UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended March 31, 2002
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 1-9293
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PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main Street
Ada, Oklahoma 74821-0145
(Address of principal executive offices) (Zip Code)
(580) 436-1234
(Registrants' telephone number, including area code)
--------------------------------------------------------------
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 the number of shares outstanding of each of the issuer's classes
of common stock as of April 15, 2002:
Common Stock $.01 par value 20,143,579
CONTENTS
Part I. Financial Statements
Item 1. Financial Statements of Registrant:
Consolidated Balance Sheets
as of March 31, 2002 (Unaudited) and
December 31, 2001
Consolidated Statements of Income
(Unaudited) for the three months ended
March 31, 2002 and 2001
Consolidated Statements of Comprehensive Income
(Unaudited) for the three months ended
March 31, 2002 and 2001
Consolidated Statements of Cash Flows
(Unaudited) for the three months ended
March 31, 2002 and 2001
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Part II. Other Information
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
ITEM 1. FINANCIAL STATEMENTS OF REGISTRANT
----------------------------------
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)
ASSETS
March 31, December 31,
2002 2001
(Unaudited)
Current assets: ------------ ------------
Cash and cash equivalents........................................................ $ 9,477 $ 14,290
Available-for-sale investments, at fair value.................................... 5,900 6,070
Membership income receivable..................................................... 5,300 5,472
Inventories...................................................................... 1,009 922
Deferred member and associate service costs...................................... 15,163 14,228
Deferred income taxes............................................................ 3,469 3,413
------------ ------------
Total current assets......................................................... 40,318 44,395
Available-for-sale investments, at fair value...................................... 13,815 13,386
Investments pledged................................................................ 4,291 4,315
Property and equipment, net........................................................ 16,262 14,755
Deferred member and associate service costs........................................ 3,021 2,907
Other assets....................................................................... 6,224 5,962
------------ ------------
Total assets............................................................... $ 83,931 $ 85,720
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.............................................................. $ 7,807 $ 7,664
Deferred revenue and fees........................................................ 22,227 20,893
Income taxes payable............................................................. 4,319 1,087
Accounts payable and accrued expenses............................................ 13,636 9,678
------------ ------------
Total current liabilities...................................................... 47,989 39,322
Deferred revenue and fees........................................................ 4,326 4,158
Deferred income taxes ........................................................... 63 16
------------ ------------
Total liabilities............................................................ 52,378 43,496
------------ ------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 24,860 and
24,806 issued at March 31, 2002 and December 31, 2001, respectively............ 249 248
Capital in excess of par value................................................... 67,361 66,223
Retained earnings................................................................ 63,110 54,240
Accumulated other comprehensive income (loss).................................... (139) 186
Treasury stock, at cost; 4,852 and 3,989 shares held at
March 31, 2002 and December 31, 2001, respectively............................. (99,028) (78,673)
------------ ------------
Total stockholders' equity................................................... 31,553 42,224
------------ ------------
Total liabilities and stockholders' equity................................. $ 83,931 $ 85,720
------------ ------------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
(Unaudited)
Three Months Ended March
31,
-------------------------
2002 2001
----------- -----------
Revenues:
Membership fees................................................................ $ 71,894 $ 59,287
Associate services............................................................. 9,019 10,137
Other.......................................................................... 1,118 901
----------- -----------
82,031 70,325
Costs and expenses:
Membership benefits............................................................ 24,312 20,041
Commissions.................................................................... 27,808 23,626
Associate services and direct marketing........................................ 7,568 8,186
General and administrative..................................................... 7,802 6,322
Other, net..................................................................... 999 982
----------- -----------
68,489 59,157
Income from continuing operations before income taxes............................ 13,542 11,168
Provision for income taxes....................................................... 4,672 3,650
----------- -----------
Income from continuing operations................................................ 8,870 7,518
Income from operations of discontinued UFL segment, net of applicable
income tax of $0............................................................... - 158
----------- -----------
Net income....................................................................... $ 8,870 $ 7,676
----------- -----------
Basic earnings per common share from continuing operations....................... $ .44 $ .34
Basic earnings per common share from discontinued operations..................... - .01
----------- -----------
Basic earnings per common share.................................................. $ .44 $ .35
----------- -----------
Diluted earnings per common share from continuing operations..................... $ .43 $ .34
Diluted earnings per common share from discontinued operations................... - .01
----------- -----------
Diluted earnings per common share................................................ $ .43 $ .35
