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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 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: 1-9293
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Pre-Paid Way
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark if registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes | | No |X|
Indicate by check mark if registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes | | No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K | |.
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer | | Accelerated filer |X| Non-accelerated file | |
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act) Yes | | No |X|
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. As of June 30, 2006 -$323,799,000
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: As of February 16, 2006 there
were 13,622,131 shares of Common Stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of our definitive proxy statement for our 2007 annual meeting of
shareholders are incorporated into Part III of this Form 10-K by reference.
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PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the Year Ended December 31, 2006
TABLE OF CONTENTS
PART I
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ITEM 1. BUSINESS
General
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Identity Theft Shield Provider
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
Availability of Information
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
Equity Compensation Plans
Issuer Purchases of Equity Securities
Shareholder Return Performance Graph
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Overview of our Financial Model
Critical Accounting Policies
Other General Matters
Measures of Member Retention
Results of Operations
Comparison of 2006 to 2005
Comparison of 2005 to 2004
Liquidity and Capital Resources
Forward Looking Statements
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
ItEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III (Information required by Part III is incorporated by reference
-------- from our definitive proxy statement for our 2007 annual meeting
of shareholders.)
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
SIGNATURES
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2006
PART I
ITEM 1. BUSINESS.
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General
We were one of the first companies in the United States organized solely to
design, underwrite and market legal expense plans. Our predecessor commenced
business in 1972 and began offering legal expense reimbursement services as a
"motor service club" under Oklahoma law. In 1976, we were formed and acquired
our predecessor in a stock exchange. We began offering Memberships independent
of the motor service club product by adding a legal consultation and advice
service, and in 1979 we implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. Our legal expense plans (referred to as "Memberships")
currently provide for a variety of legal services in a manner similar to medical
plans. In most states and provinces, standard plan benefits include preventive
legal services, motor vehicle legal defense services, trial defense services,
IRS audit services and a 25% discount off legal services not specifically
covered by the Membership for an average monthly Membership fee of approximately
$20. Additionally, in approximately 44 states, the Legal Shield rider can be
added to the standard plan for only $1 per month and provides members with
24-hour access to a toll-free number for attorney assistance if the member is
arrested or detained. Also, during the third quarter of 2003, we began offering
our Identity Theft Shield ("IDT") to new and existing members at $9.95 per month
if added to a legal service Membership ("add-on IDT") or it may be purchased
separately for $12.95 per month ("stand-alone IDT"). The identity theft related
benefits include a credit report and related instructional guide, a credit score
and related instructional guide, credit report monitoring with daily online and
monthly offline notification of any changes in credit information and
comprehensive identity theft restoration services.
Legal plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province and IDT plan
benefits are provided by Kroll Background America, Inc., a subsidiary of Kroll
Inc. ("Kroll"). Members have direct, toll-free access to Kroll or their provider
law firm rather than having to call for a referral. At December 31, 2006, we had
1,538,740 Memberships in force with members in all 50 states, the District of
Columbia and the Canadian provinces of Ontario, British Columbia, Alberta and
Manitoba. Approximately 90% of such Memberships were in 29 states and provinces.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. The National Resource Center for
Consumers of Legal Services ("NRC") previously provided market information for
different types of legal service plans and estimates of number of users.
However, the NRC is no longer in existence and we are unaware of any current
comparable information sources. In the last NRC report in 2002, the NRC
estimated there were 164 million Americans without any type of legal service
plan. The NRC estimated that 122 million Americans were entitled to service
through at least one legal service plan in 2002 although more than half are
"free" plans that generally provide limited benefits on an automatic enrollment
without any direct cost to the individual. The 122 million Americans compares to
4 million in 1981, 58 million in 1990 and 115 million in 2000. We believe the
legal service plan industry continues to evolve and market acceptance of legal
service plans, as indicated by the continuing growth in the number of
individuals covered by plans, is increasing.
"Public Perceptions of Lawyers: Consumer Research Findings, April 2002"
prepared on behalf of the American Bar Association concluded that nearly seven
in ten households had some occasion during the past year that might have led
them to hire a lawyer. This report further suggested that "for the consumer,
legal services are among the most difficult services to buy. The prospect of
doing so is rife with uncertainty and potential risk." And further concluded
that "the challenge (and opportunity) for the legal profession is to make
lawyers more accessible and less threatening to consumers who might need them."
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association and employee assistance plans
that are also automatic enrollment plans without direct cost to participants
designed to provide limited telephonic access to attorneys for members of
employee groups. There are also employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit. Finally,
there are individual enrollment plans, other employment based plans, including
voluntary payroll deduction plans, and miscellaneous plans. These plans
typically have more comprehensive benefits, higher utilization, involve higher
costs to participants, and are offered on an individual enrollment or voluntary
basis. This is the market segment in which we compete.
According to the latest estimates of the census bureaus of the United
States and Canada, the two geographic areas in which we operate, the number of
households in the combined area exceeds 127 million. Since we have always
disclosed our members in terms of Memberships and individuals covered by the
Membership include the individual who purchases the Membership together with his
or her spouse and never married children living at home up to age 21 or up to
age 23 if the children are full time college students, we believe that our
market share should be viewed as a percentage of households. Historically, our
primary market focus has been the "middle" eighty percent of such households
rather than the upper and lower ten percent segments based on our belief that
the upper ten percent may already have a relationship with an attorney or law
firm and the lower ten percent may not be able to afford the cost of a legal
service plan. As a percentage of this defined "middle" market of approximately
100 million households, we currently have an approximate 1.5% share of the
estimated market based on our existing 1.5 million active Memberships and, over
the last 30 years, an additional 6% of households have previously purchased, but
no longer own, Memberships. We routinely remarket to previous members and
reinstated approximately 76,000, 79,000 and 72,000 Memberships during 2006, 2005
and 2004, respectively.
Description of Memberships
The Memberships we sell generally allow members to access legal services
through a network of independent law firms ("provider law firms") under contract
with us. Provider law firms are paid a monthly fixed fee on a capitated basis to
render services to plan members residing within the state or province in which
the provider law firm attorneys are licensed to practice. Because the fixed fee
payments by us to provider law firms do not vary based on the type and amount of
benefits utilized by the member, this capitated arrangement provides significant
advantages to us in managing claims risk. At December 31, 2006, Memberships
subject to the capitated provider law firm arrangement comprised approximately
99% of our active Memberships. The remaining Memberships, approximately 1%, were
primarily sold prior to 1987 and allow members to locate their own lawyer ("open
panel") to provide legal services available under the Membership with the
member's lawyer being reimbursed for services rendered based on usual,
reasonable and customary fees, or are in states where there is no provider law
firm in place and our referral attorney network described below is utilized.
Family Legal Plan
The Family Legal Plan we currently market in most jurisdictions consists of
five basic benefit groups that provide coverage for a broad range of preventive
and litigation-related legal expenses. The Family Legal Plan accounted for
approximately 91% and 92% of our Membership fees (including the add-on identity
theft shield benefit, 79% and 82%, respectively, excluding such add-ons) in 2006
and 2005, respectively. In addition to the Family Legal Plan, we market other
specialized legal services products specifically related to employment in
certain professions described below.
In 12 states, certain of our plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and we have bilingual staff for customer service, attorney resources
and marketing service functions. We will continue to evaluate making our plans
available in additional languages in markets where demand for such a product is
expected to be sufficient to justify this additional cost.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, we
have not raised rates to existing members. If new benefits become available,
existing members may choose the newer, more comprehensive plan at a higher rate
or keep their existing Memberships. Memberships are automatically renewed at the
end of each Membership period unless the member cancels prior to the renewal
date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $25.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Motor Vehicle Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. There were approximately 549,000 subscribers of
this benefit at December 31, 2006 compared to 571,000 at December 31, 2005.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount for All Other Services. Provider law firms have
agreed to provide to members any legal services beyond those stipulated in the
Membership at a fee discounted 25% from the provider law firm's customary and
usual hourly rate. This "customary and usual hourly rate" is a fixed single
hourly rate for each provider firm that is generally an average of the firm's
various hourly rates for its attorneys which typically vary based on experience
and expertise.
Legal Shield Benefit
In approximately 44 states and four Canadian provinces, the Legal Shield
plan can be added to the standard or expanded Family Legal Plan for $1 per month
and provides members with 24-hour access to a toll-free number for provider law
firm assistance if the member is arrested or detained. The Legal Shield member,
if detained, can present their Legal Shield card to the officer that has
detained them to make it clear that they have access to legal representation and
that they are requesting to contact a lawyer immediately. The benefits of the
Legal Shield plan are subject to conditions imposed by the detaining authority,
which may not allow for the provider law firm to communicate with the member on
an immediate basis. The Legal Shield benefit was introduced in 1999. There were
approximately 1,032,000 Legal Shield subscribers at December 31, 2006 compared
to approximately 1,015,000 at December 31, 2005.
Identity Theft Shield Benefit
During the third quarter of 2003, we announced a joint marketing agreement
with Kroll Background America Inc., a subsidiary of Kroll Inc., that allows our
independent sales associates to market Kroll's identity theft benefits in 49
states and four Canadian provinces. By adding the Identity Theft Shield to their
existing family Membership, members have toll free access to the identity theft
specialists at Kroll. This benefit can be added to a legal service Membership
for $9.95 per month or purchased separately for $12.95 per month. The identity
theft related benefits include a credit report and related instructional guide,
a credit score and related instructional guide, credit report monitoring with
daily online and monthly offline notification of any changes in credit
information and comprehensive identity theft restoration services. There were
approximately 605,000 and 513,000 subscribers at December 31, 2006 and 2005,
respectively, comprised of 540,000 and 461,000 subscribers at $9.95 per month
and 65,000 and 52,000 subscribers at $12.95 per month.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. We began operations in Ontario
and British Columbia during 1999 and Alberta and Manitoba in 2001. Benefits of
the Canadian plan include expanded preventive benefits including assistance with
Canadian Government agencies, warranty assistance and small claims court
assistance as well as the preferred member discount. Canadian Membership fees
collected during 2006 were approximately $6.8 million in U.S. dollars compared
to $5.6 million collected in 2005 and $4.4 million collected in 2004.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, we also offer other
specialty or niche legal service plans. These specialty plans usually contain
many of the Family Legal Plan benefits adjusted as necessary to meet specific
industry or prospective member requirements. In addition to those specialty
plans described below, we will continue to evaluate and develop other such plans
as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $69 to $150 ($175 in Canada)
depending on the number of employees and provides business oriented legal
service benefits for any for-profit business with 99 or fewer employees. This
plan is available in 43 states and three Canadian provinces and represented
approximately 5.1%, 3.4% and 4.3% of our Membership fees during 2006, 2005 and
2004, respectively.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage by a provider law firm for persons who
drive a commercial vehicle. This legal service plan is currently offered in 45
states. In certain states, the Commercial Driver Legal Plan is underwritten by
the Road America Motor Club, an unrelated motor service club. During the years
ended December 31, 2006, 2005 and 2004, this plan accounted for approximately
..9%, .9% and 1.2%, respectively, of Membership fees. The Plan underwritten by
the Road America Motor Club is available at the monthly rate of $35.95 or at a
group rate of $32.95. Plans underwritten by us are available at the monthly rate
of $32.95 or at a group rate of $29.95. Benefits include the motor vehicle
related benefits described above, defense of Department of Transportation
violations and the 25% discounted rate for services beyond plan scope, such as
defense of non-moving violations. The Road America Motor Club underwritten plan
includes bail and arrest bonds and services for family vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 37 states and one Canadian province and represented approximately
1.8%, 1.8% and 1.4% of our Membership fees during 2006, 2005 and 2004,
respectively.
Comprehensive Group Legal Services Plan
In late 1999 we introduced the Comprehensive Group plan, designed for the
large group employee benefit market. This plan, available in 35 states, provides
all the benefits of the Family Legal Plan as well as mortgage document
preparation, assistance with uncontested legal situations such as adoptions,
name changes, separations and divorces. Additional benefits include the
preparation of health care power of attorney and living wills or directives to
physicians. Although sales of this plan during the last three years (5,892
Memberships, 4,444 Memberships and 4,482 Memberships during 2006, 2005 and 2004,
respectively) are not significant compared to our total Membership sales, we
still believe this plan improves our competitive position in the large group
market. We continue to emphasize group marketing to employee groups of less than
50 rather than larger groups where there is more competition, price negotiation
and typically a longer sales cycle.
Other than additional benefits such as the Legal Shield and Identity Theft
Shield benefits described above, the basic structure and design of the
Membership benefits has not significantly changed over the last several years.
The consistency in plan design and delivery provides us consistent, accurate
data about plan utilization which enables us to manage our benefit costs through
the capitated payment structure to provider firms. We frequently evaluate and
consider other plan benefits that may include other services complimentary to
the basic legal service plan.
Provider Law Firms
Our Memberships generally allow members to access legal services through a
network of independent provider law firms under contract with us generally
referred to as "provider law firms." Provider law firms are paid a fixed fee on
a per capita basis to render services to plan members residing within the state
or province as provided by the contract. Because the fixed fee payments by us to
provider law firms in connection with the Memberships do not vary based on the
type and amount of benefits utilized by the member, this arrangement provides
significant advantages to us in managing our cost of benefits. Pursuant to these
provider law firm arrangements and due to the volume of revenue directed to
these firms, we have the ability to more effectively monitor the customer
service aspects of the legal services provided, the financial leverage to help
ensure a customer friendly emphasis by the provider law firms and access to
larger, more diversified law firms. Through our members, we are typically the
largest client base of our provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, our investigation of bar association standing and client references,
evaluation of the education, experience and areas of practice of lawyers within
the firm, on-site evaluations by our management, and interviews with lawyers in
the firm who would be responsible for providing services. Most importantly,
these candidate law firms are evaluated on the firm's customer service
philosophy.
Approximately 87% of provider law firms, representing 98% of our legal
service members, are connected to us via high-speed digital links to our
management information systems, thereby providing real-time monitoring
capability. This online connection offers the provider law firm access to
specially designed software developed by us for administration of legal services
by the firm. These systems provide statistical reports of each law firm's
activity and performance and allow virtually all of the members served by
provider law firms to be monitored on a near real-time basis. The few provider
law firms that are not online with us typically have a small Membership base and
must provide various weekly reports to us to assist in monitoring the firm's
service level. The combination of the online statistical reporting and weekly
service reports for smaller provider law firms allows quality control monitoring
of over 15 separate service delivery benchmarks. In addition, we regularly
conduct extensive random surveys of members who have used the legal services of
a provider law firm. We survey members in each state every 60 days, compile the
results of such surveys and provide the provider law firms with copies of each
survey and the overall summary of the results. If a member indicates on a survey
the service did not meet their expectation, the member is contacted as soon as
possible to resolve the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to our online monitoring, member complaints, member survey
evaluations, telephone reports and other information developed in connection
with member service monitoring. If a problem is detected, we recommend immediate
remedial actions to the provider law firms to eliminate service deficiencies. In
the event the deficiencies of a provider law firm are not eliminated through
discussions and additional training with us, such deficiencies may result in the
termination of the provider law firm. We are in constant communication with our
provider law firms and meet with them frequently for additional training, to
encourage increased communications with us and to share suggestions relating to
the timely and effective delivery of services to our members. We have recently
empanelled a provider committee consisting of four specific provider law firm
members to meet with us on a quarterly basis in order to improve the flow of
communications between our provider law firms and our management.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless we waive this requirement
due to special circumstances such as instances when the lawyer demonstrates
significant legal experience acquired in an academic, judicial or similar
capacity other than as a lawyer. We provide customer service training to the
provider law firms and their support staff through on-site training that allows
us to observe the individual lawyers of provider law firms as they directly
assist the members.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit us to
terminate the Agreement for cause immediately upon written notice, (c) require
the firm to maintain a minimum amount of malpractice insurance on each of its
attorneys, in an amount not less than $100,000, (d) preclude us from
interference with the lawyer-client relationship, (e) provide for periodic
review of services provided, (f) provide for protection of our proprietary
information and (g) require the firm to indemnify us against liabilities
resulting from legal services rendered by the firm. We are precluded from
contracting with other law firms to provide the same service in the same
geographic area, except in situations where the designated law firm has a
conflict of interest, we enroll a group of 500 or more members, or when the
agreement is terminated by either party. Provider law firms are precluded from
contracting with other prepaid legal service companies without our approval.
Provider law firms receive a fixed monthly payment for each member who are
residents in the service area and are responsible for providing the Membership
benefits without additional remuneration. If a provider law firm delivers legal
services to an open panel member, the law firm is reimbursed for services
rendered according to the open panel Membership. As of December 31, 2006,
provider law firms averaged approximately 47 employees each and on average are
evenly split between support staff and lawyers.
We have had occasional disputes with provider law firms, some of which have
resulted in litigation. The toll-free telephone lines utilized and paid for by
the provider law firms are owned by us so that in the event of a termination,
the members' calls can be rerouted very quickly. Nonetheless, we believe that
our relations with provider law firms are generally very good. At the end of
2006, we had provider law firms representing 48 states and four provinces
compared to 46 states and four provinces at the end of 2005 and 2004. During the
last three calendar years, our relationships with a total of nine provider law
firms were terminated by us or the provider law firm. As of December 31, 2006,
27 provider law firms have been under contract with us for more than eight years
with the average tenure of all provider law firms being approximately 8.2 years.
We have an extensive database of referral lawyers who have provided
services to our members for use by members when a designated provider law firm
is not available. Lawyers with whom members have experienced verified service
problems, or are otherwise inappropriate for the referral system, are removed
from our list of referral lawyers.
Identity Theft Shield Benefits Provider
Kroll is one of the world's leading risk consulting companies. For more
than 30 years, Kroll has helped companies, government agencies and individuals
reduce their exposure to risk and capitalize on business opportunities. Kroll is
an operating unit of Marsh & McLennan Companies, Inc., the global professional
services firm. With offices in more than 60 cities in the U.S. and abroad, Kroll
can operate and restructure businesses; scrutinize accounting practices and
financial documents; gather and filter electronic evidence for attorneys;
recover lost or damaged data from computers and servers; conduct in-depth
investigations; screen domestic and foreign-born job candidates; protect
individuals; and enhance security systems and procedures. Kroll's clients
include many of the world's largest and most prestigious corporations, law
firms, academic institutions, non-profit organizations, sovereign governments
and high net-worth individuals, entertainers and celebrities. Kroll's seasoned
professionals were handpicked and recruited from leading management consulting
companies, top law firms, international auditing companies, multinational
corporations, special operations forces, law enforcement and intelligence
agencies. Kroll also maintains a network of highly trained specialists in cities
throughout the world who can respond to global needs 24 hours a day, seven days
a week. Over the last three years, Kroll has developed a unique solution for
victims of identity theft and this service is now available to our members
through the Identity Theft Shield benefit. Similar to the provider law firms,
Kroll is paid a fixed fee on a monthly per capita basis to render services to
IDT members.
Marketing
Multi-Level Marketing
We market Memberships through a multi-level marketing program that
encourages individuals to sell Memberships and allows individuals to recruit and
develop their own sales organizations. Commissions are paid only when a
Membership is sold. No commissions are paid based solely on recruitment. When a
Membership is sold, commissions are paid to the associate making the sale, and
to other associates (on average, 9 others at December 31, 2006 and December 31,
2005 compared to 13 others at December 31, 2004) who are in the line of
associates who directly or indirectly recruited the selling associate. We
provide training materials, organize area-training meetings and designate
personnel at the home office specially trained to answer questions and inquiries
from associates. We offer various communication avenues to our sales associates
to keep such associates informed of any changes in the marketing of our
Memberships. The primary communication vehicles we utilize to keep our sales
associates informed include extensive use of conference calls and e-mail, an
interactive voice-mail service, The Connection monthly magazine, an interactive
voice response system, a monthly DVD (digital video disc) program and our
website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. Our marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 76% of
our Memberships in force at December 31, 2006, compared to 80% at December 31,
2005 and 75% at December 31, 2004. Although other means of payment are
available, approximately 75% of fees on Memberships purchased by individuals or
families are paid on a monthly basis by means of automatic bank draft or credit
card.
Group marketing
Our marketing efforts towards employee groups, principally on a payroll
deduction payment basis, are designed to permit our sales associates to reach
more potential members with each sales presentation and strive to capitalize on,
among other things, what we perceive to be a growing interest among employers in
the value of providing legal and identity theft service plans to their
employees. Memberships sold through employee groups constituted approximately
24% of total Memberships in force at December 31, 2006, compared to 20% and 25%
at December 31, 2005 and 2004, respectively. Most employee group Memberships are
sold to school systems, governmental entities and businesses. We emphasize group
marketing to employee groups of less than 50 rather than larger groups where
there is more competition, price negotiation and typically a longer sales cycle.
No group accounted for more than 1% of our consolidated revenues from
Memberships during 2006, 2005 or 2004. Substantially all group Memberships are
paid on a monthly basis. We are active in legislative lobbying efforts to
enhance our ability to market to public employee groups and to encourage
Congress to reenact legislation to permit legal service plans to qualify for
pre-tax payments under tax qualified employee cafeteria plans.
Affirmative Defense Response System
We developed the Affirmative Defense Response System ("ADRS") during 2006
to provide businesses and their employees a way to minimize their risk in regard
to identity theft by encouraging businesses to take proactive measures to
protect non-public information. Once our sales associates have been through the
required training, they can begin to offer businesses the forms they will need
and the education their employees will require to take reasonable and
affirmative steps to reduce the harm and risk of having a breach of non-public
information. We encourage businesses to host mandatory employee meetings and
training sessions on identity theft and privacy compliance. At such meetings,
our associates will provide the employees of the business an opportunity to
purchase our legal service and identity theft plans. Since our Identity Theft
Shield provides identity restoration benefits and our legal plans provide help
on related issues, we believe the majority of the time in restoring an
employee's identity is covered by our plan and therefore is not done on company
time or at company expense. We believe our suite of services including our legal
plan, the Legal Shield and the Identity Theft Shield provide employees
assistance in every phase of identity theft - before, during and after the crime
occurs. The ADRS was developed to enhance our group marketing efforts and we
have been pleased with the additional opportunities it created in 2006 and
intend to continue to utilize this program in 2007.
