UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2002
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
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PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
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Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K ( ).
State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within the past 60 days prior to the date of
the filing: As of March 7, 2003 - $203,210,000.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes |X| No [ ]
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, 2002---$285,577,000
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of March 7, 2003
there were 17,866,510 shares of Common Stock, par value $.01 per share,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 2003 annual
meeting of shareholders are incorporated into Part III of this Form 10-K by
reference.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the year ended December 31, 2002
TABLE OF CONTENTS
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
Availability of Information
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
Equity Compensation Plans
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Measures of Member retention
Results of Operations:
Comparison of 2002 to 2001
Comparison of 2001 to 2000
Liquidity and Capital Resources
Forward-Looking Statements
Risk Factors
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
PART III. **
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PART IV.
ITEM 14. CONTROLS AND PROCEDURES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
SIGNATURES
** Information required by Part III is incorporated by reference from the
Company's definitive proxy statement for its 2003 annual meeting of
shareholders.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2002
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Pre-Paid Legal Services, Inc. (the "Company") was one of the first
companies in the United States organized solely to design, underwrite and market
legal expense plans. The Company's predecessor commenced business in 1972 and
began offering legal expense reimbursement services as a "motor service club"
under Oklahoma law. In 1976, the Company was formed and acquired its predecessor
in a stock exchange. The Company began offering Memberships independent of the
motor service club product by adding a legal consultation and advice service,
and in 1979 the Company implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. The Company's legal expense plans (referred to as
"Memberships") currently provide for a variety of legal services in a manner
similar to medical plans. In most states and provinces, standard plan benefits
include preventive legal services, motor vehicle legal defense services, trial
defense services, IRS audit services and a 25% discount off legal services not
specifically covered by the Membership for an average monthly Membership fee of
approximately $21. Additionally, in approximately 39 states, the Legal Shield
rider can be added to the standard plan for only $1 per month and provides
members with 24-hour access to a toll-free number for attorney assistance if the
member is arrested or detained.
Plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province. Members have
direct, toll-free access to their provider law firm rather than having to call
for a referral. At December 31, 2002, the Company had 1,382,306 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.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. According to the latest estimates
developed by the National Resource Center for Consumers of Legal Services
("NRC") for 2002, there were 164 million Americans without any type of legal
service plan. The NRC estimates 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. The
legal service plan industry continues to evolve and market acceptance of legal
service plans, as indicated by the continuing growth in the number of
individuals covered by plans, is increasing.
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association according to NRC estimates, and
accounted for approximately 56% of covered persons in 2002. The NRC estimates
that an additional 27% are covered by employee assistance plans that are also
automatic enrollment plans without direct cost to participants designed to
provide limited telephonic access to attorneys for members of employee groups.
Free plans and employee assistance plans therefore comprise approximately 83% of
covered persons in 2002. Employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit and the
Armed Forces are each estimated by the NRC to account for approximately 5% of
covered persons in 2002.
According to the NRC, the remaining covered persons in 2002 were covered by
individual enrollment plans, other employment based plans, including voluntary
payroll deduction plans, and miscellaneous plans. These plans were estimated by
the NRC to account for approximately 8% of the market in 2002 and represent the
market segment in which the Company primarily competes. According to the NRC,
these plans typically have more comprehensive benefits, higher utilization,
involve higher costs to participants, and are offered on an individual
enrollment or voluntary basis.
Of the current work force covered by legal service plans, only 7% were
estimated by the NRC to be covered by plans having full coverage. The Company
believes these plans include benefits comparable to those provided by the
Company's Memberships. Accordingly, the Company believes that significant
opportunities exist for successful marketing of the Company's Memberships to
employee groups and other individual consumers.
According to the latest estimates of the census bureaus of the United
States and Canada, currently the two geographic areas in which the Company
operates, the number of households in the combined area exceeds 127 million.
Since the Company has always disclosed its members in terms of Memberships and
individuals covered by the Membership include the individual who purchases the
Membership together with his or her spouse and never married children living at
home up to age 21 or up to age 23 if the children are full time college
students, the Company believes that its market share should be viewed as a
percentage of households. Historically, the Company's primary market focus has
been the "middle" eighty percent of such households rather than the upper and
lower ten percent segments based on the Company's belief that the upper ten
percent may already have a relationship with an attorney or law firm and the
lower ten percent may not be able to afford the cost of a legal service plan. As
a percentage of this defined "middle" market of approximately 100 million
households, the Company currently has an approximate 1.4% share of the estimated
market based on its existing 1.4 million active memberships and, over the last
30 years, an additional 3% of households have previously purchased, but no
longer own, memberships. The Company routinely remarkets to previous members and
reinstated approximately 57,000 and 54,000 Memberships during 2002 and 2001,
respectively.
Description of Memberships
The Memberships sold by the Company generally allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with the Company. Provider law firms are paid a monthly fixed fee on a
capitated basis to render services to plan members residing within the state or
province in which the provider law firm attorneys are licensed to practice.
Because the fixed fee payments by the Company to provider law firms do not vary
based on the type and amount of benefits utilized by the member, this capitated
arrangement provides significant advantages to the Company in managing claims
risk. At December 31, 2002, Memberships subject to the capitated provider law
firm arrangement comprised approximately 99% of the Company's active
Memberships. The remaining Memberships, approximately 1%, were primarily sold
prior to 1987 and allow members to locate their own lawyer ("open panel") to
provide legal services available under the Membership with the member's lawyer
being reimbursed for services rendered based on usual, reasonable and customary
fees, or are in states where there is no provider law firm in place and the
Company's referral attorney network is utilized.
Family Legal Plan
The Family Legal Plan currently marketed in most jurisdictions by the
Company consists of five basic benefit groups that provide coverage for a broad
range of preventive and litigation-related legal expenses. The Family Legal Plan
accounted for more than 91% of the Company's Membership fees in 2002 and
approximately 90% of the outstanding Memberships at December 31, 2002. In
addition to the Family Legal Plan, the Company markets other specialized legal
services products specifically related to employment in certain professions
described below.
In 12 states, the Company's plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and the Company has bilingual staff for both customer service and
marketing service functions. The Company will continue to evaluate making its
plans available in additional languages in markets where demand for such a
product is expected to be sufficient to justify this additional cost.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, the
Company has not raised rates to existing members. If new benefits become
available, existing members may choose the newer, more comprehensive plan at a
higher rate or keep their existing Memberships. Memberships are automatically
renewed at the end of each Membership period unless the member cancels prior to
the renewal date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $26.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Automobile Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. The Company has experienced increased sales of
this option during the last three years.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount. Provider law firms have agreed to provide to
members any legal services beyond those stipulated in the Membership at a fee
discounted 25% from the provider law firm's customary and usual hourly rate.
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 39 states, the Legal Shield plan can be added to the
standard or expanded Family Legal Plan for $1 per month and provides members
with 24-hour access to a toll-free number for provider law firm assistance if
the member is arrested or detained. The Legal Shield member, if detained, can
present their Legal Shield card to the officer that has detained them to make it
clear that they have access to legal representation and that they are requesting
to contact a lawyer immediately. The benefits of the Legal Shield plan are
subject to conditions imposed by the detaining authority, which may not allow
for the provider law firm to communicate with the member on an immediate basis.
There were approximately 613,000 Legal Shield subscribers at December 31, 2002
compared to approximately 591,000 at December 31, 2001.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. The Company began operations in
Ontario and British Columbia during 1999, Alberta in February 2001 and Manitoba
in August 2001. Benefits of the Canadian plan include expanded preventive
benefits including assistance with Canadian Government agencies, warranty
assistance and small claims court assistance as well as the preferred member
discount. Canadian Membership fees collected during 2002 were approximately $3.7
million in U.S. dollars compared to $4.3 million collected in 2001 and $3.8
million collected in 2000. The Company plans to expand operations in other
provinces and territories of Canada.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, the Company also
offers other specialty or niche legal service plans. These specialty plans
usually contain many of the Family Legal Plan benefits adjusted as necessary to
meet specific industry or prospective member requirements. In addition to those
specialty plans described below, the Company will continue to evaluate and
develop other such plans as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $75 to $125 depending on the
number of employees and provides business oriented legal service benefits for
any for-profit business with 99 or fewer employees. This plan is available in 40
states and represented approximately 4.0%, 3.8% and 5.5% of the Company's
Membership fees during 2002, 2001 and 2000, respectively.
Law Officers Legal Plan
The Law Officers Legal Plan, developed in 1991 and marketed to law
enforcement officers, provides 24-hour job-related emergency toll-free access to
a provider law firm and provides legal services associated with administrative
hearings. This plan was designed to meet the legal needs of persons in the law
enforcement profession and is currently marketed at the monthly rate of $16.00
or at a group rate of $14.95. The Company has members covered under the Law
Officers Legal Plan in 27 states. The Law Officers Legal Plan offers the basic
family legal plan benefits described above without the motor vehicle related
benefits. These motor vehicle benefits are available in the Law Officers Legal
Plan only for defense of criminal charges resulting from the operation of a
licensed motor vehicle. Additionally, at no charge to the member, a 24-hour
emergency hotline is available to access the services of the provider law firm
in situations of job-related urgency. The Law Officers Legal Plan also offers
representation at no additional charge for up to ten hours (five hours per
occurrence) for two administrative hearings or inquiries per year and one
pre-termination hearing per Membership year before a review board or arbitrator.
Preparation and/or counsel for post-termination hearings are also available to
members as a schedule of benefits, which increases with each Membership year.
The schedule of benefits is similar to that offered under the Family Legal Plan
Trial Defense, including the availability of the optional pre-trial hours
described above for an additional $9.00 per month. During the years ended
December 31, 2002, 2001 and 2000, the Law Officers Legal Plan accounted for
approximately 1.4%, 1.5% and 4.8%, respectively, of the Company's Membership
fees.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage on a closed panel plan basis for persons
who drive a commercial vehicle. This legal service plan is currently offered in
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, 2002, 2001 and 2000, this plan accounted for
approximately 1.3%, .9% and 2.5%, respectively, of Membership fees. The Plan
underwritten by the Road America Motor Club is available at the monthly rate of
$35.95 or at a group rate of $32.95. Plans underwritten by the Company are
available at the monthly rate of $32.95 or at a group rate of $29.95. Benefits
include the motor vehicle related benefits described above, defense of
Department of Transportation violations and the 25% discounted rate for services
beyond plan scope, such as defense of non-moving violations. The Road America
Motor Club underwritten plan includes bail and arrest bonds and services for
family vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 35 states and represented approximately 1.7%, 1.5% and .6% of the
Company's Membership fees during 2002, 2001 and 2000, respectively.
Comprehensive Group Legal Services Plan
The Company introduced in late 1999 the Comprehensive Group plan, designed
for the large group employee benefit market. This plan provides all the benefits
of the Family Legal Plan as well as mortgage document preparation, assistance
with uncontested legal situations such as adoptions, name changes, separations
and divorces. Additional benefits include the preparation of health care power
of attorney and living wills or directives to physicians. Although the Company
has not experienced any significant sales of this plan, the Company expects this
plan to improve its competitive position in the large group market.
Other than additional benefits such as the Legal Shield benefit 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 the Company consistent, accurate data about plan
utilization which enables the Company to mange its benefit costs through the
capitated payment structure to provider firms.
Provider Law Firms
The Company's Memberships generally allow members to access legal services
through a network of independent provider law firms under contract with the
Company generally referred to as "provider law firms." Provider law firms are
paid a fixed fee on a per capita basis to render services to plan members
residing within the state or province as provided by the contract. Because the
fixed fee payments by the Company to provider law firms in connection with the
Memberships do not vary based on the type and amount of benefits utilized by the
member, this arrangement provides significant advantages to the Company in
managing its cost of benefits. Pursuant to these provider law firm arrangements
and due to the volume of revenue directed to these firms, the Company has the
ability to more effectively monitor the customer service aspects of the legal
services provided and the financial leverage to help ensure a customer friendly
emphasis by the provider law firms. Generally, due to the volume of revenue that
may be directed to particular provider law firms, the Company has access to
larger, more diversified law firms. The Company, through its members, is
typically the largest client base of its provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, investigation by the Company of bar association standing and client
references, evaluation of the education, experience and areas of practice of
lawyers within the firm, on-site evaluations by Company management, and
interviews with lawyers in the firm who would be responsible for providing
services. Most importantly, these candidate law firms are evaluated on the
firm's customer service philosophy.
The majority of provider law firms are connected to the Company via
high-speed digital links to the Company's management information systems,
thereby providing real-time monitoring capability. This online connection offers
the provider law firm access to specially designed software developed by the
Company for administration of legal services by the firm. These systems provide
statistical reports of each law firm's activity and performance and allow
approximately 98% of members to be monitored on a near real-time basis. The few
provider law firms that are not online with the Company typically have a small
Membership base and must provide various weekly reports to the Company to assist
in monitoring the firm's service level. The combination of the online
statistical reporting and weekly service reports for smaller provider law firms
allows quality control monitoring of over 15 separate service delivery
benchmarks. In addition, the Company regularly conducts extensive random surveys
of members who have used the legal services of a provider law firm. The Company
surveys members in each state every 60 days, compiles the results of such
surveys and provides the provider law firms with copies of each survey and the
overall summary of the results. If a member indicates on a survey the service
did not meet their expectation, the member is contacted immediately to resolve
the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to the Company's online monitoring, member complaints, member
survey evaluations, telephone reports and other information developed in
connection with member service monitoring. If a problem is detected, immediate
remedial actions are recommended by the Company to the provider law firms to
eliminate service deficiencies. In the event the deficiencies of a provider law
firm are not eliminated through discussions and additional training with the
Company, such deficiencies may result in the termination of the provider law
firm. The Company is in constant communication with its provider law firms and
meets with them frequently for additional training, to encourage increased
communications with the Company and to share suggestions relating to the timely
and effective delivery of services to the Company's members.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless the Company waives this
requirement due to special circumstances such as instances when the lawyer
demonstrates significant legal experience acquired in an academic, judicial or
similar capacity other than as a lawyer. The Company provides customer service
training to the provider law firms and their support staff through on-site
training that allows the Company to observe the individual lawyers of provider
law firms as they directly assist the members.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit the
Company to terminate the Agreement for cause immediately upon written notice,
(c) require the firm to maintain a minimum amount of malpractice insurance on
each of its attorneys, in an amount not less than $100,000, (d) preclude the
Company from interference with the lawyer-client relationship, (e) provide for
periodic review of services provided, (f) provide for protection of the
Company's proprietary information and (g) require the firm to indemnify the
Company against liabilities resulting from legal services rendered by the firm.
The Company is precluded from contracting with other law firms to provide the
same service in the same geographic area, except in situations where the
designated law firm has a conflict of interest, the Company enrolls a group of
500 or more members, or when the agreement is terminated by either party.
Provider law firms are precluded from contracting with other prepaid legal
service companies without Company approval. Provider law firms receive a fixed
monthly payment for each member who are residents in the service area and are
responsible for providing the Membership benefits without additional
remuneration. If a provider law firm delivers legal services to an open panel
member, the law firm is reimbursed for services rendered according to the open
panel Membership. As of December 31, 2002, provider law firms averaged
approximately 60 employees each and on average are evenly split between support
staff and lawyers.
The Company has had occasional disputes with provider law firms, some of
which have resulted in litigation. The toll-free telephone lines utilized and
paid for by the provider law firms are owned by the Company so that in the event
of a termination, the members' calls can be rerouted very quickly. Nonetheless,
the Company believes that its relations with provider law firms are generally
very good. At the end of 2002 and 2001, the Company had provider law firms
representing 45 states and three provinces compared to 43 states and two
provinces at the end of 2000. During the last three calendar years, the
Company's relationships with a total of five provider law firms were terminated
by the Company or the provider law firm. As of December 31, 2002, 14 provider
law firms have been under contract with the Company for more than eight years
with the average tenure of all provider law firms being approximately 6 1/2
years.
The Company has an extensive database of referral lawyers who have provided
services to its members for use by members when a designated provider law firm
is not available. Lawyers with whom members have experienced verified service
problems, or are otherwise inappropriate for the referral system, are removed
from the Company's list of referral lawyers.
Marketing
Multi-Level Marketing
The Company markets Memberships through a multi-level marketing program
that encourages individuals to sell Memberships and allows individuals to
recruit and develop their own sales organizations. Commissions are paid only
when a Membership is sold and no commissions are paid based solely on
recruitment. When a Membership is sold, commissions are paid to the associate
making the sale, and to other associates (on average, 17 others at December 31,
2002 compared to 16 others at December 31, 2001) who are in the line of
associates who directly or indirectly recruited the selling associate. The
Company provides training materials, organizes area-training meetings and
designates personnel at the home office specially trained to answer questions
and inquiries from associates. The Company offers various communication avenues
to its sales associates to keep such associates informed of any changes in the
marketing of its Memberships. The primary communication vehicles utilized by the
Company to keep its sales associates informed include extensive use of email, an
interactive voice-mail service, The Connection monthly magazine, the weekly
Communication Show that may be heard via the Company's Internet webcasts, an
interactive voice response system, a monthly DVD (digital video disc) program
and the Company's website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. The Company's marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 73% of
the Company's Memberships in force at December 31, 2002 compared to 74% and 73%
at December 31, 2001 and 2000, respectively. Although other means of payment are
available, approximately 73% of fees on Memberships purchased by individuals or
families are paid on a monthly basis by means of automatic bank draft or credit
card.
The Company's marketing efforts towards employee groups, principally on a
payroll deduction payment basis, are designed to permit its sales associates to
reach more potential members with each sales presentation and strive to
capitalize on, among other things, what the Company perceives to be a growing
interest among employers in the value of providing legal service plans to their
employees. Memberships sold through employee groups constituted approximately
27% of total Memberships in force at December 31, 2002 compared to 26% and 27%
at December 31, 2001 and 2000, respectively. The majority of employee group
Memberships are sold to school systems, governmental entities and businesses. No
group accounted for more than 1% of the Company's consolidated revenues from
Memberships during 2002, 2001 or 2000. Substantially all group Memberships are
paid on a monthly basis. The Company has recently begun a legislative lobbying
effort to enhance the ability of the Company 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.
Sales associates are generally engaged as independent contractors and are
provided with training materials and are given the opportunity to participate in
Company training programs. Sales associates are required to complete a specified
training program prior to marketing the Company's Memberships to employee
groups. All advertising and solicitation materials used by sales associates must
be approved by the Company prior to use. At December 31, 2002, the Company had
341,116 "vested" sales associates compared to 286,488 and 242,085 "vested" sales
associates at December 31, 2001 and 2000, 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 2002, the
Company had 103,112 sales associates who personally sold at least one
Membership, of which 65,383 (63%) made first time sales. During 2000 and 1999
the Company had 81,613 and 73,826 sales associates producing at least one
Membership sale, respectively, of which 46,687 (57%) and 43,169 (58%),
respectively, made first time sales. During 2002, the Company had 12,738 sales
associates who personally sold more than ten Memberships compared to 13,749 and
11,055 in 2001 and 2000, respectively. A substantial number of the Company's
sales associates market the Company's Memberships on a part-time basis only.
The Company derives revenues from its multi-level marketing sales force,
principally from a one-time enrollment fee of $65 from each new sales associate
for which the Company provides initial marketing supplies and enrollment
services to the associate. In January 1997, the Company implemented a new
combination classroom and field training program, titled Fast Start to Success
("Fast Start"), aimed at increasing the level of new Membership sales per
associate. The Fast Start program provides a direct economic incentive to
existing associates to help train new recruits. Associates who successfully
complete the program by writing three new Memberships and recruiting three new
sales associates or by personally selling five new Memberships within 60 days of
the associate's start date advance through the various commission levels at a
faster rate and qualify for advance commissions. Associates in states that
require the associate to become licensed will have 60 days from the issue date
on their license to complete the same requirements. The program typically
requires a fee ranging from $34 to $184 per new associate, depending on special
promotions the Company implements from time to time, that is earned by the
Company upon completion of the training program. Upon successful completion of
the program (including the required sales of memberships), the sponsoring
associates may be paid certain training bonuses. Amounts collected from sales
associates are intended primarily to offset the Company's costs incurred in
recruiting and training and providing materials to sales associates and are not
intended to generate profits from such activities. Other revenues from sales
associates represent the sale of marketing supplies and promotional materials.
The Company's compensation plan for the multi-level marketing force is
under continuous review by the Company to assure that the various financial
incentives in the plan encourage the Company's desired goals. The Company offers
various incentive programs from time to time and frequently adjusts the program
to maintain appropriate incentives and to improve membership production and
retention.
Regional Vice Presidents
The Company has a group of employees that serve as Regional Vice Presidents
("RVPs") responsible for associate activity in a given geographic region and
with the ability to appoint independent contractors as Area Coordinators within
the RVP's region. The RVPs have weekly reporting requirements as well as
quarterly sales and recruiting goals. The RVP and Area Coordinator program
provides a basis to effectively monitor current sales activity, further educate
and motivate the sales force and otherwise enhance the relationships between the
associates and the Company. New products and initiatives will continue to be
channeled through the RVPs and Area Coordinators. At December 31, 2002, the
Company had 63 RVPs in place.
Pre-Paid Legal Benefits Association
The Pre-Paid Legal Benefits Association was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this association is open to sales associates that reach a certain
level within the Company's marketing programs who also maintain an active
personal legal services Membership. The Benefits Association is a separate
association not owned or controlled by the Company and is governed by a 16
member Board of Directors, including four officer positions. None of the
officers or directors of the Benefits Association serve in any such capacity
with the Company. The Benefits Association employs a Director of Associate
Benefits as well as a third-party benefits administration company, both paid by
the Association. Affinity programs available to members of the Benefits
Association include credit cards, long-distance plans including paging, wireless
services and Internet service provider offerings, real estate planning programs
and a travel club. As determined by its Board of Directors, some of the revenue
generated by the Benefits Association through commissions from vendors of the
benefit and affinity programs or contributed to the Benefits Association by the
Company may be used to make open-market purchases of the Company's stock for use
in awards to Benefit Association members based on criteria established by the
Benefits Association. Since inception and through December 31, 2002,
approximately 21,000 shares had been purchased by the Benefits Association for
future awards to its members. In 2002, the Benefits association decided to offer
cash in lieu of stock awards and the shares purchased by the Benefits
Association were sold to the Company on January 2, 2003 at the stock's closing
price to fund such awards.
Cooperative Marketing
The Company has in the past, and may in the future, develop marketing
strategies pursuant to which the Company seeks arrangements with insurance and
service companies that have established sales forces. Under such arrangements,
the agents or sales force of the cooperative marketing partner market the
Company's Memberships along with the products already marketed by the partner's
agents or sales force. Such arrangements allow the cooperative marketing partner
to enhance its existing customer relationships and distribution channels by
adding the Company's product to the marketing partner's existing range of
products and services, while the Company is able to gain broader Membership
distribution and access to established customer bases.
The Company has a cooperative marketing agreement with Atlanta-based
Primerica Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one
of the largest financial services marketing organizations in North America with
more than 100,000 personal financial analysts across the U.S. and Canada. The
PFS cooperative marketing agreement resulted in approximately 15,000 and 13,000
Memberships during 2002 and 2001, respectively.
The Company has had limited success with cooperative marketing arrangements
in the past and is unable to predict with certainty what success it
will achieve, if any, under its existing or future cooperative marketing
arrangements.
Operations
The Company's corporate operations involve Membership application
processing, member-related customer service, various associate-related services
including commission payments, receipt of Membership fees, related general
ledger accounting, and managing and monitoring the provider law firm
relationships.
The Company utilizes a management information system to control operations
costs and monitor benefit utilization. Among other functions, the system
evaluates benefit claims, monitors member use of benefits, and monitors
marketing/sales data and financial reporting records. Dominant company concerns
in the architecture of private networks and web systems include security,
capacity to accommodate peak traffic, disaster recovery, and scalability. The
Company believes its management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
required. The Company believes this excess capacity will enable it to experience
a significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
The Company has built a strong Internet presence to strengthen the services
provided to both members and associates. The Company's Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors, and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
The Company's operations also include departments specifically responsible
for marketing support and regulatory and licensing compliance. The Company has
an internal production staff that is responsible for the development of new
audio and video sales materials.
Quality Control
In addition to the Company's quality control efforts for provider law firms
described above, the Company also closely monitors the performance of its home
office personnel, especially those who have telephone contact with members or
sales associates. The Company records home office employee telephone calls with
its members and sales associates to assure that Company policies are being
followed and to gather data about recurring problems that may be avoided through
modifications in policies. The Company also uses such recorded calls for
training and recognition purposes.
Competition
The Company competes in a variety of market segments in the prepaid legal
services industry, including, among others, individual enrollment plans,
employee benefit plans and certain specialty segments. According to 2002
estimates by NRC, an estimated 35% of the total estimated market in the segments
in which the Company competes is served by a large number of small companies
with regional areas of emphasis or union-based automatic enrollment plans. The
remaining 65% of such market are served primarily by the Company and five other
principal competitors: Hyatt Legal Plans (a MetLife company), ARAG Group
(formerly Midwest Legal Services), LawPhone/ACS, National Legal Plan and Legal
Services Plan of America (a GE Financial Assurance Partnership Marketing Group
company, formerly the Signature Group). For employment-based plans other than
employer paid, union-based automatic enrollment plans and employee assistance
plans and for individual enrollment plans, the Company represents approximately
51% of the market share garnered by this group according to the NRC.
If a greater number of companies seek to enter the prepaid legal services
market, the Company will experience increased competition in the marketing of
its Memberships. However, the Company believes its competitive position is
enhanced by its actuarial database, its existing network of provider attorney
law firms and its ability to tailor products to suit various types of
distribution channels or target markets. The Company believes that no other
competitor has the ability to monitor the customer service aspect of the
delivery of legal services to the same extent the Company does. Serious
competition is most likely from companies with significant financial resources
and advanced marketing techniques.
Regulation
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, Secretaries of State, State Bar Associations and
State Attorney General offices depending on individual state opinions of
regulatory responsibility for legal expense plans. The Company is also required
to file with similar government agencies in Canada. While some states or
provinces regulate legal expense plans as insurance or specialized legal expense
products, others regulate them as services.
As of December 31, 2002, the Company or one of its subsidiaries was
marketing new Memberships in 35 states or provinces that require no special
licensing or regulatory compliance. The Company's subsidiaries serve as
operating companies in 16 states that regulate Memberships as insurance or
specialized legal expense products. The most significant of these wholly owned
subsidiaries are Pre-Paid Legal Casualty, Inc. ("PPLCI") and Pre-Paid Legal
Services, Inc. of Florida ("PPLSIF"). Of the Company's total Memberships in
force as of December 31, 2002, 34% were written in jurisdictions that subject
the Company or one of its subsidiaries to insurance or specialized legal expense
plan regulation.