----------- -----------
The accompanying notes are an integral part of these financials.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in 000's)
(Unaudited)
Three Months Ended March
31,
-------------------------
2002 2001
----------- -----------
Net income....................................................................... $ 8,870 $ 7,676
----------- -----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment........................................ 42 (92)
----------- -----------
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during period...................... (334) 416
Less: reclassification adjustment for realized gains included in net income (33) (12)
----------- -----------
(367) 404
----------- -----------
Other comprehensive income, net of income taxes of ($88) and $168................ (325) 312
----------- -----------
Comprehensive income............................................................. $ 8,545 $ 7,988
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
(Unaudited)
Three Months Ended March
31,
-------------------------
2002 2001
----------- -----------
Cash flows from operating activities:
Net income....................................................................... $ 8,870 $ 7,676
Adjustments to reconcile net income to net cash provided
by operating activities:
Income from discontinued operations............................................ - (158)
Provision for deferred income taxes............................................ 189 1,434
Depreciation and amortization.................................................. 1,197 928
Tax benefit on exercise of stock options....................................... 164 -
Decrease in Membership income receivable....................................... 172 289
(Increase) decrease in inventories............................................. (87) 477
Increase in deferred member and associate service costs........................ (1,049) (1,975)
Increase in other assets....................................................... (262) (549)
Increase in accrued Membership benefits........................................ 143 363
Increase in deferred revenue and fees.......................................... 1,502 1,783
Increase (decrease) in income taxes payable.................................... 3,232 (396)
Increase in accounts payable and accrued expenses.............................. 3,992 917
----------- -----------
Net cash provided by operating activities of continuing operations........... 18,063 10,789
----------- -----------
Cash flows from investing activities:
Additions to property and equipment............................................ (2,704) (2,857)
Purchases of investments - available for sale.................................. (5,867) -
Maturities and sales of investments - available for sale....................... 5,067 5,191
----------- -----------
Net cash (used in) provided by investing activities of continuing operations. (3,504) 2,334
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of common stock options................................. 983 -
Decrease in capital lease obligations.......................................... - (84)
Purchases of treasury stock.................................................... (20,355) (12,804)
----------- -----------
Net cash used in financing activities of continuing operations............... (19,372) (12,888)
----------- -----------
Net (decrease) increase in cash and cash equivalents............................. (4,813) 235
Cash and cash equivalents at beginning of period................................. 14,290 10,866
----------- -----------
Cash and cash equivalents at end of period....................................... $ 9,477 $ 11,101
----------- -----------
Supplemental disclosure of cash flow information:
Net cash used in discontinued operations....................................... $ - $ (237)
----------- -----------
Cash paid for interest......................................................... $ - $ 1
----------- -----------
Income taxes paid.............................................................. $ 1,087 $ 1,000
----------- -----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands unless
otherwise indicated)
(Unaudited)
Note 1 - Basis Of Presentation
The accompanying consolidated financial statements and notes thereto have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") have been omitted. The
accompanying consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's 2001 Annual Report on Form 10-K.
The consolidated financial statements include the financial statements of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying unaudited financial
statements as of March 31, 2002, and for the three months ended March 31, 2002
and 2001, reflect adjustments (which were normal and recurring) which, in the
opinion of management, are necessary for a fair statement of the financial
position and results of operations of the interim periods presented. Results for
the three months ended March 31, 2002 are not necessarily indicative of results
expected for the full year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Note 2 - Contingencies
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. The plaintiffs have filed a motion to reconsider and an appeal, and
the Company has responded to the motion for reconsideration and will respond to
the appeal according to a schedule to be set by the appellate court.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On August 14, 2001, Mr. Strykowski filed an amended
complaint, which added Deloitte & Touche, the Company's previous outside
auditors, as defendants. The complaints allege that the defendant directors
caused the Company to violate generally accepted accounting principles and
federal securities laws by improperly capitalizing commission expenses, caused
the Company to allegedly pay increased salaries and bonuses based upon financial
performance which was allegedly improperly inflated, and caused the Company to
expend significant dollars in connection with the defense of its accounting
policy, including cost incurred in connection with the defense of the securities
class actions described above, and in connection with the repurchase of its own
shares on the open market at allegedly artificially inflated prices. These
derivative actions are related to the putative securities class actions
described above, which have been dismissed with prejudice. On March 1, 2002,
plaintiffs filed a consolidated amended derivative complaint making claims and
allegations similar to those contained in the original derivative complaints.
