 2004 were up 8% to $355.5 million from $330.3 million
for the prior year marking the twelfth consecutive year of increased Membership
revenue.
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period. The active Memberships in force are determined by both the number of new
Memberships sold in any period together with the renewal rate of existing
Memberships. New Membership sales decreased 7% during 2004 to 624,525 from
671,857 during 2003. At December 31, 2004, there were 1,451,700 active
Memberships in force compared to 1,418,997 at December 31, 2003, an increase of
2%. Additionally, the average annual fee per Membership has increased from $262
for all Memberships in force at December 31, 2003 to $274 for all Memberships in
force at December 31, 2004, a 5% increase, as a result of a larger number of
Legal Shield subscribers, increased sales of our business oriented Memberships,
and the introduction of the Identity Theft Shield Membership during the last
quarter of 2003.
Associate services revenue decreased 3% from $25.7 million for 2003 to
$24.9 million during 2004 primarily as a result of a decline in new enrollments
of sales associates and fewer associates enrolling in the eService program. The
eService fees totaled $7.6 million during 2004 compared to $8.4 million for
2003, a decrease of 9%. We had a slight increase in fees for the Fast Start
program for 2004. We received training fees of approximately $8.9 million during
2004 compared to $7.7 million during 2003. The $8.9 million and $7.7 million for
2004 and 2003, respectively, in training fees was collected from approximately
105,247 new sales associates who elected to participate in Fast Start in 2004
compared to 107,490 during 2003. New associates electing to participate in Fast
Start decreased to 98% of new associates during 2004 from 99% for 2003. Total
new associates enrolled during 2004 were 107,552 compared to 108,557 for 2003, a
decrease of 1%.
Other revenue increased 6%, from $5.3 million to $5.6 million primarily due
to the increase in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $385.9 million for 2004 from $361.3 million during 2003, an
increase of 7%.
Membership benefits, which represent payments to provider law firms and
Kroll, totaled $122.3 million for 2004 compared to $111.2 million for 2003, and
represented 34% of Membership fees for both years.
Commissions to associates increased 3% from $115.4 million for 2003 to
$118.8 million for 2004, and represented 35% and 33% of Membership fees for such
years. These amounts were reduced by $196,000 and $165,000, respectively,
representing Membership lapse fees. New Memberships sold during 2004 totaled
624,525, a 7% decrease from the 671,857 sold during 2003, but the "add-on" IDT
Memberships are not included in these totals and have increased from 86,602 at
December 31, 2003 to 283,889 at December 31, 2004 which caused our total
commissions to increase during 2004.
Associate services and direct marketing expenses increased to $29.3 million
for 2004 from $28.9 million for 2003. Fast Start training bonuses incurred were
approximately $3.1 million during 2004 compared to $2.9 million in 2003. This
$200,000 increase in bonuses, a $233,000 increase in the amortization of
deferred associate costs and a $1.0 million increase in the cost of marketing
supplies were primarily offset by a $1.1 million decrease in direct marketing
costs and marketing team overrides. The Fast Start training bonuses are affected
by the number of new sales associates that successfully meet the qualification
criteria established by us, i.e. more training bonuses will be paid when a
higher number of new sales associates meet such criteria. These expenses also
include the costs of providing associate services and marketing expenses as
discussed under Member and Associate Costs.
General and administrative expenses during 2004 and 2003 were $43.7 million
and $36.7 million, respectively, and represented 12% and 11%, respectively, of
Membership fees for such years. Increases in the 2004 period were attributable
primarily to increases in printing and fulfillment costs associated with our new
Membership kit which we fully introduced in 2004, increases in other taxes
(other than Federal income tax), higher employee costs, legal fees and Sarbanes
Oxley compliance costs.
Other expenses, net, which includes depreciation and amortization,
litigation accruals and premium taxes reduced by interest income, increased 12%
to $9.6 million for 2004 from $8.5 million for 2003. Depreciation and
amortization increased to $7.7 million for 2004 from $7.1 million for 2003.
Premium taxes decreased from $2.7 million for 2003 to $1.7 million for 2004 due
to decreased revenues in the states in which we pay premium taxes. Interest
income increased to $1.7 million for 2004 from $1.4 million for 2003. Interest
expense increased to $2.0 million for 2004 compared to $123,000 for the prior
year. At December 31, 2004 we reported $56.6 million in cash and investments
(after utilizing $37.4 million to purchase approximately 1.5 million treasury
shares of our common stock during 2004) compared to $51.6 million at December
31, 2003.
The provision for income taxes increased during 2004 to $21.5 million
compared to $20.7 million for 2003, representing 34.5% and 34.1% of income
before income taxes for 2004 and 2003, respectively.
Liquidity and Capital Resources
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees collected and their contribution to cash flow
from operations during any period. Cash receipts from associate services are
directly impacted by the number of new sales associates enrolled and the price
of entry during the period, the number of associates subscribing to our eService
offering and the amount of sales tools purchased by the sales force.
The cash outlay related to Membership benefits is directly impacted by the
number of active Memberships and the contractual rate that exists between us and
our benefits providers. Commissions paid to associates are primarily dependent
on the number and price of new Memberships sold during a period and any special
incentives that may be in place during the period. Cash requirements related to
associate services and direct marketing activities are directly impacted by the
number of new associates enrolled during a period due to the cost of materials
provided to such new associates, the number of associates subscribing to our
eService offering, the amount of sales tools purchased by the sales force as
well as the number of those associates who successfully meet the Fast Start to
Success training and incentive award program qualifications.
Membership revenues are more than sufficient to fund the cash requirements
for membership benefits (at approximately 34%-35% of Membership revenues),
commissions (ranging from 33% to 36% of Membership revenues) and general and
administrative expense (at approximately 12.5% of Membership revenues). We have
generated significant cash flow from operations before changes in assets and
liabilities of approximately $45 million, $52 million and $48 million in 2005,
2004 and 2003, respectively. As discussed below, we have used a significant
portion of our cash flow to repurchase shares of our stock in the open market.
Cash flow from operations could be reduced if we experienced significant growth
in new members because of the negative cash flow characteristics of our
commission advance policies discussed above.
As a result of our ability to generate cash flow from operations, including
in periods of Membership growth, we have not historically been dependent on, and
do not expect to need in the future, external sources of financing from the sale
of securities or from bank borrowings to fund our basic business operations.
However, as described below, during the last three years, we incurred debt for
limited and specific purposes to permit us to construct a new corporate
headquarters, purchase equipment and to accelerate our treasury stock purchase
program.
General
Consolidated net cash provided by operating activities before changes in
assets and liabilities was $45.4 million, $51.7 million and $47.7 million for
2005, 2004 and 2003, respectively. Consolidated net cash provided by operating
activities was $50.1 million, $47.3 million and $51.7 million for 2005, 2004 and
2003, respectively. Cash provided by operating activities decreased $2.9 million
during 2005 compared to 2004 primarily due to a $4.1 million increase in the
change in accounts payable and accrued expenses and other net, the $2.5 million
increase in the change in deferred member and associate service costs and the
$2.1 million increase in the change in refundable income taxes partially offset
by the $5.0 million decrease in net income a $1.3 million decrease in the
provision for deferred income taxes and a $220,000 decrease in depreciation and
amortization
Net cash used in investing activities was $15.5 million, $11.3 million and
$36.9 million for 2005, 2004 and 2003, respectively. In addition to capital
expenditures of $14.8 million, $10.9 million and $27.0 million during 2005, 2004
and 2003, respectively, our purchases of available-for-sale investments exceeded
the maturities and sales of such investments by $767,000, $443,000 and $9.9
million in 2005, 2004 and 2003, respectively.
Net cash used in financing activities was $26.6 million, $31.4 million and
$14.2 million for 2005, 2004 and 2003, respectively. This $4.8 million change
during 2005 was primarily comprised of a $25.8 million decrease in purchases of
treasury stock partially offset by a $5.2 million decrease in proceeds from
issuance of debt, a $3.1 million increase in repayment of debt, a $700,000
decrease in proceeds from sale of common stock on exercise of options and a
$12.4 million increase in dividends paid.
We had a consolidated working capital deficit of $3.1 million at December
31, 2005, a decrease of $18.6 million compared to a consolidated working capital
deficit of $21.7 million at December 31, 2004. The decrease was primarily due to
the $8.0 million increase in cash and a $5.9 million increase in current
available-for-sale investments. The $3.1 million working capital deficit at
December 31, 2005 would have been $7.0 million in excess working capital
excluding the $10.1 million of current portion of deferred revenue and fees in
excess of the current portion of deferred member and associate service costs.
These amounts will be eliminated by the passage of time without the utilization
of other current assets or us incurring other current liabilities. Additionally,
at the current rate of cash flow provided by continuing operations ($50.1
million during 2005) and our contractual commitment that limits the amount of
any future dividends, we do not expect any difficulty in meeting our financial
obligations in the short term or the long term.
We generally advance significant commissions to associates at the time a
Membership is sold. We expense these advances ratably over the first month of
the related Membership. During 2005, we paid advance commissions to associates
of $138.8 million on new Membership sales compared to $115.9 million for 2004.
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, we typically derive significant positive cash flow
from the Membership over its remaining life. See Commissions to Associates above
for additional information on advance commissions.
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to
10,000,000 shares during subsequent board meetings. At December 31, 2005, we had
purchased 9.4 million treasury shares under these authorizations for $222.5
million, an average price of $23.64 per share, including $11.7 million of
purchases in 2005. 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 our liquidity, however, due to restrictions contained in
our debt agreements with lenders, we are limited in our treasury stock
purchases. At December 31, 2005, we had more than $19.8 million availability
under existing bank covenant restrictions to purchase additional treasury
shares. No time limit has been set for completion of the treasury stock purchase
program. Given the current interest rate environment, the nature of other
investments available and our expected cash flows, management believes that
purchasing treasury shares enhances shareholder value. We expect to continue our
treasury stock program. From time to time, we evaluate alternative sources of
financing to continue or accelerate this program.
We believe that we have significant ability to finance expected future
growth in Membership sales based on our existing amount of cash and cash
equivalents and unpledged investments at December 31, 2005 of $59.9 million. We
expect to maintain cash and cash equivalents and investment balances on an
on-going basis of approximately $20 million to $30 million in order to meet
expected working capital needs and regulatory capital requirements. Balances in
excess of this amount would be used for discretionary purposes such as treasury
stock purchases, dividends, and advance repayment of debt subject to the
restrictions contained in our debt agreements.
As more fully discussed in Item 2 - Description of Property, we completed a
new office complex during 2004 containing approximately 170,000 square feet of
office space constructed on approximately 87 acres contributed to us by the City
of Ada in 2001 as part of an economic development incentive package. Costs
incurred of approximately $34.1 million, including $706,000 in capitalized
interest costs, have been paid from existing resources and proceeds from a $20
million line of credit for the new office construction.
Our real estate loan of $20 million was fully funded in December 2003 with
interest at the 30 day LIBOR rate plus 2.25%, adjusted monthly, and repayments
began in December 2003 with monthly principal payments of $190,000 plus interest
with a balloon payment on September 30, 2008. The interest rate at December 31,
2005 was 6.56%. The loan is primarily collateralized by a first mortgage on the
87 acre home office complex, the 170,000 square foot home office complex, our
rights to receive Membership fees on a portion of our Memberships and by a
security interest covering all equipment. The real estate loan agreement
provides for financial covenants substantially the same as those described below
for the stock purchase loan.