The Company began selling Memberships in the Canadian provinces of Ontario
and British Columbia during 1999, Alberta during February 2001 and Manitoba
during August 2001. The Memberships currently marketed by the Company in such
provinces do not constitute an insurance product and therefore are exempt from
insurance regulation.
In states with no special licensing or regulatory requirements, the Company
commences operations only when advised by the appropriate regulatory authority
that proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
the Company or one of its subsidiaries would be required to qualify as an
insurance company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate the Company's forms, rates, trade practices, allowable
investments and licensing of agents and sales associates. These agencies also
prescribe various reports, require regular evaluations by regulatory
authorities, and set forth-minimum capital and reserve requirements. The
Company's insurance subsidiaries are routinely evaluated and examined by
representatives from the various regulatory authorities in the normal course of
business. Such examinations have not and are not expected to adversely impact
the Company's operations or financial condition in any material way. The Company
believes that all of its subsidiaries meet any required capital and reserve
requirements. Dividends paid by PPLCI are restricted under Oklahoma law to
available surplus funds derived from realized net profits.
The Company is required to register and file reports with the Oklahoma
Insurance Commissioner as a member of a holding company system under the
Oklahoma Insurance Holding Company System Regulatory Act. Transactions between
PPLCI and the Company or any other subsidiary must be at arms-length with
consideration for the adequacy of PPLCI's surplus, and must have prior approval
of the Oklahoma Insurance Commissioner. Payment of any extraordinary dividend by
PPLCI to the Company requires approval of the Oklahoma Insurance Commissioner.
During 2001, PPLCI declared a $5 million dividend payable to the Company which
was paid in 2002. During 2002, PPLCI declared a $6 million dividend which was
paid in December of 2002. Any change in control of the Company, defined as
acquisition by any method of more than 10% of the Company's outstanding voting
stock, including rights to acquire such stock by conversion of preferred stock,
exercise of warrants or otherwise, requires approval of the Oklahoma Insurance
Commissioner. Holding company laws in some states in which PPLCI operates, such
as Texas, provide for comparable registration and regulation of the Company.
Certain states have enacted special licensing or regulatory requirements
designed to apply only to companies offering legal service products. These
states most often follow regulations similar to those regulating casualty
insurance providers. Thus, the operating company may be expected to comply with
specific minimum capitalization and unimpaired surplus requirements; seek
approval of forms, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to the
Company by such subsidiaries. PPLSIF is subject to restrictions of this type
under the laws of the State of Florida, including restrictions with respect to
payment of dividends to the Company.
As the legal plan industry matures, additional legislation may be enacted
that would affect the Company and its subsidiaries. The Company cannot predict
with any accuracy if such legislation would be adopted or its ultimate effect on
operations, but expects to continue to work closely with regulatory authorities
to minimize any undesirable impact.
The Company's operations are further impacted by the American Bar
Association Model Rules of Professional Conduct ("Model Rules") and the American
Bar Association Code of Professional Responsibility ("ABA Code") as adopted by
various states. Arrangements for payments to a lawyer by an entity providing
legal services to its members are permissible under both the Model Rules and the
ABA Code, so long as the arrangement prohibits the entity from regulating or
influencing the lawyer's professional judgment. The ABA Code prohibits lawyer
participation in closed panel legal service programs in certain circumstances.
The Company's agreements with provider law firms comply with both the Model
Rules and the ABA Code. The Company relies on the lawyers serving as the
designated provider law firms for the closed panel benefits to determine whether
their participation would violate any ethical guidelines applicable to them. The
Company and its subsidiaries comply with filing requirements of state bar
associations or other applicable regulatory authorities.
The Company also is required to comply with state, provincial and federal
laws governing the Company's multi-level marketing approach. These laws
generally relate to unfair or deceptive trade practices, lotteries, business
opportunities and securities. The Company has experienced no material problems
with marketing compliance. In jurisdictions that require associates to be
licensed, the Company receives all applications for licenses from the associates
and forwards them to the appropriate regulatory authority. The Company maintains
records of all associates licensed, including effective and expiration dates of
licenses and all states in which an associate is licensed. The Company does not
accept new Membership sale applications from any unlicensed associate in such
jurisdictions.
Employees
At December 31, 2002, the Company and its subsidiaries employed 660
individuals on a full-time basis, exclusive of independent agents and sales
associates who are not employees. None of the Company's employees are
represented by a union. Management considers its employee relations to be good.
Foreign Operations
The Company began operations in the Canadian provinces of Ontario and
British Columbia during 1999, Alberta in February 2001 and Manitoba in August
2001 and derived aggregate revenues, including Membership fees and revenues from
associate services, from Canada of $4.0 million in U.S. dollars during 2002
compared to $4.4 million and $4.9 million in 2001 and 2000, respectively. Due to
the relative stability of the United States and Canadian foreign relations and
currency exchange rates, the Company believes that any risk of foreign
operations or currency valuations is minimal and would not have a material
effect on the Company's financial condition, liquidity or results of operations.
Availability of Information
The Company files periodic reports and proxy statements with the Securities
and Exchange Commission. The public may read and copy any materials the Company
files 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. The Company
files its 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.
The Company's Internet address is www.prepaidlegal.com. The Company makes
available on its website free of charge copies of its 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 the Company electronically files such
material with, or furnishes it to, the SEC.
ITEM 2. DESCRIPTION OF PROPERTY
The executive and administrative offices of the Company and its
subsidiaries are located at 321 East Main Street, Ada, Oklahoma. These offices,
containing approximately 40,000 square feet of office space, are owned by the
Company. Additionally, the Company completed construction during 1999, of a new
facility containing approximately 17,000 square feet of office and warehouse and
shipping space. The Company now has three buildings on its property located
approximately five miles from the Company's executive and administrative
offices. The Company previously completed construction of its Customer Care
facility during 1998 that contains approximately 10,000 square feet of office
and call center space. The Customer Care facility is adjacent to the material
distribution center constructed during 1997 containing 8,600 square feet that is
now used for general office space. The Company currently fully utilizes these
three existing facilities with combined square footage of more than 35,000
square feet and has begun construction of a new home office complex in Ada
located approximately five miles from its current location. The new home office
is being constructed on approximately 87 acres contributed to the Company by the
City of Ada in 2001 as part of an economic development incentive package. The
Company began construction in November 2001 and scheduled completion of the
estimated $30 million complex, which will include a sales associate Hall of Fame
and six-story tower, is September 2003. Costs incurred through December 31, 2002
of approximately $12.6 million, including $120,000 in capitalized interest
costs, have been paid from existing resources and $8.3 million outstanding on
its $20 million line of credit for its new office construction. The Company has
entered into construction contracts in the amount of $28.4 million with the
general contractor pertaining to the new office complex. Total remaining costs
of construction from January 1, 2003 are estimated at approximately $17.4
million.
In addition to the property described above that is owned by the Company,
the Company opened an additional Customer Care facility in Antlers, Oklahoma
during March 2000, in building space provided by the City of Antlers at no cost
to the Company. In conjunction with a rural economic development program
coordinated by the City of Antlers, a new facility was built at no cost to the
Company that can accommodate approximately 100 customer service representatives.
The Company leased the facilities from the City of Antlers upon completion of
the construction in November 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. Plaintiffs thereafter filed a motion requesting reconsideration of
the dismissal which was denied. The plaintiffs have appealed the judgment and
the order denying their motion to reconsider the judgment to the Tenth Circuit
Court of Appeals, and as of February 28, 2003, the case was in the briefing
stage. The Company is unable to predict when a decision will be made on this
appeal. In August 2002, the lead institutional plaintiff withdrew from the case,
leaving two individual plaintiffs as lead plaintiffs on behalf of the putative
class. The ultimate outcome of this case is not determinable.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On March 1, 2002, plaintiffs filed a consolidated
amended derivative complaint. The amended complaint alleges that the defendant
directors caused the Company to violate generally accepted accounting principles
and federal securities laws by improperly capitalizing commission expenses,
caused the Company to allegedly pay increased salaries and bonuses based upon
financial performance which was allegedly improperly inflated, and caused the
Company to expend significant dollars in connection with the defense of its
accounting policy, including cost incurred in connection with the defense of the
securities class action described above, and in connection with the repurchase
of its own shares on the open market at allegedly artificially inflated prices.
This derivative action is related to the putative securities class action
described above, which has been dismissed with prejudice. After the Pre-Paid
defendants moved to dismiss the consolidated amended derivative complaint, the
plaintiffs filed a voluntary dismissal of the case in August 2002 without
prejudice. The Pre-Paid defendants objected to the voluntary dismissal, but the
court approved the dismissal subject to plaintiffs' publishing notice to
shareholders and allowing a 30-day objection period regarding their proposed
dismissal without prejudice. Plaintiffs' notice was published on January 28,
2003 and the deadline for objections was February 28, 2003. On March 13, 2003
the case was dismissed without prejudice.
Beginning in the second quarter of 2001 and through December 31, 2002,
multiple lawsuits were filed against the Company, certain officers, employees,
sales associates and other defendants in various Alabama and Mississippi state
courts by current or former members seeking actual and punitive damages for
alleged breach of contract, fraud and various other claims in connection with
the sale of memberships. As of December 31, 2002, the Company was aware of 28
separate lawsuits involving approximately 298 plaintiffs that have been filed in
multiple counties in Alabama. One suit involving two plaintiffs which was filed
as a class action has been dismissed with prejudice as to the class allegations
and without prejudice as to the individual claims. As of December 31, 2002, the
Company was aware of 14 separate lawsuits involving approximately 428 plaintiffs
in multiple counties in Mississippi. Certain of the Mississippi lawsuits also
name the Company's provider attorney in Mississippi as a defendant. Proceedings
in the eleven cases which name the Company's provider attorney as a defendant
have been stayed for at least 90 days as to the provider attorney due to the
rehabilitation proceeding involving the provider law firm's insurer. At least
two complaints have been filed on behalf of certain of the Mississippi
plaintiffs and others with the Attorney General of Mississippi in March 2002 and
December 2002. The Company has responded to the Attorney General's requests for
information with respect to both complaints, and as of February 28, 2003, the
Company was not aware of any further actions being taken by the Attorney
General. In Mississippi, the Company has filed lawsuits in the United States
District Court for the Southern and Northern Districts of Mississippi in which
the Company seeks to compel arbitration of the various Mississippi claims under
the Federal Arbitration Act and the terms of the Company's membership
agreements, and has appealed the state court rulings in favor of certain of the
plaintiffs on the arbitration issue to the Mississippi Supreme Court. These
cases are all in various stages of litigation, including trial settings
beginning in Alabama in May, 2003, and seek varying amounts of actual and
punitive damages. While the amount of membership fees paid by the plaintiffs in
the Mississippi cases is $500,000 or less, certain of the cases seek damages of
$90 million. Additional suits of a similar nature have been threatened. The
ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against the Company and certain of its officers in the
District Court of Creek County, Oklahoma on behalf of Jeff and Jana Weller
individually and doing business as Hi-Tech Auto making similar allegations
relating to the Company's memberships and seeking unspecified damages on behalf
of a "nationwide" class. The Company's preliminary motions in this case have
been denied, and, as of February 28, 2003, the Company's appeal of the denial of
its motion to compel arbitration is pending before the Oklahoma Supreme Court.
The ultimate outcome of this case is not determinable.
On June 29, 2001, an action was filed against the Company in the District
Court of Canadian County, Oklahoma. In 2002, the petition was amended to add
five additional named plaintiffs and to add and drop certain claims. This action
is a putative class action brought by Gina Kotwitz, George Kotwitz, Rick Coker,
Richard Starke, Jeff Turnipseed and Aaron Bouren on behalf of all sales
associates of the Company. The amended petition seeks injunctive and declaratory
relief, with such other damages as the court deems appropriate, for alleged
violations of the Oklahoma Uniform Consumer Credit Code in connection with the
Company's commission advances, and seeks injunctive and declaratory relief
regarding the enforcement of certain contract provisions with sales associates.
The impact of the claims alleged under the Consumer Credit Code and the
assertion of entitlement to injunctive relief could exceed $315 million if
plaintiffs are successful both in their request for class certification and on
the merits. The plaintiffs' request for class certification is set for hearing
on July 22, 2003. The ultimate outcome of this case is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is a putative class action seeking unspecified
damages filed on behalf of all sales associates of the Company and alleges that
the marketing plan offered by the Company constitutes a security under the
Securities Act of 1933 and seeks remedies for failure to register the marketing
plan as a security and for violations of the anti-fraud provisions of the
Securities Act of 1933 and the Securities Exchange Act of 1934 in connection
with representations alleged to have been made in connection with the marketing
plan. The complaint also alleges violations of the Oklahoma Securities Act, the
Oklahoma Business Opportunities Sales Act, breach of contract, breach of duty of
good faith and fair dealing and unjust enrichment and violation of the Oklahoma
Consumer Protection Act and negligent supervision. This case is subject to the
Private Litigation Securities Reform Act. Pursuant to the Act, the Court has
approved the named plaintiffs and counsel and an amended complaint was filed in
August 2002. The Company filed motions to dismiss the complaint and to strike
the class action allegations on September 19, 2002. All discovery in the action
is stayed pending a ruling on the motion to dismiss. As of February 28, 2003,
all briefs had been filed by the parties on the motion to dismiss and a decision
on the motion will be made by the Court. The Company is unable to predict when a
decision will be made. The ultimate outcome of this case is not determinable.
In December 2002, the West Virginia Supreme Court reversed a summary
judgment which had been granted by the Circuit Court of Monangalia County, West
Virginia in favor of the Company in connection with the claims of a former
member, Georgia Poling and her daughters against the Company and a referral
lawyer with respect to a 1995 referral. That action was originally filed in
March 2000, and alleges breach of contract and fraud against the Company in
connection with the referral. The case is now scheduled for trial in August
2003, and plaintiffs seek actual and punitive damages in unspecified amounts.
The ultimate outcome of this case is not determinable.
On January 30, 2003, the Company announced that it had received a subpoena
from the office of the United States Attorney for the Southern District of New
York requesting information relating to trading activities in the Company's
stock in advance of the January 2003 announcement of recruiting and membership
production results for the fourth quarter of 2002. The Company also received
notice from the Securities and Exchange Commission that it is conducting an
informal inquiry into the same subject. The Company is cooperating fully in
responding to these requests. The ultimate outcome of these matters is not
determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in all proceedings in which it is named as a defendant. The Company
also receives periodic complaints or requests for information from various state
and federal agencies relating to its business or the activities of its marketing
force. The Company promptly responds to any such matters and provides any
information requested.
While the ultimate outcome of these proceedings is not determinable, the
Company does not currently anticipate that these contingencies will result in
any material adverse effect to its financial condition or results of operation,
unless an unexpected result occurs in one of the cases. The Company has
established an accrued liability it believes will be sufficient to cover
estimated damages in connection with various cases, which at December 31, 2002
was $3.3 million. If an unexpected result were to occur in one or more of the
pending cases, the amount of damages awarded could differ significantly from
management's estimates. The Company believes it has meritorious defenses in all
pending cases and will vigorously defend against the plaintiffs' claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Price of and Dividends on the Common Stock
At March 7, 2003, there were 5,529 holders of record (including brokerage
firms and other nominees) of the Company's common stock, which is listed on the
New York Stock Exchange under the symbol "PPD." The following table sets forth,
for the periods indicated, the range of high and low sales prices for the common
stock, as reported by the New York Stock Exchange.
High Low
2003:
1st Quarter (through March 7).. ..................... $ 26.80 $ 15.87
2002:
4th Quarter ......................................... $ 30.49 $ 17.04
3rd Quarter.......................................... 24.29 16.68
2nd Quarter...................... .................. 30.45 18.50
1st Quarter.......................................... 31.75 18.76
2001:
4th Quarter.......................................... $ 22.25 $ 15.05
3rd Quarter........................ ................. 22.48 15.80
2nd Quarter.......................................... 24.75 10.04
1st Quarter.......................................... 28.63 10.05
The Company has never declared a cash dividend on its common stock. For the
foreseeable future, it is anticipated that earnings generated from the
operations of the Company will be used to finance the Company's growth and to
purchase shares of its stock and that cash dividends will not be paid to holders
of the common stock. Additionally, the Company has lines of credit with Bank of
Oklahoma, N.A. as described in "Management's Discussion and Analysis - Liquidity
and Capital Resources," which prohibit payment of cash dividends on its common
stock. Any decision by the Board of Directors of the Company to pay cash
dividends in the future will depend upon, among other factors, the Company's
earnings, financial condition, capital requirements and approval from its
lender. In addition, the Company's ability to pay dividends is dependent in part
on its ability to derive dividends from its subsidiaries. The payment of
dividends by PPLCI is restricted under the Oklahoma Insurance Code to available
surplus funds derived from realized net profits and requires the approval of the
Oklahoma Insurance Commissioner for any dividend representing more than 10% of
such accumulated available surplus or an amount representing more than the
previous years' net profits. During 2002 and 2001, PPLCI declared a $6 million
and a $5 million dividend payable to the Company. Both the 2001 and 2002
dividends were paid during 2002. Additionally, during 2001, the Company received
a $2.8 million dividend from UFL after receiving all necessary regulatory
approvals. PPLSIF is similarly restricted pursuant to the insurance laws of
Florida. At December 31, 2002, PPLSIF did not have funds available for payment
of substantial dividends without the prior approval of the insurance
commissioner while PPLCI had approximately $3.5 million in surplus funds
available for payment of an ordinary dividend in December 2003. At December 31,
2002 the amount of restricted net assets of consolidated subsidiaries was $11.2
million.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plans
The following table provides information with respect to the Company's
equity compensation plans as of December 31, 2002, (other than its 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)................. 1,192,752 $26.69 15,250 (1)
Equity compensation plans not approved
by security holders (2).............. 305,640 23.72 - (2)
----------------------- -------------------- -------------------------
Total.................................. 1,498,392 $26.09 15,250
----------------------- -------------------- -------------------------
-----------
(1) These stock options have been issued pursuant to the Company's Stock Option
Plan which has been approved by security holders. At the Company's next
Annual Meeting of Shareholders on May 29, 2003, the Company expects to ask
security holders to approve the amendment of the Company's Stock Option
Plan to increase the maximum number of shares of Common Stock in respect of
which options may be granted under the Stock Option Plan from 2,000,000
shares to 3,000,000 shares.
(2) These stock options have been issued to the Company's Regional Vice
Presidents ("RVPs") (described above) in order to encourage stock ownership
by its RVPs and to increase the proprietary interest of such persons in its
growth and financial success. These options have been granted periodically
to RVPs since 1996. Options are granted at fair market value at the date of
the grant and are generally immediately exercisable for a period of three
years or within 90 days of termination, whichever occurs first. There were
244,679, 131,288 and 90,892 total options granted to RVPs in the years
ended December 31, 2002, 2001 and 2000, respectively. The Company has not
adopted any limit for the number of options that may be granted to RVPs.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data for
the Company as of the dates and for the periods indicated. As a result of the
1998 fourth quarter acquisition of TPN, Inc. ("TPN") that was accounted for as a
pooling of interests, the 1998 period has been restated to include the operating
results of TPN. This information is not necessarily indicative of the Company's
future performance. The following information should be read in conjunction with
the Company's Consolidated Financial Statements and Notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operation included elsewhere herein.
Year Ended December 31,
------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees...................................... $ 308,401 $ 263,514 $ 211,763 $ 153,918 $ 107,393
Associate services................................... 37,418 36,485 30,372 22,816 17,255
Product sales (2).................................... - 60 1,016 5,888 27,779
Other................................................ 4,804 3,602 3,232 3,809 2,901
---------- ---------- ---------- ---------- ----------
Total revenues..................................... 350,623 303,661 246,383 186,431 155,328
---------- ---------- ---------- ---------- ----------
Costs and expenses:
Membership benefits.................................. 103,761 87,429 69,513 51,089 35,465
Commissions.......................................... 119,371 111,060 96,614 74,333 50,652
Associate services and direct marketing.............. 32,566 29,879 23,251 15,815 14,738
General and administrative expenses.................. 33,256 28,243 21,524 19,280 21,902
Product costs (2).................................... - 33 675 4,174 17,967
Other, net........................................... 6,685 5,884 4,403 3,226 2,152
---------- ---------- ---------- ---------- ----------
Total costs and expenses........................... 295,639 262,528 215,980 167,917 142,876
---------- ---------- ---------- ---------- ----------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle.... 54,984 41,133 30,403 18,514 12,452
Provision for income taxes............................. 18,970 13,519 9,550 6,480 1,013
---------- ---------- ---------- ---------- ----------
Income from continuing operations before cumulative
effect of change in accounting principle............. 36,014 27,614 20,853 12,034 11,439
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit (expense) of
$0, $387 and ($444) for years 2001, 2000 and 1999,
respectively)........................................ - (504) 649 826 -
---------- ---------- ---------- ---------- ----------
Income before cumulative effect of change in accounting
principle............................................ 36,014 27,110 21,502 12,860 11,439
Cumulative effect of adoption of SAB 101 (net of
applicable income tax benefit of $546)............... - - (1,013) - -
---------- ---------- ---------- ---------- ----------
Net income............................................... 36,014 27,110 20,489 12,860 11,439
Less dividends on preferred shares..................... - - 4 10 10
---------- ---------- ---------- ---------- ----------
Net income applicable to common stockholders............. $ 36,014 $ 27,110 $ 20,485 $ 12,850 $ 11,429
---------- ---------- ---------- ---------- ----------
Basic earnings per common share from continuing operations
before cumulative effect of accounting change ......... $ 1.83 $ 1.28 $ .93 $ .52 $ .49
Basic earnings per common share from discontinued operations - (.02) .03 .04 -
---------- ---------- ---------- ---------- ----------
Basic earnings per common share before cumulative effect of
change in accounting principle....................... 1.83 1.26 .96 .56 .49
Cumulative effect of adoption of SAB 101................. - - (.05) - -
---------- ---------- ---------- ---------- ----------
Basic earnings per common share.......................... $ 1.83 $ 1.26 $ .91 $ .56 $ .49
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share from continuing
operations before cumulative effect of accounting change $ 1.82 $ 1.28 $ .92 $ .51 $ .48
Diluted earnings per common share from discontinued
operations........................................... - (.02) .03 .04 -
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share before cumulative
effect of accounting change.......................... 1.82 1.26 .95 .55 .48
Cumulative effect of adoption of SAB 101................. - - (.05) - -
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share........................ $ 1.82 $ 1.26 $ .90 $ .55 $ .48
---------- ---------- ---------- ---------- ----------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net income...................................................................... $ 21,502 $ 12,786 $ 11,155
Basic earnings per common share................................................. $ .96 $ .55 $ .48
Diluted earnings per common share............................................... $ .95 $ .55 $ .47
Weighted average number of common shares
outstanding - basic.................................. 19,674 21,504 22,504 23,099 23,456
Weighted average number of common shares
outstanding - diluted................................ 19,764 21,544 22,679 23,374 23,906
Membership Benefit Cost and Statistical Data:
Membership benefits ratio (1).......................... 33.6% 33.2% 32.8% 33.2% 33.0%
Commissions ratio (1).................................. 38.7% 42.1% 45.6% 48.3% 47.2%
General & administrative expense ratio (1)............. 10.8% 10.7% 10.2% 12.5% 20.4%
Product cost ratio (1)................................. - 55.0% 66.4% 70.9% 64.7%
Commission cost per new Membership sold................ $ 154 $ 152 $ 144 $ 141 $ 129
New Memberships sold................................... 773,767 728,295 670,118 525,352 391,827
Period end Memberships in force........................ 1,382,306 1,242,908 1,064,805 827,979 603,017
Cash Flow Data:
Net cash provided by continuing operating activities..... $ 52,073 $ 37,801 $ 23,201 $ 17,031 $ 11,295
Net cash (used in) provided by continuing investing
activities............................................ (11,074) (6,963) (7,965) 12,070 (33,531)
Net cash (used in) provided by continuing financing
activities............................................ (34,431) (27,414) (13,714) (26,687) 1,444
Balance Sheet Data:
Total assets........................................... $ 96,836 $ 85,720 $ 77,766 $ 58,156 $ 68,789
Total liabilities...................................... 61,864 43,496 35,999 25,518 23,218
Stockholders' equity .................................. 34,972 42,224 41,767 32,638 45,571
-----------
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. The product cost ratio represents product costs as a
percentage of product sales for those years in which the Company sold
products. These ratios do not measure total profitability because they do
not take into account all revenues and expenses.
(2) During the fourth quarter of 1998, the Company completed the acquisition of
TPN. Since its inception in late 1994, TPN had marketed personal and home
care products, personal development products and services together with
PRIMESTAR(R) satellite subscription television service to its members
through a network marketing sales force. Product sales declined and were
eventually eliminated following the TPN acquisition due to the
concentration on Membership sales as opposed to the sale of goods and
services.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Critical Accounting Policies
The Company's 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 the Company's
financial condition or operating results. Many of these "critical accounting
policies" are common in the insurance and financial services industries; others
are specific to the Company's businesses and operations. The Company's critical
accounting policies include revenue recognition related to membership and
associate fees, deferral of membership and associate related costs, accrual of
membership benefits liability, expense recognition related to commissions to
associates and accounting for legal contingencies.
Revenue recognition - Membership and Associate Fees
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis, of which approximately 71% are paid in advance and, therefore,
are deferred and recognized over the following month.
The Company also charges 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"). The Company computes
the expected Membership life using over 20 years of actuarial data as explained
in more detail in the Measures of Membership Retention section of MD&A. At
December 31, 2002, management computed the expected Membership life to be
approximately 3 years. If the expected membership life were to change
significantly, which management does not expect in the short term, the deferred
Membership enrollment fee and related costs would be recognized over a longer or
shorter period.
The Company derives revenues from services provided to its marketing sales
force from a one-time non-refundable enrollment fee of $65 from each new sales
associate for which the Company provides initial sales and marketing supplies
and enrollment services to the associate. 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 $54 of 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, 2002 is estimated to be approximately six months. 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, the deferred revenue and related costs will be recognized
over the new estimated active service period.
The Company also encourages participation in a training program ("Fast
Start") that allows an associate who successfully completes the program to
advance through the various commission levels at a faster rate. Associates
participating in this training program typically pay a fee ranging from $34 to
$184, depending on special promotions the Company implements from time to time.
