================================================================================
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 September 30, 2006
[ ] 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: 001-09293
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 74820-5813
(Address of principal executive offices) (Zip Code)
(Registrants' telephone number, including area code): (580) 436-1234
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 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]
The number of shares outstanding of the registrant's common stock (excluding
4,852,179 shares held in treasury) as of October 20, 2006 was 14,204,958.
================================================================================
PRE-PAID LEGAL SERVICES, INC.
FORM 10-Q
For the Quarter Ended September 30, 2006
CONTENTS
Part I. Financial Information
Item 1. Financial Statements:
a) Consolidated Balance Sheets
as of September 30, 2006 (Unaudited) and December 31, 2005
b) Consolidated Statements of Income (Unaudited)
for the three months and nine months ended September 30, 2006 and 2005
c) Consolidated Statements of Comprehensive Income (Unaudited)
for the three months and nine months ended September 30, 2006 and 2005
d) Consolidated Statements of Cash Flows (Unaudited)
for the nine months ended September 30, 2006 and 2005
e) Notes to Consolidated Financial Statements (Unaudited)
Item 1A. Risk Factors
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Signatures
ITEM 1. FINANCIAL STATEMENTS
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in 000's, except par values)
ASSETS
September 30, December 31,
------------- ------------
2006 2005
------------- ------------
Current assets: (Unaudited)
Cash and cash equivalents............................................................ $ 34,360 $ 33,957
Available-for-sale investments, at fair value........................................ 34,165 6,742
Membership fees receivable........................................................... 5,719 5,395
Inventories.......................................................................... 1,371 1,717
Refundable income taxes.............................................................. 19 -
Deferred member and associate service costs.......................................... 17,646 16,210
Deferred income taxes................................................................ 4,420 4,894
Other assets......................................................................... 5,994 5,236
------------- ------------
Total current assets............................................................. 103,694 74,151
Available-for-sale investments, at fair value.......................................... 27,234 19,213
Investments pledged.................................................................... 4,174 4,307
Property and equipment, net............................................................ 60,854 58,947
Deferred member and associate service costs............................................ 2,826 3,003
Other assets........................................................................... 6,830 5,244
------------- ------------
Total assets................................................................... $ 205,612 $ 164,865
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 11,983 $ 11,638
Deferred revenue and fees............................................................ 27,178 26,287
Current portion of capital leases payable............................................ 21 321
Current portion of notes payable..................................................... 18,437 15,250
Common stock dividends payable....................................................... - 4,643
Income taxes payable................................................................. - 1,738
Accounts payable and accrued expenses................................................ 14,154 17,357
------------- ------------
Total current liabilities.......................................................... 71,773 77,234
------------- ------------
Capital leases payable............................................................... 1,281 1,296
Notes payable........................................................................ 78,142 23,220
Deferred revenue and fees............................................................ 2,826 3,007
Deferred income taxes................................................................ 4,618 4,782
Other non-current liabilities........................................................ 4,813 3,932
------------- ------------
Total liabilities................................................................ 163,453 113,471
------------- ------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 19,058 and
20,326 issued at September 30, 2006 and December 31, 2005, respectively............ 191 203
Retained earnings.................................................................... 140,459 149,832
Accumulated other comprehensive income............................................... 537 387
Treasury stock, at cost; 4,852 shares held at September 30, 2006 and
December 31, 2005, respectively.................................................... (99,028) (99,028)
------------- ------------
Total stockholders' equity....................................................... 42,159 51,394
------------- ------------
Total liabilities and stockholders' equity..................................... $ 205,612 $ 164,865
------------- ------------
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 Nine Months Ended
September 30, September 30,
---------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ----------- ----------
Revenues:
Membership fees............................................. $ 103,592 $ 99,009 $ 308,443 $ 288,606
Associate services.......................................... 6,368 7,335 20,151 21,552
Other....................................................... 1,234 1,238 3,758 3,938
---------- ---------- ----------- ----------
111,194 107,582 332,352 314,096
---------- ---------- ----------- ----------
Costs and expenses:
Membership benefits......................................... 36,578 34,919 108,696 101,350
Commissions................................................. 31,393 37,374 96,023 107,871
Associate services and direct marketing..................... 7,144 7,687 22,030 24,746
General and administrative.................................. 12,229 12,015 37,716 35,451
Other, net.................................................. 2,932 2,390 8,555 7,357
---------- ---------- ----------- ----------
90,276 94,385 273,020 276,775
---------- ---------- ----------- ----------
Income before income taxes.................................... 20,918 13,197 59,332 37,321
Provision for income taxes.................................... 7,512 4,553 20,765 12,876
---------- ---------- ----------- ----------
Net income.................................................... $ 13,406 $ 8,644 $ 38,567 $ 24,445
---------- ---------- ----------- ----------
Basic earnings per common share............................... $ .93 $ .56 $ 2.59 $ 1.58
---------- ---------- ----------- ----------
Diluted earnings per common share............................. $ .93 $ .55 $ 2.58 $ 1.55
---------- ---------- ----------- ----------
Dividends declared per common share........................... $ - $ - $ - $ .30
---------- ---------- ----------- ----------
The accompanying notes are an integral part of these financial statements.
=
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in 000's)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- -----------
Net income..................................................... $ 13,406 $ 8,644 $ 38,567 $ 24,445
---------- ---------- ----------- ----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment...................... (31) 162 160 147
---------- ---------- ----------- ----------
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during period.... 358 (234) (14) (731)
Reclassification adjustment for realized (gains) losses
included in net income................................... (15) 1 4 10
---------- ---------- ----------- ----------
343 (233) (10) (721)
---------- ---------- ----------- ----------
Other comprehensive income (loss), net of income taxes of $219
and $(152) for the three months and $(6) and $(463) for the
nine months ended September 30, 2006 and 2005,
respectively............................................... 312 (71) 150 (574)
---------- ---------- ----------- ----------
Comprehensive income........................................... $ 13,718 $ 8,573 $ 38,717 $ 23,871
---------- ---------- ----------- ----------
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)
Nine Months Ended
September 30,
----------------------
2006 2005
---------- ----------
Cash flows from operating activities:
Net income....................................................................... $ 38,567 $ 24,445
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision (benefit) for deferred income taxes.................................. 310 (875)
Depreciation and amortization.................................................. 6,139 5,462
---------- ----------
Cash provided by operating activities before changes in assets and liabilities 45,016 29,032
Increase in Membership income receivable....................................... (324) (145)
Decrease in inventories........................................................ 346 490
(Increase) decrease in refundable income taxes................................. (19) 1,241
Increase in deferred member and associate service costs........................ (1,259) (2,350)
Increase in other assets....................................................... (2,344) (3,389)
Increase in accrued Membership benefits........................................ 345 1,189
Increase in deferred revenue and fees.......................................... 710 3,199
Increase in other non-current liabilities...................................... 881 869
Decrease in income taxes payable............................................... (1,738) -
(Decrease) increase in accounts payable and accrued expenses................... (3,043) 1,094
---------- ----------
Net cash provided by operating activities.................................... 38,571 31,230
---------- ----------
Cash flows from investing activities:
Additions to property and equipment............................................ (8,046) (3,910)
Purchases of investments - available for sale.................................. (88,843) (10,190)
Maturities and sales of investments - available for sale....................... 53,522 12,577
---------- ----------
Net cash used in investing activities........................................ (43,367) (1,523)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of stock options........................................ 288 4,180
Tax benefit on exercise of stock options....................................... 649 1,137
Proceeds from issuance of debt................................................. 85,000 2,314
Decrease in capital lease obligations.......................................... (315) (335)
Common stock dividends paid.................................................... (4,643) (12,412)
Repayments of debt............................................................. (26,891) (13,720)
Purchases and retirement of treasury stock..................................... (48,889) (11,673)
---------- ----------
Net cash provided by (used in) financing activities ......................... 5,199 (30,509)
---------- ----------
Net increase (decrease) in cash and cash equivalents............................. 403 (802)
Cash and cash equivalents at beginning of period................................. 33,957 25,972
---------- ----------
Cash and cash equivalents at end of period....................................... $ 34,360 $ 25,170
---------- ----------
Supplemental disclosure of cash flow information:
Cash paid for interest......................................................... $ 3,233 $ 1,818
---------- ----------
Cash paid for income taxes..................................................... $ 21,633 $ 11,015
---------- ----------
Purchases of treasury stock pursuant to tender offer........................... $ 6,584 $ -
---------- ----------
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 our 2005 Annual Report on Form 10-K. Terms such as "we", "our" and
"us" are sometimes used as abbreviated references to Pre-Paid Legal Services,
Inc.