Our $31.5 million stock purchase loan was fully funded in September 2004
with interest at the 30 day LIBOR rate plus 3%, adjusted monthly, and repayments
began in October 2004 with 24 monthly principal payments of $1.3 million ending
September 30, 2006. The interest rate at December 31, 2005 was 7.31%. The loan
is primarily collateralized by our rights to receive Membership fees on a
portion of our Memberships and a pledge of the stock of our subsidiaries. The
definitive agreement contains covenants prohibiting us from pledging assets,
incurring additional indebtedness and selling assets. In addition to customary
events of default, an additional event of default occurs if Harland C.
Stonecipher ceases to be our chairman and Chief Executive Officer for 90 days.
Pre-payment of the loan is permitted. The loan agreements contain the following
financial covenants: (a) our quarterly Debt Coverage Ratio (as defined in the
loan agreements) shall not be less than 110%; (b) our cancellation rate on
contracts less than or equal to twelve months old shall not exceed 45% on a
trailing 12 month basis, calculated on a quarterly basis; (c) we shall maintain
a rolling twelve month average retention rate of Membership contracts in place
for greater than eighteen months of not less than 70%, calculated on a monthly
basis; (d) we shall not pay dividends or purchase treasury shares, which during
any fiscal quarter, on a combined basis, would exceed sixty five percent (65%)
of our cumulative net income for all previous fiscal quarters beginning July 1,
2004 less any dividends or stock purchases in such previous fiscal quarters,
with provisions for carry forwards of unused availability; and, (e) our tangible
net worth shall not fall below $10 million for the period of time dating from
September 30, 2004, $15 million beginning March 31, 2005 and $25 million
beginning December 31, 2005. At December 31, 2005, we were restricted from
paying dividends or purchasing treasury shares in excess of $19.8 million
pursuant to these covenants. We were in compliance with the above covenants at
December 31, 2005.
Our $11.5 million aircraft loan was fully funded in November 2005 with
interest payable monthly at the 30 day LIBOR rate plus 1.75%, adjusted monthly,
and requires monthly principal installments of $96,000 beginning December 31,
2005 with the remaining balance payable in a final installment due November 30,
2012. The interest rate at December 31, 2005 was 6.06%. The loan is primarily
collateralized by the aircraft purchased. In addition to customary events of
default, if Harland C. Stonecipher ceases to be our Chief Executive Officer for
a period of 90 consecutive days an event of default will occur.
Parent Company Funding and Dividends
Although we are the operating entity in many jurisdictions, our
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, PPLSIF and LSPV. The
ability of these subsidiaries to provide funds to us is subject to a number of
restrictions under various insurance laws in the jurisdictions in which they
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, PPLSIF or LSPV, or any of our
regulated subsidiaries, will be funded by us in the form of capital
contributions or surplus debentures. During February 2004, we made a capital
contribution to a wholly-owned subsidiary of PPLCI, Pre-Paid Legal Services of
Tennessee, Inc. in the amount of $600,000. At January 1, 2006, neither PPLSIF
nor LSPV had funds available for payment of substantial dividends without the
prior approval of the insurance commissioner. While PPLCI had surplus funds
available for payment of an ordinary dividend, no such dividend was declared or
paid during 2004 or 2003. At January 1, 2006 PPLCI had approximately $6.1
million available for payment of an ordinary dividend. At December 31, 2005 the
amount of restricted net assets of consolidated subsidiaries was $25.3 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Contractual Obligations
The following table reflects our contractual obligations as of December 31,
2005.
Payments Due by Period (In Thousands)
More
Less than than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
-------------------------------------------------- ----------- ---------- ---------- ---------- ----------
Long-term debt.................................... $ 38,470 $ 15,250 $ 15,255 $ 2,304 $ 5,661
Purchase obligations (1).......................... 13,778 9,561 4,116 101 -
Capital leases.................................... 2,647 420 501 162 1,564
Deferred compensation plan........................ 3,932 - - - 3,932
Operating leases.................................. 300 127 169 4 -
----------- ---------- ---------- ---------- ----------
Total (2)......................................... $ 59,127 $ 25,358 $ 20,041 $ 2,571 $ 11,157
----------- ---------- ---------- ---------- ----------
(1) Includes contractual commitments pursuant to executory contracts for
products and services such as voice and data services and contractual
obligations related to future Company events such as hotel room blocks,
meeting space and food and beverage guarantees. We expect to receive
proceeds from such future events and reimbursement from provider law firms
for certain voice and data services that will partially offset these
obligations.
(2) Does not include commitments for attorney provider payments, commissions,
etc. which are expected to remain in existence for several years but as to
which our obligations vary directly either based on Membership revenues or
new Memberships sold and are not readily estimable.
Forward-Looking Statements
All statements in this report other than purely historical information,
including but not limited to, statements relating to our future plans and
objectives, 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 our historical operating
trends and financial condition as of December 31, 2005 and other information
currently available to management. We caution that the Forward-Looking
Statements are subject to all the risks and uncertainties incident to our
business, including but not limited to risks described below. Moreover, we 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.
We assume no obligation to update the Forward-Looking Statements to reflect
events or circumstances occurring after the date of the statement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
-------------------------------------------------------------------------
Disclosures About Market Risk
Our consolidated balance sheets include a certain amount of assets and
liabilities whose fair values are subject to market risk. Due to our significant
investment in fixed-maturity investments, interest rate risk represents the
largest market risk factor affecting our 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, 2005, substantially all of our investments were in
investment grade (rated Baa or higher) fixed-maturity investments and
interest-bearing money market accounts including certificates of deposit. We do
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 our 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, 2005 (1).... $ 27,541 100 bp increase $ 26,129
200 bp increase 24,809
50 bp decrease 27,723
100 bp decrease 28,613
Fixed-maturity investments at December 31, 2004 (1).... $ 27,023 100 bp increase $ 25,454
200 bp increase 24,024
50 bp decrease 27,605
100 bp decrease 28,288
--------------------
(1) Excluding short-term investments with a fair value of $2.6 million and $2.5
million at December 31, 2005 and 2004, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2005 would reduce
the estimated fair value of our fixed-maturity investments by approximately
$2.7 million at that date. At December 31, 2004, and based on the fair
value of fixed-maturity investments of $27.0 million, an instantaneous 200
basis point increase in market interest rates would have reduced the
estimated fair value of our fixed-maturity investments by approximately
$3.0 million at that date. The definitive extent of the interest rate risk
is not quantifiable or predictable due to the variability of future
interest rates, but we do not believe such risk is material.
We primarily manage our exposure to interest rate risk by purchasing
investments that can be readily liquidated should the interest rate environment
begin to significantly change.
Interest Rate Risk
We are exposed to market risk related to changes in interest rates. As of
December 31, 2005, we had $38.5 million in notes payable outstanding at interest
rates indexed to the 30 day LIBOR rate that exposes it to the risk of increased
interest costs if interest rates rise. Assuming a 100 basis point increase in
interest rates on the floating rate debt, interest expense would increase by
approximately $385,000. As of December 31, 2005, we had not entered into any
interest rate swap agreements with respect to the term loans.
Foreign Currency Exchange Rate Risk
Although we are exposed to foreign currency exchange rate risk inherent in
revenues, net income and assets and liabilities denominated in Canadian dollars,
the potential change in foreign currency exchange rates is not a substantial
risk, as approximately 1% of our revenues are derived outside of the United
States.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
----------------------------------------------------------
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm
Management's Annual Report on Internal Control over Financial Reporting
Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2005 and 2004
Consolidated Statements of Income - For the years ended December 31, 2005, 2004
and 2003
Consolidated Statements of Cash Flows - For the years ended December 31, 2005,
2004 and 2003
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
Financial Statement Schedules
-----------------------------
Schedule I - Condensed Financial Information of the Registrant
(All other schedules have been omitted since the required information is
not applicable or because the information is included in the consolidated
financial statements or the notes thereon.)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that Pre-Paid
Legal Services, Inc. and subsidiaries (the "Company") maintained effective
internal control over financial reporting as of December 31, 2005 based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO").
Management of the Company is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A Company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on criteria established in
Internal Control--Integrated Framework issued by COSO. Also in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2005, based on criteria established in
Internal Control--Integrated Framework issued by COSO. We have also audited, in
accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheets of the Company as of December
31, 2005 and 2004, and the related statements of income, cash flows and changes
in stockholders' equity for each of the three years in the period ended December
31, 2005 and our report dated February 23, 2006 expressed an unqualified opinion
on those financial statements.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 23, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2005 and
2004, 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, 2005. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2005 and 2004, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2005, in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2005 and 2004 and for each of
the three years in the period ended December 31, 2005. In our opinion, this
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated February 23, 2006 expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company's
internal control over financial reporting.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 23, 2006
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. In order to evaluate the
effectiveness of internal control over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act, our management has conducted an
assessment, including testing, using the criteria in Internal Control-Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission ("COSO"). Our system of internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and (iii)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Based on the assessment, our management has concluded that we maintained
effective internal control over financial reporting as of December 31, 2005,
based on criteria in Internal Control-Integrated Framework issued by the COSO.
Management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005, has been audited by Grant Thornton
LLP, an independent registered public accounting firm, as stated in their report
which is included herein.
Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
---------------------------
2005 2004
------------ -------------
Current assets:
Cash and cash equivalents............................................................ $ 33,957 $ 25,972
Available-for-sale investments, at fair value........................................ 6,742 804
Membership fees receivable........................................................... 5,395 4,961
Inventories.......................................................................... 1,717 1,623
Refundable income taxes.............................................................. - 1,241
Deferred member and associate service costs.......................................... 16,210 15,420
Deferred income taxes................................................................ 4,894 4,829
Other assets......................................................................... 5,236 3,518
------------ -------------
Total current assets............................................................. 74,151 58,368
Available-for-sale investments, at fair value.......................................... 19,213 25,455
Investments pledged.................................................................... 4,307 4,381
Property and equipment, net............................................................ 58,947 51,232
Deferred member and associate service costs............................................ 3,003 2,580
Other assets........................................................................... 5,244 4,048
------------ -------------
Total assets................................................................... $ 164,865 $ 146,064
------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 11,638 $ 10,340
Deferred revenue and fees............................................................ 26,287 24,585
Current portion of capital leases payable............................................ 321 338
Current portion of notes payable..................................................... 15,250 18,036
Common stock dividends payable....................................................... 4,643 7,796
Accounts payable and accrued expenses................................................ 19,095 15,451
------------ -------------
Total current liabilities.......................................................... 77,234 76,546
Capital leases payable............................................................... 1,296 1,618
Notes payable........................................................................ 23,220 27,050
Deferred revenue and fees............................................................ 3,007 2,361
Deferred income taxes................................................................ 4,782 4,248
Other non-current liabilities........................................................ 3,932 2,794
------------ -------------
Total liabilities................................................................ 113,471 114,617
------------ -------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 20,326 and
20,465 issued at December 31, 2005 and 2004, respectively.......................... 203 205
Retained earnings.................................................................... 149,832 129,290
Accumulated other comprehensive income............................................... 387 980
Treasury stock, at cost; 4,852 shares held at December 31, 2005
and 2004, respectively............................................................. (99,028) (99,028)
------------ -------------
Total stockholders' equity....................................................... 51,394 31,447
------------ -------------
Total liabilities and stockholders' equity..................................... $ 164,865 $ 146,064
------------ -------------
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,
------------------------------------------
2005 2004 2003
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 389,255 $ 355,461 $ 330,322
Associate services................................................... 28,963 24,901 25,704
Other................................................................ 5,162 5,575 5,287
------------- ------------- -------------
423,380 385,937 361,313
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 137,150 122,280 111,165
Commissions.......................................................... 141,631 118,757 115,386
Associate services and direct marketing.............................. 30,453 29,325 28,929
General and administrative........................................... 49,015 43,742 36,711
Other, net........................................................... 10,456 9,578 8,546
------------- ------------- -------------
368,705 323,682 300,737
------------- ------------- -------------
Income before income taxes............................................. 54,675 62,255 60,576
Provision for income taxes............................................. 18,863 21,478 20,669
------------- ------------- -------------
Net income............................................................. $ 35,812 $ 40,777 $ 39,907
------------- ------------- -------------
Basic earnings per common share........................................ $ 2.31 $ 2.50 $ 2.28
------------- ------------- -------------
Diluted earnings per common share...................................... $ 2.29 $ 2.48 $ 2.27
------------- ------------- -------------
Dividends declared per common share.................................... $ .60 $ .50 $ -
------------- ------------- -------------
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,
-----------------------------------
2005 2004 2003
---------- ---------- ----------
Cash flows from operating activities:
Net income....................................................................... $ 35,812 $ 40,777 $ 39,907
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for deferred income taxes............................................ 912 2,197 288
Depreciation and amortization.................................................. 7,489 7,709 7,082
Tax benefit on exercise of stock options....................................... 1,221 775 234
Compensation expense relating to contribution of stock to ESOP................. - 231 220
---------- ---------- ----------
Cash provided by operating activities before changes in assets and liabilities 45,434 51,689 47,731
---------- ---------- ----------
(Increase) decrease in accrued Membership income............................... (434) (386) 672
(Increase) decrease in inventories............................................. (94) (766) 355
Decrease (increase) in refundable income taxes................................. 1,241 (910) (56)
(Increase) decrease in deferred member and associate service costs............. (1,213) (1,410) 40
Increase in other assets....................................................... (2,914) (2,431) (2,407)
Increase in accrued Membership benefits........................................ 1,298 1,051 679
Increase (decrease) in deferred revenue and fees............................... 2,348 (147) 215
Increase in other non-current liabilities...................................... 1,138 1,349 1,445
Increase (decrease) in accounts payable and accrued expenses and other, net.... 3,327 (776) 3,019
---------- ---------- ----------
Net cash provided by operating activities.................................... 50,131 47,263 51,693
---------- ---------- ----------
Cash flows from investing activities:
Additions to property and equipment............................................ (14,778) (10,879) (27,012)
Purchases of investments - available-for-sale.................................. (18,312) (24,135) (15,695)
Maturities and sales of investments - available-for-sale....................... 17,545 23,692 5,806
---------- ---------- ----------
Net cash used in investing activities........................................ (15,545) (11,322) (36,901)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt................................................. 13,829 19,000 42,700
Repayments of debt............................................................. (20,445) (17,335) (9,912)
Proceeds from exercise of stock options........................................ 4,439 5,176 2,014
Purchases of treasury stock.................................................... (11,673) (37,461) (48,292)
Proceeds from other financing.................................................. - - 1,000
Decrease in capital lease obligations.......................................... (339) (808) (1,701)
Dividends paid................................................................. (12,412) - -
---------- ---------- ----------
Net cash used in financing activities........................................ (26,601) (31,428) (14,191)
Net increase in cash and cash equivalents........................................ 7,985 4,513 601
Cash and cash equivalents at beginning of year................................... 25,972 21,459 20,858
---------- ---------- ----------
Cash and cash equivalents at end of year......................................... $ 33,957 $ 25,972 $ 21,459
---------- ---------- ----------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized.............................. $ 2,432 $ 1,752 $ 78
---------- ---------- ----------
Cash paid for income taxes..................................................... $ 13,350 $ 19,429 $ 20,200
---------- ---------- ----------
Non-cash activities - cash dividends declared but not paid..................... $ 4,643 $ 7,796 $ -
---------- ---------- ----------
Non-cash activities - capital lease obligations incurred....................... $ - $ 1,058 $ 2,481
---------- ---------- ----------
Non-cash activities - asset additions due to trade-in allowance................ $ 426 $ - $ -
---------- ---------- ----------
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)
Common Stock Capital in Treasury Stock
------------------- Excess of Retained Accum. --------------------
Shares Amount Par Value Earnings OCI(1) Shares Amount Total
--------- --------- ----------- ----------- -------- --------- ---------- ----------
January 1, 2003........................... 23,688 $ 237 $ 43,219 $ 90,254 $ 290 4,852 $(99,028) $34,972
Contributed to Company's ESOP plan....... 8 - 220 - - - - 220
Exercise of stock options and other...... 105 - 2,014 - - - - 2,014
Income tax benefit related to exercise
of stock options....................... - - 234 - - - - 234
Net income............................... - - - 39,907 - - - 39,907
Other comprehensive income............... - - - - 519 - - 519
Treasury shares purchased................ - - - - - 2,127 (48,292) (48,292)
Treasury shares retired.................. (2,127) (20) (45,687) (2,585) - (2,127) 48,292 -
--------- --------- ----------- ----------- -------- --------- ---------- ----------
December 31, 2003.......................... 21,674 217 - 127,576 809 4,852 (99,028) 29,574
Contributed to Company's ESOP plan....... 10 - - 231 - - - 231
Exercise of stock options and other...... 234 2 - 5,174 - - - 5,176
Income tax benefit related to exercise
of stock options....................... - - - 775 - - - 775
Net income............................... - - - 40,777 - - - 40,777
Other comprehensive income............... - - - - 171 - - 171
Treasury shares purchased................ - - - - - 1,453 (37,461) (37,461)
Treasury shares retired.................. (1,453) (14) - (37,447) - (1,453) 37,461 -
Common stock dividends incurred.......... - - - (7,796) - - - (7,796)
--------- --------- ----------- ----------- -------- --------- ---------- ----------
December 31, 2004.......................... 20,465 205 - 129,290 980 4,852 (99,028) 31,447
Exercise of stock options and other...... 197 1 - 4,438 - - - 4,439
Income tax benefit related to exercise
of stock options....................... - - - 1,221 - - - 1,221
Net income............................... - - - 35,812 - - - 35,812
Other comprehensive income............... - - - - (593) - - (593)
Treasury shares purchased................ - - - - - 336 (11,673) (11,673)
Treasury shares retired.................. (336) (3) - (11,670) - (336) 11,673 -
Common stock dividends incurred.......... - - - (9,259) - - - (9,259)
--------- --------- ----------- ----------- -------- --------- ---------- ----------
December 31, 2005.......................... 20,326 $ 203 $ - $ 149,832 $ 387 4,852 $(99,028) $51,394
--------- --------- ----------- ----------- -------- --------- ---------- ----------
(1) Other Comprehensive Income Year Ended December 31,
----------------------------
2005 2004 2003
-------- -------- -------
Net income.................................................................... $35,812 $40,777 $39,907
Other comprehensive income, net of tax:
Foreign currency translation adjustment..................................... 100 153 137
-------- -------- -------
Unrealized gains on investments:
Unrealized holding (losses) gains arising during period,.................. (871) 116 469
Less: reclassification adjustment for losses (gains) included in net
income............................................................ 178 (98) (87)
-------- -------- -------
(693) 18 382
-------- -------- -------
Other comprehensive income, net of income taxes of $(443), $12 and $206 in
2005, 2004 and 2003, respectively........................................... (593) 171 519
-------- -------- -------
Comprehensive income.......................................................... $35,219 $40,948 $40,426
-------- -------- -------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands unless
otherwise indicated)
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Pre-Paid Legal Services, Inc. (the "Parent") and subsidiaries
(collectively, the "Company") develops and markets legal service plans (referred
to as "Memberships"). The Memberships sold by us allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with us. During the third quarter of 2003, we began offering our
Identity Theft Shield to new and existing members at $9.95 per month if added to
a legal service Membership or it may be purchased separately for $12.95 per
month. The nationwide provider of the Identity Theft Shield benefits and the
Provider law firms are paid a fixed fee on a capitated basis to render services
to plan members residing within the state or province in which the provider law
firm is licensed to practice. Because the fixed fee payments by us to benefit
providers do not vary based on the type and amount of benefits utilized by the
member, this capitated arrangement provides significant advantages to us in
managing claims risk. At December 31, 2005, Memberships subject to the capitated
benefit provider arrangement comprised approximately 99% of our 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, 2005, we had 1,542,789 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 provinces. The Memberships are marketed by an independent sales force
referred to as "associates."
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities.
Principles of Consolidation
The consolidated financial statements include our accounts and our wholly
owned subsidiaries, as well as those of PPL Agency, Inc. (See Note 10 for
additional information regarding PPL Agency, Inc.). Our primary subsidiaries
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.
Reclassifications
Certain amounts in the prior periods presented have been reclassified to
conform to the current period financial statement presentation. These
reclassifications have no effect on previously reported net income.
Foreign Currency Translation
The financial results of our Canadian operations are measured in local
currency and then translated into U.S. dollars. All balance sheet accounts have
been translated using the current rate of exchange at the balance sheet date.
Results of operations have been translated using the average rates prevailing
throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash, certificates of
deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by us, using
available market information and appropriate valuation methodologies. The
carrying value of cash, certificates of deposit, Membership fees receivable,
Membership benefits payable and accounts payable and accrued expenses are
considered to be representative of their respective fair value, due to the short
term nature of these instruments. The carrying value of notes payable is
considered to be representative of their respective fair value, due to the
variable interest rate feature of such notes. The fair value disclosures
relating to debt and equity securities are presented in Note 2.
Cash and Cash Equivalents
We consider all highly liquid unpledged investments with maturities of
three months or less at time of acquisition to be cash equivalents. We place our
temporary cash investments with high credit quality financial institutions. At
times such investments may be in excess of the Federal Deposit Insurance
Corporation (FDIC) insurance limit. We have not experienced any losses in such
accounts and believe we are not exposed to any significant credit risk on cash
and cash equivalents.
Investments
We classify our investments held as available-for-sale and account for them
at fair value with unrealized gains and losses, net of taxes, excluded from
earnings and reported as other comprehensive income. We classify
available-for-sale securities as current if we expect to sell the securities
within one year, or if we intend 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
our investments in certain state and political subdivision debt instruments is
not generally taxable for federal income tax purposes.
Membership fees receivable
Our Membership fees receivable consists of amounts due from members for
services provided pursuant to their Membership contract. Membership fees are
principally collected on a monthly basis. Membership fees receivable is a result
of a portion of members, mostly group members, who pay their Membership fees in
arrears and are recorded at amounts due under the terms of the Membership
agreement. An allowance for doubtful accounts is not necessary as the recorded
amount is adjusted to net realizable value at period-end based on our historical
experience and the short period of time after period-end in which the accounts
will be collected.
Inventories
Inventories include the cost of materials and packaging and are stated at
the lower of cost or market.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and
amortization. Depreciation of property and equipment is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the estimated useful lives of the related assets
or the period of the lease, whichever is shorter. Maintenance and repairs are
expensed as incurred and renewals and betterments are capitalized. Interest cost
incurred during the construction period of major facilities is capitalized. The
capitalized interest is recognized as part of the asset to which it relates and
is amortized over the asset's estimated useful life.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
basis. Approximately 95% of members remit their Membership fees on a monthly
basis, of which approximately 73% are paid in advance and, therefore, are
deferred and recognized over the following month.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs of $10 for 2005 are deferred and recognized in income over the
estimated life of a Membership in accordance with SEC Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," ("SAB 101"). We compute
the expected Membership life using more than 20 years of actuarial data. At
December 31, 2005, we computed the expected Membership life to be approximately
3 years. If the expected Membership life were to change significantly, which
management does not expect in the short term, the deferred Membership enrollment
fee and related costs would be recognized over a longer or shorter period.