The fee covers the additional training and materials used in the training
program, and is recognized in income upon completion of the training. Associate
services also includes revenue recognized on the sale of marketing supplies and
promotional material to associates and includes fees related to the Company's
eService program for associates. The eService program provides subscribers
Internet based back office support such as reports, on-line documents, tools, a
personal email account and up to three personalized web sites with "flash" movie
presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs the
Company incurs 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 as discussed above. Deferred costs that
will be recognized within one year of the balance sheet date are classified as
current and all remaining deferred costs are considered noncurrent. Associate
related costs are reflected as associate services and direct marketing, and are
expensed as incurred if not related to the deferred revenue discussed above.
These costs include providing materials and services to associates, Fast Start
bonuses, associate introduction kits, the associate incentive program, group
marketing and marketing services departments (including costs of related travel,
marketing events, leadership summits and international sales convention).
Membership Benefits Liability
Approximately 99% of active Memberships at December 31, 2002 have benefits
delivered by a designated provider law firm with whom the Company has arranged
for the services to be provided in a particular geographic area, typically a
state or province. Provider law firms receive a fixed monthly payment for each
member in their service area and are responsible for providing the Membership
benefits without additional remuneration. The fixed cost aspect of this
arrangement provides significant advantages to the Company in managing its
claims risk. Amounts due the provider law firms at period end under these
"capitated" agreements are included in the Membership benefits liability.
Membership benefit costs relating to non-provider Memberships ("open panel"
Memberships primarily sold prior to 1987 or Memberships in states where a
provider law firm is not in place), which constituted approximately 1% of
Memberships in force at December 31, 2002, are based on the usual, reasonable
and customary fee for providing the required services. Such costs are generally
paid on a current basis, as most costs are certain in amount and require only
limited investigation. The Company maintains a reserve for estimated incurred
but not reported open panel Membership benefit costs as well as costs which are
in the payment process. These reserves, which are recorded in the Membership
benefits liability, are reviewed annually by an independent actuary as necessary
in conjunction with the preparation and filing of financial statements and other
reports with various state insurance regulatory authorities. Underwriting risks
associated with the open panel Memberships are managed primarily through
contractual benefit limitations and, as a result, underwriting decisions are not
necessarily based on individual Membership purchases.
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, the Company
implemented a level commission schedule (approximately 27% per annum at December
31, 2001) with up to a three-year advance commission payment. Prior to March 1,
1995, the Company's commission program provided for advance commission payments
to associates of approximately 70% of first year Membership premiums on new
Membership sales and commissions were earned by the associate at a rate of
approximately 16% in all subsequent years. Effective March 1, 2002, and in order
to offer additional incentives for increased Membership retention rates, the
Company returned to a differential commission structure with rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from 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. Prior to March 1, 2002, the Company had a
level Membership commission schedule of approximately 27% of Membership fees,
with up to a three-year advance commission payment on new Membership sales.
Prior to January 1997 the Company advanced commissions at the time of sale
of all new Memberships. In January 1997, the Company implemented a policy
whereby the associate receives only earned commissions on the first three sales
unless the associate has successfully completed the Fast Start training program.
For all sales beginning with the fourth Membership or all sales made by an
associate successfully completing the Fast Start training program, the Company
currently advances commission payments at the time of sale of a new Membership.
The amount of cash potentially advanced upon the sale of a new Membership, prior
to the recoupment of any charge-backs (described below), represents an amount
equal to up to one-year commission earnings. Although the average number of
marketing associates receiving an advance commission payment on a new Membership
is 18, the overall initial advance may be paid to more than thirty different
individuals, each at a different level within the overall commission structure.
The commission advance immediately increases an associate's unearned advance
commission balance to the Company.
Although the Company, prior to March 1, 2002, advanced its sales associates
up to three years commission when a membership is sold and subsequent to March
1, 2002, up to one years commission, the average commission advance paid to its
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 the
Company pays less than a full advance on some of its specialty products. In
addition, the Company 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. Also, any residual
commissions due an associate (defined as commission on an individual membership
after the advance has been earned) are retained to reduce any remaining unearned
commission advance balances prior to being paid to that sales associate. The
commission cost per new Membership sold has increased over each of the last
three years by 1%, 6% and 2% for 2002, 2001 and 2000, respectively, and varies
depending on the compensation structure that is in place at the time a new
membership is sold and the amount of any charge-backs (recoupment of previous
commission advances) that are deducted from amounts that would otherwise be paid
to the various sales associates that are compensated for the membership sale.
Should the Company add additional commissions to its compensation plan or reduce
the amount of chargebacks collected from its associates, the commission cost per
new Membership will increase accordingly. The average commission advance in 2002
for the period subsequent to March 1, 2002 was 0.77 years and for the period
prior to March 1, 2002 was 2.06 years compared to the 2001 and 2000 averages of
approximately 2.18 years and 2.31 years, respectively.
The Company expenses advance commissions ratably over the first month of
the related membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates for the following years
ended December 31 were:
2002 2001 2000
---- ---- ----
(Amounts in 000's)
Beginning unearned advance commission balances (1)............... $ 211,609 $ 167,193 $ 125,257
Advance commissions, net......................................... 118,917 110,211 97,500
Earned commissions applied....................................... (101,030) (63,870) (48,255)
Advance commission write-offs (2)................................ (2,412) (1,925) (7,309)
----------- ----------- -----------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)..................................... 227,084 211,609 167,193
Estimated unrecoverable advance commission balances (1)(3)....... (25,156) (15,868) (11,055)
----------- ----------- -----------
Ending unearned advance commission balances, net (1)............. $ 201,928 $ 195,741 $ 156,138
----------- ----------- -----------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2) In 2000, the Company began writing off unearned advanced commission
balances rather than increasing the estimated unrecoverable balance when
the associate had no remaining active memberships since the associate would
no longer have any future commission earnings.
(3) Estimated unrecoverable advances increased as a percentage of ending
advances from 7% at December 31, 2001 to 11% at December 31, 2002 due to
the change in the compensation structure described above from a 36-month
possible advance to a 12-month possible advance. This change allows the
advances to be earned more quickly by the associate so the increase in
advances before estimated unrecoverable balances increased 7% from 2001 to
2002 compared to an increase of 27% from 2000 to 2001.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $26.0 million,
$20.0 million and $14.2 million at December 31, 2002, 2001 and 2000,
respectively. As such, at December 31, 2002 future commissions and related
expense will be reduced as unearned advance commission balances of $175.9
million are recovered. Commissions are earned by the associate as Membership
premiums are earned by the Company, usually on a monthly basis. The Company
reduces unearned advance commission balances or remits payment to an associate,
as appropriate, when commissions are earned. Should a Membership lapse before
the advances have been recovered for each commission level, the Company
generates an immediate "charge-back" to the applicable sales associate to
recapture up to 50% of any unearned advance on Memberships written prior to
March 1, 2002, and 100% on any Memberships written thereafter. This charge-back
is deducted from any future advances that would otherwise be payable to the
associate for additional new Memberships. In order to encourage additional
Membership sales, the Company waived chargebacks for associates that met certain
criteria in December 2002 and March 2003, which effectively increases the
Company's 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. The Company also has 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. The Company may adjust
chargebacks from time to time in the future in order to encourage certain
production incentives.
Prior to March 1, 2002, the Company charged associates a fee on unearned
advance commission balances relating to lapsed Memberships ("Membership lapse
fee"). The fee that was recorded on the associates unearned commission balance
was determined by applying the prime interest rate to the unearned advance
commission balance pertaining to lapsed Memberships. The Company realized and
recognized this fee only when the amount of the calculated fee was collected by
withholding from cash commission payments due the associate. The fees collected
reduced commission expense. The Company's ability to recover these fees was
primarily dependant on the associate selling new Memberships, which qualify for
commission advances. The Company eliminated the Membership lapse fee for
Memberships sold after March 1, 2002 in conjunction with the change in the
commission structure described above.
The Company has the contractual right to require associates to repay
unearned advance commission balances from sources other than earned commissions
including cash (a) from all associates either (i) upon termination of the
associate relationship, which includes but is not limited to when an associate
becomes non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, the Company has not demanded repayments of the
unearned advance commission balances from associates, including terminated
associates, because collection efforts would likely increase costs and have the
potential to disrupt the Company's relationships with its sales associates. This
business decision by the Company has a significant effect on the Company's cash
flow by electing to defer collection of advance payments of which approximately
$25.2 million were not expected to be collected from future commissions at
December 31, 2002. However, the Company regularly reviews the unearned advance
commission balance status of associates and will exercise its right to require
associates to repay advances when management believes that such action is
appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet the Company's established vesting requirements by selling at least
three new Memberships per quarter or retaining a personal Membership. Non-vested
associates lose their right to any further commissions earned on Memberships
previously sold at the time they become non-vested. As a result the Company has
no continuing obligation to individually account to these associates as it does
to active associates and is entitled to retain all commission earnings that
would be otherwise payable to these terminated associates. The Company does
continue to reduce the unearned advance commission balances for commissions
earned on active Memberships previously sold by those associates. Substantially
all individual non-vested associate unearned advance commission balances were
less than $1,000 and the average balance was $441 at December 31, 2002.
Although the advance commissions are expensed ratably over the first month
of the related Membership, the Company assesses, at the end of each quarter, on
an associate-by-associate basis, the recoverability of each associate's unearned
advanced commission balance by estimating the associate's future commissions to
be earned on active Memberships. Each active Membership is assumed to lapse in
accordance with the Company's estimated future lapse rate, which is based on the
Company's actual historical Membership retention experience as applied to each
active Membership's year of origin. The lapse rate is based on the Company's
more than 20-year history of Membership retention rates, which is updated
quarterly to reflect actual experience. The Company also closely reviews current
data for any trends that would affect the historical lapse rate. The sum of all
expected future commissions to be earned for each associate is then compared to
that associate's unearned advance commission balance. The Company estimates
unrecoverable advance commission balances when expected future commissions to be
earned on active Memberships (aggregated on an associate-by-associate basis) are
less than the unearned advance commission balance. If an associate with an
outstanding unearned advance commission balance has no active Memberships, the
unearned advance commission balance is written off 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 the Company to estimate future commission earnings.
Further, the Company's analysis of the recoverability of unearned advance
commission balances is also based on the assumption that the associate does not
write any new Memberships. The Company believes that this assessment methodology
is highly conservative since its actual experience is that many associates do
continue to sell new Memberships and the Company, through its chargeback rights,
gains an additional source to recover unearned advance commission balances.
Legal Contingencies
The Company is 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 the Company's 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. The
Company evaluates, among other factors, the degree of probability of an
unfavorable outcome and the ability to make a reasonable estimate of the amount
of loss. The Company has established an accrued liability it believes will be
sufficient to cover estimated damages in connection with various cases, which at
December 31, 2002 was $3.3 million. This process requires subjective judgment
about the likely outcomes of litigation. Liabilities related to most of the
Company's 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 the Company does 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 the Company's financial
condition, operating results or cash flows in particular quarterly or annual
periods. See "Legal Proceedings."
Operating Ratios
Three principal operating measures monitored by the Company in addition to
measures of Membership retention are the Membership benefit ratio, commission
ratio and the general and administrative expense ratio. The Membership benefits
ratio, the Commissions ratio and the general and administrative expense ratio
represent those costs as a percentage of Membership fees. The Company strives to
maintain these ratios as low as possible while at the same time providing
adequate incentive compensation to its sales associates and provider law firms.
These ratios do not measure total profitability because they do not take into
account all revenues and expenses.
Cash Flow Considerations Relating to Sales of Memberships
The Company generally advances significant commissions at the time a
Membership is sold. Since approximately 95% of Membership fees are collected on
a monthly basis, a significant cash flow deficit is created at the time a
Membership is sold. This deficit is reduced as monthly Membership fees are
remitted and no additional commissions are paid on the Membership until all
previous unearned advance commission balances have been fully recovered. Since
the cash advanced at the time of sale of a new Membership may be recovered over
a multi-year period, cash flow from operations may be adversely affected
depending on the number of new Memberships written in relation to the existing
active base of Memberships and the composition of new or existing sales
associates producing such Memberships.
Income Tax Matters-Net Operating Losses
The Company has a net operating loss carryforward ("NOL") in the amount of
$888,000 as of December 31, 2002 representing the remaining NOLs of TPN. The
ability of the Company to utilize NOLs and tax credit carryforwards to reduce
future federal income taxes is subject to various limitations under the Internal
Revenue Code of 1986, as amended, but the Company expects to fully utilize the
remaining TPN NOL in the income tax return for 2003.
Investment Policy
The Company's investment policy is to some degree controlled by certain
insurance regulations, which, coupled with management's own investment
philosophy, results in a conservative investment portfolio that is not risk
oriented. The Company's investments consist of common stocks, investment grade
(rated Baa or higher) preferred stocks and investment grade bonds primarily
issued by corporations, the United States Treasury, federal agencies, federally
sponsored agencies and enterprises, as well as mortgage-backed securities and
state and municipal tax-exempt bonds. The Company is required to pledge
investments to various state insurance departments as a condition to obtaining
authority to do business in certain states.
Disclosures About Market Risk
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to the
Company's significant investment in fixed-maturity investments, interest rate
risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing interest
rates generally translate into decreases and increases in fair values of those
instruments. Additionally, fair values of interest rate sensitive instruments
may be affected by the creditworthiness of the issuer, prepayment options,
relative values of alternative investments, liquidity of the instrument and
other general market conditions.
As of December 31, 2002, substantially all of the Company's investments
were in investment grade (rated Baa or higher) fixed-maturity investments and
interest-bearing money market accounts including certificates of deposit. The
Company does not hold any investments classified as trading account assets or
derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on the Company's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly, with
no effect given to any steps that management might take to counteract that
change.
The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table:
Hypothetical change Estimated fair value
in interest rate after hypothetical
Fair value (bp = basis points) change in interest rate
---------- ------------------- -----------------------
(Dollars in thousands)
Fixed-maturity investments at December 31, 2002 (1).... $ 16,111 100 bp increase $ 14,740
200 bp increase 13,806
50 bp decrease 16,310
100 bp decrease 16,794
Fixed-maturity investments at December 31, 2001 (1).... $ 18,983 100 bp increase $ 17,635
200 bp increase 16,437
50 bp decrease 19,575
100 bp decrease 20,167
--------------------
(1) Excluding short-term investments with a fair value of $2.7 million and $3.3
million at December 31, 2002 and 2001, respectively.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2002 would reduce
the estimated fair value of the Company's fixed-maturity investments by
approximately $2.3 million at that date. At December 31, 2001, and based on
the fair value of fixed-maturity investments of $19.0 million, an
instantaneous 200 basis point increase in market interest rates would have
reduced the estimated fair value of the Company's fixed-maturity
investments by approximately $2.5 million at that date. The Company's
decreased sensitivity to rising interest rates is due to the $2.9 million
decrease in fixed-maturity investments at December 31, 2002 of $16.1
million from $19.0 million at December 31, 2001. The definitive extent of
the interest rate risk is not quantifiable or predictable due to the
variability of future interest rates, but the Company does not believe such
risk is material.
The Company primarily manages its exposure to interest rate risk by
purchasing investments that can be readily liquidated should the interest rate
environment begin to significantly change.
Accounting Standards to be Adopted
In July 2001, the Financial Accounting Standards Board issued SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 143 requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred and a corresponding increase in the carrying
amount of the related long-lived asset. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company does not expect SFAS 143 to
materially impact its reported results.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections,
that, among other things, rescinded SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt. With the rescission of SFAS No. 4, the early
extinguishment of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002. The Company does not
anticipate that the adoption of SFAS No. 145 will have a material effect on its
financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which replaces Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The new standard required companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The statement is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company does not anticipate that the adoption of SFAS No. 146 will
have a material effect on its financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amended SFAS No. 123, Accounting
for Stock-Based Compensation. The new standard provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Additionally, the statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in the
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used in reported
results. This statement is effective for financial statements for fiscal years
ending after December 15, 2002. In compliance with SFAS No. 148, the Company has
elected to continue to follow the intrinsic value method in accounting for its
stock-based employee compensation arrangement as defined by APB No. 25.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. For a guarantee subject to FASB
Interpretation No. 45, a guarantor is required to measure and recognize the fair
value of the guarantee liability at inception. For many guarantees, fair value
will likely be determined using the expected present value method described in
FASB Concepts Statement 7, Using Cash Flow Information and Present Value in
Accounting Measurements. In addition, FIN 45 provides new disclosure
requirements. The disclosure requirements of FIN 45 were effective for the
Company as of December 31, 2002. The measurement and liability recognition
provisions are applied prospectively to guarantees or modifications after
December 31, 2002. The Company anticipates that FIN 45 will not have a material
impact on the financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). Subject to certain criteria defined in the
Interpretation, FIN 46 will require consolidation by business enterprises of
variable interest entities if the enterprise has a variable interest that will
absorb the majority of the entity's expected losses, receives a majority of its
expected returns, or both. The provisions of FIN 46 are effective immediately
for interests acquired in variable interest entities after January 31, 2003, and
at the beginning of the first interim or annual period beginning after June 15,
2003, for interests acquired in variable interest entities before February 1,
2003 (for the Company in the third quarter of 2003). The Company is in the
process of determining what impact, if any, the adoption of the provisions of
FIN 46 will have upon its financial condition or results of operations. Certain
transitional disclosures required by FIN 46 in all financial statements
initially issued after January 31, 2003, have been included in the accompanying
financial statements.
Measures of Member Retention
One of the major factors affecting the Company's profitability and cash
flow is the ability of the Company to retain a Membership, and therefore
continue to receive fees, once it has been sold. The Company monitors its
overall Membership persistency rate, as well as the retention rates with respect
to Memberships sold by individual associates and agents and retention rates with
respect to Memberships by year of issue, geographic region, utilization
characteristics and payment method, and other sub groupings.
Terminology
The following terms are used in describing the various measures of
retention:
o Membership life is a period that commences on the day of initial enrollment
of a member and continues until the individual's Membership eventually
terminates or lapses (the terms terminate or lapse may be used
interchangeably here).
o Membership age means the time since the Membership has been in effect.
o Lapse rate means the percentage of Memberships of a specified group of
Memberships that lapse in a specified time period.
o Retention rate is the complement of a lapse rate, and means the percentage
of Memberships of a specified group that remain in force at the end of a
specified time period.
o Persistency and retention are used in a general context to mean the
tendency for Memberships to continue to remain in force, while the term
persistency rate is a specific measure that is defined below.
o Lapse rates, retention rates, persistency rates, and expected Membership
life may be referred to as measures of Membership retention.
o Expected Membership life means the average number of years a new Membership
is expected to remain in force.
o Blended rate when used in reference to any measure of member retention
means a rate computed across a mix of Memberships of various Membership
ages.
o Expected remaining Membership life means the number of additional years
that an existing member is expected to continue to renew from a specific
point in time based on the Membership life.
Variations in Membership Retention by Sub-Groups, Impact on Aggregate
Numbers
Company wide measures of Membership retention include data relating to
members who can potentially be further sorted by identifiable sub-groupings. For
example, Memberships may be subdivided into those owned by members who are or
are not sales associates, to those who are or are not members of group plans,
etc.
Measures of Membership retention of different sub-groups may vary. For
example, the Company's experience indicates that first year retention rate of
Memberships owned by members who also are sales associates is approximately 10%
better than retention of Memberships owned by non-associate members. While this
correlation can be identified, the cause and effect relationship here cannot be
isolated. These sales associate members may have a financial incentive to retain
the Membership in order to continue to receive commissions. They also likely
have a better understanding and appreciation of the benefits of the Membership,
which may have contributed in fact to their decision to also become a sales
associate. Additionally, members who have accessed the services of the provider
law firms historically have higher retention rates than those who have not.
All aggregate measures of Membership retention or expected life may be
impacted by shifts in the underlying enrollment mix of sub-groups that have
different retention rates. For example Memberships owned by non-associate new
members have comprised an increasing percentage of new Memberships enrolled each
year over the past five years. Since non-associate members have a known lower
first year retention rate, a shift in mix alone will cause a reduction in
reported aggregate retention measures and expected member life, even if the
retention rates within each sub-group do not change. It is important to note
that all blended rates discussed here may reflect the impact of such shifts in
enrollment mixes. At December 31, 2002, 289,011 of the active 1,382,306
Memberships were also vested associates which represents 21% of the total active
Memberships. The following table shows total new Memberships sold during each
year and the number and percentage of Memberships sold to persons who are
associates.
Total New Associate
Year Memberships Memberships Ratio
---- ----------- ----------- -----
1998 391,827 69,890 17.8%
1999 525,352 85,219 16.2%
2000 670,118 90,684 13.5%
2001 728,295 103,515 14.2%
2002 773,767 119,326 15.4%
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, the Company has observed that Memberships in their first year have
a significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 48.2% of all new Memberships lapse during the first year, leaving 51.8%
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, 2002 the Company's blended retention rate and lapse rates based on
its historical experience for the last 21 years. The blended retention and lapse
rates as of the end of 2002 did not differ materially from those previously
reported at the end of 2001.
Membership Retention versus Membership Age
-----------------------------------------------------------
Membership Yearly Lapse Yearly End of Year
Year Rate Retention Memberships
------------ ------------ --------- -----------
0 100.0
1 48.2% 51.8% 51.8
2 30.2% 69.8% 36.2
3 21.1% 78.9% 28.6
4 17.0% 83.0% 23.7
5 15.2% 84.8% 20.1
6 11.8% 88.2% 17.7
7 9.4% 90.6% 16.1
Membership Persistency
The Company's Membership persistency rate is a specific computation that
measures the number of Memberships in force at the end of a year as a percentage
of the total of (i) Memberships in force at the beginning of such year, plus
(ii) new Memberships sold during such year. From 1981 through the year ended
December 31, 2002, the Company's annual Membership persistency rates, using the
foregoing method, have averaged approximately 72.4%.
Beginning New Memberships Ending
Year Memberships Total Memberships Persistency
------ ------------- ----------------- ---------- ------------- -------------
1998 425,381 391,827 817,208 603,017 73.8%
1999 603,017 525,352 1,128,369 827,979 73.4%
2000 827,979 670,118 1,498,097 1,064,805 71.1%
2001 1,064,805 728,295 1,793,100 1,242,908 69.3%
2002 1,242,908 773,767 2,016,675 1,382,306 68.5%
The Company's overall Membership persistency rate varies based on, among
other factors, the relative age of total Memberships in force, and shifts in the
mix of members enrolled. The Company's overall Membership persistency rate could
become lower when the Memberships in force include a higher proportion of newer
Memberships, as will happen following periods of rapid growth. The Company's
overall Membership persistency rate could also become lower when the new
enrollments include a higher proportion of non-associate members, a trend that
has been observed over the past five years.
Unless offset by other factors, these factors could result in a decline in
the Company's overall Membership persistency rate as determined by the formula
described above, but does not necessarily indicate that the new Memberships
written are less persistent.
Expected Membership Life, Expected Remaining Membership Life
Using historical data through 2002 for all past Members enrolled, the
expected Membership life can be computed to be approximately three years. This
number represents the average number of years a new Membership can be expected
to remain in force. Although about half of all new Memberships may lapse in the
first year, the expected Membership life is much longer due to the contribution
of higher annual retention rates in subsequent years.
Since the Company's experience is that the retention rate of a given
generation of new Memberships improves with Membership age, the expected
remaining Membership life of a Membership also increases with Membership age.
For example, while a new Membership may have an expected Membership life of
three years, the expected remaining Membership life of a Membership that reaches
its first year anniversary is approximately five years.
Since the actual population of Memberships in force at any time is a
distribution of ages from zero to more than 20 years, the expected remaining
Membership life of the entire population at large greatly exceeds three years
per Membership. As of December 31, 2002, based on the historical data described
above, the current expected remaining Membership life of the actual population
is over six years per Membership. This measure is used by the Company to
estimate the future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 20 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
Actions that May Impact Retention in the Future
The potential impact on the Company's future profitability and cash flow
due to future changes in Membership retention can be significant. While blended
retention rates have not changed significantly over the past five years, the
Company has recently taken actions that may impact retention rates in the
future. The Company has implemented several new initiatives aimed at improving
the retention rate of both new and existing Memberships. Such initiatives
include a revised compensation structure, effective March 1, 2002, featuring
variable renewal commission rates ranging from five to 25% per annum based on
the 12 month Membership retention rate of the associate's personal sales and
those of his organization; implementation of a "non-taken" administrative fee to
sales associates of $35 for any Membership application that is processed by the
Company after March 1, 2002, but for which a payment is never received; and, an
increase in the amount of the commission "charge-back" (described above) for
Memberships written after March 1, 2002 from 50% of the unearned Membership
commission advance balance to 100% of the unearned Membership commission advance
balance except during the months of December 2002 and March 2003 when the
Company waived chargebacks for associates that met certain criteria. The Company
has designed and implemented an enhanced member "life cycle" communication
process aimed at both increasing the overall amount of communication from the
Company to the members as well as more specific target messaging to members
based on the length of their Membership as well as utilization characteristics.
The Company believes that such efforts may increase the utilization by members
and therefore lead to higher retention rates. The Company's 2002 retention rates
did not differ materially from 2001 and the Company intends to continue to
develop programs and initiatives designed to improve retention.
Results of Operations
Comparison of 2002 to 2001
The Company reported net income applicable to common shares of $36.0
million, or $1.82 per diluted common share, for 2002. The net income per diluted
share was up 44% from net income applicable to common shares of $27.1 million,
or $1.26 per diluted common share, for 2001. The increase in the net income
applicable to common shares for 2002 is primarily the result of increases in
Membership fees for 2002 as compared to 2001 as well as a decrease in the
weighted average number of shares outstanding of 8%.
Membership fees totaled $308.4 million during 2002 compared to $263.5
million for 2001, an increase of 17%. 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 6%
during 2002 to 773,767 from 728,295 during 2001. At December 31, 2002, there
were 1,382,306 active Memberships in force compared to 1,242,908 at December 31,
2001, an increase of 11%. Additionally, the average annual fee per Membership
has increased from $251 for all Memberships in force at December 31, 2001 to
$256 for all Memberships in force at December 31, 2002, a 2% increase, as a
result of a higher portion of active Memberships containing the additional
pre-trial hours benefit at an additional cost to the member, a larger number of
Legal Shield subscribers and increased sales of the Company's business oriented
memberships.