General
Sales associates are generally engaged as independent contractors, are
provided with training materials and are given the opportunity to participate in
our training programs. Sales associates are required to complete a specified
training program prior to marketing our Memberships to employee groups. All
advertising and solicitation materials used by sales associates must be approved
by us prior to use. At December 31, 2006, we had 444,499 "vested" sales
associates compared to 468,365 and 343,696 "vested" sales associates at December
31, 2005 and 2004, respectively. A sales associate is considered to be "vested"
if he or she has personally sold at least three new Memberships per quarter or
if he or she retains a personal Membership. A vested associate is entitled to
continue to receive commissions on prior sales after all previous commission
advances have been recovered. However, a substantial number of vested associates
do not continue to market the Membership, as they are not required to do so in
order to continue to be vested. During 2006, we had 90,206 sales associates who
personally sold at least one Membership, of which 49,955 (55%) made first time
sales. During 2005 and 2004 we had 103,248 and 79,716 sales associates producing
at least one Membership sale, respectively, of which 61,238 (59%) and 41,699
(52%), respectively, made first time sales. During 2006, we had 8,858 sales
associates who personally sold more than ten Memberships compared to 11,221 and
9,895 in 2005 and 2004, respectively. A substantial number of our sales
associates market our Memberships on a part-time basis only. For the year 2006,
new sales associates enrolled decreased 29% to 172,999 with an average
enrollment fee of $50 from the 242,223 enrolled in 2005 with an average
enrollment fee of $57.
We derive revenues from our multi-level marketing sales force, principally
from a one-time enrollment fee from each new sales associate for which we
provide initial marketing supplies and enrollment services to the associate. We
have a field training program, titled Certified Field Training ("CFT"), aimed at
increasing the level of new Membership sales per associate. Associates
successfully complete the program by writing three new Memberships and
recruiting a new sales associate or by personally selling five new Memberships
within 45 days of the associate's start date. Associates in states that require
the associate to become licensed have 45 days from the issue date on their
license to complete the same requirements. Amounts collected from sales
associates are intended primarily to offset our costs incurred in recruiting and
training and providing materials to sales associates and are not intended to
generate profits from such activities. Other revenues from sales associates
represent the sale of marketing supplies and promotional materials and include
fees related to our eService program for associates. The eService program
provides subscribers Internet based back office support such as reports, on-line
documents, tools, a personal e-mail account and multiple personalized web sites
with "flash" movie presentations.
We continually review our compensation plan for the multi-level marketing
force to assure that the various financial incentives in the plan encourage our
desired goals. We offer various incentive programs from time to time and
frequently adjust the program to maintain appropriate incentives and to improve
Membership production and retention.
We hold our International Convention once a year, typically in the spring,
and a Leadership Summit, typically in the fall, and routinely host more than
10,000 of our sales associates at these events. These events are intended to
provide additional training, corporate updates, new announcements, motivation
and associate recognition. Additionally, we offer the Player's Club incentive
program providing additional incentives to our associates as a reward for
consistent, quality business. Associates can earn the right to attend an annual
incentive trip by meeting certain qualification requirements and maintaining
certain personal retention rates. Associates can also earn the right to receive
additional monthly bonuses by meeting the monthly qualification requirements for
twelve consecutive months and maintaining certain personal retention rates for
the Memberships sold during that twelve month period.
Regional Vice Presidents
Prior to January 1, 2007, we had a group of approximately 115 employees
that served as Regional Vice Presidents ("RVPs") and were responsible for
associate activity in given geographic regions and had the ability to appoint
independent contractors as Area Coordinators within the RVP's region. Effective
January 1, 2007, we dramatically revamped this program by reducing the number of
RVPs from approximately 115 to 15; eliminated the employee relationship of the
RVPs so that all are independent contractors; significantly increased both the
size of their regions and the commission override percentages that can be earned
by the RVPs; put in place additional bonus compensation available based on
growth in their assigned regions; replaced the previous large number of Area
Coordinators with substantially fewer Regional Managers appointed by the RVPs;
created commission overrides than can be earned by the Regional Managers in
their regions and created a new class of appointees, Certified Meeting
Coordinators that are appointed by the Regional Managers. Additionally, we have
significantly increased the frequency of communications between us and the RVPs
and expect to increase the frequency and the amount of reporting both from and
to, the RVPs.
The RVP/Regional Manager/Certified Meeting Coordinator program provides a
basis to effectively monitor current sales activity, further educate and
motivate the sales force and otherwise enhance the relationships between the
associates and us. New products, incentives and initiatives will be channeled
through the RVPs.
Pre-Paid Legal Benefits Association
The PPL Benefits Association ("PPLBA") was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this Association is open to sales associates that reach a certain
level within our marketing programs who also maintain an active personal legal
services Membership. The PPLBA is a separate association not owned or controlled
by us and is governed by an 8 member Board of Directors, including four officer
positions. None of the officers or directors of the PPLBA serve in any such
capacity with us. The PPLBA employs a Director of Associate Benefits paid by the
Association. Affinity programs available to members of the PPLBA include credit
cards, long-distance, wireless services, vehicle purchasing services, safety
trip plan, mortgage and real estate assistance and a travel club. As determined
by its Board of Directors, some of the revenue generated by the PPLBA through
commissions from vendors of the benefits and affinity programs or contributed to
the Association by us may be used to make open-market purchases of our stock for
use in stock bonus awards to Association members based on criteria established
from time to time by the Board of Directors of the PPLBA. Since inception and
through December 31, 2006, approximately 42,000 shares were purchased by the
PPLBA for awards to its members. The PPLBA awarded approximately 3,000, 3,300
and 5,000 shares of stock to Association members representing the 2006, 2005 and
2004 stock bonus awards, respectively.
Cooperative Marketing
We have in the past, and may in the future, develop marketing strategies
pursuant to which we seek arrangements with insurance and service companies that
have established sales forces. Under such arrangements, the agents or sales
force of the cooperative marketing partner market our Memberships along with the
products already marketed by the partner's agents or sales force. Such
arrangements allow the cooperative marketing partner to enhance its existing
customer relationships and distribution channels by adding our product to the
marketing partner's existing range of products and services, while we are able
to gain broader Membership distribution and access to established customer
bases.
We have a cooperative marketing agreement with Atlanta-based Primerica
Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one of the
largest financial services marketing organizations in North America with more
than 100,000 personal financial analysts across the U.S. and Canada. The PFS
cooperative marketing agreement resulted in approximately 26,000 new Membership
sales during 2006 compared to 23,000 and 19,000, respectively for 2005 and 2004.
We have had limited success with cooperative marketing arrangements in the
past and are unable to predict with certainty what success we will achieve, if
any, under our existing or future cooperative marketing arrangements.
Operations
Our corporate operations involve Membership application processing,
member-related customer service, various associate-related services including
commission payments, receipt of Membership fees, related general ledger
accounting, human resources, internal audit and managing and monitoring the
provider law firm relationships.
We utilize a management information system to control operations costs and
monitor benefit utilization. Among other functions, the system evaluates benefit
claims, monitors member use of benefits and monitors marketing/sales data and
financial reporting records. Our dominant concerns in the architecture of
private networks and web systems include security, scalability, capacity to
accommodate peak traffic and business continuity in the event of a disaster. We
believe our management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
required. We believe this excess capacity will enable us to experience a
significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
We have built a strong Internet presence to strengthen the services
provided to both members and associates. Our Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
Our operations also include departments specifically responsible for
marketing support and regulatory and licensing compliance. We have an internal
production staff that is responsible for the development of new audio and video
sales materials.
Quality Control
In addition to our quality control efforts for provider law firms described
above, we also closely monitor the performance of our home office personnel,
especially those who have telephone contact with members or sales associates. We
record home office employee telephone calls with our members and sales
associates to assure that our policies are being followed and to gather data
about recurring problems that may be avoided through modifications in policies.
We also use such recorded calls for training and recognition purposes.
Competition
We compete in a variety of market segments in the legal service plan
industry, including, among others, individual enrollment plans, employee benefit
plans and certain specialty segments. Our principal competitors are Hyatt Legal
Plans (a MetLife company), ARAG(R) North America, National Legal Plan and Legal
Services Plan of America (a GE Financial company, formerly the Signature Group).
Most of these concentrate their marketing to larger employer groups and offer
open panel plans.
If a greater number of companies seek to enter the legal service plan
market, we will experience increased competition in the marketing of our
Memberships. However, we believe our competitive position is enhanced by our
actuarial database, our existing network of provider attorney law firms and our
ability to tailor products to suit various types of distribution channels or
target markets. We believe that no other competitor has the ability to monitor
the customer service aspect of the delivery of legal services to the same extent
we do. Finally, we have intentionally concentrated our group marketing to small
employer groups. Serious competition is most likely from companies with
significant financial resources and advanced marketing techniques.
Regulation
We are regulated by or required to file with or obtain approval of State
Insurance Departments, Secretaries of State, State Bar Associations and State
Attorney General offices depending on individual state opinions of regulatory
responsibility for legal expense plans. We are also required to file with
similar government agencies in Canada. While some states or provinces regulate
legal expense plans as insurance or specialized legal expense products, others
regulate them as services.
As of December 31, 2006, we or one of our subsidiaries were marketing new
Memberships in 37 jurisdictions that require no special licensing. Our
subsidiaries serve as operating companies in 17 jurisdictions that regulate
Memberships as insurance or specialized legal expense products. The most
significant of these wholly owned subsidiaries are Pre-Paid Legal Casualty, Inc.
("PPLCI"), Pre-Paid Legal Services, Inc. of Florida ("PPLSIF") and Legal Service
Plans of Virginia, Inc. ("LSPV"). Of our total Memberships in force as of
December 31, 2006, 26% were written in jurisdictions that subject us or one of
our subsidiaries to insurance or specialized legal expense plan regulation. We
are actively working with regulators in the various states in which our
subsidiaries are regulated as insurance to explore other regulatory alternatives
to eliminate some of the agent licensing or financial and marketing regulation
that is prevalent in the insurance industry.
We began selling Memberships in the Canadian provinces of Ontario and
British Columbia during 1999, Alberta during February 2001 and Manitoba during
August 2001. The Memberships we currently market in such provinces do not
constitute an insurance product and therefore are exempt from insurance
regulation.
In states with no special licensing or regulatory requirements, we commence
operations only when advised by the appropriate regulatory authority that
proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
we or one of our subsidiaries would be required to qualify as an insurance
company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate PPLCI's forms, rates, trade practices, allowable investments
and licensing of agents and sales associates. These agencies also prescribe
various reports, require regular evaluations by regulatory authorities, and set
forth-minimum capital and reserve requirements. Our insurance subsidiaries are
routinely evaluated and examined by representatives from the various regulatory
authorities in the normal course of business. Such examinations have not and are
not expected to adversely impact our operations or financial condition in any
material way. We believe that all of our subsidiaries meet any required capital
and reserve requirements. Dividends paid by PPLCI are restricted under Oklahoma
law to available surplus funds derived from realized net profits.
We are required to register and file reports with the Oklahoma Insurance
Commissioner as a member of a holding company system under the Oklahoma
Insurance Holding Company System Regulatory Act. Transactions between PPLCI and
us or any other subsidiary must be at arms-length with consideration for the
adequacy of PPLCI's surplus, and may require prior approval of the Oklahoma
Insurance Commissioner. Payment of any extraordinary dividend by PPLCI to us
requires approval of the Oklahoma Insurance Commissioner. The payment of
dividends by PPLCI is restricted under the Oklahoma Insurance Code to available
surplus funds derived from realized net profits and requires the approval of the
Oklahoma Insurance Commissioner for any dividend representing more than the
greater of 10% of such accumulated available surplus or the previous years' net
profits. During 2006, PPLCI declared and after obtaining all necessary
regulatory approvals, paid extraordinary dividends to us of $13.4 million
compared to the $4.1 million dividend paid to us during 2005. No dividends were
declared or paid by PPLCI during 2004. Any change in our control, defined as
acquisition by any method of more than 10% of our outstanding voting stock,
including rights to acquire such stock by conversion of preferred stock,
exercise of warrants or otherwise, requires approval of the Oklahoma Insurance
Commissioner. Holding company laws in some states in which PPLCI operates
provide for comparable registration and regulation of us.
Certain states have enacted special licensing or regulatory requirements
designed to apply only to companies offering legal service products. These
states most often follow regulations similar to those regulating casualty
insurance providers. Thus, the operating company may be expected to comply with
specific minimum capitalization and unimpaired surplus requirements; seek
approval of forms, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to us by
such subsidiaries. PPLSIF is subject to restrictions of this type under the laws
of the State of Florida, including restrictions with respect to payment of
dividends to us. At January 1, 2007, neither PPLCI nor PPLSIF had funds
available for payment of substantial dividends without the prior approval of the
insurance commissioner. LSPV declared and paid us a $3.7 million dividend during
2005, none during 2006, but had approximately $1.6 million available for payment
of an ordinary dividend at January 1, 2007.
As the legal plan industry continues to mature, additional legislation may
be enacted that would affect us and our subsidiaries. We cannot predict with any
accuracy if such legislation would be adopted or its ultimate effect on
operations, but expect to continue to work closely with regulatory authorities
to minimize any undesirable impact and, as noted above, to reduce regulatory
cost and burden where possible.
Our operations are further impacted by the American Bar Association Model
Rules of Professional Conduct ("Model Rules") and the American Bar Association
Code of Professional Responsibility ("ABA Code") as adopted by various states.
Arrangements for payments to a lawyer by an entity providing legal services to
its members are permissible under both the Model Rules and the ABA Code, so long
as the arrangement prohibits the entity from regulating or influencing the
lawyer's professional judgment. The ABA Code prohibits lawyer participation in
closed panel legal service programs in certain circumstances. Our agreements
with provider law firms comply with both the Model Rules and the ABA Code. We
rely on the lawyers serving as the designated provider law firms for the closed
panel benefits to determine whether their participation would violate any
ethical guidelines applicable to them. We and our subsidiaries comply with
filing requirements of state bar associations or other applicable regulatory
authorities.
We are also required to comply with state, provincial and federal laws
governing our multi-level marketing approach. These laws generally relate to
unfair or deceptive trade practices, lotteries, business opportunities and
securities. The U.S. Federal Trade Commission has proposed business opportunity
regulations which may have an effect upon our method of operating in the United
States, but such regulations are in the early stages of development and it is
not possible to gauge the potential impact or the effective date at this time.
We have experienced no material problems with marketing compliance. In
jurisdictions that require associates to be licensed, we receive all
applications for licenses from the associates and forward them to the
appropriate regulatory authority. We maintain records of all associates
licensed, including effective and expiration dates of licenses and all states in
which an associate is licensed. We do not accept new Membership sale
applications from any unlicensed associate in such jurisdictions.
Employees
At December 31, 2006, we employed 840 individuals on a full-time basis,
exclusive of independent agents and sales associates who are not employees, and
excluding RVPs described above. None of our employees are represented by a
union. We consider our employee relations generally to be very good.
Foreign Operations
We began operations in the Canadian provinces of Ontario and British
Columbia during 1999 and Alberta and Manitoba in 2001 and derived aggregate
revenues, including Membership fees and revenues from associate services, from
Canada of $7.1 million in U.S. dollars during 2006 compared to $6.0 million and
$4.7 million in 2005 and 2004, respectively. In addition, we incur expenses in
Canada in relation to these revenues. Due to the relative stability of the
United States and Canadian foreign relations and currency exchange rates, we
believe that any risk of foreign operations or currency valuations is minimal
and would not have a material effect on our financial condition, liquidity or
results of operations.
Availability of Information
We file periodic reports and proxy statements with the Securities and
Exchange Commission ("SEC"). The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our Internet address is www.prepaidlegal.com. We make available on our
website free of charge copies of our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably possible after we electronically file such material with, or
furnish it to, the SEC.
ITEM 1A. RISK FACTORS
--------------------------
Our financial position, results of operations and cash flows are subject to
various risks, many of which are not exclusively within our control that may
cause actual performance to differ materially from historical or projected
future performance. Information contained within this Form 10-K should be
carefully considered by investors in light of the risk factors described below.
In addition to factors discussed elsewhere in this report, the following are
some of the important factors that could affect our financial condition or
results of operations:
Our future results may be adversely affected if Membership persistency or
renewal rates are lower than our historical experience.
We have over 20 years of actual historical experience to measure the
expected retention of new members. These retention rates could be adversely
affected by the quality of services delivered by provider law firms, the
existence of competitive products or services, our ability to provide
administrative services to members or other factors. If our Membership
persistency or renewal rates are less than we have historically experienced, our
cash flow, earnings and growth rates could be adversely affected.
We may not be able to grow Memberships and revenues at the same rate as we
have historically experienced and have recently experienced declines in new
Membership sales and associate recruitment.
Our year end active Memberships remained virtually unchanged at December
31, 2006 from December 31, 2005 and only increased 6% and 2% in the years ended
December 31, 2005 and 2004, respectively. Changes in net income for the same
three years were 45%, (12%) and 2%, respectively. In years prior to 2004, we
were able to grow Memberships more significantly. Our ability to grow
Memberships and revenues is substantially dependent upon our ability to expand
or enhance the productivity of our sales force, develop additional legal expense
products, develop alternative marketing methods or expand geographically. There
is no assurance that we will be able to achieve increases in Membership and
revenue growth comparable to our historical growth rates.
We are dependent upon the continued active participation of our principal
executive officer.
Our success depends substantially on the continued active participation of
our principal executive officer, Harland C. Stonecipher. Although our management
includes other individuals with significant experience in our business, the loss
of the services of Mr. Stonecipher could have a material adverse effect on our
financial condition and results of operations.
There is litigation pending that may have a material adverse effect on us
if adversely determined. See "Item 3. Legal Proceedings."
We are in a regulated industry and regulations could have an adverse effect
on our ability to conduct our business.
We are regulated by or required to file with or obtain approval of State
Insurance Departments, State Bar Associations and State Attorney General's
Offices, depending on individual state positions regarding regulatory
responsibility for legal service plans. Regulation of our activities is
inconsistent among the various states in which we do business with some states
regulating legal service plans as insurance or specialized legal service
products and others regulating such plans as services. Such disparate regulation
requires us to structure our Memberships and operations differently in certain
states in accordance with the applicable laws and regulations. Our multi-level
marketing strategy is also subject to U.S. federal, Canadian provincial and U.S.
state regulation under laws relating to consumer protection, pyramid sales,
business opportunity, lotteries and multi-level marketing. The U.S. Federal
Trade Commission has proposed business opportunity regulations which may have an
effect upon our method of operating in the United States, but such regulations
are in the early stages of development and it is not possible to gauge the
potential impact or the effective date at this time. Changes in the regulatory
environment for our business could increase the compliance costs we incur in
order to conduct our business or limit the jurisdictions in which we are able to
conduct business.
The business in which we operate is competitive.
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect our ability to
grow. In addition, we may face competition from a growing number of Internet
based legal sites with the potential to offer legal and related services at
competitive prices. Increased competition could have a material adverse effect
on our financial condition and results of operations. See "Description of
Business - Competition."
We are dependent upon the success of our marketing force.
Our principal method of product distribution is through multi-level
marketing. The success of a multi-level marketing force is highly dependent upon
our ability to offer a commission and organizational structure and sales
training and incentive program that enable sales associates to recruit and
develop other sales associates to create an organization. There are a number of
other products and services that use multi-level marketing as a distribution
method and we must compete with these organizations to recruit, maintain and
grow our multi-level marketing force. In order to do so, we may be required to
increase our marketing costs through increases in commissions, sales incentives
or other features, all of which could adversely affect our future earnings. In
addition, the level of confidence of the sales associates in our ability to
perform is an important factor in maintaining and growing a multi-level
marketing force. Adverse financial developments concerning us, including
negative publicity or common stock price declines, could adversely affect our
ability to maintain the confidence of our sales force.
Our stock price may be affected by the significant level of short sellers
of our stock.
As of January 12, 2007, the New York Stock Exchange reported that
approximately 4.5 million shares of our stock were sold short, which constitutes
approximately 33% of our outstanding shares and 48% of our public float,
representing one of the largest short interest percentages of any New York Stock
Exchange listed company. Short sellers expect to make a profit if our shares
decline in value. We have been the subject of a negative publicity campaign from
several known sources of information who support short sellers. The existence of
this short interest position may contribute to volatility in our stock price and
may adversely affect the ability of our stock price to rise if market conditions
or our performance would otherwise justify a price increase.
We have not been able to significantly increase our employee group
Membership sales.
Our success in growing Membership sales is dependent in part on our ability
to market to employee groups. At December 31, 2006, group memberships
represented 24% of total Memberships compared to 20% at December 31, 2005 and
25% at December 31, 2004. Adverse publicity about us may affect our ability to
market successfully to employee groups, particularly larger groups. There is no
assurance that we will be able to increase our group business.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
----------------------------------------
None.
ITEM 2. PROPERTIES.
-------------------------
Our executive and administrative offices and our subsidiaries are located
at One Pre-Paid Way, Ada, Oklahoma. The office complex, owned by us, contains
approximately 170,000 square feet of office space and was constructed on
approximately 87 acres contributed to us by the City of Ada in 2001 as part of
an economic development incentive package. Construction was completed in 2004 at
a cost of approximately $34.1 million, including $706,000 in capitalized
interest costs, and was funded from existing resources and proceeds from a $20
million line of credit.
The new headquarters contains two long bars of open office area designed to
serve as podiums, which stretch east from the northern and southern edges of the
tower. Two and three stories high respectively, the podiums house the call
centers and Information Technology departments. Only 60 feet across, they are
designed to ensure that employees are never more that thirty feet from a source
of daylight. Shared corporate services -- including a 650-seat auditorium,
dining hall, exercise facility, and a connecting corridor containing a company
history gallery -- are located at the east end of the bars, creating a central
courtyard. The courtyard features a reflecting pool and a 12-foot bronze
sculpture of our logo, the Lady of Justice, a universal symbol of justice. The
building's main entrance welcomes its frequent visitors, celebrates our history,
and is designed to convey the tradition of civic judicial buildings. Although we
substantially occupy our current facility, the building is designed to expand
over time without negatively impacting the site layout or the building concept
and we emphasized the use of modular furnishings to provide enhanced
flexibility. We placed importance on the goal of providing each employee with an
excellent work environment.