The plaintiffs' have sought to stay their action and have agreed to dismiss the
case if judgment on the securities action is affirmed on appeal. The Pre-Paid
defendants have opposed plaintiffs' motion to stay because the defendants
believe the claims are entirely without merit and wish to bring a motion to
dismiss them summarily. While the outcome of these cases is uncertain, based on
the information currently available to the Company, it appears that the
complaint should be dismissed because the plaintiffs failed to make or excuse
the requisite demand that the Company pursue the claims of alleged misconduct as
well as for failure to state a claim.
In the second quarter of 2001 and through January 30, 2002, multiple
lawsuits were filed against the Company, certain sales associates and other
unnamed defendants in Alabama state courts by current or former members seeking
unspecified actual and punitive damages for alleged breach of contract and fraud
in connection with the sale of memberships. As of April 22, 2002, the Company
was aware of 20 separate lawsuits involving approximately 113 plaintiffs that
have been filed in multiple counties in Alabama, and additional suits of a
similar nature have been threatened to be filed in Alabama and elsewhere by one
or more of the counsel involved in these suits in Alabama. One such similar suit
has been filed by one plaintiff and a different attorney in Mississippi. These
cases make allegations similar to allegations made in cases previously filed
against the Company in Alabama state courts by multiple plaintiffs which were
previously settled for a payment of $1.5 million to settle claims by 97 separate
claimants. In January 2002, one of the law firms representing individual
plaintiffs filed a putative class action on behalf of all Alabama residents
purchasing memberships seeking damages and injunctive relief based on alleged
failures to provide coverage under the memberships. Based on the Company's
preliminary investigation of the new cases, the facts involved are in many
respects significantly different from the facts involved in the case the company
previously settled. These cases are all in various stages of litigation, and the
ultimate outcome of any particular case is not determinable. One of the suits
has been dismissed with prejudice by the plaintiff due to her attorney's
assessment of the merits of the case.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit in Oklahoma on behalf of two members making similar
allegations and seeking "nationwide" class certification. The case is in the
preliminary stages and the ultimate outcome is not determinable.
On June 29, 2001, an action was filed in the District Court of Canadian
County, Oklahoma by Gina Cotwitz against the Company. This action is a putative
class action on behalf of all sales associates of the Company and alleges
violations of the Oklahoma Consumer Protection Act, the Oklahoma Uniform
Consumer Credit Code and breach of contract in connection with certain of the
Company's practices relating to advancing commissions to sales associates. The
Company has filed an answer denying the plaintiff's claims and raising
affirmative defenses and intends to vigorously defend this case. The case is in
the preliminary stages and the ultimate outcome is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is putative class action filed on behalf of all
sales associates of the Company and alleges that the marketing plan offered by
the Company constitutes a security under the Securities Act of 1933 and seeks
remedies for failure to register the marketing plan as a security and for
violations of the anti-fraud provisions of the Securities Act of 1933 and the
Securities Exchange Act of 1934 in connection with representations alleged to
have been made in connection with the marketing plan. The Complaint also alleges
violations of the Oklahoma Securities Act, the Oklahoma Business Opportunities
Sales Act, breach of contract, breach of duty of good faith and fair dealing and
unjust enrichment and violation of the Oklahoma Consumer Protection Act and
negligent supervision. The Company intends to vigorously defend this case. The
case is in the preliminary stages and the ultimate outcome is not determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in these proceedings. While the ultimate outcome of these proceedings
is not determinable, the Company does not currently anticipate that these
contingencies will result in any material adverse effect to its financial
condition or results of operation.
The Company is constructing a new corporate office complex with an
estimated completion date of June 2003 at an estimated cost of approximately $30
million. Costs incurred through March 31, 2002 of approximately $3.2 million
have been paid from existing resources and cash flow. The Company continues to
consider incurring indebtedness in order to finance the remaining costs of its
new corporate headquarters in order to allow cash flow from operations to
continue to be used to purchase treasury stock. Since December 31, 2001, the
Company has entered into a construction contract in the amount of $2.9 million
with the general contractor pertaining to site work for the new office complex.
The Company expects to enter into similar types of construction contracts for
various phases of construction during the remainder of the construction period.
Total remaining costs of construction are estimated at approximately $27 million
during the 15-month period beginning April 1, 2002.
Note 3 - Treasury Stock Purchases
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 4.5 million shares during subsequent board meetings. At March 31,
2002, the Company had purchased 4.1 million shares under these authorizations
for a total consideration of $95.3 million, an average price of $23.51 per
share.
Treasury stock purchases will be made at prices that are considered
attractive by management and at such times that management believes will not
unduly impact the Company's liquidity. No time limit has been set for completion
of the purchase program. The Company obtained on November 6, 2001 a $17.5
million line of credit facility that may be used for additional purchases. The
Company had not drawn on this available credit line as of April 22, 2002.