We derive revenues from services provided to our marketing sales force
primarily from a one-time non-refundable enrollment fee from each new sales
associate for which we provide initial sales and marketing supplies and
enrollment services to the associate. Average enrollment fees paid by new sales
associates were $57, $142 and $136 for 2005, 2004 and 2003, respectively.
Revenue from, and costs of, the initial sales and marketing supplies
(approximately $14) are recognized when the materials are delivered to the
associates. The remaining revenues and related incremental direct and
origination costs are deferred and recognized over the estimated average active
service period of associates which at December 31, 2005 is estimated to be
approximately six months, unchanged from year end 2004. At both December 31,
2005 and 2004, the deferred revenue associated with sales associate enrollment
fees was $1.6 million, which is classified as a current liability. Management
estimates the active service period of an associate periodically based on the
average number of months an associate produces new Memberships including those
associates that fail to write any Memberships. If the active service period of
associates changes significantly, which management does not expect in the short
term, the deferred revenue and related costs would be recognized over the new
estimated active service period.
We also encourage participation in a training program ("Fast Start") that
allows an associate who successfully completes the program to advance through
the various commission levels at a faster rate. Associate services revenue also
includes revenue recognized on the sale of marketing supplies and promotional
material to associates and includes fees related to our eService program for
associates. The eService program provides subscribers Internet based back office
support such as reports, on-line documents, tools, a personal e-mail account and
multiple personalized web sites with "flash" movie presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
and associates related to deferred Membership revenue. Deferred costs for
enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments. Deferred costs
for enrolling new associates include training and success bonuses paid to
individuals involved in recruiting the associate and salary and benefit costs of
employees who process associate enrollments. Such costs are deferred to the
extent of the lesser of actual costs incurred or the amount of the related fee
charged for such services. Deferred costs are amortized to expense over the same
period as the related deferred revenue. Deferred costs that will be recognized
within one year of the balance sheet date are classified as current and all
remaining deferred costs are considered noncurrent. Associate related costs are
reflected as associate services and direct marketing, and are expensed as
incurred if not related to the deferred revenue discussed above. These costs
include providing materials and services to associates, Fast Start bonuses,
associate introduction kits, the associate incentive program, group marketing
and marketing services departments (including costs of related travel, marketing
events, leadership summits and international sales convention). Shipping and
handling costs of $2.8 million in 2005 and $2.4 million in 2004 are primarily
included in Associate services and direct marketing costs.
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due the
provider of Identity Theft Shield benefits and provider law firms on
approximately 99% of the Memberships and claims reported but not paid and
actuarially estimated claims incurred but not reported on the remaining
non-provider Memberships which represent approximately 1%. We calculate 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 us and subsequently paid. Processing costs related to
these claims are accrued based on an estimate of expenses to process such
claims.
Income Taxes
We account 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
our financial statements and tax returns. In estimating future tax consequences,
we generally consider all future events other than future changes in the tax law
or rates that have not been enacted.
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
We record 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, we establish a valuation allowance to reduce such assets to the estimated
realizable amount.
Commissions to Associates
Prior to March 1, 2002, we had a level Membership commission schedule of
approximately 27% of Membership fees and advanced the equivalent of up to three
years of commissions on new Membership sales. Effective March 1, 2002, and in
order to offer additional incentives for increased Membership retention rates,
we returned to a differential commission structure with rates of approximately
80% of first year Membership fees on new Memberships written and variable
renewal commission rates ranging from five to 25% per annum based on the 12
month Membership retention rate of the associate's sales organization. Beginning
in August 2003, we allowed the associate to choose between the level commission
structure and up to three year commission advance or the differential commission
structure with a one year commission advance.
We expense advance commissions ratably over the first month of the related
Membership. As a result of this accounting policy, our advance commission
expenses are recorded in the first month of a Membership and there is no
commission expense recognized for the same Membership during the remainder of
the advance period. Associates must qualify for advance commissions by writing
at least three Memberships.
Long-Lived Assets
We review 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
We have a stock-based employee compensation plan, which is described more
fully in Note 13. We account for this plan under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if we had applied
the fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation. Year Ended
December 31,
Year Ended December 31,
----------------------------------
2005 2004 2003
--------- --------- ---------
Net income, as reported................................................... $ 35,812 $ 40,777 $ 39,907
Deduct: Total stock-based employee compensation expense determined under
fair value based method for all awards, net of related tax effects........ - (441) (860)
--------- --------- ---------
Pro forma net income...................................................... $ 35,812 $ 40,336 $ 39,047
--------- --------- ---------
Earnings per share:
Basic - as reported................................................... $ 2.31 $ 2.50 $ 2.28
Basic - pro forma..................................................... $ 2.31 $ 2.47 $ 2.23
Diluted - as reported................................................. $ 2.29 $ 2.48 $ 2.27
Diluted - pro forma................................................... $ 2.29 $ 2.45 $ 2.22
The estimated fair value of options granted to employees during 2004 and
2003 (no options were granted during 2005) was estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions used: no dividend yield; risk-free interest rate of 2.16% for 2004
and 2.38% for 2003; expected life of 3-5 years; and expected volatility for the
years ending December 31, 2004 and 2003 were 52.8% and 55.9%, respectively.
Using these assumptions, the weighted average fair values at date of grant for
options granted during 2004 and 2003 were $8.74 and $8.63, respectively.
The exercise of certain stock options which have been granted gives rise to
compensation which is includable in the taxable income of the option grantee and
deductible by us for federal and state income tax purposes. Such compensation
results from increases in the fair market value of our common stock subsequent
to the date of grant of the applicable exercised stock options, and in
accordance with Accounting Principles Board Opinion No. 25, such compensation is
not recognized as an expense for financial accounting purposes and the related
tax benefits are recorded in capital in excess of par value.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. Changes to any of these
assumptions would directly affect the amount accrued but we do not expect any of
the significant trends impacting this account to change significantly in the
near term.
Legal Contingencies
We account for legal contingencies in accordance with SFAS 5, Accounting
for Contingencies, which requires that a loss contingency should be accrued by a
charge to income if it is probable that an asset has been impaired or a
liability has been incurred and the amount of the loss can be reasonably
estimated. Disclosure of a contingency is required if there is at least a
reasonable possibility that a loss has been incurred. We evaluate, among other
factors, the degree of probability of an unfavorable outcome and the ability to
make a reasonable estimate of the amount of loss. This process requires
subjective judgment about the likely outcomes of litigation. Liabilities related
to most of our lawsuits are especially difficult to estimate due to the nature
of the claims, limitation of available data and uncertainty concerning the
numerous variables used to determine likely outcomes or the amounts recorded.
Litigation expenses are recorded as incurred and we do not accrue for future
legal fees. It is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Segment Information
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosures about products and services and geographic
areas are presented in Note 16.
New Accounting Standards Issued
In November 2005, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position ("FSP") FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
This FSP addresses the determination as to when an investment is considered
impaired, whether that impairment is other than temporary, and the measurement
of an impairment loss. This FSP also includes accounting considerations
subsequent to the recognition of an other-than-temporary impairment and requires
certain disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance in this FSP is applicable to
reporting periods beginning after December 15, 2005. Management does not expect
the adoption of this FSP to have a material effect on our consolidated financial
position and results of operations.
In December 2004, the FASB issued SFAS No. 123(R) "Share-Based Payment,"
which replaces SFAS No. 123 "Accounting for Stock-Based Compensation," and
supersedes APB Opinion No. 25 "Accounting for Stock Issued to Employees." In
March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 107 "Share-Based Payment," which provides interpretive guidance
related to SFAS No. 123(R). SFAS No. 123(R) requires compensation costs related
to share-based payment transactions to be recognized in the financial
statements. With limited exceptions, the amount of compensation cost is measured
based on the grant-date fair value of the equity or liability instruments
issued. SFAS No. 123(R) requires liability awards to be remeasured each
reporting period and compensation costs to be recognized over the period that an
employee provides service in exchange for the award. Management plans to adopt
this statement on the modified prospective basis beginning January 1, 2006, and
does not expect adoption of this statement to have a material effect on our
consolidated financial position and results of operations. Subsequent to
adoption of this statement, share-based benefits will be valued at fair value
using the Black-Scholes option pricing model for option grants and the grant
date fair market value for stock awards. Compensation amounts so determined will
be expensed over the applicable vesting period.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20, and FASB Statement No. 3"
("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, "Accounting Changes," and
FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements," and changes the requirements for the accounting for and reporting
of a change in accounting principle. This statement applies to all voluntary
changes in accounting principle. It also applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 31, 2005.
Note 2 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of our investments at December 31, 2005 and 2004 follows:
December 31, 2005
-------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ----------- --------- --------- ---------
U.S. Government obligations........................ $ 9,482 $ 65 $ (120) $ 9,427
Corporate obligations.............................. 2,453 8 (80) 2,381
Equity securities.................................. 136 23 - 159
Obligations of state and political subdivisions.... 15,743 133 (142) 15,734
Certificates of deposit............................ 2,561 - - 2,561
----------- --------- --------- ---------
Total.............................................. $ 30,375 $ 229 $ (342) $ 30,262
----------- --------- --------- ---------
December 31, 2004
-------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ----------- --------- --------- ---------
U.S. Government obligations........................ $ 9,784 $ 146 $ (39) $ 9,891
Corporate obligations.............................. 2,982 28 (9) 3,001
Equity securities.................................. 417 663 - 1,080
Obligations of state and political subdivisions.... 13,898 271 (38) 14,131
Certificates of deposit............................ 2,537 - - 2,537
----------- --------- --------- ---------
Total.............................................. $ 29,618 $ 1,108 $ (86) $ 30,640
----------- --------- --------- ---------
In determining whether declines in the fair value of available-for-sale
securities below their cost are other than temporary, management considers the
financial condition of the issuer, causes for the decline in fair value (i.e.,
interest rate fluctuations or declines in creditworthiness) and severity and
duration of the decline, among other things. At December 31, 2005 we had 60
securities (primarily municipal securities) with unrealized losses in four
consecutive quarters with combined market losses of $94,000. These losses were
determined to be temporary since substantially all of these securities were AAA
rated and we intend to hold to maturity Additionally, we recognized a loss for
an other than temporary decline of $282,000 related to our equity securities.