Associate services revenue increased 3% from $36.5 million for 2001 to
$37.4 million during 2002 primarily as a result of more new associates enrolling
in the eService program offered by the Company. The eService fees totaled $11.2
million during 2002 compared to $7.3 million for 2001, an increase of 53%. This
increase was offset by the reduced fees for the Fast Start program for 2002. The
Company received training fees of approximately $13.1 million during 2002
compared to $17.5 million during 2001, primarily as a result of special training
promotions during 2002 that reduced the net amount of training fees received by
the Company. The field-training program, titled Fast Start to Success ("Fast
Start") is aimed at increasing the level of new Membership sales per associate.
In addition to the $65 associate fee, associates participating in this program
typically pay a fee ranging from $34 to $184, depending on special promotions
the Company implements from time to time and upon successful completion of the
program provides for the payment of certain training bonuses. In order to be
deemed successful for Fast Start purposes, the new associate must write three
new Memberships and recruit three new sales associates or personally sell five
Memberships within 60 days of becoming an associate. The $13.1 million and $17.5
million for 2002 and 2001, respectively, in training fees was collected from
approximately 150,247 new sales associates who elected to participate in Fast
Start in 2002 compared to 117,698 during 2001. New associates electing to
participate in Fast Start increased to 97% of new associates during 2002 from
96% for 2001. Total new associates enrolled during 2002 were 155,663 compared to
122,192 for 2000, an increase of 27%. Future revenues from associate services
will depend primarily on the number of new associates enrolled and the number
who choose to participate in the Company's training program, but the Company
expects that such revenues will continue to be largely offset by the direct and
indirect cost to the Company of training (including training bonuses paid),
providing associate services and other direct marketing expenses.
Other revenue increased 31%, from $3.7 million to $4.8 million primarily
due to the increase in Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $350.6 million for 2002 from $303.7 million during 2001, an
increase of 15%.
Membership benefits, which represents payments to provider law firms,
totaled $103.8 million for 2002 compared to $87.4 million for 2001, and
represented 34% and 33%, respectively of Membership fees. This Membership
benefit ratio (Membership benefits as a percentage of Membership fees) should
remain near current levels as substantially all active Memberships provide for a
capitated benefit in the absence of any changes in the capitated benefit level,
which has not changed significantly since 1993.
Commissions to associates increased 8% to $119.4 million for 2002 compared
to $111.1 million for 2001, and represented 39% and 42% of Membership fees for
such years. These amounts were reduced by $705,000 and $2.2 million,
respectively, representing Membership lapse fees. These fees were determined by
applying the prime interest rate to the unearned advance commission balance
pertaining to lapsed Memberships. The Company realizes and recognizes this fee
only when the amount of the calculated fee is collected by withholding from cash
commissions due the associate, because the Company's ability to recover fees in
excess of current payments is primarily dependent on the associate selling new
Memberships which qualify for advance commission payments. These fees were
eliminated for Memberships sold after March 1, 2002. Commissions to associates
are primarily dependent on the number of new memberships sold during a period.
New memberships sold during 2002 totaled 773,767, a 6% increase from the 728,295
sold during 2001.
Associate services and direct marketing expenses increased to $32.6 million
for 2002 from $29.9 million for 2001 primarily due to a $1.8 million increase in
the associate incentive program from $3.0 million to $4.8 million. Additional
costs of supplies due to increased enrollment of new associates, purchases by
associates and higher staffing requirements for associate related service
departments also contributed to the increase. These expenses also include the
costs of providing associate services and marketing expenses as discussed under
Member and Associate Costs.
General and administrative expenses during 2002 and 2001 were $33.3 million
and $28.2 million, respectively, and represented 11% of Membership fees for both
years. Management expects general and administrative expenses when expressed as
a percentage of Membership fees to remain relatively consistent over the near
term. The Company should experience cost efficiencies as a result of certain
economies of scale in some areas but expects such cost savings in 2003 to be
largely offset by higher levels of expenses related to legal fees and expenses
related to moving its corporate headquarters to its new facilities.
Other expenses, which includes depreciation and amortization, litigation
accruals and premium taxes reduced by interest income, increased 14% to $6.7
million for 2002 from $5.9 million for 2001. Depreciation and amortization
increased to $5.3 million for 2002 from $4.1 million for 2001. Due to the
increased amount of litigation during 2002, the Company increased the accrual by
$1.3 million to $3.3 million at December 31, 2002. Premium taxes decreased from
$2.5 million for 2001 to $2.2 million for 2002 due to a change in the tax
structure of one of the states in which the Company pays premium taxes. Interest
income increased to $2.1 million for 2002 from $1.9 million for 2001. At
December 31, 2002 the Company reported $41 million in cash and investments
(after utilizing $50.2 million to purchase approximately 2.3 million treasury
shares of its common stock during 2002) compared to $38 million at December 31,
2001.
The provision for income taxes increased during 2002 to $19.0 million
compared to $13.5 million for 2001, representing 34.5% and 32.9% of income from
continuing operations before income taxes for 2002 and 2001, respectively.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Income (loss) from discontinued operations, net of income tax, is $(504,000),
net of tax of $0 for the year ended December 31, 2001.
Comparison of 2001 to 2000
The Company reported net income applicable to common shares of $27.1
million, or $1.26 per diluted common share, for 2001. The net income per diluted
share was up 40% from net income applicable to common shares of $20.5 million,
or $.90 per diluted common share, for 2000. The increase in the net income
applicable to common shares for 2001 is primarily the result of increases in
Membership fees for 2001 as compared to 2000 as well as a decrease in the
weighted average number of shares outstanding of 5%.
Membership fees totaled $263.5 million during 2001 compared to $211.8
million for 2000, an increase of 24%. Membership fees and their impact on total
revenues in any period are determined directly by the number of active
Memberships in force during any such period. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales increased 9%
during 2001 to 728,295 from 670,118 during 2000. At December 31, 2001, there
were 1,242,908 active Memberships in force compared to 1,064,805 at December 31,
2000, an increase of 17%. Additionally, the average annual fee per Membership
has increased from $244 for all Memberships in force at December 31, 2000 to
$251 for all Memberships in force at December 31, 2001, a 3% increase, as a
result of a higher portion of active Memberships containing the additional
pre-trial hours benefit at an additional cost to the member.
Associate services revenue increased 20% from $30.4 million for 2000 to
$36.5 million during 2001 as a result of more new associates recruited and as a
result of Fast Start which resulted in the Company receiving training fees of
approximately $17.5 million during 2001 compared to $16.8 million during 2000.
The field-training program, titled Fast Start to Success ("Fast Start") is aimed
at increasing the level of new Membership sales per associate. Fast Start
typically requires a training fee of $184 per new associate, except for special
promotions the Company implements from time to time, and upon successful
completion of the program provides for the payment of certain training bonuses.
In order to be deemed successful for Fast Start purposes, the new associate must
write three new Memberships and recruit three new sales associates or personally
sell five Memberships within 60 days of becoming an associate. The $17.5 million
and $16.8 million for 2001 and 2000, respectively, in training fees was
collected from approximately 117,698 new sales associates who elected to
participate in Fast Start in 2001 compared to 91,432 during 2000. New associates
electing to participate in Fast Start increased to 96% of new associates during
2001 from 94% for 2000. Total new associates enrolled during 2001 were 122,192
compared to 97,617 for 2000, an increase of 25%.
Product sales declined 94% during 2001 to $60,000 from $1.0 million in 2000
primarily due to the concentration on Membership sales as opposed to the sale of
goods and services following the TPN acquisition. Product sales are expected to
cease in future periods as the Company no longer allows product sales.
Other revenue increased 11%, from $3.2 million to $3.6 million primarily
due to the increase in Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $303.7 million for 2001 from $246.4 million during 2000, an
increase of 23%.
Membership benefits totaled $87.4 million for 2001 compared to $69.5
million for 2000, and represented 33% of Membership fees for both years. This
Membership benefit ratio (Membership benefits as a percentage of Membership
fees) should remain near current levels as substantially all active Memberships
provide for a capitated benefit.
Commissions to associates increased 15% to $111.1 million for 2001 compared
to $96.6 million for 2000, and represented 42% and 46% of Membership fees for
such years. These amounts were reduced by $2.2 million and $1.8 million,
respectively, representing Membership lapse fees. These fees are determined by
applying the prime interest rate to the unearned advance commission balance
pertaining to lapsed Memberships. The Company realizes and recognizes this fee
only when the amount of the calculated fee is collected by withholding from cash
commissions due the associate, because the Company's ability to recover fees in
excess of current payments is primarily dependent on the associate selling new
Memberships which qualify for advance commission payments. These fees were no
longer applicable after March 1, 2002. Commissions to associates are primarily
dependent on the number of new memberships sold during a period. New memberships
sold during 2001 totaled 728,295, a 9% increase from the 670,118 sold during
2000.
Associate services and direct marketing expenses increased to $29.9 million
for 2001 from $23.3 million for 2000 primarily as a result of Fast Start
training bonuses paid of approximately $9.0 million during 2001 compared to $8.9
million in 2000. Additional costs of supplies due to increased enrollment of new
associates, purchases by associates and higher staffing requirements for
associate related service departments also contributed to the increase. These
expenses also include the costs of providing associate services and marketing
expenses as discussed under Member and Associate Costs.
General and administrative expenses during 2001 and 2000 were $28.2 million
and $21.5 million, respectively, and represented 11% and 10% of Membership fees
for such years. Management expects gradual decreases in general and
administrative expenses when expressed as a percentage of Membership fees as a
result of certain economies of scale.
Product costs declined more than $642,000, or 95%, during 2001 to $33,000
from $675,000 for 2000 in conjunction with the 94% decline in product sales.
Product costs as a percentage of product sales were 55% for 2001 compared to 66%
during 2000. Product costs are expected to cease in future periods as the
Company no longer allows product sales.
Other expenses, which includes depreciation and amortization, litigation
accruals and premium taxes reduced by interest income, increased 34% to $5.9
million for 2001 from $4.4 million for 2000. Depreciation and amortization
increased to $4.1 million for 2001 from $2.8 million for 2000. The Company's
litigation accrual has increased from $1.7 million at December 31, 2000 to $2.0
million at December 31, 2001 reflecting an additional accrual of $1.7 million
and a settlement payment of $1.4 million during 2001. Premium taxes increased
from $1.7 million for 2000 to $2.5 million for 2001. Interest income increased
to $1.9 million for 2001 from $1.8 million for 2000. At December 31, 2001 the
Company reported $38 million in cash and investments (after utilizing $27.9
million to purchase approximately 1.5 million treasury shares of its common
stock during 2001) compared to $32 million at December 31, 2000.
The provision for income taxes increased during 2001 to $13.5 million
compared to $9.6 million for 2000, representing 32.9% and 31.4% of income from
continuing operations before income taxes for 2001 and 2000, respectively.
Dividends paid on outstanding preferred stock decreased from $4,000 for
2000 to zero during 2001 due to all shares of preferred stock being converted
into shares of common stock or redeemed by the Company during the second quarter
of 2000.
The results of operations of the UFL segment have been segregated and
reported as discontinued operations in the Consolidated Statements of Income.
Income (loss) from discontinued operations, net of income tax, is $(504,000),
net of tax of $0 and $649,000 net of tax benefit of $387,000 for the years ended
December 31, 2001 and 2000, respectively.
Liquidity and Capital Resources
General
Consolidated net cash provided by operating activities of continuing
operations was $52.1 million, $37.8 million and $23.2 million for 2002, 2001 and
2000, respectively. Cash provided by operating activities increased $14.3
million during 2002 compared to 2001 primarily due to the $8.9 million increase
in net income, a $3.5 million decrease in the change in deferred member and
associate service costs, a $2.6 million decrease in the change in other assets
offset by a $2.0 million decrease in the change in deferred revenues.
Net cash used in investing activities of continuing operations was $11.1
million, $7.0 million and $8.0 million for 2002, 2001 and 2000, respectively.
During 2001 and 2000 the Company received dividends of $2.8 million and $5.0
million, respectively from UFL. Additionally, the Company received $1.2 million
in proceeds from the sale of UFL during 2001. In addition to capital
expenditures of $15.2 million, $8.3 million and $5.6 million during 2002, 2001
and 2000, respectively, the Company's purchases of available-for-sale
investments exceeded the maturities and sales of such investments by $2.6
million and $7.4 million in 2001 and 2000, respectively, but maturities and
sales exceeded purchases by $4.1 million during 2002.
Net cash used in financing activities of continuing operations was $34.4
million, $27.4 million and $13.7 million for 2002, 2001 and 2000, respectively.
This $7.0 million change during 2002 was primarily comprised of the $21.9
million increase in purchases of treasury stock offset by $4.1 million increase
in proceeds from sale of common stock on exercise of options and a $12.3
increase in proceeds from issuance of debt.
The Company had a consolidated working capital surplus of $2.7 million at
December 31, 2002, a decrease of $2.4 million compared to a consolidated working
capital surplus of $5.1 million at December 31, 2001, primarily due to the large
amount of treasury stock purchases in 2002 of approximately $50.2 million. The
$2.7 million working capital surplus at December 31, 2002 would have been an
$11.6 million working capital surplus excluding the current portion of deferred
revenue and fees in excess of the current portion of deferred member and
associate service costs. These amounts will be eliminated by the passage of time
without the utilization of other current assets or the Company incurring other
current liabilities. Additionally, at the current rate of cash flow provided by
continuing operations ($52.1 million during 2002), the Company's ability to
control the timing of its discretionary treasury stock purchases and the
availability pursuant to its lines of credit, the Company does not expect any
difficulty in meeting its financial obligations in the short term or the long
term.
The Company generally advances significant commissions to associates at the
time a Membership is sold. The Company expenses these advances ratably over the
first month of the related Membership. During 2002, the Company paid advance
commissions to associates of $118.9 million on new Membership sales compared to
$110.2 million for 2001. Since approximately 95% of Membership fees are
collected on a monthly basis, a significant cash flow deficit is created on a
per Membership basis at the time a Membership is sold. Since there are no
further commissions paid on a Membership during the advance period, the Company
typically derives significant positive cash flow from the Membership over its
remaining life. See Commissions to Associates above for additional information
on advance commissions.
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 7,000,000 shares during subsequent board meetings. At December 31,
2002, the Company had purchased 5.5 million treasury shares under these
authorizations for a total consideration of $125.1 million, an average price of
$22.76 per share. Treasury stock purchases will be made at prices that are
considered attractive by management and at such times that management believes
will not unduly impact the Company's liquidity. No time limit has been set for
completion of the treasury stock purchase program. Given the current interest
rate environment, the nature of other investments available and the Company's
expected cash flows, management believes that purchasing treasury shares
enhances shareholder value. The Company expects to continue its treasury stock
program and may seek alternative sources of financing to continue or accelerate
the program.
The Company believes that it has significant ability to finance expected
future growth in Membership sales based on its existing amount of cash and cash
equivalents and unpledged investments at December 31, 2002 of $36.4 million. The
Company expects 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.
As more fully discussed in Item-2 - Description of Property, the Company is
constructing a new corporate office complex with an estimated completion during
the third quarter of 2003 at an estimated cost of approximately $30 million.
Costs incurred through December 31, 2002 of approximately $12.6 million,
including approximately $120,000 of capitalized interest costs, have been paid
from existing resources and the real estate line of credit. The Company expects
to incur additional indebtedness in order to finance the remaining costs of its
new corporate headquarters in order to allow cash flow from operations to
continue to be used to purchase treasury stock. The Company has entered into
construction contracts in the amount of $28.2 million with the general
contractor pertaining to the new office complex. Total remaining costs of
construction from January 1, 2003 are estimated at approximately $17.4 million.
On June 11, 2002, the Company entered into two line of credit agreements
totaling $30 million with a commercial lender providing for a treasury stock
purchase line and a real estate line for funding of the Company's new corporate
office complex. The treasury stock line of credit provides for funding of up to
$10 million to finance treasury stock purchases through March 31, 2003 with
scheduled monthly repayments beginning after the initial advance and ending no
later than March 31, 2004 with interest at the 30 day LIBOR Rate plus two
percent, adjusted monthly. The real estate line of up to $20 million may be
funded over the period ending December 31, 2003 with interest at the 30 day
LIBOR Rate plus 2.25%, adjusted monthly, and will be repayable beginning after
the advance period in monthly principal payments equal to the principal balance
outstanding at December 31, 2003 divided by 105 plus interest with a balloon
payment on September 30, 2008.
As of December 31, 2002, the Company had accessed $4 million of the $10
million treasury stock purchase line and made repayments of $1.7 million and had
accessed $8.3 million of the $20 million real estate line. The interest rates as
of December 31, 2002 are 3.44% and 3.69% for the treasury stock loan and the
real estate loan, respectively. The $2.3 million used to purchase treasury
stock, net of repayments of $1.7 million, is scheduled to be paid off by July
30, 2003 and therefore has been classified as short term. Monthly principal
payments on the treasury stock line are $333,333. The Company is scheduled to
begin payments on the real estate line on December 31, 2003. As of December 31,
2002, interest capitalized pursuant to the real estate line was $120,000
Parent Company Funding and Dividends
Although the Company is the operating entity in many jurisdictions, the
Company's subsidiaries serve as operating companies in various states that
regulate Memberships as insurance or specialized legal expense products. The
most significant of these wholly owned subsidiaries are PPLCI and PPLSIF. The
ability of PPLCI and PPLSIF to provide funds to the Company is subject to a
number of restrictions under various insurance laws in the jurisdictions in
which PPLCI and PPLSIF conduct business, including limitations on the amount of
dividends and management fees that may be paid and requirements to maintain
specified levels of capital and reserves. In addition PPLCI will be required to
maintain its stockholders' equity at levels sufficient to satisfy various state
or provincial regulatory requirements, the most restrictive of which is
currently $3 million. Additional capital requirements of PPLCI or PPLSIF will be
funded by the Company in the form of capital contributions or surplus
debentures. At December 31, 2002, PPLSIF did not have funds available for
payment of substantial dividends without the prior approval of the insurance
commissioner. PPLCI had approximately $3.5 million in surplus funds available
for payment of an ordinary dividend during December 2003. At December 31, 2002
the amount of restricted net assets of consolidated subsidiaries was $11.2
million.
Commitments
The following table reflects certain of the Company's commitments as of
December 31, 2002.
Payments Due by Period (In Thousands)
-----------------------------------------------------------
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
--------------------------------------------------- ---------- ---------- ---------- ---------- ----------
Long-term debt..................................... $ 10,633 $ 2,358 $ 596 $ 596 $ 7,083
Capital leases..................................... 1,857 42 142 142 1,531
Operating leases................................... 115 72 32 11 -
Contractual obligations related to construction in
progress......................................... 18,982 18,982 - - -
---------- ---------- ---------- ---------- ----------
Total $ 31,587 $ 21,454 $ 770 $ 749 $ 8,614
---------- ---------- ---------- ---------- ----------
The foregoing table does not include contractual commitments pursuant to
executory contracts for products and services such as telephone, data, computer
maintenance, attorney provider payments and other regular payments pursuant to
contracts that are expected to remain in existence for several years but as to
which the Company's obligations are contingent upon the Company's continued
receipt of the contracted products and services.
Forward-Looking Statements
All statements in this report concerning Pre-Paid Legal Services, Inc. (the
"Company") other than purely historical information, including but not limited
to, statements relating to the Company's future plans and objectives,
discussions with the staff of the SEC, expected operating results, and the
assumptions on which such forward-looking statements are based, constitute
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are based
on the Company's historical operating trends and financial condition as of
December 31, 2002 and other information currently available to management. The
Company cautions that the Forward-Looking Statements are subject to all the
risks and uncertainties incident to its business, including but not limited to
risks described below. Moreover, the Company may make acquisitions or
dispositions of assets or businesses, enter into new marketing arrangements or
enter into financing transactions. None of these can be predicted with certainty
and, accordingly, are not taken into consideration in any of the Forward-Looking
Statements made herein. For all of the foregoing reasons, actual results may
vary materially from the Forward-Looking Statements. The Company assumes no
obligation to update the Forward-Looking Statements to reflect events or
circumstances occurring after the date of the statement.
Risk Factors
There are a number of risk factors which could affect our financial
condition or results of operations.
Our future results may be adversely affected if membership persistency or
renewal rates are lower than our historical experience.
The Company has over 20 years of actual historical experience to measure
the expected retention of new members. These retention rates could be adversely
affected by the quality of services delivered by provider law firms, the
existence of competitive products or services, the Company's ability to provide
administrative services to members or other factors. If the Company's membership
persistency or renewal rates are less than the Company has historically
experienced, the Company's cash flow, earnings and growth rates could be
adversely affected.
The Company may not be able to grow memberships and earnings at the same
rate as it has historically experienced.
The Company's year end active memberships have increased 11%, 17% and 29%
in the years ended December 31, 2002, 2001 and 2000, respectively. Net income
applicable to common stockholders for the same three years has increased 33%,
32% and 59%, respectively. However, in the fourth quarter of 2002, the Company
experienced its first decline in new memberships sold and associates recruited
compared to the comparable quarter of the prior year. The Company's ability to
grow memberships and earnings is substantially dependent upon its ability to
expand or enhance the productivity of its sales force, develop additional legal
expense products, develop alternative marketing methods or expand
geographically. There is no assurance that the Company will be able to achieve
increases in membership and earnings growth comparable to its historical growth
rates.
The Company is dependent upon the continued active participation of its
principal executive officer.
The success of the Company depends substantially on the continued active
participation of its principal executive officer, Harland C. Stonecipher.
Although the Company's management includes other individuals with significant
experience in the business of the Company, the loss of the services of Mr.
Stonecipher could have a material adverse effect on the Company's financial
condition and results of operations.
There is litigation pending that may have a material adverse effect on the
Company if adversely determined.
See "Item 3. Legal Proceedings".
The Company is in a regulated industry and regulations could have an
adverse effect on the Company's ability to conduct its business.
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, State Bar Associations and State Attorney General's
Offices, depending on individual state positions regarding regulatory
responsibility for prepaid legal expense plans. Regulation of the Company's
activities is inconsistent among the various states in which the Company does
business with some states regulating legal expense plans as insurance or
specialized legal expense products and others regulating such plans as services.
Such disparate regulation requires the Company to structure its memberships and
operations differently in certain states in accordance with the applicable laws
and regulations. The Company's multi-level marketing strategy is also subject to
U.S. federal, Canadian provincial and U.S. state regulation under laws relating
to consumer protection, pyramid sales, business opportunity, lotteries and
multi-level marketing. Changes in the regulatory environment for the Company's
business could increase the compliance costs the Company incurs in order to
conduct its business or limit the jurisdictions in which the Company is able to
conduct business.
The business in which the Company operates is competitive.
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect the Company's
ability to grow. In addition, the Company may face competition from a growing
number of Internet based legal sites with the potential to offer legal and
related services at competitive prices. Increased competition could have a
material adverse effect on the Company's financial condition and results of
operations. See "Description of Business - Competition".
The Company is dependent upon the success of its marketing force.
The Company's principal method of product distribution is through
multi-level marketing. The success of a multi-level marketing force is highly
dependent upon the Company's ability to offer a commission and organizational
structure and sales training and incentive program that enable sales associates
to recruit and develop other sales associates to create an organization. There
are a number of other products and services that use multi-level marketing as a
distribution method and the Company must compete with these organizations to
recruit, maintain and grow its multi-level marketing force. In order to do so,
the Company may be required to increase its marketing costs through increases in
commissions, sales incentives or other features, all of which could adversely
affect the Company's future earnings. In addition, the level of confidence of
the sales associates in the Company's ability to perform is an important factor
in maintaining and growing a multi-level marketing force. Adverse financial
developments concerning the Company, including negative publicity or common
stock price declines, could adversely affect the ability of the Company to
maintain the confidence of its sales force.
The Company's stock price may be affected by the significant level of short
sellers of the Company's stock.
As of February 11, 2003, the New York Stock Exchange reported that
approximately 10.3 million shares of the Company's stock were sold short, which
constitutes approximately 58% of the Company's outstanding shares and 82% of its
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
the Company's shares decline in value. The Company has 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 the Company's stock price and may adversely affect
the ability of the Company's stock price to rise if market conditions or the
Company's performance would otherwise justify a price increase.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Included in Item 7 on page 21.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants
Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2002 and 2001
Consolidated Statements of Income - For the years ended December 31, 2002, 2001
and 2000
Consolidated Statements of Cash Flows - For the years ended December 31, 2002,
2001 and 2000
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2002, 2001 and 2000
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 CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. and subsidiaries (the "Company") as of December 31, 2002 and
2001, 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, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
We have also audited Schedule I of Pre-Paid Legal Services, Inc. as of December
31, 2002 and 2001 and for each of the three years in the period ended December
31, 2002. 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 set forth therein.
As discussed in Note 1, during 2000 the Company changed certain of its revenue
recognition policies as a result of the adoption of Staff Accounting Bulletin
No. 101 "Revenue Recognition in Financial Statements."