Note 4 - Earnings Per Share
Basic earnings per common share are computed by dividing net income
applicable to common stockholders by the weighted average number of shares of
common stock outstanding during the respective periods.
Diluted earnings per common share are computed by dividing net income
applicable to common stockholders by the weighted average number of shares of
common stock and common stock equivalents outstanding during the respective
periods. The weighted average number of common shares is increased by the number
of shares issuable on the exercise of options less the number of common shares
assumed to have been purchased with the proceeds from the exercise of the
options pursuant to the treasury stock method; those purchases are assumed to
have been made at the average price of the common stock during the respective
period.
Three Months Ended
March 31,
-------------------
2002 2001
Basuc Earnings Per Share: --------- ---------
Earnings:
Income from continuing operations applicable to common stockholders......................... $ 8,870 $ 7,518
--------- ---------
Shares:
Weighted average shares outstanding......................................................... 20,304 22,002
--------- ---------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations available to common stockholders
after assumed conversions................................................................. $ 8,870 $ 7,518
--------- ---------
Shares:
Weighted average shares outstanding......................................................... 20,304 22,002
Assumed exercise of options................................................................. 140 31
--------- ---------
Weighted average number of shares, as adjusted.............................................. 20,444 22,033
--------- ---------
Note 5 - Discontinued Operations
On December 31, 2001 the Company completed the sale of its wholly owned
subsidiary Universal Fidelity Life Insurance Company ("UFL"). The Company
received a $2.8 million dividend and $1.2 million from the sale of 100% of UFL
stock. The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income for
the three months ended March 31, 2001. Cash flow impacts of discontinued
operations have been segregated in the Consolidated Statements of Cash Flows for
the three months ended March 31, 2001. Details of income from discontinued
operations are as follows:
Three Months Ended
March 31, 2001
------------------
Revenues............................................................... $ 285
------------------
Income from discontinued operations, net of tax expense of $0.......... $ 158
------------------
Note 6 - Recent Issued Accounting Pronouncements and Accounting Change
In July 2001, the Financial Accounting Standards Board issued new
pronouncements: SFAS 142, "Goodwill and Other Intangible Assets"; and SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 142 requires that goodwill
as well as other intangible assets be tested annually for impairment. In
addition, the Statement eliminates the previous requirement to amortize goodwill
or intangible assets with indefinite lives, and is effective for fiscal years
beginning after December 15, 2001. SFAS 142 was adopted effective January 1,
2002 and did not have a material impact on the Company's financial position or
results of operations. SFAS 143 requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred and a corresponding increase in the carrying amount of the related
long-lived asset. SFAS 143 is effective for fiscal years beginning after June
15, 2002. The Company does not expect SFAS 143 to materially impact its reported
results.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", (SFAS 144") is effective for the Company for the fiscal year beginning
January 1, 2002, and addresses accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business." SFAS 144 retains the
fundamental provisions of SFAS No. 121 and expands the reporting of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and that will be eliminated from the
ongoing operations of the entity in a disposal transaction. The Company adopted
SFAS 144 effective January 1, 2002. The new standard did not have a material
impact on the Company's financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Results of Operations
The Company reported net income applicable to common shares of $8.9
million, or $.43 per diluted common share, for the three months ended March 31,
2002, up 16% from net income applicable to common stockholders of $7.7 million,
or $.35 per diluted common share, for the comparable period of the prior year.
Diluted earnings per share increased 23 percent due to increased net income of
16 percent and an approximate 7 percent decrease in the number of outstanding
shares.
Membership fees totaled $71.9 million during 2002 compared to $59.3 million
for 2001, an increase of 21%. Membership fees and their impact on total revenues
in any period are determined directly by the number of active Memberships in
force during any such period. The active Memberships in force are determined by
both the number of new Memberships sold in any period together with the renewal
rate of existing Memberships. New Membership sales increased 9% during the three
months ended March 31, 2002 to 200,780 from 183,712 during the comparable period
of 2001. At March 31, 2002, there were 1,287,199 active Memberships in force
compared to 1,114,437 at March 31, 2001, an increase of 16%. Additionally, the
average annual fee per Membership has increased from $246 for all Memberships in
force at March 31, 2001 to $253 for all Memberships in force at March 31, 2002,
a 3% increase. This increase is a result of a higher portion of active
Memberships containing additional benefits at an additional cost.