The contractual maturities of our available-for-sale investments in debt
securities and certificates of deposit at December 31, 2005 by maturity date
follows:
Amortized
Cost Fair Value
----------- ------------
One year or less................................... $ 3,187 $ 3,195
Two years through five years....................... 5,928 5,882
Six years through ten years........................ 14,503 14,369
More than ten years................................ 6,621 6,657
----------- ------------
Total.............................................. $ 30,239 $ 30,103
----------- ------------
Our investment securities are included in the accompanying consolidated
balance sheets at December 31, 2005 and 2004 as follows:
December 31,
--------------------------
2005 2004
----------- ------------
Available-for-sale investments (current)........... $ 6,742 $ 804
Available-for-sale investments (non-current)....... 19,213 25,455
Investments pledged................................ 4,307 4,381
----------- ------------
Total.............................................. $ 30,262 $ 30,640
----------- ------------
We are 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,
--------------------------
2005 2004
----------- ------------
Certificates of deposit............................ $ 2,361 $ 2,537
Obligation of state and political subdivisions..... - 131
U. S. Government obligations....................... 1,946 1,713
----------- ------------
Total.............................................. $ 4,307 $ 4,381
----------- ------------
Proceeds from sales of investments during 2005, 2004 and 2003 were $13.2
million, $4.6 million and $4.7 million, respectively, and resulted in gross
realized gains of $98,000, $224,000 and $154,000 and gross realized losses of
$108,000, $63,000 and $19,000, respectively.
Note 3 - Property and Equipment
Property and equipment is comprised of the following:
Estimated December 31,
Estimated -----------------------
Useful Life 2005 2004
------------ ---------- -----------
Equipment, furniture and fixtures.......... 3-10 years $ 34,204 $ 31,727
Computer software.......................... 3 years 11,461 9,342
Building and improvements.................. 20-40 years 36,542 36,540
Automotive and aviation equipment.......... 3-10 years 13,489 3,104
Land....................................... N/A 170 170
---------- -----------
95,866 80,883
Accumulated depreciation................................. (36,919) (29,651)
---------- -----------
Property and equipment, net.............................. $ 58,947 $ 51,232
---------- -----------
As of December 31, 2005 and 2004, capitalized interest of $706,000 was
included in the cost of the building.
Note 4 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
------------------------
2005 2004
---------- ----------
Accounts payable................................... $ 6,303 $ 4,873
Marketing bonuses payable.......................... 2,099 1,792
Incentive awards payable........................... 3,082 2,616
Litigation accrual................................. 2,472 3,013
Other.............................................. 5,139 3,157
---------- ----------
Total.............................................. $ 19,095 $ 15,451
---------- ----------
Note 5 - Notes Payable
Our real estate loan of $20 million was fully funded in December 2003 with
interest at the 30 day LIBOR rate plus 2.25%, adjusted monthly, and repayments
began in December 2003 with monthly principal payments of $190,000 plus interest
with a balloon payment on September 30, 2008. The interest rate at December 31,
2005 was 6.56%. The loan is primarily collateralized by a first mortgage on the
87 acre home office complex, the 170,000 square foot home office complex, our
rights to receive Membership fees on a portion of our Memberships and by a
security interest covering all equipment. The real estate loan agreement
provides for financial covenants substantially the same as those described below
for the stock purchase loan.
Our $31.5 million stock purchase loan was fully funded in September 2004
with interest at the 30 day LIBOR rate plus 3%, adjusted monthly, and repayments
began in October 2004 with 24 monthly principal payments of $1.3 million ending
September 30, 2006. The interest rate at December 31, 2005 was 7.31%. The loan
is primarily collateralized by our rights to receive Membership fees on a
portion of our Memberships and a pledge of the stock of our subsidiaries. The
definitive agreement contains covenants prohibiting us from pledging assets,
incurring additional indebtedness and selling assets. In addition to customary
events of default, an additional event of default occurs if Harland C.
Stonecipher ceases to be our chairman and Chief Executive Officer for 90 days.
Pre-payment of the loan is permitted. The loan agreements contain the following
financial covenants: (a) our quarterly Debt Coverage Ratio (as defined in the
loan agreements) shall not be less than 110%; (b) our cancellation rate on
contracts less than or equal to twelve months old shall not exceed 45% on a
trailing 12 month basis, calculated on a quarterly basis; (c) we shall maintain
a rolling twelve month average retention rate of Membership contracts in place
for greater than eighteen months of not less than 70%, calculated on a monthly
basis; (d) we shall not pay dividends or purchase treasury shares, which during
any fiscal quarter, on a combined basis, would exceed sixty five percent (65%)
of our cumulative net income for all previous fiscal quarters beginning July 1,
2004 less any dividends or stock purchases in such previous fiscal quarters,
with provisions for carry forwards of unused availability; and, (e) our tangible
net worth shall not fall below $10 million for the period of time dating from
September 30, 2004, $15 million beginning March 31, 2005 and $25 million
beginning December 31, 2005. At December 31, 2005, we were restricted from
paying dividends or purchasing treasury shares in excess of $19.8 million
pursuant to these covenants. We were in compliance with the above covenants at
December 31, 2005.
Our $11.5 million aircraft loan was fully funded in November 2005 with
interest payable monthly at the 30 day LIBOR rate plus 1.75%, adjusted monthly,
and requires monthly principal installments of $96,000 beginning December 31,
2005 with the remaining balance payable in a final installment due November 30,
2012. The interest rate at December 31, 2005 was 6.06%. The loan is primarily
collateralized by the aircraft purchased. In addition to customary events of
default, if Harland C. Stonecipher ceases to be our Chief Executive Officer for
a period of 90 consecutive days an event of default will occur.
A schedule of outstanding balances as of December 31, 2005 and 2004 is as
follows:
December 31,
------------------------
2005 2004
---------- -----------
Real estate loan........................... $ 15,238 $ 17,524
Stock purchase loan........................ 11,813 27,562
Aircraft................................... 11,419 -
---------- -----------
Total notes payable........................ 38,470 45,086
Less: Current portion of notes payable..... (15,250) (18,036)
---------- -----------
Long term portion.......................... $ 23,220 $ 27,050
---------- -----------
A schedule of future maturities as of December 31, 2005 is as follows:
Repayment Schedule commencing
January 2006:
-------------------------------------------
Year 1..................................... $ 15,250
Year 2..................................... 3,437
Year 3..................................... 11,818
Year 4..................................... 1,152
Year 5..................................... 1,152
Thereafter................................. 5,661
-----------
Total notes payable........................ $ 38,470
-----------
Note 6 - Income Taxes
The provision for income taxes consists of the following:
Year Ended December 31,
------------------------------------
2005 2004 2003
---------- ----------- -----------
Current.................................... $ 17,951 $ 19,281 $ 20,381
Deferred................................... 912 2,197 288
---------- ----------- -----------
Total provision for income taxes......... $ 18,863 $ 21,478 $ 20,669
---------- ----------- -----------
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
------------------------------------
2005 2004 2003
---------- ----------- -----------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Tax exempt interest........................ (.4) (.2) (.1)
Wage tax credits........................... (.5) (.5) (.5)
Other...................................... .4 .2 (.3)
---------- ----------- -----------
Effective income tax rate.................. 34.5% 34.5% 34.1%
---------- ----------- -----------
Deferred tax liabilities and assets at December 31, 2005 and 2004 are
comprised of the following:
December 31,
----------------------
2005 2004
---------- ----------
Deferred tax liabilities relating to:
Unrealized investment gains, net................. $ - $ 399
Deferred member and associate service costs...... 7,493 7,020
Property and equipment........................... 7,008 4,854
---------- ----------
Total deferred tax liabilities................ 14,501 12,273
---------- ----------
Deferred tax assets relating to:
Expenses not yet deducted for tax purposes....... 2,497 2,265
Deferred revenue and fees........................ 11,425 10,509
Unrealized investment losses, net................ 44 -
Other............................................ 647 80
---------- ----------
Total deferred tax assets..................... 14,613 12,854
---------- ----------
Net deferred tax asset........................... $ 112 $ 581
---------- ----------
Our deferred tax assets and liabilities are included in the accompanying
consolidated balance sheets at December 31, 2005 and 2004 as follows.
December 31,
------------------------
2005 2004
---------- ----------
Deferred income taxes (current asset).............. $ 4,894 $ 4,829
Deferred income taxes (non-current liability)...... (4,782) (4,248)
---------- ----------
Net deferred tax asset............................. $ 112 $ 581
---------- ----------
A significant portion of the deferred tax assets recognized relate to
deferred revenue and fees. A valuation allowance was not recorded since we
believe that there was sufficient positive evidence to support our conclusion
not to record a valuation allowance. Management believes that we will realize
the tax benefit of these deferred tax assets in the future because of our
history of pre-tax income. However, there can be no assurance that we will
generate taxable income or that all of our deferred tax assets will be utilized.
Note 7 - Stockholders' Equity
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 10
million shares during subsequent board meetings. At December 31, 2005, we had
purchased 9.4 million treasury shares under these authorizations for a total
consideration of $222.5 million, an average price of $23.64 per share. We
purchased and formally retired 336,100 shares of our common stock during 2005
for $11.7 million, or an average price of $34.73 per share, reducing our common
stock by $3,361 and our retained earnings by $11.7 million. At December 31, 2005
and 2004, we had 15.5 million and 15.6 million common shares outstanding,
respectively, net of treasury shares. Given the current interest rate
environment, the nature of other investments available and our expected cash
flows, we believe that purchasing treasury shares enhances shareholder value and
may seek alternative sources of financing to continue or accelerate the program.
Any additional treasury stock purchases will be made at prices that we consider
attractive and at such times that we believe will not unduly impact our
liquidity.
We have lines of credit (see Note 5) that prohibit payment of cash
dividends on our common stock in excess of 65% of net income. Any decision by
our Board of Directors to pay cash dividends in the future will depend upon,
among other factors, our earnings, financial condition, capital requirements and
approval from our lender for any dividends in excess of 65% of net income. In
addition, our ability to pay dividends is dependent in part on our ability to
derive dividends from our 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 the greater of 10% of such
accumulated available surplus or the previous years' net profits. PPLSIF is
similarly restricted pursuant to the insurance laws of Florida. At January 1,
2006, PPLSIF did not have funds available for payment of substantial dividends
without the prior approval of the insurance commissioner. During 2005, PPLCI
declared and paid a $4.1 million dividend to us. No dividends were declared or
paid during 2004 or 2003. At January 1, 2006 PPLCI had approximately $6.1
million available for payment of an ordinary dividend. At December 31, 2005 the
amount of restricted net assets of consolidated subsidiaries was $25.3 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Note 8 - Other Expenses, net
The components of Other expenses, net are as follows:
Year Ended December 31,
-----------------------------------
2005 2004 2003
---------- ----------- ----------
Depreciation............................... $ 7,489 $ 7,709 $ 7,082
Premium taxes.............................. 2,059 1,698 2,703
Interest expense........................... 2,682 1,990 123
Litigation accrual expense................. (303) (121) -
Interest income............................ (1,471) (1,698) (1,362)
---------- ----------- ----------
Total Other expenses, net................ $ 10,456 $ 9,578 $ 8,546
---------- ----------- ----------
Interest expense is net of capitalized interest of $0, $0 and $586,000 for
the years ended December 31, 2005, 2004 and 2003, respectively.
Note 9 - Comprehensive Income
Comprehensive income is comprised of two subsets - net income and other
comprehensive income. Included in other comprehensive income for us are foreign
currency translation adjustments and unrealized gains on investments. These
items are accumulated within the Statements of Changes in Stockholders' Equity
under the caption "Accumulated Other Comprehensive Income." As of December 31,
accumulated other comprehensive income, as reflected in the Consolidated
Statements of Changes in Stockholders' Equity, was comprised of the following:
2005 2004
---------- -----------
Foreign currency translation adjustments..................................$ 456 $ 356
Unrealized gains (losses) on investments, net of income taxes of $(44)
and $399.................................................................. (69) 624
---------- -----------
Accumulated other comprehensive income................................. $ 387 $ 980
---------- -----------
Note 10 - Related Party Transactions
Through December 31, 2005, our Chairman, Harland C. Stonecipher, was the
owner of PPL Agency, Inc. ("Agency"). Effective January 1, 2006 we acquired
Agency from Mr. Stonecipher but prior to the acquisition we had agreed to
indemnify and hold him harmless for any personal losses incurred as a result of
his ownership of this corporation and any income earned by Agency accrued to us.