In our opinion, the accompanying unaudited financial statements as of
September 30, 2006, and for the three month and nine month periods ended
September 30, 2006 and 2005, reflect adjustments (which were normal and
recurring) which, in our opinion, are necessary for a fair statement of our
financial position and results of operations of the interim periods presented.
Results for the three month and nine month periods ended September 30, 2006 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 us 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.
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.
Note 2 - 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
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. The briefing in
the appeal was completed and on January 14, 2004 oral argument was held in the
appeal. On July 14, 2006 the Tenth Circuit Court of Appeals entered an Order and
Judgment affirming the trial court's dismissal with prejudice in our favor. On
September 6, 2006, the Tenth Circuit Court of Appeals entered an order denying
plaintiffs' petition for rehearing en banc.
Beginning in the second quarter of 2001 multiple lawsuits were filed
against us, certain officers, employees, sales associates and other defendants
in various 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. As of July 14, 2006, we were
aware of 11 separate lawsuits involving approximately 400 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 ordered arbitration of a case
involving 8 plaintiffs. These cases are all in various stages of litigation, and
seek varying amounts of actual and punitive damages. We 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. Our motions for post judgment relief are pending with
the trial court. On September 11, 2006 we reached a settlement agreement with
counsel for the more than 400 plaintiffs in numerous pending cases in
Mississippi. Upon closing of the settlement for an amount significantly less
than our accrued reserves of $2.5 million, all pending litigation against us
will be resolved in Mississippi, including the Barbara Booth v. Pre-Paid Legal
Services, Inc. case in which the $9.9 million punitive damage verdict was
entered as described above. Consummation of the settlement and dismissal of the
lawsuits is subject to approval of the individual plaintiffs.
On April 19, 2002, counsel in certain previously pending Alabama suits
(which have previously been settled) 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
allegations relating to our Memberships similar to those made in the Alabama
cases 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. On April 13, 2006 we
filed a motion to dismiss the case based on the failure of timely substitution
of the parties and failure to prosecute. The case was dismissed without
prejudice on May 22, 2006.
On March 27, 2006 we received a complaint filed by a former provider
attorney law firm in Davidson County, Tennessee seeking compensatory and
punitive damages on the basis of allegations of breach of contract. On May 15,
2006 the trial court dismissed plaintiff's complaint in its entirety. Plaintiff
filed a notice of appeal on June 13, 2006. 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 we are 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, including the
Mississippi settlement discussed above, 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 September 30, 2006 was $1.8
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 and,
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
September 30, 2006 we have accrued $472,000 for this assessment.
Note 3 - Treasury Stock Purchases
---------------------------------
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 12
million shares during subsequent board meetings. At September 30, 2006, we had
purchased 10.8 million treasury shares under these authorizations for a total
consideration of $271.4 million, an average price of $25.14 per share. We
purchased and formally retired 311,484 shares of our common stock during the
2006 third quarter for $11.3 million, or an average price of $36.34 per share,
reducing our common stock by $3,115 and our retained earnings by $11.3 million.
See Note 6 below. 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.
Note 4 - 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
respective period. 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 respective period. The weighted
average number of common shares is 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.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
Basic Earnings Per Share: 2006 2005 2006 2005
--------- --------- --------- ---------
Earnings:
Net income........................................................... $ 13,406 $ 8,644 $ 38,567 $ 24,445
--------- --------- --------- ---------
Shares:
Weighted average shares outstanding.................................. 14,360 15,451 14,867 15,471
--------- --------- --------- ---------
Diluted Earnings Per Share:
Earnings:
Net income........................................................... $ 13,406 $ 8,644 $ 38,567 $ 24,445
--------- --------- --------- ---------
Shares:
-------
Weighted average shares outstanding.................................. 14,360 15,451 14,867 15,471
Assumed exercise of options.......................................... 67 275 101 282
--------- --------- --------- ---------
Weighted average number of shares, as adjusted....................... 14,427 15,726 14,968 15,753
--------- --------- --------- ---------
Shares issued pursuant to option exercises........................... 3 45 113 40
--------- --------- --------- ---------
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. No options were excluded for the three
months and nine months ended September 30, 2006 and 2005.
Note 5 - Recently Issued Accounting Pronouncements
--------------------------------------------------
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 adoption of this FSP January 1, 2006 did
not have a material effect on our consolidated financial position and results of
operations.
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.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB 108 was issued to
provide consistency between how registrants quantify financial statement
misstatements.
Historically, there have been two widely-used methods for quantifying the
effects of financial statement misstatements. These methods are referred to as
the "roll-over" and "iron curtain" method. The roll-over method quantifies the
amount by which the current year income statement is misstated. Exclusive
reliance on an income statement approach can result in the accumulation of
errors on the balance sheet that may not have been material to any individual
income statement, but which may misstate one or more balance sheet accounts. The
iron curtain method quantifies the error as the cumulative amount by which the
current year balance sheet is misstated. Exclusive reliance on a balance sheet
approach can result in disregarding the effects of errors in the current year
income statement that results from the correction of an error existing in
previously issued financial statements. SAB 108 established an approach that
requires quantification of financial statement misstatements based on the
effects of the misstatement on each of the company's financial statements and
the related financial statement disclosures. This approach is commonly referred
to as the "dual approach" because it requires quantification of errors under
both the roll-over and iron curtain methods.
We will initially apply SAB 108 in connection with the preparation of our
annual financial statements for the year ending December 31, 2006 and we do not
expect to record an adjustment.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"), to clarify certain aspects of accounting for uncertain tax positions,
including issues related to the recognition and measurement of those tax
positions. FIN 48 is effective for fiscal years beginning after December 15,
2006. We are in the process of evaluating the impact of the adoption of this
interpretation on our results of operations and financial condition.
Note 6 - Notes Payable
----------------------
On June 23, 2006, we received $80 million of senior, secured financing (the
"Senior Loan") from Wells Fargo Foothill, Inc. ("Wells Fargo") consisting of a
$75 million five year term loan facility (the "Term Facility") and a $5 million
five year revolving credit facility (the "Revolving Facility"). After payment of
an origination fee of 1%, lender costs and refinancing $15.3 million of existing
bank indebtedness, the net proceeds of the Term Facility we received were $58.8
million. During the three months ended September 30, 2006, we used a portion of
the net proceeds to purchase 311,484 shares of treasury stock at a cost of $11.3
million, or an average price of $36.34 per share. The remaining proceeds will be
used primarily to fund further share repurchases.
The Term Facility was fully funded on June 23, 2006 and provides for a
five-year maturity and amortizes in monthly installments of $1.25 million
commencing August 1, 2006, with interest on the outstanding balances under the
Term Facility and the Revolving Facility payable, at our option, at a rate equal
to Wells Fargo base rate plus 150 basis points or at the LIBOR plus 250 basis
points. The interest rate at September 30, 2006 was 7.83%. We are also obligated
to make additional quarterly payments equal to 50% of our "excess cash flow" (as
defined in the Senior Loan agreement) if our Leverage Ratio is greater than or
equal to 1 to 1 at the end of a quarter. We expect to be able to repay the
facilities with cash flow from operations. We have the right to prepay the Term
Facility in whole or in part, subject to a prepayment premium of 1% in the first
year, 0.5% in the second year and none thereafter, with a reduction of 50% of
the prepayment premium if the prepayment is from the proceeds of another loan
provided by Wells Fargo.