Additionally, we fully utilize another distribution facility located about
two miles from our new offices and containing approximately 17,000 square feet
of office and warehouse and shipping space. Our previous headquarters of
approximately 40,000 square feet and two other buildings containing
approximately 18,600 combined square feet located adjacent to the distribution
facility are now used as disaster recovery, or business continuity, sites.
During 2005, in conjunction with economic development incentives, we leased
additional office space in Duncan, Oklahoma and during January 2006, we acquired
an additional 40,000 square foot building in Duncan for $1 million. We
completely refurbished the space at an additional cost of $3.4 million,
resulting in total capitalized cost of $4.4 million, which was funded from
existing resources. We moved from the space previously leased to the completely
refurbished and redesigned space with redundant infrastructure components in
July 2006 and currently have approximately 110 customer service representatives
in the facility but have the capacity to accommodate 350 employees.
In addition to the property described above that we own, we opened an
additional Customer Care facility in Antlers, Oklahoma during March 2000, in
building space provided by the City of Antlers at no cost to us. In conjunction
with a rural economic development program coordinated by the City of Antlers, a
new facility was built at no cost to us that can accommodate approximately 100
customer service representatives. We leased the facilities from the City of
Antlers upon completion of the construction in November 2002.
ITEM 3. LEGAL PROCEEDINGS.
--------------------------------
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. At one time, we were aware of
11 separate lawsuits involving approximately 400 plaintiffs in multiple counties
in Mississippi. These cases seek varying amounts of actual and punitive damages.
We tried three separate lawsuits in Mississippi. On September 11, 2006 we
reached a settlement agreement with counsel for the more than 400 plaintiffs in
numerous pending cases in Mississippi. For an amount significantly less than our
then accrued reserves of $2.5 million, all pending litigation against us is
being 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. Settlement and dismissal of almost all pending litigation has been
approved by the plaintiffs.
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, we believe will
be sufficient to cover estimated damages in connection with various cases
(exclusive of ongoing defense costs which are expensed as incurred), which at
December 31, 2006 was $150,000. We believe that we have meritorious defenses in
all pending cases and will vigorously defend against the plaintiffs' claims.
However, it is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments which aggregate $5.7 million. The Canadian taxing authorities
contend commission deductions should be matched with the membership revenue as
received, we contend these commissions are deductible when paid. Under Canadian
tax laws, our commission payments are treated as a prepaid expense. We base our
deduction of commission on the fact that all the services (the sale of the
membership) have been performed by the sales associate at the time of sale
therefore this prepaid expense (the commission payments) is deductible when
paid. Also, the commission payment is taxable to the sales associate when paid
and each year we issue a T4 (Canadian 1099 equivalent) to sales associates for
the total commission payments made during that year. In addition, Canadian
taxing authorities have challenged our allocation of general and administrative
expenses to Canadian operations. We contend the allocation of general and
administrative expenses, based on the percentage of Canadian new memberships
written and the Canadian percentage memberships in force, is reasonable. We have
established an accrued liability we believe will be sufficient to cover the
estimated tax assessment in connection with these items, which at December 31,
2006 was $477,000. As stated above, we believe that we have reasonable basis for
our tax position relative to these items, however, it is possible that an
adverse outcome could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
------------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
--------------------------------------------------------------------------------
AND ISSUER PURCHASES OF EQUITY SECURITIES.
------------------------------------------
Market Price of and Dividends on the Common Stock
At February 16, 2007, there were 1,217 holders of record (including
brokerage firms and other nominees) of our common stock, which is listed on the
New York Stock Exchange under the symbol "PPD." The following table sets forth,
for the periods indicated, the range of high and low sales prices for the common
stock, as reported by the New York Stock Exchange.
High Low
---- ---
2007:
1st Quarter (through February 16)............... $ 40.18 $ 37.68
2006:
4th Quarter..................................... $ 45.10 $ 39.00
3rd Quarter..................................... 40.00 33.70
2nd Quarter..................................... 37.50 32.15
1st Quarter..................................... 40.50 34.04
2005:
4th Quarter..................................... $ 48.40 $ 37.20
3rd Quarter..................................... 52.77 36.35
2nd Quarter..................................... 47.00 33.51
1st Quarter..................................... 38.37 30.69
On December 6, 2004, we declared our first cash dividend of $0.50 per share
on our outstanding shares of common stock. The following table sets forth, for
2005 and 2004, the declaration date, the per share dividend amount, the
aggregate dividend amount, the record date and the payable date of cash
dividends that we have declared on our outstanding shares of common stock. No
dividends were declared in 2006.
Declared Per Share Aggregate Amount Record Date Payment Date
--------------------------- -------------- -------------------- ------------------------ ------------------
December 6, 2004 $ 0.50 $ 7.8 million December 20, 2004 January 14, 2005
April 4, 2005 0.30 4.6 million April 25, 2005 May 16, 2005
December 19, 2005 0.30 4.6 million December 30, 2005 January 13, 2006
It is anticipated that earnings generated from our operations will be used
to finance our growth, to continue to purchase shares of our stock, to retire
existing debt and possibly pay cash dividends. Our ability to pay dividends is
dependent in part on our ability to derive dividends from our subsidiaries. The
payment of dividends by PPLCI is restricted under the Oklahoma Insurance Code to
available surplus funds derived from realized net profits and requires the
approval of the Oklahoma Insurance Commissioner for any dividend representing
more than the greater of 10% of such accumulated available surplus or the
previous years' net profits. PPLSIF and LSPV are similarly restricted pursuant
to their respective insurance laws. The following table reflects subsidiary
dividends during the last three years:
Dividends Paid Dividends Available
Regulated Subsidiary 2006 2005 2004 1/1/2007
--------------------------------------------- ----------------- ------------------ ----- ------------------------
Pre-Paid Legal Casualty, Inc. $13.4 million $ 4.1 million - $ -
Legal Service Plans of Virginia - 3.7 million - 1.6 million
At December 31, 2006 the amount of restricted net assets of consolidated
subsidiaries was $22.6 million, representing amounts that may not be paid to us
as dividends either under the applicable regulations or without regulatory
approval.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plans
The following table provides information with respect to our equity
compensation plans as of December 31, 2006, (other than our tax qualified
Employee Stock Ownership Plan designed to provide retirement benefits).
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
--------------------------------------- ---------------------- ---------------------- --------------------------
Equity compensation plans approved by
security holders (1)................. 264,500 $ 23.28 1,346,252
Equity compensation plans not approved
by security holders (2).............. 8,540 22.87 -
---------------------- ---------------------- --------------------------
Total.................................. 273,040 $ 23.26 1,346,252
---------------------- ---------------------- --------------------------
-----------
(1) These stock options have been issued pursuant to our Stock Option Plan
which has been approved by security holders. We do not expect to grant any
additional options under this plan.
(2) These stock options have been issued to our Regional Vice Presidents
("RVPs") (described above) in order to encourage stock ownership by our
RVPs and to increase the proprietary interest of such persons in our growth
and financial success. These options have been granted periodically to RVPs
since 1996. Options were granted at fair market value at the date of the
grant and are generally immediately exercisable for a period of three years
or within 90 days of termination, whichever occurs first. We discontinued
the RVP stock option grants immediately after the 2003 fourth quarter stock
options were awarded in the first quarter of 2004. There were 36,751
options granted to RVPs during 2004.
Issuer Purchases of Equity Securities
The following table provides information about our purchases of stock in the
open market during the fourth quarter of 2006.
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Part of Publicly Be Purchased Under
Total Number of Average Price Paid Announced Plans or the Plans or
Period Shares Purchased per Share Programs Programs (1)
----------------------- --------------------- --------------------- --------------------- ---------------------
October 2006........... 64,074 $ 42.61 64,074 1,139,798
November 2006.......... 354,747 42.70 354,747 785,051
December 2006.......... 158,456 42.02 158,456 626,595
--------------------- --------------------- ---------------------
Total.................. 577,277 $ 42.50 577,277
--------------------- --------------------- ---------------------
-----------
(1) We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock.
The Board of Directors has subsequently from time to time increased such
authorization from 500,000 shares to 12 million shares. The most recent
authorization was for 1,000,000 additional shares June 28, 2006 and there
has been no time limit set for completion of the repurchase program.
Shareholder Return Performance Graph
The following graph compares the cumulative total shareholder returns of
our Common Stock during the five years ended December 31, 2006 with the
cumulative total shareholder returns of the Russell 2000 Index and the Hemscott,
Inc. Personal Services industry index. The comparison assumes an investment of
$100 on January 1, 2002 in each of our Common Stock, the Russell 2000 Index and
Hemscott's Personal Services industry index and that any dividends were
reinvested.
Comparison of Cumulative Total Return of Our Stock,
Russell 2000 Index and Industry Index
---------------------00----FISCAL YEAR ENDING-------------------------
COMPANY/INDEX/MARKET 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006
Pre-Paid Legal Services, Inc. 100.00 119.63 119.27 173.29 179.78 184.11
Personal Services 100.00 96.87 121.42 128.25 133.54 147.18
Russell 2000 Index 100.00 78.42 114.00 133.94 138.40 162.02
ITEM 6. SELECTED FINANCIAL DATA.
--------------------------------------
The following table sets forth selected financial and statistical data for
us as of the dates and for the periods indicated. This information is not
necessarily indicative of our future performance. The following information
should be read in conjunction with our Consolidated Financial Statements and
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operation included elsewhere herein.
Year Ended December 31,
-------------------------------------------------------------
2006 2005 2004 2003 2002
---------- ---------- ---------- ----------- ----------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees...................................... $ 412,200 $ 389,255 $ 355,461 $ 330,322 $ 308,401
Associate services................................... 26,857 28,963 24,901 25,704 37,418
Other................................................ 4,967 5,162 5,575 5,287 4,804
---------- ---------- ---------- ----------- ----------
Total revenues..................................... 444,024 423,380 385,937 361,313 350,623
---------- ---------- ---------- ----------- ----------
Costs and expenses:
Membership benefits.................................. 145,771 137,150 122,280 111,165 103,761
Commissions.......................................... 126,762 141,631 118,757 115,386 119,371
Associate services and direct marketing.............. 29,493 30,453 29,325 28,929 32,566
General and administrative expenses.................. 50,078 49,015 43,742 36,711 33,256
Other, net........................................... 12,232 10,456 9,578 8,546 6,685
---------- ---------- ---------- ----------- ----------
Total costs and expenses........................... 364,336 368,705 323,682 300,737 295,639
---------- ---------- ---------- ----------- ----------
Income before income taxes............................... 79,688 54,675 62,255 60,576 54,984
Provision for income taxes............................... 27,890 18,863 21,478 20,669 18,970
---------- ---------- ---------- ----------- ----------
Net income............................................... $ 51,798 $ 35,812 $ 40,777 $ 39,907 $ 36,014
---------- ---------- ---------- ----------- ----------
Basic earnings per common share.......................... $ 3.54 $ 2.31 $ 2.50 $ 2.28 $ 1.83
---------- ---------- ---------- ----------- ----------
Diluted earnings per common share........................ $ 3.51 $ 2.29 $ 2.48 $ 2.27 $ 1.82
---------- ---------- ---------- ----------- ----------
Dividends declared per common share...................... $ - $ .60 $ .50 $ - $ -
Weighted avg. number of common shares outstanding - basic 14,642 15,470 16,313 17,530 19,674
Weighted avg. number of common shares outstanding -
diluted................................................ 14,739 15,652 16,458 17,599 19,764
Membership Benefits Cost and Statistical Data:
Membership benefits ratio (1)........................... 35.4% 35.2% 34.4% 33.7% 33.6%
Commissions ratio (1)................................... 30.8% 36.4% 33.4% 34.9% 38.7%
General and administrative expense ratio (1)............ 12.1% 12.6% 12.3% 11.1% 10.8%
Commission cost per new Membership sold................. $ 207 $ 202 $ 190 $ 172 $ 154
New Memberships and stand-alone IDT plans sold.......... 612,726 700,727 624,525 671,857 773,767
Period end Memberships and stand-alone IDT plans in
force.................................................. 1,538,740 1,542,789 1,451,700 1,418,997 1,382,306
New add-on IDT memberships sold......................... 389,157 441,108 335,792 89,928 -
Period end add-on IDT memberships in force.............. 540,253 461,094 283,889 86,602 -
Average annual Membership fee........................... $ 293 $ 287 $ 274 $ 262 $ 256
Cash Flow Data:
Net cash provided before changes in assets and liabilities $ 60,832 $ 45,434 $ 51,689 $ 47,731 $ 42,699
Net cash provided by operating activities................. 54,385 50,131 47,263 51,693 52,073
Net cash used in investing activities..................... (52,613) (15,545) (11,322) (36,901) (11,074)
Net cash used in financing activities.................... (23,698) (26,601) (31,428) (14,191) (34,431)
Balance Sheet Data:
Total assets............................................ $ 188,547 $ 164,865 $ 146,064 $ 131,012 $ 96,836
Total liabilities....................................... 157,687 113,471 114,617 101,438 61,864
Stockholders' equity.................................... 30,860 51,394 31,447 29,574 34,972
-----------
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. These ratios do not measure total profitability because
they do not take into account all revenues and expenses.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
-----------------------------------------------------------------------------
RESULTS OF OPERATIONS.
----------------------
Overview of the Our Financial Model
We are in one line of business - the marketing of legal expense and other
complimentary plans primarily through a multi-level marketing force to
individuals. Our principal revenues are derived from Membership fees, and to a
much lesser extent, revenues from marketing associates. Our principal expenses
are commissions, Membership benefits, associate services and direct marketing
costs and general and administrative expense. The following table reflects the
changes in these categories of revenues and expenses in the last three years
(dollar amounts in 000's):
% % %
Change Change Change
% of from % of from % of from
Total Prior Total Prior Total Prior
2006 Revenue Year 2005 Revenue Year 2004 Revenue Year
Revenues: --------- ------- -------- -------- -------- -------- -------- -------- --------
Membership fees............ $412,200 92.8 5.9 $389,255 91.9 9.5 $355,461 92.1 7.6
Associate services......... 26,857 6.1 (7.3) 28,963 6.9 16.3 24,901 6.5 (3.1)
Other...................... 4,967 1.1 (3.8) 5,162 1.2 (7.4) 5,575 1.4 5.5
--------- ------- -------- -------- -------- -------- -------- -------- --------
444,024 100.0 4.9 423,380 100.0 9.7 385,937 100.0 6.8
--------- ------- -------- -------- -------- -------- -------- -------- --------
Costs and expenses:
Membership benefits........ 145,771 32.8 6.3 137,150 32.4 12.2 122,280 31.7 10.0
Commissions................ 126,762 28.6 (10.5) 141,631 33.5 19.3 118,757 30.8 2.9
Associate services and
direct marketing......... 29,493 6.6 (3.2) 30,453 7.2 3.9 29,325 7.6 1.4
General and administrative. 50,078 11.3 2.2 49,015 11.6 12.1 43,742 11.3 19.2
Other, net................. 12,232 2.8 17.0 10,456 2.5 9.2 9,578 2.5 12.1
--------- ------- -------- -------- -------- -------- -------- -------- --------
364,336 82.1 (1.2) 368,705 87.1 13.9 323,682 83.9 7.6
--------- ------- -------- -------- -------- -------- -------- -------- --------
Provision for income taxes... 27,890 6.3 47.9 18,863 4.5 (12.2) 21,478 5.6 3.9
--------- ------- -------- -------- -------- -------- -------- -------- --------
Net income................... $ 51,798 11.7 44.6 $ 35,812 8.5 (12.2) $ 40,777 10.6 2.2
--------- ------- -------- -------- -------- -------- -------- -------- --------
The following table reflects certain data concerning our Membership sales and
associate recruiting:
% Change % Change
from from
New Memberships: 12/31/2006 Prior Year 12/31/2005 Prior Year 12/31/2004
---------------- ---------- ---------- ----------- ---------- ----------
New legal service Membership sales................. 584,408 (12.3) 666,595 11.1 599,929
New "stand-alone" IDT Membership sales............. 28,318 (17.0) 34,132 38.7 24,596
---------- ---------- ----------- ---------- ----------
Total new Membership sales......................... 612,726 (12.6) 700,727 12.2 624,525
---------- ---------- ----------- ---------- ----------
New "add-on" IDT Membership sales.................. 389,157 (11.8) 441,108 31.4 335,792
Average Annual Membership fee...................... $328.36 2.0 $322.04 6.2 $303.36
Active Memberships:
Active legal service memberships at end of period.. 1,473,710 (1.1) 1,490,847 4.6 1,424,707
Active "stand-alone" IDT memberships at end of period 65,030 25.2 51,942 92.4 26,993
---------- ---------- ----------- ---------- ----------
Total active memberships at end of period.......... 1,538,740 (0.3) 1,542,789 6.3 1,451,700
---------- ---------- ----------- ---------- ----------
Active "add-on" IDT memberships at end of period... 540,253 17.2 461,094 62.4 283,889
New Sales Associates:
New sales associates recruited..................... 172,999 (28.6) 242,223 125.2 107,552
Average enrollment fee paid by new sales associates $49.69 (12.2) $56.61 (60.3) $142.49
Average Membership fee in force:
Average Annual Membership fee...................... $293.00 2.2 $286.60 4.6 $274.02
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees and their impact on total revenues during any
period. The two most important variables impacting the number of active
Memberships during a period are the number of new Memberships written during the
period combined with the retention characteristics of both new and existing
Memberships. See "Measures of Member Retention" below for a discussion of our
Membership retention. Associate services revenues are a function of the number
of new sales associates enrolled and the price of entry during the period, the
number of associates subscribing to our eService offering and the amount of
sales tools purchased by the sales force.
Membership benefits expense is primarily determined by the number of active
Memberships and the per capita contractual rate that exists between us and our
benefits providers and during the last five years has been and is expected to
continue to be a relatively consistent percentage of Membership revenues of
approximately 33%-35% but could increase should the number of IDT memberships
increase at a faster pace than the legal Memberships. Commissions paid to
associates are primarily dependent on the number and price of new Memberships
sold during a period and any special incentives that may be in place during the
period. We expense advance commissions ratably over the first month of the
related Membership. The level of commission expense in relation to Membership
revenues varies depending on the level of new Memberships written and is
expected to be higher when we experience increases in new Membership sales.
During the last five years this percentage has ranged from approximately 33% to
42% of Membership revenues. Associate services and direct marketing expenses are
directly impacted by the number of new associates enrolled during a period due
to the cost of materials provided to such new associates, the number of
associates subscribing to our eService offering, the amount of sales tools
purchased by the sales force as well as the number of those associates who
successfully meet the CFT training and incentive award program qualifications.
Prior to 2003, these costs were more than offset by associate services revenue,
however this did not occur in 2006, 2005 or 2004 primarily due to the lower
entry fees charged during most of the periods. General and administrative
expenses are expected to trend up in terms of dollars, but remain relatively
constant as a percent of Membership fees. During the past five years, general
and administrative expenses have ranged from 11% to 13% of Membership fees.
The primary benchmarks monitored by us throughout the various periods
include the number of active Memberships and their related retention
characteristics, the number of new Memberships written, the number of new
associates enrolled and the percentage of new associates that successfully meet
the CFT qualification requirements.
Although we have grown our Membership fees in each of the past 14 years,
the rate of growth has not been one we find acceptable. We believe however, that
our current product design, pricing parameters and business model are generally
appropriate and we have no immediate plans to change these fundamental sectors.
Our focus during 2007 will continue to be on improved training of our
associates, enhancing the quality of sales tools provided to new and existing
associates, providing incentives for associates to write consistent, quality
business and continued emphasis on improving the basic retention characteristics
of our Memberships.
Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance
with accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. If these estimates or assumptions are
incorrect, there could be a material change in our financial condition or
operating results. Many of these "critical accounting policies" are common in
the insurance and financial services industries; others are specific to our
business and operations. Our critical accounting policies include estimates
relating to revenue recognition related to Membership and associate fees,
deferral of Membership and associate related costs, expense recognition related
to commissions to associates, accrual of incentive awards payable and accounting
for legal contingencies.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
basis. Approximately 95% of members remit their Membership fees on a monthly
basis. Approximately 75% of our Membership fees are paid in advance and,
therefore, are deferred and recognized over their respective periods. At
December 31, 2006 the deferred revenue associated with the Membership fees was
$21.1 million which is classified as a current liability.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs are deferred and recognized in income over the estimated life
of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101") as revised by SEC
Staff Accounting Bulletin No. 104. At December 31, 2006 the deferred revenue
associated with the Membership enrollment fees was $6.2 million, of which $3.6
million was classified as a current liability. We compute the expected
Membership life using more than 20 years of actuarial data as explained in more
detail in "Measures of Membership Retention" below. At December 31, 2006,
management computed the expected Membership life to be approximately three
years, which is unchanged from year end 2005. If the expected Membership life
were to change significantly, which management does not expect in the short
term, the deferred Membership enrollment fee and related costs would be
recognized over a longer or shorter period.
We derive revenues from services provided to our marketing sales force
primarily from a one-time non-refundable enrollment fee from each new sales
associate for which we provide initial sales and marketing supplies and
enrollment services to the associate. Average enrollment fees paid by new sales
associates were $50, $57 and $142 for 2006, 2005 and 2004, respectively. Revenue
from, and costs of, the initial sales and marketing supplies (approximately $11)
are recognized when the materials are delivered to the associates. The remaining
revenues and related incremental direct and origination costs are deferred and
recognized over the estimated average active service period of associates which
at December 31, 2006 is estimated to be approximately five months, down slightly
from six months at year end 2005. At December 31, 2006, the deferred revenue
associated with sales associate enrollment fees was $888,000, which is
classified as a current liability. Management estimates the active service
period of an associate periodically based on the average number of months an
associate produces new Memberships including those associates that fail to write
any Memberships. If the active service period of associates changes
significantly, which management does not expect in the short term, the deferred
revenue and related costs would be recognized over the new estimated active
service period.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
($6.8 million deferred at December 31, 2006 which is classified as a current
asset) and associates related to deferred Membership revenue. Deferred costs for
enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments, and were $6.2
million at December 31, 2006, of which $3.6 million is classified in current
assets. Deferred costs for enrolling new associates include training and success
bonuses paid to individuals involved in recruiting the associate and salary and
benefit costs of employees who process associate enrollments, and were $728,000
at December 31, 2006, and are classified as a current asset. Such costs are
deferred to the extent of the lesser of actual costs incurred or the amount of
the related fee charged for such services. Deferred costs are amortized to
expense over the same period as the related deferred revenue as discussed above.