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 18, 2003
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
-----------------------
2002 2001
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 20,858 $ 14,290
Available-for-sale investments, at fair value........................................ 3,970 6,070
Membership income receivable......................................................... 5,247 5,472
Inventories.......................................................................... 1,212 922
Refundable income taxes.............................................................. 275 -
Deferred member and associate service costs.......................................... 13,639 14,228
Deferred income taxes................................................................ 4,603 3,413
---------- ----------
Total current assets............................................................. 49,804 44,395
Available-for-sale investments, at fair value.......................................... 11,560 13,386
Investments pledged.................................................................... 4,160 4,315
Property and equipment, net............................................................ 25,593 14,755
Deferred member and associate service costs............................................ 2,991 2,907
Other assets........................................................................... 2,728 5,962
---------- ----------
Total assets................................................................... $ 96,836 $ 85,720
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 8,610 $ 7,664
Deferred revenue and fees............................................................ 22,612 20,893
Current portion of capital leases payable............................................ 14 -
Current portion of notes payable..................................................... 2,412 -
Income taxes payable................................................................. - 1,087
Accounts payable and accrued expenses................................................ 13,498 9,678
---------- ----------
Total current liabilities.......................................................... 47,146 39,322
Capital leases payable............................................................... 912 -
Notes payable........................................................................ 8,221 -
Deferred revenue and fees............................................................ 4,266 4,158
Deferred income taxes ............................................................... 1,319 16
---------- ----------
Total liabilities................................................................ 61,864 43,496
---------- ----------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 23,688 and
24,806 issued at December 31, 2002 and 2001, respectively.......................... 237 248
Capital in excess of par value....................................................... 43,219 66,223
Retained earnings.................................................................... 90,254 54,240
Accumulated other comprehensive income............................................... 290 186
Treasury stock, at cost; 4,852 and 3,989 shares held at
December 31, 2002 and 2001, respectively........................................... (99,028) (78,673)
---------- ----------
Total stockholders' equity....................................................... 34,972 42,224
---------- ----------
Total liabilities and stockholders' equity..................................... $ 96,836 $ 85,720
---------- ----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
Year Ended December 31,
------------------------------------------
2002 2001 2000
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 308,401 $ 263,514 $ 211,763
Associate services................................................... 37,418 36,485 30,372
Other................................................................ 4,804 3,662 4,248
------------- ------------- -------------
350,623 303,661 246,383
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 103,761 87,429 69,513
Commissions.......................................................... 119,371 111,060 96,614
Associate services and direct marketing.............................. 32,566 29,879 23,251
General and administrative........................................... 33,256 28,243 21,524
Other, net........................................................... 6,685 5,917 5,078
------------- ------------- -------------
295,639 262,528 215,980
------------- ------------- -------------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle.................. 54,984 41,133 30,403
Provision for income taxes............................................. 18,970 13,519 9,550
------------- ------------- -------------
Income from continuing operations before cumulative effect
of change in accounting principle.................................... 36,014 27,614 20,853
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit of $0 and $387 for years
2001 and 2000, respectively)......................................... - (504) 649
------------- ------------- -------------
Income before cumulative effect of change in accounting principle...... 36,014 27,110 21,502
Cumulative effect of adoption of SAB 101 (net of applicable
income tax benefit of $546).......................................... - - (1,013)
------------- ------------- -------------
Net income............................................................. 36,014 27,110 20,489
Less dividends on preferred shares..................................... - - 4
------------- ------------- -------------
Net income applicable to common stockholders........................... $ 36,014 $ 27,110 $ 20,485
------------- ------------- -------------
Basic earnings per common share from continuing operations
before cumulative effect of accounting change........................ $ 1.83 $ 1.28 $ .93
Basic earnings per common share from discontinued operations........... - (.02) .03
------------- ------------- -------------
Basic earnings per common share before cumulative effect of accounting
change............................................................... 1.83 1.26 .96
Cumulative effect of adoption of SAB 101............................... - - (.05)
------------- ------------- -------------
Basic earnings per common share........................................ $ 1.83 $ 1.26 $ .91
------------- ------------- -------------
Diluted earnings per common share from continuing operations
before cumulative effect of accounting change........................ $ 1.82 $ 1.28 $ .92
Diluted earnings per common share from discontinued operations......... - (.02) .03
------------- ------------- -------------
Diluted earnings per common share before cumulative effect of
accounting change.................................................... 1.82 1.26 .95
Cumulative effect of adoption of SAB 101............................... - - (.05)
------------- ------------- -------------
Diluted earnings per common share...................................... $ 1.82 $ 1.26 $ .90
------------- ------------- -------------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net Income....................................................................................... $ 21,502
-------------
Basic earnings per common share.................................................................. $ .96
-------------
Diluted earnings per common share................................................................ $ .95
-------------
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,
-----------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net income................................................................$ 36,014 $ 27,110 $ 20,489
Cumulative change in accounting principle................................. - - 1,013
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss (income) from UFL's discontinued operations........................ - 504 (649)
Provision (benefit) for deferred income taxes........................... 102 (1,314) (550)
Depreciation and amortization........................................... 5,272 4,135 2,770
Tax benefit on exercise of stock options................................ 1,104 82 1,044
Compensation expense relating to contribution of stock to ESOP.......... 207 162 130
Decrease (increase) in accrued Membership income........................ 225 (909) (1,409)
(Increase) decrease in inventories...................................... (290) 620 (100)
(Increase) in refundable income taxes................................... (275) - -
Decrease in prepaid product commissions................................. - - 125
Decrease (increase) in deferred member and associate service costs...... 505 (3,016) (8,521)
Decrease (increase) in other assets..................................... 3,234 614 (1,059)
Increase in accrued Membership benefits................................. 946 833 1,579
Increase in deferred revenue and fees................................... 1,827 3,838 10,370
(Decrease) increase in income taxes payable............................. (1,087) 327 (1,053)
Increase (decrease) in accounts payable and
accrued expenses and other............................................ 4,289 4,815 (978)
------------ ------------ ------------
Net cash provided by operating activities of continuing operations.... 52,073 37,801 23,201
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sale of UFL............................................... - 1,200 -
Dividends received from UFL............................................. - 2,800 5,000
Additions to property and equipment..................................... (15,184) (8,326) (5,577)
Purchases of investments - available for sale........................... (12,280) (12,642) (8,501)
Maturities and sales of investments - available for sale................ 16,390 10,005 1,113
------------ ------------ ------------
Net cash used in investing activities
of continuing operations............................................ (11,074) (6,963) (7,965)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from sale of common stock on exercise of options............... 5,088 1,022 4,110
Decrease in capital lease obligations................................... - (223) (330)
Purchases of treasury stock............................................. (50,152) (28,213) (17,323)
Proceeds from issuance of debt.......................................... 12,300 - -
Repayments of debt...................................................... (1,667) - -
Redemption of preferred stock........................................... - - (167)
Dividends paid on preferred stock....................................... - - (4)
------------ ------------ ------------
Net cash used in financing activities of continuing operations........ (34,431) (27,414) (13,714)
------------ ------------ ------------
Net increase in cash and cash equivalents................................. 6,568 3,424 1,522
Cash and cash equivalents at beginning of year............................ 14,290 10,866 9,344
------------ ------------ ------------
Cash and cash equivalents at end of year..................................$ 20,858 $ 14,290 $ 10,866
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Net cash used in discontinued operations................................$ - $ (704) $ (143)
------------ ------------ ------------
Cash paid for interest..................................................$ 119 $ 2 $ 10
------------ ------------ ------------
Income taxes paid.......................................................$ 19,116 $ 12,700 $ 9,102
------------ ------------ ------------
Non-cash activities - capital lease obligations incurred................$ 926 $ - $ -
------------ ------------ ------------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts and shares in 000's, except dividend rates and par values)
Special Preferred
$3 Preferred Stock Stock
-------- -------- -------- --------
Shares Amount Shares Amount
-------- -------- -------- --------
January 1, 2000 3 $ 3 18 $ 18
Redemption or conversion of Preferred Stock........................ (3) (3) (18) (18)
Contributed to Company's ESOP plan................................. - - - -
Exercise of stock options and other................................ - - - -
Income tax benefit related to exercise of stock options............ - - - -
Net income......................................................... - - - -
Cash dividends on preferred shares................................. - - - -
Other comprehensive income......................................... - - - -
Treasury shares purchased.......................................... - - - -
-------- -------- -------- --------
December 31, 2000 - - - -
Contributed to Company's ESOP plan................................. - - - -
Exercise of stock options and other................................ - - - -
Income tax benefit related to exercise of stock options............ - - - -
Net income......................................................... - - - -
Other comprehensive income......................................... - - - -
Treasury shares purchased.......................................... - - - -
-------- -------- -------- --------
December 31, 2001 - - - -
Contributed to Company's ESOP plan................................. - - - -
Exercise of stock options and other................................ - - - -
Income tax benefit related to exercise of stock options............ - - - -
Subscriptions receivable retired (net of additional advances
of $489 and interest recognized of $85).......................... - - - -
Net income......................................................... - - - -
Other comprehensive income......................................... - - - -
Treasury shares purchased.......................................... - - - -
Treasury shares retired............................................ - - - -
-------- -------- -------- --------
December 31, 2002.................................................... - $ - - $ -
-------- -------- -------- --------
(1) Other Comprehensive Income Year Ended December 31,
-------------------------------
2002 2001 2000
---------- --------- ----------
Net income........................................................... $ 36,014 $ 27,110 $ 20,489
---------- --------- ----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment............................ 85 (7) (12)
---------- --------- ----------
Unrealized gains on investments:
Unrealized holding gains arising during period,.................. 75 299 893
Less: reclassification adjustment for (gains) losses included
in net income.................................................. (56) 2 (31)
---------- --------- ----------
19 301 862
---------- --------- ----------
Comprehensive income, net of income taxes of $11, $162 and $464 in
2002, 2001 and 2000, respectively.................................. 104 294 850
---------- --------- ----------
Comprehensive income................................................. $ 36,118 $ 27,404 $ 21,339
---------- --------- ----------
The accompanying notes are an integral part of these financial statements.
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(continued) (Amounts and shares in 000's, except
dividend rates and par values)
Accumulated
Capital in Other
Common Stock Excess of Retained Comprehensive Treasury Stock
Par Value Earnings Income (Loss) 1
Shares Amount Shares Amount Total
---------- -------- ----------- ------------- --------------- --------- ------------ ---------
24,507 $ 245 $ 59,822 $ 6,645 $ (958) 1,960 $ (33,137) $ 32,638
30 - (146) - - - - (167)
6 - 130 - - - - 130
197 2 4,108 - - - - 4,110
- - 1,044 - - - - 1,044
- - - 20,489 - - - 20,489
- - - (4) - - - (4)
- - - - 850 - - 850
- - - - - 520 (17,323) (17,323)
---------- -------- ----------- ------------- --------------- --------- ------------ ---------
24,740 247 64,958 27,130 (108) 2,480 (50,460) 41,767
6 - 162 - - - - 162
60 1 1,021 - - - - 1,022
- - 82 - - - - 82
- - - 27,110 - - - 27,110
- - - - 294 - - 294
- - - - - 1,509 (28,213) (28,213)
---------- -------- ----------- ------------- --------------- --------- ------------ ---------
24,806 248 66,223 54,240 186 3,989 (78,673) 42,224
10 - 207 - - - - 207
314 3 5,085 - - - - 5,088
- - 1,104 - - - - 1,104
- - 383 - - - - 383
- - - 36,014 - - - 36,014
- - - - 104 - - 104
- - - - - 2,305 (50,152) (50,152)
(1,442) (14) (29,783) - - (1,442) 29,797 -
---------- -------- ----------- ------------- --------------- --------- ------------ ---------
23,688 $ 237 $ 43,219 $ 90,254 $ 290 4,852 $ (99,028) $ 34,972
---------- -------- ----------- ------------- --------------- --------- ------------ ---------
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 the Company allow members to
access legal services through a network of independent law firms ("provider law
firms") under contract with the Company. Provider law firms are paid a fixed fee
on a capitated basis to render services to plan members residing within the
state or province in which the provider law firm is licensed to practice.
Because the fixed fee payments by the Company to provider law firms do not vary
based on the type and amount of benefits utilized by the member, this capitated
arrangement provides significant advantages to the Company in managing claims
risk. At December 31, 2002, Memberships subject to the provider law firm
arrangement comprised approximately 99% of the Company's active Memberships. The
remaining Memberships, approximately 1%, were primarily sold prior to 1987 and
allow members to locate their own lawyer to provide legal services available
under the Membership with the member's lawyer being reimbursed for services
rendered based on usual, reasonable and customary fees. Memberships are
generally guaranteed renewable and Membership fees are principally collected on
a monthly basis, although approximately 5% of Members have elected to pay their
fees in advance on an annual or semi-annual basis. At December 31, 2002, the
Company had 1,382,306 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.
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 the accounts of the Company
and its wholly owned subsidiaries, as well as those of PPL Agency, Inc. (See
Note 10 for additional information regarding PPL Agency, Inc.). The primary
subsidiaries of the Company include Pre-Paid Legal Casualty, Inc. ("PPLCI") and
Pre-Paid Legal Services, Inc. of Florida ("PPLSIF"). All significant
intercompany accounts and transactions have been eliminated.
Notes 6 and 12 and the first two paragraphs of Note 10 to these
consolidated financial statements relate to the Parent.
Foreign Currency Translation
The financial results of the Company's Canadian operations are measured in
its local currency and then translated into U.S. dollars. All balance sheet
accounts have been translated using the current rate of exchange at the balance
sheet date. Results of operations have been translated using the average rates
prevailing throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash, certificates
of deposit, short-term investments, debt and equity securities, receivables and
trade payables. Fair value estimates have been determined by the Company, using
available market information and appropriate valuation methodologies. The
carrying value of cash, certificates of deposit, short-term investments, net
receivables and trade payables are considered to be representative of their
respective fair value, due to the short term nature of these instruments.
Cash and Cash Equivalents
The Company considers all highly liquid unpledged investments with
maturities of three months or less at time of acquisition to be cash
equivalents.
Investments
The Company classifies its investments held as available for sale and
accounts for them at fair value with unrealized gains and losses, net of taxes,
excluded from earnings and reported as other comprehensive income. The Company
classifies available-for-sale securities as current if the Company expects to
sell the securities within one year, or if the Company intends to utilize the
securities for current operations. All other available-for-sale securities are
classified as non-current.
All investment securities are adjusted for amortization of premiums and
accretion of discounts. Amortization of premiums and accretion of discounts are
recorded to income over the contractual maturity or estimated life of the
individual investment on the level yield method. Gain or loss on sale of
investments is based upon the specific identification method. Income earned on
the Company's investments in certain state and political subdivision debt
instruments is not generally taxable for federal income tax purposes.
Membership income receivable
The Company's Membership income 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 income 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
the Company's 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
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis, of which approximately 71% are paid in advance and, therefore,
are deferred and recognized over the following month.
The Company also charges 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"). The Company computes
the expected Membership life using over 20 years of actuarial data. At December
31, 2002, management computed the expected Membership life to be approximately 3
years. If the expected membership life were to change significantly, which
management does not expect in the short term, the deferred Membership enrollment
fee and related costs would be recognized over a longer or shorter period.
The Company derives revenues from services provided to its marketing sales
force from a one-time non-refundable enrollment fee of $65 from each new sales
associate for which the Company provides initial sales and marketing supplies
and enrollment services to the associate. 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 $54 of 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, 2002 is estimated to be approximately six months. 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, the deferred revenue and related costs will be recognized
over the new estimated active service period.
The Company also encourages participation in a training program ("Fast
Start") that allows an associate who successfully completes the program to
advance through the various commission levels at a faster rate. Associates
participating in this training program typically pay a fee ranging from $34 to
$184, depending on special promotions the Company implements from time to time.
The fee covers the additional training and materials used in the training
program, and is recognized in income upon completion of the training. Associate
services also includes revenue recognized on the sale of marketing supplies and
promotional material to associates and includes fees related to the Company's
eService program for associates. The eService program provides subscribers
Internet based back office support such as reports, on-line documents, tools, a
personal email account and up to three personalized web sites with "flash" movie
presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs the
Company incurs in enrolling new Members and new associates related to the
deferred revenue discussed above, and that portion of payments made to provider
law firms and associates related to deferred Membership revenue. Deferred costs
for enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments. Deferred costs
for enrolling new associates include training and success bonuses paid to
individuals involved in recruiting the associate and salary and benefit costs of
employees who process associate enrollments. Such costs are deferred to the
extent of the lesser of actual costs incurred or the amount of the related fee
charged for such services. Deferred costs are amortized to expense over the same
period as the related deferred revenue. Deferred costs that will be recognized
within one year of the balance sheet date are classified as current and all
remaining deferred costs are considered noncurrent. Associate related costs are
reflected as associate services and direct marketing, and are expensed as
incurred if not related to the deferred revenue discussed above. These costs
include providing materials and services to associates, Fast Start bonuses,
associate introduction kits, the associate incentive program, group marketing
and marketing services departments (including costs of related travel, marketing
events, leadership summits and international sales convention).
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due
provider law firms on approximately 99% of the Memberships and claims reported
but not paid and actuarially estimated claims incurred but not reported on the
remaining non-provider Memberships which represent approximately 1%. The Company
calculates the benefit liability on the non-provider Memberships based on
completion factors that consider historical claims experience based on the dates
that claims are incurred, reported to the Company and subsequently paid.
Processing costs related to these claims are accrued based on an estimate of
expenses to process such claims.
Income Taxes
The Company accounts for income taxes using the asset and liability
approach that requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that are recognized in
different periods in the Company's financial statements and tax returns. In
estimating future tax consequences, the Company generally considers all future
events other than 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.
The Company records deferred tax assets related to the recognition of future tax
benefits of temporary differences and net operating loss and tax credit
carryforwards. To the extent that realization of such benefits is not considered
more likely than not, the Company establishes a valuation allowance to reduce
such assets to the estimated realizable amount.
Commissions to Associates
Prior to March 1, 2002, the Company 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. In January 1997, the
Company implemented a new policy whereby associates do not receive advance
commissions on the first three Memberships submitted unless the associate
successfully completes a Company training program, produces three Memberships
and recruits three associates within 60 days from becoming an associate.
Effective March 1, 2002, and in order to offer additional incentives for
increased Membership retention rates, the Company returned to a differential
commission structure with rates of approximately 80% of first year Membership
premiums on new Memberships written and variable renewal commission rates
ranging from five to 25% per annum based on the 12 month Membership retention
rate of the associate's sales organization.
The Company expenses advance commissions ratably over the first month of
the related Membership. As a result of this accounting policy, the Company's
commission expenses are recorded in the first month of a Membership and there is
no commission expense recognized for the same Membership during the remainder of
the advance period.
Long-Lived Assets
The Company reviews long-lived assets to be held and used in operations
when events or changes in circumstances indicate that the assets might be
impaired. The carrying value of long-lived assets is considered impaired when
the identifiable undiscounted cash flows estimated to be generated by those
assets are less than their carrying amounts. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair value of the
long-lived asset. Fair value is determined primarily using the anticipated cash
flows discounted at a rate commensurate with the risk involved. Losses on
long-lived assets to be disposed of are determined in a similar manner, except
that fair values are reduced by disposal costs.
Stock-Based Compensation
At December 31, 2002, the company had a stock-based employee compensation
plan, which is described more fully in Note 13. The company accounts for this
plan under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the company had
applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
2002 2001 2000
--------- --------- ---------
Net income, as reported................................................... $ 36,014 $ 27,110 $ 20,485
Deduct: Total stock-based employee compensation expense determined under
fair value based method for all awards, net of related tax effects........ (3,201) (2,471) (4,017)
--------- --------- ---------
Pro forma net income...................................................... $ 32,813 $ 24,639 $ 16,468
--------- --------- ---------
Earnings per share:
Basic - as reported................................................... $ 1.83 $ 1.26 $ .91
Basic - pro forma..................................................... $ 1.67 $ 1.15 $ .73
Diluted - as reported................................................. $ 1.82 $ 1.26 $ .90
Diluted - pro forma................................................... $ 1.66 $ 1.14 $ .73
The estimated fair value of options granted to employees was estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions used: no dividend yield; risk-free
interest rate of 3.06% for 2002, 4.09% for 2001 and 5.15% for 2000; expected
life of 3-5 years; and expected volatility for the years ending December 31,
2002, 2001 and 2000 were 59.3%, 63.1% and 63.4%, respectively. Using these
assumptions, the weighted average fair values at date of grant for options
granted during 2002, 2001 and 2000 were $9.86, $8.58 and $17.36, respectively.
The exercise of certain stock options which have been granted under the
Company's various stock option plans give rise to compensation which is
includable in the taxable income of the option grantee and deductible by the
Company for federal and state income tax purposes. Such compensation results
from increases in the fair market value of the Company's common stock subsequent
to the date of grant of the applicable exercised stock options, and in
accordance with Accounting Principles Board Opinion No. 25, such compensation is
not recognized as an expense for financial accounting purposes and the related
tax benefits are recorded in capital in excess of par value.
Legal Contingencies
The Company accounts for legal contingencies in accordance with SFAS 5,
Accounting for Contingencies, which 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. The
Company evaluates, 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 the Company's 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 the Company does 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 the Company's 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, geographic areas
and major customers are presented in Note 16.
New Accounting Standards Issued
In July 2001, the Financial Accounting Standards Board issued SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 143 requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred and a corresponding increase in the carrying
amount of the related long-lived asset. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company does not expect SFAS 143 to
materially impact its reported results.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections
that, among other things, rescinded SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt. With the rescission of SFAS No. 4, the early
extinguishment of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002. The Company does not
anticipate that the adoption of SFAS No. 145 will have a material effect on its
financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which replaces Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The new standard required companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The statement is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company does not anticipate that the adoption of SFAS No. 146 will
have a material effect on its financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amended SFAS No. 123, Accounting
for Stock-Based Compensation. The new standard provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Additionally, the statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in the
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used in reported
results. This statement is effective for financial statements for fiscal years
ending after December 15, 2002. In compliance with SFAS No. 148, the Company has
elected to continue to follow the intrinsic value method in accounting for its
stock-based employee compensation arrangement as defined by APB No. 25.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. For a guarantee subject to FASB
Interpretation No. 45, a guarantor is required to measure and recognize the fair
value of the guarantee liability at inception. For many guarantees, fair value
will likely be determined using the expected present value method described in
FASB Concepts Statement 7, Using Cash Flow Information and Present Value in
Accounting Measurements. In addition, FIN 45 provides new disclosure
requirements. The disclosure requirements of FIN 45 were effective for the
Company as of December 31, 2002. The measurement and liability recognition
provisions are applied prospectively to guarantees or modifications after
December 31, 2002. The Company anticipates that FIN 45 will not have a material
impact on the financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). Subject to certain criteria defined in the
Interpretation, FIN 46 will require consolidation by business enterprises of
variable interest entities if the enterprise has a variable interest that will
absorb the majority of the entity's expected losses, receives a majority of its
expected returns, or both. The provisions of FIN 46 are effective immediately
for interests acquired in variable interest entities after January 31, 2003, and
at the beginning of the first interim or annual period beginning after June 15,
2003, for interests acquired in variable interest entities before February 1,
2003 (for the Company in the third quarter of 2003). The Company is in the
process of determining what impact, if any, the adoption of the provisions of
FIN 46 will have upon its financial condition or results of operations. Certain
transitional disclosures required by FIN 46 in all financial statements
initially issued after January 31, 2003, have been included in the accompanying
financial statements.
Accounting Change
SAB 101 was issued in December 1999. This Staff Bulletin summarizes certain
of the staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. SAB 101 was effective no later than
the fourth fiscal quarter of fiscal years, beginning after December 15, 1999.
The Company implemented SAB 101 in the fourth quarter of 2000, but effective
January 1, 2000, and deferred the non-refundable Membership and a portion of the
associate enrollment fees and the related incremental direct and origination
costs associated with services provided members and associates in return for
such fees. These deferred revenues and related costs will be amortized to income
over the estimated life of the Membership or the estimated average active
service period of associates. The implementation of SAB 101 resulted in a
cumulative effect type adjustment of $1.0 million, net of tax, which decreased
net income for the year ended December 31, 2000.
Note 2 - Discontinued Operations
On December 31, 2001 the Company completed the sale of its wholly owned
subsidiary, Universal Fidelity Life Insurance Company ("UFL"). The Company
received a $2.8 million dividend and $1.2 million from the sale of 100% of UFL
stock resulting in no gain or loss on the sale. The results of operations of the
UFL segment have been segregated and reported as discontinued operations in the
Consolidated Statements of Income. Details of income from discontinued
operations, net of income tax, are as follows:
Year Ended December 31,
2001 2000
---------- ----------
Revenues............................................................... $ 1,703 $ 2,590
---------- ----------
Income (loss) from discontinued operations, net of tax benefit of $0 and
$387 for years 2001 and 2000, respectively........................... $ (504) $ 649
---------- ----------
Note 3 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of the Company's investments at December 31, 2002 and 2001 follows:
December 31, 2002
--------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ----------- -------- -------- ----------
U.S. Government obligations........................ $ 5,915 $ 276 $ - $ 6,191
Corporate obligations.............................. 5,540 88 (83) 5,545
Equity securities.................................. 917 5 (56) 866
Obligations of state and political subdivisions.... 4,260 120 (5) 4,375
Certificates of deposit............................ 2,713 - - 2,713
----------- -------- -------- ----------
Total.............................................. $ 19,345 $ 489 $ (144) $ 19,690
----------- -------- -------- ----------
December 31, 2001
---------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------- ----------- -------- -------- ----------
U.S. Government obligations........................ $ 7,773 $ 246 $ - $ 8,019
Corporate obligations.............................. 7,172 73 (104) 7,141
Equity securities.................................. 1,418 63 1,481
Obligations of state and political subdivisions.... 3,785 52 (14) 3,823
Certificates of deposit............................ 3,307 - - 3,307
----------- -------- -------- ----------
Total.............................................. $ 23,455 $ 434 $ (118) $ 23,771
----------- -------- -------- ----------
The contractual maturities of the Company's available-for-sale investments
in debt securities and certificates of deposit at December 31, 2002 by maturity
date follows:
Amortized
Cost Fair Value
------------ ----------
One year or less................................... $ 3,374 $ 3,391
Two years through five years....................... 2,826 2,951
Six years through ten years........................ 2,627 2,620
More than ten years................................ 9,601 9,862
Total.............................................. ------------ ----------
$ 18,428 $ 18,824
------------ ----------
The Company's investment securities are included in the accompanying
consolidated balance sheets at December 31, 2002 and 2001 as follows.
December 31,
------------------------
2002 2001
---------- ----------
Available-for-sale investments (current)........... $ 3,970 $ 6,070
Available-for-sale investments (non-current)....... 11,560 13,386
Investments pledged................................ 4,160 4,315
---------- ----------
Total.............................................. $ 19,690 $ 23,771
---------- ----------
The Company is required to pledge investments to various state insurance
departments as a condition to obtaining authority to do business in certain
states. The fair value of investments pledged to state regulatory agencies is as
follows:
December 31,
------------------------
2002 2001
---------- ----------
Certificates of deposit............................ $ 2,243 $ 2,407
Obligation of state and political subdivisions..... 139 138
U. S. Government obligations....................... 1,778 1,770
---------- ----------
Total $ 4,160 $ 4,315
---------- ----------
Proceeds from sales of investments during 2002 were $7.6 million and
resulted in gross realized gains of $95,000 and gross realized losses of $9,000.
Sales of investments during 2001 and 2000 were not significant.
Note 4 - Property and Equipment
Property and equipment is comprised of the following:
Estimated December 31,
Useful Life 2002 2001
------------ ---------- ----------
Equipment, furniture and fixtures.......... 3-10 years $ 17,696 $ 12,910
Computer software.......................... 3 years 6,585 6,478
Building and improvements.................. 20 years 3,185 2,942
Automotive................................. 3 years 171 171
Construction in progress................... N/A 12,649 1,675
Land....................................... N/A 170 170
------------ ---------- ----------
40,456 24,346
Accumulated depreciation................... (14,863) (9,591)
---------- ----------
Property and equipment, net................ $ 25,593 $ 14,755
---------- ----------
Construction in progress includes all construction costs, including
capitalized interest on funds borrowed of $120,000 during 2002, associated with
the design and construction of the Company's new corporate headquarters. No
interest was capitalized in 2001 or 2000.