The Senior Loan is guaranteed by our non-regulated subsidiaries and is
secured by all of our tangible and intangible personal property (other than
aircraft), including stock in all of our direct subsidiaries, and a mortgage on
a building we recently acquired in Duncan, Oklahoma and remodeled to relocate
and expand our existing customer service facility in Duncan.
In addition to customary covenants for loans of a similar type, the
principal covenants for the Senior Loan are:
* limitation on incurring any indebtedness in excess of the remaining
existing bank indebtedness outstanding and $2.3 million in permitted
capitalized leases or purchase money debt;
* limitation on our ability to pay dividends or make stock purchases,
other than with the net proceeds of the Term Loan, unless we meet
certain cash flow tests;
* prohibition on prepayment of other debt;
* requirement to maintain consolidated EBITDA for the nine month period
ending September 30, 2006 of at least $60 million ($55 million for us
and our top tier direct subsidiaries) and for the twelve month period
ending each quarter thereafter of at least $80 million ($75 million
for us and our top tier direct subsidiaries);
* requirement to maintain a quarterly fixed charge coverage ratio
(EBITDA (with certain adjustments) divided by the sum of interest
expense, income taxes and scheduled principal payments) of at least
1.1 to 1;
* requirement to maintain at least 1.3 million members; and
* requirement to maintain a Leverage Ratio (funded indebtedness as of
the end of each quarter divided by EBITDA for the trailing twelve
months) of no more than 1.5 to 1.
We were in compliance with these covenants at September 30, 2006.
In addition to customary events of default, it is an event of default if
Harland Stonecipher ceases to be our Chairman and Chief Executive Officer for a
period of 120 days unless replaced with a person approved by Wells Fargo.
We used the proceeds of the Term Facility to repay in full the $5.3
remaining balance of our existing stock loan with Bank of Oklahoma, N.A., First
United Bank and Trust and Comerica Bank, which was originated in 2003 and the
$10 million we borrowed from Bank of Oklahoma, N. A. earlier in June 2006. The
related loan agreements were thereby terminated and the associated collateral
was released. As a part of the transaction, we also amended our existing $20
million real estate loan which we incurred in 2002 to finance our new
headquarters building in Ada, Oklahoma to extend the final maturity
from September 2008 to August 2011. This loan, with interest at the 30 day LIBOR
rate plus 2.25%, adjusted monthly, remains secured by a mortgage on our
headquarters, but the additional security interest in our membership contracts
was released. The interest rate at September 30, 2006 was 7.58%. We will
continue to be required to make the same monthly payments on this loan of
$191,000 plus interest with the balance of approximately $2.3 million due at
maturity. The real estate loan was also amended to conform the financial
covenants to those under the new Senior Loan.
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 which began December 31,
2005 with the remaining balance payable in a final installment due November 30,
2015. The interest rate at September 30, 2006 was 7.08%. 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 September 30, 2006 is as
follows:
Senior loan................................ $ 72,500
Real estate loan........................... 13,524
Aircraft loan.............................. 10,555
-----------
Total notes payable........................ 96,579
Less: Current portion of notes payable..... (18,437)
-----------
Long term portion.......................... $ 78,142
-----------
A schedule of future maturities as of September 30, 2006 is as follows:
Repayment Schedule commencing
July 2006:
Year 1..................................... $ 18,437
Year 2..................................... 18,437
Year 3..................................... 18,437
Year 4..................................... 18,437
Year 5..................................... 18,033
Thereafter................................. 4,798
-----------
Total notes payable........................ $ 96,579
-----------
Note 7 - Share-based Compensation
---------------------------------
During the nine months ended September 30, 2006, the stock option activity
under our stock option plans was as follows:
Weighted
Average
Remaining
Weighted Contractual Aggregate
Average Number of Term Intrinsic
Price Shares (In Years) Value
------------ ---------- ------------ -----------
Outstanding, January 1, 2006.................... $ 20.94 507,167
Granted....................................... - -
Cancelled..................................... 22.13 (4,798)
Exercised..................................... 17.83 (218,629)
------------ ------------
Outstanding, September 30, 2006................. $ 23.32 283,740 1.42 $ 4,640
------------ ------------ ------------ -----------
Options exercisable as of September 30, 2006.... $ 23.32 283,740 1.42 $ 4,640
------------ ------------ ------------ -----------
Other information pertaining to option activity during the nine months
ended September 30, 2006 and 2005 was as follows:
September 30, September 30,
2006 2005
------------------ ------------------
Weighted average grant-date fair value of stock options granted.. Not applicable Not applicable
Total fair value of stock options vested......................... Not applicable $ 192
Total intrinsic value of stock options exercised................. $3,638 $ 3,006
Under our stock option plan, 1,346,252 shares of our Common Stock are
available for issuance. Options outstanding and exercisable were granted at a
stock option price which was not less than the fair market value of our Common
Stock on the date the option was granted and no option has a term in excess of
ten years. Additionally, options vested and became exercisable either on the
grant date or up to five years from the option grant date.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123R, Share-Based Payment ("SFAS No. 123R" or the "Statement"). This Statement
is a revision of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS
123"), and supersedes Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB No. 25") and its related implementation
guidance. On January 1, 2006, we adopted the provisions of SFAS No. 123R using
the modified prospective method. SFAS No. 123R focuses primarily on accounting
for transactions in which an entity obtains employee services in share-based
payment transactions. The Statement requires entities to recognize compensation
expense for awards of equity instruments to employees based on the grant-date
fair value of those awards (with limited exceptions). SFAS No. 123R also
requires the benefits of tax deductions in excess of recognized compensation
expense to be reported as financing cash flows, rather than as an operating cash
flow as prescribed under the prior accounting rules. This requirement reduces
net operating cash flows and increases net financing cash flows in periods after
adoption. Total cash flow remains unchanged from what would have been reported
under prior accounting rules.
Prior to the adoption of SFAS No. 123R, we followed the intrinsic value
method in accordance with APB No. 25 to account for our employee stock options.
Accordingly, no compensation expense was recognized in connection with the
issuance of stock options under any of our stock option plans for periods ended
prior to January 1, 2006. The adoption of SFAS No. 123R primarily resulted in a
change in our method of recognizing the fair value of share-based compensation.
Our adoption of SFAS No. 123R did not result in our recording compensation
expense for employee stock options, since all options had vested, no
modifications were made to existing options and no new options were granted.
We do not expect to grant any additional employee options or modify any
existing options and therefore recognize any share-based payments' expense from
the issuance of employee stock options in 2006. The options outstanding at
December 31, 2005 did not and will not impact 2006 consolidated results of
operations and financial position since all option-holders were fully vested in
such options at December 31, 2005.