Deferred costs that will be recognized within one year of the balance sheet date
are classified as current and all remaining deferred costs are considered
noncurrent. Associate related costs are reflected as associate services and
direct marketing, and are expensed as incurred if not related to the deferred
revenue discussed above. These costs include providing materials and services to
associates, associate introduction kits, associate incentive programs, group
marketing and marketing services departments (including costs of related travel,
marketing events, leadership summits and international sales convention).
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, we implemented
a level commission schedule (approximately 27% per annum at December 31, 2001)
with up to a three-year advance commission payment. Prior to March 1, 1995, our
commission program provided for advance commission payments to associates of
approximately 70% of first year Membership fees on new Membership sales and
commissions were earned by the associate at a rate of approximately 16% in all
subsequent years. Effective March 1, 2002, and in order to offer additional
incentives for increased Membership retention rates, we returned to a
differential commission structure with rates of approximately 80% of first year
Membership fees on new Memberships written and variable renewal commission rates
ranging from five to 25% per annum based on the first 12 month Membership
retention rate of the associate's personal sales and those of his organization.
Beginning in August 2003, we allowed the associate to choose between the level
commission structure and up to a three year commission advance or the
differential commission structure with a one year commission advance.
Prior to January 1997 we advanced commissions at the time of sale of all
new Memberships. In January 1997, we implemented a policy whereby the associate
receives only earned commissions on the first three sales unless the associate
has successfully completed the CFT training program. For all sales beginning
with the fourth Membership or all sales made by an associate successfully
completing the CFT training program, we currently advance commission payments at
the time of sale of a new Membership. The amount of cash potentially advanced
upon the sale of a new Membership, prior to the recoupment of any charge-backs
(described below), represents an amount equal to up to one-year commission
earnings. Although the average number of marketing associates receiving an
advance commission payment on a new Membership is 10, the overall initial
advance may be paid to approximately 30 different individuals, each at a
different level within the overall commission structure. The commission advance
immediately increases an associate's unearned advance commission balance to us.
Although prior to March 1, 2002, we advanced our sales associates up to
three years commission when a Membership was sold and subsequent to March 1,
2002, up to one year commission, the average commission advance paid to our
sales associates as a group is actually less than the maximum amount possible
because some associates choose to receive less than a full advance and we pay
less than a full advance on some of our specialty products. In addition, we may
from time to time place associates on a less than full advance basis if there
are problems with the quality of the business being submitted or other
performance problems with an associate. Additionally, we do not advance
commissions on certain categories of group business which have historically
demonstrated below average retention characteristics. Also, any residual
commissions due an associate (defined as commission on an individual Membership
after the advance has been earned) are retained to reduce any remaining unearned
commission advance balances prior to being paid to that sales associate. For
those associates that have made at least 10 personal sales, opened at least one
group and personally write 15% or more of their organizational business, 15% of
their commissions are set aside in individual reserve balance accounts, further
reducing the amount of advance commissions. The average commission advance paid
as a percentage of the maximum advance possible pursuant to our commission
structures was approximately 78%, 75% and 78% during 2006, 2005 and 2004,
respectively. The commission cost per new Membership sold has increased over the
prior year by 2%, 6% and 10% for 2006, 2005 and 2004, respectively, and varies
depending on the compensation structure that is in place at the time a new
Membership is sold, the monthly Membership fee of the Membership sold and the
amount of any charge-backs (recoupment of previous commission advances) that are
deducted from amounts that would otherwise be paid to the various sales
associates that are compensated for the Membership sale. Should we add
additional products, such as the Identity Theft Shield described above or add
additional commissions to our compensation plan or reduce the amount of
chargebacks collected from our associates, the commission cost per new
Membership will increase accordingly.
We expense advance commissions ratably over the first month of the related
Membership. At December 31, 2006, advance commissions deferred were $4.8 million
and included as a current asset. As a result of this accounting policy, our
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. We track our unearned advance commission
balances outstanding in order to ensure the advance commissions are recovered
before any renewal commissions are paid and for internal purposes of analyzing
our commission advance program. While not recorded as an asset, unearned advance
commission balances from associates for the following years ended December 31
were:
2006 2005 2004
------------ ------------ ------------
(Amounts in 000's)
Beginning unearned advance commission balances (1).............. $ 195,792 $ 183,060 $ 191,894
Advance commissions, net of chargebacks and other............... 121,737 142,535 115,942
Earned commissions applied...................................... (124,983) (127,084) (122,393)
Advance commission write-offs................................... (3,899) (2,719) (2,383)
------------ ------------- -------------
Ending unearned advance commission balances before estimated
unrecoverable balances (1).................................... 188,647 195,792 183,060
Estimated unrecoverable advance commission balances (1)(2)...... (40,091) (33,879) (28,554)
------------ ------------- -------------
Ending unearned advance commission balances, net (1)............ $ 148,556 $ 161,913 $ 154,506
------------ ------------- -------------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2) Estimated unrecoverable advances increased as a percentage of ending
advances from 16% at December 31, 2004 to 21% at December 31, 2006
primarily due to the change in the compensation structure described above
from a 36-month possible advance to a 12-month possible advance and fewer
new Memberships written during 2003 and 2004. The commission structure
change allows the advances to be earned more quickly by the associate and
the reduction in new Memberships written creates fewer new advances.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $49 million,
$40 million and $27 million at December 31, 2006, 2005 and 2004, respectively.
As such, at December 31, 2006 future commissions and related expense will be
reduced as unearned advance commission balances of $99 million are recovered.
Commissions are earned by the associate as Membership fees are earned by us,
usually on a monthly basis. We reduce unearned advance commission balances or
remit payments to associates, as appropriate, when commissions are earned.
Should a Membership lapse before the advances have been recovered for each
commission level, we, except as described below, generate an immediate
"charge-back" to the applicable sales associate to recapture up to 50% of any
unearned advance on Memberships written prior to March 1, 2002, and 100% on any
Memberships written thereafter. Beginning in August 2003, we allowed the
associate to choose between the level commission structure and up to three year
commission advance and up to 50% chargebacks or the differential commission
structure with a one year commission advance and up to 100% chargebacks. This
charge-back is deducted from any future advances that would otherwise be payable
to the associate for additional new Memberships. In order to encourage
additional Membership sales, we waived chargebacks for associates that met
certain criteria in December 2002 and March 2003, which effectively increased
our commission expense. Any remaining unearned advance commission balance may be
recovered by withholding future residual earned commissions due to an active
associate on active Memberships. Additionally, even though a commission advance
may have been fully recovered on a particular Membership, no additional
commission earnings from any Membership are paid to an associate until all
previous advances on all Memberships, both active and lapsed, have been
recovered. We also have reduced chargebacks from 100% to 50% for certain senior
marketing associates who have demonstrated the ability to maintain certain
levels of sales over specified periods and maintain certain Membership retention
levels. We may adjust chargebacks from time to time in the future in order to
encourage certain production incentives.
We have the contractual right to require associates to repay unearned
advance commission balances from sources other than earned commissions including
cash (a) from all associates either (i) upon termination of the associate
relationship, which includes but is not limited to when an associate becomes
non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, we have not demanded repayments of the unearned
advance commission balances from associates, including terminated associates,
because collection efforts would likely increase costs and have the potential to
disrupt our relationships with our sales associates. This business decision by
us has a significant effect on our cash flow by electing to defer collection of
advance payments of which approximately $40.1 million were not expected to be
collected from future commissions at December 31, 2006. However, we regularly
review the unearned advance commission balance status of associates and will
exercise our right to require associates to repay advances when management
believes that such action is appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet our established vesting requirements by selling at least three new
Memberships per quarter or retaining a personal Membership. Non-vested
associates lose their right to any further commissions earned on Memberships
previously sold at the time they become non-vested. As a result we have no
continuing obligation to individually account to these associates as we do to
active associates and are entitled to retain all commission earnings that would
be otherwise payable to these terminated associates. We do continue to reduce
the unearned advance commission balances for commissions earned on active
Memberships previously sold by those associates. Substantially all individual
non-vested associate unearned advance commission balances were less than $1,000
and the average balance was $413 at December 31, 2006.
Although the advance commissions are expensed ratably over the first month
of the related Membership, we assess, at the end of each quarter, on an
associate-by-associate basis, the recoverability of each associate's unearned
advanced commission balance by estimating the associate's future commissions to
be earned on active Memberships. Each active Membership is assumed to lapse in
accordance with our estimated future lapse rate, which is based on our actual
historical Membership retention experience as applied to each active
Membership's year of origin. The lapse rate is based on our more than 20-year
history of Membership retention rates, which is updated quarterly to reflect
actual experience. We also closely review current data for any trends that would
affect the historical lapse rate. The sum of all expected future commissions to
be earned for each associate is then compared to that associate's unearned
advance commission balance. We estimate unrecoverable advance commission
balances when expected future commissions to be earned on active Memberships
(aggregated on an associate-by-associate basis) are less than the unearned
advance commission balance. If an associate with an outstanding unearned advance
commission balance has no active Memberships, the unearned advance commission
balance is written off but has no financial statement impact as advance
commissions are expensed ratably over the first month of the related
Memberships. Refer to "Measures of Member Retention - Expected Membership Life,
Expected Remaining Membership Life" for a description of the method used by us
to estimate future commission earnings.
Further, our analysis of the recoverability of unearned advance commission
balances is also based on the assumption that the associate does not write any
new Memberships. We believe that this assessment methodology is highly
conservative since our actual experience is that many associates do continue to
sell new Memberships and we, through our chargeback rights, gain an additional
source to recover unearned advance commission balances.
Changes in our estimates with respect to recoverability of unearned
commissions could occur if the underlying Membership persistency changes from
historical levels. Should Membership persistency decrease, the unearned
commissions would be recovered over a longer period and the amount not recovered
would most likely increase, although any increase in uncollectible unearned
commissions would not have any immediate expense impact since the commission
advances are expensed in the month they are incurred. Holding all other factors
constant, the decline in persistency would also lead to lower Membership fees,
less net income and less cash flow from operations. Conversely, should
persistency increase, the unearned commissions would be recovered more quickly,
the amount unrecovered would decrease and, holding all other factors constant,
we would enjoy higher Membership fees, more net income and more cash flow from
operations.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. At December 31, 2006, the accrued
amount payable was $2.9 million. Changes to any of these assumptions would
directly affect the amount accrued but we do not expect any of the significant
trends impacting this account to change significantly in the near term.
Legal Contingencies
We are subject to various legal proceedings and claims, the outcomes of
which are subject to significant uncertainty. Given the inherent
unpredictability of litigation, it is difficult to estimate the impact of
litigation on our financial condition or results of operation. SFAS 5,
Accounting for Contingencies, requires that an estimated loss from a loss
contingency should be accrued by a charge to income if it is probable that an
asset has been impaired or a liability has been incurred and the amount of the
loss can be reasonably estimated. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been incurred. We
evaluate, among other factors, the degree of probability of an unfavorable
outcome and the ability to make a reasonable estimate of the amount of loss. We
have established an accrued liability we believe will be sufficient to cover
estimated damages in connection with various cases, which at December 31, 2006
was $150,000. This process requires subjective judgment about the likely
outcomes of litigation. Liabilities related to most of our lawsuits are
especially difficult to estimate due to the nature of the claims, limitation of
available data and uncertainty concerning the numerous variables used to
determine likely outcomes or the amounts recorded. Litigation expenses are
recorded as incurred and we do not accrue for future legal fees. It is possible
that an adverse outcome in certain cases or increased litigation costs could
have an adverse effect upon our financial condition, operating results or cash
flows in particular quarterly or annual periods. See "Legal Proceedings."
Other General Matters
Operating Ratios
Three principal operating measures monitored by us in addition to measures
of Membership retention are the Membership benefits ratio, commission ratio and
the general and administrative expense ratio. The Membership benefits ratio, the
commissions ratio and the general and administrative expense ratio represent
those costs as a percentage of Membership fees. We strive to maintain these
ratios as low as possible while at the same time providing adequate incentive
compensation to our sales associates and provider law firms. These ratios do not
measure total profitability because they do not take into account all revenues
and expenses.
Cash Flow Considerations Relating to Sales of Memberships
We generally advance significant commissions at the time a Membership is
sold. Since approximately 95% of Membership fees are collected on a monthly
basis, a significant cash flow deficit is created at the time a Membership is
sold. This deficit is reduced as monthly Membership fees are remitted and no
additional commissions are paid on the Membership until all previous unearned
advance commission balances have been fully recovered. Since the cash advanced
at the time of sale of a new Membership may be recovered over a multi-year
period, cash flow from operations may be adversely affected depending on the
number of new Memberships written in relation to the existing active base of
Memberships and the composition of new or existing sales associates producing
such Memberships.
Investment Policy
Our investment policy is to some degree controlled by certain insurance
regulations, which, coupled with management's own investment philosophy, results
in a conservative investment portfolio that is not risk oriented. Our
investments consist of common stocks, investment grade (rated Baa or higher)
preferred stocks and investment grade bonds primarily issued by corporations,
the United States Treasury, federal agencies, federally sponsored agencies and
enterprises, as well as mortgage-backed securities and state and municipal
tax-exempt bonds, auction rate securities and EURO deposits. We are required to
pledge investments to various state insurance departments as a condition to
obtaining authority to do business in certain states.
New Accounting Standards Issued
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("Interpretation No. 48"). Interpretation No. 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS No. 109, "Accounting
for Income Taxes." Interpretation No. 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. Interpretation No.
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. For us,
Interpretation No. 48 was effective beginning January 1, 2007, and the
cumulative effect adjustment, if any, will be recorded in the first quarter of
2007. We are currently evaluating the impact of the adoption of Interpretation
No. 48 and have not yet determined the effect on our consolidated financial
statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
clarifies how to measure fair value as permitted under other accounting
pronouncements but does not require any new fair value measurements. However,
for some entities, the application of this statement will change current
practice. We will be required to adopt SFAS No. 157 as of January 1, 2008 and
are currently evaluating the impact of SFAS No. 157 and have not yet determined
the effect on our earnings or financial position.
In September 2006, the Securities and Exchange Commission staff published
Staff Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements." SAB No. 108 addresses quantifying the financial statement effects
of misstatements, specifically, how the effects of prior year uncorrected errors
must be considered in quantifying misstatements in the current year financial
statements. SAB No. 108 is effective for fiscal years ending after November 15,
2006. The adoption of SAB No. 108 by us in the fourth quarter of 2006 did not
have a material impact on our consolidated financial statements.
In March 2006, the FASB Emerging Issues Task Force issued Issue 06-3, How
Sales Taxes Collected From Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement ("EITF 06-3"). A tentative consensus
was reached that a company should disclose its accounting policy (i.e., gross or
net presentation) regarding presentation of taxes within the scope of EITF 06-3.
If taxes are significant, a company should disclose the amount of such taxes for
each period for which an income statement is presented. The guidance is
effective for periods beginning after December 15, 2006. We are currently
evaluating the impact of adopting EITF 06-3 on our consolidated financial
statement disclosure.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities---Including an amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS 159 is effective
for us January 1, 2008. We are evaluating the impact that the adoption of SFAS
No. 159 will have on our consolidated financial statements.
Measures of Member Retention
One of the major factors affecting our profitability and cash flow is our
ability to retain a Membership, and therefore continue to receive fees, once it
has been sold. We monitor our overall Membership persistency rate, as well as
the retention rates with respect to Memberships sold by individual associates
and agents and retention rates with respect to Memberships by year of issue,
geographic region, utilization characteristics and payment method, and other sub
groupings.
Terminology
The following terms are used in describing the various measures of
retention:
o Membership life is a period that commences on the day of initial
enrollment of a member and continues until the individual's Membership
eventually terminates or lapses (the terms terminate or lapse may be used
interchangeably here).
o Membership age means the time since the Membership has been in effect.
o Lapse rate means the percentage of Memberships of a specified group of
Memberships that lapse in a specified time period.
o Retention rate is the complement of a lapse rate, and means the
percentage of Memberships of a specified group that remain in force at the end
of a specified time period.
o Persistency and retention are used in a general context to mean the
tendency for Memberships to continue to remain in force, while the term
persistency rate is a specific measure that is defined below.
o Lapse rates, retention rates, persistency rates, and expected Membership
life may be referred to as measures of Membership retention.
o Expected Membership life means the average number of years a new
Membership is expected to remain in force.
o Blended rate when used in reference to any measure of member retention
means a rate computed across a mix of Memberships of various Membership ages.
o Expected remaining Membership life means the number of additional years
that an existing member is expected to continue to renew from a specific point
in time based on the Membership life.
Variations in Membership Retention by Sub-Groups, Impact on Aggregate
Numbers
Company wide measures of Membership retention include data relating to
members who can potentially be further sorted by identifiable sub-groupings. For
example, Memberships may be subdivided into those owned by members who are or
are not sales associates, to those who are or are not members of group plans,
etc.
Measures of Membership retention of different sub-groups may vary. For
example, our experience indicates that first year retention rate of Memberships
owned by members who have accessed the services of the provider law firms
historically have higher retention rates than those who have not. They also
likely have a better understanding and appreciation of the benefits of the
Membership, which may have contributed in fact to their decision to keep their
Membership active.
All aggregate measures of Membership retention or expected life may be
impacted by shifts in the underlying enrollment mix of sub-groups that have
different retention rates. A shift in mix alone could, over time, cause an
increase in reported aggregate retention measures and expected member life, even
if the retention rates within each sub-group do not change. It is important to
note that all blended rates discussed here may reflect the impact of such shifts
in enrollment mixes. At December 31, 2006, 395,068 of the active 1,538,740
Memberships were also vested associates which represent 26% of the total active
Memberships compared to 27% at December 31, 2005 and 21% at December 31, 2004.
The following table shows total new Memberships sold during each year and the
number and percentage of Memberships sold to persons who are associates.
Total New Associate
Year Memberships Memberships Ratio
------- ----------- ----------- --------
2002 773,767 119,326 15.4%
2003 671,857 86,406 12.9%
2004 624,525 89,230 14.3%
2005 700,727 220,290 31.4%
2006 612,726 134,789 22.0%
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, we have observed that Memberships in their first year have a
significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 49.4% of all new Memberships lapse during the first year, leaving 50.6%
still in force at the end of the first year. More tenured Memberships have
significantly lower lapse rates. For example, by year seven lapse rates are
under 10% and annual retention exceeds 90%. The following table shows as of
December 31, 2006 and 2005 our blended retention rate and lapse rates based on
our historical experience for the last 25 years.
Membership Retention versus Membership Age
-----------------------------------------------------------------------------------------
As of December 31, 2006 As of December 31, 2005
------------------------------------- -----------------------------------
Yearly Yearly
Lapse Yearly End of Year Membership Year Lapse Yearly End of Year
Rate Retention Memberships Rate Retention Memberships
---------- ------------ ------------- --------------- ---------- ------------ -----------
100.0 0 100.0
49.4% 50.6% 50.6 1 49.1% 50.9% 50.9
31.6% 68.4% 34.6 2 31.8% 68.2% 34.7
23.4% 76.6% 26.5 3 23.3% 76.7% 26.6
18.3% 81.7% 21.7 4 16.5% 83.5% 22.2
13.0% 87.0% 18.8 5 12.2% 87.8% 19.5
10.1% 89.9% 16.9 6 10.3% 89.7% 17.5
7.9% 92.1% 15.6 7 9.1% 90.9% 15.9
Membership Persistency
Our Membership persistency rate is a specific computation that measures the
number of Memberships in force at the end of a year as a percentage of the total
of (i) Memberships in force at the beginning of such year, plus (ii) new
Memberships sold during such year. From 1981 through the year ended December 31,
2006, our annual Membership persistency rates, using the foregoing method, have
averaged approximately 71.7%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
-------- --------------- --------------- ------------- ---------------- ----------------
2002 1,242,908 773,767 2,016,675 1,382,306 68.5%
2003 1,382,306 671,857 2,054,163 1,418,997 69.1%
2004 1,418,997 624,525 2,043,522 1,451,700 71.0%
2005 1,451,700 700,727 2,152,427 1,542,789 71.7%
2006 1,542,789 612,726 2,155,515 1,538,740 71.4%
Our overall Membership persistency rate varies based on, among other
factors, the relative age of total Memberships in force, and shifts in the mix
of members enrolled. Our overall Membership persistency rate could become lower
when the Memberships in force include a higher proportion of newer Memberships,
as will happen following periods of rapid growth. Our overall Membership
persistency rate could also become lower when the new enrollments include a
higher proportion of non-associate members.
Unless offset by other factors, these factors could result in a decline in
our overall Membership persistency rate as determined by the formula described
above, but does not necessarily indicate that the new Memberships written are
less persistent.
Expected Membership Life
Using historical data through 2006 for all past Members enrolled, the
expected Membership life can be computed to be approximately three years. This
number represents the average number of years a new Membership can be expected
to remain in force. Although about half of all new Memberships may lapse in the
first year, the expected Membership life is much longer due to the contribution
of higher annual retention rates in subsequent years.
Since our experience is that the retention rate of a given generation of
new Memberships improves with Membership age, the expected remaining Membership
life of a Membership also increases with Membership age. For example, while a
new Membership may have an expected Membership life of three years, the expected
remaining Membership life of a Membership that reaches its first year
anniversary is more than 4.5 years.