Associate services revenue decreased 11% from $10.1 million for the first
three months of 2001 to $9.0 million during the same period of 2002 primarily as
a result of a reduced associate entry fee of $149 during the month of March 2002
compared to the typical associate fee of $249 and due to slightly fewer new
associates recruited. The associate entry fee has been reduced periodically in
the past and may continue to be reduced at certain times in future periods.
Although the reduction in price may lead to lower associate services revenues
overall, the reduced price typically increases the number of new associates that
join and to a great extent offsets the overall reduction in revenue. As a result
of this lower fee for part of the 2002 quarter, the Fast Start program generated
training fees of approximately $3.6 million during the first three months of
2002 compared to $6.0 million for the comparable period of 2001. The field
training program, titled Fast Start to Success ("Fast Start") is aimed at
increasing the level of new Membership sales per associate. Fast Start typically
requires a training fee of $184 per new associate, except for special promotions
the Company implements from time to time, and upon successful completion of the
program provides for the payment of certain training bonuses. The $3.6 million
and $6.0 million for the three month periods ending March 31, 2002 and 2001,
respectively, in training fees was collected from approximately 31,187 new sales
associates who elected to participate in Fast Start during the first three
months of 2002 compared to 32,790 that participated during the comparable
quarter of 2001. Total new associates enrolled during the first three months of
2002 were 33,493 compared to 34,286 for the same period of 2001, a decrease of
2%. The number of new associates recruited in the first three months of 2001
represents the highest recruiting quarter in the Company's history.
Other income increased 24%, to $1.1 million for the three months ended
March 31, 2002 from $900,000 for the comparable period of 2001 primarily due to
an increase in enrollment fees of $200,000.
Primarily as a result of the increase in Membership fees, total revenues
increased to $82.0 million for the three months ended March 31, 2002 from $70.3
million during the comparable period of 2001, an increase of 17%.
Membership benefits totaled $24.3 million for the three months ended March
31, 2002 compared to $20.0 million for the comparable period of 2001, and
represented 34% of Membership fees for both the 2002 and 2001 periods. This
Membership benefit ratio (Membership benefits as a percentage of Membership
fees) should remain near current levels as substantially all active Memberships
provide for a capitated cost.
Commissions to associates increased 18% to $27.8 million for the three
months ended March 31, 2002 compared to $23.6 million for the comparable period
of 2001, and represented 39% and 40% of Membership fees for such periods. These
amounts were reduced by $438,000 and $582,000, respectively, representing
Membership lapse fees. Prior to March 1, 2002, these fees were determined by
applying the prime interest rate to the advance commission balance pertaining to
lapsed Memberships. The Company realizes and recognizes this fee only when the
amount of the calculated fee is collected by withholding from cash commissions
payments due the associate, because the Company's ability to recover fees in
excess of current payments is primarily dependent on the associate selling new
Memberships which qualify for advance commissions. The Company eliminated these
fees for Memberships sold after March 1, 2002 in conjunction with the change in
the commission structure as discussed in "Liquidity and Capital Resources".
Commissions to associates are primarily dependent on the number of new
memberships sold during a period. New memberships sold during the three months
ended March 31, 2002 totaled 200,780, a 9% increase from the 183,712 sold during
the comparable period of 2001. Commissions to associates per new membership sold
were $138 per membership for the three months ended March 31, 2002 compared to
$129 for the comparable period of 2001. The average commission per new
membership sold varies depending on the compensation structure that is in place
at the time a new membership is sold and the amount of any charge-backs
(recoupment of previous commission advances) that are deducted from amounts that
would otherwise be paid to the various sales associates that are compensated for
the membership sale.
Associate services and direct marketing expenses decreased to $7.6 million
for the three months ended March 31, 2002 from $8.2 million for the comparable
period of 2001. Fast Start bonuses incurred were approximately $1.6 million
during the first three months of 2002 compared to $3.6 million in the same
period of 2001. Fast Start bonuses are typically eliminated during those times
the Company reduces the sales associate entry fee as it did in March 2002. These
Fast Start training bonuses are also affected by the number of new sales
associates that successfully meet the qualification criteria established by the
Company, i.e. more training bonuses will be paid when a higher number of new
sales associates meet such criteria. These expenses also include marketing
costs, other than commissions, that are directly associated with new Membership
sales.
General and administrative expenses during the three months ended March 31,
2002 and 2001 were $7.8 million and $6.3 million, respectively, and represented
11% of Membership fees for each period. Management expects general and
administrative expenses as a percentage of Membership fees to remain near
current levels in the near term but to gradually decrease as a percentage of
Membership fees as a result of certain economies of scale.