We used the modified prospective method at the date of adoption and
therefore results for the 2005 first quarter have not been restated. Had
compensation expense for employee stock options granted under our stock option
plans been determined based on fair value at the grant date consistent with SFAS
No. 123, our net income and earnings per share for the 2005 period would have
been the pro forma amounts indicated below and were estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Risk free interest rate 5.16%
Expected volatility 29.46%
Dividend yield 0.0%
Weighted average expected life 5.92 years
Nine Months Ended
September 30,
2005
-----------------
Net Income:
As reported...................................................... $ 24,445
Deduct:
Total share-based employee compensation expense determined under
fair value based method for all awards, net of related tax
effects:
Stock option plans............................................... (117)
-----------------
Pro forma net income................................................. $ 24,328
-----------------
Basic Earnings Per Common Share:
As reported...................................................... $ 1.58
-----------------
Pro forma........................................................ $ 1.57
-----------------
Diluted Earnings Per Common Share:
As reported...................................................... $ 1.55
-----------------
Pro forma........................................................ $ 1.54
-----------------
ITEM 1A. RISK FACTORS
There are a number of risk factors that could affect our financial
condition or results of operations. See Note 2 - Contingencies and Part II, Item
1 - Legal Proceedings. Please refer to page 14 and 15 of our 2005 Annual Report
on Form 10-K for a description of other risk factors. There has not been any
material changes in the risk factors disclosed in the Annual Report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations in our Form 10-K for the year ended December 31, 2005, which
describes, among other things, our basic business model, critical accounting
policies, measures of Membership retention, and basic cash flow characteristics
of our business. The following tables set forth changes in the principal
categories of revenues and expenses and Membership and recruiting activity for
the third quarter of 2006 compared to the third quarter of 2005 and the second
quarter of 2006 (Table amounts in 000's). The sum of the percentages in the
tables may not total due to rounding.
Three Months Ended September 30, 2006 Three % % Three Three
compared to Months Change Change Months Months
Three Months Ended September 30, 2005 Ended % of from from Ended % of Ended % of
and compared to Sept. 30, Total Prior Sequential Sept. 30, Total Jun 30, Total
Three Months Ended June 30, 2006 2006 Revenue Year Period 2005 Revenue 2006 Revenue
-------------------------------------- ---------- ------- ------- ----------- -------- -------- ---------- --------
Revenues:
Membership fees.................... $103,592 93.2 4.6 0.5 $99,009 92.0 $103,111 92.7
Associate services................. 6,368 5.7 (13.2) (6.6) 7,335 6.8 6,820 6.1
Other.............................. 1,234 1.1 (0.3) (2.6) 1,238 1.2 1,267 1.1
---------- ------- ------ ---------- --------- -------- ---------- -------
111,194 100.0 3.4 0.0 107,582 100.0 111,198 100.0
---------- ------- ------ ---------- --------- -------- ---------- -------
Costs and expenses:
Membership benefits................ 36,578 32.9 4.8 0.2 34,919 32.5 36,490 32.8
Commissions........................ 31,393 28.2 (16.0) (4.1) 37,374 34.7 32,745 29.5
Associate services and direct 7,144 6.4 (7.1) (5.8) 7,687 7.2 7,584 6.8
marketing........................
General and administrative......... 12,229 11.0 1.8 (6.1) 12,015 11.2 13,020 11.7
Other, net......................... 2,932 2.6 22.7 1.1 2,390 2.2 2,900 2.6
---------- ------- ------ ---------- --------- -------- ---------- -------
90,276 81.2 (4.4) (2.7) 94,385 87.7 92,739 83.4
---------- ------- ------ ---------- --------- -------- ---------- -------
Income before income taxes........... 20,918 18.8 58.5 13.3 13,197 12.3 18,459 16.6
Provision for income taxes........... 7,512 6.8 65.0 17.9 4,553 4.2 6,369 5.7
---------- ------- ------ ---------- --------- -------- ---------- -------
Net income .......................... $13,406 12.1 55.1 10.9 $ 8,644 8.0 $12,090 10.9
---------- ------- ------ ---------- --------- -------- ---------- -------
Nine % Nine
Months Change Months
Nine Months Ended September 30, 2006 Ended % of from Ended % of
compared to Sept. 30, Total Prior Sept. 30, Total
Nine Months Ended September 30, 2005 2006 Revenue Year 2005 Revenue
--------------------------------------- ---------- ------- -------- -------- --------
Revenues:
Membership fees.................... $308,443 92.8 6.9 $288,606 91.9
Associate services................. 20,151 6.1 (6.5) 21,552 6.9
Other.............................. 3,758 1.1 (4.6) 3,938 1.3
---------- ------- ------- -------- --------
332,352 100.0 5.8 314,096 100.0
---------- ------- ------- -------- --------
Costs and expenses:
Membership benefits................ 108,696 32.7 7.2 101,350 32.3
Commissions........................ 96,023 28.9 (11.0) 107,871 34.3
Associate services and direct
marketing........................ 22,030 6.6 (11.0) 24,746 7.9
General and administrative......... 37,716 11.3 6.4 35,451 11.3
Other, net......................... 8,555 2.6 16.3 7,357 2.3
---------- ------- ------- -------- --------
273,020 82.1 (1.4) 276,775 88.1
---------- ------- ------- -------- --------
Income before income taxes........... 59,332 17.9 59.0 37,321 11.9
Provision for income taxes........... 20,765 6.2 61.3 12,876 4.1
---------- ------- ------- -------- --------
Net income........................... $38,567 11.6 57.8 $24,445 7.8
---------- ------- ------- -------- --------
Three Months Ended
New Memberships: 9/30/2006 6/30/2006 9/30/2005
---------------- --------- --------- ---------
New legal service membership sales........................... 148,311 146,043 171,281
New "stand-alone" IDT membership sales....................... 7,047 6,461 8,583
------------ --------- ---------
Total new membership sales......................... 155,358 152,504 179,864
------------ --------- ---------
New "add-on" IDT membership sales............................ 102,341 98,156 118,556
Average Annual Membership fee................................ $334.70 $327.34 $335.67
Active Memberships:
-------------------
Active legal service memberships at end of period............ 1,484,456 1,484,498 1,502,022
Active "stand-alone" IDT memberships at end of period (see
note below).............................................. 60,816 57,167 45,785
------------- --------- ---------
Total active memberships at end of period........... 1,545,272 1,541,665 1,547,807
------------ --------- ---------
Active "add-on" IDT memberships at end of period (see note
below)................................................... 529,983 507,049 439,962
New Sales Associates:
---------------------
New sales associates recruited............................... 42,395 45,517 67,321
Average enrollment fee paid by new sales associates.......... $49.74 $49.70 $50.12
Average Membership fee in force:
--------------------------------
Average Annual Membership fee................................ $292.60 $291.22 $285.18
Note - reflects 6,775 net transfers from "add-on" status to "stand-alone" status during the quarter
Identity Theft Shield ("IDT") memberships sold in conjunction with new
legal plan memberships or "added-on" to existing legal plan memberships sell for
$9.95 per month and are not counted as "new" memberships but do increase the
average premium and related direct expenses (membership benefits and
commissions) of our membership base, while "stand alone" Identity Theft Shield
memberships are not attached to a legal plan membership and sell for $12.95 per
month.
Recently Issued Accounting Pronouncements
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 adoption of this FSP January 1, 2006 did
not have a material effect on our consolidated financial position and results of
operations.
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.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB 108 was issued to
provide consistency between how registrants quantify financial statement
misstatements.
Historically, there have been two widely-used methods for quantifying the
effects of financial statement misstatements. These methods are referred to as
the "roll-over" and "iron curtain" method. The roll-over method quantifies the
amount by which the current year income statement is misstated. Exclusive
reliance on an income statement approach can result in the accumulation of
errors on the balance sheet that may not have been material to any individual
income statement, but which may misstate one or more balance sheet accounts. The
iron curtain method quantifies the error as the cumulative amount by which the
current year balance sheet is misstated. Exclusive reliance on a balance sheet
approach can result in disregarding the effects of errors in the current year
income statement that results from the correction of an error existing in
previously issued financial statements. SAB 108 established an approach that
requires quantification of financial statement misstatements based on the
effects of the misstatement on each of the company's financial statements and
the related financial statement disclosures. This approach is commonly referred
to as the "dual approach" because it requires quantification of errors under
both the roll-over and iron curtain methods.
We will initially apply SAB 108 in connection with the preparation of our
annual financial statements for the year ending December 31, 2006 and we do not
expect to record an adjustment.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"), to clarify certain aspects of accounting for uncertain tax positions,
including issues related to the recognition and measurement of those tax
positions. FIN 48 is effective for fiscal years beginning after December 15,
2006. We are in the process of evaluating the impact of the adoption of this
interpretation on our results of operations and financial condition.