Since the actual population of Memberships in force at any time is a
distribution of ages from zero to more than 20 years, the expected remaining
Membership life of the entire population at large greatly exceeds three years
per Membership. As of December 31, 2006, based on the historical data described
above, the current expected remaining Membership life of the actual population
is over eight years per Membership. This measure is used by us to estimate the
future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 25 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
Actions that May Impact Retention in the Future
The potential impact on our future profitability and cash flow due to
future changes in Membership retention can be significant. While blended
retention rates have not changed dramatically over the past five years, we have
implemented several initiatives aimed at improving the retention rate of both
new and existing Memberships. Such initiatives include an optional revised
compensation structure featuring variable renewal commission rates ranging from
five to 25% per annum based on the 12 month Membership retention rate of the
associate's personal sales and those of his organization and implementation of a
"non-taken" administrative fee to sales associates of $35 for any Membership
application that is processed but for which a payment is never received. We have
designed and implemented an enhanced member "life cycle" communication process
aimed at both increasing the overall amount of communication from us to the
members as well as more specific target messaging to members based on the length
of their Membership as well as utilization characteristics.
During 2006, we began providing an additional service focused on Membership
retention, Member Advantage Services, to our associates for a one time fee of
$5.95 per Membership. This service consists of several out-bound calls, emails
and letters by our employees during the first year of the Membership as well as
out-bound calls to the member any time the Membership moves into pre-cancel
status throughout the life of the Membership. We verify the Membership data in
our files on the very first call and make any necessary changes immediately as
well as fully explain the Membership benefits and answer any questions the
member may have, essentially reselling the Membership. We provide Provider law
firm contact information and make sure the member understands how to contact
their Provider. We encourage our members to immediately begin the process of
having their will prepared and also help the member begin the credit monitoring
process for Identity Theft Shield members. We believe that such efforts may
ultimately increase the utilization by members and therefore lead to higher
retention rates. However, the effects of these efforts through 2006 on improving
retention have not been meaningful. We intend to continue to develop programs
and initiatives designed to improve retention.
Results of Operations
Comparison of 2006 to 2005
Net income for 2006 increased 45% to $51.8 million from $35.8 million for
2005. Diluted earnings per share for 2006 increased 53% to $3.51 per share from
$2.29 per share for the prior year due to increased net income of 45% and an
approximate 6% decrease in the weighted average number of outstanding shares.
Membership revenues for 2006 were up 6% to $412.2 million from $389.3 million
for the prior year marking the fourteenth consecutive year of increased
Membership revenue.
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period. The active Memberships in force are determined by both the number of new
Memberships sold in any period together with the renewal rate of existing
Memberships. New Membership sales decreased 13% during 2006 to 612,726 from
700,727 during 2005. At December 31, 2006, there were 1,538,740 active
Memberships in force compared to 1,542,789 at December 31, 2005, a decrease of
less than 1%. Additionally, the average annual fee per Membership has increased
from $287 for all Memberships in force at December 31, 2005 to $293 for all
Memberships in force at December 31, 2006, a 2% increase, primarily as a result
of increased sales of our Identity Theft Shield Membership during year 2006.
Associate services revenue decreased 7% from $29.0 million for 2005 to
$26.9 million during 2006 primarily as a result of fewer associates recruited.
The eService fees totaled $12.8 million during 2006 compared to $10.8 million
for 2005, an increase of 18%. We recognized revenue from associate fees of
approximately $10.6 million during 2006 compared to $13.9 million during 2005, a
decrease of 24%. New associates typically pay a fee ranging from $49 to $249,
depending on special promotions we implement from time to time. Although the new
enrollments of sales associates decreased 29% during 2006 to 172,999 from
242,223 for 2005, the average associate fee paid during 2006 was $49.69 compared
to $56.61 for 2005, a decrease of 12%. Future revenues from associate services
will depend primarily on the number of new associates enrolled, the price
charged for new associates and the number who choose to participate in our
eService program, but we expect that such revenues will continue to be largely
offset by the direct and indirect cost to us of training, providing associate
services and other direct marketing expenses.
Other revenue decreased 4%, from $5.2 million to $5.0 million primarily due
to the decrease in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $444.0 million for 2006 from $423.4 million during 2005, an
increase of 5%.
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $145.8 million for 2006 compared to $137.2 million for
2005 and represented 35% of Membership fees for both years. This Membership
benefits ratio (Membership benefits as a percentage of Membership fees) should
remain near current levels as substantially all active Memberships provide for a
capitated benefit in the absence of any changes in the capitated benefit level,
which has not changed significantly since 1993. However, since the benefit ratio
of the IDT Memberships is higher than the legal Memberships, we expect the
benefits ratio to increase above 35% if we continue to increase the IDT
Membership base and revenues.
Commissions to associates decreased 10% from $141.6 million for 2005 to
$126.8 million for 2006, and represented 36% and 31% of Membership fees for such
years. Commissions to associates are primarily dependent on the number of new
Memberships sold during a period and the average fee of those Memberships. New
Memberships sold during 2006 totaled 612,726, a 13% decrease from the 700,727
sold during 2005, and the "add-on" IDT Membership sales which are not included
in these totals decreased 12% to 389,157 for 2006 from 441,108 for 2005. Our
average Annual Membership fee written during 2006 increased 2% to $328.36 from
$322.04 for 2005. The decrease in the number of new Memberships sold during 2006
was more than offset by the increase in the average Annual Membership fee and
resulted in a 6% increase in the Membership Fees written.
Associate services and direct marketing expenses decreased to $29.5 million
for 2006 from $30.5 million for 2005. Training fees and bonuses incurred were
approximately $4.2 million during 2006 compared to $4.8 million in 2005. We also
had a $1.2 million decrease in Players Club costs, a $770,000 decrease in new
associate fulfillment costs and a $1.5 million decrease in the cost of supplies.
These decreases were partially offset by the $3.5 million increase in direct
marketing and marketing services costs. Training fees and bonuses are affected
by the number of new sales associates that successfully meet the qualification
criteria established by us, i.e. more training bonuses will be paid when a
higher number of new sales associates meet such criteria. These expenses include
the costs of providing associate services and marketing expenses as discussed
under Member and Associate Costs.
General and administrative expenses during 2006 and 2005 were $50.1 million
and $49.0 million, respectively, and represented 12.1% and 12.6%, respectively,
of Membership fees for such years. Increases in the 2006 period were
attributable primarily to higher employee costs.
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, increased 17% to $12.2 million for 2006 from $10.5 million for 2005.
Depreciation and amortization increased to $8.3 million for 2006 from $7.5
million for 2005. Litigation accruals have been reduced $710,000 and $303,000
during 2006 and 2005, respectively. Premium taxes decreased from $2.1 million
for 2005 to $1.8 million for 2006 due to certain premiums no longer being
subject to premium taxes. Interest expense increased to $5.7 million for 2006
compared to $2.7 million for the prior year. Interest income increased to $2.9
million for 2006 from $1.5 million for 2005.
The provision for income taxes increased during 2006 to $27.9 million
compared to $18.9 million for 2005, representing 35.0% and 34.5%, respectively,
of income before income taxes.
Comparison of 2005 to 2004
Net income for 2005 decreased 12% to $35.8 million from $40.8 million for
2004. Diluted earnings per share for 2005 decreased 8% to $2.29 per share from
$2.48 per share for the prior year due to decreased net income of 12% and an
approximate 5% decrease in the weighted average number of outstanding shares.
Membership revenues for 2005 were up 10% to $389.3 million from $355.5 million
for the prior year marking the thirteenth consecutive year of increased
Membership revenue.
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period. The active Memberships in force are determined by both the number of new
Memberships sold in any period together with the renewal rate of existing
Memberships. New Membership sales increased 12% during 2005 to 700,727 from
624,525 during 2004. At December 31, 2005, there were 1,542,789 active
Memberships in force compared to 1,451,700 at December 31, 2004, an increase of
6%. Additionally, the average annual fee per Membership has increased from $274
for all Memberships in force at December 31, 2004 to $287 for all Memberships in
force at December 31, 2005, a 5% increase, primarily as a result of increased
sales of our Identity Theft Shield Membership during year 2005.
Associate services revenue increased 16% from $24.9 million for 2004 to
$29.0 million during 2005 primarily as a result of more associates enrolling in
the eService program. The eService fees totaled $10.8 million during 2005
compared to $7.6 million for 2004, an increase of 42%. We recognized revenue
from associate fees of approximately $13.9 million during 2005 compared to $14.6
million during 2004, a decrease of 5%. New associates typically pay a fee
ranging from $49 to $249, depending on special promotions we implement from time
to time. Although the new enrollments of sales associates increased 125% during
2005 to 242,223 from 107,552 for 2004, the average associate fee paid during
2005 was $56.61 compared to $142.49 for 2004, a decrease of 60%.
Other revenue decreased 7%, from $5.6 million to $5.2 million primarily due
to the decrease in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $423.4 million for 2005 from $385.9 million during 2004, an
increase of 10%.
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $137.2 million for 2005 compared to $122.3 million for
2004, and represented 35% of Membership fees for 2005 and 34% for 2004.
Commissions to associates increased 19% from $118.8 million for 2004 to
$141.6 million for 2005, and represented 33% and 36% of Membership fees for such
years. Commissions to associates are primarily dependent on the number of new
Memberships sold during a period and the average fee of those Memberships. New
Memberships sold during 2005 totaled 700,727, a 12% increase from the 624,525
sold during 2004, but the "add-on" IDT Membership sales are not included in
these totals and have increased 31% to 441,108 for 2005 from 335,792 for 2004
which increased our average Annual Membership fee 6% to $322.04 for 2005 from
$303.36 for 2004. The increase in the number of new Memberships sold with an
increase in the average Annual Membership fee resulted in a 19% increase in the
Membership Fees written.
Associate services and direct marketing expenses increased to $30.5 million
for 2005 from $29.3 million for 2004. Fast Start training fees and bonuses
incurred were approximately $4.8 million during 2005 compared to $3.7 million in
2004. This $1.1 million increase in Fast Start training fees and bonuses, a $1.5
million increase in the cost of new Associate kits, a $1.4 million increase in
direct marketing and marketing services costs, and a $150,000 increase in
Players Club and supply costs was partially offset by a $1.0 million decrease in
promotional bonuses and management team overrides and a $2.0 million decrease in
amortization of deferred associate cost and other costs. The Fast Start training
fees and bonuses are affected by the number of new sales associates that attend
Fast Start class and successfully meet the qualification criteria established by
us, i.e. more training bonuses will be paid when a higher number of new sales
associates meet such criteria. These expenses include the costs of providing
associate services and marketing expenses as discussed under Member and
Associate Costs.
General and administrative expenses during 2005 and 2004 were $49.0 million
and $43.7 million, respectively, and represented 12.6% and 12.3%, respectively,
of Membership fees for such years. Increases in the 2005 period were
attributable primarily to increases in printing and fulfillment costs associated
with our new Membership kit, higher employee costs, bank services charges and
Sarbanes Oxley compliance costs.
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, increased 9% to $10.5 million for 2005 from $9.6 million for 2004.
Depreciation and amortization decreased to $7.5 million for 2005 from $7.7
million for 2004. Litigation accruals have been reduced $303,000 and $121,000
during 2005 and 2004, respectively. Premium taxes increased from $1.7 million
for 2004 to $2.1 million for 2005 due to increased revenues in the states in
which we pay premium taxes. Interest expense increased to $2.7 million for 2005
compared to $2.0 million for the prior year. Interest income decreased to $1.5
million for 2005 from $1.7 million for 2004.
The provision for income taxes decreased during 2005 to $18.9 million
compared to $21.5 million for 2004, representing 34.5% of income before income
taxes for both years.
Liquidity and Capital Resources
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees collected and their contribution to cash flow
from operations during any period. Cash receipts from associate services are
directly impacted by the number of new sales associates enrolled and the price
of entry during the period, the number of associates subscribing to our eService
offering and the amount of sales tools purchased by the sales force.
The cash outlay related to Membership benefits is directly impacted by the
number of active Memberships and the contractual rate that exists between us and
our benefits providers. Commissions paid to associates are primarily dependent
on the number and price of new Memberships sold during a period and any special
incentives that may be in place during the period. Cash requirements related to
associate services and direct marketing activities are directly impacted by the
number of new associates enrolled during a period due to the cost of materials
provided to such new associates, the number of associates subscribing to our
eService offering, the amount of sales tools purchased by the sales force as
well as the number of those associates who successfully meet the CFT training
and incentive award program qualifications.
Membership revenues are more than sufficient to fund the cash requirements
for membership benefits (at approximately 34%-35% of Membership revenues),
commissions (ranging from 31% to 39% of Membership revenues) and general and
administrative expense (at approximately 12% of Membership revenues). We have
generated significant cash flow from operations before changes in assets and
liabilities of approximately $61 million, $45 million and $52 million in 2006,
2005 and 2004, respectively. As discussed below, we have used a significant
portion of our cash flow to repurchase shares of our stock in the open market.
Cash flow from operations could be reduced if we experienced significant growth
in new members because of the negative cash flow characteristics of our
commission advance policies discussed above.
As a result of our ability to generate cash flow from operations, including
in periods of Membership growth, we have not historically been dependent on, and
do not expect to need in the future, external sources of financing from the sale
of securities or from bank borrowings to fund our basic business operations.
However, as described below, during the last three years, we incurred debt for
limited and specific purposes to permit us to construct a new corporate
headquarters, purchase equipment and to accelerate our treasury stock purchase
program.
General
Consolidated net cash provided by operating activities before changes in
assets and liabilities was $60.8 million, $45.4 million and $51.7 million for
2006, 2005 and 2004, respectively. Consolidated net cash provided by operating
activities was $54.4 million, $50.1 million and $47.3 million for 2006, 2005 and
2004, respectively. Cash provided by operating activities increased $4.3 million
during 2006 compared to 2005 primarily due to a $16.0 million increase in net
income partially offset by the $8.8 million change in accounts payable and
accrued expenses and the $3.0 million change in deferred revenue and fees.
Net cash used in investing activities was $52.6 million, $15.5 million and
$11.3 million for 2006, 2005 and 2004, respectively. In addition to capital
expenditures of $9.0 million, $14.8 million and $10.9 million during 2006, 2005
and 2004, respectively, our purchases of available-for-sale investments exceeded
the maturities and sales of such investments by $43.7 million, $767,000 and
$443,000 in 2006, 2005 and 2004, respectively.
Net cash used in financing activities was $23.7 million, $26.6 million and
$31.4 million for 2006, 2005 and 2004, respectively. This $2.9 million change
during 2006 was primarily comprised of a $71.2 million increase in proceeds from
issuance of debt and a $7.8 million decrease in dividends paid partially offset
by the $61.8 million increase in purchases of treasury stock, an $11.1 million
increase in repayment of debt and a $4.0 million decrease in proceeds from sale
of common stock on exercise of options.
We had a consolidated working capital surplus of $17.9 million at December
31, 2006, an increase of $21.0 million compared to a consolidated working
capital deficit of $3.1 million at December 31, 2005. The increase was primarily
due to the $35.5 million increase in current available-for-sale investments
(representing in substantial part temporary investments of unexpended proceeds
from our Wells Fargo loan described below), the $5.5 million decrease in
accounts payable and accrued expenses and the $4.6 million decrease in dividends
payable partially offset by the $21.9 million decrease in cash and cash
equivalents and the $3.2 million increase in the current portion of notes
payable. The $17.9 million working capital surplus at December 31, 2006 would
have been $28.0 million in excess working capital excluding the $10.2 million of
current portion of deferred revenue and fees in excess of the current portion of
deferred member and associate service costs. These amounts will be eliminated by
the passage of time without the utilization of other current assets or us
incurring other current liabilities. Additionally, at the current rate of cash
flow provided by operations ($54.4 million during 2006), we do not expect any
difficulty in meeting our financial obligations in the short term or the long
term.
We generally advance significant commissions to associates at the time a
Membership is sold. We expense these advances ratably over the first month of
the related Membership. During 2006, we paid advance commissions to associates
of $121.7 million on new Membership sales compared to $142.5 million for 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. See Commissions to Associates above
for additional information on advance commissions.
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 12
million shares during subsequent board meetings. At December 31, 2006, we had
purchased 11.4 million treasury shares under these authorizations for $296.0
million, an average price of $26.02 per share, including $73.4 million of
purchases in 2006. Treasury stock purchases will be made at prices that are
considered attractive by management and at such times that management believes
will not unduly impact our liquidity, however, due to restrictions contained in
our debt agreements with lenders, we are limited in our treasury stock
purchases. At December 31, 2006, we had approximately $32 million availability
under existing bank covenant restrictions to purchase additional treasury
shares. No time limit has been set for completion of the treasury stock purchase
program. Given the current interest rate environment, the nature of other
investments available and our expected cash flows, management believes that
purchasing treasury shares enhances shareholder value. We expect to continue our
treasury stock program. From time to time, we evaluate alternative sources of
financing to continue or accelerate this program.
We believe that we have significant ability to finance expected future
growth in Membership sales based on our existing amount of cash and cash
equivalents and unpledged investments at December 31, 2006 of $81.8 million. We
expect to maintain cash and cash equivalents and investment balances on an
on-going basis of approximately $20 million to $30 million in order to meet
expected working capital needs and regulatory capital requirements. Balances in
excess of this amount would be used for discretionary purposes such as treasury
stock purchases, dividends, and advance repayment of debt subject to the
restrictions contained in our debt agreements.
As more fully discussed in Item 2 - Description of Property, we completed a
new office complex during 2004 containing approximately 170,000 square feet of
office space constructed on approximately 87 acres contributed to us by the City
of Ada in 2001 as part of an economic development incentive package. Costs
incurred of approximately $34.1 million, including $706,000 in capitalized
interest costs, have been paid from existing resources and proceeds from a $20
million line of credit for the new office construction.
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"). At December 31,
2006, we have the full Revolving Facility available to us. After payment of an
origination fee of 1%, lender costs and retirement of $15.3 million of existing
bank indebtedness, the net proceeds of the Term Facility we received were $58.8
million. During the six months ended December 31, 2006, we used a portion of the
net proceeds to purchase 888,761 shares of treasury stock at a cost of $35.9
million, or an average price of $40.34 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 December 31, 2006 was 7.85%. 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:
* a 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;
* a 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;
* a requirement to maintain consolidated EBITDA for the twelve month
period ending December 31, 2006 and each quarter thereafter of at
least $80 million ($75 million for us and our top tier direct
subsidiaries);
* a 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;
* a requirement to maintain at least 1.3 million members; and
* a 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 December 31, 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 December 31, 2006 was 7.60%. 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,
2012. The interest rate at December 31, 2006 was 7.10%. The loan is
collateralized by the aircraft purchased. In addition to customary events of
default, if Harland C. Stonecipher ceases to be our Chief Executive Officer for
a period of 90 consecutive days an event of default will occur.
Parent Company Funding and Dividends
Although we are the operating entity in many jurisdictions, our
subsidiaries serve as operating companies in various states that regulate
Memberships as insurance or specialized legal expense products. The most
significant of these wholly owned subsidiaries are PPLCI, PPLSIF and LSPV. The
ability of these subsidiaries to provide funds to us is subject to a number of
restrictions under various insurance laws in the jurisdictions in which they
conduct business, including limitations on the amount of dividends and
management fees that may be paid and requirements to maintain specified levels
of capital and reserves. In addition PPLCI will be required to maintain its
stockholders' equity at levels sufficient to satisfy various state or provincial
regulatory requirements, the most restrictive of which is currently $3 million.
Additional capital requirements of PPLCI, PPLSIF or LSPV, or any of our
regulated subsidiaries, will be funded by us in the form of capital
contributions or surplus debentures. During February 2004, we made a capital
contribution to a wholly-owned subsidiary of PPLCI, Pre-Paid Legal Services of
Tennessee, Inc. in the amount of $600,000. At January 1, 2007, neither PPLCI nor
PPLSIF had funds available for payment of substantial dividends without the
prior approval of the insurance commissioner. While PPLCI had surplus funds
available for payment of an ordinary dividend, no such dividend was declared or
paid during 2004. At January 1, 2007 LSPV had approximately $1.6 million
available for payment of an ordinary dividend. At December 31, 2006 the amount
of restricted net assets of consolidated subsidiaries was $22.6 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Contractual Obligations
The following table reflects our contractual obligations as of December
31, 2006.
Payments Due by Period (In Thousands)
-------------------------------------------------------------
More
Less than than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
-------------------------------------------------- ----------- ----------- ---------- ---------- ----------
Long-term debt.................................... $ 91,970 $ 18,437 $ 36,874 $ 32,148 $ 4,511
Purchase obligations (1).......................... 22,774 5,815 5,864 897 198
Capital leases.................................... 2,231 420 162 162 1,487
Deferred compensation plan........................ 5,207 - - - 5,207
Operating leases.................................. 576 144 142 60 230
----------- ----------- ---------- ---------- ----------
Total (2)......................................... $ 112,758 $ 24,816 $ 43,042 $ 33,267 $ 11,633
----------- ----------- ---------- ---------- ----------
(1) Includes contractual commitments pursuant to executory contracts for
products and services such as voice and data services and contractual
obligations related to future Company events such as hotel room blocks,
meeting space and food and beverage guarantees. We expect to receive
proceeds from such future events and reimbursement from provider law firms
for certain voice and data services that will partially offset these
obligations.
(2) Does not include commitments for attorney provider payments, commissions,
etc. which are expected to remain in existence for several years but as to
which our obligations vary directly either based on Membership revenues or
new Memberships sold and are not readily estimable.
Forward-Looking Statements
All statements in this report other than purely historical information,
including but not limited to, statements relating to our future plans and
objectives, expected operating results and the assumptions on which such
forward-looking statements are based, constitute "Forward-Looking Statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 and are based on our historical operating
trends and financial condition as of December 31, 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 below. Moreover, we may
make acquisitions or dispositions of assets or businesses, enter into new
marketing arrangements or enter into financing transactions. None of these can
be predicted with certainty and, accordingly, are not taken into consideration
in any of the Forward-Looking Statements made herein. For all of the foregoing
reasons, actual results may vary materially from the Forward-Looking Statements.
We assume no obligation to update the Forward-Looking Statements to reflect
events or circumstances occurring after the date of the statement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
-------------------------------------------------------------------------
Disclosures About Market Risk
Our consolidated balance sheets include a certain amount of assets and
liabilities whose fair values are subject to market risk. Due to our significant
investment in fixed-maturity investments, interest rate risk represents the
largest market risk factor affecting our consolidated financial position.