Note 5 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
------------------------
2002 2001
---------- ----------
Accounts payable................................... $ 3,340 $ 1,518
Marketing bonuses payable.......................... 1,201 577
Incentive awards payable........................... 3,345 3,000
Litigation accrual................................. 3,290 2,000
Other.............................................. 2,322 2,583
---------- ----------
Total.............................................. $ 13,498 $ 9,678
---------- ----------
The Company's litigation accrual increased from $1.7 million at December
31, 2000 to $2.0 million at December 31, 2001 reflecting an additional accrual
of $1.7 million and a settlement payment of $1.4 million during 2001. Due to
increased litigation during 2002 (See Note 12), the Company increased the
accrual by $1.3 million to $3.3 million at December 31, 2002. The incentive
awards payable began in 2001 when the Company introduced its associate incentive
program consisting of monthly car bonuses and annual trips for those that
qualify and represents the estimated costs at December 31, 2002.
Note 6 - Notes Payable
On June 11, 2002, the Company entered into two line of credit agreements
totaling $30 million with a commercial lender providing for a treasury stock
purchase line and a real estate line for funding of the Company's new corporate
office complex. The treasury stock line of credit provides for funding of up to
$10 million to finance treasury stock purchases through March 31, 2003 with
scheduled monthly repayments beginning after the initial advance and ending no
later than March 31, 2004 with interest at the 30 day LIBOR Rate plus two
percent, adjusted monthly. The real estate line of up to $20 million may be
funded over the period ending December 31, 2003 with interest at the 30 day
LIBOR Rate plus 2.25%, adjusted monthly, and will be repayable beginning after
the advance period in monthly principal payments equal to the principal balance
outstanding at December 31, 2003 divided by 105 plus interest with a balloon
payment on September 30, 2008. Additionally, interest on the outstanding balance
of the real estate line is payable monthly through November 30, 2003.
As of December 31 2002, the Company had accessed $4 million of the $10
million treasury stock purchase line and made repayments of $1.7 million and had
accessed $8.3 million of the $20 million real estate line. The interest rates as
of December 31, 2002 are 3.44% and 3.69% for the treasury stock loan and the
real estate loan, respectively. The $2.3 million used to purchase treasury
stock, net of repayments of $1.7 million, is scheduled to be paid off by July
30, 2003 and therefore has been classified as short term. Monthly principal
payments on the treasury stock line are $333,333. The Company is scheduled to
begin principal payments on the real estate line on December 31, 2003. As of
December 31, 2002, interest capitalized related to construction in progress was
$120,000.
These lending agreements contain the following financial covenants: (a) the
Company's quarterly Debt Coverage Ratio shall not be less than 125%; (b) the
Company shall not permit the ratio of its Total Liabilities to its Tangible Net
Worth to exceed 2.50 to 1.00, measured at the end of each calendar quarter; (c)
the Company's cancellation rate on contracts less than or equal to twelve months
old shall not exceed 50% for fiscal year 2002 and 45% for each fiscal year
thereafter, on a trailing twelve months basis, and (d) the Company shall
maintain a rolling twelve month average retention rate of membership contracts
in place for greater than eighteen months of not less than 70%, calculated on a
calendar quarter basis. At December 31, 2002 the Company was in compliance with
each of these financial covenants.
A schedule of outstanding balances and future maturities as of December 31,
2002 follows:
Real estate line of credit................. $ 8,300
Stock purchase line of credit.............. 2,333
Total notes payable........................ 10,633
Less: Current portion of notes payable..... (2,412)
Long term portion.......................... ----------------
$ 8,221
----------------
Repayment Schedule commencing January 2003:
Year 1..................................... $ 2,412
Year 2..................................... 949
Year 3..................................... 949
Year 4..................................... 949
Year 5..................................... 949
Thereafter................................. 4,425
Total notes payable........................ ----------------
$ 10,633
----------------
Note 7 - Income Taxes
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
----------------------------------
2002 2001 2000
--------- --------- ---------
Current.................................... 18,868 14,833 10,100
Deferred................................... 102 (1,314) (550)
--------- --------- ---------
Total provision for income taxes......... $ 18,970 $ 13,519 $ 9,550
--------- --------- ---------
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
-------------------------------
2002 2001 2000
------ ------ ------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Change in valuation allowance.............. - (.8) (3.4)
Tax exempt interest........................ (.1) (.1) (.2)
Other...................................... (.4) (1.2) -
------ ------ ------
Effective income tax rate.................. 34.5% 32.9% 31.4%
------ ------ ------
Deferred tax liabilities and assets at December 31, 2002 and 2001 are
comprised of the following:
December 31,
-----------------------
2002 2001
----------- -----------
Deferred tax liabilities:
Unrealized investment gains (net)............ $ 121 $ 110
Deferred member and associate service costs.. 5,821 5,997
Depreciation................................. 1,735 655
----------- -----------
Total deferred tax liabilities............ 7,677 6,762
----------- -----------
Deferred tax assets:
Expenses not yet deducted for tax purposes... 1,152 746
Deferred revenue and fees.................... 9,407 8,768
Net operating loss carryforward.............. 402 645
----------- -----------
Total deferred tax assets................. 10,961 10,159
----------- -----------
Net deferred tax asset....................... $ 3,284 $ 3,397
----------- -----------
The Company's deferred tax assets and liabilities are included in the
accompanying consolidated balance sheets at December 31, 2002 and 2001 as
follows.
December 31,
------------------------
2002 2001
---------- ----------
Deferred tax asset (current)....................... $ 4,603 $ 3,413
Deferred tax liability (non-current)............... (1,319) (16)
---------- ----------
Net deferred tax asset............................. $ 3,284 $ 3,397
---------- ----------
At December 31, 2002, the Company has net operating loss carryforwards
(NOLs) in the amount of $888,000 that expire in 2015 through 2018 representing
remaining NOLs of TPN generated prior to the merger date.
Note 8 - Stockholders' Equity
The Company announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of the Company's common
stock. The Board of Directors has increased such authorization from 500,000
shares to 7,000,000 shares during subsequent board meetings. At December 31,
2002, the Company had purchased 5.5 million treasury shares under these
authorizations for a total consideration of $125.1 million, an average price of
$22.76 per share.
The Company has lines of credit (see Note 6) which prohibit payment of cash
dividends on its common stock. Any decision by the Board of Directors of the
Company to pay cash dividends in the future will depend upon, among other
factors, the Company's earnings, financial condition, capital requirements and
approval from its lender. In addition, the Company's ability to pay dividends is
dependent in part on its ability to derive dividends from its subsidiaries. The
payment of dividends by PPLCI is restricted under the Oklahoma Insurance Code to
available surplus funds derived from realized net profits and requires the
approval of the Oklahoma Insurance Commissioner for any dividend representing
more than 10% of such accumulated available surplus or an amount representing
more than the previous years' net profits. During 2002 and 2001, PPLCI declared
a $6 million and a $5 million dividend payable to the Company. Both the 2001 and
2002 dividends were paid during 2002. Additionally, during 2001, the Company
received a $2.8 million dividend from UFL after receiving all necessary
regulatory approvals. PPLSIF is similarly restricted pursuant to the insurance
laws of Florida. At December 31, 2002, PPLSIF did not have funds available for
payment of substantial dividends without the prior approval of the insurance
commissioner while PPLCI had approximately $3.5 million in surplus funds
available for payment of an ordinary dividend in December 2003. At December 31,
2002 the amount of restricted net assets of consolidated subsidiaries was $11.2
million.
Note 9 - Comprehensive Income
Comprehensive income is comprised of two subsets - net income and other
comprehensive income. Included in other comprehensive income for the Company 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:
2002 2001
-------- --------
Foreign currency translation adjustments.................................. $ 66 $ (19)
Unrealized gains on investments, net of income taxes of $121 and $110..... 224 205
-------- --------
Accumulated Other Comprehensive income.................................. $ 290 $ 186
-------- --------
Note 10 - Related Party Transactions
The Company's Chairman, Harland C. Stonecipher, is the owner of PPL Agency,
Inc. ("Agency"). The Company has agreed to indemnify and hold harmless the
Chairman for any personal losses incurred as a result of his ownership of this
corporation and any income earned by Agency accrues to the Company. The Company
provides management and administrative services for Agency, for which it
receives specified management fees and expense reimbursements.
Agency's financial position and results of operations are included in the
Company's financial statements on a combined basis. Agency earned commissions,
net of amounts paid directly to its agents by the underwriter, during 2002, 2001
and 2000 of $138,000, $121,000 and $122,000, respectively, through its sales of
insurance products of an unaffiliated company. Agency had net income of $33,000,
$16,000 and $12,000 for the years ended December 31, 2002, 2001 and 2000,
respectively after incurring commissions earned by the Chairman of $58,000,
$57,000 and $50,000, respectively, and annual management fees paid to the
Company of $36,000 for 2002, 2001 and 2000.
Mr. Stonecipher and Shirley A. Stonecipher own Stonecipher Aviation LLC
("SA") and Mr. and Mrs. Stonecipher together with Wilburn L. Smith, National
Marketing Director and formerly President and a director of the Company, own S &
S Aviation LLC ("S&SA"). The Company has agreed to reimburse SA and S&SA for
certain expenses pertaining to trips made by Company personnel for Company
business purposes using aircraft owned by SA and S&SA. Such reimbursement
represents the pro rata portion of direct operating expenses, such as fuel,
maintenance, pilot fees and landing fees, incurred in connection with such
aircraft based on the relative number of flights taken for Company business
purposes versus the number of other flights during the applicable period. No
reimbursement is made for depreciation, capital expenditures or improvements
relating to such aircraft. During 2002, 2001 and 2000, the Company paid
$397,000, $214,000 and $264,000, respectively, to SA as reimbursement for such
transportation expenses. S&SA was organized during 2000, and the Company paid
$436,000, $355,000 and $372,000 to S&SA during 2002, 2001 and 2000,
respectively, as reimbursement for such transportation expenses.
The Company indemnified Mr. Stonecipher for litigation expenses and
settlement costs in connection with a lawsuit filed by Frank Jaques, a former
director of the Company, in 1999 against Mr. Stonecipher in the District Court
of Pontotoc County, Oklahoma. Mr. Jaques claimed damages relating to an
agreement between Mr. Jaques and Mr. Stonecipher relating to a stock
subscription agreement with the Company that Mr. Stonecipher entered into in
order to obtain the approval of the Oklahoma Securities Department for the
Company's original intrastate public offering in 1977. The stock subscription
agreement was executed by Mr. Stonecipher for the benefit of the Company in his
capacity as the Chairman and founder. The Board of Directors determined that the
requirements for indemnification under the Company's Bylaws had been satisfied
and that Mr. Stonecipher was entitled to such indemnification. In 2000, the
Company reimbursed Mr. Stonecipher $130,000 for litigation expenses, and in
2001, the Company reimbursed him for $1,000 in litigation expenses and $275,000
for settlement of the case which was accrued as of December 31, 2000.
Mr. Smith had loans from the Company made in December 1992, December 1996
and October 1998. The largest aggregate balance of the loans during the year
ended December 31, 2002 was $521,000. These loans were fully repaid during 2002
including interest of $24,100. Mr. Smith also owns corporations or partnerships
not affiliated with the Company but engaged in the marketing of the Company's
legal service memberships and which earn commissions from sales of memberships.
These entities earned commissions of $15,000, $18,000 and $20,000 during 2002,
2001 and 2000, respectively, of which $9,000, $10,000 and $13,000, respectively,
was net of amounts passed through as commissions to their sales agents.
Randy Harp, Chief Operating Officer and a director of the Company, had
loans from the Company made in 2000 and 2002, including an advance of $489,000
during 2002. The largest aggregate balance of the loans during the year ended
December 31, 2002 was $1.0 million. These loans were fully repaid during 2002
including interest of $105,200.
John W. Hail, a director of the Company, served as Executive Vice
President, Director and Agency Director of the Company from July 1986 through
May 1988 and also served as Chairman of the Board of Directors of TVC Marketing,
Inc., which was the exclusive marketing agent of the Company from April 1984
through September 1985. Pursuant to agreements between Mr. Hail and the Company
entered into during the period in which Mr. Hail was an executive officer of the
Company, Mr. Hail receives override commissions from renewals of certain
memberships initially sold by the Company during such period. During 2002, 2001
and 2000, such override commissions on renewals totaled $87,000, $92,000 and
$90,000, respectively. Mr. Hail also owns interests ranging from 12% to 100% in
corporations not currently affiliated with the Company, including TVC Marketing,
Inc., but which were engaged in the marketing of the Company's legal service
memberships and which earn renewal commissions from memberships previously sold.
These entities earned renewal commissions of $526,000, $543,000 and $571,000
during 2002, 2001 and 2000, respectively, of which $266,000, $294,000 and
$313,000, respectively, was net of amounts passed through as commissions to
their sales agents.
David A. Savula, a former director of the Company, is actively engaged as
an independent contractor in the marketing of the Company's legal service
memberships. During 2002, 2001 and 2000, Mr. Savula received from the Company
$1.8 million, $1.1 million and $936,000 respectively, pursuant to a previous
agreement with the Company providing for the payment to Mr. Savula of override
commissions and other fees with respect to commissions earned by, and new sales
associate sponsorships within, the Company's multilevel marketing sales force,
as well as amounts received pursuant to his individual associate agreement.
The Company also has notes receivable from certain marketing consultants
who provide significant marketing-related services to the Company. Such notes
aggregated approximately $1.4 million and $2.7 million at December 31, 2002 and
2001, respectively, and bear interest at the rate of 10% or prime plus 3%.
Payments were received during 2002 of $1.8 million, including interest of
$313,700.
Note 11 - Leases
At December 31, 2002, the Company was committed under noncancelable
operating and capital leases, principally for buildings and equipment. Aggregate
rental expense under all operating leases was $174,000, $142,000 and $50,000 in
2002, 2001 and 2000, respectively.
Future commitments commencing January 2003 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2003............................................... $ 72
2004............................................... 16
2005............................................... 16
2006............................................... 10
2007............................................... 1
Thereafter......................................... -
Total operating lease commitments.................. ------------
$ 115
------------
Future minimum lease payments commencing in January 2003 related to capital
leases are as follows:
Year Ended December 31,
2003............................................... $ 42
2004............................................... 71
2005............................................... 71
2006............................................... 71
2007............................................... 71
Thereafter......................................... 1,531
----------
Total minimum lease payments....................... 1,857
Less: Imputed interest............................. (931)
----------
Present value of net minimum lease payments........ 926
Less: Current portion.............................. (14)
----------
Non current portion of capital leases payable...... $ 912
----------
The Company entered into two capital leases near the end of 2002 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, 2002.
Equipment, furniture and fixtures.................. $ 612
Buildings and improvements......................... 314
----------
926
Less: accumulated amortization..................... -
----------
Net capital lease assets........................... $ 926
----------
Note 12 - Commitments and Contingencies
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. Plaintiffs thereafter filed a motion requesting reconsideration of
the dismissal which was denied. The plaintiffs have appealed the judgment and
the order denying their motion to reconsider the judgment to the Tenth Circuit
Court of Appeals, and as of February 28, 2003, the case was in the briefing
stage. The Company is unable to predict when a decision will be made on this
appeal. In August 2002, the lead institutional plaintiff withdrew from the case,
leaving two individual plaintiffs as lead plaintiffs on behalf of the putative
class. The ultimate outcome of this case is not determinable.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On March 1, 2002, plaintiffs filed a consolidated
amended derivative complaint. The amended complaint alleges that the defendant
directors caused the Company to violate generally accepted accounting principles
and federal securities laws by improperly capitalizing commission expenses,
caused the Company to allegedly pay increased salaries and bonuses based upon
financial performance which was allegedly improperly inflated, and caused the
Company to expend significant dollars in connection with the defense of its
accounting policy, including cost incurred in connection with the defense of the
securities class action described above, and in connection with the repurchase
of its own shares on the open market at allegedly artificially inflated prices.
This derivative action is related to the putative securities class action
described above, which has been dismissed with prejudice. After the Pre-Paid
defendants moved to dismiss the consolidated amended derivative complaint, the
plaintiffs filed a voluntary dismissal of the case in August 2002 without
prejudice. The Pre-Paid defendants objected to the voluntary dismissal, but the
court approved the dismissal subject to plaintiffs' publishing notice to
shareholders and allowing a 30-day objection period regarding their proposed
dismissal without prejudice. Plaintiffs' notice was published on January 28,
2003 and the deadline for objections was February 28, 2003. On March 13, 2003
the case was dismissed without prejudice.
Beginning in the second quarter of 2001 and through December 31, 2002,
multiple lawsuits were filed against the Company, certain officers, employees,
sales associates and other defendants in various Alabama and Mississippi state
courts by current or former members seeking actual and punitive damages for
alleged breach of contract, fraud and various other claims in connection with
the sale of memberships. As of December 31, 2002, the Company was aware of 28
separate lawsuits involving approximately 298 plaintiffs that have been filed in
multiple counties in Alabama. One suit involving 2 plaintiffs which was filed as
a class action has been dismissed with prejudice as to the class allegations and
without prejudice as to the individual claims. As of December 31, 2002, the
Company was aware of 14 separate lawsuits involving approximately 428 plaintiffs
in multiple counties in Mississippi. Certain of the Mississippi lawsuits also
name the Company's provider attorney in Mississippi as a defendant. Proceedings
in the eleven cases which name the Company's provider attorney as a defendant
have been stayed for at least 90 days as to the provider attorney due to the
rehabilitation proceeding involving the provider law firm's insurer. At least
two complaints have been filed on behalf of certain of the Mississippi
plaintiffs and others with the Attorney General of Mississippi in March 2002 and
December 2002. The Company has responded to the Attorney General's requests for
information with respect to both complaints, and as of February 28, 2003, the
Company was not aware of any further actions being taken by the Attorney
General. In Mississippi, the Company has filed lawsuits in the United States
District Court for the Southern and Northern Districts of Mississippi in which
the Company seeks to compel arbitration of the various Mississippi claims under
the Federal Arbitration Act and the terms of the Company's membership
agreements, and has appealed the state court rulings in favor of certain of the
plaintiffs on the arbitration issue to the Mississippi Supreme Court. These
cases are all in various stages of litigation, including trial settings
beginning in Alabama in May, 2003, and seek varying amounts of actual and
punitive damages. While the amount of membership fees paid by the plaintiffs in
the Mississippi cases is $500,000 or less, certain of the cases seek damages of
$90 million. Additional suits of a similar nature have been threatened. The
ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against the Company and certain of its officers in the
District Court of Creek County, Oklahoma on behalf of Jeff and Jana Weller
individually and doing business as Hi-Tech Auto making similar allegations
relating to the Company's memberships and seeking unspecified damages on behalf
of a "nationwide" class. The Company's preliminary motions in this case have
been denied, and, as of February 28, 2003, the Company's appeal of the denial of
its motion to compel arbitration is pending before the Oklahoma Supreme Court.
The ultimate outcome of this case is not determinable.
On June 29, 2001, an action was filed against the Company in the District
Court of Canadian County, Oklahoma. In 2002, the petition was amended to add
five additional named plaintiffs and to add and drop certain claims. This action
is a putative class action brought by Gina Kotwitz, George Kotwitz, Rick Coker,
Richard Starke, Jeff Turnipseed and Aaron Bouren on behalf of all sales
associates of the Company. The amended petition seeks injunctive and declaratory
relief, with such other damages as the court deems appropriate, for alleged
violations of the Oklahoma Uniform Consumer Credit Code in connection with the
Company's commission advances, and seeks injunctive and declaratory relief
regarding the enforcement of certain contract provisions with sales associates.
The impact of the claims alleged under the Consumer Credit Code and the
assertion of entitlement to injunctive relief could exceed $315 million if
plaintiffs are successful both in their request for class certification and on
the merits. The plaintiffs' request for class certification is set for hearing
on July 22, 2003. The ultimate outcome of this case is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is a putative class action seeking unspecified
damages filed on behalf of all sales associates of the Company and alleges that
the marketing plan offered by the Company constitutes a security under the
Securities Act of 1933 and seeks remedies for failure to register the marketing
plan as a security and for violations of the anti-fraud provisions of the
Securities Act of 1933 and the Securities Exchange Act of 1934 in connection
with representations alleged to have been made in connection with the marketing
plan. The complaint also alleges violations of the Oklahoma Securities Act, the
Oklahoma Business Opportunities Sales Act, breach of contract, breach of duty of
good faith and fair dealing and unjust enrichment and violation of the Oklahoma
Consumer Protection Act and negligent supervision. This case is subject to the
Private Litigation Securities Reform Act. Pursuant to the Act, the Court has
approved the named plaintiffs and counsel and an amended complaint was filed in
August 2002. The Company filed motions to dismiss the complaint and to strike
the class action allegations on September 19, 2002. All discovery in the action
is stayed pending a ruling on the motion to dismiss. As of February 28, 2003,
all briefs had been filed by the parties on the motion to dismiss and a decision
on the motion will be made by the Court. The Company is unable to predict when a
decision will be made. The ultimate outcome of this case is not determinable.
In December 2002, the West Virginia Supreme Court reversed a summary
judgment which had been granted by the Circuit Court of Monangalia County, West
Virginia in favor of the Company in connection with the claims of a former
member, Georgia Poling and her daughters against the Company and a referral
lawyer with respect to a 1995 referral. That action was originally filed in
March 2000, and alleges breach of contract and fraud against the Company in
connection with the referral. The case is now scheduled for trial in August
2003, and plaintiffs seek actual and punitive damages in unspecified amounts.
The ultimate outcome of this case is not determinable.
On January 30, 2003, the Company announced that it had received a subpoena
from the office of the United States Attorney for the Southern District of New
York requesting information relating to trading activities in the Company's
stock in advance of the January 2003 announcement of recruiting and membership
production results for the fourth quarter of 2002. The Company also received
notice from the Securities and Exchange Commission that it is conducting an
informal inquiry into the same subject. The Company is cooperating fully in
responding to these requests. The ultimate outcome of these matters is not
determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in all proceedings in which it is named as a defendant. The Company
also receives periodic complaints or requests for information from various state
and federal agencies relating to its business or the activities of its marketing
force. The Company promptly responds to any such matters and provides any
information requested.
While the ultimate outcome of these proceedings is not determinable, the
Company does not currently anticipate that these contingencies will result in
any material adverse effect to its financial condition or results of operation,
unless an unexpected result occurs in one of the cases. The Company has
established an accrued liability it believes will be sufficient to cover
estimated damages in connection with various cases, which at December 31, 2002
was $3.3 million. If an unexpected result were to occur in one or more of the
pending cases, the amount of damages awarded could differ significantly from
management's estimates. The Company believes it has meritorious defenses in all
pending cases and will vigorously defend against the plaintiffs' claims.
Certain of the Company's officers and directors are named as defendants in
some of the pending litigation against the Company, including the matters
described above. Pursuant to the terms of the Oklahoma General Corporation Act
and the Company's bylaws and Board of Director authorizations, the Company
advances litigation costs and indemnifies its officers and directors, subject to
a finding that they have acted with the requisite standard of care. Other than
described in Note 10 above, the amount of such expense advancement and
indemnification in 2002, 2001 and 2000 was not material as in almost every
instance there were no incremental costs of defending the officers and directors
over the costs incurred to defend the Company.
The Company is constructing a new corporate office complex with an
estimated completion during the third quarter of 2003 at an estimated cost of
approximately $30 million. Costs incurred through December 31, 2002 of
approximately $12.6 million, including approximately $120,000 of capitalized
interest costs, have been paid from existing resources and the real estate line
of credit. The Company expects to incur additional indebtedness in order to
finance the remaining costs of its new corporate headquarters in order to allow
cash flow from operations to continue to be used to purchase treasury stock. The
Company has entered into construction contracts in the amount of $28.4 million
with the general contractor pertaining to the new office complex. Total
remaining costs of construction from January 1, 2003 are estimated at
approximately $17.5 million.
Near the end of 2002, the Company committed to acquire significant new
computer hardware to supplement its current information technology platform and
provide redundancy for its critical business systems. The commitment calls for
the Company to expend approximately $1.6 million in 2003 and $800,000 in each of
2004 and 2005. The Company will receive a $1 million vendor rebate during 2003
as a result of this commitment.
Note 13 - Stock Options and Purchase Plan
The Company has a stock option plan (the "Plan") under which the Board of
Directors (the "Board") or its Stock Option Committee (the "Committee") may
grant options to purchase shares of the Company's common stock. The Plan permits
the granting of options to directors, officers and employees of the Company to
purchase the Company's common stock at not less than the fair value at the time
the options are granted. The Plan provides for option grants to acquire up to
2,000,000 shares and permits the granting of incentive stock options as defined
under Section 422 of the Internal Revenue Code at an exercise price for each
option equal to the market price of the Company's common stock on the date of
the grant and a maximum term of 10 years. Options not qualifying as incentive
stock options under the Plan have a maximum term of 15 years. The Board or
Committee determines vesting of options granted under the Plan. No options may
be granted under the Plan after December 12, 2005.
The Plan provides for automatic grants of options to non-employee directors
of the Company. Under the Plan, each incumbent non-employee director and any new
non-employee director receives options to purchase 10,000 shares of common stock
on March 1 of each year. The options granted each year are immediately
exercisable as to 2,500 shares and vest in additional increments of 2,500 shares
on the following June 1st, September 1st, and December 1st in the year of grant,
subject to continued service by the non-employee director during such periods.
Options granted to non-employee directors under the Plan have an exercise price
equal to the closing price of the common stock on the date of grant.
Also included below are stock options that have been issued to the
Company's Regional Vice Presidents ("RVPs") in order to encourage stock
ownership by its RVPs and to increase the proprietary interest of such persons
in its growth and financial success. These options have been granted
periodically to RVPs since 1996. Options are granted at fair market value at the
date of the grant and are generally immediately exercisable for a period of
three years or within 90 days of termination, whichever occurs first. There were
244,679, 131,288 and 90,892 total options granted to RVPs in the years ended
December 31, 2002, 2001 and 2000, respectively. The Company has not adopted any
limit for the number of options that may be granted to RVPs.