Results of Operations - Third Quarter of 2006 compared to Third Quarter of 2005
-------------------------------------------------------------------------------
Net income increased 55% for the third quarter of 2006 to $13.4 million
from $8.6 million for the prior year's third quarter primarily due to an
increase in membership fees of $4.6 million and a decrease in commissions of
$6.0 million partially offset by an increase in Membership benefits of $1.7
million and an increase in the provision for income taxes of $3.0 million.
Diluted earnings per share increased 69% to 93 cents per share from 55 cents per
share for the prior year's comparable quarter due to the 55% increase in net
income and an approximate 8% decrease in the weighted average number of
diluted shares outstanding.
Membership fees totaled $103.6 million during the 2006 third quarter
compared to $99.0 million for 2005, an increase of 5%. 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 and the monthly amount of
such Memberships. 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 14% during the three months
ended September 30, 2006 to 155,358 from 179,864 during the comparable period of
2005. At September 30, 2006, there were 1,545,272 active Memberships in force
compared to 1,547,807 at September 30, 2005, a decrease of .2%. Additionally,
the average annual fee per Membership has increased from $285 for all
Memberships in force at September 30, 2005 to $293 for all Memberships in force
at September 30, 2006, primarily as a result of a larger number of Identity
Theft Shield memberships.
Associate services revenue decreased by approximately $967,000 from the
third quarter of 2006 compared to the comparable period of 2005 with a 37%
decrease in new associates recruited. Total new associates enrolled during the
third quarter of 2006 were 42,395 compared to 67,321 for the same period of
2005. Average enrollment fees paid by new sales associates during both periods
were $50 due to specialized reduced rate $49 enrollment programs aimed at
varying market niches. We expect to continue some form of reduced enrollment
programs for the remainder of the year. Associate fees revenue decreased from
$3.1 million for the third quarter of 2005 to $2.2 million during the comparable
period of 2006. The eService fees increased 7% to $3.1 million during the third
quarter of 2006 compared to $2.9 million for the comparable period of 2005.
Future revenues from associate services will depend primarily on the number of
new associates enrolled, the average enrollment fee paid and the number who
choose to participate in our eService program, but we expect that such revenues
will continue to be offset by the direct and indirect cost to us of training,
providing associate services and other direct marketing expenses.
Other revenue remained unchanged at $1.2 million for both periods.
Total revenues increased 3% to $111.2 million for the three months ended
September 30, 2006 from $107.6 million during the comparable period of 2005 due
to a $4.6 million increase in Membership fees partially offset by a $1.0 million
decrease in associate services revenue.
Membership benefits totaled $36.6 million for the three months ended
September 30, 2006 compared to $34.9 million for the comparable period of 2005,
and represented 35% of Membership fees for both periods. This Membership benefit
ratio (Membership benefits as a percentage of Membership fees) pertaining to
legal service plans should remain near current levels as substantially all
active Memberships provide for a capitated cost in the absence of any changes in
the capitated benefit level, which has not changed significantly since 1993.
However, the higher benefit ratio of the Identity Theft Shield Membership may
increase the blended benefit ratio if we continue to increase the number of
Identity Theft Shield Memberships in force.
Commissions to associates decreased 16% to $31.4 million for the three
months ended September 30, 2006 compared to $37.4 million for the comparable
period of 2005, and represented 30% and 38% of Membership fees for the
respective periods. Commissions to associates are primarily dependent on the
number of new memberships sold, including add-on membership sales, during a
period. Commissions to associates per new membership sold were $202 per
membership for the three months ended September 30, 2006 compared to $208 for
the comparable period of 2005. 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, the amount of the Membership fee 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 commissions to our
compensation plan or reduce the amount of chargebacks collected from our
associates as we have from time to time, the commission cost per new Membership
will increase accordingly.
Associate services and direct marketing expenses decreased to $7.1 million
for the three months ended September 30, 2006 from $7.7 million for the
comparable period of 2005. The decrease was primarily a result of decreased
costs for incentive trips and bonuses and decreased costs for materials sent to
new associates due to the reduction in the number of new associates enrolled
during the quarter. We offer the Player's Club incentive program to provide
additional incentives to our associates as a reward for consistent, quality
business. Associates can earn the right to receive additional monthly bonuses by
meeting monthly qualification requirements for the entire calendar year and
maintaining certain personal retention rates for the Memberships sold during the
calendar year. These expenses also include the costs of providing associate
services and marketing expenses.
General and administrative expenses during the three months ended September
30, 2006 and 2005 were $12.2 million and $12.0 million, respectively, and
represented 12% of Membership fees for both periods.
Other expenses, net, which include depreciation and amortization,
litigation accruals, interest expense and premium taxes reduced by interest
income, was $2.9 million for the three months ended September 30, 2006 compared
to $2.4 million for the 2005 comparable period. Depreciation increased to $2.1
million for the third quarter of 2006 from $1.8 million for the comparable
period of 2005. Litigation accruals have been reduced $710 000 and $48,000
during the three months ended September 30, 2006 and 2005, respectively.
Interest expense increased to $2.2 million during the 2006 period from $612,000
during the comparable period of 2005 as a result of higher average interest rate
and additional debt. Premium taxes decreased from $500,000 for the three months
ended September 30, 2005 to $487,000 for the comparable period of 2006. Interest
income increased $663,000 to $1.1 million for the three months ended September
30, 2006 from $441,000 for the comparable period of 2005, due to an increase in
interest rates and cash and investment balances.
We have recorded a provision for income taxes of $7.5 million (35.9% of
pretax income) and $4.6 million (34.5% of pretax income) for the three months
ended September 30, 2006 and 2005, respectively. The increase in the tax rate is
primarily due to lower income tax credits and the increase in pretax income.
Results of Operations - Third Quarter of 2006 compared to Second Quarter of 2006
--------------------------------------------------------------------------------
Third quarter 2006 membership fees increased slightly to $103.6 million
from $103.1 million for the second quarter of 2006. Associate services revenues
decreased during the 2006 third quarter by approximately $452,000 to $6.4
million from $6.8 million for the 2006 second quarter and associate services and
direct marketing expenses decreased by $440,000 during the same period.
Membership benefits totaled $36.6 million in the third quarter of 2006 compared
to $36.5 million for the 2006 second quarter and represented 35% of membership
fees for both periods. Commissions to associates totaled $31.4 million in the
2006 third quarter compared to $32.7 million for the 2006 second quarter and
represented 30% and 32%, respectively, of membership fees for the two periods.
General and administrative expenses decreased during the 2006 third quarter to
$12.2 million compared to $13.0 million for the 2006 second quarter and
represented 12% and 13%, respectively, of membership fees for the two periods.
Results of Operations - First nine months of 2006 compared to first nine months
of 2005
-------------------------------------------------------------------------------
Membership revenues increased 8% the first nine months of 2006 to a record
$308.4 million compared to $288.6 million for the first nine months of 2005. Net
income increased 58% for the first nine months of 2006 to $38.6 million from
$24.4 million for the prior year's comparable period primarily due to the
increase of $19.8 million in membership fees and a decrease in commission
expense of $11.8 million caused by fewer new memberships sold during the 2006
period, partially offset by an increase in Membership benefits expense of $7.3
million, an increase in general and administrative expenses of $2.3 million and
an increase in the provision of income taxes of $7.9 million. Diluted earnings
per share increased 66% to $2.58 per share from $1.55 per share for the prior
year's comparable nine month period due to the 58% increase in net income and an
approximate 5% decrease in the weighted average number of diluted shares
outstanding.
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 13% during the nine months ended
September 30, 2006 to 473,088 from 543,533 during the comparable period of 2005.