We provide management and administrative services for Agency, for which we
received specified management fees and expense reimbursements. No consideration
was paid to Mr. Stonecipher.
Agency's financial position and results of operations are included in our
financial statements on a combined basis after elimination of intercompany
transactions. Agency earned commissions, net of amounts paid directly to its
agents by the underwriter, during 2005, 2004 and 2003 of $114,000, $220,000 and
$119,000, respectively, through its sales of insurance products of an
unaffiliated company. Agency had net income of $16,000, $127,000 and $20,000 for
the years ended December 31, 2005, 2004 and 2003, respectively, after incurring
commissions earned by Mr. Stonecipher of $57,000, $55,000 and $57,000,
respectively, and annual management fees paid to us of $36,000 for 2005, 2004
and 2003.
Mr. Stonecipher and his wife, Shirley A. Stonecipher, own Stonecipher
Aviation LLC ("SA") and Mr. and Mrs. Stonecipher together with Wilburn L. Smith,
our National Marketing Director and formerly our President and one of our
directors , own S & S Aviation LLC ("S&SA"). We had 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 2004 and 2003 we paid $329,000 and $307,000,
respectively, to SA and paid $561,000 and $592,000 to S&SA during 2004 and 2003,
respectively, as reimbursement for such transportation expenses.
On December 9, 2004, we entered into and consummated an agreement with SA
to purchase a 1980 Beech King Air 200 airplane for a purchase price of
$1,083,355. On the same date, we entered into and consummated an agreement to
purchase a 1983 Mitsubishi MU-300 jet airplane owned by S&SA for a purchase
price of $1,230,200. In connection with the purchase of this plane, we also
agreed to pay the expenses associated with a pending avionics upgrade,
inspection and maintenance of approximately $450,000. On the same date, we also
purchased the leasehold interest in a hangar building located at the Ada
Municipal airport which is used as the hangar facility for the two purchased
planes for a purchase price of $465,000 and also purchased certain equipment and
furniture used at the facility for a purchase price of $9,272. The hangar and
related equipment was purchased from SA, which constructed the hangar and
acquired the equipment at its expense. Under the terms of the lease, which we
assumed, which expires in 2027, we are obligated to pay annual rental of $10 per
year. The purchase prices were paid in cash from our existing cash resources.
The Audit Committee of the Board of Directors and the full Board, with Mr.
Stonecipher abstaining, approved all of the transactions. The prices for each of
the planes and hangar were determined by independent appraisals and the related
equipment and furniture was purchased for book value, which approximates fair
market value. The Board determined that it was appropriate for us to acquire
ownership of the airplanes and hangar in light of the fact that the planes are
used almost exclusively in furtherance of our business. On November 30, 2005, we
purchased a LearJet 60 and traded in our existing Mitsubishi MU-300 jet
airplane. We will be reimbursed for personal use of our aircraft, if any.
John W. Hail, one of our directors, served as our Executive Vice President,
Director and Agency Director from July 1986 through May 1988 and also served as
Chairman of the Board of Directors of TVC Marketing, Inc., which was our
exclusive marketing agent from April 1984 through September 1985. Pursuant to
agreements between Mr. Hail and us entered into during the period in which Mr.
Hail was one of our executive officers, Mr. Hail receives override commissions
from renewals of certain Memberships initially sold by us during such period.
During 2005, 2004 and 2003, such override commissions on renewals totaled
$75,000, $79,000 and $81,000, respectively. Mr. Hail also owns interests ranging
from 12% to 100% in corporations not currently affiliated with us, including TVC
Marketing, Inc., but which were engaged in the marketing of our legal service
Memberships and which earn renewal commissions from Memberships previously sold.
These entities earned renewal commissions of $551,000, $557,000 and $552,000
during 2005, 2004 and 2003, respectively, of which $314,000, $322,000 and
$300,000, respectively, was passed through as commissions to their sales agents.
During 2003, we terminated a marketing services agreement with a senior
marketing associate, and commenced an action in the District Court of Pontotoc
County, Oklahoma alleging breach of contract and seeking to collect $1.4 million
in outstanding notes receivable arising from loans made by us at various times
between 1998 and 2001. Due to uncertainties about the full recoverability of
these notes, we recorded a reserve and bad debt expense of $515,000 in 2003 to
write down the notes to our estimate of their recoverable value. Each quarter,
we evaluate the recoverability of these notes receivable and adjust the reserve
accordingly. During 2005 we increased the reserve by $21,000 to $555,000 at
December 31, 2005.
Note 11 - Leases
At December 31, 2005, we were committed under noncancelable operating and
capital leases, principally for buildings and equipment. Aggregate rental
expense under all operating leases was $108,000, $79,000 and $93,000 in 2005,
2004 and 2003, respectively.
Future commitments commencing January 2006 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2006............................................... $ 127
2007............................................... 106
2008............................................... 63
2009............................................... 4
----------
Total operating lease commitments.................. $ 300
----------
Future minimum lease payments commencing in January 2006 related to capital
leases are as follows:
Year Ended December 31,
2006............................................... $ 420
2007............................................... 420
2008............................................... 81
2009............................................... 81
2010............................................... 81
Thereafter......................................... 1,564
----------
Total minimum lease payments....................... 2,647
Less: Imputed interest............................. (1,030)
----------
Present value of net minimum lease payments........ 1,617
Less: Current portion.............................. (321)
----------
Non current portion of capital leases payable...... $ 1,296
----------
We entered into two capital leases near the end of 2002 and one early in
2003 to acquire equipment and buildings. These capital leases expire at various
dates through 2032. The capital lease assets are included in property and
equipment as follows at December 31, 2005 and December 31, 2004.
December 31,
------------------------
2005 2004
---------- ----------
Equipment, furniture and fixtures.................. $ 1,670 $ 1,670
Buildings and improvements......................... 314 314
---------- ----------
1,984 1,984
Less: accumulated amortization..................... (445) (91)
---------- ----------
Net capital lease assets........................... $ 1,539 $ 1,893
---------- ----------
Note 12 - Commitments and Contingencies
We and various 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 we issued false and misleading
financial information, primarily related to the method we used to account for
commission advance receivables from sales associates. On March 5, 2002, the
Court granted our motion to dismiss the complaint, with prejudice, and entered a
judgment in favor of the defendants. Plaintiffs thereafter filed a motion
requesting reconsideration of the dismissal which was denied. The plaintiffs
have appealed the judgment and the order denying their motion to reconsider the
judgment to the Tenth Circuit Court of Appeals. In August 2002 the lead
institutional plaintiff withdrew from the case, leaving two individual
plaintiffs as lead plaintiffs on behalf of the putative class. As of December
31, 2003, the briefing in the appeal had been completed. On January 14, 2004
oral argument was held in the appeal and as of February 17, 2006, a decision was
pending. We are unable to predict when a decision will be made on this appeal,
and the ultimate outcome of the case is not determinable.
Beginning in the second quarter of 2001 multiple lawsuits were filed
against us, certain officers, employees, sales associates and other defendants
in various Alabama and Mississippi state courts by current or former members
seeking actual and punitive damages for alleged breach of contract, fraud and
various other claims in connection with the sale of Memberships. During 2004,
there were at one time as many as 30 separate lawsuits involving approximately
285 plaintiffs in Alabama. As of February 17, 2006, as a result of dismissals,
summary judgments, or settlements for nominal amounts, there were no lawsuits
remaining in Alabama. As of February 17, 2006, we were aware of 7 separate
lawsuits involving approximately 406 plaintiffs in multiple counties in
Mississippi. Certain of the Mississippi lawsuits also name our former provider
attorney in Mississippi as a defendant. In Mississippi, we filed lawsuits in the
United States District Court for the Southern and Northern Districts of
Mississippi in which we seek to compel arbitration of the various Mississippi
claims under the Federal Arbitration Act and the terms of our Membership
agreements. One of the federal courts has ordered arbitration of a case
involving 8 plaintiffs. These cases are all in various stages of litigation,
including trial settings in Mississippi in May, 2006, and seek varying amounts
of actual and punitive damages. We have tried three separate lawsuits in
Mississippi. The first trial in Mississippi on these cases resulted in a
unanimous jury verdict in our favor, including other named defendants, on all
claims on October 19, 2004, while the second and third trials in Mississippi
resulted in insubstantial plaintiffs' verdicts on February 15, 2005 and May 9,
2005, respectively. On August 16, 2005 the Circuit Judge in the February 15,
2005 trial overturned the jury's finding of fraud and fraudulent
misrepresentation on the grounds that the evidence was insufficient to support
those claims and reduced the damages awarded by the jury to a total of $525 for
four plaintiffs. On July 18, 2005 the Circuit Judge in the May 9, 2005 trial
entered an order granting plaintiff's motion to reconsider the submission of the
issue of punitive damages to the jury, and trial on that issue was held in
November 2005. The trial on that issue resulted in punitive damage verdicts
against us and against our chief executive officer in the collective total
amount of $9.9 million. Pre-Paid will seek post judgment and appellate relief in
that case. Although the amount of Membership fees paid by the plaintiffs in the
Mississippi cases is $500,000 or less, certain of the cases seek damages of $90
million. The ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against us and certain officers in the District Court
of Creek County, Oklahoma on behalf of Jeff and Jana Weller individually and
doing business as Hi-Tech Auto making similar allegations relating to our
Memberships and seeking unspecified damages on behalf of a "nationwide" class.
The Pre-Paid defendants' preliminary motions in this case were denied, and on
June 17, 2003, the Oklahoma Court of Civil Appeals reversed the trial court's
denial of the Pre-Paid defendants' motion to compel arbitration, finding that
the trial court erred when it denied Pre-Paid's motion to compel arbitration
pursuant to the terms of the valid Membership contracts, and remanded the case
to the trial court for further proceedings consistent with that opinion. On
December 3, 2004, the District Court ordered the plaintiffs to proceed with the
arbitration. On October 16, 2005 plaintiff Jana Weller died, and on December 20,
2005 we filed a Suggestion of Death Upon the Record with respect thereto. The
ultimate outcome of this case is not determinable.
On October 3, 2005 we received a Civil Investigative Demand from the
Commissioner of Consumer Protection of the State of Connecticut requesting
information relating to our memberships and commissions to associates in
Connecticut. As of February 17, 2006, we were in the process of responding to
the request. The ultimate outcome of this matter is not determinable.
We are a defendant in various other legal proceedings that are routine and
incidental to our business. We will vigorously defend our interests in all
proceedings in which it is named as a defendant. We also receive periodic
complaints or requests for information from various state and federal agencies
relating to our business or the activities of our marketing force. We promptly
respond to any such matters and provide any information requested.
While the ultimate outcome of these proceedings is not determinable, we do
not currently anticipate that these contingencies will result in any material
adverse effect to our financial condition or results of operation, unless an
unexpected result occurs in one of the cases. The costs of the defense of these
various matters are reflected as a part of general and administrative expense,
or Membership benefits if fees relate to Membership issues, in the consolidated
statements of income. We have established an accrued liability we believe will
be sufficient to cover estimated damages in connection with various cases
(exclusive of ongoing defense costs which are expensed as incurred), which at
December 31, 2005 was $2.5 million. We believe that we have meritorious defenses
in all pending cases and will vigorously defend against the plaintiffs' claims.