A summary of the status of the Company's total stock option activity as of
December 31, 2002, 2001 and 2000 for the years ended on those dates is presented
below:
2002 2001 2000
---------- --------- ---------- --------- ---------- ---------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- ---------- --------- ---------- ---------
Outstanding at beginning of year..... 1,336,636 $ 25.09 1,199,086 $ 29.06 1,083,019 $ 26.38
Granted.............................. 499,679 22.54 443,288 17.64 355,892 32.06
Exercised............................ (329,229) 16.73 (43,175) 20.77 (226,937) 21.09
Terminated........................... (8,694) 23.31 (262,563) 32.51 (12,888) 28.17
---------- --------- ---------- --------- ---------- ---------
Outstanding at end of year........... 1,498,392 $ 26.09 1,336,636 $ 25.09 1,199,086 $ 29.06
---------- --------- ---------- --------- ---------- ---------
Options exercisable at year end...... 1,378,392 $ 26.54 1,199,644 $ 25.56 1,117,086 $ 28.96
---------- --------- ---------- --------- ---------- ---------
The following table summarizes information about stock options outstanding
at December 31, 2002:
Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
-------------------------- ------------------ ---------------- ----------------
$15.65 - $22.00 478,622 3.3 $ 18.25
$24.20 - $29.63 518,266 3.0 25.50
$30.00 - $42.13 501,504 1.2 34.17
------------------ ---------------- ----------------
1,498,392 2.5 $ 26.09
------------------ ---------------- ----------------
The following table summarizes information about stock options exercisable
at December 31, 2002:
Weighted Average
Remaining Weighted Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price
-------------------------- ------------------ ---------------- ----------------
$15.65 - $22.00 413,622 2.9 $ 18.27
$24.20 - $29.63 463,266 2.8 25.65
$30.00 - $42.13 501,504 1.2 34.17
------------------ ---------------- ----------------
1,378,392 2.2 $ 26.54
------------------ ---------------- ----------------
During 1988, the Company adopted an employee stock ownership plan. Under
the plan, employees may elect to defer a portion of their compensation by making
contributions to the plan. Up to seventy-five percent of the contributions made
by employees may be used to purchase Company common stock. The Company, at its
option, may make matching contributions to the plan, and recorded expense during
2002, 2001 and 2000 of $207,000, $162,000 and $130,000, based on annual
contributions of Company stock of 10,000 shares, 6,100 shares and 5,500 shares,
respectively.
Note 14 - Earnings Per Share
Basic earnings per common share are computed by dividing net income
applicable to common stockholders by the weighted average number of shares of
common stock outstanding during the year.
Diluted earnings per common share are computed by dividing net income
applicable to common stockholders by the weighted average number of shares of
common stock and dilutive potential common shares outstanding during the year.
The $3.00 Cumulative Convertible Preferred stock and the Special Preferred stock
are considered to be dilutive potential common shares for all periods through
the conversion/redemption date and the number of shares issuable on conversion
of the $3.00 Cumulative Convertible Preferred stock and the Special Preferred
Stock were added to the weighted average number of common shares. At December
31, 2000 all such shares had been converted or redeemed. The weighted average
number of common shares is also increased by the number of shares issuable on
the exercise of options less the number of common shares assumed to have been
purchased with the proceeds from the exercise of the options pursuant to the
treasury stock method; those purchases are assumed to have been made at the
average price of the common stock during the respective period.
Year Ended December 31,
------------------------------
Basic Earnings Per Share: 2002 2001 2000
--------- --------- ---------
Earnings:
Income from continuing operations before cumulative effect of change in
accounting principle........................................................ $ 36,014 $ 27,614 $ 20,853
Less dividends on preferred shares............................................ - - 4
--------- --------- ---------
Income from continuing operations before cumulative effect of change in
accounting principle applicable to common stockholders...................... $ 36,014 $ 27,614 $ 20,849
--------- --------- ---------
Shares:
Weighted average shares outstanding........................................... 19,674 21,504 22,504
--------- --------- ---------
Diluted Earnings Per Share:
Earnings:
Income from continuing operations before cumulative effect of change in
accounting principle available to common stockholders after assumed
conversions................................................................. $ 36,014 $ 27,614 $ 20,853
--------- --------- ---------
Shares:
Weighted average shares outstanding........................................... 19,674 21,504 22,504
Assumed conversion of preferred stock......................................... - - 35
Assumed exercise of options................................................... 90 40 140
--------- --------- ---------
Weighted average number of shares, as adjusted................................ 19,764 21,544 22,679
--------- --------- ---------
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 921,000 shares,
903,000 shares and 547,000 shares with an average exercise price of $29.76,
$29.57 and $35.99, were excluded from the calculation of diluted earnings per
share for the years ended December 31, 2002, 2001 and 2000, respectively.
Note 15 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations for
the years ended December 31, 2002 and 2001.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2002 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---- ----------- ----------- ----------- -----------
Revenues........................................... $ 82,031 $ 87,944 $ 90,159 $ 90,489
Net income......................................... 8,870 8,527 8,957 9,660
Basic income per common share (1):
Net Income....................................... $ .44 $ .42 $ .46 $ .51
Diluted income per common share (1):
Net Income....................................... $ .43 $ .42 $ .46 $ .51
2001
Revenues........................................... $ 70,325 $ 76,808 $ 76,215 $ 80,313
Income from continuing operations.................. 7,518 4,823 7,520 7,753
Income (loss) from discontinued operations,
net of tax..................................... 158 (102) (562) 2
Net income......................................... 7,676 4,721 6,958 7,755
Basic income per common share (1):
Income from continuing operations................ $ .34 $ .22 $ .35 $ .36
Income (loss) from discontinued operations....... .01 - (.03) -
Net Income....................................... .35 .22 .32 .36
Diluted income per common share (1):
Income from continuing operations................ $ .34 $ .22 $ .35 $ .36
Income (loss) from discontinued operations....... .01 - (.03) -
Net Income....................................... .35 .22 .32 .36
(1) The sum of EPS for the four quarters may differ from the annual EPS due to
rounding and the required method of computing weighted average number of
shares in the respective periods.
Note 16 - Segment Information
The Company previously reported UFL as a segment. On December 31, 2001 the
Company completed the sale of UFL and as a result has made the disclosures
required by discontinued operations accounting, see Note 2 to Consolidated
Financial Statements.
Substantially all of the Company's business is currently conducted in the
United States. Revenues from the Company's Canadian operations for 2002, 2001
and 2000 were $4.0 million, $4.4 million and $4.9 million, respectively. The
Company has no significant long-lived assets located in Canada.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10, 11, 12 and 13 of Form 10-K are incorporated herein by
reference to the Company's Proxy Statement for the Annual Meeting of
Shareholders to be filed prior to April 30, 2003.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. The Company's Principal
Executive Officer and Principal Financial Officer have reviewed and
evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rule 240.13a-14(c)) as of a date
within ninety days before the filing date of this annual report. Based on
that evaluation, the Principal Executive Officer and the Principal
Financial Officer have concluded that the Company's current disclosure
controls and procedures are effective, providing them with material
information relating to the Company as required to be disclosed in the
reports the Company files or submits under the Exchange Act on a timely
basis.
(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly
affect those controls subsequent to the date of their evaluation.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements: See Index to Consolidated Financial Statements
and Consolidated Financial Statement Schedule set forth on page 39 of
this report.
(2) Exhibits: For a list of the documents filed as exhibits to this
report, see the Exhibit Index following the signatures to this report.
(b) Reports on Form 8-K: None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
March 17, 2003 By: /s/ Randy Harp
-------------------------------------------
Randy Harp
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
---- -------- ----
/s/ Harland C. Stonecipher Chairman of the Board of Directors March 17, 2003
----------------------------------------------------
Harland C. Stonecipher (Principal Executive Officer)
/s/ Randy Harp Chief Operating Officer and March 17, 2003
---------------------------------------------------- Director
Randy Harp
/s/ Steve Williamson Chief Financial Officer March 17, 2003
---------------------------------------------------- (Principal Financial and
Steve Williamson Accounting Officer)
/s/ Peter K. Grunebaum Director March 17, 2003
----------------------------------------------------
Peter K. Grunebaum
/s/ John W. Hail Director March 17, 2003
----------------------------------------------------
John W. Hail
/s/ Martin H. Belsky Director March 17, 2003
----------------------------------------------------
Martin H. Belsky
CERTIFICATIONS
I, Harland C. Stonecipher, Chief Executive Officer, 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 annual 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 annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures 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 annual report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003 /s/ Harland C. Stonecipher
---------------------------------------------
Harland C. Stonecipher
Chairman, Chief Executive Officer and
President
CERTIFICATIONS, continued
I, Steve Williamson, Chief Financial Officer, 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 annual 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 annual report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures 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 annual report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
(6) The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003 /s/ Steve Williamson
---------------------------------------------
Steve Williamson
Chief Financial Officer
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,
-----------------------
2002 2001
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 18,828 $ 12,999
Membership income receivable......................................................... 3,201 3,424
Dividends receivable................................................................. - 5,000
Inventories.......................................................................... 1,212 922
Deferred member and associate service costs.......................................... 11,873 12,560
Deferred income taxes................................................................ 3,187 2,217
---------- ----------
Total current assets............................................................. 38,301 37,122
Available-for-sale investments, at fair value.......................................... 450 613
Investments pledged.................................................................... 274 274
Property and equipment, net............................................................ 25,124 14,202
Investments in and amounts due to/from subsidiaries, net............................... 21,561 19,604
Deferred member and associate service costs............................................ 2,991 2,907
Other assets........................................................................... 2,415 5,439
---------- ----------
Total assets................................................................... $ 91,116 $ 80,161
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits.................................................................. $ 8,329 $ 7,383
Deferred revenue and fees............................................................ 16,796 15,806
Current portion of capital leases payable............................................ 14 -
Current portion of notes payable..................................................... 2,412 -
Income taxes payable................................................................. 1,234 1,892
Accounts payable and accrued expenses................................................ 12,550 8,682
---------- ----------
Total current liabilities.......................................................... 41,335 33,763
Capital leases payable............................................................... 912 -
Notes payable........................................................................ 8,221 -
Deferred revenue and fees............................................................ 4,266 4,158
Deferred income taxes ............................................................... 1,410 16
---------- ----------
Total liabilities................................................................ 56,144 37,937
---------- ----------
Stockholders' equity:
Common stock......................................................................... 237 248
Capital in excess of par value....................................................... 43,219 66,223
Retained earnings.................................................................... 90,254 54,240
Accumulated other comprehensive income............................................... 290 186
Treasury stock, at cost.............................................................. (99,028) (78,673)
---------- ----------
Total stockholders' equity....................................................... 34,972 42,224
---------- ----------
Total liabilities and stockholders' equity..................................... $ 91,116 $ 80,161
---------- ----------
See accompanying notes to condensed financial statements.
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
------------------------------------------
2002 2001 2000
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 199,849 $ 169,036 $ 137,139
Associate services................................................... 37,195 36,019 29,437
Other................................................................ 3,004 2,065 2,434
------------- ------------- -------------
240,048 207,120 169,010
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 63,515 52,017 43,491
Commissions.......................................................... 83,097 88,040 77,249
Associate services and direct marketing.............................. 32,516 29,829 22,621
General and administrative........................................... 13,773 12,307 8,991
Other, net........................................................... 5,829 4,553 3,068
------------- ------------- -------------
198,730 186,746 155,420
------------- ------------- -------------
Income from continuing operations before income taxes, equity in net income of
subsidiaries and cumulative effect of
change in accounting principle....................................... 41,318 20,374 13,590
Provision for income taxes............................................. 14,271 6,593 2,395
------------- ------------- -------------
Income from continuing operations before equity in net income
of subsidiaries and cumulative effect of change in accounting
principle............................................................ 27,047 13,781 11,195
Equity in net income of subsidiaries................................... 8,967 13,833 9,658
Income from continuing operations before cumulative effect of
------------- ------------- -------------
change in accounting principle....................................... 36,014 27,614 20,853
------------- ------------- -------------
Income (loss) from operations of discontinued UFL segment (net of applicable
income tax benefit of $0 and $387 for years
2001 and 2000, respectively)......................................... - (504) 649
Income before cumulative effect of change in accounting principle...... 36,014 27,110 21,502
------------- ------------- -------------
Cumulative effect of adoption of SAB 101 (net of applicable
income tax benefit of $546).......................................... - - (1,013)
------------- ------------- -------------
Net income............................................................. $ 36,014 $ 27,110 $ 20,489
------------- ------------- -------------
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,
-----------------------------------------
2002 2001 2000
------------ ------------ ------------
Net cash provided by operating activities of continuing operations........$ 55,380 $ 39,673 $ 19,870
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sale of UFL............................................... - 1,200 -
Additions to property and equipment..................................... (15,184) (8,326) (5,516)
Maturities and sales of investments - available for sale................ 64 - 113
------------ ------------ ------------
Net cash used in investing activities
of continuing operations............................................ (15,120) (7,126) (5,403)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from sale of common stock on exercise of options.............. 5,088 1,022 4,110
Decrease in capital lease obligations.................................. - (223) (330)
Purchases of treasury stock............................................ (50,152) (28,213) (17,323)
Proceeds from issuance of debt......................................... 12,300 - -
Repayments of debt..................................................... (1,667) - -
Redemption of preferred stock.......................................... - - (167)
Dividends paid on preferred stock...................................... - - (4)
------------ ------------ ------------
Net cash used in financing activities of continuing operations........ (34,431) (27,414) (13,714)
------------ ------------ ------------
Net increase in cash and cash equivalents................................. 5,829 5,133 753
Cash and cash equivalents at beginning of year............................ 12,999 7,866 7,113
------------ ------------ ------------
Cash and cash equivalents at end of year..................................$ 18,828 $ 12,999 $ 7,866
------------ ------------ ------------
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 6 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 its
general and administrative expenses determined in accordance with the
agreements.
Dividends from Subsidiaries
Dividends paid to the Parent Company from its subsidiaries accounted for by the
equity method are summarized as follows:
Year Ended December 31,
------------------------------------------
2002 2001 2000
------------- ----------- ------------
Pre-Paid Legal Casualty, Inc........................................... $ 11,000 $ 3,500 $ 1,500
Universal Fidelity Life Insurance Company.............................. - 2,800 5,000
------------- ----------- ------------
$ 11,000 $ 6,300 $ 6,500
------------- ----------- ------------
INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Certificate of Incorporation of the Company, as
amended (Incorporated by reference to Exhibit 4.1 of the Company's Report
on Form 8-K dated January 10, 1997)
3.2 Amended and Restated Bylaws of the Company (Incorporated by reference to
Exhibit 3.1 of the Company's Report on Form 10-Q for the period ended
September 30, 1996)
*10.1Employment Agreement effective January 1, 1993 between the Company and
Harland C. Stonecipher (Incorporated by reference to Exhibit 10.1 of the
Company's Annual Report on Form 10-KSB for the year ended December 31,
1992)
*10.2Agreements 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)
*10.3Amendment 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)
*10.4Form of New Business Generation Agreement Between the Company and Harland
C. Stonecipher (Incorporated by reference to Exhibit 10.22 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1986)
*10.5Amendment 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)
*10.6Amendment No. 1 to Stock Option Plan, as amended effective May 2000
(Incorporated by reference to Exhibit 10.6 of the Company's Annual Report
on Form 10-K for the year ended December 31, 2000)
*10.7Letter Agreements dated July 8, 1993 and March 7, 1994 between the Company
and Wilburn L. Smith (Incorporated by reference to Exhibit 10.17 of the
Company's Form 10-KSB filed for the year ending December 31, 1993)
10.8 Demand Note of Randy Harp dated December 22, 2000 in favor of the Company
(Incorporated by reference to Exhibit 10.17 of the Company's Annual Report
on Form 10-K for the year ended December 31, 2000)
10.9 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)
10.10Security agreement dated June 11, 2002 between Bank of Oklahoma, N.A. and
the Company (Incorporated by reference to Exhibit 10.2 of the Company's
Quarterly Report on Form 10-Q for the six months ended June 30, 2002)
10.11Form 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)
10.12 Demand Note of Randy Harp dated April 14, 2002 in favor of the Company
10.13Amendment No. 2 to New Business Generation Agreement between the Company
and Harland C. Stonecipher effective January, 1990
*10.14 Deferred compensation plan effective November 6, 2002
21.1 List of Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP
99.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
--------------------
* Constitutes a management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report.
EXHIBIT 10.12
Demand Note of Randy Harp dated April 14, 2002 in favor of the Company
PROMISSORY NOTE
April 14, 2002 $489,259.50
FOR VALUE RECEIVED, the undersigned hereby promises to pay to the order of
Pre-Paid Legal Services, Inc., an Oklahoma corporation ("Company"), the
principal sum of Four Hundred Eighty Nine Thousand Two Hundred Fifty Nine and
50/100 dollars ($489,259.50), together with interest thereon at the rate of ten
percent (10%) per annum from the Effective Date. Payments pursuant to this Note
shall be made at the offices of the Company, 321 East Main Street, Ada, Oklahoma
74820 or such other place as the holder may designate in writing, in lawful
currency of the United States of America.
The undersigned agrees to pledge all of his current and future commissions
derived from all existing and future memberships from all of his associate
accounts with Company or its subsidiaries and options to purchase Company common
stock that undersigned now has or acquires during the term of this Note or until
its final payment. The Company is not required to rely on the above security for
the payment of this Note in the case of default, but may proceed directly
against the Promisor.
The undersigned agrees that if, and as often as, this Note is placed in the
hands of an attorney for collection or to defend or enforce any of the holder's
rights hereunder, the undersigned will pay to the holder such holder's
reasonable attorneys' fees, together with all court costs and other expenses of
collection, defense or enforcement incurred by such holder.
The undersigned and all endorsers, sureties, guarantors and other persons
who may be liable for all or any part of this obligation severally waive
presentment for payment, protest, demand and notice of nonpayment. Such parties
consent to any extension of time (whether one or more) of payment hereof, or
release of any party liable for the payment of this obligation. Any such
extension or release may be made without notice to any such party and without
discharging such party's liability hereunder.
The Promisor reserves the right to prepay this Note (in whole or in part)
prior to the Due Date with no prepayment penalty.
No renewal or extension of this Note, delay in enforcing any right of the
Company under this Note, or assignment by Company of this Note shall affect the
liability of the Promisor. All rights of the Company under this Note are
cumulative and may be exercised concurrently or consecutively at the Company's
option.
This Note shall be construed in accordance with the laws of the State of
Oklahoma.
If any one or more of the provisions of this Note is determined to be
unenforceable, in whole or in part, for any reason, the remaining provisions
shall remain fully operative.
All payments of principal and interest on this Note shall be paid in the
legal currency of the United States.
IN WITNESS HEREOF, this Note has been executed and delivered effective this
14th of April 2002 (the "Effective Date").
/s/ Randy Harp
-----------------------------------------------------
Randy Harp ("Promisor")
EXHIBIT 10.13
Amendment No. 2 to New Business Generation Agreement between the Company
and Harland C. Stonecipher effective January, 1990
SECOND AMENDMENT
TO
NEW BUSINESS GENERATION AGREEMENT
This Second Amendment to New Business Generation Agreement ("Second
Amendment") is entered into effective as of the date hereof between Pre-Paid
Legal Services, Inc., an Oklahoma corporation ("Pre-Paid") and Harland C.
Stonecipher ("Stonecipher") in order to confirm and document the actions of the
Board of Directors of Pre-Paid taken on February 26, 2001 with reference to the
following circumstances:
A. Pre-Paid and Stonecipher have entered into a certain New Business
Generation Agreement dated as of January 6, 1986, as amended by the First
Amendment dated January 1, 1990 ("Agreement"), the existence, validity and
continued effectiveness of which the parties hereby confirm, providing for
the payment by Pre-Paid to Stonecipher of an override commission with
respect to certain membership fee income.
B. Pre-Paid and Stonecipher desire to document a modification to the
Agreement to confirm the original intent of such Agreement that the
override commission provided for in the Agreement extends beyond the
lifetime of Stonecipher.
In consideration of the premises and the mutual terms, the covenants and
conditions contained herein and in the Agreement, Section 3 and 4 of the
Agreement shall be amended to read in their entirety as follows:
"3. Continuation of Commissions. The commissions payable pursuant to
Section 2 shall continue to be paid to Stonecipher or his successors or
assigns for so long as Pre-Paid or any successor continues in the business
of offering legal expense plans. In the event of Stonecipher's death, such
commissions shall be paid to such beneficiary or beneficiaries as
Stonecipher shall have designated in writing to Pre-Paid, or if no such
designation has been made, in accordance with his last will and testament
or the laws of descent and distribution, whichever are applicable. Such
beneficiaries shall have the right to similarly designate successor
beneficiaries.
4. Business Promotion. For so long as Stonecipher is employed by
Pre-Paid, he shall devote reasonable efforts to the generation of new
membership sales for Pre-Paid and its affiliates. In addition, and not in
limitation of the foregoing, Stonecipher shall provide such specific
services with respect to generation of new memberships as may be requested
from time to time by Pre-Paid, including assistance in arranging financing
to fund acquisition costs of new memberships."
Executed as of the 30th day of December 2002.
PRE-PAID LEGAL SERVICES, INC.
By: /s/ Randy Harp
--------------------------------------------
Randy Harp, Chief Operating Officer
/s/ Harland C. Stonecipher
--------------------------------------------
Harland C. Stonecipher
EXHIBIT 10.14
PRE-PAID LEGAL SERVICES, INC.
DEFERRED COMPENSATION PLAN
Article I
Establishment of Plan
1.1 Purpose. The Pre-Paid Legal Services, Inc. Deferred Compensation Plan is
hereby established by the Board of Directors of Pre-Paid Legal Services, Inc.,
an Oklahoma Corporation, to provide deferred compensation benefits to selected
executives of the Corporation as more fully provided herein. The benefits
provided under the Plan are intended to be in addition to other employee
benefits programs offered by the Corporation, including but not limited to
tax-qualified employee benefit plans.
1.2 Effective Date and Term. Pre-Paid Legal Services, Inc. adopts this unfunded
deferred compensation plan effective as of November 6, 2002, to be known as the
Pre-Paid Legal Services, Inc. Deferred Compensation Plan, hereinafter referred
to as the "Plan."
1.3 Applicability of ERISA. This Plan is intended to be a "top-hat" plan. This
Plan is an unfunded plan maintained primarily for the purpose of providing
deferred compensation to a select group of executives or highly compensated
employees within the meaning of ERISA.
Article II
Definitions
As used within this document, the following words and phrases have the
meanings described in this Article II unless a different meaning is required by
the context. Some of the words and phrases used in the Plan are not defined in
this Article II, but for convenience, are defined as they are introduced into
the text. Words in the masculine gender shall be deemed to include the feminine
gender. Any headings used are included for ease of reference only and are not to
be construed so as to alter any of the terms of the Plan.
2.1 Annual Deferral. The amount of Base Salary and/or Bonuses which the
Participant elects to defer in each Deferral Period pursuant to Article 4.1 of
the Plan.
2.2 Base Salary. A Participant's basic annual salary (or other amounts paid as a
percentage of membership fees or of some other performance criteria) for the
applicable Plan Year.
2.3 Beneficiary. An individual or entity designated by a Participant in
accordance with Section 13.6.
2.4 Board or Board of Directors. The Board of Directors of the Corporation.
2.5 Bonus. Earnings awarded to a Participant at the option of the Corporation
which may or may not occur during each Plan Year.
2.6 Change in Control. A "Change in Control" of the Corporation shall mean the
occurrence after the effective date of the Plan of:
(i) An acquisition (other than directly from the Corporation) of any voting
securities of the Corporation (the "Voting Securities") by any "Person" (as the
term person is used for purposes of Section 13(d) or 14(d) of the Securities
Exchange Act of 1934 ("Exchange Act")) immediately after which such Person has
"Beneficial Ownership" (within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of fifty percent (50%) or more of the combined voting power of the
Company's then outstanding Voting Securities; provided, however, this subsection
(i) shall not apply to acquisitions of Voting Securities by Harland C.
Stonecipher or his affiliates.
(ii) The individuals who, as of the date of adoption of the Plan by the
Board, are members of the Board (the "Incumbent Board"), cease for any reason to
constitute at least two-thirds of the members of the Board; provided, however,
that if the election, or nomination for election by the Corporation's common
stockholders, of any new director was approved by a vote of at least two-thirds
of the Incumbent Board, such new director shall, for purposes of this Plan, be
considered as a member of the Incumbent Board; provided further, however, that
no individual shall be considered a member of the Incumbent Board if such
individual initially assumed office as a result of either an actual or
threatened 'election contest' (as described in Rule 14A-11 promulgated under the
Exchange Act) or other actual or threatened solicitation of proxies or consents
by or on behalf of a Person other than the Board (a "Proxy Contest") including
by reason of any agreement intended to avoid or settle any Election Contest or
Proxy Contest; or
(iii) The consummation of:
(A) A merger, consolidation or reorganization involving the
Corporation, unless
(1) the stockholders of the Corporation, immediately before
such merger, consolidation or reorganization, own, directly or
indirectly immediately following such merger, consolidation or
reorganization, at least sixty percent (60%) of the combined
voting power of the outstanding voting securities of the
corporation resulting from such merger or consolidation or
reorganization (the "Surviving Corporation") in substantially the
same proportion as their ownership of the Voting Securities
immediately before such merger, consolidation or reorganization,
(2) the individuals who were members of the Incumbent Board
immediately prior to the execution of the agreement providing for
such merger, consolidation or reorganization constitute at least
two-thirds of the members of the board of directors of the
Surviving Corporation, and
(3) no Person, other than the Corporation, any Subsidiary,
any employee benefit plan (or any trust forming a part thereof)
maintained by the Corporation, the Surviving Corporation, or any
Subsidiary or any Person who, immediately prior to such merger,
consolidation or reorganization had Beneficial Ownership of fifty
percent (50%) or more of the then outstanding Voting Securities,
has Beneficial Ownership of fifty percent (50%) or more of the
combined voting power of the Surviving Corporation's then
outstanding voting securities;
(B) A complete liquidation or dissolution of the Corporation; or
(C) An agreement for the sale or other disposition of all or
substantially all of the assets of the Corporation to any Person (other
than a transfer to a Subsidiary).
Notwithstanding the foregoing, a Change in Control shall not be deemed to
occur solely because any Person (the "Subject Person") acquired Beneficial
Ownership of more than the permitted amount of the outstanding Voting Securities
as a result of the acquisition of Voting Securities by the Corporation that, by
reducing the number of Voting Securities outstanding, increases the proportional
number of shares Beneficially Owned by the Subject Person, provided that if a
Change in Control would occur (but for the operation of this sentence) as a
result of the acquisition of Voting Securities by the Corporation, and after
such share acquisition by the Corporation, the Subject Person becomes the
Beneficial Owner of any additional Voting Securities which increases the
percentage of the then outstanding Voting Securities Beneficially Owned by the
Subject Person, then a Change in Control shall occur.
2.7 Code. The Internal Revenue Code of 1986. Reference to a section of the Code
shall include that section and any comparable section or sections of any future
legislation that amends, supplements or supersedes such section.