Increases and decreases in prevailing interest rates generally translate into
decreases and increases in fair values of those instruments. Additionally, fair
values of interest rate sensitive instruments may be affected by the
credit worthiness of the issuer, prepayment options, relative values of
alternative investments, liquidity of the instrument and other general market
conditions.
As of December 31, 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,
auction rate securities and EURO deposits. We do not hold any investments
classified as trading account assets or derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on our fixed-maturity investment portfolio. It
is assumed that the changes occur immediately and uniformly, with no effect
given to any steps that management might take to counteract that change.
The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table:
Hypothetical change Estimated fair
interest rate after hypothetical
Fair value (bp = basis points) change in interest rate
----------- --------------------- -----------------------
(Dollars in thousands)
Fixed-maturity investments at December 31, 2006 (1).... $ 31,420 100 bp increase $ 30,170
200 bp increase 28,975
50 bp decrease 31,965
100 bp decrease 32,568
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 $42.4 million
(Certificates of deposit, auction rate securities and EURO deposits) and
$2.6 million at December 31, 2006 and 2005, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2006 would reduce
the estimated fair value of our fixed-maturity investments by approximately
$2.4 million at that date. At December 31, 2005, and based on the fair
value of fixed-maturity investments of $27.5 million, an instantaneous 200
basis point increase in market interest rates would have reduced the
estimated fair value of our fixed-maturity investments by approximately
$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
December 31, 2006, we had $92.0 million in notes payable outstanding at interest
rates indexed to the 30 day LIBOR rate that exposes it to the risk of increased
interest costs if interest rates rise. Assuming a 100 basis point increase in
interest rates on the floating rate debt, interest expense would increase by
approximately $920,000. As of December 31, 2006, we had not entered into any
interest rate swap agreements with respect to the term loans.
Foreign Currency Exchange Rate Risk
Although we are exposed to foreign currency exchange rate risk inherent in
revenues, net income and assets and liabilities denominated in Canadian dollars,
the potential change in foreign currency exchange rates is not a substantial
risk, as less than 2% of our revenues are derived outside of the United States.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
----------------------------------------------------------
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm
Management's Annual Report on Internal Control over Financial Reporting
Consolidated Financial Statements
---------------------------------
Consolidated Balance Sheets - December 31, 2006 and 2005
Consolidated Statements of Income - For the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows - For the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
Financial Statement Schedules
-----------------------------
Schedule I - Condensed Financial Information of the Registrant
(All other schedules have been omitted since the required information is
not applicable or because the information is included in the
consolidated financial statements or the notes thereon.)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control over Financial Reporting, that
Pre-Paid Legal Services, Inc. and subsidiaries (the "Company") maintained
effective internal control over financial reporting as of December 31, 2006
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO"). Management of the Company is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management's assessment and an opinion on the
effectiveness of the Company's internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on criteria established in Internal
Control--Integrated Framework issued by COSO. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal
Control--Integrated Framework issued by COSO.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
the Company as of December 31, 2006 and 2005, and the related statements of
income, cash flows and changes in stockholders' equity for each of the three
years in the period ended December 31, 2006 and our report dated February 27,
2007 expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. and subsidiaries (the "Company") as of December 31, 2006 and
2005, and the related consolidated statements of income, cash flows and changes
in stockholders' equity for each of the three years in the period ended December
31, 2006. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 2006 and 2005, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006 in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2006 and 2005 and for each of
the three years in the period ended December 31, 2006. In our opinion, this
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated February 27, 2007 expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company's
internal control over financial reporting.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2007
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. In order to evaluate the
effectiveness of internal control over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act, our management has conducted an
assessment, including testing, using the criteria in Internal Control-Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission ("COSO"). Our system of internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and (iii)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Based on the assessment, our management has concluded that we maintained
effective internal control over financial reporting as of December 31, 2006,
based on criteria in Internal Control-Integrated Framework issued by COSO.
Management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2006, has been audited by Grant Thornton
LLP, an independent registered public accounting firm, as stated in their report
which is included herein.
Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
--------------------------
2006 2005
------------ ------------
Current assets:
Cash and cash equivalents............................................................ $ 12,031 $ 33,957
Available-for-sale investments, at fair value........................................ 42,275 6,742
Membership fees receivable........................................................... 5,518 5,395
Inventories.......................................................................... 1,337 1,717
Refundable income taxes.............................................................. 653 -
Deferred member and associate service costs.......................................... 15,879 16,210
Deferred income taxes................................................................ 4,235 4,894
Other assets......................................................................... 6,404 5,236
------------ ------------
Total current assets............................................................. 88,332 74,151
------------ ------------
Available-for-sale investments, at fair value.......................................... 27,461 19,213
Investments pledged.................................................................... 4,145 4,307
Property and equipment, net............................................................ 59,643 58,947
Deferred member and associate service costs............................................ 2,636 3,003
Other assets........................................................................... 6,330 5,244
------------ ------------
Total assets................................................................... $ 188,547 $ 164,865
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 11,995 $ 11,638
Deferred revenue and fees............................................................ 26,040 26,287
Current portion of capital leases payable............................................ 340 321
Current portion of notes payable..................................................... 18,437 15,250
Common stock dividends payable....................................................... - 4,643
Accounts payable and accrued expenses................................................ 13,645 19,095
------------ ------------
Total current liabilities.......................................................... 70,457 77,234
------------ ------------
Capital leases payable............................................................... 957 1,296
Notes payable........................................................................ 73,533 23,220
Deferred revenue and fees............................................................ 2,636 3,007
Deferred income taxes................................................................ 4,897 4,782
Other non-current liabilities........................................................ 5,207 3,932
------------ ------------
Total liabilities................................................................ 157,687 113,471
------------ ------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 18,488 and
20,326 issued at December 31, 2006 and 2005, respectively.......................... 185 203
Retained earnings.................................................................... 129,413 149,832
Accumulated other comprehensive income............................................... 290 387
Treasury stock, at cost; 4,852 shares held at December 31, 2006
and 2005, respectively............................................................. (99,028) (99,028)
------------ ------------
Total stockholders' equity....................................................... 30,860 51,394
------------ ------------
Total liabilities and stockholders' equity..................................... $ 188,547 $ 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)
Year Ended December 31,
------------------------------------------
2006 2005 2004
-------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 412,200 $ 389,255 $ 355,461
Associate services................................................... 26,857 28,963 24,901
Other................................................................ 4,967 5,162 5,575
-------------- ------------- -------------
444,024 423,380 385,937
-------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 145,771 137,150 122,280
Commissions.......................................................... 126,762 141,631 118,757
Associate services and direct marketing.............................. 29,493 30,453 29,325
General and administrative........................................... 50,078 49,015 43,742
Other, net........................................................... 12,232 10,456 9,578
-------------- ------------- -------------
364,336 368,705 323,682
-------------- ------------- -------------
Income before income taxes............................................. 79,688 54,675 62,255
Provision for income taxes............................................. 27,890 18,863 21,478
-------------- ------------- -------------
Net income............................................................. $ 51,798 $ 35,812 $ 40,777
-------------- ------------- -------------
Basic earnings per common share........................................ $ 3.54 $ 2.31 $ 2.50
-------------- ------------- -------------
Diluted earnings per common share...................................... $ 3.51 $ 2.29 $ 2.48
-------------- ------------- -------------
Dividends declared per common share.................................... $ - $ .60 $ .50
-------------- ------------- -------------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
-----------------------------------
2006 2005 2004
---------- ---------- ----------
Cash flows from operating activities:
Net income....................................................................... $ 51,798 $ 35,812 $ 40,777
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for deferred income taxes............................................ 774 912 2,197
Depreciation and amortization.................................................. 8,260 7,489 7,709
Tax benefit on exercise of stock options....................................... - 1,221 775
Compensation expense relating to contribution of stock to ESOP................. - - 231
---------- ---------- ----------
Cash provided by operating activities before changes in assets and liabilities 60,832 45,434 51,689
Increase in accrued Membership fees receivable................................. (123) (434) (386)
Decrease (increase) decrease in inventories.................................... 380 (94) (766)
(Increase) decrease in refundable income taxes................................. (653) 1,241 (910)
Decrease (increase) in deferred member and associate service costs............. 698 (1,213) (1,410)
Increase in other assets....................................................... (2,254) (2,914) (2,431)
Increase in Membership benefits................................................ 357 1,298 1,051
(Decrease) increase in deferred revenue and fees............................... (618) 2,348 (147)
Increase in other non-current liabilities...................................... 1,275 1,138 1,349
(Decrease) increase in accounts payable and accrued expenses................... (5,509) 3,327 (776)
---------- ---------- ----------
Net cash provided by operating activities.................................... 54,385 50,131 47,263
---------- ---------- ----------
Cash flows from investing activities:
Additions to property and equipment............................................ (8,956) (14,778) (10,879)
Purchases of investments - available-for-sale.................................. (179,799) (18,312) (24,135)
Maturities and sales of investments - available-for-sale....................... 136,142 17,545 23,692
---------- ---------- ----------
Net cash used in investing activities........................................ (52,613) (15,545) (11,322)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt................................................. 85,000 13,829 19,000
Repayments of debt............................................................. (31,500) (20,445) (17,335)
Proceeds from exercise of stock options........................................ 485 4,439 5,176
Tax benefit on exercise of stock options....................................... 703 - -
Purchases of treasury stock.................................................... (73,423) (11,673) (37,461)
Decrease in capital lease obligations.......................................... (320) (339) (808)
Dividends paid................................................................. (4,643) (12,412) -
---------- ---------- ----------
Net cash used in financing activities........................................ (23,698) (26,601) (31,428)
---------- ---------- ----------
Net increase in cash and cash equivalents........................................ (21,926) 7,985 4,513
Cash and cash equivalents at beginning of year................................... 33,957 25,972 21,459
---------- ---------- ----------
Cash and cash equivalents at end of year......................................... $ 12,031 $ 33,957 $ 25,972
---------- ---------- ----------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized.............................. $ 5,540 $ 2,432 $ 1,752
---------- ---------- ----------
Cash paid for income taxes..................................................... $ 28,780 $ 13,350 $ 19,429
---------- ---------- ----------
Non-cash activities - cash dividends declared but not paid..................... $ - $ 4,643 $ 7,796
---------- ---------- ----------
Non-cash activities - capital lease obligations incurred....................... $ - $ - $ 1,058
---------- ---------- ----------
Non-cash activities - asset additions due to trade-in allowance................ $ - $ 426 $ -
---------- ---------- ----------
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.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts and shares in 000's, except dividend rates and par values)
Retained Accum.
Common Stock Earnings OCI(1) Treasury Stock Total
Shares Amount Shares Amount
--------- --------- ----------- -------- --------- ----------- ---------
January 1, 2004............................ 21,674 $ 217 $ 127,576 $ 809 4,852 $(99,028) $29,574
Contributed to Company's ESOP plan....... 10 - 231 - - - 231
Exercise of stock options and other...... 234 2 5,174 - - - 5,176
Income tax benefit related to exercise
of stock options....................... - - 775 - - - 775
Net income............................... - - 40,777 - - - 40,777
Other comprehensive income............... - - - 171 - - 171
Treasury shares purchased................ - - - - 1,453 (37,461) (37,461)
Treasury shares retired.................. (1,453) (14) (37,447) - (1,453) 37,461 -
Common stock dividends incurred.......... - - (7,796) - - - (7,796)
--------- --------- ----------- -------- --------- ----------- ---------
December 31, 2004.......................... 20,465 205 129,290 980 4,852 (99,028) 31,447
Exercise of stock options and other...... 197 1 4,438 - - - 4,439
Income tax benefit related to exercise
of stock options....................... - - 1,221 - - - 1,221
Net income............................... - - 35,812 - - - 35,812
Other comprehensive income............... - - - (593) - - (593)
Treasury shares purchased................ - - - - 336 (11,673) (11,673)
Treasury shares retired.................. (336) (3) (11,670) - (336) 11,673 -
Common stock dividends incurred.......... - - (9,259) - - - (9,259)
--------- --------- ----------- -------- --------- ----------- ---------
December 31, 2005.......................... 20,326 203 149,832 387 4,852 (99,028) 51,394
Exercise of stock options and other...... 121 1 484 - - - 485
Income tax benefit related to exercise
of stock options....................... - - 703 - - - 703
Net income............................... - - 51,798 - - - 51,798
Other comprehensive income............... - - - (97) - - (97)
Treasury shares purchased................ - - - - 1,959 (73,423) (73,423)
Treasury shares retired.................. (1,959) (19) (73,404) - (1,959) 73,423 -
December 31, 2006.......................... --------- --------- ----------- -------- --------- ----------- ---------
18,488 $ 185 $ 129,413 $ 290 4,852 $(99,028) $30,860
--------- --------- ----------- -------- --------- ----------- ---------
(1) Other Comprehensive Income Year Ended December 31,
-----------------------------
2006 2005 2004
-------- -------- --------
Net income.................................................................... $51,798 $35,812 $40,777
Other comprehensive income, net of tax:
Foreign currency translation adjustment..................................... (59) 100 153
-------- -------- --------
Unrealized (losses) gains on investments:
Unrealized holding (losses) gains arising during period................... (14) (871) 116
Less: reclassification adjustment for losses (gains) included in net
income................................................................ (24) 178 (98)
-------- -------- --------
(38) (693) 18
-------- -------- --------
Other comprehensive income, net of income taxes of $(24), $(443) and $12 in
2006, 2005 and 2004, respectively........................................... (97) (593) 171
-------- -------- --------
Comprehensive income.......................................................... $51,701 $35,219 $40,948
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Except for per share amounts, dollar amounts in tables are in thousands
unless otherwise indicated)
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Pre-Paid Legal Services, Inc. (the "Parent") and subsidiaries
(collectively, the "Company") develops and markets legal service plans (referred
to as "Memberships"). The Memberships sold by us allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with us. During the third quarter of 2003, we began offering our
Identity Theft Shield to new and existing members at $9.95 per month if added to
a legal service Membership or it may be purchased separately for $12.95 per
month. The nationwide provider of the Identity Theft Shield benefits and the
Provider law firms are paid a fixed fee on a capitated basis to render services
to plan members residing within the state or province in which the provider law
firm is licensed to practice. Because the fixed fee payments by us to benefit
providers do not vary based on the type and amount of benefits utilized by the
member, this capitated arrangement provides significant advantages to us in
managing claims risk. At December 31, 2006, Memberships subject to the capitated
benefit provider arrangement comprised approximately 99% of our active
Memberships. The remaining Memberships, approximately 1%, were primarily sold
prior to 1987 and allow members to locate their own lawyer to provide legal
services available under the Membership with the member's lawyer being
reimbursed for services rendered based on usual, reasonable and customary fees.
Memberships are generally guaranteed renewable and Membership fees are
principally collected on a monthly basis, although approximately 5% of Members
have elected to pay their fees in advance on an annual or semi-annual basis. At
December 31, 2006, we had 1,538,740 Memberships in force with members in all 50
states, the District of Columbia and the Canadian provinces of Ontario, British
Columbia, Alberta and Manitoba. Approximately 90% of the Memberships were in 29
states and provinces. The Memberships are marketed by an independent sales force
referred to as "associates."
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities.
Principles of Consolidation
The consolidated financial statements include our accounts and our wholly
owned subsidiaries, as well as those of PPL Agency, Inc. (See Note 10 for
additional information regarding PPL Agency, Inc.). Our primary subsidiaries
include Pre-Paid Legal Casualty, Inc. ("PPLCI") and Pre-Paid Legal Services,
Inc. of Florida ("PPLSIF"). All significant intercompany accounts and
transactions have been eliminated.
Foreign Currency Translation
The financial results of our Canadian operations are measured in local
currency and then translated into U.S. dollars. All balance sheet accounts have
been translated using the current rate of exchange at the balance sheet date.
Results of operations have been translated using the average rates prevailing
throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash, certificates of
deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by us, using
available market information and appropriate valuation methodologies. The
carrying value of cash, certificates of deposit, Membership fees receivable,
Membership benefits payable and accounts payable and accrued expenses are
considered to be representative of their respective fair value, due to the short
term nature of these instruments. The carrying value of notes payable is
considered to be representative of their respective fair value, due to the
variable interest rate feature of such notes. The fair value disclosures
relating to debt and equity securities are presented in Note 2.
Cash and Cash Equivalents
We consider all highly liquid unpledged investments with maturities of
three months or less at time of acquisition to be cash equivalents. We place our
temporary cash investments with high credit quality financial institutions. At
times such investments may be in excess of the Federal Deposit Insurance
Corporation (FDIC) insurance limit. We have not experienced any losses in such
accounts and believe we are not exposed to any significant credit risk on cash
and cash equivalents.
Investments
We classify our investments held as available-for-sale and account for them
at fair value with unrealized gains and losses, net of taxes, excluded from
earnings and reported as other comprehensive income. We classify
available-for-sale securities as current if we expect to sell the securities
within one year, or if we intend to utilize the securities for current
operations. All other available-for-sale securities are classified as
non-current.
All investment securities are adjusted for amortization of premiums and
accretion of discounts. Amortization of premiums and accretion of discounts are
recorded to income over the contractual maturity or estimated life of the
individual investment on the level yield method. Gain or loss on sale of
investments is based upon the specific identification method. Income earned on
our investments in certain state and political subdivision debt instruments is
not generally taxable for federal income tax purposes.
Membership fees receivable
Our Membership fees receivable consists of amounts due from members for
services provided pursuant to their Membership contract. Membership fees are
principally collected on a monthly basis. Membership fees receivable is a result
of a portion of members, mostly group members, who pay their Membership fees in
arrears and are recorded at amounts due under the terms of the Membership
agreement. An allowance for doubtful accounts is not necessary as the recorded
amount is adjusted to net realizable value at period-end based on our historical
experience and the short period of time after period-end in which the accounts
will be collected.
Inventories
Inventories include the cost of materials and packaging and are stated at
the lower of cost or market.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and
amortization. Depreciation of property and equipment is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the estimated useful lives of the related assets
or the period of the lease, whichever is shorter. Maintenance and repairs are
expensed as incurred and renewals and betterments are capitalized. Interest cost
incurred during the construction period of major facilities is capitalized. The
capitalized interest is recognized as part of the asset to which it relates and
is amortized over the asset's estimated useful life.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
basis. Approximately 95% of members remit their Membership fees on a monthly
basis. Approximately 75% of our Membership fees are paid in advance and,
therefore, are deferred and recognized over their respective periods.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs of $10 for 2006 are deferred and recognized in income over the
estimated life of a Membership in accordance with SEC Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," ("SAB 101"). We compute
the expected Membership life using more than 20 years of actuarial data. At
December 31, 2006, we computed the expected Membership life to be approximately
three years. If the expected Membership life were to change significantly, which
management does not expect in the short term, the deferred Membership enrollment
fee and related costs would be recognized over a longer or shorter period.
We derive revenues from services provided to our marketing sales force
primarily from a one-time non-refundable enrollment fee from each new sales
associate for which we provide initial sales and marketing supplies and
enrollment services to the associate. Average enrollment fees paid by new sales
associates were $50, $57 and $142 for 2006, 2005 and 2004, respectively. Revenue
from, and costs of, the initial sales and marketing supplies (approximately $11)
are recognized when the materials are delivered to the associates. The remaining
revenues and related incremental direct and origination costs are deferred and
recognized over the estimated average active service period of associates which
at December 31, 2006 is estimated to be approximately five months, down slightly
from six months at year end 2005. At December 31, 2006 and 2005, the deferred
revenue associated with sales associate enrollment fees was $888,000 and $1.6
million, respectively, which is classified as a current liability. Management
estimates the active service period of an associate periodically based on the
average number of months an associate produces new Memberships including those
associates that fail to write any Memberships. If the active service period of
associates changes significantly, which management does not expect in the short
term, the deferred revenue and related costs would be recognized over the new
estimated active service period.
We also encourage participation in a field training program ("Certified
Field Trainer", or "CFT") that allows an associate who successfully completes
the program to advance through the various commission levels at a faster rate.
Associate services revenue also includes revenue recognized on the sale of
marketing supplies and promotional material to associates and includes fees
related to our eService program for associates. The eService program provides
subscribers Internet based back office support such as reports, on-line
documents, tools, a personal e-mail account and multiple personalized web sites
with "flash" movie presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
and associates related to deferred Membership revenue. Deferred costs for
enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments. Deferred costs
for enrolling new associates include training and success bonuses paid to
individuals involved in recruiting the associate and salary and benefit costs of
employees who process associate enrollments. Such costs are deferred to the
extent of the lesser of actual costs incurred or the amount of the related fee
charged for such services. Deferred costs are amortized to expense over the same
period as the related deferred revenue. Deferred costs that will be recognized
within one year of the balance sheet date are classified as current and all
remaining deferred costs are considered noncurrent. Associate related costs are
reflected as associate services and direct marketing, and are expensed as
incurred if not related to the deferred revenue discussed above. These costs
include providing materials and services to associates, CFT bonuses, associate
introduction kits, the associate incentive program, group marketing and
marketing services departments (including costs of related travel, marketing
events, leadership summits and international sales convention). Shipping and
handling costs of $2.2 million in 2006 and $2.8 million in 2005 are primarily
included in Associate services and direct marketing costs.
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due the
provider of Identity Theft Shield benefits and provider law firms on
approximately 99% of the Memberships and claims reported but not paid and
actuarially estimated claims incurred but not reported on the remaining
non-provider Memberships which represent approximately 1%. We calculate the
benefit liability on the non-provider Memberships based on completion factors
that consider historical claims experience based on the dates that claims are
incurred, reported to us and subsequently paid. Processing costs related to
these claims are accrued based on an estimate of expenses to process such
claims.
Income Taxes
We account for income taxes using the asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that are recognized in different periods in
our financial statements and tax returns. In estimating future tax consequences,
we generally consider all future events other than future changes in the tax law
or rates that have not been enacted.