Other expenses, net, which include depreciation and amortization and
premium taxes reduced by interest income, were approximately $1.0 million for
both three-month periods. Depreciation and amortization increased to $1.2
million for the first three months of 2002 from $948,000 for the comparable
period of 2001 but premium taxes decreased $295,000 from $580,000 for the three
months ended March 31, 2001 to $285,000 for the comparable period of 2002 due to
a change in the tax structure of one of the states in which the Company pays
premium taxes. Interest income decreased by approximately $61,000 for the first
three months of 2002 to $483,000 from $544,000 for the 2001 period due to a
decrease in investment balances.
The Company has recorded a provision for income taxes of $4.7 million (35%
of pretax income) for the first three months of 2002 compared to $3.7 million
(33% of pretax income) for the same period of 2001. The lower effective tax rate
for the 2001 period was primarily attributable to the utilization of net
operating loss carryforwards and tax credits.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Income from discontinued operations, net of income tax of $0, was $158,000 for
the three months ended March 31, 2001. UFL was sold on December 31, 2001.
Liquidity and Capital Resources
General
Consolidated net cash provided by operating activities of continuing
operations was $18.1 million for the first three months of 2002 compared to cash
provided of $10.8 million for the 2001 period. The increase of $7.3 million
resulted primarily from the increase in net income of $1.2 million, a net
increase in the change in income taxes payable of $3.6 million and a net
increase in the change in accounts payable and accrued expenses of $3.1 million,
partially offset by a decrease in the provision for deferred taxes of $1.2
million.
Consolidated net cash used in investing activities of continuing operations
was $3.5 million for the first three months of 2002 compared to net cash
provided by investing activities of $2.3 million for the comparable period of
2001. This $5.8 million increase in cash used in investing activities resulted
primarily from the $5.9 million increase in the purchases of investments.
Net cash used in financing activities of continuing operations during the
first three months of 2002 was $19.4 million compared to $12.9 million for the
comparable period of 2001. This $6.5 million change was primarily comprised of
the $7.6 million increase in treasury stock purchases during the first three
months of 2002 compared to the first three months of 2001 offset by a $1.0
million increase in proceeds from the exercise of stock options during the 2002
period when compared to the comparable period of 2001.
Primarily due to the large amount of treasury stock purchases in the first
three months of 2002 of approximately $20.4 million, the Company had a
consolidated working capital deficit of $7.7 million at March 31, 2002, a
decrease of $12.7 million compared to a consolidated working capital surplus of
$5.1 million at December 31, 2001. More than $7 million of the working capital
deficit at March 31, 2002 is related to deferred revenue and fees in excess of
deferred member and associate service costs. These amounts will be eliminated by
the passage of time without the utilization of other current assets or the
Company incurring other current liabilities. Additionally, at the current rate
of cash flow provided by continuing operations ($18.1 million during the first
quarter of 2002), the Company's ability to control the timing of its
discretionary treasury stock purchases and the availability pursuant to its line
of credit, the Company does not expect any difficulty in meeting its financial
obligations in the short term or the long term.
At March 31, 2002 the Company reported $29.2 million in cash and cash
equivalents and unpledged investments (after utilizing more than $20.4 million
to purchase approximately 862,800 shares of its common stock during the three
months ended March 31, 2002) compared to $33.7 million at December 31, 2001. The
Company's investments consist of common stocks, investment grade (rated Baa or
higher) preferred stocks and investment grade bonds primarily issued by
corporations, the United States Treasury, federal agencies, federally sponsored
agencies and enterprises as well as mortgage-backed securities and state and
municipal tax-exempt bonds.
The Company generally advances significant commissions at the time a
Membership is sold. During the three months ended March 31, 2002, the Company
advanced commissions of $29.3 million on new Membership sales compared to $25.2
million for the same period of 2001. Since approximately 94% of Membership
premiums are collected on a monthly basis, a significant cash flow deficit is
created at the time a Membership is sold. This deficit is reduced as monthly
premiums are remitted and commissions payable on those Memberships are withheld
to recover the advance. Effective March 1, 2002, and in order to offer
additional incentives for increased Membership retention rates, the Company
returned to a differential commission structure with advance rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from zero to 25% per annum based
on the first year Membership retention rate of the associate's sales
organization. This 12-month advance structure replaces the prior compensation
structure utilized by the Company that included up to a 3-year commission
advance based on an average commission rate of approximately 27% for all
membership years.