2.8 Corporation. Pre-Paid Legal Services, Inc.
2.9 Deferral Account. The account established for a Participant pursuant to
Section 5.1 of the Plan.
2.10 Deferral Election. The election made by the Participant pursuant to Section
4.1 of the Plan.
2.11 Deferral Period. The Plan Year, or in the case of a newly hired or promoted
employee who becomes an Eligible Employee during a Plan Year, the remaining
portion of the Plan Year. In the case of the first Plan Year, the Deferral
Period commences on November 6, 2002 and ends on December 31, 2002.
2.12 Disability. In the case of a Participant who is covered by a Corporation
sponsored disability insurance policy, total disability as defined in such
policy without regard to any waiting period. For Participants not covered by
such a policy, disability means the Participant suffering a sickness, accident
or injury which, in the judgment of a physician satisfactory to the Corporation,
prevents the Participant from performing substantially all of his or her normal
duties for the Corporation. As a condition to receiving benefits under the Plan
for Disability, the Corporation may require the Participant to submit to such
physical or mental evaluations and tests as the Corporation may deem
appropriate.
2.13 Effective Date. November 6, 2002.
2.14 Eligible Employee. An employee of the Corporation or of any of its
subsidiaries who is designated by the Board of Directors of the Corporation.
Provided, however, an eligible employee must be a member of a select group of
management or highly compensated employee within the meanings of Section
2.01(2), 3.01(a)(3) and 4.01(a)(1) of ERISA.
2.15 ERISA. The Employee Retirement Income Security Act of 1974, as amended.
2.16 IRS. The Internal Revenue Service.
2.17 Normal Retirement Age. Sixty-five (65) years, except that Normal Retirement
Age for Harland Stonecipher and Wilburn Smith will be their respective ages ten
years from commencement of the Plan.
2.18 Normal Retirement Date. The first day of the first month coincident with or
next following the date on which a (i) Participant reaches Normal Retirement Age
or (ii) for each of Harland Stonecipher and Wilburn Smith only, the earlier of
(x) ten (10) years from the inception date of the Plan or (y) his actual date of
retirement from the Corporation.
2.19 Participant. Any individual who becomes eligible to participate in the Plan
pursuant to Article III of the Plan.
2.20 Participant Agreement. The written agreement to defer Salary and/or Bonuses
made by the Participant. Such written agreement shall be in a format designated
by the Corporation.
2.21 Plan. The Pre-Paid Legal Services, Inc. Deferred Compensation Plan.
2.22 Plan Administrator. The Corporation unless the Corporation designates
another individual or entity to hold the position of the Plan Administrator.
2.23 Plan Year. For the initial Plan Year, the period beginning November 6,
2002, and ending on December 31, 2002. Thereafter, "Plan Year" means the
12-month period beginning each January 1 and ending on the following December
31.
2.24 Rabbi Trust. The Rabbi Trust, which the Corporation may, in its discretion,
establish for the Plan, as amended from time to time.
2.25 Valuation Date. Each business day of the Plan Year.
2.26 Years of Service. Each consecutive twelve (12) month period during which a
Participant is continuously employed by the Corporation.
Article III
Eligibility and Participation
3.1 Participation - Eligibility and Initial Period. Participation in the Plan is
open only to Eligible Employees of the Corporation. Each Eligible Employee of
the Corporation, as of the Effective Date, may become a Participant for the
Deferral Period if he submits a properly completed Participant Agreement to the
Corporation prior to November 6, 2002 and prior to January 1 for each subsequent
year. Any employee becoming an Eligible Employee after the Effective Date, e.g.,
new hires or promoted employees, may become a Participant for the Deferral
Period commencing on or after he becomes an Eligible Employee if he submits a
properly completed Participant Agreement within thirty days after becoming
eligible for participation.
3.2 Participation - Subsequent Entry into Plan. An Eligible Employee who does
not elect to participate at the time of initial eligibility as set forth in
Section 3.1 shall remain eligible to become a Participant in subsequent Plan
Years as long as he continues his status as an Eligible Employee. In such event,
the Eligible Employee may become a Participant by submitting a properly executed
Participant Agreement prior to January 1 of the Plan Year for which it is
effective.
Article IV
Contributions
4.1 Deferral Election. Before the first day of each Plan Year, a Participant may
file with the Corporation, a Deferral Election Form indicating the amount of
Salary and/or Bonus Deferrals for that Plan Year. A Participant shall not be
obligated to make a Deferral Election in each Plan Year. After a Plan Year
commences, such Deferral Election shall continue for the entire Plan Year and
subsequent years except that it shall terminate upon the execution and
submission of a newly completed Deferral Election Form or termination of
employment.
4.2 Maximum Deferral Election. A Participant may elect to defer up to 50% of
Base Salary and/or up to 50% of Bonuses earned during the first Plan Year dated
November 6, 2002 to December 31, 2002. Thereafter, a Participant may elect to
defer up to 50% of Base Salary and/or up to 50% of Bonuses earned during the
corresponding Deferral Period, or such greater percentages the Corporation may
permit. A Deferral Election may be automatically reduced if the Corporation
determines that such action is necessary to meet Federal or State tax
withholding obligations.
4.3 Employer Contributions. The Corporation may, in its sole discretion, make a
contribution to the Participants' Deferral Accounts.
Article V
Accounts
5.1 Deferral Accounts. Solely for record keeping purposes, the Plan
Administrator shall establish a Deferral Account for each Participant. A
Participant's Deferral Account shall be credited with the contributions made by
him or on his behalf by the Corporation and shall be credited (or charged, as
the case may be) with the hypothetical or deemed investment earnings and losses
determined pursuant to Section 5.3, and charged with distributions made to or
with respect to him.
5.2 Crediting of Deferral Accounts. Salary and Bonus Deferrals under Section 4.1
shall be credited to a Participant's Deferral Account as of the date on which
such contributions were withheld from a Participant's compensation.
Contributions under Section 4.3 shall be credited to the Participant's Deferral
Account on the date made by the Corporation. Any distribution with respect to a
Deferral Account shall be charged to that Account as of the date such payment is
made by the Corporation.
5.3 Earning Credits or Losses. Amounts credited to a Deferral Account shall be
credited with deemed net income, gain and loss, including the deemed net
unrealized gain and loss based on hypothetical investment directions made by the
Participant with respect to his Deferral Account on a form designated by the
Corporation, in accordance with investment options and procedures adopted by the
Corporation in its sole discretion, from time to time. Each Participant shall be
permitted to change his investment directions from time to time but no more
frequently than quarterly.
5.4 Hypothetical Nature of Accounts. The Plan constitutes a mere promise by the
Corporation to make the benefit payments in the future. Any Deferral Account
established for a Participant under this Article V shall be hypothetical in
nature and shall be maintained for the Corporation's record keeping purposes
only, so that any contributions can be credited and so that deemed investment
earnings and losses on such amounts can be credited (or charged, as the case may
be). Neither the Plan nor any of the Accounts (or sub accounts) shall hold any
actual funds or assets. The right of any individual or entity to receive one or
more payments under the Plan shall be an unsecured claim against the general
assets of the Corporation. Any liability of the Corporation to any Participant,
former Participant, or Beneficiary with respect to a right to payment shall be
based solely upon contractual obligations created by the Plan. The Corporation,
the Board of Directors or any employee, agent, individual or entity shall not be
deemed to be a trustee of any amounts to be paid under the Plan. Nothing
contained in the Plan, and no action taken pursuant to its provisions, shall
create or be construed to create a trust of any kind, or a fiduciary
relationship, between the Corporation and a Participant, former Participant,
Beneficiary, or any other individual or entity. The Corporation may, in its sole
discretion, establish a Rabbi Trust as a vehicle in which to place funds with
respect to this Plan. The Corporation does not in any way guarantee any
Participant's Deferral Account against loss or depreciation, whether caused by
poor investment performance, insolvency of a deemed investment or by any other
event or occurrence. In no event shall any employee, officer, director, or
stockholder of the Corporation be liable to any individual or entity on account
of any claim arising by reason of the Plan provisions or any instrument or
instruments implementing its provisions, or for the failure of any Participant,
Beneficiary or other individual or entity to be entitled to any particular tax
consequences with respect to the Plan or any credit or payment thereunder.
5.5 Statement of Deferral Accounts. The Plan Administrator shall provide to each
Participant quarterly statements setting forth the value of the Deferral Account
maintained for such Participant.
Article VI
Vesting
Vesting. The Corporation's contributions credited to a Participant's Deferral
Account under Section 4.3 and any deemed investment earnings attributable to
these contributions shall be one hundred percent (100%) vested or nonforfeitable
unless the Corporation at the time of making any contribution elects to
establish a vesting schedule for any Eligible Employees.
Article VII
Benefits
7.1 Retirement. Unless benefits have already commenced pursuant to another
section in this Article VII, a Participant shall be entitled to begin receipt of
the vested amount credited to his Deferral Account as of the Valuation Date
coinciding with his Normal Retirement Date. Payment of any amount under this
Section shall commence within thirty (30) days of the Participant's retirement
and be in accordance with the payment method elected by the Participant on his
Participant Agreement.
7.2 Disability. If a Participant suffers a Disability while employed with the
Corporation and before he is entitled to benefits under this Article, he shall
receive the amount credited to his Deferral Account as of the Valuation Date
coinciding with the Date on which the Participant is determined to have suffered
a Disability. Payment of any amount under this Section shall commence within
thirty (30) days of when the Corporation determines the existence of the
Participant's Disability and be in accordance with the payment method elected by
the Participant on his Participant Agreement.
7.3 Pre-Retirement Survivor. If a Participant dies before becoming entitled to
benefits under this Article, the Beneficiary or Beneficiaries designated under
Section 13.6 shall receive a lump sum payment equal to $500,000 in addition to
the vested amount credited to his Deferral Account as of the Valuation Date
coinciding with the date of death. Payment of any amount under this Section
shall commence within thirty (30) days of the Participant's death and be in
accordance with the payment method elected by the Participant on his Participant
Agreement.
7.4 Post-Retirement Survivor Benefit. If a Participant dies after benefits have
commenced, but prior to receiving complete payment of benefits under this
Article, the Beneficiary or Beneficiaries designated under Section 12.6, shall
receive in a single lump sum the vested amount credited to the Participant's
Deferral Account as of the Valuation Date coinciding with the date of the
Participant's death. Payment of any amount under this Section shall be made
within thirty (30) days of the Participant's death, or if later, within 30 days
of when the Corporation receives notification of or otherwise confirms the
Participant's death. If the Beneficiary elects, they can continue to receive
benefits over the same period which the Participant had previously elected.
7.5 Termination. If a Participant's employment terminates with the Corporation
before he becomes entitled to receive benefits by reason of any of the above
Sections, he shall receive the vested amount credited to his Deferral Account as
of the Valuation Date coinciding with the date on which the Participant's
employment terminates. Payment of any amount under this Section shall be made
within thirty (30) days of when the Participant terminates his employment with
the Corporation and be in accordance with the payout method elected by the
Participant on his/her Participant Agreement. Irrespective of the Participant's
election, the Corporation may, at its discretion, pay the Participant in a lump
sum.
7.6 Change in Control. If a Change in Control occurs before a Participant
becomes entitled to receive benefits by reason of any of the above Sections or
before the Participant has received complete payment of his benefits under this
Article, the Participant shall receive the vested amount credited to his Account
as of the Valuation Date immediately preceding the date on which the Change in
Control occurs. Payment of any amount under this Section shall be made within
thirty (30) days of the date of the Change in Control and be in accordance with
the payout method elected by the Participant on his/her Participant Agreement.
7.7 Payment Methods. Unless otherwise provided in this Article VII, a
Participant may elect to receive payment of the amount credited to his Deferral
Account in a single lump sum or in five (5), ten (10) or fifteen (15) annual
installments. This election must be made on the Participant Agreement and
Election Form for the corresponding Plan Year. Any installment payments shall be
paid monthly on the first practicable day after the distributions are scheduled
to commence. The Deferral Account shall continue to be credited with earnings
and losses as provided in Section 5.3 during any installment payment period.
Each installment payment shall be determined by multiplying the Deferral Account
Balance at the time of the payment by a fraction, the numerator of which is one
and the denominator of which is the number of remaining installment payments.
7.8 Emergency Distribution. A Participant receiving benefits in installments may
request an additional distribution or change in method of distribution to such
Participant as a result of an "unforeseeable emergency", which, if approved as
provided below, shall be made to the requesting Participant. Such distribution
may be approved if the Corporation determines after reviewing such information
as the requesting Participant submits, that an unforeseeable emergency has
occurred. The amount of any distribution shall be limited to the amount
necessary to meet the unforeseeable emergency. "Unforeseeable emergency" means
any unanticipated emergency caused by an event beyond the control of a
Participant that results in severe financial hardship.
7.9 Unscheduled In-Service Distributions. A Participant may request an
unscheduled in-service distribution of all or any portion of his Deferral
Account balance before he would otherwise become entitled to receive the
benefits under the Plan. The Corporation, in its sole and unfettered discretion,
may approve such a request upon the imposition of a ten percent (10%) forfeiture
penalty to the Corporation from the amount of the in-service distribution
requested by the Participant.
7.10 Acceleration of Distributions. The Corporation may, in its sole discretion,
accelerate the distribution of, or alternate the method of payment of, benefits
payable to a Participant. In addition, if a Participant's total vested Deferral
Account balance, determined as of the date on which the Participant terminates
employment is $50,000 or less, or if an income tax assessment has been levied
against Participant with respect to the Deferral Account before distribution,
the Participant's Deferral Account shall be distributed in a lump sum as soon as
administratively practicable following his or her termination of employment or
the receipt by the Corporation of evidence of such income tax assessment.
Article VIII
Establishment of Trust
8.1 Establishment of Trust. The Corporation may establish a Rabbi Trust for the
Plan. If established, all benefits payable under this Plan to a Participant
shall be paid directly by the Corporation from the Rabbi Trust. To the extent
that such benefits are not paid from the Rabbi Trust, the benefits shall be paid
from the general assets of the Corporation. The Rabbi Trust is, if any, shall be
an irrevocable grantor trust which conforms to the terms of the model trust as
described in IRS Revenue Procedure 92-64, I.R.B. 1992-33. The assets of the
Rabbi Trust are subject to the claims of the Corporation's creditors in the
event of its insolvency. Except as provided under a Rabbi Trust, the Corporation
shall not be obligated to set aside, earmark or escrow any funds or other assets
to satisfy its obligations under this Plan, and the Participant and/or his
designated Beneficiaries shall not have any property interest in any specific
assets of the Corporation other than the unsecured right to receive payments
from the Corporation, as provided in this Plan.
Article IX
Plan Administration
9.1 Plan Administration. The Plan shall be administered by such persons as the
Corporation shall appoint. The Corporation shall construe and interpret the
Plan, including disputed and doubtful terms and provisions and, in its sole
discretion, decide all questions of eligibility and determine the amount, manner
and time of payment of benefits under the Plan. The determinations and
interpretations of the Corporation shall be consistently and uniformly applied
to all Participants and Beneficiaries, including but not limited to
interpretations and determinations of amounts due under this Plan, and shall be
final and binding on all parties. The Plan at all times shall be interpreted and
administered as an unfunded deferred compensation plan, and no provision of the
Plan shall be interpreted so as to give any Participant or Beneficiary any right
in any asset of the Corporation which is a right greater than the right of a
general unsecured creditor of the Corporation.
Article X
Nonalienation of Benefits
10.1 Nonalienation of Benefits. The interests of Participants and their
Beneficiaries under this Plan are not subject to the claims of their creditors
and may not be voluntarily or involuntarily sold, transferred, alienated,
assigned, pledged, anticipated, or encumbered, attached or garnished. Any
attempt by a Participant, his Beneficiary, or any other individual or entity to
sell, transfer, alienate, assign, pledge, anticipate, encumber, attach, garnish,
charge or otherwise dispose of any right to benefits payable shall be void. The
Corporation may cancel and refuse to pay any portion of a benefit which is sold,
transferred, alienated, assigned, pledged, anticipated, encumbered, attached or
garnished. The benefits which a Participant may accrue under this Plan are not
subject to the terms of any Qualified Domestic Relations Order (as that term is
defined in Section 414(p) of the Code) with respect to any Participant, and the
Plan Administrator, Board of Directors and Corporation shall not be required to
comply with the terms of such order in connection with this Plan. The
withholding of taxes from Plan payments, the recovery of Plan overpayments of
benefits made to a Participant or Beneficiary, the transfer of Plan benefit
rights from the Plan to another plan, or the direct deposit of Plan payments to
an account in a financial institution (if not actually a part of an arrangement
constituting an assignment or alienation) shall not be construed as assignment
or alienation under this Article.
Article XI
Amendment and Termination
11.1 Amendment and Termination. The Corporation reserves the right to amend or
alter, retroactively or prospectively, or discontinue this Plan at any time.
Such action may be taken in writing by any officer of the Corporation who has
been duly authorized by the Corporation to perform acts of such kind. However,
no such amendment shall deprive any Participant or Beneficiary of any portion of
any benefit which would have been payable had the Participant's employment with
the Corporation terminated on the effective date of such amendment or
termination. Notwithstanding the provisions of this Article to the contrary, the
Corporation may amend the Plan at any time, in any manner, if the Corporation
determines any such amendment is required to ensure that the Plan is
characterized as providing deferred compensation for a select group of
management or highly compensated employees and as described in ERISA Sections
201(2), 301(a)(3) and 401(a)(1) or to otherwise conform the Plan to the
provisions of any applicable law including ERISA and the Code.
Article XII
General Provisions
12.1 Good Faith Payment. Any payment made in good faith in accordance with
provisions of the Plan shall be a complete discharge of any liability for the
making of such payment under the provisions of this Plan.
12.2 No Right to Employment. This Plan does not constitute a contract of
employment, and participation in the Plan shall not give any Participant the
right to be retained in the employment of the Corporation.
12.3 Binding Effect. The provisions of this Plan shall be binding upon the
Corporation and its successors and assigns and upon every Participant and his
heirs, Beneficiaries, estates and legal representatives.
12.4 Participant or Beneficiary Change of Address. Each Participant or
Beneficiary entitled to benefits shall file with the Plan Administrator, in
writing, any change of post office address. Any check representing payment and
any communication addressed to a Participant or Beneficiary or a former
Participant or Beneficiary at this last address filed with the Plan
Administrator, or if no such address has been filed, then at his last address as
indicated on the Corporation's records, shall be binding on such Participant or
Beneficiary for all purposes of the Plan, and neither the Plan Administrator nor
the Corporation or other payer shall not be obliged to search for or ascertain
the location of any such Participant or Beneficiary. If the Plan Administrator
is in doubt as to the address of any Participant or Beneficiary entitled to
benefits or as to whether benefit payments are being received by a Participant
or Beneficiary, it shall, by registered mail addressed to such Participant or
Beneficiary at his last known address, notify such Participant or Beneficiary
that:
(i) All unmailed and future Plan payments shall be withheld until
Participant or Beneficiary provides the Plan Administrator with evidence of
such Participant's or Beneficiary's continued life and proper mailing
address; and
(ii) Participant's or Beneficiary's right to any Plan payment shall, at the
option of the Corporation, be canceled forever, if, at the expiration of
five (5) years from the date of such mailing, such Participant or
Beneficiary shall not have provided the Corporation with evidence of his
continued life and proper mailing address.
12.5 Notices. Each Participant and Beneficiary shall furnish to the Plan
Administrator any information the Plan Administrator deems necessary for
purposes of administering the Plan, and the payment provisions of the Plan are
conditional upon the Participant and Beneficiary furnishing promptly such true
and complete information as the Plan Administrator may request. Each Participant
and Beneficiary shall submit proof of his age when required by the Plan
Administrator. The Plan Administrator shall, if such proof of age is not
submitted as required, use such information as is deemed by it to be reliable,
regardless of the lack of proof, or the misstatement of the age of individuals
entitled to benefits. Any notice or information which, according to the terms of
the Plan or requirements of the Plan Administrator, must be filed with the Plan
Administrator, shall be deemed so filed if addressed and either delivered in
person or mailed to and received by the Plan Administrator, in care of the
Corporation at:
Pre-Paid Legal Services, Inc.
321 East Main Street
Ada, OK 74821
Attn: Chief Financial Officer
12.6 Designation of Beneficiary. Each Participant shall designate, by name, on
Beneficiary designation forms provided by the Plan Administrator, the
Beneficiary(ies) who shall receive any benefits which might be payable after
such Participant's death. A Beneficiary designation may be changed or revoked
without such Beneficiary's consent at any time or from time to time in the
manner as provided by the Plan Administrator, and the Plan Administrator shall
have no duty to notify any individual or entity designated as a Beneficiary of
any change in such designation which might affect such individual or entity's
present or future rights. If the designated Beneficiary does not survive the
Participant, all amounts which would have been paid to such deceased Beneficiary
shall be paid to any remaining Beneficiary in that class of beneficiaries,
unless the Participant has designated that such amounts go to the lineal
descendants of the deceased Beneficiary. If none of the designated primary
Beneficiaries survive the Participant, and the Participant did not designate
that payments would be payable to such Beneficiary's lineal descendants, amounts
otherwise payable to such Beneficiaries shall be paid to any successor
Beneficiaries designated by the Participant, or if none, to the Participant's
spouse, or, if the Participant was not married at the time of death, the
Participant's estate.
No Participant shall designate more than five (5) simultaneous beneficiaries,
and if more than one (1) beneficiary is named, Participant shall designate the
share to be received by each Beneficiary. Despite the limitation on five (5)
Beneficiaries, a Participant may designate more than five (5) beneficiaries
provided such beneficiaries are the surviving spouse and children of the
Participant. If a Participant designates alternative, successor, or contingent
beneficiaries, such Participant shall specify the shares, terms and conditions
upon which amounts shall be paid to such multiple, alternative, successor or
contingent beneficiaries. Except as provided otherwise in this Section, any
payment made under this Plan after the death of a Participant shall be made only
to the Beneficiary or Beneficiaries designated pursuant to this Section.
12.7 Claims. Any claim for benefits must initially be submitted in writing to
the Plan Administrator. If such claim is denied (in whole or in part), the
claimant shall receive notice from the Plan Administrator, in writing, setting
forth the specific reasons for denial, with specific reference to applicable
provisions of this Plan. Such notice shall be provided within ninety (90) days
of the date the claim for benefits is received by the Plan Administrator, unless
special circumstances require an extension of time for processing the claim, in
which event notification of the extension shall be provided to the claimant
prior to the expiration of the initial 90 day period. The extension notification
shall indicate the special circumstances requiring the extension of time and the
date by which the Plan Administrator expects to render its decision. Any such
extension shall not exceed 90 days. Any disagreements about such interpretations
and construction may be appealed in writing by the claimant to the Chief
Executive Officer of the Corporation (or the Board of Directors if the Chief
Executive Officer is a Participant) within sixty (60) days. After receipt of
such Appeal, the Chief Executive Officer of the Corporation (or the Board of
Directors if the Chief Executive Officer is a Participant) shall respond to such
appeal within sixty (60) days, with a notice in writing fully disclosing its
decision and its reasons. If special circumstances require an extension of time
to process the appealed claim, notification of the extension shall be provided
to the claimant prior to the commencement of the extension. Any such extension
shall not exceed 60 days. No member of the Board of Directors, or any committee
thereof, or any employee or officer of the Corporation, shall be liable to any
individual or entity for any action taken hereunder, except those actions
undertaken with lack of good faith.
12.8 Action by Board of Directors. Any action required to be taken by the Board
of Directors of the Corporation pursuant to the Plan provisions may be performed
by a committee of the Board, to which the Board of Directors of the Corporation
delegates the authority to take actions of that kind.
12.9 Governing Law. To the extent not superseded by the laws of the United
States, the laws of the State of Oklahoma shall be controlling in all matters
relating to this Plan.
12.10 Severability. In the event any provision of this Plan shall be held
illegal or invalid for any reason, such illegality or invalidity shall not
affect the remaining provisions of the Plan, and the Plan shall be interpreted
and enforced as if such illegal and invalid provisions had never been set forth.
12.11 Withholding. The Corporation may withhold from any payment of benefits
under the Plan such amounts as the Corporation determines or required to be
withheld for payment of any taxes as required by applicable law.
EXHIBIT 21.1
PRE-PAID LEGAL SERVICES, INC.
Subsidiaries of Registrant
State or Percentage of
Province Ownership by
Name of Subsidiary Incorporation Registrant
------------------ ------------- --------------
Pre-Paid Legal Casualty, Inc. Oklahoma 100%
American Legal Services, Inc. Oklahoma 100%
Pre-Paid Legal Services, Inc. of Florida Florida 100%
C & A Investments, Inc. Oklahoma 100%
Pre-Paid Legal Administrators, Inc. Oklahoma 100%
Justice 900, Inc. Oklahoma 100%
Legal Service Plans of Virginia, Inc. Virginia 100%
Ada Travel Service, Inc. Oklahoma 100%
Pre-Paid Canadian Holdings, L.L.C. Oklahoma 100%
National Pre-Paid Legal Services of Mississippi, Inc. Georgia 100% owned by
Pre-Paid Legal
Services, Inc. of
Florida
Pre-Paid Legal Services of Tennessee, Inc. Tennessee 100% owned by
Pre-Paid Legal
Casualty, Inc.
PPL Legal Care of Canada Corporation Nova Scotia, 100% owned by
Canada Pre-Paid Canadian
Holdings, L.L.C.
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated February 18, 2003, accompanying the consolidated
financial statements included in the Annual Report of Pre-Paid Legal Services,
Inc. on Form 10-K for the year ended December 31, 2002. We hereby consent to the
incorporation by reference of said report in the Registration Statements of
Pre-Paid Legal Services, Inc. on Forms S-8 (File No. 33-82144, effective July
28, 1994, File No. 33-62663, effective September 14, 1995, File No. 333-53183,
effective May 20, 1998 and File No. 333-38386, effective June 1, 2000).
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 18, 2003
Exhibit 99.1
CERTIFICATION
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, 2002 (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: March 17, 2003 /s/ Harland C. Stonecipher
Harland C. Stonecipher
------------------------------------------
Chairman, Chief Executive Officer and
President
The foregoing certification is being furnished solely pursuant
to 18 U.S.C.ss.1350.
Exhibit 99.2
CERTIFICATION
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, 2002 (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: March 17, 2003 /s/ Steve Williamson
Steve Williamson
------------------------------------------
Chief Financial Officer
The foregoing certification is being furnished solely pursuant
to 18 U.S.C.ss.1350.