However, it is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
During January 2006, we acquired an additional 40,000 square foot building
in Duncan for $1 million that can hold 350 customer service representatives when
remodeling is completed later in 2006.
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments which aggregate $5.7 million. The Canadian taxing authorities
contend commission deductions should be matched with the membership revenue as
received, we contend these commissions are deductible when paid. Under Canadian
tax laws, our commission payments are treated as a prepaid expense. We base our
deduction of commission on the fact that all the services (the sale of the
membership) have been performed by the sales associate at the time of sale
therefore this prepaid expense (the commission payments) is deductible when
paid. Also, the commission payment is taxable to the sales associate when paid
and each year we issue a T4 (Canadian 1099 equivalent) to sales associates for
the total commission payments made during that year. In addition, Canadian
taxing authorities have challenged our allocation of general and administrative
expenses to Canadian operations. We contend the allocation of general and
administrative expenses, based on the percentage of Canadian new memberships
written and the Canadian percentage memberships in force, is reasonable. At
December 31, 2005 we have accrued $472,000 for this assessment.
Note 13 - Stock Options, Stock Ownership Plan and Benefit Plan
We have a stock option plan (the "Plan") under which the Board of Directors
(the "Board") or our Stock Option Committee (the "Committee") may grant options
to purchase shares of our common stock. The Plan permits the granting of options
to our directors, officers and employees to purchase our common stock at not
less than the fair value at the time the options are granted. The Plan provides
for option grants to acquire up to 3,000,000 shares and permits the granting of
incentive stock options as defined under Section 422 of the Internal Revenue
Code at an exercise price for each option equal to the market price of our
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, 2012. We have
not granted options under the Plan since March 2004.
The Plan previously provided for automatic grants of options to our
non-employee directors. Under the Plan, each incumbent non-employee director and
any new non-employee director received options to purchase 10,000 shares of
common stock on March 1 of each year. The options granted each year were
immediately exercisable as to 2,500 shares and vested 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. These automatic grants of options to non-employee directors were
eliminated effective January 1, 2005, and therefore no further grants to
non-employee directors will be made.
Also included below are stock options that were issued to our Regional Vice
Presidents ("RVPs") in order to encourage stock ownership by our RVPs and to
increase the proprietary interest of such persons in our growth and financial
success. These options have been granted periodically to RVPs since 1996.
Options were granted at fair market value at the date of the grant and were
generally immediately exercisable for a period of three years or within 90 days
of termination, whichever occurs first. Although there we no options granted to
RVPs during 2005, there were 36,751 and 106,002 total options granted to RVPs in
the years ended December 31, 2004 and 2003, respectively. We discontinued the
RVP stock option grants immediately after the 2003 fourth quarter stock options
were awarded in the first quarter of 2004.
A summary of the status of our total stock option activity as of December
31, 2005, 2004 and 2003, and for the years ended on those dates is presented
below:
2005 2004 2003
----------------------- ------------------------ ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ --------- ----------- ----------- ------------ ---------
Outstanding at beginning of year..... 862,490 $ 23.88 1,275,499 $ 24.06 1,498,392 $ 26.09
Granted.............................. - - 76,751 23.42 153,502 20.99
Exercised............................ (345,642) 28.24 (234,170) 22.10 (105,514) 25.42
Terminated........................... (9,681) 22.33 (255,590) 26.27 (270,881) 35.45
------------ --------- ----------- --------- ------------ ---------
Outstanding at end of year........... 507,167 $ 20.94 862,490 $ 23.88 1,275,499 $ 24.06
------------ --------- ----------- --------- ------------ ---------
Options exercisable at year end...... 507,167 $ 20.94 837,490 $ 23.99 1,206,124 $ 24.18
------------ --------- ----------- --------- ------------ ---------
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2005:
Range of Exercise Prices
------------------------ Weighted Average
Remaining Weighted Average
Number Outstanding Contractual Life Exercise Price
------------------ ------------------------- -----------------
$16.46 - $17.03 176,000 .6 $ 16.51
$19.20 - $23.93 117,219 3.4 21.37
$24.20 - $26.11 213,948 1.4 24.35
------------------ ------------------------- -----------------
507,167 1.5 $ 20.94
------------------ ------------------------- -----------------
During 1988, we 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. At our option, we may
make matching contributions to the plan, and recorded expense during 2005, 2004
and 2003 of $342,000, $232,000 and $220,000, based on contributions of cash
during 2005 and contributions of Company stock of 10,100 shares and 8,220 shares
during 2004 and 2003, respectively.
In November 2002, we adopted a deferred compensation plan, which permits
executive officers and key employees to defer receipt of a portion of their
compensation. Deferred amounts accrue hypothetical returns based upon investment
options selected by the participant. We have amended the deferred compensation
plan, effective January 1, 2005, to comply with new provisions of Section 409A
of the Internal Revenue Code. Deferred amounts are paid in cash based on the
value of the investment option and are generally payable following termination
of employment in a lump sum or in installments as elected by the participant,
but the plan provides for financial hardship distributions, distributions in the
event of total disability or death and distributions upon a change in control.
The plan also provides for a death benefit of $500,000 for each participant.
Although the plan is unfunded and represents an unsecured liability of ours to
the participants, we have purchased variable life insurance policies owned by us
to insure the lives of the group of participants and to finance our obligations
under the plan. As of December 31, 2005 and 2004, we had an aggregate deferred
compensation liability of $3.9 million and $2.8 million, respectively, which is
included in other non-current liabilities. At December 31, 2005, the cash value
of the underlying insurance policies owned by us was $3.7 million and included
in other assets.
Note 14 - Earnings Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock and dilutive potential
common shares outstanding during the year. The weighted average number of common
shares is also increased by the number of dilutive potential common shares
issuable on the exercise of options less the number of common shares assumed to
have been purchased with the proceeds from the exercise of the options pursuant
to the treasury stock method; those purchases are assumed to have been made at
the average price of the common stock during the respective period.
Year Ended December 31,
-------------------------------
Basic Earnings Per Share: 2005 2004 2003
--------- ---------- ----------
Earnings:
Income from continuing operations............................................. $ 35,812 $ 40,777 $ 39,907
--------- ---------- ----------
Shares:
Weighted average shares outstanding........................................... 15,470 16,313 17,530
--------- ---------- ----------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations after assumed conversions................... $ 35,812 $ 40,777 $ 39,907
--------- ---------- ----------
Shares:
Weighted average shares outstanding........................................... 15,470 16,313 17,530
Assumed exercise of options................................................... 182 145 69
--------- ---------- ----------
Weighted average number of shares, as adjusted................................ 15,652 16,458 17,599
--------- ---------- ----------
Options to purchase shares of common stock are excluded from the
calculation of diluted earnings per share when their inclusion would have an
anti-dilutive effect on the calculation. Options to purchase 218,000 shares and
799,000 shares with an average exercise price of $32.05 and $27.48 were excluded
from the calculation of diluted earnings per share for the years ended December
31, 2004 and 2003, respectively. No options were excluded from the diluted
earnings per share calculation for the year ended December 31, 2005.
Note 15 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations for
the years ended December 31, 2005 and 2004.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2005 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------------------------------------------- ----------- ------------ ------------ ------------
Revenues........................................... $ 100,895 $ 105,619 $ 107,582 $ 109,284
Net income......................................... 8,948 6,853 8,644 11,367
Basic income per common share (1):
Net Income....................................... $ .57 $ .45 $ .56 $ .73
Diluted income per common share (1):
Net Income....................................... $ .57 $ .44 $ .55 $ .73
2004
---------------------------------------------------
Revenues........................................... $ 94,609 $ 95,429 $ 96,853 $ 99,046
Net income......................................... 10,622 10,006 9,657 10,492
Basic income per common share (1):
Net Income....................................... $ .63 $ .61 $ .59 $ .68
Diluted income per common share (1):
Net Income....................................... $ .63 $ .60 $ .58 $ .66
(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
Substantially all of our business is currently conducted in the United
States. Revenues from our Canadian operations for 2005, 2004 and 2003 were $6.0
million, $4.7 million and $4.5 million, respectively. We have no significant
long-lived assets located in Canada.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE.
-------------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
--------------------------------------
Controls and Procedures
Our principal executive officer (Chairman, Chief Executive Officer and
President) and principal financial officer (Chief Financial Officer) have
evaluated our disclosure controls and procedures as of December 31, 2005, and
have concluded that these controls and procedures are effective to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act of 1934 (15 U.S.C. ss. 78a et seq) is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms. These disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in the
reports that we file or submit is accumulated and communicated to management,
including the principal executive officer and the principal financial officer,
as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of 2005, no change occurred in our internal
control over financial reporting that materially affected, or is likely to
materially affect, our internal control over financial reporting.
Management's Annual Report on Internal Control over Financial Reporting
At year end 2004 as disclosed in our Form 10-K, we were unable to complete
the required assessment of our internal control over financial reporting for the
reasons stated in the 2004 Form 10-K. During 2005, we have remedied the various
material deficiencies that existed at year end 2004 and as of December 31, 2005
are able to complete our assessment and report which is located in Item 8 of
this report.
Certifications
Our Chief Executive and Chief Financial Officers have completed the
certifications required to be filed as an Exhibit to this Report (See Exhibits
31.1 and 31.2) relating to the design of our disclosure controls and procedures
and the design of our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
--------------------------------
None.