At September 30, 2006, there were 1,545,272 active Memberships in force compared
to 1,547,807 at September 30, 2005, a decrease of .2%. Additionally, the average
annual fee per Membership has increased from $285 for all Memberships in force
at September 30, 2005 to $293 for all Memberships in force at September 30,
2006, primarily as a result of a larger number of Identity Theft Shield
memberships.
Associate services revenue decreased 7% from $21.6 million for the first
nine months of 2005 to $20.2 million during the comparable period of 2006
primarily as a result of a 28% decrease in new associates recruited. Total new
associates enrolled during the first nine months of 2006 were 137,688 compared
to 190,055 for the same period of 2005. We expect to continue some form of
reduced enrollment programs for the remainder of the year. Future revenues from
associate services will depend primarily on the number of new associates
enrolled, the price charged for the Certified Field Trainer program and the
number who choose to participate in the Company's eService program, but the
Company expects that such revenues will continue to be offset by the direct and
indirect cost to the Company of training (including training bonuses paid),
providing associate services and other direct marketing expenses. The eService
fees increased 26% to $9.6 million during the first nine months of 2006 compared
to $7.6 million for the comparable period of 2005.
Other revenue decreased slightly from $3.9 million for the nine month
period ending September 2005 to $3.8 million for the same period of 2006.
Primarily as a result of the increase in Membership fees, total revenues
increased to $332.4 million for the nine months ended September 30, 2006 from
$314.1 million during the comparable period of 2005 an increase of 6%.
Membership benefits totaled $108.7 million for the nine months ended
September 30, 2006 compared to $101.4 million for the comparable period of 2005,
and represented 35% of Membership fees for both 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 in the absence of any changes in the capitated benefit level,
which has not changed significantly since 1993. However, the higher benefit
ratio of the Identity Theft Shield Membership may increase the blended benefit
ratio if the Company continues to sell significant numbers of Identity Theft
Shield Memberships.
Commissions to associates decreased 11% to $96.0 million for the nine
months ended September 30, 2006 compared to $107.9 million for the comparable
period of 2005, and represented 31% and 37% of Membership fees for such periods.
Commissions to associates are primarily dependent on the number of new
memberships sold during a period. Commissions to associates per new membership
sold were $203 per membership for the nine months ended September 30, 2006
compared to $198 for the comparable period of 2005. 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. Should we add additional commissions to our compensation
plan or reduce the amount of chargebacks collected from its associates as it has
from time to time, the commission cost per new Membership will increase
accordingly.
Associate services and direct marketing expenses decreased to $22.0 million
for the nine months ended September 30, 2006 from $24.7 million for the
comparable period of 2005. The decrease was primarily a result of fewer new
associates enrolled during the nine month period and decreased cost for
incentive trips and bonuses. We offer the Player's Club incentive program to
provide additional incentives to our associates as a reward for consistent,
quality business. Associates can earn the right to receive additional monthly
bonuses by meeting monthly qualification requirements for the entire calendar
year and maintaining certain personal retention rates for the Memberships sold
during the calendar year. These expenses also include the costs of providing
associate services and marketing expenses.
General and administrative expenses during the nine months ended September
30, 2006 and 2005 were $37.7 million and $35.5 million, respectively, and
represented 12% of Membership fees for both periods. The increases in general
and administrative expense were primarily due to increased employee costs and
property and other taxes.
Other expenses, net, which include depreciation and amortization,
litigation accruals, interest expense and premium taxes reduced by interest
income, was $8.6 million for the nine months ended September 30, 2006 compared
to $7.4 million for the 2005 comparable period. Depreciation increased to $6.1
million for the first nine months of 2006 from $5.5 million for the comparable
period of 2005. Litigation accruals have been reduced $710,000 and $303,000
during the nine months ended September 30, 2006 and 2005, respectively. Interest
expense increased to $3.7 million during the 2006 period from $1.9 million
during the comparable period of 2005 as a result of higher indebtedness and
higher average interest rates. Premium taxes decreased from $1.6 million for the
nine months ended September 30, 2005 to $1.4 million for the comparable period
of 2006. Interest income increased $733,000 to $1.9 million for the nine months
ended September 30, 2006 from $1.2 million for the comparable period of 2005,
primarily due to higher average interest rates and increased cash and investment
balances.
We have recorded a provision for income taxes of $20.8 million (35.0% of
pretax income) for the first nine months of 2006 compared to $12.9 million
(34.5% of pretax income) for the same period of 2005. The increase in the tax
rate is primarily due to lower income tax credits and the increase in pretax
income.
Liquidity and Capital Resources
-------------------------------
General
Consolidated net cash provided from operating activities for the first nine
months of 2006 increased $7.3 million to $38.6 million from $31.2 million for
the 2005 period, although cash provided from operating activities before changes
in working capital items increased $16.0 million from $29.0 million to $45.0
million. The increase of $16.0 million resulted primarily from the increase in
net income of $14.1 million.
Consolidated net cash used in investing activities was $43.4 million for
the first nine months of 2006 compared to $1.5 million for the comparable period
of 2005. This $41.8 million change in investing activities resulted from a $4.1
million increase in additions to property and equipment and a $78.7 million
increase in investment purchases (partially funded by a portion of the unused
net proceeds of the term loan), partially offset by the $40.9 million increase
in the maturities and sales of investments.
Net cash provided by financing activities during the first nine months of
2006 was $5.2 million compared to $30.5 million net cash used in the comparable
period of 2005. This $35.7 million change was primarily comprised of the $82.7
million increase in proceeds from issuance of debt; a $7.8 million decrease in
common stock dividends paid offset by $37.2 million increase in purchases of
treasury stock; $3.9 million decrease in proceeds from exercise of stock options
and $13.2 million increase in repayments of debt.
We purchased and formally retired 311,484 shares of our common stock during
the 2006 third quarter for $11.3 million, or an average price of $36.34 per
share, reducing our common stock by $3,115 and our retained earnings by $11.3
million. We had positive consolidated working capital of $31.9 million at
September 30, 2006, an increase of $35.0 million compared to a consolidated
working capital deficit of $3.1 million at December 31, 2005. The increase was
primarily due to a $403,000 increase in cash and cash equivalents and an
increase of $27.4 million in the current portion of available-for-sale
investments, a decrease in common stock dividends payable of $4.6 million and a
$3.2 million decrease in accounts payable and accrued expenses partially offset
by an increase of $3.2 million in the current portion of notes payable. The
$31.9 million positive working capital at September 30, 2006 would have been a
$41.4 million positive working capital excluding the 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. We do not expect any difficulty in meeting our financial
obligations in the short term or the long term.
At September 30, 2006 we reported $95.8 million in cash and cash
equivalents and unpledged investments compared to $59.9 million at December 31,
2005. Our investments consist of common stocks, investment grade (rated Baa or
higher) bonds primarily issued by corporations, the United States Treasury,
federal agencies, federally sponsored agencies and enterprises as well as
mortgage-backed securities, auction rate certificates and state and municipal
tax-exempt bonds.
We generally advance significant commissions at the time a Membership is
sold. During the nine months ended September 30, 2006, we advanced commissions,
net of chargebacks, of $94.4 million on new Membership sales compared to $108.6
million for the same period of 2005. 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.
We expense advance commissions ratably over the first month of the related
Membership. 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 as of September 30, 2006, and related activity for the nine month
period then ended, were:
(Amounts in 000's)
------------------
Beginning unearned advance commission payments (1)............................... $ 195,792
Advance commission payments, net................................................. 94,394
Earned commissions applied....................................................... (94,978)
Advance commission payment write-offs............................................ (2,886)
-------------
Ending unearned advance commission payments before
estimated unrecoverable payments (1)........................................... 192,322
Estimated unrecoverable advance commission payments (1).......................... (38,602)
-------------
Ending unearned advance commission payments, net (1)............................. $ 153,720
-------------
(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 $46.4 million.