The Company expenses advance commissions ratably over the first month of
the related membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates as of March 31, 2002 were:
(Amounts in 000's)
------------------
Beginning unearned advance commission payments (1)............................... $ 211,609
Advance commission payments, net................................................. 29,310
Earned commissions applied....................................................... (18,473)
Advance commission payment write-offs............................................ (564)
-------------
Ending unearned advance commission payments before
estimated unrecoverable payments (1)........................................... 221,882
Estimated unrecoverable advance commission payments (1).......................... (17,562)
-------------
Ending unearned advance commission payments, net (1)............................. $ 204,320
-------------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
The ending unearned advance commission payments, net, above includes net
unearned advance commission payments to non-vested associates of $22 million. As
such, at March 31, 2002 future commission payments and related expense should be
reduced as unearned advance commission payments of $182 million are recovered.
Commissions are earned by the associate as Membership premiums are earned by the
Company, usually on a monthly basis. For additional information concerning these
commission advances, see the Company's Annual report on Form 10-K under the
heading Commissions to Associates in Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
The Company believes that it has significant ability to finance expected
future growth in Membership sales based on its existing amount of cash and cash
equivalents and unpledged investments at March 31, 2002 of $29.2 million. The
Company expects to maintain cash and investment balances, including pledged
investments, on an on-going basis of approximately $25 to $35 million in order
to meet expected working capital needs and regulatory capital requirements. Cash
balances in excess of this amount would be used for discretionary purposes such
as treasury stock purchases. The Company continues to consider incurring
indebtedness in order to continue or increase the rate of treasury stock
purchases, including financing its new corporate headquarters in order to allow
cash flow from operations to continue to be used to purchase treasury stock.
The Company is constructing a new corporate office complex. Costs incurred
through March 31, 2002 of approximately $3.2 million have been paid from
existing resources and cash flow. Since December 31, 2001, the Company has
entered into a construction contract in the amount of $2.9 million with the
general contractor pertaining to site work for the new office complex. The
Company expects to enter into similar types of construction contracts for
various phases of construction during the remainder of the construction period.
Total remaining costs of construction are estimated at approximately $27 million
during the 15-month period beginning April 1, 2002.
On November 6, 2001, the Company entered into a $17.5 million line of
credit with Bank of Oklahoma, N.A. in order to fund additional treasury stock
purchases. The line of credit provides for immediate funding of up to $17.5
million with repayments originally scheduled to begin February 15, 2002 and end
November 15, 2002 with interest at the Libor rate plus 2% per annum or the prime
rate minus 1/2 percent per annum as selected by the Company. Since the Company
did not access this line of credit prior to February 15, 2002, the Company has
asked the bank to amend the terms of the loan to allow for advances subsequent
to February 15, 2002 without extending the repayment time frame. The bank has
indicated their willingness to make such amendment and submitted formal
amendment documentation to the Company, but those documents have not been
finalized. The loan is secured by the Company's rights to receive membership
fees on a portion of its memberships. The terms of this loan have various
covenants customary for similar transactions. The Company had not drawn on this
available credit line as of April 22, 2002.
Actions that May Impact Retention in the Future
The potential impact on the Company's future profitability and cash flow
due to future changes in Membership retention can be significant. While blended
retention rates have not changed significantly over the past five years, the
Company has recently taken actions that may impact retention rates in the
future. Since December 31, 2001, the Company has implemented several new
initiatives aimed at improving the retention rate of both new and existing
Memberships. Such initiatives include a revised compensation structure,
effective March 1, 2002, featuring variable renewal commission rates ranging
from zero to 25% per annum based on the first year Membership retention rate of
the associate's sales organization; implementation of a "non-taken"
administrative fee to sales associates of $35 for any Membership application
that is processed by the Company after March 1, 2002, but for which a payment is
never received; and, an increase in the amount of the commission "charge-back"
for Memberships written after March 1, 2002 which are subsequently terminated
from 50% of the unearned Membership commission advance balance to 100% of the
unearned Membership commission advance balance. The Company is also in the
process of designing and implementing an enhanced member "life cycle"
communication process aimed at both increasing the overall amount of
communication from the Company to the members as well as more specific target
messaging to members based on the length of their Membership as well as
utilization characteristics. The Company believes that such efforts may increase
the utilization by members and therefore lead to higher retention rates.