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10 through 14 of Form 10-K are incorporated herein by
reference to our Proxy Statement for the Annual Meeting of Shareholders to be
filed prior to April 30, 2006.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
------------------------------------------------------
(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 39 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.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: February 27, 2006 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 February 27, 2006
---------------------------------------------------- (Principal Executive Officer)
Harland C. Stonecipher
/s/ Randy Harp Chief Operating Officer February 27, 2006
----------------------------------------------------
Randy Harp
/s/ Steve Williamson Chief Financial Officer February 27, 2006
---------------------------------------------------- (Principal Financial and
Steve Williamson Accounting Officer)
/s/ Orland G. Aldridge Director February 27, 2006
----------------------------------------------------
Orland G. Aldridge
/s/ Martin H. Belsky Director February 27, 2006
----------------------------------------------------
Martin H. Belsky
/s/ Peter K. Grunebaum Director February 27, 2006
----------------------------------------------------
Peter K. Grunebaum
/s/ John W. Hail Director February 27, 2006
----------------------------------------------------
John W. Hail
/s/ Thomas W. Smith Director February 27, 2006
----------------------------------------------------
Thomas W. Smith
PRE-PAID LEGAL SERVICES, INC AND SUBSIDIARIES
Schedule I - Condensed Financial Information of the Registrant
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
(Amounts in 000's)
ASSETS
December 31,
------------------------
2005 2004
---------- -----------
Current assets:
Cash and cash equivalents............................................................ $ 28,505 $ 22,991
Available-for-sale investments, at fair value........................................ - 510
Membership income receivable......................................................... 3,971 3,225
Inventories.......................................................................... 1,717 1,623
Refundable income taxes.............................................................. - 1,241
Deferred member and associate service costs.......................................... 14,854 13,893
Other assets......................................................................... 2,874 2,933
---------- -----------
Total current assets............................................................. 51,921 46,416
Available-for-sale investments, at fair value.......................................... 239 1,181
Investments pledged.................................................................... 374 374
Property and equipment, net............................................................ 58,702 50,916
Investments in and amounts due to/from subsidiaries, net............................... 39,626 31,331
Deferred member and associate service costs............................................ 2,752 2,325
Other assets........................................................................... 5,755 4,538
---------- -----------
Total assets................................................................... $ 159,369 $ 137,081
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 11,241 $ 9,903
Deferred revenue and fees............................................................ 21,767 19,544
Current portion of capital leases payable............................................ 321 338
Current portion of notes payable..................................................... 15,250 18,036
Common stock dividends payable....................................................... 4,643 7,796
Accounts payable and accrued expenses................................................ 18,335 11,963
---------- -----------
Total current liabilities.......................................................... 71,557 67,580
Capital leases payable............................................................... 1,296 1,618
Notes payable........................................................................ 23,220 27,050
Deferred revenue and fees............................................................ 2,490 1,877
Deferred income taxes................................................................ 5,480 4,715
Other non-current liabilities........................................................ 3,932 2,794
---------- -----------
Total liabilities................................................................ 107,975 105,634
---------- -----------
Stockholders' equity:
Common stock......................................................................... 203 205
Retained earnings.................................................................... 149,832 129,290
Accumulated other comprehensive income............................................... 387 980
Treasury stock, at cost.............................................................. (99,028) (99,028)
---------- -----------
Total stockholders' equity....................................................... 51,394 31,447
---------- -----------
Total liabilities and stockholders' equity..................................... $ 159,369 $ 137,081
---------- -----------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
------------------------------------------
2005 2004 2003
------------ ------------ --------------
Revenues:
Membership fees...................................................... $ 289,553 $ 260,959 $ 211,824
Associate services................................................... 28,683 24,618 25,499
Other................................................................ 4,714 5,247 3,796
------------ ------------ --------------
322,950 290,824 241,119
------------ ------------ --------------
Costs and expenses:
Membership benefits.................................................. 102,354 89,016 66,524
Commissions.......................................................... 111,129 88,963 68,353
Associate services and direct marketing.............................. 30,311 24,618 28,823
General and administrative........................................... 30,127 32,037 14,711
Other, net........................................................... 9,385 9,157 6,792
------------ ------------ --------------
283,306 243,791 185,203
------------ ------------ --------------
Income before income taxes and equity in net income of subsidiaries.... 39,644 47,033 55,916
Provision for income taxes............................................. 13,677 16,226 19,080
------------ ------------ --------------
Income before equity in net income of subsidiaries..................... 25,967 30,807 36,836
Equity in net income of subsidiaries................................... 9,845 9,970 3,071
------------ ------------ --------------
Net income............................................................. $ 35,812 $ 40,777 $ 39,907
------------ ------------ --------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2005 2004 2003
------------ ------------ ------------
Net cash provided by operating activities.............................. $ 46,586 $ 38,393 $ 50,271
------------ ------------ ------------
Cash flows from investing activities:
Additions to property and equipment.................................. (14,778) (10,879) (27,012)
Purchases of investments - available-for-sale........................ - (2,858) (9,915)
Maturities and sales of investments - available-for-sale............. 307 11,783 -
------------ ------------ ------------
Net cash used in investing activities.............................. (14,471) (1,954) (36,927)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 4,439 5,176 2,014
Decrease in capital lease obligations................................ (339) (808) (1,701)
Purchases of treasury stock.......................................... (11,673) (37,462) (48,292)
Proceeds from issuance of debt....................................... 13,829 19,000 42,700
Repayments of debt................................................... (20,445) (17,335) (9,912)
Dividends paid....................................................... (12,412) - -
Proceeds from other financing........................................ - - 1,000
------------ ------------ ------------
Net cash used in financing activities.............................. (26,601) (31,429) (14,191)
------------ ------------ ------------
Net increase in cash and cash equivalents.............................. 5,514 5,010 (847)
Cash and cash equivalents at beginning of year......................... 22,991 17,981 18,828
------------ ------------ ------------
Cash and cash equivalents at end of year............................... $ 28,505 $ 22,991 $ 17,981
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized.................... $ 2,432 $ 1,752 $ 78
------------ ------------ ------------
Cash paid for income taxes........................................... $ 13,350 $ 19,429 $ 20,200
------------ ------------ ------------
Non-cash activities - cash dividends declared but not paid........... $ 4,643 $ 7,796 $ -
------------ ------------ ------------
Non-cash activities - capital lease obligations incurred............. $ - $ 1,058 $ 2,481
------------ ------------ ------------
Non-cash activities - asset additions due to trade-in allowance...... $ 426 $ - $ -
------------ ------------ ------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
Notes to Condensed Financial Statements
Basis of Presentation
In the parent-company-only financial statements, Pre-Paid Legal Services, Inc.'s
("Parent Company") investment in subsidiaries is stated at cost plus equity in
undistributed earnings of subsidiaries since the date of acquisition. The
parent-company-only financial statements should be read in conjunction with the
Parent Company's consolidated financial statements.
Notes 5 and 12 and the first two paragraphs of Note 10 to the consolidated
financial statements of Pre-Paid Legal Services, Inc. relate to the Parent
Company and therefore have not been repeated in these notes to condensed
financial statements.
Expense Advances and Reimbursements
Pursuant to management agreements with certain subsidiaries, which have been
approved by insurance regulators, commission advances are paid and expensed by
the Parent Company and the Parent Company is compensated for a portion of its
general and administrative expenses determined in accordance with the
agreements.
Dividends from Subsidiaries
Dividends paid to the Parent Company from its subsidiaries are accounted for by
the equity method. During 2005, PPLCI declared and paid a $4.1 million dividend
to us. No dividends were declared or paid during 2004 or 2003.
INDEX TO EXHIBITS
Exhibit No. Description
------------- -----------
3.1 Restated Certificate of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 of
our Annual Report on Form 10-K for the year ended December 31, 2004)
3.2 Amended and Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.1 of our Report
on Form 10-Q for the period ended June 30, 2003)
*10.1 Employment Agreement effective January 1, 1993 between the Company and Harland C. Stonecipher
(Incorporated by reference to Exhibit 10.1 of our 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 Exhibi 10.21 of
our 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 our 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 our 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 our Annual Report on Form
10-KSB for the year ended December 31, 1992)
*10.6 Amendment No. 2 to New Business Generation Agreement between the Company and Harland C. Stonecipher
effective January, 1990 (Incorporated by reference to Exhibit 10.13 of our Annual Report on Form
10-K for the year ended December 31, 2002)
*10.7 Stock Option Plan, as amended effective May 2003 (Incorporated by reference to Exhibit 10.7 of our
Annual report on Form 10-K for the year ended December 31, 2004)
10.8 Loan agreement dated June 11, 2002 between Bank of Oklahoma, N.A. and the Company (Incorporated by
reference to Exhibit 10.1 of our Quarterly Report on Form 10-Q for the six-months ended June 30,
2002)
10.9 Security agreement dated June 11, 2002 between Bank of Oklahoma, N.A. and the Company (Incorporated
by reference to Exhibit 10.2 of our Quarterly Report on Form 10-Q for the six months ended June 30,
2002)
10.10 Form of Mortgage dated July 23, 2002 between Bank of Oklahoma, N.A. and the Company (Incorporated
by reference to Exhibit 10.3 of our Quarterly Report on Form 10-Q for the six months ended June 30,
2002)
*10.11 Deferred compensation plan effective November 6, 2002 (Incorporated by reference to Exhibit 10.14
of our Annual Report on Form 10-K for the year ended December 31, 2002)
10.12 Loan agreement dated September 19, 2003 between Registrant and Bank of Oklahoma, N.A., Comerica
Bank and First United Bank & Trust (Incorporated by reference to Exhibit 10.1 of our Report on Form
10-Q for the period ended September 30, 2003)
10.13 Aircraft purchase agreement dated December 9, 2004 by and between S&S Aviation, LLC and the Company
(Incorporated by reference to Exhibit 10.13 of our Annual Report on Form 10-K for the year ended
December 31, 2004)
10.14 Aircraft purchase agreement dated December 9, 2004 by and between Harland C. Stonecipher and/or
Shirley A. Stonecipher and Stonecipher Aviation, LLC and the Company (Incorporated by reference to
Exhibit 10.14 of our Annual Report on Form 10-K for the year ended December 31, 2004)
10.15 Assignment and Assumption of Lease dated December 20, 2004 between Harland C. and Shirley
Stonecipher and the Company (Incorporated by reference to Exhibit 10.15 of our Annual Report on
Form 10-K for the year ended December 31, 2004)
*10.16 Amended Deferred Compensation Plan effective January 1, 2005 (Incorporated by reference to Exhibit
10.16 of our Annual Report on Form 10-K for the year ended December 31, 2004)
21.1 List of Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP
31.1 Certification of Harland C. Stonecipher, Chairman and Chief Executive Officer, pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934
31.2 Certification of Steve Williamson, Chief Financial Officer, pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934
32.1 Certification of Harland C. Stonecipher, Chairman and Chief Executive Officer, pursuant to 18
U.S.C. Section 1350
32.2 Certification of Steve Williamson, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350
--------------------
* Constitutes a management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report.
EXHIBIT 21.1
PRE-PAID LEGAL SERVICES, INC.
Subsidiaries of Registrant
State or Percentage of
Province Ownership by
Name of Subsidiary Incorporation Registrant
Pre-Paid Legal Casualty, Inc. Oklahoma 100%
American Legal Services, Inc. Oklahoma 100%
Pre-Paid Legal Services, Inc. of Florida Florida 100%
Legal Service Plans of Virginia, Inc. Virginia 100%
Ada Travel Service, Inc. Oklahoma 100%
Pre-Paid Canadian Holdings, L.L.C. Oklahoma 100%
Pre-Paid Legal Access, Inc. 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 REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our reports dated February 23, 2005, accompanying the
consolidated financial statements and schedule and management's assessment of
the effectiveness of internal control over financial reporting included in the
Annual Report of Pre-Paid Legal Services, Inc. on Form 10-K for the year ended
December 31, 2005. We hereby consent to the incorporation by reference of said
reports in the Registration Statements of Pre-Paid Legal Services, Inc. on Forms
S-8 (File No. 333-120403, effective November 12, 2004, 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).
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 23, 2006
EXHIBIT 31.1
CERTIFICATION
I, Harland C. Stonecipher, Chief Executive Officer of the registrant, certify
that:
1. I have reviewed this annual report on Form 10-K of Pre-Paid Legal
Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information;
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Dated: February 27, 2006 /s/ Harland C. Stonecipher
-------------------------------------
Harland C. Stonecipher
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Steve Williamson, Chief Financial Officer of the registrant, certify that:
1. I have reviewed this annual report on Form 10-K of Pre-Paid Legal
Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information;
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Dated: February 27, 2006 /s/ Steve Williamson
-------------------------------------
Steve Williamson
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Annual
Report on Form 10-K for the year ended December 31, 2005 (the "Report") fully
complies with the requirements of Section 13(a) or 15(d), as applicable, of the
Securities Exchange Act of 1934 and that the information contained in the Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Date: February 27, 2006 /s/ Harland C. Stonecipher
-------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer
and President
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Annual
Report on Form 10-K for the year ended December 31, 2005 (the "Report") fully
complies with the requirements of Section 13(a) or 15(d), as applicable, of the
Securities Exchange Act of 1934 and that the information contained in the Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Date: February 27, 2006 /s/ Steve Williamson
-------------------------------------
Steve Williamson
Chief Financial Officer