As such, at September 30, 2006 future commission payments and related expense
should be reduced as unearned advance commission payments of $107 million are
recovered. Commissions are earned by the associate as Membership premiums are
earned by us, usually on a monthly basis. For additional information concerning
these commission advances, see our 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.
We believe that we have significant ability to finance expected future
growth in Membership sales based on our recurring cash flow and existing amount
of cash and cash equivalents and unpledged investments at September 30, 2006 of
$95.8 million. We expect to maintain cash and investment balances, including
pledged investments, on an on-going basis of approximately $20 to $30 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 additional treasury stock purchases subject to
limitations in the Term Facility.
On June 23, 2006, we received $80 million of senior, secured financing (the
"Senior Loan") from Wells Fargo Foothill, Inc. ("Wells Fargo") consisting of a
$75 million five year term loan facility (the "Term Facility") and a $5 million
five year revolving credit facility (the "Revolving Facility"). After payment of
an origination fee of 1%, lender costs and refinancing $15.3 million of existing
bank indebtedness, the net proceeds of the Term Facility we received were $58.8
million. During the three months ended September 30, 2006, we used a portion of
the net proceeds to purchase 311,484 shares of treasury stock at a cost of $11.3
million, or an average price of $36.34 per share. The remaining proceeds will be
used primarily to fund further share repurchases.
The Term Facility was fully funded on June 23, 2006 and provides for a
five-year maturity and amortizes in monthly installments of $1.25 million
commencing August 1, 2006, with interest on the outstanding balances under the
Term Facility and the Revolving Facility payable, at our option, at a rate equal
to Wells Fargo base rate plus 150 basis points or at the LIBOR plus 250 basis
points. The interest rate at September 30, 2006 was 7.83%. We are also obligated
to make additional quarterly payments equal to 50% of our "excess cash flow" (as
defined in the Senior Loan agreement) if our Leverage Ratio is greater than or
equal to 1 to 1 at the end of a quarter. We expect to be able to repay the
facilities with cash flow from operations. We have the right to prepay the Term
Facility in whole or in part, subject to a prepayment premium of 1% in the first
year, 0.5% in the third year and none thereafter, with a reduction of 50% of the
prepayment premium if the prepayment is from the proceeds of another loan
provided by Wells Fargo.
The Senior Loan is guaranteed by our non-regulated subsidiaries and is
secured by all of our tangible and intangible personal property (other than
aircraft), including stock in all of our direct subsidiaries, and a mortgage on
a building we recently acquired in Duncan, Oklahoma and remodeled to relocate
and expand our existing customer service facility in Duncan.
In addition to customary covenants for loans of a similar type, the
principal covenants for the Senior Loan are:
* limitation on incurring any indebtedness in excess of the remaining
existing bank indebtedness outstanding and $2.3 million in permitted
capitalized leases or purchase money debt;
* limitation on our ability to pay dividends or make stock purchases,
other than with the net proceeds of the Term Loan, unless we meet
certain cash flow tests; a prohibition on prepayment of other debt;
* requirement to maintain consolidated EBITDA for the nine month period
ending September 30, 2006 of at least $60 million ($55 million for us
and our top tier direct subsidiaries) and for the twelve month period
ending each quarter thereafter of at least $80 million ($75 million
for us and our top tier direct subsidiaries);
* requirement to maintain a quarterly fixed charge coverage ratio
(EBITDA (with certain adjustments) divided by the sum of interest
expense, income taxes and scheduled principal payments) of at least
1.1 to 1;
* requirement to maintain at least 1.3 million members; and
* requirement to maintain a Leverage Ratio (funded indebtedness as of
the end of each quarter divided by EBITDA for the trailing twelve
months) of no more than 1.5 to 1.
We were in compliance with these covenants at September 30, 2006.
In addition to customary events of default, it is an event of default if
Harland Stonecipher ceases to be our Chairman and Chief Executive Officer for a
period of 120 days unless replaced with a person approved by Wells Fargo.
We used the proceeds of the Term Facility to repay in full the $5.3
remaining balance of our existing stock loan with Bank of Oklahoma, N.A., First
United Bank and Trust and Comerica Bank, which was originated in 2003 and the
$10 million we borrowed from Bank of Oklahoma, N. A. earlier in June 2006. The
related loan agreements were thereby terminated and the associated collateral
was released. As a part of the transaction, we also amended our existing $20
million real estate loan which we incurred in 2002 to finance our new
headquarters building in Ada, Oklahoma to extend the final maturity from
September 2008 to August 2011. This loan, with interest at the 30 day LIBOR rate
plus 2.25%, adjusted monthly, remains secured by a mortgage on our headquarters,
but the additional security interest in our membership contracts was released.
The interest rate at September 30, 2006 was 7.58%. We will continue to be
required to make the same monthly payments on this loan of $191,000 plus
interest with the balance of approximately $2.3 million due at maturity. The
real estate loan was also amended to conform the financial covenants to those
under the new Senior Loan.
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 which began December 31,
2005 with the remaining balance payable in a final installment due November 30,
2015. The interest rate at September 30, 2006 was 7.08%. 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 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 us 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, or any of our regulated
subsidiaries, will be funded by us in the form of capital contributions or
surplus debentures. At September 30, 2006, neither PPLSIF nor PPLCI had funds
available for payment of substantial dividends without the prior approval of the
insurance commissioner.
Contractual Obligations
There have been no material changes outside of the ordinary course of
business in our contractual obligations from those disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2005 except as disclosed
below:
As of September 30, 2006: Payments Due by Period (In Thousands)
------------------------- -------------------------------------
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
----------------------- --------- --------- --------- --------- ---------
Long-term debt.................................... $ 96,579 $ 18,437 $ 36,874 $ 36,470 $ 4,798
Critical Accounting Policies
----------------------------
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. Each of these accounting policies and the application
of critical accounting policies and estimates was discussed in our Annual Report
on Form 10-K for the year ended December 31, 2005. There were no significant
changes in the application of critical accounting policies or estimates during
the first nine months of 2006. We are not aware of any reasonably likely events
or circumstances which would result in different amounts being reported that
would materially affect our financial condition or results of operations.
Capital and Dividend Plans
--------------------------
We continue to evaluate the desirability of additional share repurchases
and additional cash dividends. We declared dividends of $0.50 per share during
2004 and $0.60 per share during 2005 and have previously announced that we will
continue share repurchases, pay a dividend, or both, depending on our financial
condition, available resources and market conditions, as well as compliance with
our various loan covenants which limit our ability to repurchase shares or pay
cash dividends. We expect to continue our open market repurchase program as we
have existing authorization from the Board to purchase an additional 1.2 million
shares. We also continue to evaluate additional sources of financing that may
enable us to accelerate the repurchase program at prices we believe are
attractive.
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 September 30, 2006 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 in Item 1A of our Annual
Report on Form 10-K for the year ended December 31, 2005. 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 3. QUANTITATIVE AND QUALITATIVE 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 September 30, 2006, 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 we 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 000's) in interest rate after hypothetical change
Fair value (bp = basis points) change in interest rate
---------- -------------------- -------------------------
Fixed-maturity investments at September 30, 2006 (1)... $ 29,401 100 bp increase $ 28,116
200 bp increase 26,934
50 bp decrease 29,952
100 bp decrease 30,536
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
-------------------
(1) Excluding short-term investments with a fair value of $36.1 million at
September 30, 2006 and $2.6 million at December 31, 2005.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at September 30, 2006 would reduce
the estimated fair value of our fixed-maturity investments by approximately
$2.5 million at that date. At December 31, 2005, an instantaneous 200 basis
point increase in market interest rates would have reduced the estimated
fair value of our fixed-maturity investments by approximately $2.7 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
September 30, 2006, we had $96.6 million in notes payable outstanding at
interest rates indexed to the 30 day LIBOR rate that exposes us 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, annual interest expense
would increase by approximately $966,000. As of September 30, 2006, we had not
entered into any interest rate swap agreements with respect to the term loans or
our floating rate municipal bonds.