Parent Company Funding and Dividends
Although the Company is the operating entity in many jurisdictions, the
Company's subsidiaries serve as operating companies in various states that
regulate Memberships as insurance or specialized legal expense products. The
most significant of these wholly owned subsidiaries are Pre-Paid Legal Casualty,
Inc. ("PPLCI") and Pre-Paid Legal Services, Inc. of Florida ("PPLSIF"). The
ability of PPLCI and PPLSIF to provide funds to the Company is subject to a
number of restrictions under various insurance laws in the jurisdictions in
which PPLCI and PPLSIF conduct business, including limitations on the amount of
dividends and management fees that may be paid and requirements to maintain
specified levels of capital and reserves. In addition PPLCI will be required to
maintain its stockholders' equity at levels sufficient to satisfy various state
or provincial regulatory requirements, the most restrictive of which is
currently $3 million. Additional capital requirements of PPLCI or PPLSIF will be
funded by the Company in the form of capital contributions or surplus
debentures. At March 31, 2002, PPLSIF did not have funds available for payment
of substantial dividends without the prior approval of the respective insurance
commissioner. PPLCI had approximately $5 million in surplus funds available for
payment of an ordinary dividend.
Forward-Looking Statements
All statements in this report concerning Pre-Paid Legal Services, Inc. (the
"Company") other than purely historical information, including but not limited
to, statements relating to the Company's future plans and objectives, expected
operating results, and the assumptions on which such forward-looking statements
are based, constitute "Forward-Looking Statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934 and are based on the Company's historical operating trends and financial
condition as of March 31, 2002 and other information currently available to
management. The Company cautions that the Forward-Looking Statements are subject
to all the risks and uncertainties incident to its business, including but not
limited to risks described below. Moreover, the Company may make acquisitions or
dispositions of assets or businesses, enter into new marketing arrangements or
enter into financing transactions. None of these can be predicted with certainty
and, accordingly, are not taken into consideration in any of the Forward-Looking
Statements made herein. For all of the foregoing reasons, actual results may
vary materially from the Forward-Looking Statements. The Company assumes no
obligation to update the Forward-Looking Statements to reflect events or
circumstances occurring after the date of the statement.
Risk Factors
There are a number of risk factors that could affect our financial
condition or results of operations. See Note 2 - Contingencies and Item 1 -
Legal Proceedings. Please refer to page 33 and 34 of the Company's 2001 Annual
Report on Form 10-K for a description of other risk factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to the
Company's significant investment in fixed-maturity investments, interest rate
risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in fair values of those
instruments. Additionally, fair values of interest rate sensitive instruments
may be affected by the creditworthiness of the issuer, prepayment options,
relative values of alternative investments, liquidity of the instrument and
other general market conditions.
As of March 31, 2002, substantially all of the Company's investments were
in investment grade (rated Baa or higher) fixed-maturity investments,
interest-bearing money market accounts and a collateralized repurchase
agreement. The Company does not hold any investments classified as trading
account assets or derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on the Company's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly, with
no effect given to any steps that management might take to counteract that
change. The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table (dollars in 000's):
Estimated fair value
Hypothetical change after hypothetical
in interest rate change in interest
Fair Value (bp=basis points rate
---------- ------------------- ---------------------
Fixed-maturity investments at March 31, 2002 (1)............ $ 19,834 100 bp increase $ 18,356
200 bp increase 17,030
50 bp decrease 20,544
100 bp decrease 21,254
Fixed-maturity investments at December 31, 2001 (1)......... $ 18,983 100 bp increase $ 17,635
200 bp increase 16,437
50 bp decrease 19,575
100 bp decrease 20,167
--------------------
(1) Excluding short-term investments with a fair value of $3.3 million at March
31, 2002 and December 31, 2001, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at March 31, 2002 would reduce the
estimated fair value of the Company's fixed-maturity investments by
approximately $2.8 million at that date. At December 31, 2001, an
instantaneous 200 basis point increase in market interest rates would have
reduced the estimated fair value of the Company's fixed-maturity
investments by approximately $2.5 million at that date. The definitive
extent of the interest rate risk is not quantifiable or predictable due to
the variability of future interest rates, but the Company does not believe
such risk is material.
The Company primarily manages its exposure to interest rate risk by
purchasing investments that can be readily liquidated should the interest rate
environment begin to significantly change.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
------------------
See Note 2 of the Notes to Consolidated Financial Statements included in
Part I, Item 1 of this report for information with respect to legal proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
---------------------------------
(a) Exhibits: none
(b) Reports on Form 8-K: none
SIGNATURES
----------
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: April 22, 2002 /s/ Randy Harp
------------------------------------------
Chief Operating Officer
(Duly Authorized Officer)
Date: April 22, 2002 /s/ Steve Williamson
------------------------------------------
Chief Financial Officer
(Principal Accounting Officer)