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
We record deferred tax assets related to the recognition of future tax benefits
of temporary differences and net operating loss and tax credit carryforwards. To
the extent that realization of such benefits is not considered more likely than
not, we establish a valuation allowance to reduce such assets to the estimated
realizable amount.
Commissions to Associates
Prior to March 1, 2002, we had a level Membership commission schedule of
approximately 27% of Membership fees and advanced the equivalent of up to three
years of commissions on new Membership sales. Effective March 1, 2002, and in
order to offer additional incentives for increased Membership retention rates,
we returned to a differential commission structure with rates of approximately
80% of first year Membership fees on new Memberships written and variable
renewal commission rates ranging from five to 25% per annum based on the 12
month Membership retention rate of the associate's sales organization. Beginning
in August 2003, we allowed the associate to choose between the level commission
structure and up to three year commission advance or the differential commission
structure with a one year commission advance.
We expense advance commissions ratably over the first month of the related
Membership. As a result of this accounting policy, our advance commission
expenses are recorded in the first month of a Membership and there is no
commission expense recognized for the same Membership during the remainder of
the advance period. Associates must qualify for advance commissions by writing
at least three Memberships.
Long-Lived Assets
We review long-lived assets to be held and used in operations when events
or changes in circumstances indicate that the assets might be impaired. The
carrying value of long-lived assets is considered impaired when the identifiable
undiscounted cash flows estimated to be generated by those assets are less than
their carrying amounts. In that event, a loss is recognized based on the amount
by which the carrying value exceeds the fair value of the long-lived asset. Fair
value is determined primarily using the anticipated cash flows discounted at a
rate commensurate with the risk involved. Losses on long-lived assets to be
disposed of are determined in a similar manner, except that fair values are
reduced by disposal costs.
Stock-Based Compensation
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 equity instruments to
employees. Accordingly, no compensation expense was recognized in connection
with the issuance of equity instruments to employees 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 equity instruments issued to
employees, since all options had vested, no modifications were made to existing
options and no new options were granted.
We did not grant any additional equity instruments to employees or modify
any existing options and therefore did not recognize any share-based payments'
expense from the issuance of equity instruments to employees in 2006. The
options outstanding at December 31, 2005 did not affect 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 2005 and 2004 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 periods would have been the pro
forma amounts indicated below:
Year Ended
December 31,
-------------------------
2005 2004
------------- -----------
Net Income:
As reported............................................................. $ 35,812 $ 40,777
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) (441)
------------- -----------
Pro forma net income........................................................ $ 35,695 $ 40,336
------------- -----------
Basic Earnings Per Common Share:
As reported............................................................. $ 2.31 $ 2.50
Pro forma............................................................... $ 2.31 $ 2.47
Diluted Earnings Per Common Share:
As reported............................................................. $ 2.29 $ 2.48
Pro forma............................................................... $ 2.28 $ 2.45
The pro forma amounts above were estimated using the Black-Scholes option
pricing model with the following weighted average assumptions:
2005 2004
----------- -------------
Risk free interest rate.................... 5.16% 2.16%
Expected volatility........................ 29.46 52.8
Dividend yield............................. 0.00 0.00
Weighted average expected life............. 5.92 years 3-5 years
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. Changes to any of these
assumptions would directly affect the amount accrued but we do not expect any of
the significant trends impacting this account to change significantly in the
near term.
Legal Contingencies
We account for legal contingencies in accordance with SFAS 5, Accounting
for Contingencies, which requires that a loss contingency should be accrued by a
charge to income if it is probable that an asset has been impaired or a
liability has been incurred and the amount of the loss can be reasonably
estimated. Disclosure of a contingency is required if there is at least a
reasonable possibility that a loss has been incurred. We evaluate, among other
factors, the degree of probability of an unfavorable outcome and the ability to
make a reasonable estimate of the amount of loss. This process requires
subjective judgment about the likely outcomes of litigation. Liabilities related
to most of our lawsuits are especially difficult to estimate due to the nature
of the claims, limitation of available data and uncertainty concerning the
numerous variables used to determine likely outcomes or the amounts recorded.
Litigation expenses are recorded as incurred and we do not accrue for future
legal fees. It is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Segment Information
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosures about products and services and geographic
areas are presented in Note 16.
New Accounting Standards Issued
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("Interpretation No. 48"). Interpretation No. 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS No. 109, "Accounting
for Income Taxes." Interpretation No. 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. Interpretation No.
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. For us,
Interpretation No. 48 was effective beginning January 1, 2007, and the
cumulative effect adjustment, if any, will be recorded in the first quarter of
2007. We are currently evaluating the impact of the adoption of Interpretation
No. 48 and have not yet determined the effect on our consolidated financial
statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
clarifies how to measure fair value as permitted under other accounting
pronouncements but does not require any new fair value measurements. However,
for some entities, the application of this statement will change current
practice. We will be required to adopt SFAS No. 157 as of January 1, 2008 and
are currently evaluating the impact of SFAS No. 157 and have not yet determined
the effect on our earnings or financial position.
In September 2006, the Securities and Exchange Commission staff published
Staff Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements." SAB No. 108 addresses quantifying the financial statement effects
of misstatements, specifically, how the effects of prior year uncorrected errors
must be considered in quantifying misstatements in the current year financial
statements. SAB No. 108 is effective for fiscal years ending after November 15,
2006. The adoption of SAB No. 108 by us in the fourth quarter of 2006 did not
have a material impact on our consolidated financial statements.
In March 2006, the FASB Emerging Issues Task Force issued Issue 06-3, How
Sales Taxes Collected From Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement ("EITF 06-3"). A tentative consensus
was reached that a company should disclose its accounting policy (i.e., gross or
net presentation) regarding presentation of taxes within the scope of EITF 06-3.
If taxes are significant, a company should disclose the amount of such taxes for
each period for which an income statement is presented. The guidance is
effective for periods beginning after December 15, 2006. We are currently
evaluating the impact of adopting EITF 06-3 on our consolidated financial
statement disclosure.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities---Including an amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS 159 is effective
for us January 1, 2008. We are evaluating the impact that the adoption of SFAS
No. 159 will have on our consolidated financial statements.
Note 2 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of our investments at December 31, 2006 and 2005 follows:
December 31, 2006
----------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------- -------------- ------------ ----------- ------------
U.S. Government obligations........................ $ 7,750 $ 5 $ (131) $ 7,624
Corporate obligations.............................. 1,991 11 (31) 1,971
Equity securities.................................. 136 - (40) 96
Obligations of state and political subdivisions.... 59,265 150 (141) 59,274
Certificates of deposit............................ 2,416 - - 2,416
EURO............................................... 2,500 - - 2,500
-------------- ------------ ----------- ------------
Total.............................................. $ 74,058 $ 166 $ (343) $ 73,881
-------------- ------------ ----------- ------------
December 31, 2005
----------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------- -------------- ------------ ----------- ------------
U.S. Government obligations........................ $ 9,482 $ 65 $ (120) $ 9,427
Corporate obligations.............................. 2,453 8 (80) 2,381
Equity securities.................................. 136 23 - 159
Obligations of state and political subdivisions.... 15,743 133 (142) 15,734
Certificates of deposit............................ 2,561 - - 2,561
-------------- ------------ ----------- ------------
Total.............................................. $ 30,375 $ 229 $ (342) $ 30,262
-------------- ------------ ----------- ------------
In determining whether declines in the fair value of available-for-sale
securities below their cost are other than temporary, management considers the
financial condition of the issuer, causes for the decline in fair value (i.e.,
interest rate fluctuations or declines in creditworthiness) and severity and
duration of the decline, among other things. At December 31, 2006 we had 193
securities (primarily municipal securities) with unrealized losses in four
consecutive quarters with combined market losses of $327,000. These losses were
determined to be temporary since substantially all of these securities were AAA
rated and we intend to hold to maturity.
The contractual maturities of our available-for-sale investments in debt
securities and certificates of deposit at December 31, 2006 by maturity date
follows:
Amortized
Cost Fair Value
----------- -----------
One year or less................................... $ 45,335 $ 45,321
Two years through five years....................... 5,940 5,871
Six years through ten years........................ 14,742 14,682
More than ten years................................ 7,905 7,911
----------- -----------
Total.............................................. $ 73,922 $ 73,785
----------- -----------
Our investment securities are included in the accompanying consolidated
balance sheets at December 31, 2006 and 2005 as follows:
December 31,
-------------------------
2006 2005
----------- -----------
Available-for-sale investments (current)........... $ 42,275 $ 6,742
Available-for-sale investments (non-current)....... 27,461 19,213
Investments pledged................................ 4,145 4,307
----------- -----------
Total.............................................. $ 73,881 $ 30,262
----------- -----------
We are required to pledge investments to various state insurance
departments as a condition to obtaining authority to do business in certain
states. The fair value of investments pledged to state regulatory agencies is as
follows:
December 31,
---------------------------
2006 2005
------------ ------------
Certificates of deposit............................ $ 2,216 $ 2,361
U. S. Government obligations....................... 1,929 1,946
------------ ------------
Total.............................................. $ 4,145 $ 4,307
------------ ------------
Proceeds from sales of investments during 2006, 2005 and 2004 were $135.8
million, $13.2 million and $4.6 million, respectively, and resulted in gross
realized gains of $43,000, $98,000 and $224,000 and gross realized losses of
$82,000, $108,000 and $63,000, respectively.
Note 3 - Property and Equipment
Property and equipment is comprised of the following:
December 31,
Estimated -----------------------
Useful Life 2006 2005
----------- ---------- -----------
Equipment, furniture and fixtures.......... 3-10 years $ 37,650 $ 34,204
Computer software.......................... 3 years 13,263 11,461
Building and improvements.................. 20-40 years 39,326 36,542
Automotive and aviation equipment.......... 3-10 years 14,134 13,489
Land....................................... N/A 445 170
---------- -----------
104,818 95,866
Accumulated depreciation................................. (45,175) (36,919)
---------- -----------
Property and equipment, net.............................. $ 59,643 $ 58,947
---------- -----------
As of December 31, 2006 and 2005, capitalized interest of $706,000 was
included in the cost of the building. No interest was capitalized during 2006 or
2005.
Note 4 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
------------------------
2006 2005
------------- ----------
Accounts payable................................... $ 5,077 $ 6,303
Marketing bonuses payable.......................... 1,455 2,099
Incentive awards payable........................... 2,922 3,082
Litigation accrual................................. 150 2,472
Other.............................................. 4,041 5,139
------------- ----------
Total.............................................. $ 13,645 $ 19,095
------------- ----------
Note 5 - 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"). At December 31,
2006, we have the full Revolving Facility available to us. After payment of an
origination fee of 1%, lender costs and retirement of $15.3 million of existing
bank indebtedness, the net proceeds of the Term Facility we received were $58.8
million. During the six months ended December 31, 2006, we used a portion of the
net proceeds to purchase 888,761 shares of treasury stock at a cost of $35.9
million, or an average price of $40.34 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 December 31, 2006 was 7.85%. 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:
* a 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;
* a 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;
* a requirement to maintain consolidated EBITDA for the twelve month
period ending December 31, 2006 and each quarter thereafter of at
least $80 million ($75 million for us and our top tier direct
subsidiaries);
* a 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;
* a requirement to maintain at least 1.3 million members; and
* a requirement to ma divided by EBITDA for the trailing
twelve months) of no more than 1.5 to 1.
We were in compliance with these covenants at December 31, 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 December 31, 2006 was 7.60%. 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,
2012. The interest rate at December 31, 2006 was 7.10%. The loan is
collateralized by the aircraft purchased. In addition to customary events of
default, if Harland C. Stonecipher ceases to be our Chief Executive Officer for
a period of 90 consecutive days an event of default will occur.
A schedule of outstanding balances as of December 31, 2006 is as follows:
Senior loan................................ $ 68,750
Real estate loan........................... 12,952
Aircraft loan.............................. 10,268
----------
Total notes payable........................ 91,970
Less: Current portion of notes payable..... (18,437)
----------
Long term portion.......................... $ 73,533
----------
A schedule of future maturities as of December 31, 2006 is as follows:
Repayment Schedule commencing
January 2007:
Year 1..................................... $ 18,437
Year 2..................................... 18,437
Year 3..................................... 18,437
Year 4..................................... 18,437
Year 5..................................... 13,711
Thereafter................................. 4,511
-----------
Total notes payable........................ $ 91,970
----------
Note 6 - Income Taxes
The provision for income taxes consists of the following:
Year Ended December 31,
------------------------------------
2006 2005 2004
---------- ----------- -----------
Current.................................... $ 27,116 $ 17,951 $ 19,281
Deferred................................... 774 912 2,197
---------- ----------- -----------
Total provision for income taxes......... $ 27,890 $ 18,863 $ 21,478
---------- ----------- -----------
A reconciliation of the statutory Federal income tax rate to the
effective income tax rate is as follows:
Year Ended December 31,
------------------------------------
2006 2005 2004
---------- ----------- -----------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Tax exempt interest........................ (.7) (.4) (.2)
Wage tax credits........................... (.3) (.5) (.5)
Other...................................... 1.0 .4 .2
---------- ----------- -----------
Effective income tax rate.................. 35.0% 34.5% 34.5%
---------- ----------- -----------
Deferred tax liabilities and assets at December 31, 2006 and 2005 are
comprised of the following:
December 31,
-----------------------
2006 2005
----------- -----------
Deferred tax liabilities relating to:
Deferred member and associate service costs...... $ 7,221 $ 7,493
Property and equipment........................... 7,232 7,008
----------- -----------
Total deferred tax liabilities................ 14,453 14,501
----------- -----------
Deferred tax assets relating to:
Expenses not yet deducted for tax purposes....... 2,079 2,497
Deferred revenue and fees........................ 11,184 11,425
Unrealized investment losses, net................ 69 44
Other............................................ 459 647
----------- -----------
Total deferred tax assets..................... 13,791 14,613
----------- -----------
Net deferred tax (liability) asset............... $ (662) $ 112
----------- -----------
Our deferred tax assets and liabilities are included in the accompanying
consolidated balance sheets at December 31, 2006 and 2005 as follows.
December 31,
-----------------------
2006 2005
----------- ----------
Deferred income taxes (current asset).............. $ 4,235 $ 4,894
Deferred income taxes (non-current liability)...... (4,897) (4,782)
----------- -----------
Net deferred tax (liability) asset................. $ (662) $ 112
----------- -----------
A significant portion of the deferred tax assets recognized relate to
deferred revenue and fees. A valuation allowance was not recorded since we
believe that there was sufficient positive evidence to support our conclusion
not to record a valuation allowance. Management believes that we will realize
the tax benefit of these deferred tax assets in the future because of our
history of pre-tax income. However, there can be no assurance that we will
generate taxable income or that all of our deferred tax assets will be utilized.
Note 7 - Stockholders' Equity
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 12
million shares during subsequent board meetings. At December 31, 2006, we had
purchased 11.4 million treasury shares under these authorizations for a total
consideration of $296.0 million, an average price of $26.02 per share. We
purchased and formally retired 1,959,487 shares of our common stock during 2006
for $73.4 million, or an average price of $37.47 per share, reducing our common
stock by $19,595 and our retained earnings by $73.4 million. At December 31,
2006 and 2005, we had 13.6 million and 15.5 million common shares outstanding,
respectively, net of treasury shares. Given the current interest rate
environment, the nature of other investments available and our expected cash
flows, we believe that purchasing treasury shares enhances shareholder value and
may seek alternative sources of financing to continue or accelerate the program.
Any additional treasury stock purchases will be made at prices that we consider
attractive and at such times that we believe will not unduly impact our
liquidity.
Our ability to pay dividends is dependent in part on our ability to derive
dividends from our subsidiaries. The payment of dividends by PPLCI is restricted
under the Oklahoma Insurance Code to available surplus funds derived from
realized net profits and requires the approval of the Oklahoma Insurance
Commissioner for any dividend representing more than the greater of 10% of such
accumulated available surplus or the previous years' net profits. PPLSIF is
similarly restricted pursuant to the insurance laws of Florida. At January 1,
2007, neither PPLCI nor PPLSIF had funds available for payment of substantial
dividends without the prior approval of the insurance commissioner. During 2006,
PPLCI declared and after obtaining all necessary regulatory approvals, paid
extraordinary dividends to us of $13.4 million compared to the $4.1 million
dividend paid to us during 2005. At January 1, 2007 LSPV had approximately $1.6
million available for payment of an ordinary dividend. At December 31, 2006 the
amount of restricted net assets of consolidated subsidiaries was $22.6 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Note 8 - Other Expenses, net
The components of other expenses, net are as follows:
Year Ended December 31,
-----------------------------------
2006 2005 2004
---------- ---------- ----------
Depreciation............................... $ 8,260 $ 7,489 $ 7,709
Premium taxes.............................. 1,840 2,059 1,698
Interest expense........................... 5,726 2,682 1,990
Litigation accrual expense................. (710) (303) (121)
Interest income............................ (2,884) (1,471) (1,698)
---------- ---------- ----------
Total Other expenses, net................ $ 12,232 $ 10,456 $ 9,578
---------- ---------- ----------
Note 9 - Comprehensive Income
Comprehensive income is comprised of two subsets - net income and other
comprehensive income. Included in other comprehensive income for us are foreign
currency translation adjustments and unrealized gains on investments. These
items are accumulated within the Statements of Changes in Stockholders' Equity
under the caption "Accumulated Other Comprehensive Income." As of December 31,
accumulated other comprehensive income, as reflected in the Consolidated
Statements of Changes in Stockholders' Equity, was comprised of the following:
2006 2005
---------- -----------
Foreign currency translation adjustments............................. $ 397 $ 456
Unrealized losses on investments, net of income taxes
of $(70) and $(44)................................................. (107) (69)
---------- -----------
Accumulated other comprehensive income............................. $ 290 $ 387
---------- -----------
Note 10 - Related Party Transactions
Through December 31, 2005, our Chairman, Harland C. Stonecipher, was the
owner of PPL Agency, Inc. ("Agency"). Effective January 1, 2006 we acquired
Agency from Mr. Stonecipher but prior to the acquisition we had agreed to
indemnify and hold him harmless for any personal losses incurred as a result of
his ownership of this corporation and any income earned by Agency accrued to us.
We provide management and administrative services for Agency, for which we
received specified management fees and expense reimbursements. No consideration
was paid to Mr. Stonecipher.
Agency's financial position and results of operations are included in our
financial statements on a combined basis after elimination of intercompany
transactions. Agency earned commissions, net of amounts paid directly to its
agents by the underwriter, during 2006, 2005 and 2004 of $107,000, $114,000 and
$220,000, respectively, through its sales of insurance products of an
unaffiliated company. Agency had net income of $7,000, $16,000 and $127,000 for
the years ended December 31, 2006, 2005 and 2004, respectively, after incurring
commissions earned by Mr. Stonecipher of $58,000, $57,000 and $55,000,
respectively, and annual management fees paid to us of $36,000 for 2006, 2005
and 2004.
John W. Hail, one of our directors, served as our Executive Vice President,
Director and Agency Director from July 1986 through May 1988 and also served as
Chairman of the Board of Directors of TVC Marketing, Inc., which was our
exclusive marketing agent from April 1984 through September 1985. Pursuant to
agreements between Mr. Hail and us entered into during the period in which Mr.
Hail was one of our executive officers, Mr. Hail receives override commissions
from renewals of certain Memberships initially sold by us during such period.
During 2006, 2005 and 2004, such override commissions on renewals totaled
$71,000, $75,000 and $79,000, respectively. Mr. Hail also owns interests ranging
from 12% to 100% in corporations not currently affiliated with us, including TVC
Marketing, Inc., but which were engaged in the marketing of our legal service
Memberships and which earn renewal commissions from Memberships previously sold.
These entities earned renewal commissions of $519,000, $551,000 and $557,000
during 2006, 2005 and 2004, respectively, of which $273,000, $314,000 and
$322,000, respectively, was passed through as commissions to their sales agents.
Note 11 - Leases
At December 31, 2006, we were committed under noncancelable operating and
capital leases, principally for buildings and equipment. Aggregate rental
expense under all operating leases was $143,000, $108,000 and $79,000 in 2006,
2005 and 2004, respectively.
Future commitments commencing January 2007 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2007............................................... $ 144
2008............................................... 101
2009............................................... 41
2010............................................... 36
2011............................................... 24
Thereafter......................................... 230
------------
Total operating lease commitments.................. $ 576
------------
Future minimum lease payments commencing in January 2007 related to capital
leases are as follows:
Year Ended December 31,
2007............................................... $ 420
2008............................................... 81
2009............................................... 81
2010............................................... 81
2011............................................... 81
Thereafter......................................... 1,487
------------
Total minimum lease payments....................... 2,231
Less: Imputed interest............................. (934)
------------
Present value of net minimum lease payments........ 1,297
Less: Current portion.............................. (340)
------------
Non current portion of capital leases payable...... $ 957
------------
We entered into two capital leases near the end of 2002 and one early in
2003 to acquire equipment and buildings. These capital leases expire at various
dates through 2032. The capital lease assets are included in property and
equipment as follows at December 31, 2006 and December 31, 2005.
December 31,
-------------------------
2006 2005
------------ -----------
Equipment, furniture and fixtures.................. $ 1,670 $ 1,670
Buildings and improvements......................... 314 314
------------ -----------
1,984 1,984
Less: accumulated amortization..................... (798) (445)
Net capital lease assets........................... ------------ -----------
$ 1,186 $ 1,539
------------ -----------
Note 12 - Commitments and Contingencies
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. At one time, we were aware of
11 separate lawsuits involving approximately 400 plaintiffs in multiple counties
in Mississippi. These cases seek varying amounts of actual and punitive damages.
We tried three separate lawsuits in Mississippi. On September 11, 2006 we
reached a settlement agreement with counsel for the more than 400 plaintiffs in
numerous pending cases in Mississippi. For an amount significantly less than our
then accrued reserves of $2.5 million, all pending litigation against us is
being 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. Settlement and dismissal of almost all pending litigation has been
approved by the plaintiffs.
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, we believe will
be sufficient to cover estimated damages in connection with various cases
(exclusive of ongoing defense costs which are expensed as incurred), which at
December 31, 2006 was $150,000. We believe that we have meritorious defenses in
all pending cases and will vigorously defend against the plaintiffs' claims.