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 4. CONTROLS AND PROCEDURES
----------------------------------
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that, as of September 30, 2006, our
disclosure controls and procedures were effective to ensure that information
required to be disclosed by us in reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.
There were no changes in our internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the
quarter ended September 30, 2006, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
---------------------------------------------------------------------
Issuer Purchases of Equity Securities
The following table provides information about our purchases of stock in
the open market during the third quarter of 2006.
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Total Number Part of Publicly Be Purchased Under
of Shares Average Price Announced Plans or the Plans or
Period Purchased Paid per Share Programs Programs (1)
---------------------- -------------- ---------------- -------------------- --------------------
July 2006............. - $ - - 1,515,356
August 2006........... 285,020 36.16 285,020 1,230,336
September 2006........ 26,464 38.20 26,464 1,203,872
Total................. --------------- ---------------- --------------------
311,484 $ 36.34 311,484
--------------- ---------------- --------------------
-----------
(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
in the open market. The Board of Directors has subsequently from time to
time increased such authorization from 500,000 shares to 12,000,000 shares.
The most recent authorization was for 1,000,000 additional shares on June
28, 2006 and there has been no time limit set for completion of the
repurchase program.
See Part I, Item 2, "Management's Discussion and Analysis of Financial Condition
and Results of Operation-Liquidity and Capital Resources" for a description of
loan covenants that limit our ability to repurchase shares and pay dividends.
ITEM 6. EXHIBITS.
(a) Exhibits:
Exhibit No. Description
3.1 Amended and Restated Certificate of Incorporation of the Company, as amended (Incorporated by
reference to Exhibit 3.1 of the Company's Report on Form 8-K dated June 27, 2005)
3.2 Amended and Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.1 of the
Company's Report on Form 10-Q for the period ended 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 the Company's Annual Report on Form 10-KSB for the
year ended December 31, 1992)
*10.2 Agreements between Shirley Stonecipher, New York Life Insurance Company and the Company regarding
life insurance policy covering Harland C. Stonecipher (Incorporated by reference to Exhibit 10.21 of
the Company's Annual Report on Form 10-K for the year ended December 31, 1985)
*10.3 Amendment dated January 1, 1993 to Split Dollar Agreement between Shirley Stonecipher and the Com-
pany regarding life insurance policy covering Harland C. Stonecipher (Incorporated by reference to
Exhibit 10.3 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992)
*10.4 Form of New Business Generation Agreement Between the Company and Harland C. Stonecipher (Incorpora-
ted by reference to Exhibit 10.22 of the Company's Annual Report on Form 10-K for the year ended
December 31, 1986)
*10.5 Amendment to New Business Generation Agreement between the Company and Harland C. Stonecipher
effective January, 1990 (Incorporated by reference to Exhibit 10.12 of the Company's Annual Report
on Form 10-KSB for the year ended December 31, 1992)
*10.6 Amendment No. 2 to New Business Generation Agreement between the Company and Harland C. Stonecipher
effective January, 1990 (Incorporated by reference to Exhibit 10.13 of the Company's 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 the
Company's 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 the Company's 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 the Company's 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 the Company's 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 the Company's Annual Report on Form 10-K for the year ended December 31, 2002)
10.12 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 the Company's Report on Form 10-K for the year ended
December 31, 2004)
10.13 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 the Company's Report on Form 10-K
for the year ended December 31, 2004)
10.14 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 the Company's Report on
Form 10-K for the year ended December 31, 2004)
*10.15 Amended Deferred Compensation Plan effective January 1, 2005 (Incorporated by reference to Exhibit
10.16 of the Company's Report on Form 10-K for the year ended December 31, 2004)
10.16 Purchase Agreement dated August 19, 2005 between us and Learjet, Inc., with Addendum.
(Incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K dated August 19,
2005)
10.17 Loan Agreement dated November 30, 2005 between Pre-Paid legal Services, Inc and Bank of Oklahoma,
N.A. and First United Bank and Trust (Incorporated by reference to Exhibit 10.1 of the Company's
Report on Form 8-K dated November 30, 2005)
10.18 Aircraft Chattel Mortgage, Security Agreement and Assignment of Rents dated November 30, 2005
between Pre-Paid legal Services, Inc and Bank of Oklahoma, N.A. and First United Bank and Trust
(Incorporated by reference to Exhibit 10.2 of the Company's Report on Form 8-K dated November 30,
2005)
10.19 Credit Agreement dated June 23, 2006 among Pre-Paid Legal Services, Inc, the lenders signatory
thereto and Wells Fargo Foothill, Inc. as Arranger and Administrative Agent and Bank of Oklahoma,
N.A. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K filed
June 27, 2006)
10.20 Security Agreement dated June 23, 2006 between Pre-Paid Legal Services, Inc and certain of its
subsidiaries and Wells Fargo Foothill, Inc., as Agent (Incorporated by reference to Exhibit 10.2 of
the Company's Current Report on Form 8-K filed June 26, 2006)
10.21 Guaranty Agreement dated June 23, 2006 between certain subsidiaries of Pre-Paid Legal Services,
Inc. and Wells Fargo Foothill, Inc., as Agent (Incorporated by reference to Exhibit 10.3 of the
Company's Current Report on Form 8-K filed June 27, 2006)
10.22 Mortgage, Assignment of Rents and Leases and Security Agreement by Pre-Paid Legal Services, Inc. in
favor of Wells Fargo Foothill, Inc as Agent (Incorporated by reference to Exhibit 10.4 of the
Company's Current Report on Form 8-K filed June 26, 2006)
10.23 First Amendment to Loan Agreement dated June 23, 2006 between Pre-Paid Legal Services, Inc. and
Bank of Oklahoma, N.A. (Incorporated by reference to Exhibit 10.5 of the Company's of the Company's
Current Report on Form 8-K filed June 26, 2006)
31.1 Certification of Harland C. Stonecipher, Chairman, Chief Executive Officer and President, 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, Chief Executive Officer and President, 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.
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.
(Registrant)
Date: October 23, 2006 /s/ Harland C. Stonecipher
----------------------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer and President
(Principal Executive Officer)
Date: October 23, 2006 /s/ Randy Harp
----------------------------------------------------
Randy Harp
Chief Operating Officer
(Duly Authorized Officer)
Date: October 23, 2006 /s/ Steve Williamson
----------------------------------------------------
Steve Williamson
Chief Financial Officer
(Principal Financial and Accounting Officer)
Exhibit 31.1
CERTIFICATION
I, Harland C. Stonecipher, Chief Executive Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q 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(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rule 13 (a)-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; and
(5) The registrant's other certifying officer(s) 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; and
(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.
Date: October 23, 2006 /s/ Harland C. Stonecipher
----------------------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer and President
Exhibit 31.2
CERTIFICATION
I, Steve Williamson, Chief Financial Officer, certify that:
(1) I have reviewed this quarterly report on Form 10-Q 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(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rule 13 (a)-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; and
(5) The registrant's other certifying officer(s) 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; and
(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.
Date: October 23, 2006 /s/ Steve Williamson
----------------------------------------------------
Chief Financial Officer
Exhibit 32.1
Certification Pursuant to 18 U.S.C. Section 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 Quarterly
Report on Form 10-Q for the quarter ended September 30, 2006 (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: October 23, 2006 /s/ Harland C. Stonecipher
----------------------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer and President
Exhibit 32.2
Certification Pursuant to 18 U.S.C. Section 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 Quarterly
Report on Form 10-Q for the quarter ended September 30, 2006 (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: October 23, 2006 /s/ Steve Williamson
----------------------------------------------------
Steve Williamson
Chief Financial Officer