However, it is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments which aggregate $5.7 million. The Canadian taxing authorities
contend commission deductions should be matched with the membership revenue as
received, we contend these commissions are deductible when paid. Under Canadian
tax laws, our commission payments are treated as a prepaid expense. We base our
deduction of commission on the fact that all the services (the sale of the
membership) have been performed by the sales associate at the time of sale
therefore this prepaid expense (the commission payments) is deductible when
paid. Also, the commission payment is taxable to the sales associate when paid
and each year we issue a T4 (Canadian 1099 equivalent) to sales associates for
the total commission payments made during that year. In addition, Canadian
taxing authorities have challenged our allocation of general and administrative
expenses to Canadian operations. We contend the allocation of general and
administrative expenses, based on the percentage of Canadian new memberships
written and the Canadian percentage memberships in force, is reasonable. We have
established an accrued liability we believe will be sufficient to cover the
estimated tax assessment in connection with these items, which at December 31,
2006 was $477,000. As stated above, we believe that we have reasonable basis for
our tax position relative to these items, however, it is possible that an
adverse outcome could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
Note 13 - Stock Options, Stock Ownership Plan and Benefit Plan
We have a stock option plan (the "Plan") under which the Board of Directors
(the "Board") or our Stock Option Committee (the "Committee") may grant options
to purchase shares of our common stock. The Plan permits the granting of options
to our directors, officers and employees to purchase our common stock at not
less than the fair value at the time the options are granted. The Plan provides
for option grants to acquire up to 3,000,000 shares and permits the granting of
incentive stock options as defined under Section 422 of the Internal Revenue
Code at an exercise price for each option equal to the market price of our
common stock on the date of the grant and a maximum term of 10 years. Options
not qualifying as incentive stock options under the Plan have a maximum term of
15 years. The Board or Committee determines vesting of options granted under the
Plan. No options may be granted under the Plan after December 12, 2012. We have
not granted options under the Plan since March 2004.
The Plan previously provided for automatic grants of options to our
non-employee directors. Under the Plan, each incumbent non-employee director and
any new non-employee director received options to purchase 10,000 shares of
common stock on March 1 of each year. The options granted each year were
immediately exercisable as to 2,500 shares and vested in additional increments
of 2,500 shares on the following June 1st, September 1st, and December 1st in
the year of grant, subject to continued service by the non-employee director
during such periods. Options granted to non-employee directors under the Plan
have an exercise price equal to the closing price of the common stock on the
date of grant. These automatic grants of options to non-employee directors were
eliminated effective January 1, 2005, and therefore no further grants to
non-employee directors have been made.
Also included below are stock options that were issued to our Regional Vice
Presidents ("RVPs") in order to encourage stock ownership by our RVPs and to
increase the proprietary interest of such persons in our growth and financial
success. These options have been granted periodically to RVPs since 1996.
Options were granted at fair market value at the date of the grant and were
generally immediately exercisable for a period of three years or within 90 days
of termination, whichever occurs first. Although there we no options granted to
RVPs during 2006 or 2005, there were 36,751 total options granted to RVPs in the
year ended December 31, 2004. We discontinued the RVP stock option grants
immediately after the 2003 fourth quarter stock options were awarded in the
first quarter of 2004.
A summary of the status of our total stock option activity as of December
31, 2006, 2005 and 2004, and for the years ended on those dates is presented
below:
2006 2005 2004
------------------------- ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ---------- ----------- ---------- ------------- ----------
Outstanding at beginning of year....... 507,167 $ 20.94 862,490 $ 23.88 1,275,499 $ 24.06
Granted................................ - - - - 76,751 23.42
Exercised.............................. (226,719) 18.07 (345,642) 28.24 (234,170) 22.10
Terminated............................. (7,408) 23.29 (9,681) 22.33 (255,590) 26.27
------------ ---------- ----------- ---------- ------------- ----------
Outstanding at end of year............. 273,040 $ 23.26 507,167 $ 20.94 862,490 $ 23.88
------------ ---------- ----------- ---------- ------------- ----------
Options exercisable at year end........ 273,040 $ 23.26 507,167 $ 20.94 837,490 $ 23.99
------------ ---------- ----------- ---------- ------------- ----------
Aggregate intrinsic value of outstanding
options................................ $ 4,332 $ 8,757 $ 11,158
--------- ---------- ----------
Intrinsic value of options exercised... $ 3,776 $ 3,357 $ 1,987
--------- ---------- ----------
Fair value of options vested during
period................................. $ - $ 180 $ 678
--------- ---------- ----------
Weighted average grant date fair value
per share.............................. N/A N/A $ 8.74
--------- ---------- ----------
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2006:
Weighted Average
Range of Remaining Weighted Average
Exercise Prices Number Outstanding Contractual Life Exercise Price
------------------------ ------------------------ ------------------------- -----------------------
$17.03 - $19.20 47,000 3.78 $ 18.92
$22.21 - $24.20 193,540 .66 24.06
$24.46 - $26.11 32,500 .82 24.84
------------------------ ------------------------- ------------------------
273,040 1.21 $ 23.26
------------------------ ------------------------- ------------------------
During 1988, we adopted an employee stock ownership plan. Under the plan,
employees may elect to defer a portion of their compensation by making
contributions to the plan. Prior to December 31, 2006, up to seventy-five
percent of the contributions made by employees were used to purchase Company
common stock with the remaining twenty-five percent allocated to other
investment options within the plan. For plan years beginning after December 31,
2006, the plan allows participants to move any portion of their account that is
invested in our stock from that investment into other investment alternatives
under the plan. At our option, we may make matching contributions to the plan,
and recorded expense of $459,000, $445,000 and $342,000 for 2006, 2005 and 2004
respectively, based on contributions of cash during 2006 and 2005 and
contributions of Company stock of 10,100 shares during 2004.
In November 2002, we adopted a deferred compensation plan, which permits
executive officers and key employees to defer receipt of a portion of their
compensation. Deferred amounts accrue hypothetical returns based upon investment
options selected by the participant. We have amended the deferred compensation
plan, effective January 1, 2005, to comply with new provisions of Section 409A
of the Internal Revenue Code. Deferred amounts are paid in cash based on the
value of the investment option and are generally payable following termination
of employment in a lump sum or in installments as elected by the participant,
but the plan provides for financial hardship distributions, distributions in the
event of total disability or death and distributions upon a change in control.
The plan also provides for a death benefit of $500,000 for each participant.
Although the plan is unfunded and represents an unsecured liability of ours to
the participants, we have purchased variable life insurance policies owned by us
to insure the lives of the group of participants and to finance our obligations
under the plan. As of December 31, 2006 and 2005, we had an aggregate deferred
compensation liability of $5.2 million and $3.9 million, respectively, which is
included in other non-current liabilities. At December 31, 2006, the cash value
of the underlying insurance policies owned by us was $4.7 million and included
in other assets.
Note 14 - Earnings Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock and dilutive potential
common shares outstanding during the year. The weighted average number of common
shares is also increased by the number of dilutive potential common shares
issuable on the exercise of options less the number of common shares assumed to
have been purchased with the proceeds from the exercise of the options pursuant
to the treasury stock method; those purchases are assumed to have been made at
the average price of the common stock during the respective period.
Year Ended December 31,
------------------------------
Basic Earnings Per Share: 2006 2005 2004
-------- -------- ---------
Earnings:
Income........................................................................ $ 51,798 $ 35,812 $ 40,777
-------- -------- ---------
Shares:
Weighted average shares outstanding........................................... 14,642 15,470 16,313
-------- -------- ---------
Diluted Earnings Per Share:
Earnings:
Income after assumed conversions.............................................. $ 51,798 $ 35,812 $ 40,777
-------- -------- ---------
Shares:
Weighted average shares outstanding........................................... 14,642 15,470 16,313
Assumed exercise of options................................................... 97 182 145
-------- -------- ---------
Weighted average number of shares, as adjusted................................ 14,739 15,652 16,458
-------- -------- ---------
Options to purchase shares of common stock are excluded from the
calculation of diluted earnings per share when their inclusion would have an
anti-dilutive effect on the calculation. Options to purchase 218,000 shares with
an average exercise price of $32.05 were excluded from the calculation of
diluted earnings per share for the year ended December 31, 2004. No options were
excluded from the diluted earnings per share calculation for the years ended
December 31, 2006 and 2005.
Note 15 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations for
the years ended December 31, 2006 and 2005.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2006 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------------------------------------------- ------------ ------------- ------------ ------------
Revenues........................................... $ 109,960 $ 111,198 $ 111,194 $ 111,672
Net income......................................... 13,071 12,090 13,406 13,231
Basic income per common share (1):
Net Income....................................... $ .85 $ .81 $ .93 $ .95
Diluted income per common share (1):
Net Income....................................... $ .84 $ .81 $ .93 $ .94
2005
---------------------------------------------------
Revenues........................................... $ 100,895 $ 105,619 $ 107,582 $ 109,284
Net income......................................... 8,948 6,853 8,644 11,367
Basic income per common share (1):
Net Income....................................... $ .57 $ .45 $ .56 $ .73
Diluted income per common share (1):
Net Income....................................... $ .57 $ .44 $ .55 $ .73
(1) The sum of EPS for the four quarters may differ from the annual EPS
due to rounding and the required method of computing weighted average
number of shares in the respective periods.
Note 16 - Segment Information
We operate a consistent business model, marketing Memberships to our
customers in the United States and four Canadian provinces. We maintain regional
geographic management to facilitate local execution of our marketing strategies.
However, the most significant performance evaluations and resource allocations
made by our chief operating decision makers are made on a global basis. As such,
we have concluded that we maintain one operating and reportable segment.
Substantially all of our business is currently conducted in the United States.
Revenues from our Canadian operations for 2006, 2005 and 2004 were $7.1 million,
$6.0 million and $4.7 million, respectively. We have no significant long-lived
assets located in Canada.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE.
-------------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
--------------------------------------
Controls and Procedures
Our principal executive officer (Chairman, Chief Executive Officer and
President) and principal financial officer (Chief Financial Officer) have
evaluated our disclosure controls and procedures as of December 31, 2006, and
have concluded that these controls and procedures are effective to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act of 1934 (15 U.S.C. ss. 78a et seq) is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms. These disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in the
reports that we file or submit is accumulated and communicated to management,
including the principal executive officer and the principal financial officer,
as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of 2006, no change occurred in our internal
control over financial reporting that materially affected, or is likely to
materially affect, our internal control over financial reporting.
Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. Under the supervision and with the
participation of our management, including the Chief Executive Officer and Chief
Financial Officer, we evaluated the effectiveness of the design and operation of
our internal control over financial reporting based on the framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our internal
control over financial reporting was effective as of December 31, 2006 as
reflected in our report included in Item 8 above.
Grant Thornton LLP, our independent registered public accounting firm,
audited management's assessment of the effectiveness of internal control over
financial reporting and, based on that audit, issued the report set forth in
Item 8 above.
Certifications
Our Chief Executive and Chief Financial Officers have completed the
certifications required to be filed as an Exhibit to this Report (See Exhibits
31.1 and 31.2) relating to the design of our disclosure controls and procedures
and the design of our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
--------------------------------
None.
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10 through 14 of Form 10-K are incorporated herein by
reference to our Proxy Statement for the Annual Meeting of Shareholders to be
filed prior to April 30, 2007.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
------------------------------------------------------
(a) The following documents are filed as part of this report:
(1) Financial Statements: See Index to Consolidated Financial
Statements and Consolidated Financial Statement Schedule set
forth on page 41 of this report.
(2) Exhibits: For a list of the documents filed as exhibits to this
report, see the Exhibit Index following the signatures to this
report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: February 27, 2007 By: /s/ Randy Harp
--------------------------------------
Randy Harp
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
---- -------- ----
/s/ Harland C. Stonecipher Chairman of the Board of Directors February 27, 2007
---------------------------------------------------- (Principal Executive Officer)
Harland C. Stonecipher
/s/ Randy Harp Chief Operating Officer February 27, 2007
----------------------------------------------------
Randy Harp
/s/ Steve Williamson Chief Financial Officer February 27, 2007
---------------------------------------------------- (Principal Financial and
Accounting Officer)
Steve Williamson
/s/ Orland G. Aldridge Director February 27, 2007
----------------------------------------------------
Orland G. Aldridge
/s/ Martin H. Belsky Director February 27, 2007
----------------------------------------------------
Martin H. Belsky
/s/ Peter K. Grunebaum Director February 27, 2007
----------------------------------------------------
Peter K. Grunebaum
/s/ John W. Hail Director February 27, 2007
----------------------------------------------------
John W. Hail
/s/ Thomas W. Smith Director February 27, 2007
----------------------------------------------------
Thomas W. Smith
PRE-PAID LEGAL SERVICES, INC AND SUBSIDIARIES
Schedule I - Condensed Financial Information of the Registrant
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
BALANCE SHEETS
(Amounts in 000's)
ASSETS
December 31,
-----------------------
2006 2005
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 9,245 $ 28,505
Available-for-sale investments, at fair value........................................ 39,950 -
Membership income receivable......................................................... 4,156 3,971
Inventories.......................................................................... 1,337 1,717
Refundable income taxes.............................................................. 653 -
Deferred member and associate service costs.......................................... 14,491 14,854
Other assets......................................................................... 2,634 2,874
---------- ----------
Total current assets............................................................. 72,466 51,921
---------- ----------
Available-for-sale investments, at fair value.......................................... 147 239
Investments pledged.................................................................... 323 374
Property and equipment, net............................................................ 59,108 58,702
Investments in and amounts due to/from subsidiaries, net............................... 48,679 39,626
Deferred member and associate service costs............................................ 2,406 2,752
Other assets........................................................................... 6,847 5,755
---------- ----------
Total assets................................................................... $ 189,976 $ 159,369
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 11,588 $ 11,241
Deferred revenue and fees............................................................ 22,192 21,767
Current portion of capital leases payable............................................ 340 321
Current portion of notes payable..................................................... 18,437 15,250
Common stock dividends payable....................................................... - 4,643
Accounts payable and accrued expenses................................................ 13,141 18,335
---------- ----------
Total current liabilities.......................................................... 65,698 71,557
---------- ----------
Capital leases payable............................................................... 957 1,296
Notes payable........................................................................ 73,533 23,220
Deferred revenue and fees............................................................ 1,479 2,490
Deferred income taxes................................................................ 12,241 5,480
Other non-current liabilities........................................................ 5,208 3,932
---------- ----------
Total liabilities................................................................ 159,116 107,975
---------- ----------
Stockholders' equity:
Common stock......................................................................... 185 203
Retained earnings.................................................................... 129,413 149,832
Accumulated other comprehensive income............................................... 290 387
Treasury stock, at cost.............................................................. (99,028) (99,028)
---------- ----------
Total stockholders' equity....................................................... 30,860 51,394
---------- ----------
Total liabilities and stockholders' equity..................................... $ 189,976 $ 159,369
---------- ----------
See accompanying notes to codensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2006 2005 2004
------------ ------------- ------------
Revenues:
Membership fees...................................................... $ 309,765 $ 289,553 $ 260,959
Associate services................................................... 26,674 28,683 24,618
Other................................................................ 4,717 4,714 5,247
------------ ------------- ------------
341,156 322,950 290,824
------------ ------------- ------------
Costs and expenses:
Membership benefits.................................................. 110,415 102,354 89,016
Commissions.......................................................... 98,249 111,129 88,963
Associate services and direct marketing.............................. 29,381 30,311 24,618
General and administrative........................................... 31,362 30,127 32,037
Other, net........................................................... 9,626 9,385 9,157
------------ ------------- ------------
279,033 283,306 243,791
------------ ------------- ------------
Income before income taxes and equity in net income of subsidiaries.... 62,123 39,644 47,033
Provision for income taxes............................................. 21,746 13,677 16,226
------------ ------------- ------------
Income before equity in net income of subsidiaries..................... 40,377 25,967 30,807
Equity in net income of subsidiaries................................... 11,421 9,845 9,970
------------ ------------- ------------
Net income............................................................. $ 51,798 $ 35,812 $ 40,777
------------ ------------- ------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2006 2005 2004
------------ ------------ ------------
Net cash provided by operating activities.............................. $ 52,899 $ 46,586 $ 38,393
------------ ------------ ------------
Cash flows from investing activities:
Additions to property and equipment.................................. (8,631) (14,778) (10,879)
Purchases of investments - available-for-sale........................ (164,309) - (2,858)
Maturities and sales of investments - available-for-sale............. 124,479 307 11,783
------------ ------------ ------------
Net cash used in investing activities.............................. (48,461) (14,471) (1,954)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 485 4,439 5,176
Tax benefit on exercise of stock options............................. 703 - -
Decrease in capital lease obligations................................ (320) (339) (808)
Purchases of treasury stock.......................................... (73,423) (11,673) (37,462)
Proceeds from issuance of debt....................................... 85,000 13,829 19,000
Repayments of debt................................................... (31,500) (20,445) (17,335)
Dividends paid....................................................... (4,643) (12,412) -
------------ ------------ ------------
Net cash used in financing activities.............................. (23,698) (26,601) (31,429)
------------ ------------ ------------
Net increase in cash and cash equivalents.............................. (19,260) 5,514 5,010
Cash and cash equivalents at beginning of year......................... 28,505 22,991 17,981
------------ ------------ ------------
Cash and cash equivalents at end of year............................... $ 9,245 $ 28,505 $ 22,991
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized.................... $ 5,536 $ 2,432 $ 1,752
------------ ------------ ------------
Cash paid for income taxes........................................... $ 28,710 $ 13,350 $ 19,429
------------ ------------ ------------
Non-cash activities - cash dividends declared but not paid........... $ - $ 4,643 $ 7,796
------------ ------------ ------------
Non-cash activities - capital lease obligations incurred............. $ - $ - $ 1,058
------------ ------------ ------------
Non-cash activities - asset additions due to trade-in allowance...... $ - $ 426 $ -
------------ ------------ ------------
Purchases of treasury stock pursuant to tender offer................. $ 6,584 $ - $ -
------------ ------------ ------------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
Notes to Condensed Financial Statements
Basis of Presentation
In the parent-company-only financial statements, Pre-Paid Legal Services, Inc.'s
("Parent Company") investment in subsidiaries is stated at cost plus equity in
undistributed earnings of subsidiaries since the date of acquisition. The
parent-company-only financial statements should be read in conjunction with the
Parent Company's consolidated financial statements.
Notes 5 and 12 and the first two paragraphs of Note 10 to the consolidated
financial statements of Pre-Paid Legal Services, Inc. relate to the Parent
Company and therefore have not been repeated in these notes to condensed
financial statements.
Expense Advances and Reimbursements
Pursuant to management agreements with certain subsidiaries, which have been
approved by insurance regulators, commission advances are paid and expensed by
the Parent Company and the Parent Company is compensated for a portion of its
general and administrative expenses determined in accordance with the
agreements.
Dividends from Subsidiaries
Dividends paid to the Parent Company from its subsidiaries are accounted for by
the equity method. During 2006, PPLCI declared and after obtaining all necessary
regulatory approvals, paid extraordinary dividends to us of $13.4 million
compared to the $4.1 million dividend paid to us during 2005. No dividends were
declared or paid by PPLCI during 2004.
INDEX TO 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 (Incor-
porated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1992)
*10.2 Agreements between Shirley Stonecipher, New York Life Insurance Company and the Company regarding
life insurance policy covering Harland C. Stonecipher (Incorporated by reference to Exhibit 10.21 of
the Company's Annual Report on Form 10-K for the year ended December 31, 1985)
*10.3 Amendment dated January 1, 1993 to Split Dollar Agreement between Shirley Stonecipher and the
Company regarding life insurance policy covering Harland C. Stonecipher (Incorporated by reference
to Exhibit 10.3 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992)
*10.4 Form of New Business Generation Agreement Between the Company and Harland C. Stonecipher (Incorpor-
ated 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 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)
*10.10 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)
*10.11 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)
10.12 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)
10.13 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)
10.14 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)
10.15 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)
10.16 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)
10.17 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)
10.18 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)
10.19 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)
21.1 List of Subsidiaries of the Company (Incorporated by reference to Exhibit 21.1 of our Annual Report
on Form 10-K for the year ended December 31, 2005)
23.1 Consent of Grant Thornton LLP
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.
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our reports dated February 27, 2007, accompanying the
consolidated financial statements and schedule and management's assessment of
the effectiveness of internal control over financial reporting included in the
Annual Report of Pre-Paid Legal Services, Inc. on Form 10-K for the year ended
December 31, 2006. We hereby consent to the incorporation by reference of said
reports in the Registration Statements of Pre-Paid Legal Services, Inc. on Forms
S-8 (File No. 333-120403, effective November 12, 2004, File No. 33-82144,
effective July 28, 1994, File No. 33-62663, effective September 14, 1995, File
No. 333-53183, effective May 20, 1998 and File No. 333-38386, effective June 1,
2000).
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2007
EXHIBIT 31.1
CERTIFICATION
I, Harland C. Stonecipher, Chief Executive Officer of the registrant, certify
that:
1. I have reviewed this annual report on Form 10-K of Pre-Paid Legal Services,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information;
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Dated: February 27, 2007 /s/ Harland C. Stonecipher
--------------------------------------
Harland C. Stonecipher
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Steve Williamson, Chief Financial Officer of the registrant, certify that:
1. I have reviewed this annual report on Form 10-K of Pre-Paid Legal Services,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information;
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Dated: February 27, 2007 /s/ Harland C. Stonecipher
--------------------------------------
Harland C. Stonecipher
Chief Executive Officer
Dated: February 27, 2007 /s/ Steve Williamson
--------------------------------------
Steve Williamson
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Annual
Report on Form 10-K for the year ended December 31, 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: February 27, 2007 /s/ Harland C. Stonecipher
--------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer
and President
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350
Pursuant to 18 U.S.C. ss. 1350, the undersigned officer of Pre-Paid Legal
Services, Inc. (the "Company"), hereby certifies that the Company's Annual
Report on Form 10-K for the year ended December 31, 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: February 27, 2007 /s/ Steve Williamson
--------------------------------------
Steve Williamson
Chief Financial Officer